BARNWELL INDUSTRIES INC 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cautionary Statement Relevant to Forward-Looking Information For the Purpose Of “Safe Harbor” Provisions Of The Private Securities Litigation Reform Act of 1995 This Form 10-Q, and the documents incorporated herein by reference, contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). A forward-looking statement is one which is based on current expectations of future events or conditions and does not relate to historical or current facts. These statements include various estimates, forecasts, projections of Barnwell’s future performance, statements of Barnwell’s plans and objectives, and other similar statements. All such statements we make are forward-looking statements made under the safe harbor of the PSLRA, except to the extent such statements relate to the operations of a partnership or limited liability company. Forward-looking statements include phrases such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “predicts,” “estimates,” “assumes,” “projects,” “may,” “will,” “will be,” “should,” or similar expressions. Although Barnwell believes that its current expectations are based on reasonable assumptions, it cannot assure that the expectations contained in such forward-looking statements will be achieved. Forward-looking statements involve risks, uncertainties and assumptions which could cause actual results to differ materially from those contained in such statements. The risks, uncertainties and other factors that might cause actual results to differ materially from Barnwell’s expectations are set forth in the “Forward-Looking Statements” and “Risk Factors” sections of Barnwell’s 2024 Annual Report. Investors should not place undue reliance on these forward-looking statements, as they speak only as of the date of filing of this Form 10-Q, and Barnwell expressly disclaims any obligation or undertaking to publicly release any updates or revisions to any forward-looking statements contained herein. Critical Accounting Policies and Estimates Management has determined that our most critical accounting policies and estimates are those related to the full-cost ceiling calculation and depletion of our oil and natural gas properties, the estimation of our contract drilling segment's revenues and expenses, and the calculation of our income taxes, all of which are discussed in our 2024 Annual Report. There have been no significant changes to these critical accounting policies and estimates during the three months ended December 31, 2024. We continue to monitor our accounting policies to ensure proper application of current rules and regulations. Impact of Recently Issued Accounting Standards on Future Filings In November 2023, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2023-07 “Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures,” which expands reportable segment disclosure requirements on an annual and interim basis, primarily through enhanced disclosures about significant segment expenses. This ASU is effective for annual reporting periods beginning after December 15, 2023 (our fiscal 2025) and interim periods within fiscal years beginning after December 15, 2024 (our fiscal 2026), with early adoption permitted. The Company is currently evaluating the impact of this standard on Barnwell’s consolidated financial statements but does not expect that the adoption of this update will have a material impact on Barnwell's consolidated financial statements. 23 In December 2023, the FASB issued ASU No. 2023-09 “Income Taxes (Topic 740): Improvements to Income Tax Disclosures,” which requires disclosure of incremental income tax information within the tax rate reconciliation and expanded disclosures of income taxes paid both in the U.S. and foreign jurisdiction, among other disclosure requirements. This ASU is effective for annual reporting periods beginning after December 15, 2024, with early adoption permitted. The Company is currently evaluating the impact of this standard on Barnwell’s consolidated financial statements . In November 2024, the FASB issued ASU No. 2024-03 “Income Statement - Reporting Comprehensive Income - Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses,” which requires public companies to disclose specified information about certain costs and expenses in the notes to the financial statements at interim and annual reporting periods. This ASU is effective for annual reporting periods beginning after December 15, 2026 and interim reporting periods within annual reporting periods beginning after December 15, 2027, with early adoption permitted. The Company is currently evaluating the impact of this standard on Barnwell’s consolidated financial statements. Overview Barnwell is engaged in the following lines of business: 1) acquiring, developing, producing and selling oil and natural gas in Canada and the U.S. (oil and natural gas segment), 2) leasehold land interests in Hawaii (land investment segment), and 3) drilling wells and installing and repairing water pumping systems in Hawaii (contract drilling segment). Oil and Natural Gas Segment Barnwell is involved in the acquisition