Business Context and Reporting Period
Mexco Energy Corporation (Mexco) is engaged in the exploration, development, and production of natural gas, crude oil, condensate, and natural gas liquids (NGLs), with primary operations in West Texas and interests in ten states. This Form 10-Q covers the quarterly period ended December 31, 2007, and the nine-month period ended December 31, 2007 (Fiscal Year 2008).
Key Financial Metrics
| Metric | Three Months Ended Dec 31, 2007 | Nine Months Ended Dec 31, 2007 | Nine Months Ended Dec 31, 2006 |
|---|---|---|---|
| Total Operating Revenue | $955,080 | $2,646,505 | $2,216,365 |
| Net Income | $221,114 | $247,164 | $424,905 |
| Net Income Per Share (Diluted) | $0.12 | $0.14 | $0.23 |
| Operating Cash Flow | N/A | $658,241 | $1,097,463 |
| Long-Term Debt | $3,075,000 | $3,075,000 | $700,000 |
| Cash and Equivalents | $219,954 | $219,954 | $72,537 |
| Working Capital | $579,268 | $579,268 | $446,831 |
Profitability Margins (Nine Months 2007): Operating profit margin was approximately 15.8% ($417,695 / $2,646,505). Net profit margin was approximately 9.3% ($247,164 / $2,646,505).
Material Changes vs. Prior Period
- Revenue Growth: Oil and gas sales increased 44% in the third quarter and 19% for the nine-month period compared to the prior year, driven by higher commodity prices (oil avg. $86.05/bbl vs. $49.35/bbl in Q3; gas avg. $6.36/mcf vs. $5.34/mcf in Q3) and modest production increases (7% oil, 4% gas in Q3).
- Net Income Volatility: While Q3 net income surged 230% to $221,114, the nine-month net income decreased 42% to $247,164 compared to $424,905 in the prior year. This decline is attributed to higher production costs, increased interest expense, and a higher effective tax rate (32% vs. 10% in the prior year).
- Expense Increases: Production costs rose 62% for the nine months due to repairs and higher production taxes. Interest expense increased 211% to $58,484 due to higher borrowings.
- Capital Expenditures: Cash used for additions to oil and gas properties increased significantly to $2,810,831 for the nine months ended Dec 31, 2007, compared to $582,870 in the prior year.
Outlook, Risks, and Management Commentary
- Capital Strategy: Management focuses on increasing profit margins by acquiring low-cost gas properties and secondarily oil properties. Capital expenditures are funded by operating cash flow and a $5.0 million revolving credit facility with Bank of America (borrowing base set at $4,225,000 as of Sept 2007).
- Operational Updates:
- Drilled a producing well in Crane County, Texas ($161k cost).
- Encountered mechanical failure in a Lea County, New Mexico well ($237k cost); lawsuit filed against the drilling company.
- Active drilling/completion in Borden County ($316k) and San Patricio County ($166k), Texas.
- Acquired 118 mineral acres (22% royalty interest) in Tarrant County, Texas for $1.85 million on Dec 31, 2007.
- Risks:
- Commodity Price Volatility: No hedging arrangements are in place. A $1/bbl change in oil price impacts pretax income by ~$13,348; a $0.10/mcf change in gas price impacts pretax income by ~$26,444.
- Interest Rate Risk: Debt bears interest at the prime rate. A 1% rate change impacts annual pretax income by $30,750.
- Legal Proceedings: A lawsuit is pending against a drilling company regarding the failed well in Lea County, NM.
Investor Verification Checklist
- Verify the status and potential recovery amount of the lawsuit against the drilling company for the failed Lea County well.
- Confirm the production results and economic viability of the newly drilled wells in Borden, San Patricio, and Loving Counties.
- Monitor the borrowing base redetermination (annually around August 1) to ensure the $4.225 million facility remains sufficient for planned capital expenditures.
- Review the impact of the $1.85 million Tarrant County acquisition on future cash flows and reserve additions.
- Assess the sustainability of the 32% effective tax rate compared to the 10% rate in the prior year.