Riley Exploration Permian - 10-Q quarterly report FY2020 Q1

Tengasco, Inc. (the “Company”) is a Delaware corporation.  The Company is in the business of exploration for and production of oil and natural gas.  The Company’s primary area of exploration and production is in Kansas.

The accompanying unaudited condensed consolidated financial statements as of March 31, 2020 and March 31, 2019 have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Item 210 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  The condensed consolidated balance sheet as of December 31, 2019 is derived from the audited financial statements, but does not include all disclosures required by U.S. GAAP.  The Company believes that the disclosures made are adequate to make the information not misleading. In the opinion of management, all adjustments (consisting of only normal recurring accruals) considered necessary for a fair presentation for the periods presented have been included as required by Regulation S-X, Rule 10-01.  Operating results for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ended December 31, 2020. It is suggested that these condensed consolidated financial statements be read in conjunction with the Company’s consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of all significant intercompany transactions and balances.

The accompanying condensed consolidated financial statements are prepared in conformity with U.S. GAAP which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Significant estimates include reserve quantities and estimated future cash flows associated with proved reserves, which significantly impact depletion expense and potential impairments of oil and natural gas properties, income taxes and the valuation of deferred tax assets, stock-based compensation, and commitments and contingencies.  We analyze our estimates based on historical experience and various other assumptions that we believe to be reasonable. While we believe that our estimates and assumptions used in preparation of the condensed consolidated financial statements are appropriate, actual results could differ from those estimates and assumptions.

The Company identifies the contracts with each of its customers and the separate performance obligations associated with each of these contracts.  Revenues are recognized when the performance obligations are satisfied and when control of goods or services are transferred to customers at an amount that reflects the consideration to which it expects to be entitled in exchange for those goods or services.

Crude oil is sold on a month-to-month contract at a price based on an index price from the purchaser, net of differentials.  Crude oil that is produced is stored in storage tanks.  The Company will contact the purchaser and request it to pick up the crude oil from the storage tanks.  When the purchaser picks up the crude from the storage tanks, control of the crude transfers to the purchaser, the Company’s contractual obligation is satisfied, and revenues are recognized.  The sales of oil represent the Company’s share of revenues net of royalties and excluding revenue interests owned by others.  When selling oil on behalf of royalty owners or working interest owners, the Company is acting as an agent and thus reports revenues on a net basis to the Company.  Fees and other deductions incurred prior to transfer of control are recorded as production costs.  Revenues are reported net of fees and other deductions incurred after transfer of control.

The Company operates certain salt water disposal wells, some of which accept water from third parties.  The contracts with the third parties primarily require a flat monthly fee for the third parties to dispose water into the wells.  In some cases, the contract is based on a per barrel charge to dispose water into the wells.  There is no requirement under the contracts for these third parties to use these wells for their water disposal.  If the third parties do dispose water into the Company operated wells during a given month, the Company has met its contractual obligations and revenues are recognized for that month.

The following table presents the disaggregated revenue by commodity for the three months ended March 31, 2020 and 2019 (in thousands):

There were no natural gas imbalances at March 31, 2020 or December 31, 2019.

Cash and cash equivalents include temporary cash investments with a maturity of ninety days or less at date of purchase.

Inventory consists of crude oil in tanks and is carried at lower of cost or market value.  The cost value component of the oil inventory is calculated using the average cost per barrel for the three months ended March 31, 2020 and December 31, 2019.  These costs include production costs and taxes.  At December 31, 2019, the cost component was used to value oil inventory.  The market value component is calculated using the average March 2020 and December 2019 oil sales prices received by the Company.  At March 31, 2020, the market component was used to value oil inventory.  At March 31, 2020 and December 31, 2019, inventory consisted of the following (in thousands):

