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 crude oil, natural gas, condensate and natural gas liquids (“NGLs”).
Most of the Company’s oil and gas interests are centered in West Texas and Southeastern New Mexico; however, the Company owns producing
properties and undeveloped acreage in fourteen states. All of Company’s oil and gas interests are operated by others.
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, 2021,
and the results of its operations and cash flows for the interim periods ended June 30, 2021 and 2020. The consolidated financial statements
as of June 30, 2021 and for the three-month periods ended June 30, 2021 and 2020 are unaudited. The consolidated balance sheet as of
March 31, 2021 was derived from the audited balance sheet filed in the Company’s 2021 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.
Investments.
The Company accounts for investments of less than 1% in limited liability companies at cost. The Company has no control of the limited
liability companies. The cost of the investment is recorded as an asset on the consolidated balance sheets and when income from the investment
is received, it is immediately recognized on the consolidated statements of operations.
Derivative
Financial Instruments. The Company’s derivative financial instruments are used to manage commodity price risk attributable
to expected oil and gas production. While there is risk the financial benefit of rising oil and gas prices may not be captured, the Company
believes the benefits of stable and predictable cash flows outweigh the potential risks.
The
Company accounts for derivative financial instruments using fair value accounting and recognizes gains and losses in earnings during
the period in which they occur. Unsettled derivative instruments are recorded in the accompanying consolidated balance sheets as either
a current or non-current asset or a liability measured at its fair value. The Company only offsets derivative assets and liabilities
for arrangements with the same counterparty when right of setoff exists. Derivative assets and liabilities with different counterparties
are recorded gross in the consolidated balance sheets. Derivative contract settlements are reflected in operating activities in the accompanying
consolidated statements of cash flows.
As
of June 30, 2021, the Company had no derivative contracts. During the quarter ended June 30, 2020, the Company entered into a series
of crude oil put option contracts. All of these such contracts expired in July and August 2020.
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 until the liability is settled
or the well is sold, at which time the liability is removed. The related asset retirement cost is capitalized as part of the carrying
amount of our oil and natural gas properties. 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 2022:
Schedule
of Rollforward of Asset Retirement Obligations
Carrying amount of asset retirement obligations as of April 1, 2021
|
|
$
|
728,797
|
|
Liabilities incurred
|
|
|
3,329
|
|
Liabilities settled
|
|
|
-
|
|
Accretion expense
|
|
|
7,058
|
|
Carrying amount of asset retirement obligations as of June 30, 2021
|
|
|
739,184
|
|
Less: Current portion
|
|
|
15,000
|
|
Non-Current asset retirement obligation
|
|
$
|
724,184
|
|
4.
Long Term Debt
Long-term
debt on the Consolidated Balance Sheets consisted of the following as of the dates indicated:
Schedule
of Long-Term Debt
|
|
June 30, 2021
|
|
|
March 31, 2021
|
|
Credit facility
|
|
$
|
800,000
|
|
|
$
|
1,180,000
|
|
Unamortized debt issuance costs
|
|
|
(21,920
|
)
|
|
|
(25,051
|
)
|
Total long-term debt
|
|
$
|
778,080
|
|
|
$
|
1,154,949
|
|
On
December 28, 2018, the Company entered into a loan agreement (the “Agreement”) with West Texas National Bank (“WTNB”),
which provided for a credit facility of $1,000,000 with a maturity date of December 28, 2021. The Agreement has no monthly commitment
reduction and a borrowing base to be evaluated annually.
On
February 28, 2020, the Agreement was amended to increase the credit facility to $2,500,000, extend the maturity date to March 28, 2023
and increase the borrowing base to $1,500,000.
Under
the Agreement, interest on the facility accrues at a rate equal to the prime rate as quoted in the Wall Street Journal plus one-half
of one percent (0.5%) floating daily. Interest on the outstanding amount under the Agreement is payable monthly. In addition, the Company
will pay an unused commitment fee in an amount equal to one-half of one percent (0.5%) times the daily average of the unadvanced amount
of the commitment. The unused commitment fee is payable quarterly in arrears on the last day of each calendar quarter. As of June 30,
2021, there was $700,000 available on the facility.
No
principal payments are anticipated to be required through the maturity date of the credit facility, March 28, 2023. Upon closing with
WTNB on the original Agreement, the Company paid a .5% loan origination fee in the amount of $5,000 plus legal and recording expenses
totaling $34,532, which were deferred over the life of the credit facility. Upon closing the amendment to the Agreement, the Company
paid a .1% loan origination fee of $2,500 and an extension fee of $3,125 plus legal and recording expenses totaling $12,266, which were
also deferred over the life of the credit facility.
