MXC

Business Context and Reporting Period

Mexco Energy Corporation, a Colorado corporation engaged in the exploration, development, and production of natural gas, crude oil, condensate, and natural gas liquids (NGLs), filed its Form 10-Q for the quarterly period ended June 30, 2006. The Company operates primarily in West Texas but holds interests in ten states. It is a non-accelerated filer with 1,743,041 shares of common stock outstanding as of August 9, 2006.

Key Financial Metrics

Margins: Operating profit was $144,944 for the quarter ended June 30, 2006, compared to $286,780 in the prior year period. The effective income tax rate resulted in a net tax benefit of $87,415 for the current quarter.

Material Changes vs. Prior Period

• Revenue Decline: Total operating revenues decreased by approximately 3% ($25,308) due to a 15% decline in natural gas production and lower gas prices ($5.86/mcf vs. $6.24/mcf), partially offset by a 9% increase in oil production and higher oil prices ($64.66/bbl vs. $48.37/bbl).
• Profit Increase: Net income increased by 41% ($66,372) primarily driven by a significant deferred tax benefit of $127,660 related to a revision in statutory depletion estimates and a net operating loss carryforward.
• Expense Growth: General and administrative expenses rose 34% to $261,493, attributed to increased consulting fees for Russian project evaluations, higher director fees, and the adoption of SFAS 123(R) for stock-based compensation ($21,497 expense). Production costs increased 22% due to well repairs.
• Debt Reduction: Long-term debt decreased by $200,000 as the Company utilized cash flow to pay down its revolving credit facility. Interest expense dropped 66% to $10,099.

Outlook, Risks, and Management Commentary

• Strategy: Management focuses on increasing profit margins by acquiring and developing low-cost gas properties and secondarily oil properties. The Company continues to review potential projects in Russia, though no further expenses are expected in the foreseeable future after expensing approximately $48,000 in the current quarter.
• Liquidity: Management believes cash flow from operations and available credit facilities will be sufficient to meet working capital and capital expenditure requirements for the fiscal year. The Company has a $5.0 million revolving credit facility with a borrowing base of $3.25 million; $400,000 was outstanding as of June 30, 2006.
• Market Risks: The Company is exposed to significant volatility in oil and gas prices and interest rates. It has not entered into any hedging arrangements. A 1% change in interest rates would impact annual pretax income by approximately $4,000.
• Accounting Changes: The Company adopted SFAS 123(R) for stock-based compensation and SFAS 154 for accounting changes. It is currently evaluating the impact of FIN 48 regarding uncertainty in income taxes, effective April 1, 2007.

Investor Verification Checklist

• Verify the sustainability of the net income increase, which was driven largely by a non-cash deferred tax benefit rather than operational revenue growth.
• Monitor the decline in natural gas production volumes (15% decrease) and the Company's ability to offset this with oil production or new acquisitions.
• Review the status of the $5.0 million credit facility and the annual borrowing base redetermination scheduled for August 1, 2006.
• Assess the impact of rising general and administrative expenses, specifically those related to Russian project evaluations and stock-based compensation.
• Confirm the Company's cash position relative to its asset retirement obligations ($337,555 total) and capital expenditure plans.