NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Nature of Operations
Mexco
Energy Corporation (a Colorado corporation) and its wholly owned subsidiaries, Forman Energy Corporation (a New York corporation),
Southwest Texas Disposal Corporation (a Texas corporation) and TBO Oil & Gas, LLC (a Texas limited liability company) (collectively,
the “Company”) are engaged in the exploration, development and production of natural gas, crude oil, condensate and
natural gas liquids (“NGLs”). Most of the Company’s oil and gas interests are centered in the Permian Basin
of West Texas; however, the Company owns producing properties and undeveloped acreage in thirteen states. Although the Company’s
oil and gas interests predominately are operated by others, the Company operates three wells on a lease in which it owns a 100%
working interest.
2.
Basis of Presentation and Significant Accounting Policies
Principles
of Consolidation
. The consolidated financial statements include the accounts of Mexco Energy Corporation and its wholly owned
subsidiaries. All significant intercompany balances and transactions associated with the consolidated operations have been eliminated.
Estimates
and Assumptions
. In preparing financial statements in conformity with accounting principles generally accepted in the United
States of America (“GAAP”), management is required to make informed judgments, estimates and assumptions that affect
the reported amounts of assets and liabilities as of the date of the financial statements and affect the reported amounts of revenues
and expenses during the reporting period. In addition, significant estimates are used in determining proved oil and gas reserves.
Although management believes its estimates and assumptions are reasonable, actual results may differ materially from those estimates.
The estimate of the Company’s oil and natural gas reserves, which is used to compute depreciation, depletion, amortization
and impairment of oil and gas properties, is the most significant of the estimates and assumptions that affect these reported
results.
Interim
Financial Statements.
In the opinion of management, the accompanying unaudited consolidated financial statements contain all
adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position of the Company as
of June 30, 2018, and the results of its operations and cash flows for the interim periods ended June 30, 2018 and 2017. The consolidated
financial statements as of June 30, 2018 and for the three month periods ended June 30, 2018 and 2017 are unaudited. The consolidated
balance sheet as of March 31, 2018 was derived from the audited balance sheet filed in the Company’s 2018 annual report
on Form 10-K filed with the Securities and Exchange Commission (“SEC”). The results of operations for the periods
presented are not necessarily indicative of the results to be expected for a full year. The accounting policies followed by the
Company are set forth in more detail in Note 2 of the “Notes to Consolidated Financial Statements” in the Form 10-K.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been condensed or omitted in this Form 10-Q pursuant to the
rules and regulations of the SEC. However, the disclosures herein are adequate to make the information presented not misleading.
It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements
and notes thereto included in the Form 10-K.
Revenue
from Contracts with Customers.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standards Update (“ASU”) No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
. The
amendments in this update are effective for fiscal years and interim periods within those years beginning after December 15,
2017 and supersedes any previous revenue recognition guidance. On April 1, 2018 we adopted ASU 2014-09 using the modified
retrospective approach which only applies to contracts that were not completed as of the date of initial application.
Recognition of revenue involves a five step approach including identifying the contract, identifying the separate performance
obligations, determining the transaction price, allocating the price to the performance obligations and recognizing revenue
as the obligations are satisfied.
Adoption
of this new standard did not have an impact on the Company’s financial statements. When comparing the Company’s historical
revenue recognition to the newly applied revenue recognition under Topic 606, there was no change to the amount or timing of revenue
recognized. Therefore, no quantitative adjustment was required to be made to the prior periods presented in the unaudited consolidated
financial statements after the adoption. Upon adoption the Company had not altered its existing information technology and internal
controls outside of the contract review processes in order to identify impacts of future revenue contracts the Company may enter
into.
Accounting
Policy - Revenues from our royalty and non-operated working interest properties are recorded under the cash receipts approach
as directly received from the remitters’ statement accompanying the revenue check. Since the revenue checks are generally
received two to four months after the production month, the Company accrues for revenue earned but not received by estimating
production volumes and product prices. Any identified differences between its revenue estimates and actual revenue received historically
have not been significant.
