UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| þ | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended September 30, 2009
| o | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 0-7914
BASIC EARTH SCIENCE SYSTEMS, INC.
633 Seventeenth St, Suite 1645
Denver, Colorado 80202-3625
Telephone (303) 296-3076
| Incorporated in Delaware | IRS ID# 84-0592823 |
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company þ
Check whether the issuer is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ
Shares of common stock outstanding on November 16, 2009: 17,113,630
BASIC EARTH SCIENCE SYSTEMS, INC.
FORM 10-Q
INDEX
| PART I. FINANCIAL INFORMATION | Page | |
| Item 1. | 4 | |
| September 30, 2009 (Unaudited) and March 31, 2009 | 4 | |
| Three and Six Months Ended September 30, 2009 and 2008 (Unaudited) | 6 | |
| Six Months Ended September 30, 2009 and 2008 (Unaudited) | 7 | |
| September 30, 2009 (Unaudited) | 8 | |
| Item 2. | 13 | |
| Item 3. | 17 | |
| Item 4T. | 17 | |
| PART II. OTHER INFORMATION | ||
| Item 1. | 18 | |
| Item 1A. | 18 | |
| Item 2. | 18 | |
| Item 3. | 18 | |
| Item 4. | 18 | |
| Item 5. | 18 | |
| Item 6. | 19 | |
| 20 |
FORWARD-LOOKING STATEMENTS
This Current Report on Form 10-Q, including information incorporated herein by reference, contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The use of any statements containing the words "anticipate," "intend," "believe," "estimate," "project," "expect," "plan," "should" or similar expressions are intended to identify such statements. Forward-looking statements relate to, among other things:
• our future financial position, including anticipated liquidity;
• amounts and nature of future capital expenditures;
• acquisitions and other business opportunities;
• operating costs and other expenses;
• wells expected to be drilled;
• asset retirement obligations; and
• estimates of proved oil and natural gas reserves, deferred tax liabilities, and depletion rates.
Factors that could cause actual results to differ materially from our expectations include, among others, such things as:
• oil and natural gas prices;
• our ability to replace oil and natural gas reserves;
• loss of senior management or technical personnel;
• inaccuracy in reserve estimates and expected production rates;
• exploitation, development and exploration results;
• the actual costs related to asset retirement obligations, and whether or not those retirements actually occur in the future;
• a lack of available capital and financing;
• the potential unavailability of drilling rigs and other field equipment and services;
• the existence of unanticipated liabilities or problems relating to acquired properties;
• general economic, market or business conditions;
• factors affecting the nature and timing of our capital expenditures, including the availability of service contractors and equipment,
• permitting issues, workovers, and weather;
• the impact and costs related to compliance with or changes in laws or regulations governing our oil and natural gas operations;
• environmental liabilities;
• acquisitions and other business opportunities (or the lack thereof) that may be presented to and pursued by us;
• competition for available properties and the effect of such competition on the price of those properties;
• risk factors discussed in this report; and
• other factors, many of which are beyond our control.
Although we believe that the expectations reflected in such forward-looking statements are reasonable, those expectations may prove to be incorrect. Disclosure of important factors that could cause actual results to differ materially from our expectations, or cautionary statements, are included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2009, under the heading "Risk Factors", and elsewhere in this report, including, without limitation, in conjunction with the forward-looking statements. All forward-looking statements speak only as of the date made. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements. Except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated or unanticipated events or circumstances.
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Basic Earth Science Systems, Inc.
Consolidated Balance Sheets
Page 1 of 2
| September 30, | March 31, | |||||||
| 2009 | 2009 | |||||||
| (Unaudited) | ||||||||
| Assets | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 5,307,000 | $ | 4,088,000 | ||||
| Accounts receivable: | ||||||||
| Oil and gas sales | 1,192,000 | 1,611,000 | ||||||
| Joint interest and other receivables, net of $71,000 and $71,000 in allowance, respectively | 274,000 | 230,000 | ||||||
| Other current assets | 390,000 | 508,000 | ||||||
| Total current assets | 7,163,000 | 6,437,000 | ||||||
| Oil and gas property, full cost method: | ||||||||
| Proved property | 32,909,000 | 32,187,000 | ||||||
| Unproved property | 796,000 | 1,077,000 | ||||||
| Accumulated depletion and impairment | (22,953,000 | ) | (22,397,000 | ) | ||||
| Net oil and gas property | 10,752,000 | 10,867,000 | ||||||
| Support equipment and other non-current assets, net of $355,000 and $337,000 in accumulated depreciation, respectively | 461,000 | 458,000 | ||||||
| Total non-current assets | 11,213,000 | 11,325,000 | ||||||
| Total assets | $ | 18,376,000 | $ | 17,762,000 | ||||
See accompanying notes to unaudited consolidated financial statements.
Basic Earth Science Systems, Inc.