and development of oil and natural gas properties in Canada where we initiate and participate in acquisition and developmental operations for oil and natural gas on properties in which we have an interest, and evaluate proposals by third parties with regard to participation in exploratory and developmental operations elsewhere. Additionally, through its wholly-owned subsidiaries, Barnwell is involved in several non-operated oil and natural gas investments in Oklahoma and Texas. Land Investment Segment Through Barnwell’s 77.6% interest in Kaupulehu Developments, 75% interest in KD Kona, and 34.45% non-controlling interest in KKM Makai, the Company’s land investment interests include the following: • The right to receive percentage of sales payments from KD I resulting from the sale of single-family residential lots by KD I, within Increment I of the Kaupulehu Lot 4A area located in the North Kona District of the island of Hawaii. However, in the quarter ended March 31, 2024, the last two remaining single-family lots of the 80 lots developed within Increment I were sold and there are no more lots available for sale in Increment I. Kaupulehu Developments was entitled to receive payments from KD I based on 10% of the gross receipts from KD I’s sales at Increment I. • The right to receive 15% of the distributions of KD II, the cost of which is to be solely borne by KDK out of its 55% ownership interest in KD II, plus a priority payout of 10% of KDK's cumulative net profits derived from Increment II sales subsequent to Phase 2A, up to a maximum 24 of $3,000,000. Such interests are limited to distributions or net profits interests and Barnwell does not have any partnership interest in KD II or KDK through its interest in Kaupulehu Developments. Barnwell also has rights to three single-family residential lots in Phase 2A of Increment II, and four single-family residential lots in phases subsequent to Phase 2A when such lots are developed by KD II, all at no cost to Barnwell. Barnwell is committed to commence construction of improvements within 90 days of the transfer of the four lots in the phases subsequent to Phase 2A as a condition of the transfer of such lots. Also, in addition to Barnwell's existing obligations to pay professional fees to certain parties based on percentages of its gross receipts, Kaupulehu Developments is also obligated to pay an amount equal to 0.72% and 0.20% of the cumulative net profits of KD II to KD Development, LLC and a pool of various individuals, respectively, all of whom are partners of KKM and are unrelated to Barnwell. The remaining acreage within Increment II is not yet under development, and there is no assurance that development of such acreage will in fact occur. No definitive development plans have been made by KD II, the developer of Increment II, as of the date of this report. • An indirect 19.6% non-controlling ownership interest in KD Kukio Resorts, LLLP, KD Maniniowali, LLLP and KD I and an indirect 10.8% non-controlling ownership interest in KD II through KDK. These entities, collectively referred to hereinafter as the “Kukio Resort Land Development Partnerships,” own certain real estate and development rights interests in the Kukio, Maniniowali and Kaupulehu portions of Kukio Resort, a private residential community on the Kona coast of the island of Hawaii, as well as Kukio Resort’s real estate sales office operations. KDK was the developer of Kaupulehu Lot 4A Increments I and II. The partnerships derive income from the sale of residential parcels in Increment I, which is now completely sold, as well as from commissions on real estate resales by the real estate sales office and revenues resulting from the sale of private club memberships, a few of which remain available for sale. The Kukio Resort Land Development Partnerships have remaining Increment I obligations to complete project amenities, infrastructure, beautification, and restoration of certain areas and therefore has yet to fully recognize its deferred profit on the Increment I project as a whole. The Increment I deferred profit at December 31, 2024 for the Kukio Resort Land Development Partnerships as a whole was approximately $4,500,000; the recognition of which is dependent upon the completion of the Increment I obligations. The Kukio Resort Land Development Partnerships have accrued estimated costs of these obligations of approximately $3,000,000. The Kukio Resort Land Development Partnerships currently appears to have the ability to fund those obligations but there are no assurances that it can ultimately do so in the future if unforeseen events occur. The Kukio Resort Land Development Partnerships will recognize the Increment I deferred revenue and costs of sales on a percentage completion basis as the cash outlays to complete the remaining project obligations are made. The Kukio Resort Land Development Partnerships’ deferred profit and accrued costs to complete are not reflected in Barnwell’s Condensed Consolidated Balance Sheets as we account for our investment in the Kukio Resort Land Development Partnerships under the equity method of accounting. No percentage of sales payments will be earned by Barnwell on any future recognition of Increment I deferred profit as such payments were already fully earned and received based on cash received by the Kukio Resort Land Development Partnerships as the Increment I lots were sold. • Approximately 1,000 acres of vacant leasehold land zoned conservation in the Kaupulehu Lot 4C area, which currently has no development potential without both a development agreement with the lessor and zoning reclassification. The lease terminates in December 2025. 