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 March 31, 2003
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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 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

Outstanding shares of Class A Common stock (voting) at May 6, 2003: 2,082,190
------------

INDEX

PART I. FINANCIAL INFORMATION

PANHANDLE ROYALTY COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Information at March 31, 2003 is unaudited)

(1)

PANHANDLE ROYALTY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(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 were available
through calendar year 2002. The Company's provision for income taxes is
also reflective of excess percentage depletion, reducing the Company's
effective tax rate from the federal statutory rate.

NOTE 3: Earnings (Loss) Per Share

The following table sets forth the number of shares utilized in the
computation of basic and diluted earnings (loss) 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

On March 25, 2003, the Company amended its Loan Agreement with BancFirst,
Oklahoma City, OK. The Agreement now consists of a term loan in the
amount of $10,000,000 and a revolving loan in the amount of $15,000,000.
The current borrowing base under the agreements is $22,500,000 which can
be re-determined semi-annually. The term loan matures on April 1, 2008,
and the revolving loan matures on April 1, 2005. Monthly payments on the
term loan are $166,667, plus accrued interest, beginning on May 1, 2003.
Interest on the term loan is fixed at 4.56% until maturity. The revolving
loan bears interest at the national prime rate minus 3/4% (3.5% at March
31, 2003) or Libor (for one, three or six month periods), plus 1.80%. The
Company, at March 31, 2003, elected a six month Libor rate (aggregate of
3.08%). At March 31, 2003, the Company had $7,547,000 outstanding under
the revolving loan ($7,047,000 at May 5, 2003).

(4)

NOTE 5: Asset Retirement Obligation

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS No. 143). SFAS No. 143 requires entities to record
the fair value of a liability for an asset retirement obligation in the period
in which it is incurred and a corresponding increase in the carrying amount of
the related long-lived asset. Subsequently, the asset retirement cost should be
allocated to expense using a systematic and rational method and the liability
should be accreted to its face amount. The Company adopted SFAS No. 143 on
October 1, 2002. The primary impact of this standard relates to oil and gas
wells on which the Company has a legal obligation to plug and abandon the wells.
Prior to SFAS No. 143, the Company had not recorded an obligation for these
plugging and abandonment costs due to its assumption that the salvage value of
the surface equipment would offset the cost of dismantling the facilities and
carrying out the necessary clean-up and reclamation activities. The adoption of
SFAS No. 143 on October 1, 2002, resulted in a net increase to Property and
Equipment and Retirement Obligations of approximately $325,000 and $250,000,
respectively, as a result of the Company separately accounting for salvage
values and recording the estimated fair value of its plugging and abandonment
obligations on the balance sheet. The increase in expense resulting from the
accretion of the asset retirement obligation and the depreciation of the
additional capitalized well costs is expected to be substantially offset by the
decrease in depreciation from the Company's consideration of the estimated
salvage values in the calculation. The proforma impact of SFAS No. 143 on the
2002 period was not material.

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

FORWARD-LOOKING STATEMENTS AND RISK FACTORS

Forward-Looking Statements for 2003 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 March 31, 2003, the Company had positive working capital of $2,132,043,
as compared to negative working capital of $2,399,457 at September 30, 2002. The
increase in working capital from September 30, 2002 to March 31, 2003, is the
result of increased oil and gas sales revenues during fiscal 2003, which is
discussed in Results of Operations below, and the reduction in the current
portion of long-term debt by $2,000,000. This reduction is the result of the
restructuring of the Company's bank debt. The fixed monthly principal payment on
the bank debt was reduced from $333,000 to $166,667. For a further discussion of
the Company's bank debt see Note 4: Long Term Debt to the Financial Statements
contained here-in. Cash flow from operating activities increased 49% to
$5,186,906 for the first six-months of fiscal 2003, as compared to the first
six-months of fiscal 2002, primarily due to a significant increase in product
sales prices.

