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, 2020, and the results of its operations and cash flows for the interim periods ended June 30, 2020 and 2019. The consolidated
financial statements as of June 30, 2020 and for the three-month periods ended June 30, 2020 and 2019 are unaudited. The consolidated
balance sheet as of March 31, 2020 was derived from the audited balance sheet filed in the Company’s 2020 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 using the cost method. 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.
The
Company uses certain pricing models to determine the fair value of its derivative financial instruments. Inputs to the pricing
models include publicly available prices and forward price curves generated from a compilation of data gathered from third parties.
Company management validates the data provided by third parties by understanding the pricing models used, obtaining market values
from other pricing sources, analyzing pricing data in certain situations and confirming that those securities trade in active
markets.
Recently
Adopted Accounting Pronouncements. In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying
the Accounting for Income Taxes” (“ASU 2019-12”), which simplifies various aspects of the income tax accounting
guidance in ASC 740, including requirements related to the following: (i) hybrid tax regimes; (ii) the tax basis step-up in goodwill
obtained in a transaction that is not a business combination; (iii) separate financial statements of entities not subject to tax;
(iv) the intraperiod tax allocation exception to the incremental approach; (v) ownership changes in investments - changes from
a subsidiary to an equity method investment (and vice versa); (vi) interim-period accounting for enacted changes in tax laws;
and (vii) the year-to-date loss limitation in interim-period tax accounting. ASU 2019-12 is effective for fiscal years beginning
after December 15, 2020, and interim periods within those fiscal years and early adoption is permitted. If an entity early adopts
these amendments in an interim period, it should reflect any adjustments as of the beginning of the annual period that includes
that interim period. In addition, an entity that elects to early adopt ASU 2019-12 is required to adopt all of the amendments
in the same period. The Company is currently assessing the effect that ASU 2019-12 will have on its financial position, results
of operations and disclosures.
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 2021:
Carrying amount of asset retirement obligations as of April 1, 2020
|
|
$
|
762,761
|
|
Liabilities incurred
|
|
|
5,748
|
|
Liabilities settled
|
|
|
-
|
|
Accretion expense
|
|
|
7,187
|
|
Carrying amount of asset retirement obligations as of June 30, 2020
|
|
|
775,696
|
|
Less: Current portion
|
|
|
7,500
|
|
Non-Current asset retirement obligation
|
|
$
|
768,196
|
|
4.
Long Term Debt
Long-term
debt on the Consolidated Balance Sheets consisted of the following as of the dates indicated:
|
|
June 30, 2020
|
|
|
March 31, 2020
|
|
Credit facility
|
|
$
|
930,000
|
|
|
$
|
795,000
|
|
Unamortized debt issuance costs
|
|
|
(34,446
|
)
|
|
|
(37,577
|
)
|
Total long-term debt
|
|
$
|
895,554
|
|
|
$
|
757,423
|
|
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, 2020, there was $570,000 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. The Company is in compliance with all covenants as of June
30, 2020.
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 Company obtained written permission prior to entering into the current hedge agreement discussed in Note 7
of this report.
The
balance outstanding on the line of credit as of June 30, 2020 was $930,000. The following table is a summary of activity on the
WTNB line of credit for the three months ended June 30, 2020:
|
|
Principal
|
|
Balance at April 1, 2020:
|
|
$
|
795,000
|
|
Borrowings
|
|
|
235,000
|
|
Repayments
|
|
|
100,000
|
|
Balance at June 30, 2020:
|
|
$
|
930,000
|
|
The
Company also maintained a Certificate of Deposit Account at WTNB to collateralize one outstanding letter of credit for $25,000
in lieu of a plugging bond with the Texas Railroad Commission covering the properties the Company operated. The operated property
was sold effective December 1, 2019 and the letter of credit was cancelled. On April 10, 2020, the Certificate of Deposit Account
was terminated and the funds deposited into the Company’s operating account.
5.
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 1,021 square feet of office space shared with and reimbursed by our majority shareholder.
The lease is a 36-month lease that was to expire in May 2021 and does not include an option to renew. 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.
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 6.0%. Significant judgement
is required when determining the incremental borrowing rate. The Company chose not to discount because the difference is not significant.
