Riley Exploration Permian, Inc.: Form 10-Q for the period ended Sep 30, 2015

Results of Operations and Financial Condition

During the first nine months of 2015, 130.2 MBbl gross of oil were sold from the Company’s properties. Of the 130.2 MBbl, 101.0 MBbl were net to the Company after required payments to all of the royalty interests and drilling program participants. The Company’s net sales from its properties during the first nine months of 2015 of 101.0 MBbl of oil compares to net sales of 114.9 MBbl of oil during the first nine months of 2014. The Company’s net oil revenue was $4.5 million during the first nine months of 2015 compared to $10.7 million during the first nine months of 2014. This decrease in net revenue was primarily due to a $4.9 million decrease related to a $48.25 per barrel decrease in the average oil price from $92.90 per barrel during the first nine months of 2014 to $44.65 per barrel during the first nine months of 2015, and $1.3 million decrease related to the 13.9 MBbl decrease in sales volumes. The 13.9 MBbl decrease was primarily due to decreased sales volumes from the Albers B, Hilgers B, Liebenau, McElhaney A, Veverka B, C, D, and Zerger leases, partially offset by sales volumes from the Howard A lease which began production in August 2014. MMC revenues during the first nine months of 2015 and 2014 were $413,000 and $393,000, respectively.

Comparison of the Quarters Ended September 30, 2015 and 2014

The Company reported a net loss of $(5.0 million) or $(0.08) per share of common stock during the third quarter of 2015 compared to net income of $425,000 or $0.01 per share of common stock during the third quarter of 2014. The $5.4 million decrease in net income was primarily due to a ceiling test impairment of $7.2 million recorded in the third quarter of 2015 as a result of the low oil prices experienced during 2015, a $2.2 million decrease in revenues, partially offset by a $335,000 decrease in production cost and taxes, a $110,000 decrease in general and administrative cost, a $112,000 decrease in DD&A, and a $3.5 million decrease in associated income tax expense.

The Company recognized $1.4 million in revenues during the third quarter of 2015 compared to $3.6 million during the third quarter of 2014. The revenue decrease from 2014 levels was primarily due to a $1.6 million decrease related to a $50.07 per barrel decrease in the average oil price from an average price of $90.31 per barrel during third quarter of 2014 compared to an average price of $40.24 per barrel during the third quarter of 2015, and a $648,000 decrease related to a 7.2 MBbl decrease in sales volumes, primarily from the Albers B, McElhaney A, and Veverka B and D, and Zerger leases, partially offset by sales from the Howard A lease which began production in August 2014. In addition, there was a $28,600 increase in methane facility revenues.

Production cost and taxes decreased $335,000 from $1.5 million during the third quarter of 2014 to $1.1 million during the third quarter of 2015. This decrease was primarily due to a $135,000 decrease in well repair costs related to costs incurred on various wells during the third quarter of 2014, an $82,000 decrease in Kansas property taxes, a $63,000 decrease in utility cost, partially offset by a $65,000 change in oil inventory.

General and administrative costs decreased $110,000 from $695,000 during the third quarter of 2014 to $585,000 during the third quarter of 2015. This decrease was primarily due to a $85,000 reduction in employee and director compensation cost related to temporary salary reductions during the third quarter of 2015 and bonus accruals during the third quarter of 2014, $59,000 related to personnel and office costs incurred during the third quarter of 2014 related to set up of the Denver office, partially offset by $64,000 increase in consulting costs incurred during the third quarter of 2015 related to the evaluation of potential transactions.

DD&A decreased $112,000 from $759,000 during the third quarter of 2014 to $647,000 during the third quarter of 2015. This decrease was primarily due to a $129,000 decrease related to a 7.2 MBbl decrease in oil sales volumes, and a $26,000 decrease in methane facility depreciation related to the impairment recorded in 2014, partially offset by a $49,000 related to an increase in the oil depletion rate.

Comparison of the Nine Months Ended September 30, 2015 and 2014

The Company reported a net loss of $(5.55 million) or $(0.09) per share of common stock during the first nine months of 2015 compared to net income of $1.2 million or $0.02 per share of common stock during the first nine months of 2014. The $6.8 million decrease in net income was primarily due to a ceiling test impairment of $7.2 million recorded in 2015 as a result of the low oil prices experienced during 2015, and a $6.15 million decrease in revenues, partially offset by a $1.55 million decrease in production cost and taxes, a $505,000 decrease in general and administrative cost, and a $4.4 million decrease in associated income tax expense.

