10QSB 1 d41328e10qsb.htm FORM 10QSB e10qsb
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
     
þ   QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2006
     
o   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 0-7914
BASIC EARTH SCIENCE SYSTEMS, INC.
1801 Broadway, Suite 620
Denver, Colorado 80202-3835
Telephone (303) 296-3076
     
Incorporated in Delaware   IRS ID# 84-0592823
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes þ No o
Check whether the issuer is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions in Rule 12b-2 of the Exchange Act.
Large accelerated filer o      Accelerated filer o      Non-accelerated filer þ
Check whether the issuer is a shell Company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Shares of common stock outstanding on November 6, 2006: 16,805,487
 
 

 


 

BASIC EARTH SCIENCE SYSTEMS, INC.
FORM 10-QSB
INDEX
         
       
 
       
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    15  
 
       
Signatures
    15  
 
       
EXHIBITS
       
 Certification of Chief Executive Officer Pursuant to Section 302
 Certification of Chief Financial Officer Pursuant to Section 302
 Certification of Chief Executive Officer Pursuant to Section 906
 Certification of Chief Financial Officer Pursuant to Section 906

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PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Basic Earth Science Systems, Inc.
Consolidated Balance Sheets
Page 1 of 2
                 
    September 30     March 31  
    2006     2006  
    (Unaudited)     (Audited)  
Assets
               
Current assets
               
Cash and cash equivalents
  $ 1,284,000     $ 78,000  
Accounts receivable
               
Oil and gas sales
    908,000       913,000  
Joint interest and other receivables
    354,000       472,000  
Less: Allowance for doubtful accounts
    (70,000 )     (70,000 )
Other current assets
    632,000       297,000  
 
           
 
               
Total current assets
    3,108,000       1,690,000  
 
           
 
               
Property and equipment
               
Oil and gas property (full cost method)
    27,743,000       27,099,000  
Support equipment
    378,000       368,000  
 
           
 
               
 
    28,121,000       27,467,000  
Accumulated depreciation and depletion – Full cost pool
    (17,512,000 )     (17,211,000 )
Accumulated depreciation – Support equipment
    (311,000 )     (314,000 )
 
           
 
               
Net property and equipment
    10,298,000       9,942,000  
Other non-current assets
    206,000       218,000  
 
           
 
               
Total non-current assets
    10,504,000       10,160,000  
 
           
 
               
Total Assets
  $ 13,612,000     $ 11,850,000  
 
           
See accompanying notes to consolidated financial statements.

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Basic Earth Science Systems, Inc.
Consolidated Balance Sheets
Page 2 of 2
                 
    September 30     March 31  
    2006     2006  
    (Unaudited)     (Audited)  
Liabilities
               
Current liabilities
               
Accounts payable
  $ 375,000     $ 389,000  
Accrued liabilities
    1,394,000       1,084,000  
 
           
 
               
Total current liabilities
    1,769,000       1,473,000  
 
           
 
               
Long-term liabilities
               
Long-term debt
          445,000  
Deferred tax liability
    613,000        
Asset retirement obligation
    1,170,000       1,372,000  
 
           
 
               
Total long-term liabilities
    1,783,000       1,817,000  
 
           
 
               
Shareholders’ Equity
               
Preferred stock, $.001 par value Authorized - 3,000,000 shares Issued - 0 shares
           
Common stock, $.001 par value 32,000,000 shares authorized; 17,154,752 shares issued at September 30 and 17,129,752 at March 31
    17,000       17,000  
Additional paid-in capital
    22,713,000       22,710,000  
Accumulated deficit
    (12,647,000 )     (14,144,000 )
Treasury stock (349,265 shares at September 30 and March 31); at cost
    (23,000 )     (23,000 )
 
           
 
               
Total shareholders’ equity
    10,060,000       8,560,000  
 
           
 
               
Total Liabilities and Shareholders’ Equity
  $ 13,612,000     $ 11,850,000  
 
           
See accompanying notes to consolidated financial statements.