Capital expenditures for oil and gas activities for the 2003 six-month
period amounted to $4,371,155, as compared to $3,865,944 for the 2002 period,
exclusive of $15,229,466 used to acquire Wood Oil Company. Capital expenditures
are anticipated to increase through fiscal 2003 as the increase in product
prices should cause an increase in drilling activity as the year progresses.
Management's current expectation for capital expenditures in 2003 is
approximately $8,000,000.

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 May 5, 2003), $7,047,000 of the $15,000,000 revolving loan to help fund these
expenditures. Management currently does not expect to borrow additional funds
under the revolving loan during the remainder of fiscal 2003. The Company has
the potential availability of equity, which could be offered in a public or
private placement, if additional capital were needed, above the amount available
from bank debt, for capital expenditures, or for debt reduction, or a
combination of uses.

(5)

RESULTS OF OPERATIONS

THREE MONTHS COMPARED TO THREE MONTHS

Revenues:

Total revenues increased $4,235,115 or 154% for the 2003 quarter as
compared to the 2002 quarter. Sales volumes for oil decreased due to normal
production decline in the 2003 quarter, and sales volumes for natural gas
increased 4% as a result of new wells coming online. However, the substantial
increase in average sales prices for both products produced the substantial
revenue increase. The table below outlines the Company's production and average
sales prices for oil and natural gas for the three month periods of fiscal 2003
and 2002:

As the table outlines the 65% increase in oil price and the 184%
increase in gas price and the slight increase in equivalent production to
1,183,054 mcfe resulted in a 157% increase in oil and gas revenue for the
quarter.

Lease Operating Expenses and Production Taxes (LOE):

LOE increased 76% or $469,779 in the 2003 quarter. Production taxes
increased $293,804 in the 2003 quarter as oil and gas sales revenues increased
and production taxes are paid as a percentage of oil and gas sales revenue. In
addition, well operating costs continue to increase ($175,975 for the quarter)
as the Company adds operating costs from the substantial number of new wells
drilled each year.

Exploration Costs:

These costs increased $121,125 in the 2003 period as there were
several exploratory wells which completed drilling in 2003, thus increasing the
chances of drilling an exploratory dry hole, which costs are charged to
exploration costs in the period incurred. Three wells accounted for the
increase.

Depreciation, Depletion, Amortization and Impairment (DD&A):

DD&A increased $25,751 or 2% in the 2003 period. This minor increase
was principally the result of the slightly increased production volume of
natural gas in the quarter.

General and Administrative Costs (G&A):

G&A expenses decreased $51,025 or 8% in the 2003 period. The
decrease was due to increased personnel related costs in the 2003 period, offset
by a reduction in the expense related to the Directors Deferred Compensation
Plan as a result of Panhandle's common share price decreasing from December 31,
2002 to March 31, 2003. In addition, the 2002 period included G&A costs for Wood
prior to the Tulsa office being closed.

Interest Expense:

Interest expense decreased in the 2003 quarter due to a lower level
of debt and due to a decrease in the interest rate on the debt. The interest
rate is tied to the prime rate which decreased throughout fiscal 2002.

Income Taxes:

The 2003 period provision for income taxes increased due to
substantially increased income before provision for income taxes. The Company
utilizes tight gas sands production tax credits (available through calendar year
2002) and excess percentage depletion to reduce its effective tax rate from the
federal statutory rate. The effective tax rate estimate was 30% for the 2003
period and a benefit of 28% for the 2002 period.

SIX MONTHS COMPARED TO SIX MONTHS

Revenues:

Total revenues increased $5,368,302 or 88% for the 2003 six months
as compared to the 2002 six months. Sales volumes for both oil and natural gas
decreased due to normal production decline in the 2003 six months but the
substantial increase in sales prices for both products produced the revenue
increase. The table below outlines the Company's production and average sales
prices for oil and natural gas for the six month periods of fiscal 2003 and
2002:

(6)

As the table outlines the 52% increase in oil price and the 117%
increase in gas price more than offset the 5% decline in equivalent production
to 2,300,243 mcfe. These price increases resulted in a 93% increase in oil and
gas revenue for the 2003 six months to $11,323,526.

