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INDEX

 

 

 

 

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The following defined terms are used in this report:

 

“Bbl” barrel.

“Board” board of directors.

“BTU” British Thermal Units.

“Company” Panhandle Oil and Gas Inc.

“completion” the process of treating a drilled well followed by the installation of permanent equipment for the production of crude oil and/or natural gas.

“DD&A” depreciation, depletion and amortization.

“dry hole” exploratory or development well that does not produce crude oil and/or natural gas in economic quantities.

“ESOP” the Panhandle Oil and Gas Inc. Employee Stock Ownership and 401(k) Plan, a tax qualified, defined contribution plan.

“exploratory well” a well drilled to find a new field or to find a new reservoir in a field previously found to be productive of crude oil or natural gas in another reservoir.

“FASB” the Financial Accounting Standards Board.

“field” an area consisting of a single reservoir or multiple reservoirs all grouped on, or related to, the same individual geological structural feature or stratigraphic condition. The field name refers to the surface area, although it may refer to both the surface and the underground productive formations.

“G&A” general and administrative costs.

“gross acres” the total acres in which an interest is owned.

“held by production” or “HBP” an oil and gas lease continued into effect into its secondary term for so long as a producing oil and/or gas well is located on any portion of the leased premises or lands pooled therewith.

“horizontal drilling” a drilling technique used in certain formations where a well is drilled vertically to a certain depth and then drilled horizontally within a specified interval.

“IDC” intangible drilling costs. 

“Independent Consulting Petroleum Engineer(s)” or “Independent Consulting Petroleum Engineering Firm” DeGolyer and MacNaughton of Dallas, Texas.

“LOE” lease operating expense.

“Mcf” thousand cubic feet.

“Mcfe” natural gas stated on an Mcf basis and crude oil and natural gas liquids converted to a thousand cubic feet of natural gas equivalent by using the ratio of one Bbl of crude oil or natural gas liquids to six Mcf of natural gas.

“Mmbtu” million BTU.

“minerals”,  “mineral acres” or “mineral interests” fee mineral acreage owned in perpetuity by the Company.

“net acres” the sum of the fractional interests owned in gross acres.

“NGL” natural gas liquids.

“NYMEX” New York Mercantile Exchange.

“Panhandle” Panhandle Oil and Gas Inc.

“play” term applied to identified areas with potential oil and/or natural gas reserves.

“proved reserves” the quantities of crude oil and natural gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates renewal is reasonably certain.

“royalty interest” well interests in which the Company does not pay a share of the costs to drill, complete and operate a well, but receives a much smaller proportionate share (as compared to a working interest) of production.

“SEC” the United States Securities and Exchange Commission.

“undeveloped acreage” lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of crude oil and/or natural gas.

“working interest” well interests in which the Company pays a share of the costs to drill, complete and operate a well and receives a proportionate share of production.

“WTI” West Texas Intermediate.

 

Fiscal year references 

All references to years in this report, unless otherwise noted, refer to the Company’s fiscal year end of September 30. For example, references to 2016 mean the fiscal year ended September 30, 2016.

 

References to oil and natural gas properties

References to oil and natural gas properties inherently include natural gas liquids associated with such properties.

 

 

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PART 1   FINANCIAL INFORMATION

PANHANDLE OIL AND GAS INC.

CONDENSED BALANCE SHEETS

 

 

 

 

(See accompanying notes)

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PANHANDLE OIL AND GAS INC.

CONDENSED STATEMENTS OF OPERATIONS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(See accompanying notes)

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PANHANDLE OIL AND GAS INC.

STATEMENTS OF STOCKHOLDERS’ EQUITY

 

Three Months Ended December 31, 2015

 

 

 

 

Three Months Ended December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(See accompanying notes)

 

 

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PANHANDLE OIL AND GAS INC.

CONDENSED STATEMENTS OF CASH FLOWS

 

 

 

 

 

 

 (See accompanying notes)

 

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PANHANDLE OIL AND GAS INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1: Accounting Principles and Basis of Presentation

 

The accompanying unaudited condensed financial statements of Panhandle Oil and Gas Inc. have been prepared in accordance with the instructions to Form 10-Q as prescribed by the SEC. Management of the Company believes that all adjustments necessary for a fair presentation of the financial position and results of operations and cash flows for the periods have been included. All such adjustments are of a normal recurring nature. The results are not necessarily indicative of those to be expected for the full year. The Company’s fiscal year runs from October 1 through September 30.

 

Certain amounts and disclosures have been condensed or omitted from these financial statements pursuant to the rules and regulations of the SEC. Therefore, these condensed financial statements should be read in conjunction with the financial statements and related notes thereto included in the Company’s 2015 Annual Report on Form 10-K.

 

NOTE 2: Income Taxes

 

The Company’s provision for income taxes differs from the statutory rate primarily due to estimated federal and state benefits generated from estimated excess federal and Oklahoma percentage depletion, which are permanent tax benefits. Excess percentage depletion, both federal and Oklahoma, can only be taken in the amount that it exceeds cost depletion which is calculated on a unit-of-production basis.