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Basic Earth Science Systems, Inc.
Consolidated Statements of Operations
(Unaudited)
                                 
    Six Months Ended     Quarters Ended  
    September 30     September 30  
    2006     2005     2006     2005  
Revenue
                               
Oil and gas sales
  $ 4,021,000     $ 3,158,000     $ 2,048,000     $ 1,633,000  
Well service revenue
    25,000       17,000       14,000       8,000  
 
                       
 
                               
Total revenue
    4,046,000       3,175,000       2,062,000       1,641,000  
 
                       
 
                               
Expenses
                               
Oil and gas production
    908,000       1,113,000       438,000       601,000  
Production tax
    265,000       234,000       143,000       123,000  
Well service expenses
    28,000       19,000       16,000       9,000  
Depreciation and depletion
    305,000       295,000       153,000       101,000  
Accretion of asset retirement obligation
    39,000       25,000       14,000       11,000  
Asset retirement expense
    94,000       51,000       80,000       47,000  
General and administrative
    273,000       258,000       123,000       121,000  
 
                       
 
                               
Total operating expenses
    1,912,000       1,995,000       967,000       1,013,000  
 
                       
 
                               
Income from operations
    2,134,000       1,180,000       1,095,000       628,000  
 
                       
Other income (expense)
                               
Interest and other income
    9,000       24,000       8,000       16,000  
Interest and other expenses
    (6,000 )                  
 
                       
 
                               
Total other income
    3,000       24,000       8,000       16,000  
 
                       
 
                               
Income before income taxes
    2,137,000       1,204,000       1,103,000       644,000  
Income tax expense
    27,000       13,000       10,000        
Provision for deferred taxes (see Note 1)
    613,000             313,000        
 
                       
 
                               
Net income
  $ 1,497,000     $ 1,191,000     $ 780,000     $ 644,000  
 
                       
 
                               
Weighted average common shares outstanding:
                               
Basic
    16,789,913       16,701,115       16,799,237       16,739,998  
Diluted
    17,129,038       17,121,445       17,128,125       17,127,407  
 
                               
Per share amounts:
                               
Basic
  $ .089     $ .071     $ .046     $ .038  
 
                       
 
                               
Diluted
  $ .087     $ .070     $ .045     $ .038  
 
                       
See accompanying notes to consolidated financial statements.

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Basic Earth Science Systems, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
                 
    Six Months Ended  
    September 30  
    2006     2005  
Cash flows from operating activities:
               
Net income
  $ 1,497,000     $ 1,191,000  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and depletion
    305,000       295,000  
Deferred tax liability
    613,000        
Accretion of asset retirement obligation
    39,000       25,000  
Change in:
               
Accounts receivable, net
    123,000       (331,000 )
Other assets
    (327,000 )     (15,000 )
Accounts payable and accrued liabilities
    55,000       536,000  
Change in asset retirement obligation
          (6,000 )
Other
    4,000       3,000  
 
           
 
               
Net cash provided by operating activities
    2,309,000       1,698,000  
 
           
 
               
Cash flows from investing activities:
               
Capital expenditures
               
Oil and gas property
    (808,000 )     (998,000 )
Support equipment
    (21,000 )     (5,000 )
Purchase of lease and well equipment inventory
    (5,000 )     (44,000 )
Insurance settlement
    161,000        
Proceeds from sale of oil and gas property and equipment
          14,000  
Proceeds from sale of lease and well equipment inventory
    12,000       6,000  
Proceeds from sale of support equipment
          1,000  
 
           
 
               
Net cash used in investing activities
    (661,000 )     (1,026,000 )
 
           
 
               
Cash flows from financing activities:
               
Proceeds from exercise of common stock options
    3,000       8,000  
Proceeds from borrowing
    565,000        
Long-term debt payments
    (1,010,000 )      
 
           
 
               
Net cash provided by (used in) financing activities
    (442,000 )     8,000  
 
           
 
               
Cash and cash equivalents:
               
Net increase
    1,206,000       680,000  
Balance at beginning of period
    78,000       892,000  
 
           
 
               
Balance at end of period
  $ 1,284,000     $ 1,572,000  
 
           
 
               
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 6,000        
See accompanying notes to consolidated financial statements.