Lease Operating Expenses and Production Taxes (LOE):

LOE increased 39% or $568,945 in the 2003 six months. Production
taxes increased $322,430 in the 2003 six months as oil and gas sales revenues
increased and production taxes are paid as a percentage of oil and gas sales
revenue. In addition, well operating costs continue to increase ($246,515 for
the six months) as the Company adds operating costs from the substantial number
of new wells drilled each year.

Exploration Costs:

These costs increased $275,371 in the 2003 period as there were
several exploratory wells which completed drilling in 2003, thus increasing the
chances of drilling an exploratory dry hole, which costs are charged to
exploration costs in the period incurred. Three wells accounted for
approximately $250,000 of the increase.

Depreciation, Depletion, Amortization and Impairment (DD&A):

DD&A decreased $36,137 in the 2003 period. This minor decrease was
principally the result of the decreased production volumes reducing the units of
production DD&A calculations for the 2003 six months.

General and Administrative Costs (G&A):

G&A expenses increased $17,462 in the 2003 period. The minor
increase was due to increased legal and personnel related costs in the 2003
period, partially offset by reduced expenses for the Non-Employee Directors
Deferred Compensation Plan due to Panhandles common share price decreasing from
September 30, 2002 to March 31, 2003. Professional service fees were also lower
in the 2003 period.

Interest Expense:

Interest expense decreased in the 2003 six month period due to a
lower level of debt and due to a decrease in the interest rate on the debt. The
interest rate is tied to the prime rate which decreased throughout fiscal 2002.

Income Taxes:

The 2003 period provision for income taxes increased due to
substantially increased income before provision for income taxes. The Company
utilizes tight gas sands production tax credits (available through calendar year
2002) and excess percentage depletion to reduce its effective tax rate from the
federal statutory rate. The effective tax rate estimate was 30% for the 2003
period and a benefit of 27% for the 2002 period.

Overview:

The Company recorded a second quarter 2003 net income of $2,500,674,
or $1.19 per share, as compared to a $287,123 net loss, or $.14 per share, in
the 2002 quarter and a 2003 six month net income of $3,152,155, or $1.50 per
share, as compared to a $363,979 net loss, or $.18 per share, in the 2002 six
months. The improved 2003 results were due to substantial increases in the sales
price of both oil and natural gas and relatively stable costs and expenses.

CRITICAL ACCOUNTING POLICIES

Preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates, judgments and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and the disclosure of contingent assets and
liabilities. However, the accounting principles used by the Company generally do
not change the Company's reported cash flows or liquidity. Generally, accounting
rules do not involve a selection among alternatives, but involve a selection of
the appropriate policies for applying the basic principles. Interpretation of
the existing rules must be done and judgments made on how the specifics of a
given rule apply to the Company.

The more significant reporting areas impacted by management's
judgments and estimates are crude oil and natural gas reserve estimation,
impairment of assets and tax accruals. Management's judgments and estimates in
these areas are based on information available from both internal and external
sources, including engineers, geologists and historical experience in similar
matters. Actual results could differ from the estimates as additional
information becomes known.

Oil and Gas Reserves

Of these judgments and estimates, management considers the
estimation of crude oil and 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

(7)

from Company geologists prepares estimates of crude oil and natural gas reserves
based on available geologic and seismic data, reservoir pressure data, core
analysis reports, well logs, analogous reservoir performance history, production
data and other available sources of engineering, geological and geophysical
information. As required by the guidelines and definitions established by the
Securities and Exchange Commission, these estimates are based on current crude
oil and natural gas pricing. Crude oil and natural gas prices are volatile and
largely affected by worldwide consumption and are outside the control of
management. Projected future crude oil and natural gas pricing assumptions are
used by management to prepare estimates of crude oil and natural gas reserves
used in formulating managements overall operating decisions in the exploration
and production segment.

Successful Efforts Method of Accounting

The Company has elected to utilize the successful efforts method of
accounting for its oil and gas exploration and development activities.
Exploration expenses, including geological and geophysical costs, rentals and
exploratory dry holes, are charged against income as incurred. Costs of
successful wells and related production equipment and developmental dry holes
are capitalized and amortized by field using the unit-of-production method as
oil and gas is produced. The accounting method may yield significantly different
operating results than the full cost method.

