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 acquisition, 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 consolidated 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, 2022,
and the results of its operations and cash flows for the interim periods ended June 30, 2022 and 2021. The consolidated financial statements
as of June 30, 2022 and for the three-month periods ended June 30, 2022 and 2021 are unaudited. The consolidated balance sheet as of
March 31, 2022 was derived from the audited balance sheet filed in the Company’s 2022 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.
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 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, 2022 | |
$ | 735,512 | |
| Liabilities incurred | |
| 14,668 | |
| Liabilities settled | |
| (10,557 | ) |
| Accretion expense | |
| 7,519 | |
| Carrying amount of asset retirement obligations as of June 30, 2022 | |
| 747,142 | |
| Less: Current portion | |
| 15,000 | |
| Non-Current asset retirement
obligation | |
$ | 732,142 | |
4.
Long Term Debt
On
December 28, 2018, the Company entered into a loan agreement (the “Agreement”) with West Texas National Bank (“WTNB”),
which originally 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,
2022, there was $1,500,000 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 prior 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.
There
was no balance outstanding on the credit facility as of June 30, 2022.
5.
Stock-based Compensation
The
Company recognized compensation expense of $25,571 and $13,865 related to vesting stock options in general and administrative expense
in the Consolidated Statements of Operations for the first quarter of fiscal 2023 and 2022, respectively. The total cost related to non-vested
awards not yet recognized at June 30, 2022 totals $188,537, which is expected to be recognized over a weighted average of 2.14 years.
The
following table is a summary of stock options activity for the three months ended June 30, 2022:
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, 2022 | |
| 114,250 | | |
$ | 5.51 | | |
| 7.40 | | |
$ | 1,221,670 | |
| Granted | |
| - | | |
| - | | |
| | | |
| | |
| Exercised | |
| - | | |
| - | | |
| | | |
| | |
| Forfeited
or Expired | |
| - | | |
| - | | |
| | | |
| | |
| Outstanding at June
30, 2022 | |
| 114,250 | | |
$ | 5.51 | | |
| 7.15 | | |
$ | 1,334,778 | |
| | |
| | | |
| | | |
| | | |
| | |
| Vested at June 30, 2022 | |
| 52,750 | | |
$ | 4.68 | | |
| 5.99 | | |
$ | 660,023 | |
| Exercisable at June 30, 2022 | |
| 52,750 | | |
$ | 4.68 | | |
| 5.99 | | |
$ | 660,023 | |
During
the three months ended June 30, 2022 and 2021, no stock options were granted.
During
the three months ended June 30, 2022, no stock options were exercised. 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.
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, 2022 and 2021, there were no stock options forfeited or expired.
Outstanding
options at June 30, 2022 expire between August 2024 and July 2031 and have exercise prices ranging from $3.34 to $8.51.
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 was to expire 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 at
a flat (unescalated) rate 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, 2022 | |
| Assets | |
| | |
| Operating lease right-of-use
asset, beginning balance | |
$ | 129,923 | |
| Current period amortization | |
| (13,383 | ) |
| Total
operating lease right-of-use asset | |
$ | 116,540 | |
| | |
| | |
| Liabilities | |
| | |
| Operating lease liability,
current | |
$ | 54,806 | |
| Operating
lease liability, long term | |
| 61,734 | |
| Total
lease liabilities | |
$ | 116,540 | |
Future
minimum lease payments as of June 30, 2022 under non-cancellable operating leases are as follows:
Schedule of Future Minimum Lease Payments
| | |
Lease
Obligation | |
| Fiscal Year Ended March 31, 2023 | |
| 43,680 | |
| Fiscal Year Ended March 31, 2024 | |
| 58,240 | |
| Fiscal Year Ended March 31, 2025 | |
| 19,413 | |
| Total lease payments | |
$ | 121,333 | |
| Less: imputed interest | |
| (4,793 | ) |
| Operating lease liability | |
| 116,540 | |
| Less: operating lease
liability, current | |
| (54,806 | ) |
| Operating lease liability,
long term | |
$ | 61,734 | |
Net
cash paid for our operating lease for the three months ended June 30, 2022 and 2021 was $10,667 and $10,929, respectively. Rent expense,
less sublease income of $3,893 and $5,200, 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, 2022. Our deferred tax asset is $526,846 as of June 30, 2022 with a valuation amount of $526,846.
We believe it is more likely than not that these deferred tax assets will not be realized. Management considers the likelihood that the
Company’s net operating losses and other deferred tax attributes will be utilized prior to their expiration, if applicable. The
determination to record a valuation allowance was based on management’s assessment of all available evidence, both positive and
negative, supporting realizability of the Company deferred tax asset as required by applicable accounting standards. In light of those
criteria for recognizing the tax benefit of deferred tax assets, the Company’s assessment resulted in application of a valuation
allowance against the deferred tax asset as of June 30, 2022.
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, 2022
and 2021 was $10,085 and $12,768, 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, 2022 and 2021 were $3,893 and $4,045, respectively.
9.
Income Per Common Share
The
following is a reconciliation of the number of shares used in the calculation of basic and diluted net income per share for the three-month
periods ended June 30, 2022 and 2021.
Schedule of Reconciliation of Basic and Diluted Net Income (loss) Per Share
| | |
2022 | | |
2021 | |
| Net income | |
$ | 1,298,672 | | |
$ | 395,006 | |
| | |
| | | |
| | |
| Shares outstanding: | |
| | | |
| | |
| Weighted average common shares outstanding
– basic | |
| 2,149,416 | | |
| 2,076,756 | |
| Effect
of the assumed exercise of dilutive stock options | |
| 67,326 | | |
| 43,199 | |
| Weighted average common
shares outstanding – dilutive | |
| 2,216,742 | | |
| 2,119,955 | |
| Income per common share: | |
| | | |
| | |
| Basic | |
$ | 0.60 | | |
$ | 0.19 | |
| Diluted | |
$ | 0.59 | | |
$ | 0.19 | |
For
the three months ended June 30, 2022 and 2021, no anti-dilutive shares relating to stock options were excluded from the computation of
diluted net income.
10.
Subsequent Events
In
July 2022, Mexco expended approximately $300,000 for the remaining balance in the drilling and completion of four horizontal wells Eddy
County, New Mexico.
In
July and August 2022, Mexco expended approximately $768,000 to purchase additional working interests and to complete three horizontal
wells in Reagan County, Texas.
In
July and August 2022, Mexco expended approximately $377,000 to purchase additional working interests and to complete a horizontal well
in Reagan County, Texas.
In
August 2022, Mexco expended approximately $33,000 to participate in the drilling of two horizontal wells in Lea County, New Mexico.
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.