The
Company does not disclose the value of unsatisfied performance obligations under its contracts with customers as it applies the
practical exemption in accordance with ASC 606. The exemption, as described in ASC 606-10-50-14(a), applies to variable consideration
that is recognized as control of the product is transferred to the customer. Since each unit of product represents a separate
performance obligation, future volumes are wholly unsatisfied and disclosure of the transaction price allocated to remaining performance
obligations is not required.
3.
Asset Retirement Obligations
The
Company’s asset retirement obligations (“ARO”) relate to the plugging of wells, the removal of facilities and
equipment, and site restoration on oil and gas properties. The fair value of a liability for an ARO is recorded in the period
in which it is initially incurred, discounted to its present value using the credit adjusted risk-free interest rate, and a corresponding
amount capitalized by increasing the carrying amount of the related long-lived asset. The liability is accreted each period, and
the capitalized cost is depreciated over the useful life of the related asset. The ARO is included on the consolidated balance
sheets with the current portion being included in the accounts payable and other accrued expenses.
The
following table provides a rollforward of the AROs for the first three months of fiscal 2019:
|
Carrying amount of asset retirement obligations as of April 1, 2018
|
|
$
|
862,553
|
|
|
Liabilities incurred
|
|
|
1,743
|
|
|
Liabilities settled
|
|
|
(6,328
|
)
|
|
Accretion expense
|
|
|
3,635
|
|
|
Carrying amount of asset retirement obligations as of June 30, 2018
|
|
|
861,605
|
|
|
Less: Current portion
|
|
|
10,000
|
|
|
Non-Current asset retirement obligation
|
|
$
|
851,605
|
|
4.
Credit Facility
The
Company has a loan agreement with Bank of America, N.A. (the “Agreement”)(“Bank”), which provided for
a credit facility of $5,570,000 with no monthly commitment reductions and a borrowing base to be evaluated on July 30 and January
1 of each year or at any additional time in the Bank’s discretion. The borrowing base also resets to the extent the Company
sells or otherwise disposes of any of its oil and gas properties as the Company is required to pay 100% of such net proceeds to
the lender resulting in a permanent reduction of the borrowing base unless prior approval by Bank states otherwise. As of June
30, 2018, the borrowing base was set at $750,000. Subsequently, the borrowing base was evaluated on July 31, 2018 and set at $525,000.
The
Agreement was renewed eleven times with the eleventh amendment effective as of March 8, 2017 with a maturity date of November
30, 2020. Under such renewal agreement, interest on the facility accrues at an annual rate equal to the British Bankers Association
London Interbank Offered Rate (“BBA LIBOR”) daily floating rate, plus 3.0 percentage points, which was 5.10% on June
30, 2018. Interest on the outstanding amount under the credit agreement is payable monthly. There was no availability of this
facility at June 30, 2018. No principal payments are anticipated to be required through November 30, 2020. Amounts borrowed under
the Agreement are collateralized by the common stock of the Company’s wholly owned subsidiaries and substantially all of
the Company’s oil and gas properties.
The
Agreement contains customary covenants for credit facilities of this type including limitations on change in control, disposition
of assets, mergers and reorganizations. The Company is also obligated to meet certain financial covenants under the Agreement
and requires minimum earnings before interest, taxes, depreciation and amortization (“EBITDA”) of $650,000 for each
trailing four fiscal quarters and minimum interest coverage ratios (EBITDA/Interest Expense) of 2.00 to 1.00 for each quarter.
The Company is in compliance with all covenants as of June 30, 2018 and believes it will remain in compliance for the next fiscal
year.
The
amended Agreement allows for up to $500,000 of the facility to be used for outstanding letters of credits. As of June 30, 2018,
one letter of credit for $50,000, in lieu of a plugging bond with the Texas Railroad Commission covering the properties the Company
operates is outstanding under the facility. The Company will pay a fee in an amount equal to 1 percent (1.0%) per annum of the
outstanding undrawn amount of each standby letter of credit, payable monthly in arrears, on the basis of the face amount outstanding
on the day the fee is calculated. This letter of credit renews annually and was subsequently renewed on July 20, 2018 with an
amended amount of $25,000.
