PANHANDLE ROYALTY CO - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

( X ) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the period ended June 30, 2002
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( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from
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to
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Commission File Number 0-9116
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PANHANDLE ROYALTY COMPANY
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(Exact name of registrant as specified in its charter)

OKLAHOMA 73-1055775
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization ) Identification No.)

Grand Centre Suite 210, 5400 N Grand Blvd., Oklahoma City, Oklahoma 73112
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(Address of principal executive offices)

Registrant's telephone number including area code (405) 948-1560
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

x Yes No
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Outstanding shares of Class A Common stock (voting) at August 6, 2002:
2,071,296
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INDEX

PART I. FINANCIAL INFORMATION

PANHANDLE ROYALTY COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Information at June 30, 2002 is unaudited)

(1)

PANHANDLE ROYALTY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

Three Months Ended June 30, Nine Months Ended June 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------

Revenues:
Oil and gas sales $ 3,548,007 $ 2,881,407 $ 9,426,408 $10,185,294
Lease bonuses and rentals 17,177 10,188 28,857 14,457
Interest and other 210,456 27,008 357,582 134,048
Equity in income of partnerships 17,354 -- 56,532 --
----------- ----------- ----------- -----------
3,792,994 2,918,603 9,869,379 10,333,799

Costs and expenses:
Lease operating expenses 512,957 230,701 1,598,484 665,915
Production taxes 221,732 210,420 593,040 690,776
Exploration costs 116,014 200,359 248,101 514,466
Depreciation, depletion,
amortization and impairment 1,648,872 435,859 4,869,449 1,323,450
General and administrative 454,903 472,550 1,747,092 1,484,098
Interest expense 214,832 779 688,791 779
----------- ----------- ----------- -----------
3,169,310 1,550,668 9,744,957 4,679,484
----------- ----------- ----------- -----------
Income before provision for income taxes 623,684 1,367,935 124,422 5,654,315
Provision for income taxes 170,000 340,000 34,717 1,550,000
----------- ----------- ----------- -----------

Net income $ 453,684 $ 1,027,935 $ 89,705 $ 4,104,315
=========== =========== =========== ===========

Basic earnings per share (Note 3) $ .22 $ .50 $ .04 $ 1.99
=========== =========== =========== ===========
Diluted earnings per share (Note 3) $ .22 $ .49 $ .04 $ 1.97
=========== =========== =========== ===========

Dividends declared per share of common stock $ .07 $ .07 $ .21 $ .28
=========== =========== =========== ===========

(2)

PANHANDLE ROYALTY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(See accompanying notes)

(3)

PANHANDLE ROYALTY COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1: Accounting Principles and Basis of Presentation

The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions to Form 10-Q as
prescribed by the Securities and Exchange Commission, and effective
October 1, 2001, include the Company's wholly-owned subsidiary, Wood Oil
Company (Wood). Management of Panhandle Royalty Company believes that all
adjustments necessary for a fair presentation of the consolidated
financial position and results of operations for the periods have been
included. All such adjustments are of a normal recurring nature. The
consolidated results are not necessarily indicative of those to be
expected for the full year.

NOTE 2: Income Taxes

The Company utilizes tight gas sands production tax credits to reduce its
federal income tax liability, if any. These credits are scheduled to be
available through the year 2002. The Company's 2001 provision for income
taxes was also reflective of excess percentage depletion, reducing the
Company's effective tax rate from the federal statutory rate.

NOTE 3: Earnings Per Share

The following table sets forth the computation of basic and diluted
earnings per share, giving consideration to, certain shares that may be
issued under the Non-Employee Director's Deferred Compensation Plan, to
the extent dilutive:

NOTE 4: Long-term Debt

The Company has a $5,000,000 line-of-credit with BancFirst in Oklahoma
City, OK. This facility matures on December 31, 2003. At June 30, 2002,
the Company had $900,000 outstanding under the BancFirst facility
($1,350,000 at August 7, 2002). In addition, on October 1, 2001, the
Company utilized a $20,000,000 five year term loan from BancFirst to
make the Wood Oil acquisition. Monthly payments on the term loan, which
began in December 2001, are $333,000 plus, accrued interest. The
line-of-credit and term loan bear interest equal to the national prime
rate minus 1/4% (4.5% at June 30, 2002).