The Company follows the full cost method of accounting for oil and gas property acquisition, exploration, and development activities.  Under this method, all costs incurred in connection with acquisition, exploration, and development of oil and gas reserves are capitalized.  Capitalized costs include lease acquisitions, seismic related costs, certain internal exploration costs, drilling, completion, and estimated asset retirement costs. The capitalized costs of oil and gas properties, plus estimated future development costs relating to proved reserves and estimated asset retirement costs which are not already included, net of estimated salvage value, are amortized on the unit-of-production method based on total proved reserves. The Company has determined its reserves based upon reserve reports provided by LaRoche Petroleum Consultants Ltd. since 2009. The costs of unproved properties are excluded from amortization until the properties are evaluated, subject to an annual assessment of whether impairment has occurred.  The Company had $0 in unevaluated properties as of March 31, 2020 and at December 31, 2019.  Proceeds from the sale of oil and gas properties are accounted for as reductions to capitalized costs unless such sales cause a significant change in the relationship between costs and the estimated value of proved reserves, in which case a gain or loss is recognized.

At the end of each reporting period, the Company performs a “ceiling test” on the value of the net capitalized cost of oil and gas properties. This test compares the net capitalized cost (capitalized cost of oil and gas properties, net of accumulated depreciation, depletion and amortization and related deferred income taxes) to the present value of estimated future net revenues from oil and gas properties using an average price (arithmetic average of the beginning of month prices for the prior 12 months) and current cost discounted at 10%  plus cost of properties not being amortized and the lower of cost or estimated  fair value of unproven properties included in the cost being amortized (ceiling). If the net capitalized cost is greater than the ceiling, a write-down or impairment is required.  A write-down of the carrying value of the asset is a non-cash charge that reduces earnings in the current period.  Once incurred, a write-down may not be reversed in a later period.  The Company did not record any impairment of its oil and gas properties during the three months ended March 31, 2020 and 2019.

Accounts receivable consist of uncollateralized joint interest owner obligations due within 30 days of the invoice date, uncollateralized accrued revenues due under normal trade terms, generally requiring payment within 30 days of sales of oil and gas production, and other miscellaneous receivables. No interest is charged on past-due balances. Payments made on accounts receivable are applied first to the earliest unpaid items. We review accounts receivable periodically and reduce the carrying amount by a valuation allowance that reflects our best estimate of the amount that may not be collectible. There was no allowance recorded at March 31, 2020 or December 31, 2019.

The following table sets forth information concerning the Company’s accounts receivable (in thousands):

Income taxes are reported in accordance with U.S. GAAP, which requires the establishment of deferred tax accounts for all temporary differences between the financial reporting and tax bases of assets and liabilities, using currently enacted federal and state income tax rates.  In addition, deferred tax accounts must be adjusted to reflect new rates if enacted into law.

The deferred income tax assets or liabilities for an oil and gas exploration and development company are dependent on many variables such as estimates of the economic lives of depleting oil and gas reserves and commodity prices.  Accordingly, the asset or liability is subject to continuous recalculation and revision of the numerous estimates required, and may change significantly in the event of occurrences such as major acquisitions, divestitures, commodity price changes, changes in reserve estimates, changes in reserve lives, and changes in tax rates or tax laws.

The estimated annual effective tax rate of 0% differs from the statutory rate of 21% due primarily to adjustments to the valuation allowance on the deferred tax assets.

At December 31, 2019, federal net operating loss carryforwards amounted to approximately $33.8 million, of which $31.5 million expires between 2020 and 2037 which can offset 100% of taxable income and $2.3 million that has an indefinite carryforward period which can offset 80% of taxable income per year. The total net deferred tax asset was $0 at March 31, 2020 and $65,000 at December 31, 2019.  The Company recorded an allowance on the remaining deferred tax asset at March 31, 2020 and December 31, 2019 primarily due to expected future losses in the near term which would cause cumulative losses being incurred during the 3 year period.  There were no recorded unrecognized tax benefits at March 31, 2020 and December 31, 2019.

Effective March 17, 2017 the Board of Directors declared a dividend of one right (a “Right”) for each of the Company’s issued and outstanding shares of common stock, $0.001 par value per share (“Common Stock”). The dividend was paid to the stockholders of record at the close of business on March 27, 2017 (the “Record Date”). Each Right entitles the registered holder, subject to the terms of the Rights Agreement dated as of March 16, 2017 (the “Rights Agreement”) between the Company and the Rights Agent, Continental Stock Transfer & Trust Company, to purchase from the Company one one-thousandth of a share of the Company’s Series A Preferred Stock at a price of $1.10 (the “Exercise Price”), subject to certain adjustments.

