UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
Commission File Number 0-9116
PANHANDLE ROYALTY COMPANY
Grand Centre Suite 305, 5400 N Grand Blvd., Oklahoma City, Oklahoma 73112
Registrant’s telephone number including area code (405) 948-1560
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Outstanding shares of Class A Common stock (voting) at February 3, 2005: 4,190,850
INDEX
PART 1 FINANCIAL INFORMATIONPANHANDLE ROYALTY COMPANY
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(See accompanying notes)
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NOTE 1: Accounting Principles and Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission, and include the Company’s wholly owned subsidiary, Wood Oil Company (Wood). Management of Panhandle Royalty Company believes that all adjustments necessary for a fair presentation of the consolidated financial position and results of operations for the periods have been included. All such adjustments are of a normal recurring nature. The consolidated 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.
NOTE 2: Income Taxes
The Company’s provision for income taxes is reflective of excess percentage depletion, reducing the Company’s effective tax rate from the federal statutory rate.
NOTE 3: Stockholders’ Equity
On December 18, 2003, the Company’s Board of Directors approved a proposal to (i) amend the Company’s Articles of Incorporation to increase the number of authorized shares of Class A common stock from 6,000,000 to 12,000,000 shares and (ii) effect a 2-for-1 stock split of outstanding Class A common stock and a corresponding reduction of the par-value per share from $.0333 to $.0166. On February 27, 2004, these proposals were put forth to a vote of the stockholders, for which a majority of the stockholders voted in favor of each proposal, causing these proposals to become effective on such date. The Class A common stock split was affected in the form of a stock dividend, distributed on April 15, 2004 to shareholders of record on April 1, 2004.
All references to number of shares, per share and authorized share information in the accompanying consolidated financial statements have been adjusted to reflect the stock split and increase in authorized shares.
NOTE 4: Earnings per Share
The following table sets forth the number of shares utilized in the computation of basic and diluted earnings per share, giving consideration to certain shares that may be issued under the Non-Employee Directors Deferred Compensation Plan, to the extent dilutive. The weighted average shares outstanding, potentially dilutive shares and earnings per share for 2004 have been restated to effect the 2-for-1 stock split discussed in Note 3.
NOTE 5: Long-term Debt
On March 25, 2003, the Company amended its Loan Agreement with BancFirst, Oklahoma City, OK. The Agreement consists of a term loan in the amount of $10,000,000 and a revolving loan in the amount of $15,000,000, which is subject to a semi-annual borrowing base determination. The current borrowing base under the agreements is $22,500,000 which can be re-determined semi-annually. The term loan matures on April 1, 2008, and the revolving loan matures on March 31, 2006. Monthly payments on the term loan are $166,667, plus accrued interest. Interest on the term loan is fixed at 4.56% until maturity. The revolving loan bears interest at the national prime rate minus 3/4% (4.5% at December 31, 2004) or Libor (for one, three or six month periods), plus 1.80%. The Company at December 31, 2004, has elected the prime rate option. At December 31, 2004, the Company had $6,666,660 outstanding under the term loan and $2,825,000 outstanding under the revolving loan.
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NOTE 6: Dividends
On December 16, 2004, the Company’s Board of Directors approved payment of a $.05 per share regular dividend and a $.05 per share additional non-recurring dividend to be paid on March 16, 2005 to shareholders of record on February 14, 2005.
NOTE 7: Stock-based Compensation
The Company applies APB Opinion No. 25 in accounting for its Deferred Compensation Plan for Outside Directors. Under APB No. 25, compensation cost is recognized for changes in the fair value of the stock credited to each director’s account at the fair market value of the stock at the date of grant. The shares are then adjusted for changes in the shares market value subsequent to the date of grant until the conversion date. 1,067 shares were issued in the 2005 quarter upon the retirement of one director.
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 2005 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 and 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 and gas reserves. These risks include, but are not limited to, oil and natural gas price risk, environmental risks, drilling risk, reserve quantity risk and operations and production risk. 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
At December 31, 2004, the Company had positive working capital of $1,708,323, as compared to positive working capital of $1,941,634 at September 30, 2004. Oil and gas sales receivable has increased due to higher oil and natural gas prices and production volumes, but was more than offset by an increase in income taxes payable and an increase in accrued liabilities other, which includes the March 2005 dividend, of approximately $419,000, declared in December 2004. The provision for income taxes increased as the result of higher earnings and the exhaustion of tax depletion carry forward deductions.