The Company recognized $5.0 million in revenues during the first nine months of 2015 compared to $11.1 million during the first nine months of 2014. The revenue decrease from 2014 levels was primarily due to a $4.9 million decrease related to a $48.25 per barrel decrease in the average oil price from an average price of $92.90 per barrel during first nine months of 2014 compared to an average price of $44.65 per barrel during the first nine months of 2015, and a $1.3 million decrease related to the 13.9 MBbl decrease in sales volumes.

Production cost and taxes decreased $1.55 million from $4.77 million during the first nine months of 2014 to $3.22 million during the first nine months of 2015. This decrease was primarily due to a one-time $386,000 recorded in the first nine months of 2014 as a result of the IBLA affirmation of the civil penalty related to the 2012 Incident of Non-Compliance by the BSEE on one of Hoactzin’s Gulf of Mexico properties, a $579,000 decrease in well repair and workover costs primarily related to work performed on the Croffoot B #6 SWD and various other wells during the first nine months of 2014, a $258,000 decrease in Kansas property taxes primarily as a result of lower production and reserves as well as successful appeals, and a $114,000 decrease in methane facility costs primarily as a result of maintenance on the electric generator during the first nine months of 2014.

General and administrative costs decreased $505,000 from $2.1 million during the first nine months of 2014 to $1.6 million during the first nine months of 2015. This decrease was primarily related to a $181,000 reduction in employee and directors compensation cost related to temporary salary reductions during the first nine months of 2015 and bonus accruals recorded during the first nine months of 2014, and a $256,000 reduction due to personnel and office costs incurred during 2014 related to set up and staffing of the Denver office.

Liquidity and Capital Resources

At September 30, 2015, the Company had a revolving credit facility with Prosperity Bank. 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 $40 million or the Company’s borrowing base in effect from time to time. As of September 30, 2015, the Company’s borrowing base was $7.8 million, the interest rate of prime plus 0.50% per annum, and the maturity date was January 27, 2017. The Company’s interest rate at September 30, 2015 was 3.75%. The borrowing base is subject to an existing periodic redetermination provision in the credit facility. The credit facility is secured by substantially all of the Company’s producing and non-producing oil and gas properties and the Company’s Manufactured Methane facilities. The credit facility includes certain covenants with which the Company is required to comply. These covenants include leverage, interest coverage, and minimum liquidity ratios. The Company is in compliance with all of the credit facility covenants.

The total borrowing by the Company under the Prosperity Bank facility at September 30, 2015 and December 31, 2014 was approximately $1.0 million and $734,000, respectively. The next borrowing base redetermination is currently under review.

Although the Company has not been required as of the date of this Report to make any payment of principal on the credit facility, the Company can make no assurance that in view of the conditions in the national and world economies, including the realistic possibility of low commodity prices being received for the Company’s oil and gas production for extended periods, that Prosperity Bank may not in the future make a redetermination of the Company’s borrowing base to a point below the level of current borrowings. In such event, Prosperity Bank may require installment or other payments in such amount in order to reduce the principal of the Company’s outstanding borrowing to a level not in excess of the borrowing base as it may be redetermined. The Company can make no assurance that it can continue normal operations indefinitely or for any specific period of time in the event of extended periods of low commodity prices, or upon the occurrence of any significant downturn or losses in operations. In such event, the Company may be required to reduce costs of operations by various means, including not undertaking certain maintenance or reworking operations that may be necessary to keep some of the Company’s properties in production or to seek additional working capital by additional means such as issuance of equity including preferred stock or such other means as may be considered and authorized by the Company’s Board of Directors from time to time.

Net cash provided by operating activities decreased $5.4 million from $5.7 million during the first nine months of 2014 to $349,000 during the first nine months of 2015. Cash flow provided by working capital was $130,000 during the first nine months of 2015 compared to $1.4 million provided by working capital during the first nine months of 2014. The $1.1 million reduction in cash flow provided by working capital was primarily related to a decrease in accrued liabilities during the first nine months of 2015 as compared to an increase in accrued liabilities during the first nine months of 2014. The $5.4 million decrease in cash flow provided by operating activities was primarily due to a $6.15 million decrease in revenues, a $1.1 million decrease in cash flow provided by working capital, partially offset by a $1.55 million decrease in production cost and taxes, and a $505,000 decrease in general and administrative cost. Net cash used in investing activities was $536,000 during the first nine months of 2015 compared to $3.1 million used in investing activities during the first nine months of 2014. The $2.6 million decrease in net cash used in investing activities was primarily a result of a $2.3 million reduction in drilling, seismic, and leasehold cost during the first nine months of 2015 as compared to the first nine months of 2014, and a $274,000 reduction in methane facility costs related to start up of the electric only operations during 2014. Cash flow provided by financing activities during the first nine months of 2015 was $225,000 as compared to cash flow used in financing activities of $2.5 million during the first nine months of 2014. This change was primarily due to lower cash flow from operating activities during the first nine months of 2015 as compared to the first nine months of 2014, partially offset by lower capital spending during the first nine months of 2015 as compared to the first nine months of 2014.

