NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2020
(UNAUDITED)
1. BASIS
OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited consolidated financial
statements of Empire Petroleum Corporation ("Empire" or the "Company") have been prepared in accordance with
United States generally accepted accounting principles for interim financial information and the instructions to Form 10-Q. Accordingly,
they do not include all of the information and footnotes required by United States generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the
Company's financial position, the results of operations, and the cash flows for the interim period are included. All adjustments
are of a normal, recurring nature. Operating results for the interim period are not necessarily indicative of the results that
may be expected for the year ending December 31, 2020.
The information contained in this Form 10-Q
should be read in conjunction with the audited financial statements and related notes for the year ended December 31, 2019 which
are contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC")
on March 30, 2020.
The Company has incurred significant losses
in recent years. The continuation of the Company as a going concern is dependent upon the ability of the Company to attain future
profitable operations and/or additional debt or equity financing until profitable operations are achieved. These financial statements
have been prepared on the basis of United States generally accepted accounting principles applicable to a company with continuing
operations, which assume that the Company will continue in operation for the foreseeable future and will be able to realize its
assets and discharge its obligations in the normal course of operations. Management believes the going concern assumption to be
appropriate for these financial statements. If the going concern assumption were not appropriate for these financial statements,
then adjustments might be necessary to adjust the carrying value of assets and liabilities and reported expenses.
The
Company’s impairment assessment of proved and unproved mineral properties is based on several factors including oil and
gas spot market prices and estimated futures prices that existed at June 30, 2020. In 2020, crude oil prices in both the spot
market and futures market experienced significant volatility. For the six months ended June 30, 2020 the Company recorded an impairment
expense of $800,452 as a result of the decline in oil prices (See Note 3). Further, the effect of lower crude oil prices on the
Company’s future financial position or results of operations is not currently determinable due to broader economic and industry
uncertainties, including the impact to the operators and other working interest owners of the properties in which the Company
owns mineral interests.
In the event crude oil or natural gas prices remain low, there is
the risk that, among other things:
|
·
|
the Company’s revenues, cash flows and profitability may decline substantially, which
could also indirectly impact expected production by reducing the amount of funds available to acquire future mineral interests;
|
|
·
|
reserves relating to the Company’s proved properties may become uneconomic to produce resulting
in impairment of proved properties; and
|
|
·
|
operators and other working interest owners are unable to execute their drilling and exploration
programs resulting in lower production or inability to prove reserves on unproved properties
|
The occurrence of certain of these events may have a
material adverse effect on the Company's business, results of operations and financial condition.
In early March 2020, there was a global outbreak
of COVID-19 that continued into the second quarter and has resulted in changes in global supply and demand of certain mineral and
energy products. These changes, including the magnitude and length of the economic downturn and any potential resulting direct
and indirect negative impact to the Company cannot be determined, but they could have a prospective material impact to the Company’s
acquisition and project development activities, and cash flows and liquidity.
Reclassification of prior
year presentation. Certain prior year amounts have been reclassified for consistency with the current year presentation.
These reclassifications had no effect on the reported results of operations. An adjustment has been made to the Consolidated Balance
Sheet for the year ended December 31, 2019 to reclassify certain utility and other deposits in the amount of $118,177 which had
previously been included in prepaids.
The continuation of the Company is dependent
upon the ability of the Company to raise capital and attain future profitable operations. The ultimate recoverability of the Company's
investment in oil and natural gas interests is dependent upon the existence and discovery of economically recoverable oil and natural
gas reserves, the ability of the Company to obtain necessary financing to further develop the interests, and the ability of the
Company to attain future profitable production.
As of June 30, 2020, the Company had $285,813
of cash and working capital deficit of $9,412,190, which includes the net balance of the Senior Revolver Loan Agreement of $8,397,253
which matures March 27, 2021. The Company has proved reserves which have been acquired within the last two years. The Company plans
to continue to look for oil and natural gas investments and will use a combination of debt and equity financing to fund the acquisitions.
The Company expects to also incur costs related to evaluating and acquiring oil and natural gas acquisitions for the foreseeable
future. It is expected that management will attempt to raise additional capital for future investment and working capital opportunities.
