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 West Texas; however,
the Company owns producing properties and undeveloped acreage in thirteen states. Although most of the Company’s oil and
gas interests are operated by others, the Company operates several properties in which it owns an 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, 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 September 30, 2016, and the results of its operations and cash flows for the interim periods ended September 30, 2016 and 2015.
The financial statements as of September 30, 2016 and for the three and six month periods ended September 30, 2016 and 2015 are
unaudited. The consolidated balance sheet as of March 31, 2016 was derived from the audited balance sheet filed in the Company’s
2016 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 financial statements be read in conjunction with the financial statements and notes
thereto included in the Form 10-K.
Recent
Accounting Pronouncements.
In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting
Standards Update No. 2016-15, “Statement of Cash Flows (Topic 230)”, which is intended to reduce diversity in practice
in how certain transactions are classified in the statement of cash flows. The guidance addresses eight specific cash flow issues
for which current GAAP is either unclear or does not include specific guidance. The guidance is effective for annual periods beginning
after December 15, 2017 and interim periods within those annual periods. Early adoption is permitted, provided that all of the
amendments are adopted in the same period. This guidance must be adopted using a retrospective transition method. The Company
is currently evaluating the effect that adopting this guidance will have on its cash flows.
In
March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee
Share-Based Payment Accounting”. The amendment is to simplify several aspects of the accounting for share-based payment
transactions including the income tax consequences, classification of awards as either equity or liabilities, and classification
on the statement of cash flows. The amendments in ASU No. 2016-09 are effective for interim and annual reporting periods beginning
after December 15, 2016. The Company is currently assessing the impact of ASU No. 2016-09 on the consolidated financial statements.
In
February 2016, the FASB issued ASU 2016-02, Topic 842 Leases, which requires companies to recognize a right of use asset and related
liability on the balance sheet for the rights and obligations arising from leases with durations greater than 12 months. The standard
is effective for fiscal years beginning after December 15, 2018, and interim periods thereafter. Early adoption is permitted.
We are currently evaluating the effect the new guidance will have on our consolidated financial statements.
In
January 2016, the FASB issued authoritative guidance that amends existing requirements on the classification and measurement of
financial instruments. The standard principally affects accounting for equity investments and financial liabilities where the
fair value option has been elected. The guidance is effective for fiscal periods after December 15, 2017, and interim periods
thereafter. Early adoption of certain provisions is permitted. We are currently evaluating the effect the new guidance will have
on our financial statements.
In
November 2015, the FASB issued ASU No. 2015-17, Topic 740 Income Taxes: Balance Sheet Classification of Deferred Taxes which requires
all deferred income tax liabilities and assets to be presented as noncurrent in a classified balance sheet. Currently, entities
are required to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified balance
sheet. The new standard will become effective for Mexco beginning on April 1, 2017, with the option to early adopt, and can be
applied either prospectively or retrospectively. The adoption of this guidance will have no impact on our results of operations
or cash flows. The reclassification of amounts from current to noncurrent could affect the presentation of our balance sheet.
In
May 2014, the FASB issued ASU No. 2014-09, Topic 606: Revenue from Contracts with Customers. This ASU provides guidance concerning
the recognition and measurement of revenue from contracts with customers. The effective date for ASU 2014-09 was delayed through
the issuance of ASU 2015-14, Revenue from Contracts with Customers – Deferral of the Effective Date, to annual and interim
periods beginning after December 15, 2017 and is required to be adopted using either the retrospective or cumulative effect transition
method, with early adoption permitted in 2017. Additionally, in March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts
with Customers (Topic 606): Principal versus agent considerations (reporting revenue gross versus net), which clarifies the implementation
guidance on principal versus agent considerations on such matters. In April 2016, the FASB issued ASU No. 2016-10, Revenue from
Contracts with Customers (Topic 606): Identifying performance obligations and licensing, which clarifies guidance related to identifying
performance obligations and licensing implementation guidance contained in the new revenue recognition standard. In May 2016,
the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-scope improvements and practical expedients,
which addresses narrow-scope improvements to the guidance on collectibility, non-cash consideration, and completed contracts at
transition. Additionally, the amendments in this update provide a practical expedient for contract modifications at transition
and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers.
Management is evaluating the effect, if any, this pronouncement will have on our consolidated financial statements.