 

Both excess federal percentage depletion, which is limited to certain production volumes and by certain income levels, and excess Oklahoma percentage depletion, which has no limitation on production volume, reduce estimated taxable income or add to estimated taxable loss projected for any year. Due to the lower expected 2016 oil and natural gas prices, fiscal 2016 percentage depletion is not expected to exceed cost depletion as much as in past years. Therefore, the permanent tax benefit in 2016 is not expected to be as significant as in 2015. The federal and Oklahoma excess percentage depletion estimates will be updated throughout the year until finalized with detailed well-by-well calculations at fiscal year-end. Federal and Oklahoma excess percentage depletion, when a provision for income taxes is recorded, decreases the effective tax rate, while the effect is to increase the effective tax rate when a benefit for income taxes is recorded. The benefits of federal and Oklahoma excess percentage depletion are not directly related to the amount of pre-tax income recorded in a period. Accordingly, in periods where a recorded pre-tax income or loss is relatively small, the proportional effect of these items on the effective tax rate may be significant. The effective tax rate for the quarter ended December 31, 2015, was 46% as compared to 31% for the quarter ended December 31, 2014.  

 

NOTE 3: Basic and Diluted Earnings (Loss) per Share

 

Basic and diluted earnings (loss) per share is calculated using net income (loss) divided by the weighted average number of voting common shares outstanding, including unissued, vested directors’ deferred compensation shares during the period. 

 

NOTE 4: Long-term Debt

 

The Company has a $200,000,000 credit facility with a group of banks headed by Bank of Oklahoma (BOK) with a current borrowing base of  $100,000,000 and a maturity date of November 30, 2018.  The credit facility is subject to a semi-annual borrowing base determination, wherein BOK applies their own current commodity pricing forecast and an 8% discount rate to the Company’s proved reserves as calculated by the Company’s Independent Consulting Petroleum Engineering Firm. The facility is secured by certain of the Company’s properties with a net book value of $185,342,249 at December 31, 2015. The interest rate is based on BOK prime plus from 0.375% to 1.125%, or 30 day LIBOR plus from 1.875% to 2.625%. The election of BOK prime or LIBOR is at the Company’s discretion. The interest rate spread from BOK prime or LIBOR will be charged based on the ratio of the loan balance to the borrowing base. The interest rate spread from LIBOR or the prime rate increases as a larger percent of the borrowing base is advanced. At December 31, 2015, the effective interest rate was 2.43%.

 

The Company’s debt is recorded at the carrying amount on its balance sheet. The carrying amount of the Company’s revolving credit facility approximates fair value because the interest rates are reflective of market rates.

 

On December  10, 2015, the borrowing base was adjusted by the banks from $120,000,000  to $100,000,000. Determinations of the borrowing base are made semi-annually or whenever the banks, in their discretion, believe that there has been a material change in the value of the oil and natural gas properties. The loan agreement contains customary covenants which, among other things, require periodic financial and reserve reporting and place certain limits on the Company’s incurrence of indebtedness, liens, payment of dividends and acquisitions of treasury stock, and require the Company to maintain certain financial ratios. At December 31, 2015, the Company was in compliance with the covenants of the loan 

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agreement and has $43,000,000 of availability under its outstanding credit facility.

 

NOTE 5: Deferred Compensation Plan for Non-Employee Directors

 

Annually, non-employee directors may elect to be included in the Deferred Compensation Plan for Non-Employee Directors. The Deferred Compensation Plan for Non-Employee Directors provides that each outside director may individually elect to be credited with future unissued shares of Company common stock rather than cash for all or a portion of the annual retainers, Board meeting fees and committee meeting fees, and may elect to receive shares, when issued, over annual time periods up to ten years. These unissued shares are recorded to each director’s deferred compensation account at the closing market price of the shares (i) on the dates of the Board and committee meetings, and (ii) on the payment dates of the annual retainers. Only upon a director’s retirement, termination, death, or a change-in-control of the Company will the shares recorded for such director under the Deferred Compensation Plan for Non-Employee Directors be issued to the director. The promise to issue such shares in the future is an unsecured obligation of the Company.

 

NOTE 6: Restricted Stock Plan

 

In March 2010, shareholders approved the Panhandle Oil and Gas Inc. 2010 Restricted Stock Plan (2010 Stock Plan), which made available 200,000 shares of common stock to provide a long-term component to the Company’s total compensation package for its officers and to further align the interest of its officers with those of its shareholders. In March 2014, shareholders approved an amendment to increase the number of shares of common stock reserved for issuance under the 2010 Stock Plan from 200,000 shares to 500,000 shares and to allow the grant of shares of restricted stock to our directors. The 2010 Stock Plan, as amended, is designed to provide as much flexibility as possible for future grants of restricted stock so that the Company can respond as necessary to provide competitive compensation in order to retain, attract and motivate directors and officers of the Company and to align their interests with those of the Company’s shareholders.