(4)

NOTE 5: Acquisition of Wood Oil Company

On October 1, 2001, the Company acquired 100% of the outstanding common
stock of Wood Oil Company (Wood). The acquisition was made pursuant to
an Agreement and Plan of Merger among the Company, PHC, Inc. and Wood
Oil Company, dated August 9, 2001. Wood merged with Panhandle's wholly
owned subsidiary PHC, Inc., on October 1, 2001, with Wood being the
surviving Company. Prior to the acquisition, Wood was a privately held
company engaged in oil and gas exploration and production and fee
mineral ownership and owned interests in certain oil and gas and real
estate partnerships and owned an office building in Tulsa, Oklahoma.
Wood will continue to operate as a subsidiary of Panhandle and was
moved to Oklahoma City in early 2002. Wood and its shareholders were
unrelated parties to Panhandle.

The Company's decision to acquire Wood was the result of desired growth
in the Company's asset base of producing oil and gas reserves and fee
mineral acreage. Wood's oil and gas activity, fee minerals and operating
philosophy in general had been very similar to the Company's.

Wood's mineral acreage ownership and leasehold position as well as its
producing oil and gas properties are located in the same general areas
as the Company's. In several cases, both companies own interests in
existing producing wells and several developing fields. The Company
intends to actively pursue drilling opportunities on Wood's properties.

The combination of the companies will provide reduced overhead expenses
as the Wood Oil office was combined with the Company's. This
acquisition should considerably enhance the medium to long term growth
of the Company and is expected to generally be accretive to earnings
and cash flow per share.

Funding for the acquisition was obtained from BankFirst of Oklahoma City,
Oklahoma in the form of a $20 million five-year term loan. Three million
of Wood's cash was used to reduce Panhandle's debt on the date of
closing.

The operations of Wood, since October 1, 2001, are included in the
accompanying financial statements.

The preliminary purchase price was determined as follows, cash
consideration to Wood shareholders $22,604,000 and transaction costs of
$244,000, for a total of $22,848,000.

The following table sets forth the preliminary allocation of the purchase
price to the assets and liabilities acquired (in thousands). The Company
is in the process of determining the final tax basis of the properties
acquired, thus, the allocation of the purchase price is subject to
refinement. No goodwill will be deductible for tax purposes.

Cash $ 3,759
Other current assets 1,260
Land and buildings held for sale 750
Oil and Gas properties - proved 17,550

Minerals:
Producing 925
Nonproducing 3,491
Other property and equipment 43
Investments in partnerships and other assets 1,731
-----------

Total assets acquired 29,509

Current liabilities (853)
Deferred income taxes (5,808)
-----------
Total liabilities assumed (6,661)
-----------
Net assets acquired $ 22,848
===========

In April 2002, the Company sold the land and building and its interest in
two partnerships for net proceeds of approximately $1.4 million, $800,000 of the
proceeds were used to pay down long term debt.

Interest and other revenues on the accompanying income statement, for the
three and nine-months of 2002, includes a gain of $56,487 on the sale of the
building and a gain of $122,550 on the sale of the two partnerships.

(5)

The following unaudited proforma results of operations give effect to
the acquisition as if consummated on October 1, 2000. The data reflects
adjustments of the historical Wood results for depreciation and amortization of
the property and equipment acquired, adjustments of expenses resulting from
contractual requirements of the acquisition agreement, incremental interest
expense relating to bank borrowing used to finance the purchase and income taxes
Total revenues for the three and nine-month periods include gains on asset sales
of $1.6 million. The pro forma adjustments are based upon available information
and assumptions that management of the Company believes are reasonable. The pro
forma results of operations data does not purport to represent the results of
operations that would have occurred had such transaction been consummated on
October 1, 2000 or the Company's results of operation for any future date or
period.