Compensation of Officers and Employees
As of June 30, 2020, the Company had three
employees. No independent Board members received compensation from the Company in the first six months of 2020 or 2019. For the
six months ended June 30, 2020, the Company paid Mr. Morrisett and Mr. Pritchard $116,000 each for services rendered. For the six
months ended June 30, 2019, the Company paid Mr. Morrisett $127,450 and Mr. Pritchard $131,450 for services rendered excluding
the value of options. In addition, as of June 30, 2020 Mr. Pritchard has outstanding advances of $26,017.
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation.
The consolidated financial statements of the Company include the accounts of the Company and its wholly owned subsidiaries, Empire
Louisiana, LLC ("Empire Louisiana"), Empire North Dakota, LLC ("Empire North Dakota"), and Empire Texas, LLC
(“Empire Texas”). All material intercompany balances and transactions have been eliminated.
Use of estimates in the preparation
of financial statements. Preparation of financial statements in conformity with generally accepted accounting principles
in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.
Depletion of oil and natural gas properties is determined using estimates of proved oil and natural gas reserves. There are numerous
uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and
the timing of development expenditures. Similarly, evaluations for impairment of proved and unproved oil and natural gas properties
are subject to numerous uncertainties including, among others, estimates of future recoverable reserves, commodity price outlooks
and prevailing market rates of other sources of income and costs. Other significant estimates include, but are not limited to,
asset retirement obligations, fair value of assets purchased in acquisitions, and taxes.
Interim financial statements.
The accompanying consolidated financial statements of the Company have not been audited by the Company's independent registered
public accounting firm. In preparing the accompanying consolidated financial statements, management has made certain estimates
and assumptions that affect reported amounts in the consolidated financial statements and disclosures of contingencies. Actual
results may differ from those estimates. The results for interim periods are not necessarily indicative of annual results.
Certain disclosures have been condensed
in or omitted from these consolidated financial statements. Accordingly, these condensed notes to the consolidated financial statements
should be read in conjunction with the audited consolidated financial statements and notes included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2019.
Inventory. Inventory
consists of oil in tanks which has not been delivered and is valued at the contract price to the buyer and pipe which has not yet
been put into production.
Revenue recognition.
The Company recognizes revenues from the sales of oil and natural gas to its customers and presents them aggregated on the Company's
consolidated statements of operations. The Company enters into contracts with customers to sell its oil and natural gas production.
Revenue on these contracts is recognized in accordance with the five-step revenue recognition model prescribed in ASC 606. Specifically,
revenue is recognized when the Company's performance obligations under these contracts are satisfied, which generally occurs with
the transfer of control of the oil and natural gas to the purchaser. Control is generally considered transferred when the following
criteria are met: (i) transfer of physical custody, (ii) transfer of title, (iii) transfer of risk of loss and (iv) relinquishment
of any repurchase rights or other similar rights. Given the nature of the products sold, revenue is recognized at a point in time
based on the amount of consideration the Company expects to receive in accordance with the price specified in the contract. Consideration
under the oil and natural gas marketing contracts is typically received from the purchaser one to two months after production.
At June 30, 2020, the Company had receivables related to contracts with customers of approximately $590,000.
Fair value measurements. The
Financial Accounting Standards Board ("FASB") fair value measurement standards define fair value, establish a consistent
framework for measuring fair value and establish a fair value hierarchy based on the observability of inputs used to measure fair
value.
Convertible debt - The carrying
value of the convertible debt approximate fair value as of December 31, 2019. As of June 30, 2020 all of the convertible debt had
been converted to shares of the Company’s common stock. Management's estimates are based on the assessment of qualitative
factors that are considered Level 3 measurements in the fair value hierarchy as required by FASB ASC 820.
Oil and natural gas properties
- The fair value of proved and unproved oil and natural gas properties was measured using valuation techniques that convert
the future cash flows to a single discounted amount. Significant inputs to the valuation of proved and unproved oil and natural
gas properties include estimates of: (i) recoverable reserves; (ii) production rates; (iii) future operating and development costs;
(iv) future commodity prices; and (v) a market-based weighted average costs of capital. The Company utilized a combination of the
New York Mercantile Exchange ("NYMEX") strip pricing and consensus pricing to value the reserves, then applied various
discount rates depending on the classification of reserves and other risk characteristics. For significant purchases, management
utilized the assistance of a third-party valuation expert to estimate the value of the oil and natural gas properties acquired.
