MEXCO ENERGY CORP - Quarter Report: 2020 December (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2020

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to              

Commission File No. 1-31785

MEXCO ENERGY CORPORATION

(Exact name of registrant as specified in its charter)

(432) 682-1119

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company as defined in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [  ] NO [X]

The number of shares outstanding of the registrant’s common stock, par value $.50 per share, as of February 10, 2021 was 2,071,666.

MEXCO ENERGY CORPORATION AND SUBSIDIARIES

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Mexco Energy Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the consolidated financial statements.

Mexco Energy Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

Mexco Energy Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

Mexco Energy Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended December 31,

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

Mexco Energy Corporation and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Nature of Operations

Mexco Energy Corporation (a Colorado corporation) and its wholly owned subsidiaries, Forman Energy Corporation (a New York corporation), Southwest Texas Disposal Corporation (a Texas corporation) and TBO Oil & Gas, LLC (a Texas limited liability company) (collectively, the “Company”) are engaged in the exploration, development and production of natural gas, crude oil, condensate and natural gas liquids (“NGLs”). Most of the Company’s oil and gas interests are centered in West Texas and Southeastern New Mexico; however, the Company owns producing properties and undeveloped acreage in fourteen states. All of the Company’s oil and gas interests are operated by others.

Recent Events

The outbreak of the novel coronavirus (“COVID-19”) in the first calendar quarter of 2020 and its continued spread across the globe in the second and third calendar quarters of 2020 has resulted, and is likely to continue to result, in significant economic disruption and has, and is likely to continue to, adversely affect the operations of the Company’s business, as the significantly reduced global and national economic activity has resulted in reduced demand for oil and natural gas. Federal, state and local governments mobilized to implement containment mechanisms to minimize impacts to their populations and economies. Various containment measures, which include the quarantining of cities, regions and countries, while aiding in the prevention of further outbreak, have resulted in a severe drop in general economic activity and a resulting decrease in energy demand. In addition, the global economy has experienced a significant disruption to global supply chains. The extent of the COVID-19 outbreak on the Company’s operational and financial performance will continue to depend on certain developments, including the duration and spread of the outbreak and its continued impact on customer activity and third-party providers. The direct impact to the Company’s operations began to take effect at the close of the fiscal year ended March 31, 2020, and continued through the issuance of these condensed consolidated financial statements. The full extent to which the COVID-19 outbreak may affect the Company’s financial conditions, results of operations or liquidity subsequent to the issuance of these condensed consolidated financial statements is uncertain. At the time of this filing, cases of COVID-19 in the U.S. remain high, including in Texas, where we are involved in significant operations.

The severe drop in economic activity, travel restrictions and other restrictions due to COVID-19 have had a significant negative impact on the demand for oil and gas. Due to the significantly reduced demand for oil and natural gas as a result of the COVID-19 pandemic and the current oversupply of oil and natural gas in the market, available storage and capacity for the Company’s customers’ production may be limited or completely unavailable in the future, which may further negatively impact the price of oil. The Company cannot predict whether, or when, the global supply and demand imbalance will be resolved or whether, or when, oil and natural gas production and economic activities will return to normalized levels. In the absence of additional reductions to global production, oil, natural gas and NGLs prices could remain at current levels, or decline further, for an extended period of time.

2. Basis of Presentation and Significant Accounting Policies

Principles of Consolidation. The consolidated financial statements include the accounts of Mexco Energy Corporation and its wholly owned subsidiaries. All significant intercompany balances and transactions associated with the consolidated operations have been eliminated.

Estimates and Assumptions. In preparing financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”), management is required to make informed judgments, estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and affect the reported amounts of revenues and expenses during the reporting period. In addition, significant estimates are used in determining proved oil and gas reserves. Although management believes its estimates and assumptions are reasonable, actual results may differ materially from those estimates. The estimate of the Company’s oil and natural gas reserves, which is used to compute depreciation, depletion, amortization and impairment of oil and gas properties, is the most significant of the estimates and assumptions that affect these reported results.

Interim Financial Statements. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position of the Company as of December 31, 2020, and the results of its operations and cash flows for the interim periods ended December 31, 2020 and 2019. The consolidated financial statements as of December 31, 2020 and for the three and nine month periods ended December 31, 2020 and 2019 are unaudited. The consolidated balance sheet as of March 31, 2020 was derived from the audited balance sheet filed in the Company’s 2020 annual report on Form 10-K filed with the Securities and Exchange Commission (“SEC”). The results of operations for the periods presented are not necessarily indicative of the results to be expected for a full year. The accounting policies followed by the Company are set forth in more detail in Note 2 of the “Notes to Consolidated Financial Statements” in the Form 10-K. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted in this Form 10-Q pursuant to the rules and regulations of the SEC. However, the disclosures herein are adequate to make the information presented not misleading. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Form 10-K.

Investments. The Company accounts for investments of less than 1% of any limited liability company using the cost method. The cost of the investment is recorded as an asset on the consolidated balance sheets and when income from the investment is received, it is immediately recognized on the consolidated statements of operations.