Capital expenditures for oil and gas activities for the 2005 three-month period amounted to $4,411,562, as compared to $1,992,210 for the 2004 period. Management currently expects capital expenditures for oil and gas activities to be approximately $13,000,000 for fiscal 2005. The substantial increase in capital expenditures is a result of increased drilling activity brought on by higher market prices for oil and gas and increases in the costs of drilling and equipping wells. As activity has increased, costs for drilling rigs and well equipment has increased, and are expected to remain so for the remainder of fiscal 2005. Acquisitions of oil and gas properties in the current quarter of $900,000 has increased, and any future acquisitions may further increase, the capital expenditure amount.
The Company has historically funded capital expenditures, overhead costs and dividend payments from operating cash flow. Due to the increased capital expenditure level of fiscal 2005 the Company has utilized, at times, the revolving line-of-credit facility to help fund these expenditures. However, the increased cash flow from higher prices being received for natural gas and oil allowed the Company to reduce outstanding bank borrowings by approximately $1,025,000 during the quarter. Management currently does not expect to borrow substantial funds under the revolving loan during the remainder of fiscal 2005, but minor amounts may be borrowed on a temporary basis. The Company currently has in excess of $13 million available under its bank debt facility and the availability could be increased, if needed.
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RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 2004 – COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2003
Overview:
The Company recorded a first quarter 2005 net income of $2,448,344, or $.58 per diluted share, as compared to a net income of $990,233 or $.23 per diluted share in the 2004 quarter. The improved results were due to increased sales prices for both oil and natural gas and increased oil and gas sales volumes, offset to some extent by a 36% increase in costs and expenses and a 183% increase in the provision for income taxes.
Revenues:
Total revenues increased $3,518,898 or 71% for the 2005 quarter. The increase was the result of a $3,514,000 increase in oil and natural gas sales revenues. The increase in oil and gas sales revenues resulted from a 53% and 47% increase in the average sales price for oil and natural gas, respectively, and oil sales volumes increased 5% while gas sales volumes increased 20%. The table below outlines the Company’s production and average sales prices for oil and natural gas for the three month periods of fiscal 2005 and 2004:
The increase in oil and gas sales volumes for the 2005 quarter is the result of production from new wells. The continuing increase in drilling expenditures should result in increased production volumes, as compared to fiscal 2004, for the remainder of the year.
Lease Operating Expenses (LOE):
LOE increased $77,318 or 12% in the 2005 quarter. The increase is a result of new wells going on line in the 2005 quarter, as new wells normally have high operating costs the first several months of production, the continuing increase in the number of wells in which the Company has an interest, and general price increases.
Production Taxes:
Production taxes increased $247,034 or 80% in the 2005 quarter. The increase is the result of the large increase in oil and gas revenues in the 2005 quarter, as production taxes are paid as a percentage of these revenues.
Exploration Costs:
These costs increased $242,745 in the 2005 quarter. This increase is principally the result of one exploratory dry hole drilled in the fiscal 2005 quarter. In the 2004 first quarter the Company had no high cost exploratory wells which resulted in dry holes. In addition, some of the Company’s leasehold was deemed worthless or the lease term expired in the 2005 quarter.
Depreciation, Depletion, Amortization and Impairment (DD&A):
DD&A increased $470,183 or 33% in the 2005 quarter. The increase is a result of increased production volumes in the 2005 quarter as well as higher costs on newly completed wells, which must be depreciated. There was no impairment charge in the 2005 quarter and only $67,000 in the 2004 quarter.
General and Administrative Costs (G&A):
G&A costs increased $304,577 or 30% in the 2005 quarter. Approximately $70,000 of the increase was due to the Directors’ Deferred Compensation Plan. Panhandle’s share price increased during the 2005 quarter, thus, increase on the potential shares in the plan was recognized as an expense in the quarter. Additionally, in the 2005 quarter personnel related expenses increased approximately $144,000.
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Interest Expense:
Interest expense decreased in the 2005 quarter due to lower outstanding debt balances.