Consolidated Balance Sheets
Page 2 of 2
| September 30, | March 31, | |||||||
| 2009 | 2009 | |||||||
| (Unaudited) | ||||||||
| Liabilities and Shareholders' Equity | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 352,000 | $ | 64,000 | ||||
| Accrued liabilities | 1,226,000 | 1,328,000 | ||||||
| Total current liabilities | 1,578,000 | 1,392,000 | ||||||
| Long-term liabilities: | ||||||||
| Deferred tax liability | 2,269,000 | 2,242,000 | ||||||
| Asset retirement obligation | 1,519,000 | 1,558,000 | ||||||
| Total long-term liabilities | 3,788,000 | 3,800,000 | ||||||
| Total liabilities | 5,366,000 | 5,192,000 | ||||||
| Shareholders’ Equity: | ||||||||
| Preferred stock, $.001 par value, 3,000,000 authorized, and none issued or outstanding | — | — | ||||||
| Common stock, $.001 par value, 32,000,000 shares authorized, and 17,703,000 and 17,506,000 shares issued and outstanding respectively | 18,000 | 18,000 | ||||||
| Additional paid-in capital | 22,910,000 | 22,825,000 | ||||||
| Treasury stock (590,000 and 380,000 shares respectively); at cost | (208,000 | ) | (43,000 | ) | ||||
| Accumulated deficit | (9,710,000 | ) | (10,230,000 | ) | ||||
| Total shareholders’ equity | 13,010,000 | 12,570,000 | ||||||
| Total liabilities and shareholders’ equity | $ | 18,376,000 | $ | 17,762,000 | ||||
See accompanying notes to unaudited consolidated financial statements.
Basic Earth Science Systems, Inc.
Consolidated Statements of Operations
(Unaudited)
| Six Months Ended | Three Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
| Revenues: | ||||||||||||||||
| Oil and gas sales | $ | 3,470,000 | $ | 6,009,000 | $ | 2,010,000 | $ | 2,697,000 | ||||||||
| Well service and water disposal revenue | 27,000 | 45,000 | 11,000 | 38,000 | ||||||||||||
| Total revenues | 3,497,000 | 6,054,000 | 2,021,000 | 2,735,000 | ||||||||||||
| Expenses: | ||||||||||||||||
| Oil and gas production | 1,020,000 | 1,129,000 | 552,000 | 563,000 | ||||||||||||
| Production tax | 385,000 | 498,000 | 265,000 | 216,000 | ||||||||||||
| Well servicing expenses | 26,000 | 53,000 | 11,000 | 44,000 | ||||||||||||
| Depreciation and depletion | 574,000 | 418,000 | 336,000 | 197,000 | ||||||||||||
| Accretion of asset retirement obligation | 83,000 | 36,000 | 41,000 | 23,000 | ||||||||||||
| Asset retirement expense | 4,000 | 129,000 | ― | 175,000 | ||||||||||||
| General and administrative | 827,000 | 558,000 | 492,000 | 255,000 | ||||||||||||
| Total expenses | 2,919,000 | 2,821,000 | 1,697,000 | 1,473,000 | ||||||||||||
| Income from operations | 578,000 | 3,233,000 | 324,000 | 1,262,000 | ||||||||||||
| Other Income (Expense): | ||||||||||||||||
| Interest and other income | 50,000 | 42,000 | 50,000 | 34,000 | ||||||||||||
| Interest and other expenses | (19,000 | ) | (16,000 | ) | (4,000 | ) | (13,000 | ) | ||||||||
| Total other income | 31,000 | 26,000 | 46,000 | 21,000 | ||||||||||||
| Income before income taxes | 609,000 | 3,259,000 | 370,000 | 1,283,000 | ||||||||||||
| Current income tax expense | 61,000 | 368,000 | 119,000 | 187,000 | ||||||||||||
| Provision for deferred income taxes | 28,000 | 565,000 | (20,000 | ) | 150,000 | |||||||||||
| Total income tax expense | 89,000 | 933,000 | 99,000 | 337,000 | ||||||||||||
| Net income | $ | 520,000 | $ | 2,326,000 | $ | 271,000 | $ | 946,000 | ||||||||
| Per share amounts: | ||||||||||||||||
| Basic | $ | 0.03 | $ | 0.13 | $ | 0.02 | $ | 0.05 | ||||||||
| Diluted | $ | 0.03 | $ | 0.13 | $ | 0.02 | $ | 0.05 | ||||||||
| Weighted average common shares outstanding: | ||||||||||||||||
| Basic | 17,069,682 | 17,116,020 | 17,114,293 | 17,116,020 | ||||||||||||
| Diluted | 17,069,682 | 17,139,192 | 17,114,293 | 17,139,037 | ||||||||||||
See accompanying notes to unaudited consolidated financial statements.