 

Effective in May 2014, the board of directors adopted resolutions to allow management, at their discretion, to purchase the Company’s common stock up to an amount equal to the aggregate number of shares of common stock awarded pursuant to the Company’s Amended 2010 Restricted Stock Plan, contributed by the Company to its ESOP and credited to the accounts of directors pursuant to the Deferred Compensation Plan for Non-Employee Directors.

 

On December 9, 2015, the Company awarded 13,482 non-performance based shares and 40,446 performance based shares of the Company’s common stock as restricted stock to certain officers. The restricted stock vests at the end of a  three year period and contains nonforfeitable rights to receive dividends and voting rights during the vesting period. The non-performance and performance based shares had a fair value on their award date of $223,397 and $376,915, respectively. The Company recognized $211,363 of compensation expense on the award date for performance based shares for officers that were eligible for retirement. The remaining fair value for the performance based awards as well as the entire fair value of the non-performance based awards will be recognized as compensation expense ratably over the vesting period. The fair value of the performance based shares on their award date is calculated by simulating the Company’s stock prices as compared to the Dow Jones Select Oil Exploration and Production Index (DJSOEP) prices utilizing a Monte Carlo model covering the performance period (December 9, 2015, through December 9, 2018).

 

On December 31, 2015, the Company awarded 12,996 non-performance based shares of the Company’s common stock as restricted stock to its non-employee directors. The restricted stock vests quarterly over one year starting on March 31, 2016. The restricted stock contains nonforfeitable rights to receive dividends and voting rights during the vesting period. These non-performance based shares had a fair value on their award date of $210,018.

 

The following table summarizes the Company’s pre-tax compensation expense for the three months ended December 31, 2015 and 2014, related to the Company’s performance based and non-performance based restricted stock.

 

 

 

A summary of the Company’s unrecognized compensation cost for its unvested performance based and non-performance based restricted stock and the weighted-average periods over which the compensation cost is expected to be recognized are shown in the following table.

 

 

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Upon vesting, shares are expected to be issued out of shares held in treasury.

 

NOTE 7: Oil, NGL and Natural Gas Reserves

 

Management considers the estimation of the Company’s crude oil, NGL and natural gas reserves to be the most significant of its judgments and estimates. Changes in crude oil, NGL and natural gas reserve estimates affect the Company’s calculation of DD&A, provision for retirement of assets and assessment of the need for asset impairments. On an annual basis, with a semi-annual update, the Company’s Independent Consulting Petroleum Engineer, with assistance from Company staff, prepares estimates of crude oil, NGL and natural gas reserves based on available geological and seismic data, reservoir pressure data, core analysis reports, well logs, analogous reservoir performance history, production data and other available sources of engineering, geological and geophysical information. Between periods in which reserves would normally be calculated, the Company updates the reserve calculations utilizing appropriate prices for the current period. The estimated oil, NGL and natural gas reserves were computed using the 12-month average price calculated as the unweighted arithmetic average of the first-day-of-the-month oil, NGL and natural gas price for each month within the 12-month period prior to the balance sheet date, held flat over the life of the properties. However, projected future crude oil, NGL and natural gas pricing assumptions are used by management to prepare estimates of crude oil, NGL and natural gas reserves and future net cash flows used in asset impairment assessments and in formulating management’s overall operating decisions. Crude oil, NGL and natural gas prices are volatile and affected by worldwide production and consumption and are outside the control of management.

 

NOTE 8: Impairment

 

All long-lived assets, principally oil and natural gas properties, are monitored for potential impairment when circumstances indicate that the carrying value of the asset may be greater than its estimated future net cash flows. The evaluations involve significant judgment since the results are based on estimated future events, such as: inflation rates; future drilling and completion costs; future sales prices for oil, NGL and natural gas; future production costs; estimates of future oil, NGL and natural gas reserves to be recovered and the timing thereof; the economic and regulatory climates and other factors. The need to test a property for impairment may result from significant declines in sales prices or unfavorable adjustments to oil, NGL and natural gas reserves. Between periods in which reserves would normally be calculated, the Company updates the reserve calculations to reflect any material changes since the prior report was issued and then utilizes updated projected future price decks current with the period. For the three months ended December 31, 2015 and 2014, the assessment resulted in impairment provisions of $3,733,273 and $2,191,997, respectively. The impairment provision for the three months ended December 31, 2015,  is principally the result of lower projected future prices for oil, NGL and natural gas. A further reduction in oil, NGL and natural gas prices or a decline in reserve volumes may lead to additional impairment in future periods that may be material to the Company.

 

NOTE 9: Capitalized Costs

 

As of December 31, 2015 and 2014, non-producing oil and natural gas properties include costs of $14,520 and $908,872, respectively, on exploratory wells which were drilling and/or testing. 