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Basic Earth Science Systems, Inc.
Notes to Consolidated Financial Statements
September 30, 2006
The accompanying interim financial statements of Basic Earth Science Systems, Inc. (Basic or the Company) are unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results for the interim period.
The financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Management believes the disclosures made are adequate to make the information not misleading and suggests that these condensed financial statements be read in conjunction with the financial statements and notes hereto included in Basic’s Form 10-KSB for the year ended March 31, 2006.
Forward-Looking Statements
This Form 10-QSB includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact included in this Form 10-QSB, including, without limitation, the statements under both “Notes To Consolidated Financial Statements” and “Item 2. Management’s Discussion and Analysis or Plan of Operation” located elsewhere herein regarding the Company’s financial position and liquidity, the amount of and its ability to make debt service payments, its strategies, financial instruments, and other matters, are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the Company’s expectations are disclosed in this Form 10-QSB in conjunction with the forward-looking statements included in this Form 10-QSB.
1. Summary of Significant Accounting Policies
Cash and Cash Equivalents. For purposes of the Consolidated Balance Sheets and Statements of Cash Flows, Basic considers all highly liquid investments with a maturity of ninety days or less when purchased to be cash equivalents.
Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. There are many factors, including global events, which may influence the production, processing, marketing, and valuation of crude oil and natural gas. A reduction in the valuation of oil and gas properties resulting from declining prices or production could adversely impact depletion rates and ceiling test limitations.
Income Taxes. The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. Accordingly, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse.

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During the quarter ended September 30, 2006 the Company recorded income tax expense of $323,000. This includes a current year expense of $10,000 and a deferred tax provision of $313,000. Projections of future income taxes and their timing require significant estimates with respect to future operating results. Accordingly, the net deferred tax liability is continually re-evaluated and numerous estimates are revised over time. As such, the net deferred tax liability may change significantly as more information and data is gathered with respect to such events as changes in commodity prices, their effect on the estimate of oil and gas reserves, and the depletion of these long-lived reserves.
Reclassifications. Certain prior year amounts may have been reclassified to conform to current year presentation.
Item 2.
Management’s Discussion and Analysis and Plan of Operation
LIQUIDITY AND CAPITAL RESOURCES
Liquidity Outlook. The Company’s primary source of funding is the net cash flow from the sale of its oil and gas production. The profitability and cash flow generated by the Company’s operations in any particular accounting period will be directly related to: (a) the volume of oil and gas produced and sold, (b) the average realized prices for oil and gas sold, and (c) lifting costs. In addition, as mentioned in the “Bank Debt” section below, Basic has $4,000,000 of borrowing capacity as of November 6, 2006.
Working Capital. At September 30, 2006 the Company had a working capital surplus of $1,339,000 (a current ratio of 1.76:1) compared to a working capital surplus at March 31, 2006 of $217,000 (a current ratio of 1.15:1).
EBITDA. The Company’s earnings before interest, taxes, depreciation, depletion and amortization (EBITDA) increased 63%, from $1,524,000 for the six months ended September 30, 2005 to $2,487,000 for the six months ended September 30, 2006. For the quarter ended September 30, 2006 EBITDA increased 68%, from $756,000 in the 2005 period to $1,270,000 in 2006. EBITDA is not a GAAP measure of operating performance. However, this non-GAAP performance measure can be used to compare the Company’s performance with other companies in the industry that make a similar disclosure. But, it should be noted that, because EBITDA is not a GAAP measure, it may not necessarily be exactly comparable to similarly titled measures employed by other companies. In addition, investors should not consider this measure in isolation or as a substitute for operating income, or any other measure for determining the Company’s operating performance that is calculated in accordance with GAAP. A reconciliation between EBITDA and net income is provided in the table below:
                                 
    Six Months Ended     Quarters Ended  
    September 30     September 30  
    2006     2005     2006     2005  
Net income
  $ 1,497,000     $ 1,191,000     $ 780,000     $ 644,000  
Add back:
                               
Interest expense
    6,000                    
Accretion of asset retirement obligation
    39,000       25,000       14,000       11,000  
Depreciation and depletion
    305,000       295,000       153,000       101,000  
Income tax expense and provision for deferred taxes
    640,000       13,000       323,000        
 