The purpose of the Rights Agreement is to reduce the risk that the Company’s ability to use its net operating losses to reduce potential future federal income tax obligations would be limited if the Company’s experiences an “ownership change,” as defined in Section 382 of the Internal Revenue Code. A company generally experiences an ownership change if the percentage of its stock owned by its “5-percent shareholders,” as defined in Section 382 of the Tax Code, increases by more than 50 percentage points over a rolling three-year period. The Rights Agreement is designed to reduce the likelihood that the Company will experience an ownership change under Section 382 of the Tax Code by discouraging any person or group from becoming a 4.95% shareholder and also discouraging any existing 4.95% (or more) shareholder from acquiring additional shares of the Company’s stock.

The Rights will not be exercisable until the “Distribution Date”, which is generally defined as the earlier to occur of:(i) a public announcement or filing that a person or group has, become an “Acquiring Person” which is defined as a person or group of affiliated or associated persons or persons acting in concert who, at any time after the date of the Rights Agreement, have acquired, or obtained the right to acquire, beneficial ownership of 4.95% or more of the Company’s outstanding shares of Common Stock; or a person or group currently owning 4.95% (or more) of the Company’s outstanding shares acquires additional shares of the Company’s stock; subject to certain exceptions; or (ii) the commencement of, or announcement of an intention to commence, a tender offer or exchange offer the consummation of which would result in any person becoming an Acquiring Person.

The Rights, unless extended by the Board of Directors will expire prior to the earlier of March 16, 2020; or a date the Board of Directors determines by resolution in its business judgment that the Agreement is no longer necessary or appropriate; or in certain other specified circumstances.  On March 16, 2020 the Board of Directors by unanimous resolution acting without meeting determined to extend the expiration date of the Rights Agreement to March 16, 2021 as expressly contemplated by the Rights Agreement.

At any time after any person or group of affiliated or associated persons becomes an Acquiring Person, the Board, at its option, may exchange each Right (other than Rights owned by such person or group of affiliated or associated persons which will have become void), in whole or in part, at an exchange ratio of two shares of Common Stock per outstanding Right (subject to adjustment).

For further information on the Rights Agreement, please refer to the Rights Agreement that was attached in full as an exhibit to the Company’s Form 8-K filed with SEC on March 17, 2017.

Series A Preferred Stock has a par value of $0.0001 and 10,000 shares have been designated.  No shares of Series A Preferred Stock have been issued by the Company pursuant to the Rights Agreement described above or otherwise.

We report basic earnings per common share, which exclude the effect of potentially dilutive securities, and diluted earnings per common share which include the effect of all potentially dilutive securities unless their impact is anti-dilutive. The following are reconciliations of the numerators and denominators of our basic and diluted earnings per share (in thousands except for share and per share amounts):

Options issued to the Company’s directors in which the exercise price was higher than the average market price each quarter were excluded from diluted shares as they would have been anti-dilutive.  In addition, the shares that would be issued to employees and Company directors if the thirty day trailing average of WTI postings as published by the U.S. Energy Information Administration meets or exceeds $85 per barrel have also been excluded from this calculation.  (See Note (10) Commitments and Contingencies)

The following table sets forth information concerning the Company’s oil and gas properties (in thousands):

The Company recorded depletion expense of $142,000 and $163,000 for the three months ended March 31, 2020 and 2019, respectively.  During the three months ended March 31, 2020 and 2019, the Company also recorded in “Accumulated depreciation, depletion, and amortization” a $2,000 loss on asset retirement obligations and a $7,000 loss on asset retirement obligations, respectively.