Derivative Financial Instruments. The Company’s derivative financial instruments are used to manage commodity price risk attributable to expected oil and gas production. While there is risk the financial benefit of rising oil and gas prices may not be captured, the Company believes the benefits of stable and predictable cash flows outweigh the potential risks.

The Company accounts for derivative financial instruments using fair value accounting and recognizes gains and losses in earnings during the period in which they occur. Unsettled derivative instruments are recorded in the accompanying consolidated balance sheets as either a current or non-current asset or a liability measured at its fair value. The Company only offsets derivative assets and liabilities for arrangements with the same counterparty when right of offset exists. Derivative assets and liabilities with different counterparties are recorded gross in the consolidated balance sheets. Derivative contract settlements are reflected in operating activities in the accompanying consolidated statements of cash flows.

The Company uses certain pricing models to determine the fair value of its derivative financial instruments. Inputs to the pricing models include publicly available prices and forward price curves generated from a compilation of data gathered from third parties. Company management validates the data provided by third parties by understanding the pricing models used, obtaining market values from other pricing sources, analyzing pricing data in certain situations and confirming that those securities trade in active markets.

Recently Adopted Accounting Pronouncements. In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” (“ASU 2019-12”), which simplifies various aspects of the income tax accounting guidance in ASC 740, including requirements related to the following: (i) hybrid tax regimes; (ii) the tax basis step-up in goodwill obtained in a transaction that is not a business combination; (iii) separate financial statements of entities not subject to tax; (iv) the intraperiod tax allocation exception to the incremental approach; (v) ownership changes in investments - changes from a subsidiary to an equity method investment (and vice versa); (vi) interim-period accounting for enacted changes in tax laws; and (vii) the year-to-date loss limitation in interim-period tax accounting. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years and early adoption is permitted. If an entity early adopts these amendments in an interim period, it should reflect any adjustments as of the beginning of the annual period that includes that interim period. In addition, an entity that elects to early adopt ASU 2019-12 is required to adopt all of the amendments in the same period. The Company is currently assessing the effect that ASU 2019-12 will have on its financial position, results of operations and disclosures.

3. Asset Retirement Obligations

The Company’s asset retirement obligations (“ARO”) relate to the plugging of wells, the removal of facilities and equipment, and site restoration on oil and gas properties. The fair value of a liability for an ARO is recorded in the period in which it is incurred, discounted to its present value using the credit adjusted risk-free interest rate, and a corresponding amount capitalized by increasing the carrying amount of the related long-lived asset. The liability is accreted each period until the liability is settled or the well is sold, at which time the liability is removed. The related asset retirement cost is capitalized as part of the carrying amount of our oil and natural gas properties. The ARO is included in the consolidated balance sheets with the current portion being included in the accounts payable and other accrued expenses.

The following table provides a rollforward of the AROs for the first nine months of fiscal 2021:

4. Stock-based Compensation

The Company recognized stock-based compensation expense of $13,865 and $8,125 in general and administrative expense in the Consolidated Statements of Operations for the three months ended December 31, 2020 and 2019, respectively. Stock-based compensation expense recognized for the nine months ended December 31, 2020 and 2019 was $41,813 and $24,375, respectively. The total cost related to non-vested awards not yet recognized at December 31, 2020 totals approximately $127,996 which is expected to be recognized over a weighted average of 2.70 years.

The following table is a summary of activity of stock options for the nine months ended December 31, 2020:

During the nine months ended December 31, 2020 and 2019, no stock options were granted.

During the nine months ended December 31, 2020, stock options covering 11,700 shares were exercised with a total intrinsic value of $12,217. The Company received proceeds of $78,795 from these exercises. During the nine months ended December 31, 2019, no stock options were exercised.

During the nine months ended December 31, 2020, 1,000 unvested stock options were forfeited due to the resignation of an employee and 34,200 vested stock options expired unexercised. There were no stock options forfeited or expired during the nine months ended December 31, 2019. No forfeiture rate is assumed for stock options granted to directors or employees due to the forfeiture rate history of these types of awards.

Outstanding options at December 31, 2020 expire between November 2021 and March 2030 and have exercise prices ranging from $3.34 to $7.00.

Subsequently, in January 2021, stock options covering 19,800 shares were exercised with a total intrinsic value of $53,751. The Company received proceeds of $134,640 from these exercises.

5. Long Term Debt

Long-term debt on the Consolidated Balance Sheets consisted of the following as of the dates indicated:

On December 28, 2018, the Company entered into a loan agreement (the “Agreement”) with West Texas National Bank (“WTNB”), which provided for a credit facility of $1,000,000 with a maturity date of December 28, 2021. The Agreement has no monthly commitment reduction and a borrowing base to be evaluated annually.

On February 28, 2020, the Agreement was amended to increase the credit facility to $2,500,000, extend the maturity date to March 28, 2023 and increase the borrowing base to $1,500,000.

