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 September 30, 2007. The Company operates primarily in West Texas but holds interests in ten states. As of November 13, 2007, there were 1,767,366 shares of common stock outstanding.

Key Financial Metrics

Note: Operating margins were significantly compressed in the quarter due to a spike in production costs. The effective income tax rate for the six-month period was 33%.

Material Changes vs. Prior Period

• Profitability Decline: Net income for the three months ended September 30, 2007, turned to a loss of $(8,756), a decrease of 107% compared to the $130,534 net income in the same period of 2006. For the six-month period, net income dropped 93% to $26,049 from $357,825.
• Revenue Growth: Oil and gas sales increased 9% year-over-year for both the quarter ($839,947 vs. $773,698) and the six-month period ($1.69M vs. $1.55M), driven by higher commodity prices and increased oil production volumes.
• Cost Inflation: Production expenses surged 126% for the quarter (from $206,968 to $467,336) and 89% for the six-month period. Management attributed this primarily to significant repairs and maintenance on operated wells in the El Cinco field and higher production taxes.
• Debt and Interest: Interest expense increased 220% for the quarter and 117% for the six-month period due to higher borrowings. Long-term debt outstanding increased from $700,000 at March 31, 2007, to $1,050,000 at September 30, 2007.
• Capital Expenditures: Cash used for additions to oil and gas properties was $866,749 for the six months ended September 30, 2007, compared to $213,213 in the prior year period.

Outlook, Risks, and Management Commentary

• Capital Strategy: Management continues to focus on acquiring royalties and minerals in areas with development potential. Funding is expected to come from operating cash flows and the revolving credit facility.
• Drilling Activities: The Company participated in drilling wells in Crane County (producing), Lea County (mechanical failure; lawsuit filed against driller), and Borden County (evaluation pending). A new commitment was made for a well in San Patricio County.
• Liquidity: Working capital decreased to approximately $219,703 from $446,831 at the end of the prior fiscal year, largely due to accrued expenses for well repairs. Management believes cash flow and credit facilities are sufficient for current requirements.
• Market Risks: The Company has no hedging arrangements. Results are highly sensitive to oil and gas price volatility. A $1.00 change in oil price or $0.10 change in gas price would impact pretax income by approximately $8,833 and $17,581, respectively, for the six-month period.
• Legal Proceedings: A lawsuit is being filed against a drilling company regarding a failed well in Lea County, New Mexico, to recover damages.

Investor Verification Checklist

• Production Cost Sustainability: Verify if the 126% increase in production costs is a one-time event related to El Cinco field repairs or indicative of rising operational costs.
• Drilling Success Rates: Monitor the outcome of the Borden County well and the status of the lawsuit regarding the failed Lea County well.
• Debt Covenants: Review the borrowing base redetermination ($4.225M) and ensure the Company remains in compliance with the Bank of America credit agreement, particularly given the volatility in commodity prices.
• Reserve Estimates: Confirm if the current production volumes and price environment support the Company's long-term reserve estimates and future capital expenditure plans.