Our asset retirement obligations represent the estimated present value of the amount we will incur to plug, abandon, and remediate our producing properties at the end of their productive lives in accordance with applicable laws. The following table summarizes the Company’s Asset Retirement Obligation transactions for the three months ended March 31, 2020 (in thousands):

At March 31, 2020, the Company had a revolving credit facility with Prosperity Bank.  This has historically been the Company’s primary source to fund working capital and capital spending.  Under the credit facility, loans and letters of credit are available to the Company on a revolving basis in an amount outstanding not to exceed the lesser of $50 million or the Company’s borrowing base in effect from time to time. As of March 31, 2020, the Company’s borrowing base was $4 million, subject to a credit limit based on current covenants of $1.97 million.  The credit facility is secured by substantially all of the Company’s producing and non-producing oil and gas properties.  The credit facility includes certain covenants with which the Company is required to comply.  At March 31, 2020, these covenants include the following: (a) Current Ratio > 1:1; (b) Funded Debt to EBITDA < 3.5x; and (c) Interest Coverage > 3.0x.  At March 31, 2020, the interest rate on this credit facility was 3.75%.  The Company was in compliance with all covenants during the quarter ended March 31, 2020.  The Company had no outstanding borrowing under the facility as of March 31, 2020 or December 31, 2019.  However, if the Company had borrowings under the credit facility at March 31, 2020, the Company would not have been in compliance with EBITDA related covenants as the Company reported negative EBITDA for the trailing four quarters ended March 31, 2020.

During April 2020, the Company’s senior credit facility with Prosperity Bank after Prosperity Bank’s most recent review of the Company’s currently owned producing properties was amended to decrease the borrowing base to $3.1 million, subject to a credit limit based on current covenants of $1.442 million.  The borrowing base remains subject to the existing periodic redetermination provisions in the credit facility. The interest rate remained prime plus 0.50% per annum.  This rate was 3.75% at the date of the amendment.  The maximum line of credit of the Company under the Prosperity Bank credit facility remained $50 million.  The next borrowing base review will take place in July 2020.

 During the second quarter of 2020, the Company was approved by the Small Business Administration to receive a Paycheck Protection Program (“PPP”) loan in the amount of approximately $166,000.  This loan was funded by Prosperity Bank in May 2020.  The PPP loan is not part of the credit facility with Prosperity Bank as described above and therefore is not subject to the same terms as Company’s credit facility.  The PPP loan has an interest rate of 1% with a maturity date of May 2022.  There are no payments due during the first six months of the loan.  After the six-month period has expired, all outstanding accrued interest is due.  At that time, the remaining unforgiven portion of the loan will be due in 18 equal monthly installments of principal and interest.  The Company may apply for forgiveness of the amount due on the PPP loan based on spending the loan proceeds on eligible expenses as defined by statute.

Effective January 1, 2019, the Company adopted ASU 2016-02 Leases (Topic 842).  We first determine if a contract is a lease at inception of the arrangement.  To the extent that we determine an arrangement represents a lease, we then classify that lease as an operating lease or a finance lease.  As of January 1, 2019, the Company capitalizes its operating leases on the Consolidated Balance Sheet as a right of use asset and a corresponding lease liability.  The Company also capitalizes its finance leases on the Consolidated Balance Sheet as other property and equipment and a corresponding lease liability.  The right of use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease.  Lease expense for operating lease payments is recognized on a straight-line basis over the lease term.  Short term leases that have an initial term of one year or less are not capitalized unless the Company intends to renew the lease to extend the initial term past one year.

We lease certain office space, a storage yard, and field vehicles to support our operations.  A more detailed description of the Company’s lease types is included below.

The Company maintains an office to support its corporate operations.  This office agreement is with a third party and was structured with a 39 month initial term.  The Company can renew the lease for 36 additional months by providing to the Landlord written notice of intent to exercise the renewal not less than nine months prior to expiration of the initial term.  The Company’s corporate office lease is classified as an operating lease.

The Company maintains a yard to store certain equipment used in its field operations.  This storage yard agreement is with a third party and is on a month-to-month lease.  However, the Company intends to continue to renew this lease for the foreseeable future.  Based on the Company’s intent to renew the lease, the Company is assuming the same lease term as its corporate office lease for calculation of its right of use asset and lease liability.  The Company’s storage yard is classified as an operating lease.

The Company leases certain vehicles from a third party for use in its field operations.  The lease term for each vehicle is based on expected daily use of the vehicles by the field personnel, typically between 18 and 36 months.  The Company also pays an upfront fee at the commencement of the lease term.  The Company can continue to lease the vehicles past the initial lease term on a month-to-month basis.  In addition, each vehicle has a residual value guarantee at the end of the lease term.  The Company’s field vehicle leases are classified as finance leases.