25 Contract Drilling Segment Barnwell’s wholly-owned subsidiary, Water Resources International, Inc. (“Water Resources”), drills water and water monitoring wells and installs and repairs water pumping systems in Hawaii. Results of Operations Summary The net loss attributable to Barnwell for the three months ended December 31, 2024 totaled $1,917,000, a $1,253,000 decrease in operating results from net loss of $664,000 for the three months ended December 31, 2023. The following factors affected the results of operations for the three months ended December 31, 2024 as compared to the same period in the prior year: • A $997,000 decrease in oil and natural gas segment operating results, before income taxes, primarily attributable to a $613,000 non-cash ceiling test impairment in the current year period and due to decreases in natural gas, oil, and natural gas liquids prices and production in the current year period as compared to the same period in the prior year; • A $477,000 increase in negative impacts due to a $351,000 foreign currency loss recorded in the current period as compared to a $126,000 gain recorded in the prior year period due to the effects of foreign currency exchange rate changes on intercompany loans and advances as a result of changes in the U.S. dollar against the Canadian dollar; and • Partially offsetting these decreases was a $123,000 decrease in general and administrative expenses primarily due to a decrease in professional fees in the current year period as compared to the same period in the prior year and a $14,000 credit loss recovery recorded in the current year period as compared to a $37,000 credit loss expense in the prior year period. General Barnwell conducts operations in the U.S. and Canada. Consequently, Barnwell is subject to foreign currency translation and transaction gains and losses due to fluctuations of the exchange rates between the Canadian dollar and the U.S. dollar. Barnwell cannot accurately predict future fluctuations of the exchange rates and the impact of such fluctuations may be material from period to period. To date, we have not entered into foreign currency hedging transactions. Foreign currency gains or losses on intercompany loans and advances that are not considered long-term investments in nature because management intends to settle these intercompany balances in the future are included in our statements of operations. The average exchange rate of the Canadian dollar to the U.S. dollar decreased 3% in the three months ended December 31, 2024 as compared to the same period in the prior year, and the exchange rate of the Canadian dollar to the U.S. dollar decreased 6% at December 31, 2024 as compared to September 30, 2024. Accordingly, the assets, liabilities, stockholders’ equity and revenues and expenses of Barnwell’s subsidiaries operating in Canada have been adjusted to reflect the change in the exchange rates. Other comprehensive income and losses are not included in net earnings and net loss. Other comprehensive income due to foreign currency translation adjustments, net of taxes, for the three months ended December 31, 2024 was $93,000, a $63,000 change from other comprehensive income due to foreign currency translation adjustments, net of taxes, of $30,000 for the same period in the prior year. 26 There were no taxes on other comprehensive income due to foreign currency translation adjustments in the three months ended December 31, 2024 and 2023 due to a full valuation allowance on the related deferred tax assets. Oil and natural gas The following tables set forth Barnwell’s average prices per unit of production and net production volumes. Production amounts reported are net of royalties. Average Price Per Unit Three months ended Increase December 31, (Decrease) 2024 2023 $ % Natural Gas (Mcf)* $ 1.09 $ 1.82 $ (0.73) (40 %) Oil (Bbls)** $ 65.53 $ 67.08 $ (1.55) (2 %) Natural gas liquids (Bbls)** $ 26.98 $ 29.23 $ (2.25) (8 %) Net Production Three months ended Increase December 31, (Decrease) 2024 2023 Units % Natural Gas (Mcf)* 298,000 379,000 (81,000) (21 %) Oil (Bbls)** 48,000 58,000 (10,000) (17 %) Natural gas liquids (Bbls)** 15,000 18,000 (3,000) (17 %) _______________________________________ * Mcf = 1,000 cubic feet. Natural gas price per unit is net of pipeline charges. ** Bbl = stock tank barrel equivalent to 42 U.S. gallons The oil and natural gas segment generated an $116,000 operating loss before general and administrative expenses in the three months ended December 31, 2024, a decrease in operating results of $997,000 as compared to a $881,000 operating profit before general and administrative expenses generated