                       
 
                               
EBITDA
  $ 2,487,000     $ 1,524,000     $ 1,270,000     $ 756,000  
 
                       

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Cash Flow. Net cash provided by operating activities rose 36% from $1,698,000 in the six months ended September 30, 2005 (2005) to $2,309,000 in the six months ended September 30, 2006 (2006). This increase was primarily due to a combination of improved oil and gas production, higher oil prices and lower operating expenses.
Net cash used in investing activities decreased 36% from $1,026,000 in 2005 to $661,000 in 2006. Capital expenditures related to oil and gas property investments declined 19% from $998,000 in 2005 to $808,000 in 2006.
Bank Debt. The Company’s current banking relationship is with American National Bank (the Bank), located in Denver, Colorado. Basic currently has a $20,000,000 line of credit with a borrowing base of $4,000,000. The Company is charged interest at prime plus one-quarter of one percent (0.25%) and an Unused Commitment fee of one-half of one percent (0.50%) per annum. During the six months ended September 30, 2006 Basic utilized the credit facility to fund its short-term working capital needs.
Hedging. The Company did not hedge any of its production during the six months ended September 30, 2006 and at September 30, 2006 the Company had no contracts in place to hedge future production. The Company does monitor the futures market and, in the future, may participate in hedging opportunities that the Company views as favorable.
CAPITAL EXPENDITURES
During the quarter ended September 30, 2006, the Company spent approximately $217,000 on various projects. When combined with first quarter investments, the Company has deployed $808,000 through the first six months of the current fiscal year. This compares to $593,000 and $998,000 for the quarter and six months ended September 30, 2005, respectively. In the current year, nearly 100 percent of expenditures have been dedicated to drilling or recompletions while in the prior year 40 percent was spent on leasehold and promotion costs with only 60 percent deployed on drilling and recompletions.
Through the first two quarters of fiscal 2007, approximately $430,000 (53 percent) of expenditures were dedicated to the Company’s Banks prospect in McKenzie County, North Dakota. Recompletion efforts in Basic’s Indian Hills project accounted for an additional $128,000 (16%) while other miscellaneous recompletion efforts – primarily on non-operated properties – consumed $100,000 (12%).
The Company is continually evaluating drilling and acquisition opportunities for possible participation. Typically, at any one time, several opportunities are in various stages of due diligence. The Company’s policy is to not disclose the specifics of a project or prospect, nor to speculate on such ventures, until such time as those various opportunities are finalized and undertaken. Basic cautions that the absence of news and/or press releases should not be interpreted as a lack of development or activity.
Divestitures/Abandonments
During the quarter just ended the Company plugged and abandoned three shut-in or marginally producing wells; two in Montana and one in Texas.