Under the Agreement, interest on the credit facility accrues at a rate equal to the prime rate as quoted in the Wall Street Journal plus one-half of one percent (0.5%) floating daily. Interest on the outstanding amount under the Agreement is payable monthly. In addition, the Company will pay an unused commitment fee in an amount equal to one-half of one percent (0.5%) times the daily average of the unadvanced amount of the commitment. The unused commitment fee is payable quarterly in arrears on the last day of each calendar quarter. As of December 31, 2020, there was $400,000 available on the credit facility.

No principal payments are anticipated to be required through the maturity date of the credit facility, March 28, 2023. Upon closing with WTNB on the original Agreement, the Company paid a .5% loan origination fee in the amount of $5,000 plus legal and recording expenses totaling $34,532, which were deferred over the original life of the credit facility. Upon closing the amendment to the Agreement, the Company paid a .1% loan origination fee of $2,500 and an extension fee of $3,125 plus legal and recording expenses totaling $12,266, which were also deferred over the new remaining life of the credit facility.

Amounts borrowed under the Agreement are collateralized by the common stock of the Company’s wholly owned subsidiaries and substantially all of the Company’s oil and gas properties.

The Agreement contains customary covenants for credit facilities of this type including limitations on change in control, disposition of assets, mergers and reorganizations. The Company is also obligated to meet certain financial covenants under the Agreement and requires senior debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”) ratios (Senior Debt/EBITDA) less than or equal to 4.00 to 1.00 measured with respect to the four trailing quarters and minimum interest coverage ratios (EBITDA/Interest Expense) of 2.00 to 1.00 for each quarter. The Company is in compliance with all covenants as of December 31, 2020 and believes it will remain in compliance for the next fiscal year.

In addition, this Agreement prohibits the Company from paying cash dividends on its common stock without written permission of WTNB. The Agreement does not permit the Company to enter into hedge agreements covering crude oil and natural gas prices without prior WTNB approval. The Company obtained written permission from WTNB prior to entering into the current hedge agreement discussed in Note 8.

The balance outstanding on the line of credit as of December 31, 2020 was $1,100,000. The following table is a summary of activity on the WTNB line of credit for the nine months ended December 31, 2020:

Subsequently, on January 11, 2021, the Company borrowed $75,000 on the WTNB credit facility and on January 15, 2021, made a payment of $75,000 on the credit facility, leaving a balance of $1,100,000.

The Company also maintained a Certificate of Deposit Account at WTNB to collateralize one outstanding letter of credit for $25,000 in lieu of a plugging bond with the Texas Railroad Commission covering the properties the Company operated. The operated property was sold effective December 1, 2019 and the letter of credit was cancelled. On April 10, 2020, the Certificate of Deposit Account was terminated and the funds deposited into the Company’s operating account.

6. Paycheck Protection Program (PPP) Loan.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act commonly referred to as the CARES Act became effective. One component of the CARES Act was the paycheck protection program (“PPP”) which provides small businesses with the resources needed to maintain their payroll and cover applicable overhead. The PPP is implemented by the United States Small Business Administration (“SBA”) with support from the Department of the Treasury. The PPP provides funds to pay up to 24 weeks of payroll costs including benefits. Funds can also be used to pay interest on mortgages, rent, and utilities. The Company applied for, and was accepted to participate in this program. On May 5, 2020, the Company received funding for approximately $68,600.

The loan was a two-year loan with a maturity date of May 5, 2022 an annual interest rate of 1% payable monthly with the first six monthly payments deferred. The Company applied for and on November 25, 2020 was approved for loan forgiveness in the amount of $68,957 under the provisions of Section 1106 of the CARES Act. This was for the forgiveness of our PPP loan in the amount of $68,574 and $383 in accrued interest expense. The Company was eligible for loan forgiveness because the Company used all loan proceeds to partially subsidize direct payroll expenses.

7. Leases

The Company leases approximately 4,160 rentable square feet of office space from an unaffiliated third party for the corporate office located in Midland, Texas. This includes 1,021 square feet of office space shared with and reimbursed by the majority shareholder. The lease is a 36-month lease that expires in May 2021 and does not include an option to renew. In June 2020, in exchange for a reduction in rent for the months of June and July 2020, the Company agreed to a 2-month extension to its current lease agreement at the regular monthly rate extending its current lease expiration date to July 2021.

The Company determines an arrangement is a lease at inception. Operating leases are recorded in operating lease right-of-use asset, operating lease liability, current, and operating lease liability, long-term on the consolidated balance sheets.

Operating lease right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. As the Company’s lease does not provide an implicit rate, the Company uses the incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate used at adoption was 6.0%. Significant judgement is required when determining the incremental borrowing rate. The Company chose not to discount because the difference is not significant. Rent expense for lease payments is recognized on a straight-line basis over the lease term.