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
senior debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”) ratios (Senior Debt/EBITDA) less
than or equal to 4.00 to 1.00 measured with respect to the four trailing quarters and minimum interest coverage ratios (EBITDA/Interest
Expense) of 2.00 to 1.00 for each quarter.
In
addition, this Agreement prohibits the Company from paying cash dividends on its common stock without written permission of WTNB. The
Agreement does not permit the Company to enter into hedge agreements covering crude oil and natural gas prices without prior WTNB approval.
The
balance outstanding on the credit facility as of June 30, 2021 was $800,000. The following table is a summary of activity on the WTNB
credit facility for the three months ended June 30, 2021:
Summary
of Line of Credit Activity
|
|
Principal
|
|
Balance at April 1, 2021:
|
|
$
|
1,180,000
|
|
Borrowings
|
|
|
100,000
|
|
Repayments
|
|
|
(480,000
|
)
|
Balance at June 30, 2021:
|
|
$
|
800,000
|
|
Subsequently,
the Company has made payments totaling $250,000, leaving a balance of $550,000 as of the date of this report.
5.
Stock-based Compensation
The
Company recognized compensation expense of $13,865 and $14,005 related to vesting stock options in general and administrative expense
in the Consolidated Statements of Operations for the first quarter of fiscal 2022 and 2021, respectively. The total cost related to non-vested
awards not yet recognized at June 30, 2021 totals $100,266, which is expected to be recognized over a weighted average of 2.10 years.
The
following table is a summary of stock options activity for the three months ended June 30, 2021 and 2020:
Summary
of Activity of Stock Options
|
|
Number of Shares
|
|
|
Weighted Average Exercise Price Per Share
|
|
|
Weighted Aggregate Average Remaining Contract Life in Years
|
|
|
Intrinsic Value
|
|
Outstanding at April 1, 2021
|
|
|
156,000
|
|
|
$
|
5.28
|
|
|
|
5.53
|
|
|
$
|
555,100
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
5,000
|
|
|
|
6.80
|
|
|
|
|
|
|
|
|
|
Forfeited or Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2021
|
|
|
151,000
|
|
|
$
|
5.23
|
|
|
|
5.45
|
|
|
$
|
685,330
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested at June 30, 2021
|
|
|
105,250
|
|
|
$
|
5.88
|
|
|
|
4.10
|
|
|
$
|
390,033
|
|
Exercisable at June 30, 2021
|
|
|
105,250
|
|
|
$
|
5.88
|
|
|
|
4.10
|
|
|
$
|
390,033
|
|
During
the three months ended June 30, 2021 and 2020, no
stock options were granted. Subsequently,
pursuant to approval from the Compensation Committee of the Board of Directors, the Company granted options covering 31,000
shares of stock at a strike
price of $8.51 effective July 26, 2021.
During
the three months ended June 30, 2021, stock options covering 5,000 shares were exercised with a total intrinsic value of $15,036. The
Company received proceeds of $34,000 from these exercises. During the three months ended June 30, 2020, no stock options were exercised.
Subsequently, in July 2021, stock options covering 10,500 were exercised with a total intrinsic value of $36,433. The Company received
proceeds of $73,500 from these exercises.
No
forfeiture rate is assumed for stock options granted to directors or employees due to the forfeiture rate history for these types of
awards. During the three months ended June 30, 2021 and 2020, there were no stock options forfeited or expired.
Outstanding
options at June 30, 2021 expire between April 2023 and March 2030 and have exercise prices ranging from $3.34 to $7.00.
6.
Leases
The
Company leases approximately 4,160 rentable square feet of office space from an unaffiliated third party for our corporate office located
in Midland, Texas. This includes 1,112 square feet of office space shared with and reimbursed by our majority shareholder. The lease
does not include an option to renew and is a 36-month lease that expired in May 2021. In June 2020, in exchange for a reduction in rent
for the months of June and July 2020, the Company agreed to a 2-month extension to its current lease agreement at the regular monthly
rate extending its current lease expiration date to July 2021. In June 2021, the Company agreed to extend its current lease for 36 months.
The amended lease now expires on July 31, 2024.