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RESULTS OF OPERATIONS
Six Months Ended September 30, 2006 Compared to Six Months Ended September 30, 2005
Overview. Net income for the six months ended September 30, 2006 (2006) was $1,497,000 compared to net income of $1,191,000 for the six months ended September 30, 2005 (2005), an increase of 26%. In turn, EBITDA increased 63%, from $1,524,000 in 2005 to $2,487,000 in 2006. The dramatic difference between the increases in net income and EBITDA was primarily due to a $613,000 provision for deferred income taxes recorded in 2006.
Revenues. Oil and gas sales revenue increased $863,000 (27%) in 2006 over 2005. Oil sales revenue increased $820,000 (31%) as a result of both higher sales volumes and prices. Gas sales revenue increased $43,000 (9%) in 2006 over 2005. A positive variance from higher sales volumes was reduced by a negative variance from lower natural gas prices.
Volumes and Prices. As a result of new production, oil sales volumes rose 10%, from 48,900 barrels in 2005 to 54,000 barrels in 2006 while there was an 18% jump in the average price per barrel from $54.72 in 2005 to $64.69 in 2006. Also because of new production, gas sales volumes increased 10%, from 74.1 million cubic feet (MMcf) in 2005 to 81.6 MMcf in 2006, while the average price per Mcf dropped 1%, from $6.55 in 2005 to $6.47 in 2006. On an equivalent barrel (BOE) basis, sales volumes increased 10% from 61,200 BOE in 2005 to 67,600 BOE in 2006.
Expenses. Oil and gas production expense decreased $205,000 (18%) in 2006 from 2005. Oil and gas production expense is comprised of two components: routine lease operating expenses and workovers. Routine expenses typically include such items as daily well maintenance, utilities, fuel, water disposal and minor surface equipment repairs. Workovers, on the other hand, which primarily include downhole repairs, are generally random in nature. Although workovers are expected, they can be much more frequent in some wells than others and their cost can be significant. Therefore, workovers account for more dramatic fluctuations in oil and gas production expense from period to period.
Routine lease operating expense increased $97,000 (15%) from $628,000 in 2005 to $725,000 in 2006 while workover expense dropped $302,000 (62%) from $485,000 in 2005 to $183,000 in 2006. Routine lease operating expense per BOE increased 4% from $10.26 in 2005 to $10.72 in 2006 while workover expense per BOE declined 66% from $7.91 in 2005 to $2.72 in 2006.
Production taxes, which are generally a percentage of sales revenue, increased $31,000 (13%) in 2006 over 2005. Production taxes, as a percent of sales revenue actually declined from 7.4 percent in 2005 to 6.6 percent in 2006. This percentage drop can be attributed to Montana tax incentives applicable to new production. The overall lifting cost per BOE declined 21% from $22.00 in 2005 to $17.36 in 2006.
Depreciation and depletion expense increased $10,000 (3%) in 2006 over 2005. The 2005 period was negatively impacted by an $85,000 ceiling limitation impairment charge applicable to the Company’s Canadian operations.
General and administrative expense increased $15,000 (6%) in 2006 over 2005 primarily as a result of an increase in consulting fees. Due to the increase in BOE sales volumes, G&A expense per BOE decreased 4% from $4.23 in 2005 to $4.05 in 2006. As a percent of total sales revenue, G&A expense dropped from 8.2% in 2005 to 6.8% in 2006.

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Quarter Ended September 30, 2006 Compared to Quarter Ended September 30, 2005
Overview. Net income for the quarter ended September 30, 2006 (2006) was $780,000 compared to net income of $644,000 for the quarter ended September 30, 2005 (2005), an increase of 21%. In turn, EBITDA increased 68%, from $756,000 in 2005 to $1,270,000 in 2006. The difference between the increases in net income and EBITDA was primarily due to a $313,000 provision for deferred income taxes recorded in 2006.
Revenues. Oil and gas sales revenue increased $415,000 (25%) in 2006 over 2005. Oil sales revenue increased $376,000 (27%) as a result of both higher sales volumes and prices. Gas sales revenue increased $39,000 (16%) in 2006 over 2005. Again, a positive variance from higher sales volumes was reduced by a negative variance from lower natural gas prices.
Volumes and Prices. As a result of new production, oil sales volumes rose 16%, from 23,100 barrels in 2005 to 26,900 barrels in 2006 while there was a 9% increase in the average price per barrel from $60.14 in 2005 to $65.56 in 2006. Also because of new production, gas sales volumes increased 24%, from 35.6 MMcf in 2005 to 44.1 MMcf in 2006, while the average price per Mcf dropped 6%, from $6.94 in 2005 to $6.49 in 2006. On an equivalent barrel (BOE) basis, sales volumes increased 18% from 29,000 BOE in 2005 to 34,200 BOE in 2006.
Expenses. Oil and gas production expense decreased $163,000 (27%) in 2006 from 2005. Routine lease operating expense increased $37,000 (11%) from $322,000 in 2005 to $359,000 in 2006 while workover expense dropped $200,000 (72%) from $279,000 in 2005 to $79,000 in 2006. Again as a result of an increase in BOE sales volumes, routine lease operating expense per BOE decreased 5% from $11.09 in 2005 to $10.49 in 2006 while workover expense per BOE declined 76% from $9.61 in 2005 to $2.30 in 2006.
Production taxes, which are typically a percentage of sales revenue, increased $20,000 (16%) in 2006 over 2005. Production taxes, as a percent of sales revenue declined from 7.5 percent in 2005 to 7.0 percent in 2006. The overall lifting cost per BOE dropped 32% from $24.93 in 2005 to $16.98 in 2006.
Depreciation and depletion expense increased $52,000 (51%) in 2006 over 2005 as a result of an increases in the full cost pool and the depletion rate.
G&A expense increased $2,000 (2%) in 2006 over 2005. As a result of the increase in BOE sales volumes, G&A expense per BOE decreased 14% from $4.19 in 2005 to $3.60 in 2006. G&A expense as a percent of total sales revenue dropped from 7.4% in 2005 to 6.0% in 2006.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires Company management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances. Although actual results may differ from these estimates under different assumptions or conditions, management believes that its estimates are reasonable and that actual results will not vary significantly from the estimated amounts. The Company believes the following accounting policies and estimates are critical in the preparation of its consolidated financial statements: the carrying value of its oil and gas property, the accounting for oil and gas reserves, the estimate of its asset retirement obligations, and the estimate of deferred income taxes.