In order to determine whether the Company’s contracts contain a lease component, the Company is required to exercise significant judgment.  The Company will review each contract to determine if: an asset is specified in the contract; the asset is physically distinct; the supplier does not have substantive substitution rights; the Company obtains substantially all economic benefit from use of the asset; and the Company can direct the use of the asset.  The Company also determines the appropriate discount rate to use on each lease.  If there is a stated rate in the contract, the Company will use the stated rate as its discount rate.  The contract associated with the field vehicles includes a stated rate typically between 5% and 6.5%.  These stated rates for the field vehicle agreements were used as the discount rates.  If there is no stated rate, the Company will use its borrowing rate as the discount rate.  The contracts associated with the offices and yard do not include a stated rate.  The Company used its borrowing rate of 6% as the discounts rate for these agreements.

Components of lease costs for the three months ended March 31, 2020 and 2019 (in thousands):

Supplemental lease related cash flow information for the three months ended March 31, 2020 and 2019 (in thousands):

Supplemental lease related balance sheet information as of March 31, 2020 and December 31, 2019 (in thousands):

Weighted average remaining lease term and discount rate as of March 31, 2020:

Maturity of lease liabilities as of March 31, 2020 (in thousands):

Through May 2021, the Company believes its revenues as well as cash on hand will be sufficient to fund operating costs and general and administrative expenses and to remain in compliance with its bank covenants.  If revenues and cash on hand are not sufficient to fund these expenses or if the Company needs additional funds for capital spending, the Company may be able to borrow funds against the credit facility depending on the borrowing base and credit limit.  Because of the drop in oil prices during the first and second quarters of 2020 and resulting projected negative EBITDA, borrowing from the Company’s credit facility would result in non-compliance with current covenants, and would require a waiver on the EBITDA related covenants, or a change in the covenants, until such time as prices improve.  In addition, if required, the Company could also issue additional shares of stock and/or sell assets as needed to further fund operations.

FASB ASC 820, “Fair Value Measurements and Disclosures”, establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820 are described as follows:

The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Further, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

Upon completion of wells, the Company records an asset retirement obligation at fair value using Level 3 assumptions.

Nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis upon impairment.  The carrying amounts of other financial instruments including cash and cash equivalents, accounts receivable, account payables, accrued liabilities and long-term debt in our balance sheet approximates fair value as of March 31, 2020 and December 31, 2019.

Commencing in the quarter ended March 31, 2015 and continuing into the quarter ended June 30, 2018, the Company implemented cost reduction measures including compensation reductions for each employee as well as members of the Board of Directors.  These compensation reductions were to remain in place until such time, if any, that the market price of crude oil, calculated as a thirty-day trailing average of WTI postings as published by the U.S. Energy Information Administration meets or exceeds $70 per barrel.  In May 2018, oil prices as so calculated exceeded $70 and compensation reverted to the levels in place before the reductions became effective. At such time, if any, that the market price of crude oil, calculated as a thirty-day trailing average of WTI postings as published by the U.S. Energy Information Administration meets or exceeds $85 per barrel, all previous reductions made will be reimbursed, a portion which may be paid in stock, to each employee and members of the Board of Directors if is still employed by the Company or still a member of the Board of Directors.  For the period January 1, 2015 through March 31, 2020, the reductions were approximately $373,000.  Of the $373,000, approximately $45,000 would be paid in the Company’s common stock.  The $45,000 value represents approximately 100,000 common shares valued at $0.45 per share which represents the closing price on March 31, 2020.  The Company has not accrued any liabilities associated with these compensation reductions.

The Company is not a party to any pending material legal proceeding.   To the knowledge of management, no federal, state, or local governmental agency is presently contemplating any proceeding against the Company which would have a result materially adverse to the Company. To the knowledge of management, no director, executive officer or affiliate of the Company or owner of record or beneficial owner of more than 5% of the Company’s common stock is a party adverse to the Company or has a material interest adverse to the Company in any proceeding.