The
Company determines an arrangement is a lease at inception. Operating leases are recorded in operating lease right-of-use asset, operating
lease liability, current, and operating lease liability, long-term on the consolidated balance sheets.
Operating
lease right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent
its obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at the commencement
date based on the present value of lease payments over the lease term. As the Company’s lease does not provide an implicit rate,
the Company uses the incremental borrowing rate based on the information available at commencement date in determining the present value
of lease payments. The incremental borrowing rate used at adoption was 3.75%. Significant judgement is required when determining the
incremental borrowing rate. Rent expense for lease payments is recognized on a straight-line basis over the lease term.
The
balance sheets classification of lease assets and liabilities was as follows:
Schedule
of Operating Lease Assets and Liabilities
|
|
June 30, 2021
|
|
Assets
|
|
|
|
|
Operating lease right-of-use asset, beginning balance
|
|
$
|
20,861
|
|
Current period amortization
|
|
|
(16,126
|
)
|
Lease amendment
|
|
|
165,007
|
|
Total operating lease right-of-use asset
|
|
$
|
169,742
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
Operating lease liability, current
|
|
$
|
53,958
|
|
Operating lease liability, long term
|
|
|
116,540
|
|
Total lease liabilities
|
|
$
|
170,498
|
|
Future
minimum lease payments as of June 30, 2021 under non-cancellable operating leases are as follows:
Schedule
of Future Minimum Lease Payments
|
|
Lease Obligation
|
|
Fiscal Year Ended March 31, 2022
|
|
|
44,318
|
|
Fiscal Year Ended March 31, 2023
|
|
|
58,240
|
|
Fiscal Year Ended March 31, 2024
|
|
|
58,240
|
|
Fiscal Year Ended March 31, 2025
|
|
|
19,413
|
|
Total lease payments
|
|
$
|
180,211
|
|
Less: imputed interest
|
|
|
(9,713
|
)
|
Operating lease liability
|
|
|
170,498
|
|
Less: operating lease liability, current
|
|
|
(53,958
|
)
|
Operating lease liability, long term
|
|
$
|
116,540
|
|
Net
cash paid for our operating lease for the three months ended June 30, 2021 and 2020 was $10,929 and $10,600, respectively. Rent expense,
less sublease income of $5,200 and $4,889, respectively, is included in general and administrative expenses.
7.
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, 2021. Our deferred tax asset is $1,180,248
as of June 30, 2021 with a
valuation amount of $1,180,248. 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 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 expected future growth.
8.
Related Party Transactions
Related
party transactions for the Company primarily 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, 2021
and 2020 was $12,768 and $10,102, respectively. The principal stockholder pays for his share of the lease amount for the shared office
space directly to the lessor. Amounts paid by the principal stockholder directly to the lessor less sublease income for the three months
ending June 30, 2021 and 2020 were $3,700 and $3,803, respectively.
9.
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, 2021 and 2020.
Schedule
of Reconciliation of Basic and Diluted Net Income (loss) Per Share
|
|
2021
|
|
|
2020
|
|
Net income (loss)
|
|
$
|
395,006
|
|
|
$
|
(299,670
|
)
|
|
|
|
|
|
|
|
|
|
Shares outstanding:
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding – basic
|
|
|
2,076,756
|
|
|
|
2,040,166
|
|
Effect of the assumed exercise of dilutive stock options
|
|
|
43,199
|
|
|
|
-
|
|
Weighted average common shares outstanding – dilutive
|
|
|
2,119,955
|
|
|
|
2,040,166
|
|
Income (loss) per common share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.19
|
|
|
$
|
(0.15
|
)
|
Diluted
|
|
$
|
0.19
|
|
|
$
|
(0.15
|
)
|
For
the three months ended June 30, 2021, no anti-dilutive shares relating to stock options were excluded from the computation of diluted
net income. Due to a net loss for the three months ended June 30, 2020, the weighted average number of common shares outstanding excludes
common stock equivalents because their inclusion would be anti-dilutive.
10.
Subsequent Events
During
July 2021, the Company made payments totaling $250,000 on the credit facility leaving a balance of $550,000.
During
July 2021, stock options covering 10,500 shares were exercised with a total intrinsic value of $36,433. The Company received proceeds
of $73,500 from these exercises.
Pursuant
to approval from the Compensation Committee of the Board of Directors, the Company granted options covering 31,000 shares of stock at
a strike price of $8.51 effective July 26, 2021.
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.