The balance sheets classification of lease assets and liabilities was as follows:

Future minimum lease payments as of December 31, 2020 under non-cancellable operating leases are as follows:

Net cash paid for our operating lease for the nine months ended December 31, 2020 and 2019 was $34,121 and $35,300, respectively. Rent expense, less sublease income of $14,315 and $13,167, respectively, is included in general and administrative expenses.

8. Fair Value Measurements

The Company applies FASB ASC Topic 820, Fair Value Measurements and Disclosure (“ASC Topic 820”), which establishes a framework for measuring fair value based upon inputs that market participants use in pricing an asset or liability, which are classified into two catagories: observable inputs or unobservable inputs. Observable inputs represent market data obtained from independent sources, whereas unobservable inputs reflect a company’s own market assumptions, which are used if observable inputs are not reasonably available without undue cost and effort. These two types of inputs are further prioritized into the following fair value input hierarchy:

Level 1: Quoted prices for identical instruments in active markets at the measurement date.

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets at the measurement date and for the anticipated term of the instrument.

Level 3: Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability acquired, based on the best information available in the circumstances.

The carrying amount reported in the accompanying consolidated balance sheets for cash and cash equivalents, accounts receivable and accounts payable approximates fair value because of the immediate or short-term maturity of these financial instruments.

The fair value amount reported in the accompanying consolidated balance sheets for long-term debt approximates fair value because the actual interest rates do not significantly differ from current rates offered for instruments with similar characteristics. See the Company’s Note 5 on Long Term Debt for further discussion.

Fair Value Measurements on a Recurring Basis

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

The Company’s commodity derivative instruments were carried at fair value on a recurring basis in the Company’s consolidated balance sheets. The Company uses certain pricing models to determine the fair value of its derivative financial instruments. Inputs to the pricing models include publicly available prices and forward price curves generated from a compilation of data gathered from third parties.

Company management validates the data provided by third parties by understanding the pricing models used, obtaining market values from other pricing sources, analyzing pricing data in certain situations and confirming that those securities trade in active markets. Assumed credit risk adjustments, based on published credit ratings and public bond yield spreads are applied to the Company’s commodity derivatives. The Company’s derivative instruments are subject to netting arrangements and qualify for net presentation in the consolidated balance sheets in those instances where such arrangements exist with the respective counterparty.

To ensure these derivative instruments are recorded at fair value, valuation adjustments may be required to reflect the creditworthiness of either party as well as market constraints on liquidity. There was no adjustment as of December 31, 2020.

Fair Value Measurements on a Nonrecurring Basis

The asset retirement obligation estimates are derived from historical costs and management’s expectation of future cost environments and, therefore, the Company has designated these liabilities as Level 3 measurements. The significant inputs to this fair value measurement include estimates of plugging, abandonment and remediation costs, well life, inflation and credit-adjusted risk-free rate. See Note 3 for a reconciliation of the beginning and ending balances of the liability for the Company’s asset retirement obligations.

9. Derivative Financial Instruments

It is the Company’s policy to enter into derivative contracts only with counterparties that are creditworthy financial institutions deemed by management as competent and competitive.

The Company is exposed to certain risks relating to its ongoing business operations, such as commodity price risk. Derivative contracts are utilized to economically hedge the Company’s exposure to price fluctuations and reduce the variability in the Company’s cash flows associated with anticipated sales of future oil and natural gas production. The Company follows FASB ASC Topic 815, Derivatives and Hedging (ASC Topic 815), to account for its derivative financial instruments.

The Company’s crude oil derivative positions consisted of put options. The Company has elected not to designate any of its derivative contracts for hedge accounting. Accordingly, the Company records the net change in the mark-to-market valuation of these derivative contracts, as well as all payments and receipts on settled derivative contracts, in net realized and unrealized gain (loss) on commodity price hedging contracts on the consolidated statements of operations. All derivative contracts are recorded at fair market value and included in the consolidated balance sheets as assets or liabilities. As of December 31, 2020, the Company has no derivative contracts.

The Company may have multiple hedge positions that span a several-month time period and result in fair value asset and liability positions. At the end of the reporting periods, those positions are offset to a single fair value asset or liability for each commodity and the netted balance is reflected in the consolidated balance sheets as an asset or liability.

During the quarter ended June 30, 2020 the Company entered into a series of crude oil put option contracts. All of these such contracts expired in July and August 2020.

The following tables summarizes the amounts of the Company’s realized and unrealized losses on derivative contracts listed as loss on derivative instruments in the Company’s consolidated statements of operations for the nine months ended December 31, 2020.

10. Income Taxes

A valuation allowance for deferred tax assets, including net operating losses, is recognized when it is more likely than not that some or all of the benefit from the deferred tax asset will not be realized. To assess that likelihood, we use estimates and judgment regarding our future taxable income, and we consider the tax consequences in the jurisdiction where such taxable income is generated, to determine whether a valuation allowance is required. Such evidence can include our current financial position, our results of operations, both actual and forecasted, the reversal of deferred tax liabilities, and tax planning strategies as well as the current and forecasted business economics of our industry.