Basic Earth Science Systems, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
| Six Months Ended | ||||||||
| September 30, | ||||||||
| 2009 | 2008 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income | $ | 520,000 | $ | 2,326,000 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Depreciation and depletion | 574,000 | 418,000 | ||||||
| Deferred tax liability | 27,000 | 565,000 | ||||||
| Accretion of asset retirement obligation | 83,000 | 36,000 | ||||||
| Share based compensation | 36,000 | 24,000 | ||||||
| Change in: | ||||||||
| Accounts receivable, net | 375,000 | (965,000) | ||||||
| Other assets | 118,000 | (13,000) | ||||||
| Accounts payable and accrued liabilities | 142,000 | 460,000 | ||||||
| Net cash provided by operating activities | 1,875,000 | 2,851,000 | ||||||
| Cash flows used in investing activities: | ||||||||
| Oil and gas property | (482,000) | (2,668,000) | ||||||
| Support equipment | (9,000) | ― | ||||||
| Net cash used in investing activities | (491,000) | (2,668,000) | ||||||
| Cash flows used in financing activities: | ||||||||
| Purchase of treasury shares | (165,000) | ― | ||||||
| Net cash used in financing activities | (165,000) | ― | ||||||
| Cash and cash equivalents: | ||||||||
| Increase in cash and cash equivalents | 1,219,000 | 183,000 | ||||||
| Balance, beginning of year | 4,088,000 | 5,571,000 | ||||||
| Balance, end of period | $ | 5,307,000 | $ | 5,754,000 | ||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid for interest | $ | 13,000 | $ | 5,000 | ||||
| Cash paid for income tax | $ | 14,000 | $ | 205,000 | ||||
| Non-cash: | ||||||||
| Decrease in oil and gas property due to asset retirement obligation | $ | 31,000 | $ | 32,000 | ||||
| Decrease in accrued liabilities of vested shares | $ | 48,000 | $ | — | ||||
| Additions to oil and gas also included in accrued liabilities | $ | 79,000 | $ | 642,000 | ||||
See accompanying notes to unaudited consolidated financial statements.
Basic Earth Science Systems, Inc.
Notes to Unaudited Consolidated Financial Statements
September 30, 2009
1. Presentation of Consolidated Financial Statements
The accompanying interim financial statements of Basic Earth Science Systems, Inc. (sometimes referred to as “the Company” “we” “our” or “us”) are unaudited. However, in the opinion of management, the interim data includes any applicable adjustments necessary for a fair presentation of the results for the interim period.
At the directive of the Securities and Exchange Commission to use “plain English” in public filings, the Company will use such terms as “we”, “our” and “us” in place of Basic Earth Science Systems, Inc. or “the Company.” When such terms are used in this manner throughout this document they are in reference only to the corporation, Basic Earth Science Systems, Inc. and its subsidiaries, and are not used in reference to the board of directors, corporate officers, management, or any individual employee or group of employees.
The financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. We believe the disclosures made are adequate to make the information not misleading and suggest that these financial statements be read in conjunction with the financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended March 31, 2009 and Quarterly Report on Form 10-Q for the quarter ended June 30, 2009.
We have evaluated events subsequent to September 30, 2009 through November 12, 2009, the filing date of this report, and determined that there were no subsequent events to recognize or disclose in these consolidated financial statements which would either impact the results reflected in this report or the Company’s results going forward.
Organization and Nature of Operations. Basic Earth Science Systems, Inc. was originally organized in July 1969 and had its first public offering in 1980. We are principally engaged in the acquisition, exploitation, development, operation and production of crude oil and natural gas. Our primary areas of operation are the Williston basin in North Dakota and Montana, south Texas and the Denver-Julesburg basin in Colorado.
Principles of Consolidation. The consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
2. Summary of Significant Accounting Policies and Recent Accounting Pronouncements
Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the actual amounts of assets and liabilities at the date of the financial statements and the actual amounts of revenues and expenses during the reporting period. We base these estimates on assumptions that we understand are reasonable under the circumstances. The estimated results that are produced by this effort will differ under different assumptions or conditions. We understand that these estimates are necessary and that actual results could vary significantly from the estimated amounts for the current and future periods. There are many factors, including global events, which may influence the production, processing, marketing, and valuation of crude oil and natural gas. A reduction in the valuation of oil and gas properties resulting from declining prices or production could adversely impact depletion rates and ceiling test limitations. We understand the following accounting policies and estimates are necessary in the preparation of our consolidated financial statements: the carrying value of our oil and gas property, the accounting for oil and gas reserves, the estimate of our asset retirement obligations, the estimate of our income tax assets and liabilities and estimates of accrued quantities and prices in our oil and gas receivable.
Oil and Gas Reserves. Oil and gas reserves represent theoretical, estimated quantities of crude oil and natural gas which geological and engineering data estimate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. There are numerous uncertainties inherent in estimating oil and gas reserves and their values, including many factors beyond our control. Accordingly, reserve estimates are different from the future quantities of oil and gas that are ultimately recovered and the corresponding lifting costs associated with the recovery of these reserves. At March 31, 2009, ninety-eight percent of our reported oil and gas reserves are based on estimates prepared by Ryder Scott Company, L.P, a nationally recognized, independent petroleum engineering firm. The remaining two percent of our oil and gas reserves were prepared by our technical in-house staff.
Each quarter, we update reserve estimates by substituting the prices we would have received at quarter-end for the year-end prices that were used by our independent petroleum engineers. In conducting this “re-pricing” no changes are made to the decline rates, tax rates or lifting costs used by our independent petroleum engineers. The determinations of depletion expense, as well as the results of ceiling tests and corresponding write-downs, if any, are highly dependent on these reserve and quarterly “re-pricing” estimates.