 

NOTE 10: Derivatives

 

The Company has entered into commodity price derivative agreements including fixed swap contracts and costless collar contracts. These instruments are intended to reduce the Company’s exposure to short-term fluctuations in the price of oil and natural gas. Fixed swap contracts set a fixed price and provide payments to the Company if the index price is below the fixed price, or require payments by the Company if the index price is above the fixed price. Collar contracts set a fixed floor price and a fixed ceiling price and provide payments to the Company if the index price falls below the floor or require payments by the Company if the index price rises above the ceiling. These contracts cover only a portion of the Company’s natural gas and oil production and provide only partial price protection against declines in natural gas and oil prices. These derivative instruments may expose the Company to risk of financial loss and limit the benefit of future increases in prices. All of the Company’s derivative contracts are with Bank of Oklahoma and are secured under its credit facility with Bank of Oklahoma. The derivative instruments have settled or will settle based on the prices below.

 

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Derivative contracts in place as of December 31, 2015

 

 

 

 

Derivative contracts in place as of September 30, 2015

 

 

 

The Company has elected not to complete all of the documentation requirements necessary to permit these derivative contracts to be accounted for as cash flow hedges. The Company’s fair value of derivative contracts was a net asset of $636,114 as of December 31, 2015, and a net asset of $4,210,764 as of September 30, 2015.

 

 

The fair value amounts recognized for the Company’s derivative contracts executed with the same counterparty under a master netting arrangement may be offset. The Company has the choice to offset or not, but that choice must be applied consistently. A master netting arrangement exists if the reporting entity has multiple contracts with a single counterparty that are subject to a contractual agreement that provides for the net settlement of all contracts through a single payment in a single currency in the event of default on or termination of any one contract. Offsetting the fair values recognized for the derivative contracts outstanding with a single counterparty results in the net fair value of the transactions being reported as an asset or a liability in the Condensed Balance Sheets.

 

The following table summarizes and reconciles the Company's derivative contracts’ fair values at a gross level back to net fair value presentation on the Company's Condensed Balance Sheets at December 31, 2015, and September 30, 2015.  The Company has offset all amounts subject to master netting agreements in the Company's Condensed Balance Sheets at December 31, 2015, and September 30, 2015.

 

 

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 (a) See Fair Value Measurements section for further disclosures regarding fair value of financial instruments.

 

The fair value of derivative assets and derivative liabilities is adjusted for credit risk. The impact of credit risk was immaterial for all periods presented.

 

NOTE 11: Fair Value Measurements

 

Fair value is defined as the amount that would be received from the sale of an asset or paid for the transfer of a liability in an orderly transaction between market participants, i.e., an exit price. To estimate an exit price, a three-level hierarchy is used. The fair value hierarchy prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or a liability, into three levels. Level 1 inputs are unadjusted quoted prices in active markets for identical assets and liabilities. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (i) quoted prices for similar assets or liabilities in active markets; (ii) quoted prices for identical or similar assets or liabilities in markets that are not active; (iii) inputs other than quoted prices that are observable for the asset or liability; or (iv) inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 3 inputs are unobservable inputs for the financial asset or liability.

 

The following table provides fair value measurement information for financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2015.

 

 

 

Level 2 – Market Approach - The fair values of the Company’s swaps are based on a third-party pricing model which utilizes inputs that are either readily available in the public market, such as natural gas curves, or can be corroborated from active markets. These values are based upon future prices, time to maturity and other factors. These values are then compared to the values given by our counterparties for reasonableness.

 

Level 3 – The fair values of the Company’s costless collar contracts are based on a pricing model which utilizes inputs that are unobservable or not readily available in the public market. These values are based upon future prices, volatility, time to maturity and other factors. These values are then compared to the values given by our counterparties for reasonableness.

 

The significant unobservable inputs for Level 3 derivative contracts include market volatility and credit risk of counterparties. Changes in these inputs will impact the fair value measurement of our derivative contracts. An increase (decrease) in the volatility of oil and natural gas prices will decrease (increase) the fair value of oil and natural gas derivatives and adverse changes to our counterparties’ creditworthiness will decrease the fair value of our derivatives.

 

The following table represents quantitative disclosures about unobservable inputs for Level 3 Fair Value Measurements.

 

 

 

A reconciliation of the Company’s derivative contracts classified as Level 3 measurements is presented below. All gains and losses are presented on the Gains (losses) on derivative contracts line item on our Statement of Operations.

 

 

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The following table presents impairments associated with certain assets that have been measured at fair value on a nonrecurring basis within Level 3 of the fair value hierarchy.

 

 

 

(a) At the end of each quarter, the Company assesses the carrying value of its producing properties for impairment. This assessment utilizes estimates of future cash flows. Significant judgments and assumptions in these assessments include estimates of future oil and natural gas prices using a forward NYMEX curve adjusted for locational basis differentials, drilling plans, expected capital costs and an applicable discount rate commensurate with risk of the underlying cash flow estimates. These assessments identified certain properties with carrying value in excess of their calculated fair values.

