MEXCO ENERGY CORP annual report, FY2014

Business context and reporting period

Mexco Energy Corporation is an independent oil and gas exploration, development and production company, focused primarily on West Texas and holding interests in properties across 12 states. This Form 10-K covers the fiscal year ended March 31, 2014; fiscal fourth-quarter figures are also noted below.

Financial and operating performance

FY2014 operating and net margins were approximately 11.8% and 7.5%, respectively, compared with an operating and net loss in FY2013. Fourth-quarter FY2014 oil and gas revenue was $953,291, operating income was $88,425 and net income was $2,272 (EPS rounded to $0.00).

Oil production increased 16.9% to 27,186 barrels, while gas production declined 9.8% to 361,652 Mcf. Average oil price was $95.33 per barrel before swap effects ($93.33 after derivatives); average gas price rose 41.1% to $3.88 per Mcf. Production costs rose 14% to $1.232 million; DD&A was $1.151 million and G&A was $1.137 million.

At year-end, cash was $156,082, working capital was $522,216, and total assets were $17.918 million. Long-term debt was $2.425 million, down from $2.950 million; the $4.9 million revolving facility had stated availability of $2.319 million after outstanding letters of credit. The facility bears floating interest at LIBOR plus 2.5 percentage points and matures November 30, 2015. The company reported $13.399 million of stockholders’ equity. Cash declined $10,324 during the year.

Material changes versus the prior comparable period

• Oil and gas sales rose 30%, driven by higher oil volume and higher realized oil and gas prices, partly offset by lower gas volume. Higher revenue, particularly from oil, reversed the prior-year loss.
• Cash from operations increased 122%. Mexco used net cash in investing activities of $1.307 million and reduced debt by $525,000 net of borrowings and repayments.
• Oil and gas reserves totaled 9.269 million Mcfe, down from 10.038 million Mcfe. Oil reserves increased to 501,550 barrels, while gas reserves fell to 6.259 Bcf. The company cited a 1.404 million Mcfe downward gas-reserve revision, primarily related to SEC rules requiring development within five years.
• PV-10 increased to $24.745 million from $17.789 million; the after-tax standardized measure of discounted future net cash flows rose to $19.329 million from $14.369 million. These reserve-based measures are estimates, not fair value.
• Mexco recorded $99,262 of derivative losses, comprising $54,281 realized and $44,981 unrealized. It had no ceiling-test impairment in FY2014, FY2013 or FY2012.

Outlook, management commentary, risks and contingencies

Management stated that cash flow from operations and available financing should provide adequate liquidity for the next fiscal year. The company planned to continue developing properties, particularly in the West Texas Wolfcamp, and projected drilling two operated PUD wells in FY2015. Development of the remaining PUD locations depends largely on third-party operators and their schedules. Mexco reported approximately 3.4 Bcfe of PUDs, about 37% of proved reserves, with estimated future development costs of approximately $4.6 million.

During FY2014, Mexco invested approximately $800,000 in seven Reagan County wells, and several other non-operated drilling and completion projects were underway. It also acquired producing properties for $450,000 on March 31, 2014. Management’s strategy emphasizes acquisitions and development of long-lived, lower-cost reserves; it cautioned that competition may prevent successful acquisitions.

Principal risks include volatile commodity prices (with greater sensitivity to natural gas), reserve-estimate uncertainty and PUD development execution, dependence on third-party operators and transport infrastructure, access to capital and borrowing-base changes, and compliance with debt covenants. The company’s $90-per-barrel oil swap covered 500 barrels per month through March 2015; swaps can limit upside and expose the company to counterparty and production-volume risks. Environmental and hydraulic-fracturing regulation may raise costs or constrain activity. The company reported substantial compliance with existing environmental requirements, no material remediation or pollution-control capital spending in FY2014, and no known environmental claims expected to require material FY2015 capital expenditure. It reported no material legal proceedings.

Nicholas C. Taylor, Chairman and CEO, beneficially owned approximately 44% of shares, giving him significant shareholder influence. Mexco paid no cash dividends and the credit agreement prohibits them without lender consent. Management concluded that internal control over financial reporting and disclosure controls were effective at March 31, 2014. The independent auditor issued an unqualified opinion on the financial statements.

Important facts for investors to verify

• Confirm the reserve revision, five-year PUD development schedule, and whether planned wells and third-party-operated locations are progressing as assumed.
• Track borrowing-base availability, covenant compliance, floating-rate exposure and the November 2015 facility maturity; stated availability includes the effect of letters of credit.
• Assess whether operating cash flow can fund planned capital spending and the company’s approximately $4.6 million estimated PUD development costs.
• Monitor realized commodity prices, gas production and the remaining oil-swap exposure, including the difference between reported prices and swap-adjusted results.
• Review future reserve reports and PV-10 assumptions: FY2014 reserve pricing used 12-month averages of $94.23 per barrel of oil and $3.67 per Mcf of gas, and actual prices, costs and recoveries may differ materially.
• Consider the impact of customer concentration: one purchaser represented 22% of FY2014 oil and gas revenue and 25% of oil and gas receivables.