The fair value of asset retirement
obligations is included in proved oil and natural gas properties with a corresponding liability in the table above. The fair value
was determined based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount
rate, inflation rate and timing associated with the incurrence of these costs.
The inputs used to value oil and
natural gas properties for impairments and asset retirement obligations require significant judgment and estimates made by management
and represent Level 3 inputs.
Financial instruments and other-
The fair values determined for accounts receivable, accrued expenses and other current liabilities were equivalent to the carrying
value due to their short-term nature.
3. PROPERTY
AND EQUIPMENT
In March 2019, the Company, through its subsidiary,
Empire North Dakota, LLC, purchased oil and natural gas properties in Montana and North Dakota (See Note 7).
On January 27, 2020, the Company, through its
wholly owned subsidiary, Empire North Dakota, LLC, entered into a Bill of Sale and Assignment to purchase lease interests in approximately
4,936 acres in Montana for $500,000.
On February 10, 2020, the Company, through
its wholly owned subsidiary, Empire North Dakota, LLC, sold overriding royalty interests for leases it owned in Montana for $325,000
to a consultant of the Company. As of June 30, 2020 $200,000 of the sales price had been received with the balance pending completion
of title work.
On February 17, 2020 the Company, through its
wholly owned subsidiary, Empire North Dakota, LLC, sold all of its interest in leases of approximately 337 acres in Montana for
$1,010,400.
On April 6, 2020 the Company, through its wholly
owned subsidiary, Empire Texas, LLC, purchased oil and natural gas properties in Texas (see Note 5).
During the six months ended June 30, 2020,
NYMEX strip prices experienced significant volatility, resulting in a significant decrease in value of the Company’s economically
recoverable proved oil and natural gas reserves. As such, the carrying amount of the Company’s proved oil and natural gas
properties exceeded the expected undiscounted future net cash flows for certain leases, resulting in impairment charges against
earnings of $800,452. These impairment charges are included in impairments of long-lived assets on the consolidated statement of
operations for the six months ended June 30, 2020. The Company did not recognize an impairment of proved oil and natural gas properties
during the six months ended June 30, 2019.
The aggregate capitalized costs
of oil and natural gas properties as of June 30, 2020, are as follows:
Proved producing wells
|
|
$
|
5,284,041
|
|
Proved undeveloped
|
|
|
2,232,458
|
|
Lease, well and gathering equipment
|
|
|
1,705,092
|
|
Asset retirement obligation
|
|
|
14,988,534
|
|
Unproved leasehold costs
|
|
|
492,741
|
|
Gross capitalized costs
|
|
|
24,702,866
|
|
Less: accumulated depreciation, depletion and impairment
|
|
|
(4,918,808
|
)
|
|
|
$
|
19,784,058
|
|
Other property and equipment consists of office
furniture and equipment.
Oher property and equipment, at cost
|
|
$
|
14,456
|
|
Less: accumulated depreciation
|
|
|
(3,400
|
)
|
Oher property and equipment, net
|
|
$
|
11,056
|
|
4. ACQUISITION
OF OVINTIV OIL AND NATURAL GAS PROPERTIES
On March 3, 2020 the Company, through its wholly
owned subsidiary, Empire North Dakota, LLC, entered into a Purchase and Sale Agreement (“the Agreement”) with Ovintiv
USA, Inc. and several related companies to purchase certain oil and natural gas properties in Montana and North Dakota comprising
26,600 net acres with 94 active wells. The purchase price is $8,500,000, subject to adjustments with an effective date of January
1, 2020 and a closing date of April 30, 2020.
The Company has made an $850,000 deposit relating
to the purchase which is recorded as a deposit on its balance sheet. Due to the COVID pandemic, and governmental state of emergency
orders related thereto, the Company was unable to meet with and obtain financing to complete the purchase from its lenders. As
of June 30, 2020 the Agreement has been terminated. The Company is currently in communication with the Seller for return of the
deposit. The Company may not be successful in obtaining return of the entire deposit and has recorded an allowance of $725,000
based on its assessment of the negotiations.