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:
|
|
June 30, 2020
|
|
Assets
|
|
|
|
|
Operating lease right-of-use asset, beginning balance
|
|
$
|
76,130
|
|
Current period amortization
|
|
|
(16,251
|
)
|
Lease amendment
|
|
|
(1,622
|
)
|
Lease extension
|
|
|
10,982
|
|
Total operating lease right-of-use asset
|
|
$
|
69,239
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
Operating lease liability, current
|
|
$
|
65,083
|
|
Operating lease liability, long term
|
|
|
5,491
|
|
Total lease liabilities
|
|
$
|
70,574
|
|
Future
minimum lease payments as of June 30, 2019 under non-cancellable operating leases are as follows:
|
|
Lease Obligation
|
|
Fiscal Year Ended March 31, 2021
|
|
|
48,609
|
|
Fiscal Year Ended March 31, 2022
|
|
|
21,965
|
|
Total lease payments
|
|
$
|
70,574
|
|
Less: imputed interest
|
|
|
-
|
|
Operating lease liability
|
|
|
70,574
|
|
Less: operating lease liability, current
|
|
|
(65,083
|
)
|
Operating lease liability, long term
|
|
$
|
5,491
|
|
Net
cash paid for our operating lease for the three months ended June 30, 2020 and 2019 was $10,600 and $11,016, respectively.
Rent expense, less sublease income of $3,803 and $3,938, respectively, is included in general and administrative expenses.
Note
6. Fair Value Measurements
The
Company applies FASB ASC Topic 820, Fair Value Measurements and Disclosure (“ASC Topic 820”), which establishes a
framework for measuring fair value based upon inputs that market participants use in pricing an asset or liability, which are
classified into two catagories: observable inputs or unobservable inputs. Observable inputs represent market data obtained from
independent sources, whereas unobservable inputs reflect a company’s own market assumptions, which are used if observable
inputs are not reasonably available without undue cost and effort. These two types of inputs are further prioritized into the
following fair value input hierarchy:
Level
1: Quoted prices for identical instruments in active markets at the measurement date.
Level
2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets
that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable
in active markets at the measurement date and for the anticipated term of the instrument.
Level
3: Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable
inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing
the asset or liability acquired, based on the best information available in the circumstances.
The
carrying amount reported in the accompanying consolidated balance sheets for cash and cash equivalents, accounts receivable and
accounts payable approximates fair value because of the immediate or short-term maturity of these financial instruments.
The
fair value amount reported in the accompanying consolidated balance sheets for long-term debt approximates fair value because
the actual interest rates do not significantly differ from current rates offered for instruments with similar characteristics.
See the Company’s note 4 on Long Term Debt for further discussion.
Fair
Value Measurements on a Recurring Basis
A
financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant
to the fair value measurement.
The
Company’s commodity derivative instruments were carried at fair value on a recurring basis in the Company’s consolidated
balance sheets. The Company uses certain pricing models to determine the fair value of its derivative financial instruments. Inputs
to the pricing models include publicly available prices and forward price curves generated from a compilation of data gathered
from third parties.
Company
management validates the data provided by third parties by understanding the pricing models used, obtaining market values from
other pricing sources, analyzing pricing data in certain situations and confirming that those securities trade in active markets.
Assumed credit risk adjustments, based on published credit ratings and public bond yield spreads are applied to the Company’s
commodity derivatives. The Company’s derivative instruments are subject to netting arrangements and qualify for net presentation
in the consolidated balance sheets in those instances where such arrangements exist with the respective counterparty.
To
ensure these derivative instruments are recorded at fair value, valuation adjustments may be required to reflect the creditworthiness
of either party as well as market constraints on liquidity. Any such adjustment was not material as of June 30, 2020.
The
following tables presents the fair value hierarchy for those derivative instruments measured at fair value on a recurring basis
as of June 30, 2020.
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total Fair
Value
June 30, 2020
|
|
Financial asset – current
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil derivative price put option contracts
|
|
$
|
-
|
|
|
$
|
550
|
|
|
$
|
-
|
|
|
$
|
550
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial asset – non-current
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil derivative price put option contracts
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total financial assets
|
|
$
|
-
|
|
|
$
|
550
|
|
|
$
|
-
|
|
|
$
|
550
|
|
Fair
Value Measurements on a Nonrecurring Basis
The
asset retirement obligation estimates are derived from historical costs and management’s expectation of future cost environments
and, therefore, the Company has designated these liabilities as Level 3 measurements. The significant inputs to this fair value
measurement include estimates of plugging, abandonment and remediation costs, well life, inflation and credit-adjusted risk-free
rate. See Note 3 for a reconciliation of the beginning and ending balances of the liability for the Company’s asset retirement
obligations.
Note
7. Derivative Financial Instruments
It
is the Company’s policy to enter into derivative contracts only with counterparties that are creditworthy financial institutions
deemed by management as competent and competitive.