During the first three months of 2020, 31.6 MBbl gross of oil were sold from the Company’s properties.  Of the 31.6 MBbl sold, 23.4 MBbl were net to the Company after required payments to all of the royalty interests and the one remaining drilling program participant.  The Company’s net sales from its properties during the first three months of 2020 of 23.4 MBbl of oil compares to net sales of 23.4 MBbl of oil during the first three months of 2019.  The Company’s net revenue from its oil and gas properties was $963,000 during the first three months of 2019 compared to $1.2 million during the first three months of 2019.  This decrease in net revenue was primarily due to an $8.82 per barrel decrease in the average oil price from $49.88 per barrel during the first three months of 2019 to $41.06 per barrel during the first three months of 2020.

The Company reported a net loss of $(527,000) or $(0.05) per share of common stock during the first quarter of 2020 compared to a net loss of $(96,000) or $(0.01) per share of common stock during the first quarter of 2019.  The $431,000 decrease in net income was primarily due to an $208,000 decrease in revenues, a $185,000 increase in production costs and taxes, and a $43,000 decrease in gain on sale of assets.

The Company recognized $963,000 in revenues during the first quarter of 2020 compared to $1.2 million during the first quarter of 2019. The $208,000 decrease in net revenues was primarily due to a $8.82 per barrel decrease in the average oil price from $49.88 per barrel during the first quarter of 2019 to $41.06 per barrel during the first quarter of 2020.

Production costs and taxes increased $185,000 from $779,000 during the first quarter of 2019 to $964,000 during the first quarter of 2020.  This increase was primarily due to a change in the oil inventory adjustment.

Gain on sale of assets decreased $43,000 from $45,000 during the first quarter of 2019 to $2,000 during the first quarter of 2020.  This decrease was primarily related to gain on sale of equipment inventory to a third party during the first quarter of 2019.

At March 31, 2020, the Company had a revolving credit facility with Prosperity Bank.  This has historically been the Company’s primary source to fund working capital and capital spending.  Under the credit facility, loans and letters of credit are available to the Company on a revolving basis in an amount outstanding not to exceed the lesser of $50 million or the Company’s borrowing base in effect from time to time. As of March 31, 2020, the Company’s borrowing base was $4 million, subject to a credit limit based on current covenants of $1.97 million.  The credit facility is secured by substantially all of the Company’s producing and non-producing oil and gas properties.  The credit facility includes certain covenants with which the Company is required to comply.  At March 31, 2020, these covenants include the following: (a) Current Ratio > 1:1; (b) Funded Debt to EBITDA < 3.5x; and (c) Interest Coverage > 3.0x.  At March 31, 2020, the interest rate on this credit facility was 3.75%.  The Company was in compliance with all covenants during the quarter ended March 31, 2020.  The Company had no outstanding borrowing under the facility as of March 31, 2020 or December 31, 2019.  However, if the Company had borrowings under the credit facility at March 31, 2020, the Company would not have been in compliance with EBITDA related covenants as the Company reported negative EBITDA for the trailing four quarters ended March 31, 2020.

During April 2020, the Company’s senior credit facility with Prosperity Bank after Prosperity Bank’s most recent review of the Company’s currently owned producing properties was amended to decrease the borrowing base to $3.1 million, subject to a credit limit based on current covenants of $1.442 million.  The borrowing base remains subject to the existing periodic redetermination provisions in the credit facility. The interest rate remained prime plus 0.50% per annum.  This rate was 3.75% at the date of the amendment.  The maximum line of credit of the Company under the Prosperity Bank credit facility remained $50 million.  The next borrowing base review will take place in July 2020.

During the second quarter of 2020, the Company was approved by the Small Business Administration to receive a Paycheck Protection Program (“PPP”) loan in the amount of approximately $166,000.  This loan was funded by Prosperity Bank in May 2020.  The PPP loan is not part of the credit facility with Prosperity Bank as described above and therefore is not subject to the same terms as Company’s credit facility.  The PPP loan has an interest rate of 1% with a maturity date of May 2022.  There are no payments due during the first six months of the loan.  After the six-month period has expired, all outstanding accrued interest is due.  At that time, the remaining unforgiven portion of the loan will be due in 18 equal monthly installments of principal and interest.  The Company may apply for forgiveness of the amount due on the PPP loan based on spending the loan proceeds on eligible expenses as defined by statute.  However, the Company anticipates that it will be eligible for forgiveness of the entire loan amount as the proceeds will be used for eligible expenses.