Based on the material write-downs of the carrying value of our oil and natural gas properties during fiscal 2016, we are in a net deferred tax asset position as of December 31, 2020. Our deferred tax asset is $1,312,129 as of December 31, 2020 with a valuation amount of $1,312,129. We believe it is more likely than not that these deferred tax assets will not be realized. Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit the use of deferred tax assets. The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income are reduced or increased or if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as future expected growth.

11. Related Party Transactions

Related party transactions for the Company relate to shared office expenditures in addition to administrative and operating expenses paid on behalf of the principal stockholder. The total billed to and reimbursed by the stockholder for the three months ended December 31, 2020 and 2019 was $9,122 and $12,289, respectively. The total billed to and reimbursed by the stockholder for the nine months ended December 31, 2020 and 2019 was $27,443 and $32,232, respectively. The principal stockholder pays for his share of the lease amount for the shared office space directly to the lessor. Amounts paid by the principal stockholder directly to the lessor for the three months ending December 31, 2020 and 2019 were $4,045 and $3,981, respectively. Amounts paid by the principal stockholder directly to the lessor for the nine months ending December 31, 2020 and 2019 were $11,694 and $11,900, respectively.

12. Income (loss) Per Common Share

The Company’s basic net income (loss) per share has been computed based on the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share assumes the exercise of all stock options having exercise prices less than the average market price of the common stock during the period using the treasury stock method and is computed by dividing net income (loss) by the weighted average number of common shares and dilutive potential common shares (stock options) outstanding during the period. In periods where losses are reported, the weighted-average number of common shares outstanding excludes potential common shares, because their inclusion would be anti-dilutive.

The following is a reconciliation of the number of shares used in the calculation of basic and diluted net income (loss) per share for the three and nine month periods ended December 31, 2020 and 2019:

For the three months ended December 31, 2019, 139,800 potential common shares relating to stock options were excluded in the computation of diluted net income per share because the price of the options was greater than the average market price of the common shares and therefore, the effect would be anti-dilutive. Anti-dilutive stock options have a weighted average exercise price of $6.12 at December 31, 2020.

Due to a net loss for the nine months ended December 31, 2020 and 2019, the weighted average number of common shares outstanding excludes common stock equivalents because their inclusion would be anti-dilutive.

13. Subsequent Events

The Company completed a review and analysis of all events that occurred after the consolidated balance sheet date to determine if any such events must be reported and has determined that there are no other subsequent events to be disclosed.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Unless the context otherwise requires, references to the “Company”, “Mexco”, “we”, “us” or “our” mean Mexco Energy Corporation and its consolidated subsidiaries.

Cautionary Statements Regarding Forward-Looking Statements. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include statements regarding our plans, beliefs or current expectations and may be signified by the words “could”, “should”, “expect”, “project”, “estimate”, “believe”, “anticipate”, “intend”, “budget”, “plan”, “forecast”, “predict” and other similar expressions. Forward-looking statements appear throughout this Form 10-Q with respect to, among other things: profitability; planned capital expenditures; estimates of oil and gas production; future project dates; estimates of future oil and gas prices; estimates of oil and gas reserves; our future financial condition or results of operations; and our business strategy and other plans and objectives for future operations. Forward-looking statements involve known and unknown risks and uncertainties that could cause actual results to differ materially from those contained in any forward-looking statement.

While we have made assumptions that we believe are reasonable, the assumptions that support our forward-looking statements are based upon information that is currently available and is subject to change. All forward-looking statements in the Form 10-Q are qualified in their entirety by the cautionary statement contained in this section. We do not undertake to update, revise or correct any of the forward-looking information. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Form 10-K.

Liquidity and Capital Resources. Historically, we have funded our operations, acquisitions, exploration and development expenditures from cash generated by operating activities, bank borrowings, sales of non-core properties and issuance of common stock. Our primary financial resource is our base of oil and gas reserves. We have pledged our producing oil and gas properties to secure our revolving line of credit. We do not have any delivery commitments to provide a fixed and determinable quantity of its oil and gas under any existing contract or agreement.

Due to the current commodity price environment, we are applying financial discipline to all aspects of our business. In order to meet obligations, we may continue to sell non-core assets.

Our long-term strategy is on increasing profit margins while concentrating on obtaining reserves with low cost operations by acquiring and developing oil and gas properties with potential for long-lived production. We focus our efforts on the acquisition of royalties and working interests and non-operated properties in areas with significant development potential.

For the first nine months of fiscal 2021, cash flow from operations was $372,863, a 31% decrease when compared to the corresponding period of fiscal 2020 primarily as a result of a 19% decrease in crude oil and natural gas sales primarily due to a 37% decrease in crude oil price partially offset by a 4% increase in natural gas price, a 17% increase in crude oil production and a 14% increase in natural gas production. Net cash of $305,000 was received from the line of credit, cash of $78,795 was received from the exercise of stock options, net cash of $793,597 was used for additions to oil and gas properties, and cash of $25,000 was used for an investment at cost basis. Accordingly, net cash increased $6,635, leaving cash and cash equivalents on hand of $41,016 as of December 31, 2020.