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, and
the capitalized cost is depreciated over the useful life of the related asset. The ARO is included in 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 six months of fiscal 2017:
Carrying amount of asset retirement obligations as of April 1, 2016
|
|
$
|
1,221,077
|
|
Liabilities incurred
|
|
|
3,614
|
|
Liabilities settled
|
|
|
(23,965
|
)
|
Accretion expense
|
|
|
17,691
|
|
Carrying amount of asset retirement obligations as of September 30, 2016
|
|
|
1,218,417
|
|
Less: Current portion
|
|
|
10,000
|
|
Non-Current asset retirement obligation
|
|
$
|
1,208,417
|
|
4.
Stock-based Compensation
The
Company recognized compensation expense of $13,085 and $30,648 in general and administrative expense in the Consolidated Statements
of Operations for the three months ended September 30, 2016 and 2015, respectively. Compensation expense recognized for the six
months ended September 30, 2016 and 2015 was $31,686 and $71,897, respectively. The total cost related to non-vested awards not
yet recognized at September 30, 2016 totals approximately $46,967 which is expected to be recognized over a weighted average of
1.51 years.
The
following table is a summary of activity of stock options for the six months ended September 30, 2016:
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted Average
Remaining Contract
Life in Years
|
|
|
Aggregate
Intrinsic
Value
|
|
Outstanding at April 1, 2016
|
|
|
153,600
|
|
|
$
|
6.52
|
|
|
|
6.36
|
|
|
$
|
-
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited or Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2016
|
|
|
153,600
|
|
|
$
|
6.52
|
|
|
|
5.86
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested at September 30, 2016
|
|
|
124,850
|
|
|
$
|
6.48
|
|
|
|
5.49
|
|
|
$
|
-
|
|
Exercisable at September 30, 2016
|
|
|
124,850
|
|
|
$
|
6.48
|
|
|
|
5.49
|
|
|
$
|
-
|
|
There
were no options granted during the six months ended September 30, 2016 and 2015.
Outstanding
options at September 30, 2016 expire between August 2020 and August 2024 and have exercise prices ranging from $5.98 to $7.00.
5.
Fair Value of Financial Instruments
Fair
value as defined by authoritative literature is the price that would be received to sell an asset or paid to transfer a liability
(exit price) in an orderly transaction between market participants at the measurement date. Fair value measurements are classified
and disclosed in one of the following categories:
Level
1 – Quoted prices in active markets for identical assets and liabilities.
Level
2 – Quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar instruments
in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are
observable.
Level
3 – Significant inputs to the valuation model are unobservable.
Financial
assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.
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
and is deemed to use Level 2 inputs. See the Company’s Note 6 on Credit Facility for further discussion.
6.
Credit Facility
The
Company has a loan agreement with Bank of America, N.A. (the “Agreement”), 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 is reset to the extent the Company sells or otherwise
disposes of any of its oil and gas properties. The Company is required to pay 100% of such net proceeds to the lender resulting
in a permanent reduction of the borrowing base. 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 was renewed ten times with the tenth amendment effective as of March 31, 2016 with a maturity date of November 30, 2020.
The revised borrowing base as of June 20, 2016 was set at $5,570,000. 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 3.522% on September 30, 2016. Interest on the outstanding amount under the credit
agreement is payable monthly. There was no availability of this line of credit at September 30, 2016. No principal payments are
anticipated to be required through November 30, 2020.
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 $100,000 for the
two fiscal quarters ending September 30, 2016, $300,000 for the three fiscal quarters ending December 31, 2016, $500,000 for the
four fiscal quarters ending March 31, 2017 and $650,000 for each trailing fiscal quarter period thereafter and minimum interest
coverage ratios (EBITDA/Interest Expense) of 2.00 to 1.00 for each quarter thereafter. The Company is in compliance with all covenants
as of September 30, 2016.
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
Agreement allows for up to $500,000 of the facility to be used for outstanding letters of credit. As of September 30, 2016, one
letter of credit for $50,000, in lieu of plugging bond with the Texas Railroad Commission (“TRRC”) covering the properties
the Company operates is outstanding under the facility. This letter of credit renews annually. 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.