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS AND RISK FACTORS

Forward-Looking Statements for 2002 and later periods are made in this
document. Such statements represent estimates of management based on the
Company's historical operating trends, its proved oil and gas reserves and
other information currently available to management. The Company cautions that
the forward-looking statements provided herein are subject to all the risks and
uncertainties incident to the acquisition, development and marketing of, and
exploration for oil and gas reserves. These risks include, but are not limited
to, oil and natural gas price risk, environmental risks, drilling risk, reserve
quantity risk and operations and production risk. For all the above reasons,
actual results may vary materially from the forward-looking statements and
there is no assurance that the assumptions used are necessarily the most likely
to occur.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2002, the Company had negative working capital of
$2,245,178, as compared to positive working capital of $1,044,334 at September
30, 2001. The decrease is a result of $3,996,000 being recorded as the current
portion of the $20,000,000 term loan used to fund the acquisition of Wood Oil
Company ("Wood Acquisition") on October 1, 2001. Monthly payments on the term
loan of $333,000, plus, accrued interest began on December 1, 2001. Cash flow
from operating activities decreased 32% to $5,102,442 for the nine-months of
fiscal 2002, as compared to the first nine-months of fiscal 2001, primarily due
to a significant reduction in product prices and increased lease operating
expense and interest expense related to the Wood Acquisition.

Capital expenditures for oil and gas activities for the 2002 nine month
amounted to $5,185,908, exclusive of $15,229,466 used to acquire Wood Oil
Company, as compared to $7,008,126 for the 2001 period. This 26% decrease was
due to the depressed market prices of oil and natural gas (early in fiscal
2002) causing operators, which the Company depends on to drill new wells, to
either cancel or postpone drilling many proposed wells. Also the costs of
drilling wells has recently dropped. The reduction in capital expenditures is
anticipated to continue through fiscal 2002.

The Company has historically funded its capital expenditures, overhead
expenditures and dividend payments from operating cash flow. With the addition
of the monthly payments required on the term loan, the Company has utilized
(as of August 7, 2002) $1,350,000 of the $5,000,000 line-of-credit to help fund
these expenditures. Management expects to borrow additional funds under the
line-of-credit during the remainder of fiscal 2002. The Company has the
potential availability of equity, which could be offered in a public or
private placement, if additional capital were needed for capital expenditures,
or for debt reduction, or a combination of uses.

(6)

RESULTS OF OPERATIONS

Revenues decreased for the nine-month period and increased for the
three-month period ended June 30, 2002, as compared to the same periods in
fiscal 2001. The nine-month decrease was a result of sharply decreased natural
gas and oil sales prices offset by increased sales volumes of both gas and
oil. For the three-month period, the decrease in sales prices was more
moderate and the increase in sales volumes during the period overcame the
price decreases, thus, increasing revenues. The table below outlines the
Company's production and average sales prices for oil and gas for the three
and nine-month periods of fiscal 2002 and 2001:

The increased sales volume of both natural gas and oil was primarily
due to production added from the Wood Acquisition properties. For the three
and nine-month periods of 2002, Wood Oil's production amounted to 17,401
barrels and 312,618 MCF and 53,984 barrels and 1,146,773 MCF, respectively.
The remaining increase in gas sales volume was due to new wells drilled in
fiscal 2001, and early 2002, coming on line in the first nine-months of fiscal
2002.

Lease operating expense (LOE) increased in the 2002 periods as compared
to the 2001 periods, principally as a result of LOE cost on the Wood Oil
properties.

Exploration costs declined in the 2002 periods as fewer exploratory
wells have been drilled in 2002, which reduced the chance of an exploratory
well being a dry hole, which under the successful efforts accounting method
would be expensed.

Depreciation, depletion, amortization and impairment (DD&A) increased
278% and 268%, respectively for the three-month and nine-month periods. The
major portion of the increase, approximately $2.3 million (for the nine-month
period), was DD&A recognized on the Wood properties. Wood DD&A is based on the
fair value of Wood oil and gas properties which was assigned in the purchase
accounting done at the acquisition date. In addition, DD&A on properties in
the Potato Hills field increased in the 2002 periods as initial production on
new costly wells in the field was realized in the 2002 periods and decline in
the field's expected reserves accelerated DD&A recognition. In addition,
impairment expense increased $248,000 in the 2002 nine-month period as
compared to the 2001 period.