In
addition, this Agreement prohibits the Company from paying cash dividends on its common stock. The Agreement does grant the Company
permission to enter into hedge agreements however, it is under no obligation to do so.
The
balance outstanding on the line of credit as of June 30, 2018 was $500,000. The following table is a summary of activity on the
Bank of America, N.A. line of credit for the three months ended June 30, 2018:
|
|
|
Principal
|
|
|
Balance at April 1, 2018:
|
|
$
|
700,000
|
|
|
Borrowings
|
|
|
-
|
|
|
Repayments
|
|
|
(200,000
|
)
|
|
Balance at June 30, 2018:
|
|
$
|
500,000
|
|
5.
Income Taxes
A
valuation allowance for deferred tax assets, including net operating losses, is recognized when it is more likely than not that
some or all of the benefit from the deferred tax asset will not be realized. To assess that likelihood, we use estimates and judgment
regarding our future taxable income, and we consider the tax consequences in the jurisdiction where such taxable income is generated,
to determine whether a valuation allowance is required. Such evidence can include our current financial position, our results
of operations, both actual and forecasted, the reversal of deferred tax liabilities, and tax planning strategies as well as the
current and forecasted business economics of our industry.
Based
on the material write-downs of the carrying value of our oil and natural gas properties during fiscal 2016, we are in a net deferred
tax asset position as of June 30, 2018. Our deferred tax asset is $1,238,530 as of June 30, 2018 with a valuation amount of $1,238,530.
We believe it is more likely than not that these deferred tax assets will not be realized. Management assesses the available positive
and negative evidence to estimate whether sufficient future taxable income will be generated to permit the use of deferred tax
assets. The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable
income are reduced or increased or if objective negative evidence in the form of cumulative losses is no longer present and additional
weight is given to subjective evidence such as future expected growth.
6.
Related Party Transactions
Related
party transactions for the Company relate to shared office expenditures in addition to administrative and operating expenses paid
on behalf of the principal stockholder. The total billed to and reimbursed by the stockholder for the quarters ended June 30,
2018 and 2017 were $16,419 and $8,832, respectively.
7.
Income (Loss) Per Common Share
The
Company’s basic net income (loss) per share has been computed based on the weighted average number of common shares outstanding
during the period. Diluted net income (loss) per share assumes the exercise of all stock options having exercise prices less than
the average market price of the common stock during the period using the treasury stock method and is computed by dividing net
income (loss) by the weighted average number of common shares and dilutive potential common shares (stock options) outstanding
during the period. In periods where losses are reported, the weighted average number of common shares outstanding excludes potential
common shares, because their inclusion would be anti-dilutive.
The
following is a reconciliation of the number of shares used in the calculation of basic and diluted net income (loss) per share
for the three month periods ended June 30, 2018 and 2017.
|
|
|
2018
|
|
|
2017
|
|
|
Net income (loss)
|
|
$
|
14,420
|
|
|
$
|
(295,552
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Shares outstanding:
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding – basic
|
|
|
2,037,266
|
|
|
|
2,037,266
|
|
|
Effect of the assumed exercise of dilutive stock options
|
|
|
-
|
|
|
|
-
|
|
|
Weighted average common shares outstanding – dilutive
|
|
|
2,037,266
|
|
|
|
2,037,266
|
|
|
Income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.01
|
|
|
$
|
(0.15
|
)
|
|
Diluted
|
|
$
|
0.01
|
|
|
$
|
(0.15
|
)
|
For
the three months ended June 30, 2018, 148,600 potential common shares relating to stock options were excluded in the computation
of diluted net income per share because the price of the options was greater than the average market price of the common shares
and therefore, the effect would be anti-dilutive. Anti-dilutive stock options have a weighted average exercise price of $6.54
at June 30, 2018.
Due
to a net loss for the three months ended June 30, 2017, the weighted average number of common shares outstanding excludes common
stock equivalents because their inclusion would be anti-dilutive.
8.
Subsequent Events
The
Company completed a review and analysis of all events that occurred after the consolidated balance sheet date to determine if
any such events must be reported and has determined that there are no other subsequent events to be disclosed.