 

At December 31, 2015, and September 30, 2015, the fair value of financial instruments approximated their carrying amounts. Financial instruments include long-term debt, which the valuation is classified as Level 3 and is based on a valuation technique that requires inputs that are both unobservable and significant to the overall fair value measurement. The fair value measurement of our long-term debt is valued using a discounted cash flow model that calculates the present value of future cash flows pursuant to the terms of the debt agreements and applies estimated current market interest rates. The estimated current market interest rates are based primarily on interest rates currently being offered on borrowings of similar amounts and terms. In addition, no valuation input adjustments were considered necessary relating to nonperformance risk for the debt agreements.

 

NOTE 12: Recently Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09-Revenue from Contracts with Customers, which will supersede nearly all existing revenue recognition guidance under GAAP. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. We are evaluating our existing revenue recognition policies to determine whether any contracts in the scope of the guidance will be affected by the new requirements. The standard is effective for us on October 1, 2018. Early adoption is not permitted. The standard allows for either “full retrospective” adoption, meaning the standard is applied to all of the periods presented, or “modified retrospective” adoption, meaning the standard is applied only to the most current period presented in the financial statements. We are currently evaluating the transition method that will be elected.

 

In April 2015, the FASB issued an accounting standards update on the presentation of debt issuance costs. The update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs is not affected by the update. For public entities, the guidance is effective for reporting periods beginning after December 15, 2015, and it is not expected to have a material impact on our financial statements.

 

In August 2015, the FASB issued an accounting standards update which allows for line-of-credit arrangements to be handled consistently with the presentation of debt issuance costs update issued in April 2015. For public entities, the guidance is effective for reporting periods beginning after December 15, 2015, and it is not expected to have a material impact on our financial statements.

 

In November 2015, the FASB issued an accounting standards update on the presentation of deferred income tax assets and liabilities. The update requires that deferred income tax assets and liabilities be classified as noncurrent in the balance sheet.  For public entities, the guidance is effective for reporting periods beginning after December 15, 2016, including interim periods within those fiscal years. This update is not expected to have a material impact on our financial

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statements.

 

In January 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended to improve the recognition and measurement of financial instruments. The new guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.

 

Other accounting standards that have been issued or proposed by the FASB, or other standards-setting bodies, that do not require adoption until a future date are not expected to have a material impact on the financial statements upon adoption.

 

ITEM 2  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS AND RISK FACTORS

 

Forward-Looking Statements for fiscal 2016 and later periods are made in this document. Such statements represent estimates by management based on the Company’s historical operating trends, its proved oil, NGL and natural gas reserves and other information currently available to management. The Company cautions that the Forward-Looking Statements provided herein are subject to all the risks and uncertainties incident to the acquisition, development and marketing of, and exploration for oil, NGL and natural gas reserves. Investors should also read the other information in this Form 10-Q and the Company’s 2015 Annual Report on Form 10-K where risk factors are presented and further discussed. For all the above reasons, actual results may vary materially from the Forward-Looking Statements and there is no assurance that the assumptions used are necessarily the most likely to occur.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company had positive working capital of $3,242,106 at December 31, 2015,  compared to $8,907,437 at September 30, 2015.

 

Liquidity:

 

Cash and cash equivalents were $1,503,691 as of December 31, 2015, compared to $603,915 at September 30, 2015,  an increase of $899,776. Cash flows for the three months ended December 31 are summarized as follows:

 

 

 

Operating activities:

 

Net cash provided by operating activities decreased $7,535,271 during the 2016 period, as compared to the 2015 period, the result of the following:

 

 

 

 

 

 

Investing activities:

 

Net cash used in investing activities decreased $17,125,023 during the 2016  period, as compared to the 2015  period, due to:

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Financing activities:

 

Net cash used in financing activities increased $8,699,826 during the 2016 period, as compared to the 2015 period, the result of the following:

 

 

Capital Resources:

 

Capital expenditures to drill and complete wells decreased $13,615,517  (91%) from the 2015 to the 2016 period. Drilling activity on Company leasehold in the Texas Eagle Ford Shale oil play in South Texas ceased late in the 2015 first quarter due to low oil prices, and has not yet resumed. Also, drilling by our largest operator in the Fayetteville Shale natural gas play has now ceased. The decrease in Eagle Ford and Fayetteville Shale drilling and completion expenditures in the 2016 first quarter, as compared to the 2015 first quarter, combined with an extremely low number of well proposals which meet our participation criteria in all of the Company’s other plays has resulted in the 91% decrease in capital expenditures to drill and complete wells during the 2016 first quarter. Due to the continuation of low oil, NGL and natural gas prices, extended now for over a year, 2016 capital expenditures to drill and complete wells are expected to be significantly less than in 2015.