Oil and Gas Sales. We derive revenue primarily from the sale of produced natural gas and crude oil. We report revenue on a gross basis for the amounts received before taking into account production taxes and transportation costs, which are reported as separate expenses. Revenue is recorded using the sales method, which occurs in the month production is delivered to the purchaser, at which time title changes hands. Payment is generally received between 30 and 90 days after the date of production. We make estimates of the amount of production delivered to purchasers and the prices we will receive. We use our knowledge of our properties, their historical performance, NYMEX and local spot market prices, and other factors as the basis for these estimates. Variances between estimates and the actual amounts received are recorded when payment is received, or when better information is available.
Oil and Gas Property. We follow the full cost method of accounting for our oil and gas property. Accordingly, all costs associated with the acquisition, exploration and development of oil and gas properties are capitalized. These capitalized costs are subject to a ceiling test that limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved oil and gas reserves using current prices and costs discounted at 10 percent plus the lower of cost or fair value of unproved properties less any associated tax effects. If the full cost pool of capitalized oil and gas property costs exceeds the ceiling, we will record a ceiling test write-down to the extent of such excess. This write-down is a non-cash charge to earnings. If required, it reduces earnings and impacts shareholders’ equity in the period of occurrence. The write-down may not be reversed in future periods, even though higher oil and gas prices in the future may subsequently and significantly increase reserve estimates in future periods. As of September 30, 2009, our capitalized costs did not exceed the ceiling test limit.
Cash and Cash Equivalents. For purposes of the Consolidated Balance Sheets and Statements of Cash Flows, we consider all highly liquid investments with a maturity of ninety days or less when purchased to be cash equivalents. The carrying amount of cash equivalents approximates fair value because of the short-term maturity of those instruments. During the period and at the balance sheet date, balances of cash and cash equivalents exceeded the federally insured limit.
Support Equipment and Other. Support equipment (including such items as vehicles, office furniture and equipment and well servicing equipment) is stated at cost. Depreciation of support equipment and other property is computed using the straight-line method over periods ranging from five to seven years.
Long-Term Assets. We regularly evaluate all long-lived assets for possible impairment. Assets are reported at the lower of cost or their estimated recoverable amounts. During 2009 and 2008, there was no impairment recorded for long-lived assets.
Fair Value Measurements. Effective April 1, 2009, we adopted the provisions for nonfinancial assets and liabilities that are not required to be measured at fair value on a recurring basis, which include, among others, those nonfinancial long-lived assets measured at fair value for impairment assessment and asset retirement obligations initially measured at fair value. Fair value used in the initial recognition of asset retirement obligations is determined based on the present value of expected future dismantlement costs incorporating our estimate of inputs used by industry participants when valuing similar liabilities. Accordingly, the fair value is based on unobservable pricing inputs and therefore, is considered a level 3 value input in the fair value hierarchy.
Asset Retirement Obligations. We have obligations related to the plugging and abandonment of our oil and gas wells. We estimate the future cost of these obligations, discount this cost to its present value, and record a corresponding asset and liability in our Consolidated Balance Sheets. The values ultimately derived are based on numerous and significant estimates, including the ultimate expected cost of the obligation, the expected future date of the required cash expenditures, and inflation rates. The nature of these estimates requires us to make judgments based on historical experience and future expectations related to timing. We review the estimate of our future asset retirement obligations quarterly. These quarterly reviews may require revisions to these estimates based on such things as changes to cost estimates or the timing of future cash outlays. Any such changes that result in upward or downward revisions in the estimated obligation will result in an adjustment to the related capitalized asset and corresponding liability on a prospective basis.
We recognize two components on our consolidated statement of operations; accretion of asset retirement obligations and asset retirement expense. Accretion of asset retirement obligation reflects the periodic accretion of the present value of future plugging and abandonment costs. Asset retirement expense reflects the actual current period gains and losses on plugging and abandonment costs relative to previously estimated future costs. We have closed gains and losses on asset retirements to the consolidated statement of operations as a component of asset retirement expense.
The information below reconciles the value of the asset retirement obligation for the period presented. This includes a short term obligation of $124,000, which is carried within the accrued liabilities line item of the balance sheet.
| Six Months Ended | ||||
| September 30, | ||||
| 2009 | ||||
| Balance beginning of period | $ | 1,698,000 | ||
| Liabilities incurred | 16,000 | |||
| Liabilities settled | (107,000 | ) | ||
| Revisions to estimates | (47,000 | ) | ||
| Accretion expense | 83,000 | |||
| Balance end of period | $ | 1,643,000 | ||
Commitments. We currently office in a 4,000 square foot office space located in downtown Denver, Colorado, and are committed to a total of $281,000 for the five-year lease term ending April 1, 2013. We have no off balance sheet transactions or arrangements.
Income Taxes. We account for income taxes with deferred tax liabilities and assets which are determined based on the temporary differences between the financial statements and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse.
Projections of future income taxes and their timing require significant estimates with respect to future operating results. Accordingly, the net deferred tax liability is continually re-evaluated and numerous estimates are revised over time. As such, the net deferred tax liability may change significantly as more information and data is gathered with respect to such events as changes in commodity prices, their effect on the estimate of oil and gas reserves, and the depletion of these long-lived reserves.