during the same period of the prior year. 27 The following table sets forth Barnwell’s oil and natural gas segment operating (loss) profit before general and administrative expenses by geographic location: Three months ended December 31, 2024 2023 Operating (loss) profit (before general and administrative expenses) Canada $ 402,000 $ 536,000 United States (1) (518,000) 345,000 Total operating (loss) profit $ (116,000) $ 881,000 ________________________ (1) The operating loss for the United States for the three months ended December 31, 2024 includes a non-cash ceiling test impairment of $613,000. Oil and natural gas segment revenues decreased $1,233,000 (24%) for the three months ended December 31, 2024, as compared to the same period in the prior year, primarily due to decreases in oil, natural gas and natural gas liquids production, which decreased 17%, 21% and 17%, respectively, as compared to the same period in the prior year. The decrease was also attributable to decreases in natural gas, oil, and natural gas liquids prices, which decreased 40%, 2%, and 8%, respectively, as compared to the same period in the prior year. The decreases in production are primarily the result of natural declines as the wells age. The production decreases were also partially due to properties sold and certain wells that were temporarily shut-in for workovers. The Company's latest Canadian well drilled, which is 100%-owned and operated, started producing in mid-September 2024 and contributed approximately 107 net barrels of equivalent per day for a total of approximately 10,000 net barrels of equivalent during the three months ended December 31, 2024. In the quarter ended December 31, 2023, the Company amended certain of its Canadian purchase and sales contracts to change the sales price on 1,055 gross Mcf per day of the Canadian natural gas that it sold during the period from April 1, 2024 to October 31, 2024 to a fixed index price before differentials of $2.55 Canadian dollars per Mcf, with remaining volumes continuing to be sold at spot prices. In July 2024, the Company amended the sales price on 1,055 gross Mcf per day of the Canadian natural gas it will sell during the period from November 1, 2024 to March 31, 2025 to a fixed index price before differentials of $2.64 Canadian dollars per Mcf, with remaining volumes continuing to be sold at spot prices. This per day volume of natural gas under this fixed index price contract that will affect the period from January 1, 2025 to March 31, 2025, is equivalent to approximately 38% of Canadian natural gas gross production per day for the quarter ended December 31, 2024. These natural gas contracts were eligible for and elected as normal purchase and normal sales exception contracts and were thus excluded from derivative accounting. In July 2024, the Company amended certain of its Canadian purchase and sales contracts to change the sales price on 100 gross barrels per day of the Canadian oil that it sold during the period from August 1, 2024 to December 31, 2024 to a fixed index price before differentials of $79.00 per net barrel, with remaining volumes continuing to be sold at spot prices. This per day volume of oil under this fixed index price contract was equivalent to approximately 17% of Canadian oil gross production per day for the quarter ended December 31, 2024. These oil contracts were eligible for and elected as normal purchase and normal sales exception contracts and were thus excluded from derivative accounting. 28 Oil and natural gas segment operating expenses decreased $295,000 (11%) for the three months ended December 31, 2024, as compared to the same period in the prior year, due to lower production, partially offset by an increase in workovers and repair costs in the current year, as compared to the same period in the prior year. Oil and natural gas segment depletion decreased $554,000 (38%) for the three months ended December 31, 2024, as compared to the prior year period. The decrease was due to both a decrease in the depletion rate and a decrease in production. The depletion rate decreased as a result of a decrease in the depletable base from significant ceiling test impairments between the prior year period and the current year period. Contract drilling The contract drilling segment generated a $201,000 operating loss before general and administrative expenses in the three months ended December 31, 2024, an increase in operating results of $27,000 as compared to a $228,000 operating loss during the same period of the prior year. Contract drilling revenues and contract drilling costs decreased $450,000 (45%) and $449,000 (38%), respectively, for the three months ended December 31, 2024, as compared to the same period in the prior year. These decreases were primarily due to less activity in the current year period as compared to the same period in the prior year. The contract drilling segment worked on only one water well drilling job in the current year period, as compared to three water well drilling jobs and one pump installation job in the prior year period. In December 2024, the Company entered into an agreement with an independent