Critical Accounting Policies

During the quarter ended September 30, 2015, there were no changes to the critical accounting policies included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Commitments and Contingencies

The Company as designated operator of the Hoactzin properties was administratively issued an “Incident of Non-Compliance” by BSEE during the quarter ended September 30, 2012 concerning one of Hoactzin’s operated properties. This action calls for payment of a civil penalty of $386,000 for failure to provide, upon request, documentation to the BSEE evidencing that certain safety inspections and tests had been conducted in 2011. In the 4th quarter of 2012, the Company filed an administrative appeal with the Interior Board of Land Appeals (“IBLA”) of this action in order to attempt to significantly reduce the civil penalty. On June 23, 2014, the IBLA affirmed the civil penalty without reduction. On September 22, 2014, the Company sought judicial review of the June 23, 2014 agency action in the federal district court in the Eastern District of Louisiana at New Orleans. As a result of the determination by the IBLA, the Company recorded a liability of $386,000 in the Company’s Consolidated Balance Sheets under “Accrued and other current liabilities” and an expense in its Consolidated Statements of Operations under “Production costs and taxes” for the year ended December 31, 2014. On July 14, 2015, the federal district court in the Eastern District of Louisiana affirmed the determination by the IBLA without reduction. The Company determined that further appeal of the determination is not likely to reduce the penalty and the Company did not further appeal.

During the second quarter of 2015, the Company received from Hoactzin a copy of an internal analysis prepared by Hoactzin setting out certain issues that Hoactzin may consider to form the basis of operational and other claims against the Company primarily under the Management Agreement. This analysis raised issues other than the “Incident of Non-Compliance” discussed previously. The Company is discussing this analysis, as well as the civil penalty discussed previously, with Hoactzin in an effort to determine whether there is possibility of a reasonable resolution of some or all of these matters on a negotiated basis.

In the third quarter of 2015, the Company paid the civil penalty affirmed on appeal and statutory interest from funds borrowed under its credit facility, and when the appeal bond is cancelled by the BOEM, the Company will receive a return of the cash collateral previously provided to RLI Insurance Company. The Company is considering seeking reimbursement of such payment from Hoactzin pursuant to the terms of the Management Agreement. However, there can be no assurance that the Company would be successful in such a claim. The Company has not advanced any funds to pay any obligations of Hoactzin and no borrowing capability of the Company has been used in connection with its obligations under the Management Agreement, except for those funds used to collateralize the appeal bond with RLI Insurance Company and to pay the civil penalty and interest thereon.

During the quarter ended March 31, 2015, the Company initiated cost reduction measures including compensation reductions for each employee as well as members of the Board of Directors. These compensation reductions will 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 when compensation shall revert 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 to each employee and members of the Board of Directors if he is still employed by the Company or still a member of the Board of Directors. As of September 30, 2015, the reductions were approximately $93,000. The Company has not accrued any liabilities associated with these compensation reductions.

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 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.

As of September 30, 2015, the Company’s borrowing base was set at $7.8 million of which $1.0 million had been drawn down by the Company. The Company’s next periodic borrowing base redetermination in currently under review.

Commodity Risk

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. Monthly Kansas oil prices received during the first nine months of 2015 ranged from a low of $36.79 per barrel to a high of $53.01 per barrel. As a result of the low prices experienced during 2015, the Company recorded an impairment of its oil and gas properties during the quarter ended September 30, 2015. The Company anticipates it will record an additional impairment during the quarter ended December 31, 2015.

As of September 30, 2015, the Company has no open positions related to derivative agreements relating to commodities.

Interest Rate Risk

At September 30, 2015, the Company had debt outstanding of $1.2 million including, as of that date, $1.0 million owed on its credit facility with Prosperity Bank. As of September 30, 2015, 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 September 30, 2015 was 3.75%. The Company’s remaining debt of $160,000 has fixed interest rates ranging from 5.5% to 8.25%.

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 $4,000 assuming borrowed amounts under the credit facility remained at the same amount owed as of September 30, 2015. The Company did not have any open derivative contracts relating to interest rates at September 30, 2015 or December 31, 2014.

Forward-Looking Statements and Risk

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.

Evaluation of Disclosure Controls and Procedures

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.

Changes in Internal Controls

During the period covered by this Report, 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.

Refer to Item 1A Risk Factors in the Company’s Report on Form 10-K for the year ended December 31, 2014 filed on March 30, 2015 which is incorporated by this reference.