The
Company is exposed to certain risks relating to its ongoing business operations, such as commodity price risk. Derivative contracts
are utilized to economically hedge the Company’s exposure to price fluctuations and reduce the variability in the Company’s
cash flows associated with anticipated sales of future oil and natural gas production. The Company follows FASB ASC Topic 815,
Derivatives and Hedging (ASC Topic 815), to account for its derivative financial instruments.
The
Company’s crude oil derivative positions consist of put options. The Company has elected not to designate any of its derivative
contracts for hedge accounting. Accordingly, the Company records the net change in the mark-to-market valuation of these derivative
contracts, as well as all payments and receipts on settled derivative contracts, in net realized and unrealized gain (loss) on
commodity price hedging contracts on the consolidated statements of operations. All derivative contracts are recorded at fair
market value and included in the consolidated balance sheets as assets or liabilities.
The
Company may have multiple hedge positions that span a several-month time period and result in fair value asset and liability positions.
At the end of the reporting periods, those positions are offset to a single fair value asset or liability for each commodity and
the netted balance is reflected in the consolidated balance sheets as an asset or liability.
During
the quarter ended June 30, 2020 the Company entered into a series of crude oil put option contracts.
The
following table summarizes the fair value amounts of derivative contracts in the consolidated balance sheets as well as the gross
recognized derivative assets in the consolidated balance sheets as of June 30, 2020.
|
|
Gross Recognized
Asset
|
|
|
Gross Amounts
Offset
|
|
|
Net Recognized
Asset
|
|
Oil price hedging contracts - current
|
|
$
|
550
|
|
|
$
|
-
|
|
|
$
|
550
|
|
Oil price hedging contracts – non-current
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
$
|
550
|
|
|
$
|
-
|
|
|
$
|
550
|
|
The
following tables summarizes the amounts of the Company’s realized and unrealized gains (losses) on derivative contracts
in the Company’s consolidated statements of operations for the quarter ended June 30, 2020.
|
|
Gain Recognized
|
|
Realized gain (loss) on oil price hedging contracts
|
|
$
|
(7,800
|
)
|
Unrealized gain (loss) on oil price hedging contracts
|
|
|
550
|
|
Net realized and unrealized loss on derivative contracts
|
|
$
|
(7,250
|
)
|
The
periods covered, notional amounts, fixed price and related commodity pricing index of the Company’s outstanding crude oil
derivative contracts as of June 30, 2020 are set forth in the table below:
Period
|
|
Type of Contract
|
|
Index
|
|
Volume
Bbls
|
|
|
Weighted Average
Floor Price
|
|
July 2020
|
|
Put Options
|
|
NY MEX WTI
|
|
|
3,000
|
|
|
$
|
25.00
|
|
August 2020
|
|
Put Options
|
|
NY MEX WTI
|
|
|
2,000
|
|
|
$
|
25.00
|
|
8.
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, 2020. Our deferred tax asset is $1,374,837 as of June 30, 2020 with a valuation amount of $1,374,837.
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.
9.
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, 2020 and 2019 was $10,102 and $10,101, 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 for the three
months ending June 30, 2020 and 2019 were $3,803 and $3,938, respectively.
10.
Loss Per Common Share
The
Company’s basic net loss per share has been computed based on the weighted average number of common shares outstanding during
the period. Diluted net 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 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 loss per share for the
three-month periods ended June 30, 2020 and 2019.
|
|
2020
|
|
|
2019
|
|
Net loss
|
|
$
|
(299,670
|
)
|
|
$
|
(54,186
|
)
|
|
|
|
|
|
|
|
|
|
Shares outstanding:
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding – basic
|
|
|
2,040,166
|
|
|
|
2,040,166
|
|
Effect of the assumed exercise of dilutive stock options
|
|
|
-
|
|
|
|
-
|
|
Weighted average common shares outstanding – dilutive
|
|
|
2,040,166
|
|
|
|
2,040,166
|
|
Loss per common share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.15
|
)
|
|
$
|
(0.03
|
)
|
Diluted
|
|
$
|
(0.15
|
)
|
|
$
|
(0.03
|
)
|
Due
to a net loss for the three months ended June 30, 2020 and 2019, the weighted average number of common shares outstanding excludes
common stock equivalents because their inclusion would be anti-dilutive.
11.
Subsequent Events
Effective
July 1, 2020, the Company sold its interest in the deep rights of a property in Martin County, Texas for a cash payment of $100,000.
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.