MXC

Business Context and Reporting Period

Mexco Energy Corporation is an independent oil and gas company incorporated in Colorado, primarily engaged in the acquisition, exploration, and development of properties in the United States, with a focus on West Texas. The company operates under the full cost method of accounting. This Form 10-K covers the fiscal year ended March 31, 2010. The company is classified as a smaller reporting company.

Key Financial Metrics

Material Changes Versus Prior Period

• Revenue Decline: Total operating revenue decreased by approximately 34% to $3.25 million, driven primarily by a 42% drop in average natural gas prices ($3.71/Mcf vs. $6.41/Mcf) and a 19% drop in average oil prices ($66.23/bbl vs. $82.22/bbl). This was partially offset by a slight increase in production volumes (6% for oil, 1% for gas).
• Profitability: Net income fell 66% to $400,839. Operating profit decreased significantly from $1.78 million to $176,208.
• Debt Reduction: The company utilized cash flow to reduce long-term debt by $700,000, bringing the outstanding balance on its revolving credit facility to $700,000.
• Reserve Adjustments: Total proved reserves decreased by approximately 8% (875,000 Mcfe) due to production and downward revisions of previous estimates, despite additions from extensions and discoveries. The company adopted new SEC reserve reporting rules in fiscal 2010, requiring the use of 12-month average prices rather than year-end prices.
• Tax Benefit: The company recorded an income tax benefit of $257,235 in 2010, compared to an expense of $528,262 in 2009, largely due to a change in estimate regarding statutory depletion carryforwards.

Guidance, Outlook, Risks, and Unusual Items

• Liquidity and Capital Resources: Management believes cash flow from operations and funds available from financing will be sufficient for the next fiscal year. The company has a $5.0 million revolving credit facility with a borrowing base of $4.9 million; availability was $4.2 million as of March 31, 2010.
• Dividends: The company does not anticipate paying cash dividends in the foreseeable future, and its credit agreement prohibits dividend payments without lender consent.
• Key Risks:
  • Commodity Price Volatility: Financial results are highly sensitive to natural gas prices, which constitute 85% of proved reserves and 63% of revenues.
  • Reserve Uncertainty: Approximately 40% of proved reserves are undeveloped, requiring significant capital and successful drilling to realize.
  • Regulatory Environment: Potential new regulations regarding hydraulic fracturing and greenhouse gas emissions could increase costs and restrict operations.
  • Concentration of Ownership: CEO Nicholas C. Taylor beneficially owns approximately 46% of the outstanding common stock, giving him significant influence over corporate matters.
• Unusual Items: The adoption of new SEC oil and gas reporting rules (Modernization of Oil and Gas Reporting) changed the methodology for calculating reserves and the standardized measure of discounted future net cash flows. No ceiling test writedowns were recorded for the period.

Investor Verification Checklist

• Reserve Estimates: Verify the impact of the new SEC 12-month average pricing rule on the reported reserve quantities and the Standardized Measure of Discounted Future Net Cash Flows.
• Debt Covenants: Confirm compliance with the tangible net worth and other financial covenants in the revolving credit facility, particularly given the reduction in commodity prices.
• Undeveloped Reserves: Assess the capital requirements and drilling success rates needed to develop the 40% of reserves classified as undeveloped.
• Related Party Transactions: Review transactions involving Board member Thomas Craddick (purchase of working interest) and geological consultant Jeff Smith (fees and overriding interests).
• Customer Concentration: Note that two customers (Chesapeake Operating and Conoco Phillips) accounted for 32% of total revenues in fiscal 2010.