Net cash provided operating activities was $174,000 during the first three months of 2020 compared to $(18,000) used in operating activities during the first three months of 2019.  Cash flow provided by working capital was $508,000 during the first three months of 2020 compared to $(102,000) used in working capital during the first three months of 2019. The $192,000 increase in cash provided by operating activities was primarily due to a $610,000 increase in cash flow provided by working capital, partially offset by the $208,000 decrease in revenues, and the $185,000 increase in production cost and taxes.  Net cash provided used in investing activities was $(81,000) during the first three months of 2020 compared to $139,000 provided by investing activities during the first three months of 2019.  This decrease in cash flow provided by investing activities was primarily due to proceeds from the sale of equipment inventory to a third party during the first three months of 2019 and drilling costs paid during the first three months of 2020.  Cash flow used in financing activities during the first three months of 2020 was $(8,000) compared to $(12,000) used in financing activities during the first three months of 2019.

Through May 2021, the Company believes its revenues as well as cash on hand will be sufficient to fund operating costs and general and administrative expenses and to remain in compliance with its bank covenants.  If revenues and cash on hand are not sufficient to fund these expenses or if the Company needs additional funds for capital spending, the Company may be able to borrow funds against the credit facility depending on the borrowing base and credit limit.  Because of the drop in oil prices during the first and second quarters of 2020 and resulting projected negative EBITDA, borrowing from the Company’s credit facility would result in non-compliance with current covenants, and would require a waiver on the EBITDA related covenants, or a change in the covenants, until such time as prices improve.  In addition, if required, the Company could also issue additional shares of stock and/or sell assets as needed to further fund operations

Effective January 1, 2019, the Company adopted ASU 2016-02 Leases (Topic 842).

Commencing in the quarter ended March 31, 2015 and continuing into the quarter ended June 30, 2018, the Company implemented cost reduction measures including compensation reductions for each employee as well as members of the Board of Directors.  These compensation reductions were to remain in place until such time, if any, that the market price of crude oil, calculated as a thirty-day trailing average of WTI postings as published by the U.S. Energy Information Administration meets or exceeds $70 per barrel.  In May 2018, oil prices as so calculated exceeded $70 and compensation reverted to the levels in place before the reductions became effective. At such time, if any, that the market price of crude oil, calculated as a thirty-day trailing average of WTI postings as published by the U.S. Energy Information Administration meets or exceeds $85 per barrel, all previous reductions made will be reimbursed, a portion which may be paid in stock, to each employee and members of the Board of Directors if is still employed by the Company or still a member of the Board of Directors.  For the period January 1, 2015 through March 31, 2020, the reductions were approximately $373,000.  Of the $373,000, approximately $45,000 would be paid in the Company’s common stock.  The $45,000 value represents approximately 100,000 common shares valued at $0.45 per share which represents the closing price on March 31, 2020.  The Company has not accrued any liabilities associated with these compensation reductions.

The Company is not a party to any pending material legal proceeding.   To the knowledge of management, no federal, state, or local governmental agency is presently contemplating any proceeding against the Company which would have a result materially adverse to the Company.  To the knowledge of management, no director, executive officer or affiliate of the Company or owner of record or beneficial owner of more than 5% of the Company’s common stock is a party adverse to the Company or has a material interest adverse to the Company in any proceeding.

The Company’s Borrowing Base under its Credit Facility may be reduced by the lender.