 

Oil, NGL and natural gas production volumes decreased 16% on an Mcfe basis during the 2016 period, as compared to the 2015 period. Little to no drilling activity resulted in new production coming on line falling considerably short of replacing the natural decline of existing wells. Oil production decreased 9% principally due to declining production from established properties in the Eagle Ford Shale established properties partially offset by five new Eagle Ford wells which began producing in September 2015. Declining production from horizontal Cleveland, Marmaton, Granite Wash and Mississippian oil plays in Oklahoma and the Texas Panhandle also contributed to the decrease. This decline was somewhat lessened by production from five North Dakota Bakken Shale wells that came on line during the second half of 2015. Natural gas production decreased 15% as a result of declining production from the Arkansas Fayetteville Shale and from the southeastern Oklahoma and Anadarko Basin Woodford Shales. Lower levels of associated natural gas production from the western Oklahoma horizontal Marmaton and Granite Wash plays also contributed to the decline. NGL production decreased 34% resulting from production declines in the Anadarko Basin Woodford Shale and the Texas Panhandle and western Oklahoma horizontal Marmaton and Granite Wash plays. As a result of the natural production decline of existing wells, combined with expected very low capital expenditures to drill and complete new wells during 2016, we expect oil, NGL and natural gas production to experience a higher rate of decline during 2016 than was experienced in 2015.

 

Since the Company is not the operator of any of its oil and natural gas properties, it is extremely difficult for us to predict levels of future participation in the drilling and completion of new wells and their associated capital expenditures. This makes 2016 capital expenditures for drilling and completion projects difficult to forecast.

 

Even at the lower levels of expected production and product prices during 2016, the Company expects to generate cash flows sufficient to fund expected capital expenditures, dividends and any treasury stock purchases. The Company did receive lease bonus payments during the 2016 first quarter totaling approximately $2.7 million, and has received a smaller amount thus far during the 2016 second quarter. The cash flow benefit from bonus payments associated with the leasing of drilling rights on the Company’s mineral acreage is very difficult to project as the Company’s mineral acreage position is so diverse and spread across several states. Excess cash will be used to reduce debt.

 

With continued oil and natural gas price volatility, management continues to evaluate opportunities for product price protection through additional hedging of the Company’s future oil and natural gas production. See NOTE 10 – “Derivatives” for a complete list of the Company’s outstanding derivative contracts.

 

The use of the Company’s cash provided by operating activities and resultant change to cash is summarized in the table below:

 

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Outstanding borrowings on the credit facility at December 31, 2015, were $57,000,000.

 

Looking forward, the Company expects to fund overhead costs, capital additions related to the drilling and completion of wells, treasury stock purchases, if any, and dividend payments primarily from cash provided by operating activities and cash on hand. As management evaluates opportunities to acquire additional assets, additional borrowings utilizing our bank credit facility could be necessary. Also, during times of oil, NGL and natural gas price decreases, or increased capital expenditures, it could be necessary to utilize the credit facility further in order to fund these expenditures. The Company has availability ($43,000,000 at December 31, 2015) under its revolving credit facility and is in compliance with its debt covenants (current ratio, debt to EBITDA and dividends as a percent of operating cash flow).

 

In future periods, should product price expectations continue to decline below levels seen at December 31, 2015, impairment charges significantly greater than the Company has incurred in prior periods could result. The most significant field that could be affected has a net book value of approximately $95 million. This field, which predominantly produces oil, is approximately 39% developed with over 100 well locations remaining to be drilled over the next several years.

 

Based on expected capital expenditure levels and anticipated cash provided by operating activities for 2016, the Company has sufficient liquidity to fund its ongoing operations and, combined with availability under its credit facility, to fund acquisitions, if any.

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED DECEMBER 31, 2015 – COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2014

 

Overview:

 

The Company recorded  a first quarter 2016 net loss of $2,799,118, or $0.17 per share, as compared to net income of $10,233,761, or $0.61 per share, in the 2015 quarter. The decrease in net income was principally the result of decreased oil, NGL and natural gas sales, decreased gains on derivative contracts, and increases in DD&A and impairment; partially offset by increases in lease bonuses and rentals, increased gains on the sale of assets, and decreased production and income taxes. These items are further discussed below.

 

Oil, NGL and Natural Gas Sales:

 

Oil, NGL and natural gas sales decreased $10,464,412 or 54% for the 2016 quarter. Oil, NGL and natural gas sales were down due to decreases in oil, NGL and natural gas sales volumes of 9%, 34% and 15%, respectively, and decreases in oil, NGL and natural gas prices of 44%, 51% and 47%, respectively. The following table outlines the Company’s production and average sales prices for oil, NGL and natural gas for the three month periods of fiscal 2016 and 2015:

 

 

 

The oil production decrease is principally the result of declining production from established properties in the Eagle Ford Shale in South Texas partially offset by five new Eagle Ford wells which began production in September 2015.