third party for the sale of a contract drilling segment drilling rig and related ancillary equipment, which are all fully depreciated, and received a payment of $585,000 from the buyer. At December 31, 2024, the delivery of the drilling rig and the transfer of the legal title to the buyer had not yet occurred and therefore, the Company did not record a sale during the three months ended December 31, 2024. The payment received from the buyer was recognized as a deposit and recorded in “Other current liabilities” on the Company's Condensed Consolidated Balance Sheet at December 31, 2024. In February 2025, the drilling rig was delivered and the legal title was transferred to the buyer and as a result, the Company will recognize a gain, net of costs, on the sale of the drilling rig in the quarter ending March 31, 2025. The Company continues to investigate strategies regarding Water Resources' future including, but not limited to, other potential opportunities for a sale of its stock or assets. If no sale of its stock or assets along with contract backlog can be secured, Water Resources will likely be wound down after all contracts in backlog are completed and any remaining drilling rigs and equipment will be liquidated. Management estimates that its three remaining contracts in backlog at December 31, 2024 will be completed in March 2025 or soon thereafter, however it is uncertain as to when the contingent liability related to the required drilling of a monitoring well in satisfaction of a regulatory assessment will be settled (see Note 14 in the “Notes to Consolidated Financial Statements” of this report). 29 General and administrative expenses General and administrative expenses decreased $123,000 (9%) for the three months ended December 31, 2024, as compared to the same period in the prior year. The decrease was due to a decrease in professional fees in the current year period as compared to the same period in the prior year and a $14,000 credit loss recovery recorded in the current year period as compared to a $37,000 credit loss expense in the prior year period. Depletion, depreciation, and amortization Depletion, depreciation, and amortization decreased $583,000 (39%) for the three months ended December 31, 2024, as compared to the same period in the prior year, primarily due to both a decrease in the depletion rate and a decrease in production, as discussed in the “Oil and natural gas” section above. Impairment of assets Under the full cost method of accounting, the Company performs quarterly oil and natural gas ceiling test calculations. Changes in the 12-month rolling average first-day-of-the-month prices for oil, natural gas and natural gas liquids prices (except where prices are defined by contractual arrangements), the value of reserve additions as compared to the amount of capital expenditures to obtain them, and changes in production rates and estimated levels of reserves, future development costs and the market value of unproved properties, impact the determination of the maximum carrying value of oil and natural gas properties. During the three months ended December 31, 2024, the Company incurred a non-cash ceiling test impairment for our U.S. oil and natural gas properties of $613,000. There was no ceiling test impairment during the three months ended December 31, 2023. As discussed above, the ceiling test uses a 12-month historical rolling average first-day-of-the-month prices. As such, declines in the 12-month historical rolling average first-day-of-the-month prices used in our ceiling test calculation in future periods could result in impairment write-downs in future periods in the absence of any offsetting factors that are not currently known or projected. Foreign currency loss (gain) During the three months ended December 31, 2024 and 2023, there was a $351,000 foreign currency loss and a $126,000 foreign currency gain, respectively, due to the effects of foreign exchange rate changes on intercompany loans and advances as a result of changes in the exchange rate between the U.S. dollar against the Canadian dollar. The foreign currency losses or gains from intercompany balances are included in our our consolidated statement of operations as the intercompany balances were not considered long-term in nature because management estimates that these intercompany balances will be settled in the future. Income taxes Barnwell’s effective consolidated income tax rate for the three months ended December 31, 2024, after adjusting loss before income taxes for non-controlling interests, was nil, as compared to an effective income tax rate of (11)% for the three months ended December 31, 2023. 