The borrowing base under the Company’s revolving credit facility will be determined from time to time by the lender, consistent with its customary natural gas and crude oil lending practices. Reductions in estimates of the Company’s natural gas and crude oil reserves could result in a reduction in the Company’s borrowing base, which would reduce the amount of financial resources available under the Company’s revolving credit facility to meet its capital requirements. Such a reduction could be the result of lower commodity prices or production, inability to drill or unfavorable drilling results, changes in natural gas and crude oil reserve engineering, the lender’s inability to agree to an adequate borrowing base or adverse changes in the lenders’ practices regarding estimation of reserves.  If cash flow from operations or the Company’s borrowing base decreases for any reason, the Company’s ability to undertake exploration and development activities could be adversely affected.  As a result, the Company’s ability to replace naturally declining production may be limited. In addition, if the borrowing base is reduced, the Company may be required to pay down its borrowings under the revolving credit facility so that outstanding borrowings do not exceed the reduced borrowing base. This requirement could further reduce the cash available to the Company for capital spending and, if the Company did not have sufficient capital to reduce its borrowing level, could cause the Company to default under its revolving credit facility.  Because of the drop in oil prices during the first and second quarters of 2020 and resulting projected negative EBITDA, borrowing from the Company’s credit facility would result in non-compliance with current covenants, and would require a waiver on the EBITDA related covenants, or a change in the covenants, until such time as prices improve.

The Company's major market risk exposure is in the pricing applicable to its oil production.  Realized pricing is primarily driven by the prevailing worldwide price for crude oil.  Historically, prices received for oil and gas production have been volatile and unpredictable and price volatility is expected to continue.  The average monthly Kansas oil prices received during the first three months of 2020 ranged from a low of $27.31 per barrel to a high of $53.04 per barrel.  The Company anticipates a continued reduction in average oil prices during the second quarter of 2020.

As of March 31, 2020 and December 31, 2019, the Company had no open positions related to derivative agreements relating to commodities.

At March 31, 2020, the Company had balances on financing leases outstanding of approximately $82,000, and no balance owed on its credit facility with Prosperity Bank.  As of March 31, 2020, the interest rate on the credit facility was variable at a rate equal to prime plus 0.50% per annum.  The Company’s credit facility interest rate at March 31, 2020 was 3.75%.  The Company’s financing leases of $82,000 have fixed interest rates ranging from 5.0% to 6.5%.

The annual impact on interest expense and the Company’s cash flows of a 10% increase in the interest rate on the credit facility would be approximately zero assuming borrowed amounts under the credit facility remained at the same amount owed as of March 31, 2020.  The Company did not have any open derivative contracts relating to interest rates at March 31, 2020 or December 31, 2019.

Certain statements in this report, including statements of the future plans, objectives, and expected performance of the Company, are forward-looking statements that are dependent upon certain events, risks and uncertainties that may be outside the Company’s control, and which could cause actual results to differ materially from those anticipated. Some of these include, but are not limited to, the market prices of oil and gas, economic and competitive conditions, inflation rates, legislative and regulatory changes, financial market conditions, political and economic uncertainties of foreign governments, future business decisions, and other uncertainties, all of which are difficult to predict.

There are numerous uncertainties inherent in projecting future rates of production and the timing of development expenditures. The total amount or timing of actual future production may vary significantly from estimates. The drilling of exploratory wells can involve significant risks, including those related to timing, success rates and cost overruns. Lease and rig availability, complex geology and other factors can also affect these risks.  Additionally, fluctuations in oil and gas prices, or a prolonged period of low prices, may substantially adversely affect the Company's financial position, results of operations, and cash flows.

The Company’s Chief Executive Officer and Chief Financial Officer has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer has concluded that the Company’s disclosure controls and procedures, as of the end of the period covered by this Report, were adequate and effective to provide reasonable assurance that information required to be disclosed by the Company in 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. The effectiveness of a system of disclosure controls and procedures is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of internal controls, and fraud. Due to such inherent limitations, there can be no assurance that any system of disclosure controls and procedures will be successful in preventing all errors or fraud, or in making all material information known in a timely manner to the appropriate levels of management.

During the three months ended March 31, 2020, there have been no changes to the Company’s system of internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s system of controls over financial reporting.  As part of a continuing effort to improve the Company’s business processes, management is evaluating its internal controls and may update certain controls to accommodate any modifications to its business processes or accounting procedures.

None.

Refer to Item 1A Risk Factors in the Company’s Report on Form 10-K for the year ended December 31, 2019 filed on March 30, 2020 which is incorporated by this reference.

None.

None.

Not Applicable

None.

The following exhibits are filed with this report:

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