We are subject to U.S. federal income tax and income tax from multiple state jurisdictions. The tax years remaining subject to examination by tax authorities are fiscal years 2006 through 2008. We recognize interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2009, we made no provisions for interest or penalties related to uncertain tax positions.
Earnings Per Share. Our earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net income by the diluted weighted average number of common shares. The diluted weighted average number of common shares is computed using the treasury stock method for common stock that may be issued for outstanding stock options. As of the balance sheet date, no dilutive securities were outstanding.
Reclassifications. Certain prior year amounts were reclassified to conform to current year presentation. Such reclassifications had no effect on net income.
Recent Accounting Pronouncements
In June 2009, The Financial Accounting Standards Board (FASB) issued Accounting Standards Codification, “Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (Codification) which will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this Statement, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of the Codification will not have a material impact on our consolidated financial statements or results of operations.
In June 2009, the FASB issued guidance related to subsequent events which incorporates the guidance contained in the auditing standards literature into authoritative accounting literature. It also requires entities to disclose the date through which they have evaluated subsequent events and whether the date corresponds with the release of their financial statements. The new guidance is effective for all interim and annual periods ending after June 15, 2009. The Company adopted the guidance upon its issuance and it had no material impact on our consolidated financial statements.
On April 29, 2009, the FASB issued guidance related to financial Instruments, which requires publicly-traded companies to provide disclosures on the fair value of financial instruments in interim financial statements, and is effective for interim periods ending after June 15, 2009. We have adopted these new provisions, which did not have a material impact on the Company’s consolidated financial statements or results of operations.
On April 1, 2009, the FASB issued guidance related to business Combinations, which addresses application issues associated with initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination, including the treatment of contingent consideration, acquisition costs, research and development assets and restructuring costs. In addition, changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period will impact income taxes. The new guidance is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We will apply the new provisions to future acquisitions.
In December 2008, the SEC announced final approval of new requirements for reporting oil and gas reserves. Among the changes to the disclosure requirements is a broader definition of reserves, which allows reporting of probable and possible reserves, in addition to consideration of new technologies and non-traditional resources. In addition, oil and gas reserves will be reported using an average price based on the prior 12-month period, rather than year-end prices, and allow companies to disclose their probable and possible reserves to investors. The new rules are expected to be effective for years ending on or after December 31, 2009. The Company is in the process of evaluating the effect of these new requirements, and has not yet determined the impact that it will have on its financial statements upon full adoption on March 31, 2010.
In September 2006, the FASB issued guidance related to fair value measurements and disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. The new guidance is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB proposed a one year deferral of the implementation for non-financial assets and liabilities that are recognized or disclosed at fair value on a nonrecurring basis (less frequent than annually). On April 1, 2008, we adopted the new guidance with the one-year deferral for non-financial assets and liabilities. The adoption of the new guidance did not have a material impact on our financial position, results of operations, or cash flows. Beginning April 1, 2009, we have adopted the provisions for non-financial assets and non-financial liabilities that are not required or permitted to be measured at fair value on a recurring basis. The adoption did not have a material impact on our financial statements.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
As a crude oil and natural gas producer, our revenue, cash flow from operations, other income and profitability, reserve values, access to capital and future rate of growth are substantially dependent upon the prevailing prices of crude oil and natural gas. Declines in commodity prices will materially and adversely affect our financial condition, liquidity, ability to obtain financing and operating results. Lower commodity prices may reduce the amount of crude oil and natural gas that we can produce economically. Prevailing prices for such commodities are subject to wide fluctuation in response to relatively minor changes in supply and demand and a variety of additional factors beyond our control, such as global, political and economic conditions. Historically, prices received for crude oil and natural gas production have been volatile and unpredictable, and such volatility is expected to continue. Most of our production is sold at market prices. Generally, if the commodity indexes fall, the price that we receive for our production will also decline. Therefore, the amount of revenue that we realize is to a large extent determined by factors beyond our control.
Liquidity and Capital Resources
Liquidity Outlook. Our primary source of funding is the net cash flow from the sale of our oil and gas production. The profitability and cash flow generated by our operations in any particular accounting period will be directly related to: (a) the volume of oil and gas produced and sold, (b) the average realized prices for oil and gas sold, and (c) lifting costs. Assuming that oil prices do not decline from current levels, we believe the cash generated from operations, along with existing cash balances, will enable us to meet our existing and normal recurring obligations during the next fiscal year and beyond.
Working Capital. At September 30, 2009, we had a working capital surplus of $5,585,000 (a current ratio of 4.53:1) compared to a working capital surplus at March 31, 2009 of $5,045,000 (a current ratio of 4.62:1). The decrease in current ratio is largely a result of the timing between payments made for payables, and cash received for revenue.
Cash Flow. Net cash provided by operating activities decreased 34.2% from $2,851,000 in the six months ended September 30, 2008 (“2008”) to $1,875,000 in the six months ended September 30, 2009 (“2009”) primarily due to decreased oil and gas commodity prices.