General and administrative costs(G&A) increased $262,994 for the
nine-month period of fiscal 2002 as compared to the same period in fiscal
2001. Substantially all of the increase was due to the addition of G&A charges
related to the Wood Oil office in Tulsa, OK. The Wood office in Tulsa was
closed on March 1, 2002 and the remaining three employees were moved to
Panhandle's Oklahoma City office. The Wood Oil building was sold in April,
2002.

Interest expense in the 2002 periods was a result of the Wood
Acquisition which closed on October 1, 2001. The acquisition was funded by a
new $20,000,000 five-year bank term loan. The Company had no debt outstanding
in the comparable periods of fiscal 2001.

Earnings were adversely affected by the severe decrease in oil and
natural gas sales prices discussed above, and increased costs associated with
the Wood Oil properties. Natural gas sales prices are recovering and appear to
be stabilizing at higher levels than those seen in the first six months of
2002. Management currently anticipates this recovery of natural gas prices to
continue through the remainder of fiscal 2002. These increased prices should
result in increased oil and gas sales revenues in the last three months of
fiscal 2002, and into fiscal 2003, as compared to the first three quarters.
However, financial results are expected to remain lower than fiscal 2001,
which benefited from oil and gas prices which were at record levels. The
Company's financial results are dependent on these natural gas and oil prices,
which fluctuate widely in response to changing market conditions.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amount of assets,
liabilities, revenues and expenses, and the disclosure of contingent assets
and liabilities. The more significant financial reporting areas impacted by
management's judgement and estimates are tax accruals, crude oil and natural
gas reserve estimation, and impairment of assets. Management's judgements and
estimates in these areas are based on information available from both internal
and external sources, including geologists, engineers and historical
experience in similar matters. Actual results could differ from those
estimates as additional information becomes known.

Of these judgements and estimates, management considers the estimation
of crude oil and natural gas reserves to be the most significant. Changes in
crude oil and natural gas reserve estimates affect the Company's calculation
of depreciation and depletion, provision for abandonment and assessment of the
need for asset impairments. The Company's consulting engineer with assistance
from Company geologists prepares estimates of crude oil and natural gas
reserves based on available geologic and seismic data, reservoir pressure
data, core analysis reports, well logs, analogous reservoir performance
history, production data and other available sources of engineering,
geological and geophysical information. As required by the guidelines and
definitions established by the Securities and Exchange Commission, these
estimates are based on current crude oil and natural gas pricing. As
previously discussed, crude oil and natural gas prices are volatile and
largely affected by worldwide consumption and are outside the control of
management. Projected future crude oil and natural gas pricing assumptions are
used by management to prepare estimates of crude oil and natural gas reserves
used in formulating management's overall operating decisions in the
exploration and production segment.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company's results of operations and operating cash flows are
impacted by changes in market prices for oil and gas. Operations and cash
flows are also impacted by changes in the market interest rates related to the
revolving credit facility and the $20 million five-year term loan, both
bearing interest at an annual variable interest rate equal to the national
prime rate minus 1/4%. A one percent change in the prime interest rate would
result in approximately a $200,000 change in annual interest expense.

(7)

PART II. OTHER INFORMATION

Item 6. EXHIBITS AND REPORT ON FORM 8-K

(a) Exhibits - Exhibit 99.1 and 99.2 - Certification Under Section 906
of the Sarbanes-Oxley Act of 2002

(b) Form 8-K - There were no reports on Form 8-K filed for the three-
months ended June 30, 2002.

SIGNATURES

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

PANHANDLE ROYALTY COMPANY

August 13, 2002 /s/ H W Peace II
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Date H W Peace II, President
and Chief Executive Officer

August 13, 2002 /s/ Michael C. Coffman
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Date Michael C. Coffman,
Vice President,
Chief Financial Officer and
Secretary and Treasurer

(8)

INDEX TO EXHIBITS