At December 31, 2020, we had working capital of $296,172 compared to working capital of $186,785 at March 31, 2020, an increase of $109,387 primarily due to the reasons set forth below.

Oil and Natural Gas Property Development. The Company’s working interests in the following mentioned 42 wells range from .03% to 1.2% with a total capital expenditure of approximately $1,295,000 through February 10, 2021, which includes subsequent events listed herein.

The Company planned to participate in the drilling and completion of 20 horizontal wells at an estimated aggregate cost of approximately $1,200,000 for the fiscal year ending March 31, 2021, of which, $600,000 has already been expended during the nine months ending December 31, 2020. The operators of these wells include Concho Resources, Inc., Marathon Oil Company, Mewbourne Oil Company, and others.

During the first six months of fiscal 2021, Mexco participated in the drilling and completion of two horizontal wells in the Wolfcamp formation of the Delaware Basin located in the western portion of the Permian Basin in Lea County, New Mexico with aggregate costs of approximately $233,000. These wells were completed in September 2020 with initial average production rates of 1,224 barrels of oil, 4,881 barrels of water and 3,422,000 cubic feet of gas per day, or 1,794 barrels of oil equivalent per day. Mexco’s working interest in these wells is 1.2%.

During the second quarter of fiscal 2021, Mexco participated in the drilling of four horizontal wells in the Wolfcamp formation of the Delaware Basin located in the western portion of the Permian Basin in Lea County, New Mexico with aggregate costs of approximately $202,000. Mexco’s working interest in these wells is 1.2%. Subsequently, in January 2021, Mexco expended $168,000 to complete these wells.

Also during the first quarter of fiscal 2021, Mexco expended $99,000 to participate in the drilling of five horizontal wells in the Upper Avalon formation of the Delaware Basin located in the western portion of the Permian Basin in Lea County, New Mexico. Mexco’s working interest in these wells is .5%. Subsequently, in January 2021, Mexco expended $172,000 to complete these wells.

During the third quarter of fiscal 2021, Mexco participated in the drilling of two horizontal wells in the Wolfcamp formation of the Delaware Basin located in the western portion of the Permian Basin in Lea County, New Mexico at an initial cost of $37,200. Subsequently, in January 2021, Mexco expended another $37,200 for an increased interest in these wells. Mexco’s working interest in these wells is 1.2%.

In October 2020, the Company also expended $10,200 for its share to participate in the drilling of two horizontal wells in the 3^rd Bone Spring Sand formation of the Delaware Basin located in the western portion of the Permian Basin in Lea County, New Mexico. Mexco’s working interest in this well is .1%.

The Company has expended approximately $270,000 which is the balance of the completion costs of 22 horizontal wells located in Eddy and Lea Counties, New Mexico which were drilled during fiscal 2020. Of these wells, thirteen wells were completed during Mexco’s first six months of fiscal 2021. In December 2020, four more of these wells were completed and initially produced at an average production rate of 1,171 barrels of oil; 4,004 barrels of water; and 2,517,000 cubic feet of gas per day, or 1,591 barrels of oil equivalent per day. Mexco’s working interest in these wells is .36%. Another three of these wells were also completed in December 2020 and the remaining two wells were completed in January 2021.

Subsequently, in January 2021, Mexco expended approximately $49,000 to participate in the drilling of four horizontal wells in the Upper and Middle Wolfcamp formation of the Delaware Basin located in the western portion of the Permian Basin in Lea County, New Mexico. Mexco’s working interest in these wells is .36%.

Effective July 1, 2020, the Company sold its interest in the deep rights of a property in Martin County, Texas for a cash payment of $100,000.

We are participating in other projects and are reviewing projects in which we may participate. The cost of such projects would be funded, to the extent possible, from existing cash balances and cash flow from operations. The remainder may be funded through borrowings on the credit facility and, if appropriate, sales of non-core properties.

Beginning in March 2020, crude oil and natural gas prices decreased significantly through May 2020. The volatility of the energy markets makes it extremely difficult to predict future oil and natural gas price movements with any certainty. For example, in the last twelve months, the NYMEX West Texas Intermediate (“WTI”) posted price for crude oil has ranged from a low of negative $41.25 per bbl in April 2020 to a high of $59.75 per bbl in January 2020. The Henry Hub Spot Market Price (“Henry Hub”) for natural gas has ranged from a low of $1.33 per MMBtu in September 2020 to a high of $3.14 per MMBtu in October 2020. On December 31, 2020 the WTI posted price for crude oil was $44.50 per bbl and the Henry Hub spot price for natural gas was $2.36 per MMBtu. See Results of Operations below for realized prices which are substantially below the Henry Hub Spot Market Price.