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Declining production from horizontal Cleveland, Marmaton, Granite Wash and Mississippian oil plays in Oklahoma and the Texas Panhandle also contributed to the decline. Drilling in these areas has decreased significantly from our fiscal year 2014 levels resulting in natural decline exceeding production from new wells. This decline was somewhat offset by production from five North Dakota Bakken Shale wells that were placed on production during the second half of 2015. The decrease in natural gas production was the result of declining production from the Fayetteville Shale in Arkansas and declining production from the southeastern Oklahoma and Anadarko Basin Woodford Shales. To a lesser extent, associated natural gas production from the western Oklahoma horizontal Marmaton and Granite Wash oil plays contributed to the decline. The decline in natural gas production was also due to significantly lower drilling activity in those areas. The NGL production decrease resulted from declining production in the Anadarko Basin Woodford Shale in addition to the Texas Panhandle and western Oklahoma horizontal Marmaton and Granite Wash oil plays.

 

The Company anticipates that the current reduced level of capital expenditures will continue as long as oil, NGL and natural gas prices remain at or near their current depressed levels. As a result of natural production decline of existing wells, combined with expected low capital expenditures to drill and complete new wells during 2016, we expect oil, NGL and natural gas production to experience a higher rate of decline in 2016 than was experienced in 2015.

 

Production for the last five quarters was as follows:

 

 

 

Gains (Losses) on Derivative Contracts:

 

The fair value of derivative contracts was a net asset of $636,114 as of December 31, 2015, and a net asset of $12,333,036 as of December 31, 2014. We had a net loss on derivative contracts of $34,936 in the 2016 quarter as compared to a net gain of $11,250,265 in the 2015 quarter. The change is principally due to the oil and natural gas collars and fixed price swaps that were in place in the 2015 quarter being settled over the past year. This was also coupled with the new natural gas collars and fixed price swaps that were added in the 2016 quarter being less favorable.

 

Lease Bonuses and Rentals:

 

Lease bonuses and rentals increased $2,396,213 in the 2016 quarter. The increase was mainly due to the Company leasing 4,057 net mineral acres in Cochran County, Texas, and 972 net mineral acres in Woodward County, Oklahoma, in the 2016 quarter.

 

Lease Operating Expenses (LOE):

 

LOE decreased $1,218,814 or 25% in the 2016 quarter. LOE per Mcfe decreased in the 2016 quarter to $1.13 compared to $1.28 in the 2015 quarter. LOE related to field operating costs decreased $728,606 in the 2016 quarter compared to the 2015 quarter, a 24% decrease. Field operating costs were $.72 per Mcfe in the 2016 quarter as compared to $.80 per Mcfe in the 2015 quarter. The decrease in rate in the 2016 quarter is principally the result of operating efficiencies gained in the Eagle Ford Shale field due to the addition of a salt water disposal system and electrification of the field.

 

The decrease in LOE related to field operating costs was coupled with a decrease in handling fees (primarily gathering, transportation and marketing costs) of $490,208 in the 2016 quarter compared to the 2015 quarter. On a per Mcfe basis, these fees decreased $.07 due mainly to a 15% decrease in natural gas production versus a 9% decrease in oil production. Natural gas sales bear the large majority of the handling fees while oil sales incur a much smaller amount. Handling fees are charged either as a percent of sales or based on production volumes.

 

Production Taxes:

 

Production taxes decreased $300,671 or 48% in the 2016 quarter as compared to the 2015 quarter. This decrease in amount is primarily the result of decreased oil, NGL and natural gas sales of $10,464,412 during the 2016 quarter. Production taxes as a percentage of oil, NGL and natural gas sales increased from 3.2% in the 2015 quarter to 3.6% in the 2016 quarter.  The increase in tax rate is the result of the expiration of production tax discounts on a number of the Company’s horizontally drilled wells in Oklahoma and Arkansas, as well as, the increased proportionate sales coming from Texas and North Dakota where initial tax rates are higher.

 

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Depreciation, Depletion and Amortization (DD&A):

 

DD&A increased $818,633 or 13% in the 2016 quarter. DD&A in the 2016 quarter was $2.21 per Mcfe as compared to $1.64 per Mcfe in the 2015 quarter. DD&A increased $1,794,447 as a result of this $.57 increase in the DD&A rate per Mcfe. An offsetting decrease of $975,814 was the result of production decreasing 16% in the 2016 quarter compared to the 2015 quarter. The rate increase is mainly due to lower oil, NGL and natural gas prices utilized in the reserve calculations during the 2016 quarter, as compared to 2015 quarter, shortening the economic life of wells thus resulting in lower projected remaining reserves on a significant number of wells causing increased units of production DD&A.

 

Provision for Impairment:

 

The provision for impairment increased $1,541,276 in the 2016 quarter as compared to the 2015 quarter. During the 2016 quarter, impairment of $3,733,273 was recorded on twenty-one fields. Three oil and liquids rich fields accounted for $3,212,968 of the impairment mainly due to continued declining oil and NGL prices. During the 2015 quarter, impairment of $2,191,997 was recorded on eleven small fields. One oil field in Hemphill County, Texas, accounted for $1,846,488 of the impairment.

 

Loss (Gain) on Asset Sales and Other:

 

Gain on asset sales increased $271,080 in the 2016 quarter. This increase is primarily related to the gain on sale of the Company’s only asset in one of its partnership investments in the 2016 quarter. This gain was partially offset by other expenses.