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Oil and Gas Property. Basic utilizes the full cost method of accounting for costs related to its oil and gas property. Capitalized costs included in the full cost pool are depleted on an aggregate basis over the estimated lives of the properties using the units-of-production method. These capitalized costs are subject to a ceiling test that limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved oil and gas reserves discounted at 10 percent plus the lower of cost or market value of unproved properties less any associated tax effects. If the full cost pool of capitalized oil and gas property costs exceeds the ceiling, Basic will record a ceiling test write-down to the extent of such excess. This write-down is a non-cash charge to earnings. If required, it reduces earnings and impacts shareholders’ equity in the period of occurrence and results in lower depreciation and depletion in future periods. The write-down may not be reversed in future periods, even though higher oil and gas prices may subsequently increase the ceiling.
Oil and Gas Reserves. The determination of depreciation and depletion expense as well as ceiling test write-downs, if any, related to the recorded value of the Company’s oil and gas properties are highly dependent on the estimates of the proved oil and gas reserves attributable to these properties. Oil and gas reserves include proved reserves that represent estimated quantities of crude oil and natural gas which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. There are numerous uncertainties inherent in estimating oil and gas reserves and their values, including many factors beyond Basic’s control. Accordingly, reserve estimates are often different from the quantities of oil and gas ultimately recovered and the corresponding lifting costs associated with the recovery of these reserves. Ninety-three percent of Basic’s reported oil and gas reserves at March 31, 2006 and September 30, 2006 are based on estimates prepared by an independent petroleum engineering firm. The remaining seven percent of the Company’s oil and gas reserves were prepared in-house.
Asset Retirement Obligations. The Company has significant obligations related to the plugging and abandonment of its oil and gas wells, the removal of equipment and facilities, and returning the land to its original condition. SFAS No. 143, “Accounting for Asset Retirement Obligations” requires that Basic estimate the future cost of this obligation, discount this cost to its present value, and record a corresponding asset and liability in its Consolidated Balance Sheets. The values ultimately derived are based on many significant estimates, including the ultimate expected cost of the obligation, the expected future date of the required cash expenditures, and inflation rates. The nature of these estimates requires management to make judgments based on historical experience and future expectations related to timing. The Company reviews the estimate of its future asset retirement obligations quarterly. These quarterly reviews may require revisions to these estimates based on such things as changes to cost estimates or the timing of future cash outlays. Any such changes that result in upward or downward revisions in the estimated obligation will result in an adjustment to the related capitalized asset and corresponding liability on a prospective basis.
Deferred Taxes. Deferred income taxes have been determined in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” During the quarter ended September 30, 2006 Basic recorded income tax expense comprised of a $10,000 current expense and a deferred tax provision of $313,000. Projections of future income taxes and their timing require significant estimates with respect to future operating results. Accordingly, the net deferred tax liability is continually re-evaluated and numerous estimates are revised over time. As such, the net deferred tax liability may change significantly as more information and data is gathered with respect to such events as changes in commodity prices, their effect on the estimate of oil and gas reserves, and the depletion of these long-lived reserves.