Income Taxes:
The 2005 quarter provision for income taxes increased due to substantially increased income before provision for income taxes. The Company utilizes excess percentage depletion to reduce its effective tax rate from the federal statutory rate. The effective tax rate estimate was 32% for the 2005 period and 29% for the 2004 period.
CRITICAL ACCOUNTING POLICIES
Preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. However, the accounting principles used by the Company generally do not change the Company’s reported cash flows or liquidity. Generally, accounting rules do not involve a selection among alternatives, but involve a selection of the appropriate policies for applying the basic principles. Interpretation of the existing rules must be done and judgments made on how the specifics of a given rule apply to the Company.
The more significant reporting areas impacted by management’s judgments and estimates are crude oil and natural gas reserve estimation, impairment of assets, oil and gas sales revenue accruals and tax accruals. Management’s judgments and estimates in these areas are based on information available from both internal and external sources, including engineers, geologists and historical experience in similar matters. Actual results could differ from the estimates as additional information becomes known.
Oil and Gas Reserves
Of these judgments and estimates, management considers the estimation of crude oil and nature gas reserves to be the most significant. Changes in crude oil and natural gas reserve estimates affect the Company’s calculation of depreciation and depletion, provision for abandonment and assessment of the need for asset impairments. On an annual basis, with a limited scope semi-annual update, the Company’s consulting engineer with assistance from Company geologists prepares estimates of crude oil and natural gas reserves based on available geologic 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. As required by the guidelines and definitions established by the Securities and Exchange Commission, these estimates are based on current crude oil and natural gas pricing. Crude oil and natural gas prices are volatile and largely affected by worldwide consumption and are outside the control of management. Projected future crude oil and natural gas pricing assumptions are used by management to prepare estimates of crude oil and natural gas reserves used in formulating management’s overall operating decisions in the exploration and production segment.
Successful Efforts Method of Accounting
The Company has elected to utilize the successful efforts method of accounting for its oil and gas exploration and development activities. Exploration expenses, including geological and geophysical costs, rentals and exploratory dry holes, are charged against income as incurred. Costs of successful wells and related production equipment and developmental dry holes are capitalized and amortized by field using the unit-of-production method as oil and gas is produced. This accounting method may yield significantly different operating results than the full cost method.
Impairment of Assets
All long-lived assets are monitored for potential impairment when circumstances indicate that the carrying value of the asset may be greater than its future net cash flows. The evaluations involve a significant amount of judgment since the results are based on estimated future events, such as inflation rates, future sales prices for oil and gas, future costs to produce these products, estimates of future oil and 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 and gas reserves. Any assets held for sale are reviewed for impairment when the Company approves the plan to sell. Estimates of anticipated sales prices are highly judgmental and subject to material revision in future periods. Because of the uncertainty inherent in these factors, the Company cannot predict when or if future impairment charges will be recorded.
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Tax Accruals
The estimation of the amounts of income tax to be recorded by the Company involves interpretation of complex tax laws and regulations as well as the completion of complex calculations, including the determination of the Company’s percentage depletion deduction. Although the Company’s management believes its tax accruals are adequate, differences may occur in the future depending on the resolution of pending and new tax matters.
The above description of the Company’s critical accounting policies is not intended to be an all-inclusive discussion of the uncertainties considered and estimates made by management in applying accounting principles and policies. Results may vary significantly if different policies were used or required and if new or different information becomes known to management.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company’s results of operations and operating cash flows are impacted by changes in market prices for oil and gas. Operations and cash flows are also impacted by changes in the market interest rates related to the revolving credit facility which bears interest at an annual variable interest rate equal to the national prime rate minus 3/4% or Libor for one, three or six month periods, plus 1.8%. A one percent change in the prime interest rate would result in approximately a $28,000 change in annual interest expense.
The Company has a $10,000,000 term loan, with a balance of $6,666,660 outstanding at December 31, 2004, which matures on April 1, 2008. The interest rate is fixed at 4.56% until maturity.
ITEM 4 CONTROLS AND PROCEDURES
Panhandle Royalty Company management, under the supervision of and with the participation of the Chief Executive Officer and Chief Financial Officer have conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in our internal controls or in factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation.
PART II OTHER INFORMATION
ITEM 6 EXHIBITS AND REPORT ON FORM 8-K
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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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