Paycheck Protection Program (PPP) Loan. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act commonly referred to as the CARES Act became effective. One component of the CARES Act was the paycheck protection program (“PPP”) which provides small businesses with the resources needed to maintain their payroll and cover applicable overhead. The PPP is implemented by the United States Small Business Administration (“SBA”) with support from the Department of the Treasury. The PPP provides funds to pay up to 24 weeks of payroll costs including benefits. Funds can also be used to pay interest on mortgages, rent, and utilities. The Company applied for, and was accepted to participate in this program. On May 5, 2020, the Company received funding for $68,574.

The loan was a two-year loan with a maturity date of May 5, 2022 an annual interest rate of 1% payable monthly with the first six monthly payments deferred. The Company applied for and on November 25, 2020 was approved for loan forgiveness under the provisions of Section 1106 of the CARES Act. The Company was eligible for loan forgiveness because the Company used all loan proceeds to partially subsidize direct payroll expenses.

Contractual Obligations. We have no off-balance sheet debt or unrecorded obligations and have not guaranteed the debt of any other party. The following table summarizes our future payments we are obligated to make based on agreements in place as of December 31, 2020:

Results of Operations – Three Months Ended December 31, 2020 and 2019. For the quarter ended December 31, 2020, there was net income of $80,497 compared to $35,196 for the quarter ended December 31, 2019, a 129% increase primarily as a result of a decrease in operating expenses that is further explained below.

Oil and gas sales. Revenue from oil and gas sales was $692,243 for the third quarter of fiscal 2021, a 10% decrease from $766,223 for the same period of fiscal 2020. This resulted from a decrease in oil prices partially offset by an increase in oil and gas production volumes and an increase in gas prices.

Production and exploration. Production costs were $235,958 for the third quarter of fiscal 2021, a 6% decrease from $249,921 for the same period of fiscal 2020. This is primarily the result of a decrease in lease operating expenses due to the sale of our marginal operated properties in Ector County, Texas and a decrease in production taxes as a result of the decrease in oil and gas sales.

Depreciation, depletion and amortization. Depreciation, depletion and amortization expense was $237,459 for the third quarter of fiscal 2021, a 4% increase from $228,762 for the same period of fiscal 2020, primarily due to an increase in oil and gas production and a decrease in oil and gas reserves partially offset by a decrease in the full cost pool amortization base.

General and administrative expenses. General and administrative expenses were $193,288 for the third quarter of fiscal 2021, a 19% decrease from $239,346 for the same period of fiscal 2020. This was primarily due to a decrease in salaries, contract services and employee insurance expense.

Interest expense. Interest expense was $14,604 for the third quarter of fiscal 2021, a 43% increase from $10,203 for the same period of fiscal 2020, due to an increase in borrowings partially offset by a decrease in interest rates.

PPP loan forgiveness. PPP loan forgiveness in the amount of $68,957 for the three months ended December 31, 2020 was for the forgiveness of our PPP loan in the amount of $68,574 and $383 in accrued interest expense. The Company received the proceeds for this loan in May 2020 and applied for and received loan forgiveness in November 2020.

Income taxes. There was no income tax expense for the quarter ended December 31, 2020 and the quarter ended December 31, 2019. The effective tax rate for the three months ended December 31, 2020 and December 31, 2019 was 0%. We are in a net deferred tax asset position and believe it is more likely than not that these deferred tax assets will not be realized.

Results of Operations – Nine Months Ended December 31, 2020 and 2019. For the nine months ended December 31, 2020, there was a net loss of $261,143 compared to a net loss of $101,777 for the nine months ended December 31, 2019. This was a result of a decrease in operating revenues partially offset by a decrease in operating expenses that is further explained below.

Oil and gas sales. Revenue from oil and gas sales was $1,686,386 for the nine months ended December 31, 2020, a 19% decrease from $2,083,667 for the same period of fiscal 2020. This resulted from a decrease in oil prices partially offset by an increase in oil and gas production volumes and an increase in gas prices.

Production and exploration. Production costs were $624,741 for the nine months ended December 31, 2020, an 11% decrease from $698,358 for the nine months ended December 31, 2019. This decrease is primarily the result of a decrease in production taxes as a result of a decrease in oil revenues and a decrease in lease operating expenses due to numerous wells being shut-in during the month of May 2020 as well as cost cutting measures being implemented by the operators because of the depressed oil prices.

Depreciation, depletion and amortization. Depreciation, depletion and amortization expense was $697,698 for the nine months ended December 31, 2020, an 8% increase from $648,729 for the nine months ended December 31, 2019, primarily due to an increase in oil and gas production and a decrease in oil and gas reserves partially offset by a decrease in the full cost pool amortization base.

General and administrative expenses. General and administrative expenses were $634,526 for the nine months ended December 31, 2020, a 21% decrease from $805,701 for the nine months ended December 31, 2019. This was primarily due to a decrease in salaries, engineering fees and accounting fees.

Interest expense. Interest expense was $39,174 for the nine months ended December 31, 2020, a 56% increase from $25,054 for the nine months ended December 31, 2019 due to an increase in borrowings partially offset by an decrease in interest rates.