30 Consolidated taxes do not bear a customary relationship to pretax results due primarily to the fact that the Company is taxed separately in Canada based on Canadian source operations and in the U.S. based on consolidated operations, and essentially all deferred tax assets, net of relevant offsetting deferred tax liabilities, are not estimated to have a future benefit as tax credits or deductions. The Company operates two subsidiaries in Canada, one of which is a U.S. corporation operating as a branch in Canada that is treated as a non-resident for Canadian tax purposes and thus has operating results that cannot be offset against or combined with the other Canadian subsidiary that files as a resident for Canadian tax purposes. Income from our non-controlling interest in the Kukio Resort Land Development Partnerships is treated as non-unitary for state of Hawaii unitary filing purposes, thus unitary Hawaii losses provide limited sheltering of such non-unitary income. Income from our investment in the Oklahoma oil venture is 100% allocable to Oklahoma. As such, Barnwell receives no benefit from consolidated or unitary losses and, therefore, is subject to Oklahoma state taxes. Our operations in Texas are subject to a franchise tax assessed by the state of Texas, however no significant amounts have been incurred to date. Liquidity and Capital Resources At December 31, 2024, Barnwell had $642,000 in working capital. Barnwell’s primary sources of liquidity are cash on hand and cash flow generated by our oil and natural gas operations, as cash flow from our land investment segment, if any, are expected to be minimal. In recent years, the Company generated a significant amount of cash inflows from its land investment segment, however, there are no more lots available for sale in Increment I. In addition, no definitive development plans have been made by the developer of Increment II as of the date of this report and thus future cash inflows from the land investment segment are uncertain. Management estimates that cash flows from the sale of the contract drilling segment business or its operating assets may also provide some level of liquidity in the near-term. The Company will primarily be reliant upon sufficient operating cash inflows from its oil and natural gas segment, which in turn will be largely determined by prices and production levels. A certain level of oil and natural gas capital expenditures will be necessary to grow reserves and production or at a minimum replace declining production from aging wells. Such a level of oil and natural gas capital expenditures may require funding from external debt or equity sources that are not currently in place, but those sources may not be feasible or sufficient. Management estimates that, barring any significant unforeseen events, it is more likely than not that there is sufficient cash on hand, cash flows from contract drilling segment asset sales and cash flows from oil and natural gas segment operations to continue as a going concern for the twelve months from the filing of this report. However, the aforementioned factors will influence the Company’s liquidity beyond that twelve month period. Cash Flows Cash flows used in operating activities totaled $759,000 for the three months ended December 31, 2024, as compared to cash flows provided by operating activities of $1,375,000 for the three months ended December 31, 2023. This $2,134,000 change in operating cash flows was primarily due to changes in working capital and lower operating results for the oil and natural gas segment in the current year period as compared to the same period in the prior year. The adjustment in operating cash flows due to the effect of changes in current assets and liabilities was a decrease of $793,000 in the current year period as compared to an increase of $606,000 in the prior year period. Cash flows used in investing activities totaled $1,662,000 during the three months ended December 31, 2024, as compared to cash flows used in investing activities of $1,019,000 during the same period of the prior year. This $643,000 change in investing cash flows was due to $1,511,000 more in cash 31 paid for investments in oil and natural gas properties in the current year as compared to the same period in the prior year, partially offset by a $585,000 deposit received for a pending sale of a contract drilling segment drilling rig and $282,000 of proceeds from the sale of oil and natural gas properties in Canada in the current year period; there were no such amounts in the same period of the prior year. Oil and Natural Gas Capital Expenditures Barnwell’s oil and natural gas capital expenditures, including accrued capital expenditures and excluding additions and revisions to estimated asset retirement obligations, totaled $314,000 for the three months ended December 31, 2024, as compared to $495,000 for the same period in the prior year. Barnwell estimates that investments in oil and natural gas properties for fiscal 2025 will range from $1,500,000 to $3,000,000. This estimated amount may increase or decrease as dictated by cash flows and management's assessment of the oil and natural gas environment and prospects. Oil and Natural Gas Property Dispositions There were no significant oil and natural gas property dispositions during the three months ended December 31, 2024. The $282,000 of proceeds from sale of oil and natural gas properties included in the Condensed Consolidated Statement of Cash Flows for the three months ended December 31, 2024 represents proceeds that were credited to our cash in October 2024 from a sale of properties that closed in late September 2024.