 

Income Taxes:

 

Provision for income taxes decreased in the 2016 quarter by $7,010,000, the result of a $20,042,879 decrease in income before provision for income taxes in the 2016 quarter compared to the 2015 quarter and an increase in the effective tax rate from 31% in the 2015 quarter to 46% in the 2016 quarter. When a provision for income taxes is recorded, federal and Oklahoma excess percentage depletion decreases the effective tax rate, while the effect is to increase the effective tax rate when a benefit for income taxes is recorded, as was the case for the 2016 quarter.  

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Critical accounting policies are those the Company believes are most important to portraying its financial conditions and results of operations and also require the greatest amount of subjective or complex judgments by management. Judgments and uncertainties regarding the application of these policies may result in materially different amounts being reported under various conditions or using different assumptions. There have been no material changes to the critical accounting policies previously disclosed in the Company’s Form 10-K for the fiscal year ended September 30, 2015.

 

ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market Risk

 

Oil, NGL and natural gas prices historically have been volatile, and this volatility is expected to continue. Uncertainty continues to exist as to the direction of oil, NGL and natural gas price trends, and there remains a rather wide divergence in the opinions held in the industry. The Company can be significantly impacted by changes in oil and natural gas prices. The market price of oil, NGL and natural gas in 2016 will impact the amount of cash generated from operating activities, which will in turn impact the level of the Company’s capital expenditures and production. Excluding the impact of the Company’s 2016 derivative contracts, the price sensitivity for each $0.10 per Mcf change in wellhead natural gas price is $974,522 for operating revenue based on the Company’s prior year natural gas volumes.  The price sensitivity in 2016 for each $1.00 per barrel change in wellhead oil price is $453,125 for operating revenue based on the Company’s prior year oil volumes.

 

Commodity Price Risk

 

The Company periodically utilizes derivative contracts to reduce its exposure to unfavorable changes in natural gas and oil prices. The Company does not enter into these derivatives for speculative or trading purposes. All of our outstanding derivative contracts are with Bank of Oklahoma and are secured. These arrangements cover only a portion of the Company’s production and provide only partial price protection against declines in natural gas and oil prices. These derivative contracts expose the Company to risk of financial loss and limit the benefit of future increases in prices. For the Company’s natural gas fixed price swaps, a change of $.10 in the NYMEX Henry Hub forward strip pricing would result in a change to pre-tax operating income of approximately $71,000. For the Company’s natural gas collars, a change of $.10 in the NYMEX Henry Hub forward strip pricing would result in a change to pre-tax operating income of approximately $238,000.  

 

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Financial Market Risk

 

Operating income could also be impacted, to a lesser extent, by changes in the market interest rates related to the Company’s credit facilities. The revolving loan bears interest at the BOK prime rate plus from 0.375% to 1.125%, or 30 day LIBOR plus from 1.875% to 2.625%. At December 31, 2015, the Company had $57,000,000 outstanding under this facility  and the effective interest rate was 2.43%. At this point, the Company does not believe that its liquidity has been materially affected by the interest rate uncertainties noted in the last few years and the Company does not believe that its liquidity will be significantly impacted in the near future.

 

ITEM 4  CONTROLS AND PROCEDURES

 

The Company maintains “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed in reports the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is collected and communicated to management, including the Company’s President/Chief Executive Officer and Vice President/Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating its disclosure controls and procedures, management recognized that no matter how well conceived and operated, disclosure controls and procedures can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. The Company’s disclosure controls and procedures have been designed to meet, and management believes they do meet, reasonable assurance standards. Based on their evaluation as of the end of the fiscal period covered by this report, the Chief Executive Officer and Chief Financial Officer have concluded, subject to the limitations noted above, the Company’s disclosure controls and procedures were effective to ensure material information relating to the Company is made known to them. There were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting made during the fiscal quarter or subsequent to the date the assessment was completed.

 

PART II  OTHER INFORMATION

 

ITEM 2   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 

 

During the three months ended December 31, 2015, the Company repurchased shares of the Company’s common stock as summarized in the table below.

 

 

 

Upon approval by the shareholders of the Company’s 2010 Restricted Stock Plan in March 2010, as amended in March 2014, the Board of Directors approved repurchase of up to $1.5 million of the Company’s common stock, from time to time, up to an amount equal to the aggregate number of shares of common stock awarded pursuant to the Company’s Amended 2010 Restricted Stock Plan, contributed by the Company to its ESOP and credited to the accounts of directors pursuant to the Deferred Compensation Plan for Non-Employee Directors. Pursuant to previously adopted board resolutions, the purchase of an additional $1.5 million of the Company’s common stock became authorized and approved effective June 26, 2013. The shares are held in treasury and are accounted for using the cost method. Effective May 14, 2014, the Board adopted resolutions to allow management to repurchase the Company’s common stock at their discretion.

 

ITEM 6  EXHIBITS

 

 

SIGNATURES

 

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

 

 

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