Impairment of Assets

All long-lived assets are monitored for potential impairment when
circumstances indicate that the carrying value of the asset may be greater than
its future net cash flows. The evaluations involve a significant amount of
judgment since the results are based on estimated future events, such as
inflation rates, future sales prices for oil and gas, future costs to produce
these products, estimates of future oil and gas reserves to be recovered and the
timing thereof, the economic and regulatory climates and other factors. The need
to test a property for impairment may result from significant declines in sales
prices or unfavorable adjustments to oil and gas reserves. Any assets held for
sale are reviewed for impairment when the Company approves the plan to sell.
Estimates of anticipated sales prices are highly judgmental and subject to
material revision in future periods. Because of the uncertainty inherent in
these factors, the Company cannot predict when or if future impairment charges
will be recorded.

Tax Accruals

The estimation of the amounts of income tax to be recorded by the
Company involves interpretation of complex tax laws and regulations as well as
the completion of complex calculations, including the determination of the
Company's percentage depletion deduction. Although the Company's management
believes its tax accruals are adequate, differences may occur in the future
depending on the resolution of pending and new tax matters.

The above description of the Company's critical accounting policies is
not intended to be an all-inclusive discussion of the uncertainties considered
and estimates made by management in applying accounting principles and policies.
Results may vary significantly if different policies were used or required and
if new or different information becomes known to management.

ITEM 3. QUANTITATIVE AND QUALITATIVE 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 which bears interest at an annual variable interest
rate equal to the national prime rate minus 3/4% or Libor for one, three or six
month periods, plus 1.8%. A one percent change in the prime interest rate would
result in approximately a $70,000 change in annual interest expense. The Company
has a $10,000,000 term loan which matures on April 1, 2008. The interest rate is
fixed at 4.56% until maturity.

ITEM 4. CONTROLS and PROCEDURES

Panhandle Royalty Company management, including, the Chief Executive
Officer and Chief Financial Officer have conducted an evaluation of the
effectiveness of disclosure controls and procedures pursuant to Exchange Act
Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that all material information required to
be filed in this quarterly report has been made known to them in a timely
fashion. There have been no significant changes in our internal controls or in
factors that could significantly affect internal controls, subsequent to the
date of the Chief Executive Officer and Chief Financial Officer completed their
evaluation.

(8)

PART II OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a) The annual meeting of shareholders was held on February
28, 2003.

(b) Two directors were elected for three-year terms at the
meeting. The directors elected and the results of voting
were as follows:

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 March 31, 2003.

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

May 13, 2003 /s/ H W Peace II
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Date H W Peace II, President
and Chief Executive Officer

May 13, 2003 /s/ Michael C. Coffman
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Date Michael C. Coffman
Vice President,
Chief Financial Officer and
Secretary and Treasurer

(9)

CERTIFICATION

I, HW Peace II, certify that:

1. I have reviewed this quarterly report on Form 10-Q;

2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:

a). designed such disclosure controls and procedures
to ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;

b). evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c). presented in this quarterly report our
conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of
the Evaluation Date;

5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the
equivalent function):

a). all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and

b). any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and

6. The registrant's other certifying officer and I have
indicated in this quarterly report whether there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regards to significant deficiencies
and material weaknesses.

Date: May 13, 2003
/s/ HW Peace II
---------------------------------
HW Peace II
Chief Financial Officer

(10)

CERTIFICATION

I, Michael C. Coffman, certify that:

1. I have reviewed this quarterly report on Form 10-Q;

2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:

a). designed such disclosure controls and procedures
to ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;

b). evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c). presented in this quarterly report our
conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of
the Evaluation Date;

5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the
equivalent function):

a). all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and

b). any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and

6. The registrant's other certifying officer and I have
indicated in this quarterly report whether there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regards to significant deficiencies
and material weaknesses.

Date: May 13, 2003
/s/ Michael C. Coffman
---------------------------------
Michael C. Coffman
Chief Financial Officer

(11)