Net cash used in investing activities decreased 81.6% from $2,668,000 during 2008 to $491,000 in the six months ended September 30, 2009. The difference relates primarily to significantly more expenditures made during the prior year on the DJ Basin wells in Colorado.
Net cash used in financing activities was $165,000 at September 30, 2009 as compared to no cash used for financing activities at September 30, 2008 since the Company did not adopt its stock buyback program until October 2008.
Credit Line. Our current banking relationship, established in March 2002, is with American National Bank (“the Bank”), located in Denver, Colorado. Subject to evaluation every six months, the line of credit amount was set at $20,000,000 with a concurrent borrowing base of $4,000,000. Effective December 31, 2008 the loan agreement was amended to extend the maturity date of the credit agreement to December 31, 2010. We renewed the line with an interest rate of prime plus 0.25% or 6.5% whichever is higher. During the year ended March 31, 2009 and for the six months ending September 30, 2009, we did not utilize our credit facility. The loan contains several covenant restrictions. At September 30, 2009, we were in compliance with all covenants. This line may be used for purposes of borrowing funds to reduce payables, finance re-completion or drilling efforts, fund property acquisitions, or pursue other opportunities that might arise.
Capital Expenditures
The amounts presented herein are presented on an accrual basis, and as such may not be consistent with the amounts presented on the consolidated statement of cash flows under investing activities for expenditures on oil and gas property in that the amounts contained therein are presented on a cash basis.
During the quarter ended September 30, 2009, we spent approximately $95,000 on various projects. This compares to $575,000 for the quarter ended September 30, 2008. The decrease in capital expenditures is primarily attributable to the timing of expenditures incurred. During the quarter ended September 30, 2009, 85% of capital expenditures were dedicated to leasing and completions. We spent approximately 71% of our capital expenditures amount on leasing acreage for the Banks prospect, 6% on recompletion of the Guenther 1-8 in Sheridan County, Montana, and 8% on completion efforts of the Lassen 41-26H in McKenzie County, North Dakota. These projects were funded with internally generated cash flow from operations.
At present cash levels, and with the extension of our available borrowing capacity, we expect to have sufficient funds available for our share of any additional acreage, seismic and/or drilling cost requirements that might arise from these opportunities. We may alter or vary all or part of any planned capital expenditures for reasons including but not limited to; changes in circumstances, unforeseen opportunities, inability to negotiate favorable acquisition, farmout or joint venture terms, lack of cash flow, and lack of additional funding.
We currently have no capital expenditure commitments. We are continually evaluating other drilling and acquisition opportunities for possible participation. Typically, at any one time, several opportunities are in various stages of due diligence. Our policy is to not disclose the specifics of a project or prospect, nor to speculate on such ventures, until such time as those various opportunities are finalized and undertaken. We caution that the absence of news and/or press releases should not be interpreted as a lack of development or activity.
Divestitures/Abandonments
During the quarter ended September 30, 2009 we commenced the plugging of one well.
Results of Operations
Overview. Net income for the three and six months ended September 30, 2009 was $271,000 and $520,000 compared to net income of $946,000 and $2,326,000, for the three and six months ended September 30, 2008. The following table shows selected financial information for the three and six months ended September 30 in the current and prior year. Certain prior year amounts may have been reclassified to conform to current year presentation.
14
Six Months Ended | Three Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
| Sales volume | ||||||||||||||||
| Oil (barrels) | 51,609 | 43,300 | 27,266 | 19,400 | ||||||||||||
| Gas (mcf) | 119,326 | 81,900 | 84,140 | 38,800 | ||||||||||||
| Revenue | ||||||||||||||||
| Oil | $ | 2,981,000 | $ | 5,106,000 | $ | 1,711,000 | $ | 2,234,000 | ||||||||
| Gas | 489,000 | 903,000 | 299,000 | 463,000 | ||||||||||||
Total revenue1 | 3,470,000 | 6,009,000 | 2,010,000 | 2,697,000 | ||||||||||||
Total production expense2 | 1,405,000 | 1,627,000 | 817,000 | 779,000 | ||||||||||||
| Gross profit | $ | 2,065,000 | $ | 4,382,000 | $ | 1,193,000 | $ | 1,918,000 | ||||||||
| Depletion expense | $ | 556,000 | $ | 400,000 | $ | 326,000 | $ | 179,000 | ||||||||
Average sales price3 | ||||||||||||||||
| Oil (per barrel) | $ | 57.76 | $ | 117.86 | $ | 62.75 | $ | 115.09 | ||||||||
| Gas (per mcf) | $ | 4.10 | $ | 10.98 | $ | 3.55 | $ | 11.98 | ||||||||
| Average per BOE | ||||||||||||||||
Production expense2,3,4 | $ | 19.65 | $ | 28.54 | $ | 19.79 | $ | 30.13 | ||||||||
Gross profit3,4 | $ | 28.88 | $ | 76.88 | $ | 28.89 | $ | 74.05 | ||||||||
Depletion expense3,4 | $ | 7.78 | $ | 7.33 | $ | 8.14 | $ | 7.61 | ||||||||
| 1 | Net of $11,000 and $27,000 in water service and disposal revenue, to total $2,021,000 and $3,497,000 in revenue for the three and six months ended September 30, 2009, compared to $38,000 and $45,000 to total $2,735,000 and $6,054,000 for the same period in 2008. | |
| 2 | Overall lifting cost (oil and gas production expenses and production taxes) | |
| 3 | Averages calculated based upon non-rounded figures | |
| 4 | Per equivalent barrel (6 Mcf of gas is equivalent to 1 barrel of oil) |
Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008
Revenues. Oil and gas sales revenue decreased $687,000 (25.5%) in 2009 from 2008 due to lower realized oil and gas prices. Oil sales revenue decreased $523,000 (23.4%), and gas sales revenue decreased $164,000 (35.4%) in 2009 from 2008.