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Liquids and Natural Gas Production, Sales Price and Production Costs
The following table shows selected financial information for the six months and quarter ended September 30 in the current and prior year. Certain prior year amounts may have been reclassified to conform to current year presentation.
                                 
    Six Months Ended     Quarters Ended  
    September 30     September 30  
    2006     2005     2006     2005  
Sales volume
                               
Oil (barrels)
    54,000       48,900       26,900       23,100  
Gas (mcf)
    81,600       74,100       44,100       35,600  
 
                               
Revenue
                               
Oil
  $ 3,493,000     $ 2,673,000     $ 1,762,000     $ 1,386,000  
Gas
    528,000       485,000       286,000       247,000  
 
                       
 
                               
 
    4,021,000       3,158,000       2,048,000       1,633,000  
Total production expense1
    1,173,000       1,347,000       581,000       724,000  
 
                       
 
                               
Gross profit
  $ 2,848,000     $ 1,811,000     $ 1,467,000     $ 909,000  
 
                       
 
                               
Depletion expense4
  $ 301,000     $ 206,000     $ 151,000     $ 99,000  
 
                               
Average sales price2
                               
Oil (per barrel)
  $ 64.69     $ 54.72     $ 65.56     $ 60.14  
Gas (per mcf)
  $ 6.47     $ 6.55     $ 6.49     $ 6.94  
Average production expense1,2,3
  $ 17.36     $ 22.00     $ 16.98     $ 24.93  
Average gross profit2,3
  $ 42.13     $ 29.61     $ 42.87     $ 31.43  
Average depletion expense2,3
  $ 4.45     $ 3.36     $ 4.41     $ 3.42  
Average general and administrative expense2,3
  $ 4.05     $ 4.23     $ 3.60     $ 4.19  
 
1   Operating expenses, including production tax
 
2   Averages calculated based upon non-rounded figures
 
3   Per equivalent barrel (6 Mcf of gas is equivalent to 1 barrel of oil)
 
4   Excluding impairment expense related to Canadian full cost pool ceiling limitation

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ITEM 3.
Controls and Procedures
The Company maintains a system of disclosure controls and procedures that are designed for the purpose of ensuring that information required to be disclosed in its SEC reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
As of September 30, 2006 Basic carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, it was concluded that the Company’s disclosure controls and procedures are effective for the purposes discussed above.
There have been no changes in the Company’s internal control over financial reporting that occurred during the Company’s second quarter of the current fiscal year that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
During the quarter ended September 30, 2006 there were no meetings of Basic’s shareholders nor were any matters submitted to a vote of security holders through the solicitation of consents, proxies or otherwise.
Item 5. Other Information
None.

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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
     
Exhibit No.   Document
 
31.1
  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Ray Singleton, Chief Executive Officer).
 
   
31.2
  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (David Flake, Chief Financial Officer).
 
   
32.1
  Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Ray Singleton, Chief Executive Officer).
 
   
32.2
  Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (David Flake, Chief Financial Officer).
Other exhibits and schedules are omitted because they are not applicable, not required or the information is included in the financial statements or notes thereto.
(b) Reports on Form 8-K
     
Date   Document
 
September 13, 2006
  The Company announced that it had commenced drilling operations on the Table Top Unit #1, the first well in the Christmas Meadows prospect in Summit County, Utah.
 
   
September 29, 2006
  The Company reported plans to re-enter the State #16-1H well in McKenzie County, North Dakota in order to drill two horizontal laterals in the Rival formation.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed by the following authorized persons on behalf of Basic.
     
BASIC EARTH SCIENCE SYSTEMS, INC.
 
   
/s/ Ray Singleton
 
Ray Singleton
   
President
   
 
   
/s/ David Flake
 
David Flake
   
Chief Financial Officer and
   
Principal Accounting Officer
   
Date: November 6, 2006
   

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EXHIBIT INDEX
     
Exhibit No.   Document
 
   
31.1
  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Ray Singleton, Chief Executive Officer).
 
   
31.2
  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (David Flake, Chief Financial Officer).
 
   
32.1
  Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Ray Singleton, Chief Executive Officer).
 
   
32.2
  Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (David Flake, Chief Financial Officer).