MXC Mexco Energy Corp

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 and Southeastern New Mexico; however, the Company owns producing properties and undeveloped acreage in fourteen states. All of the 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 December 31, 2022, and the results of its operations and cash flows for the interim periods ended December 31, 2022 and 2021. The consolidated financial statements as of December 31, 2022 and for the three and nine month periods ended December 31, 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 financial statements be read in conjunction with the financial statements and notes thereto included in the Form 10-K.

Investments. The Company accounts for investments of less than 3% of any limited liability companies at cost. The Company has no control or significant influence 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.

Reclassifications. Certain amounts in prior periods’ consolidated financial statements have been reclassified to conform with the current period’s presentation. These reclassifications had no effect on previously reported results of operations, retained earnings or net cash flows.

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 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 nine months of fiscal 2022:

4. Stock-based Compensation

The Company recognized stock-based compensation expense of $41,460 and $25,570 in general and administrative expense in the Consolidated Statements of Operations for the three months ended December 31, 2022 and 2021, respectively. Stock-based compensation expense recognized for the nine months ended December 31, 2022 and 2021 was $101,462 and $62,003, respectively. The total cost related to non-vested awards not yet recognized at December 31, 2022 totals approximately $498,285 which is expected to be recognized over a weighted average of 2.63 years.

During the nine months ended December 31, 2022, the Compensation Committee of the Board of Directors approved and the Company granted 31,000 stock options exercisable at $18.05 per share with an estimated fair value of $385,640. During the nine months ended December 31, 2021, the Compensation Committee of the Board of Directors approved and the Company granted 31,000 stock options exercisable at $8.51 per share with an estimated fair value of $187,550. These options are exercisable at a price not less than the fair market value of the stock at the date of grant, have an exercise period of ten years and generally vest over four years.

Included in the following table is a summary of the grant-date fair value of stock options granted and the related assumptions used in the Binomial models for stock options granted during the nine months ended December 31, 2022 and 2021. All such amounts represent the weighted average amounts.

Schedule of Grant-date Fair Value of Stock Options Granted and Assumptions Used Binominal Models 

The following table is a summary of activity of stock options for the nine months ended December 31, 2021:

 Summary of Activity of Stock Options

During the nine months ended December 31, 2022, stock options covering 5,000 shares were exercised with a total intrinsic value of $47,575. The Company received proceeds of $16,700 from these exercises. During the nine months ended December 31, 2021, stock options covering 45,000 shares were exercised with a total intrinsic value of $241,226. The Company received proceeds of $295,640 from these exercises.

There were no stock options forfeited or expired during the nine months ended December 31, 2022 and 2021. No forfeiture rate is assumed for stock options granted to directors or employees due to the forfeiture rate history of these types of awards.

Outstanding options at December 31, 2022 expire between August 2024 and August 2032 and have exercise prices ranging from $3.34 to $18.05.

5. 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 credit 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 December 31, 2022, there was $1,500,000 available for borrowing by the Company 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 original 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.

There was no balance outstanding on the line of credit as of December 31, 2022. The following table is a summary of activity on the WTNB line of credit for the nine months ended December 31, 2022:

Summary of Line of Credit Activity 

6. Leases

The Company leases approximately 4,160 rentable square feet of office space from an unaffiliated third party for the corporate office located in Midland, Texas. This includes 1,112 square feet of office space shared with and reimbursed by the 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:

Future minimum lease payments as of December 31, 2022 under non-cancellable operating leases are as follows:

Net cash paid for our operating lease for the nine months ended December 31, 2022 and 2021 was $32,001 and $31,570, respectively. Rent expense, less sublease income of $11,679 and $14,662, 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 December 31, 2022. Our deferred tax asset for federal income tax purposes is $202,543 as of December 31, 2022 with a valuation amount of $202,543. 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 December 31, 2022.

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 principal stockholder. The total billed to and reimbursed by the stockholder for the three months ended December 31, 2022 and 2021 was $11,598 and $12,276, respectively. The total billed to and reimbursed by the stockholder for the nine months ended December 31, 2022 and 2021 was $35,333 and $35,332, 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 December 31, 2022 and 2021 were $3,893. Amounts paid by the principal stockholder directly to the lessor for the nine months ending December 31, 2022 and 2021 were $11,679 and $11,882, 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 and nine month periods ended December 31, 2022 and 2021:

 Schedule of Reconciliation of Basic and Diluted Net Income (loss) Per Share

For the three months ended December 31, 2022, 31,000 shares relating to stock options were excluded from the computation of diluted net income because their inclusion would be anti-dilutive. Anti-dilutive stock options have a weighted average exercise price of $18.05 at December 31, 2022.

For the three and nine months ended December 31, 2021, 31,000 shares relating to stock options were excluded from the computation of diluted net income because their inclusion would be anti-dilutive. Anti-dilutive stock options have a weighted average exercise price of $8.51 at December 31, 2021.

10. Stockholders’ Equity

In June 2022, the Board of Directors authorized the use of up to $250,000 to repurchase shares of the Company’s common stock for the treasury account. This program does not have an expiration date and may be modified, suspended or terminated at any time by the board of directors. Under the repurchase program, shares of common stock may be purchased from time to time through open market purchases or other transactions. The amount and timing of repurchases will be subject to the availability of stock, prevailing market conditions, the trading price of the stock, our financial performance and other conditions. Repurchases may also be made from time-to-time in connection with the settlement our share-based compensation awards. Repurchases will be funded from cash flow from operations.

During the three months ended December 31, 2022, the Company repurchased 12,416 shares for the treasury at an aggregate cost of $168,260. There were no shares of common stock repurchased for the treasury account during the three months ended December 31, 2021. Subsequently, in January 2023, the Company repurchased 1,300 shares for the treasury at an aggregate cost of $16,359.

On September 6, 2022, one of the Company’s directors paid the Company $30,179, representing profit on Company stock purchased within the six-month window of a previous Company stock sale. Such payment was made in accordance with Section 16(b) of the Securities Exchange Act of 1934.

11. 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.