Volumes and Prices. Oil sales volumes increased 40.5%, from 19,400 barrels in 2008 to 27,266 barrels in 2009 while there was a decrease of 45.5% in the average price per barrel from $115.09 in 2008 to $62.75 in 2009. Gas sales volume changed 116.9% from 38,800 thousand cubic feet (Mcf) in 2008 to 84,140 Mcf in 2009, while the average price per Mcf decreased 70.3%, from $11.98 in 2008 to $3.55 in 2009. The increase in gas sales volume, and to some extent the change in oil sales volume, is primarily due to the receipt of sales volume information related to the production from the Antenna Federal property in Weld County, Colorado which differed significantly from accruals for prior periods. The reported sales volumes, while mathematically accurate and in accordance with GAAP, are not representative of actual sales volume for this three month period and should not be used to discern or predict future production or sales volumes. Therefore, as a result of this adjustment, any metric whose denominator is related to sales volumes may be understated. On an equivalent barrel (BOE) basis, sales volume increased 59.4% from 25,900 BOE in 2008 to 41,290 BOE in 2009.
Expenses. Oil and gas production expense decreased $11,000 (2.0%) in 2009 over 2008, primarily due to workover expense decreasing $35,000 (44.9%) from $78,000 in 2008 to $43,000 in 2009 and routine lease operating expense increasing by $24,000 (4.9%) from $485,000 in 2008 to $509,000 in 2009. Routine lease operating expense per BOE decreased 34.2% from $18.73 in 2008 to $12.33 in 2009 due to the overall increase in BOE, while workover expense per BOE decreased 65.4% from $3.01 in 2008 to $1.04 in 2009 due to fewer workover operations in 2009.
Production taxes, which are generally a percentage of sales revenue, increased $49,000 (22.7%) in 2009 compared to 2008. Production taxes, as a percent of sales revenue increased from 7.9% in 2008 to 13.1% in 2009, which is due to the adjustment as mentioned above and the corresponding rate of production tax withheld on the Antenna Federal property in Weld County, Colorado. The overall lifting cost (oil and gas production expense and production taxes) per BOE decreased 34.2% from $30.08 in 2008 to $19.79 in 2009.
Depreciation, depletion and amortization expense increased $139,000 (70.6%) in 2009 compared to 2008 as a result of the change in gas volumes as mentioned above and a decrease in our reserve values due to the decline in oil and gas prices.
General and administrative expense increased $237,000 (92.9%) in 2009 over 2008. Approximately 75% of this increase is related to professional services (legal and consulting fees) while all other categories increased 10% or less. G&A expense per BOE increased 21.0% from $9.85 in 2008 to $11.92 in 2009. As a percent of total sales revenue, G&A expense increased from 9.3% in 2008 to 24.3% in 2009.
Income Tax Expense. For the three months ended September 30, 2009 we recorded an income tax expense of $99,000. This amount consists of a current period expense of $119,000 which was partially reduced by a deferred tax benefit of $20,000. Our effective income tax rate decreased from 26.28% for the three months ended September 30, 2008 to 16.27% for the three months ended 2009. Our effective income tax rate was lower for 2009 primarily due to an increase in estimated deductions for statutory depletion.
Six Months Ended September 30, 2009 Compared to Six Months Ended September 30, 2008
Revenues. Oil and gas sales revenue decreased $2,539,000 (42.3%) in 2009 from 2008 due to lower realized oil and gas prices. Oil sales revenue decreased $2,125,000 (41.6%), and gas sales revenue decreased $414,000 (45.8%) in 2009 from 2008.
Volumes and Prices. Oil sales volumes increased 19.2%, from 43,300 barrels in 2008 to 51,609 barrels in 2009 while there was a decrease of 51.0% in the average price per barrel from $117.86 in 2008 to $57.76 in 2009. Gas sales volume changed 45.7% from 81,900 thousand cubic feet (Mcf) in 2008 to 119,326 Mcf in 2009, while the average price per Mcf decreased 62.7%, from $10.98 in 2008 to $4.10 in 2009. The increase in gas sales volume, and to some extent the change in oil sales volume, is primarily due to the receipt of sales volume information related to the production from the Antenna Federal property in Weld County, Colorado which differed significantly from accruals for prior periods. The reported sales volumes while mathematically accurate and in accordance with GAAP, are not representative of actual sales volume for the period and should not be used to discern or predict future production or sales volumes. Therefore, as a result of this adjustment, any metric whose denominator is related to sales volumes may be understated. On an equivalent barrel (BOE) basis, sales volume increased 25.4% from 57,000 BOE in 2008 to 71,497 BOE in 2009.