PPP loan forgiveness. PPP loan forgiveness in the amount of $68,957 for the three months ended December 31, 2020 was for the forgiveness of our PPP loan in the amount of $68,574 and $383 in accrued interest expense. The Company received the proceeds for this loan in May 2020 and applied for and received loan forgiveness in November 2020.

Income taxes. There was no income tax for the nine months ended December 31, 2020 and for the nine months ended December 31, 2019. The effective tax rate for the nine months ended December 31, 2020 and December 31, 2019 was 0%. We are in a net deferred tax asset position and believe it is more likely than not that these deferred tax assets will not be realized.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The primary sources of market risk for us include fluctuations in commodity prices and interest rates. All of our financial instruments are for purposes other than trading.

Credit Risk. Credit risk is the risk of loss as a result of nonperformance by other parties of their contractual obligations. Our primary credit risk is related to oil and gas production sold to various purchasers and the receivables are generally not collateralized. At December 31, 2020, our largest credit risk associated with any single purchaser was $235,604 or 65% of our total oil and gas receivables. We have not experienced any significant credit losses.

Interest Rate Risk. At December 31, 2020, we had an outstanding loan balance of $1,100,000 under our credit agreement, which bears interest at a rate equal to the prime rate as quoted in the Wall Street Journal plus one-half of one percent (0.5%) floating daily. If the interest rate on our bank debt increases or decreases by one percentage point our annual pretax income would change by $11,000 based on the outstanding balance at December 31, 2020.

Energy Price Risk. Our most significant market risk is the pricing for crude oil and natural gas. Our financial condition, results of operations, and capital resources are highly dependent upon the prevailing market prices of, and demand for, oil and natural gas. Prices for oil and natural gas fluctuate widely. We cannot predict future oil and natural gas prices with any certainty. Pricing for oil and natural gas production has been volatile and unpredictable for several years, and we expect this volatility to continue in the future.

Factors that can cause price fluctuations include the level of global demand for petroleum products, foreign and domestic supply of oil and gas, the establishment of and compliance with production quotas by oil-exporting countries, weather conditions, the price and availability of alternative fuels and overall political and economic conditions in oil producing countries.

Oil prices dropped sharply in early March 2020, and then continued to decline reaching levels below zero dollars per barrel. This was a result of multiple factors affecting supply and demand in global oil and gas markets, including the announcement of price reductions and production increases by OPEC members and other oil exporting nations and the ongoing COVID-19 pandemic. Oil and natural gas prices are expected to continue to be volatile as a result of the changes in oil and natural gas production, inventories and demand, as well as national and international economic performance. Even though oil prices improved in June 2020, we cannot predict when oil prices will stabilize.

Declines in oil and natural gas prices will materially adversely affect our financial condition, liquidity, ability to obtain financing and operating results. Changes in oil and gas prices impact both estimated future net revenue and the estimated quantity of proved reserves. Any reduction in reserves, including reductions due to price fluctuations, can reduce the borrowing base under our credit facility and adversely affect the amount of cash flow available for capital expenditures and our ability to obtain additional capital for our acquisition, exploration and development activities. In addition, a noncash write-down of our oil and gas properties could be required under full cost accounting rules if prices declined significantly, even if it is only for a short period of time. Lower prices may also reduce the amount of crude oil and natural gas that can be produced economically. Thus, we may experience material increases or decreases in reserve quantities solely as a result of price changes and not as a result of drilling or well performance.

Similarly, any improvements in oil and gas prices can have a favorable impact on our financial condition, results of operations and capital resources. Oil and natural gas prices do not necessarily fluctuate in direct relationship to each other. If the average oil price had increased or decreased by ten dollars per barrel for the first nine months of fiscal 2021, pretax income or loss would have changed by $376,810. If the average gas price had increased or decreased by one dollar per mcf for the first nine months of fiscal 2021, pretax income or loss would have changed by $251,094.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures to ensure that the information we must disclose in our filings with the SEC is recorded, processed, summarized and reported on a timely basis. At the end of the period covered by this report, our principal executive officer and principal financial officer reviewed and evaluated the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e). Based on such evaluation, such officers concluded that, as of December 31, 2020, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting. No changes in our internal control over financial reporting occurred during the nine months ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

We may, from time to time, be involved in litigation and claims arising out of our operations in the normal course of business. We are not aware of any legal or governmental proceedings against us, or contemplated to be brought against us, under various environmental protection statutes or other regulations to which we are subject.

Item 1A. Risk Factors

There have been no material changes to the information previously disclosed in Item 1A. “Risk Factors” in our 2020 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

On November 24, 2020, subsequent to the death of the Chairman of the Audit Committee and a Director on November 4, 2020, the Board of Directors appointed Thomas H. Decker as the Chairman of the Audit Committee. The Board has determined that Mr. Decker is an “audit committee financial expert” (as that term is defined under the applicable SEC rules and regulations) based on the Board’s qualitative assessment of Mr. Decker’s level of knowledge, experience and formal education.

Item 6. Exhibits

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.