The
balance outstanding on the line of credit as of September 30, 2016 was $5,520,000. The following table is a summary of activity
on the Bank of America, N.A. line of credit for the six months ended September 30, 2016:
|
|
Principal
|
|
Balance
at April 1, 2016:
|
|
$
|
5,580,000
|
|
Borrowings
|
|
|
-
|
|
Repayments
|
|
|
(60,000
|
)
|
Balance
at September 30, 2016:
|
|
$
|
5,520,000
|
|
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 project being in
a net deferred tax asset position at March 31, 2017. Our deferred tax asset is $1,043,089 as of September 30, 2016 with a valuation
amount of $1,043,089. 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.
The
income tax provision consists of the following for the three and six months ended September 30, 2016 and 2015:
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
September 30
|
|
|
September 30
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Deferred income tax benefit
|
|
|
-
|
|
|
|
(361,384
|
)
|
|
|
-
|
|
|
|
(513,331
|
)
|
Total income tax provision:
|
|
$
|
-
|
|
|
$
|
(361,384
|
)
|
|
$
|
-
|
|
|
$
|
(513,331
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective tax rate
|
|
|
0
|
%
|
|
|
(32
|
)%
|
|
|
0
|
%
|
|
|
(32
|
)%
|
8.
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 majority stockholder. The total billed to and reimbursed by the stockholder for the three months ended September
30, 2016 and 2015 was $6,852 and $24,080, respectively.
The
total billed to and reimbursed by the stockholder for the six months ended September 30, 2016 and 2015 was $12,495 and $49,701,
respectively.
9.
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. 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 and six month periods ended September 30, 2016 and 2015.
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
September 30
|
|
|
September 30
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Net loss
|
|
$
|
(237,902
|
)
|
|
$
|
(776,307
|
)
|
|
$
|
(531,358
|
)
|
|
$
|
(1,100,673
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted avg. shares outstanding – basic
|
|
|
2,037,266
|
|
|
|
2,037,266
|
|
|
|
2,037,266
|
|
|
|
2,037,266
|
|
Effect of assumed exercise of dilutive stock options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Weighted avg. shares outstanding – dilutive
|
|
|
2,037,266
|
|
|
|
2,037,266
|
|
|
|
2,037,266
|
|
|
|
2,037,266
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.12
|
)
|
|
$
|
(0.38
|
)
|
|
$
|
(0.26
|
)
|
|
$
|
(0.54
|
)
|
Due
to a net loss for the for the three and six months ended September 30, 2016 and 2015, the weighted average number of common shares
outstanding excludes common stock equivalents because their inclusion would be anti-dilutive.
10.
Impairments of Oil and Natural Gas Properties
Our
oil and natural gas properties are subject to quarterly full cost ceiling tests. Under the ceiling test, capitalized costs, less
accumulated amortization and related deferred income taxes, may not exceed an amount equal to the sum of the present value of
estimated future net revenues (adjusted for cash flow hedges) less estimated future expenditures to be incurred in developing
and producing the proved reserves, less any related income tax effects. Estimated future net revenues for the quarterly ceiling
limit are calculated using the average of commodity prices on the first day of the month over the trailing 12-month period. In
the three and six months ended September 30, 2015, capitalized costs of oil and natural gas properties exceeded the ceiling, resulting
in an impairment in the carrying value of our oil and natural gas properties of approximately $834,000. We did not have an impairment
in the carrying amount of our oil and natural gas properties for the six months ended September 30, 2016.
11.
Subsequent Events
On
October 7, 2016, the Company received approximately $2.187 million in cash from a sale of working interests to Parsley Energy,
Inc. covering 50 net acres located in Glasscock County, Texas in the horizontal Wolfcamp trend of the Permian Basin in West Texas.
Of these proceeds, approximately $1.887 million was applied to the Company’s bank debt and the balance added to working
capital of the Company.
Effective
November 1, 2016, the Company sold its 100% working interest (76.7% average net revenue interest) in eight oil and gas wells and
one disposal well of which Mexco is operator, located in the El Cinco and Tippett Fields of Pecos County, Texas. The Company received
a cash purchase price of $405,000 which has been applied to reduce bank indebtedness. These properties have been determined by
management to be non-core with limited potential for further development.
The Company applied a total of $2,292.000
from the proceeds of these two sales to the line of credit reducing its bank indebtedness to $3,228,000 as of November 10, 2016.