Expenses. Oil and gas production expense decreased $109,000 (9.7%) in 2009 over 2008, primarily due to routine lease operating expense declining by $90,000 (9.6%) from $938,000 in 2008 to $848,000 in 2009. Workover expense, which is more volatile than routine lease operating expense, decreased $19,000 (9.9%) from $191,000 in 2008 to $172,000 in 2009. Routine lease operating expense per BOE decreased 27.9% from $16.46 in 2008 to $11.86 in 2009 while workover expense per BOE decreased 28.2% from $3.35 in 2008 to $2.41 in 2009.
Production taxes, which are generally a percentage of sales revenue, decreased $113,000 (22.7%) in 2009 compared to 2008 primarily due to the overall decline of oil prices. Production taxes, as a percent of sales revenue increased from 8.2% in 2008 to 11.0% in 2009, which is due to the adjustment as mentioned above and the corresponding rate of production tax withheld on the Antenna Federal property in Weld County, Colorado. The overall lifting cost (oil and gas production expense and production taxes) per BOE decreased 31.2% from $28.54 in 2008 to $19.65 in 2009.
Depreciation, depletion and amortization expense increased $156,000 (37.3%) in 2009 compared to 2008 as a result of the change in oil and gas volumes and a decrease in our reserve values due to the decline in oil and gas prices.
General and administrative expense increased $269,000 (48.2%) in 2009 over 2008. Approximately 68% of this increase is related to professional services (legal and consulting fees) while all other categories increased 15% or less. G&A expense per BOE increased 18.2% from $9.79 in 2008 to $11.57 in 2009. As a percent of total sales revenue, G&A expense increased from 9.2% in 2008 to 23.6% in 2009.
Income Tax Expense. For the six months ended September 30, 2009 we recorded an income tax expense of $89,000. This includes current period expense of $87,000 and a deferred tax expense of $2,000. Our effective income tax rate decreased from 28.67% for the six months ended September 30, 2008 to 14.63% for the six months ended 2009. Our effective income tax rate was lower for 2009 primarily due to an increase in estimated deductions for statutory depletion.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As a “smaller reporting company,” we are not required to provide this information.
The Company maintains a system of disclosure controls and procedures for the purpose of ensuring that information required to be disclosed in its SEC reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and the Principal Accounting Officer, as appropriate to allow timely decisions regarding required disclosures.
For the quarter ended September 30, 2009, we carried out an evaluation under the supervision and with the participation of the Company’s Chief Executive Officer and Principal Accounting Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, we determined that an amendment to our Annual Report on Form 10-K for the period ended March 31, 2009, was necessary and such amendment was filed on October 9, 2009. Except for the amendment to our Annual Report on Form 10-K that was filed, it was otherwise concluded that the Company’s disclosure controls and procedures are effective for the purposes discussed above.
There have been no changes in the Company’s internal control over financial reporting that occurred during the Company’s quarter ended September 30, 2009 that have materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
As a “smaller reporting company,” we are not required to provide this information.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Purchases of Equity Securities
The following table summarizes stock repurchase activity for the three months ended September 30, 2009:
| Total Number of Shares Purchased (1) | Average Price Paid Per Share | Number of Shares Purchased as Part of a Publicly Announced Plan (1) | Maximum Shares that May Yet be Purchased under the Plan (1) | |||||||||||||
| July 1, 2009 - July 31, 2009 | 1,000 | $ | 0.85 | 1,000 | 261,800 | |||||||||||
| Aug 1, 2009 - Aug 31, 2009 | — | $ | — | — | 261,800 | |||||||||||
| Sept 1, 2009 - Sept 30, 2009 | 2,000 | $ | 0.78 | 2,000 | 259,800 | |||||||||||
| Total | 3,000 | 3,000 | ||||||||||||||
| (1) | In October 22 2008, the Company’s Board of Directors authorized a stock buyback program for the Company to repurchase up to 500,000 shares of its common stock for a period of up to 18 months. The program does not require the Company to repurchase any specific number of shares, and the Company may terminate the repurchase program at any time. During the three months ended September 30, 2009, 3,000 shares were repurchased under the stock buyback program and 259,800 shares remain available for future repurchase. |
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
| Exhibit No. | Document | |
| Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Ray Singleton, Chief Executive Officer). | ||
| Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Joseph Young, Principal Accounting Officer). | ||
| Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Ray Singleton, Chief Executive Officer). | ||
| Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Joseph Young, Principal Accounting Officer). |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed by the following authorized persons on behalf of Basic.
BASIC EARTH SCIENCE SYSTEMS, INC. | ||
By: /s/ Ray Singleton | ||
| Ray Singleton | ||
| President and Chief Executive Officer | ||
By: /s/ Joseph Young | ||
| Joseph Young | ||
| Principal Accounting Officer | ||
| Date: November 16, 2009 |