5. ACQUISITION
OF PARDUS OIL AND NATURAL GAS PROPERTIES
On April 6, 2020 the Company, through its wholly
owned subsidiary, Empire Texas, LLC, entered into a Purchase and Sale Agreement (“the Agreement”) with Pardus Oil &
Gas, LLC and Pardus Oil & Gas Operating GP, LLC (collectively “the Seller”) to purchase certain oil and natural
gas properties in Texas comprising 139 gross wells and approximately 30,000 net acres, 77.3 miles of gathering lines and pipelines
and related facilities and equipment, and all general and limited partner interest in Pardus Oil & Gas Operating, LP. The purchase
price included the assumption of certain obligations and a contingent payment not to exceed $2,000,000 reduced by certain revenue
suspense amounts. The contingent payment is based on monthly oil production in excess of a specified level from the purchased properties
and an average monthly realized oil price of $40 or more per barrel of oil through December 31, 2022. The transaction closed on
April 7, 2020.
The following table sets forth the
Company's purchase price allocation:
|
|
|
|
Fair Value of Assets Acquired
|
|
|
|
Oil and natural gas properties
|
|
$
|
1,935,366
|
|
Inventory of oil in tanks
|
|
|
147,297
|
|
Deposits
|
|
|
378,000
|
|
Equipment and gathering lines
|
|
|
109,200
|
|
Asset retirement obligation asset
|
|
|
9,508,484
|
|
|
|
|
|
|
Total Assets Acquired
|
|
$
|
12,078,347
|
|
|
|
|
|
|
Fair Value of Liabilities Assumed
|
|
|
|
|
Accounts payable, net
|
|
$
|
20,456
|
|
Note payable – current
|
|
|
378,000
|
|
Royalty suspense
|
|
|
1,185,587
|
|
Asset retirement obligations
|
|
|
9,508,484
|
|
|
|
|
|
|
Total liabilities assumed
|
|
$
|
11,092,527
|
|
|
|
|
|
|
Total consideration
|
|
$
|
985,820
|
|
The fair values of assets acquired
and liabilities assumed were based on the following key inputs:
Oil and natural gas properties
The fair value of proved oil and natural
gas properties was measured using valuation techniques that convert the future cash flows to a single discounted amount. Significant
inputs to the valuation of proved oil and natural gas properties include estimates of: (i) recoverable reserves; (ii) production
rates; (iii) future operating and development costs; (iv) future commodity prices; and (v) a market-based weighted average
costs of capital. The Company utilized a combination of the New York Mercantile Exchange ("NYMEX") strip pricing and
consensus pricing to value the reserves, then applied various discount rates depending on the classification of reserves and other
risk characteristics. Management utilized the assistance of a third-party valuation expert to estimate the value of the oil and
natural gas properties acquired.
The fair value of asset retirement
obligations totaled $9,508,484 and is included with a corresponding liability in the table above. The fair value was determined
based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount rate, inflation
rate and timing associated with the incurrence of these costs.
The total consideration consists of
a contingent payment to the seller which is due based on monthly production of oil and natural gas through December 31, 2022 and
a monthly average price of $40 or higher per barrel.
The inputs used to value oil and natural
gas properties and asset retirement obligations require significant judgment and estimates made by management and represent Level
3 inputs.
Financial instruments and other
The fair values determined for accounts
payable - trade were equivalent to the carrying value due to their short-term nature.
Accounts payable - trade includes $20,456 of
liabilities primarily related to well activity prior to close.
6. ACQUISITION
OF WARHORSE OIL AND NATURAL GAS PROPERTIES
On June 10, 2019, the Company received a process verbal and
related sheriff's deed dated as of May 29, 2019 (the "Sheriff's Deed") pertaining to two wells in St. Landry Parish purchased
from Business First Bancshares, Inc. d/b/a Business First Bank ("Business First").
Pursuant to the Sheriff's Deed, the Company acquired certain
oil and natural gas properties located in St. Landry Parish, Louisiana, including operated working interest in two producing wells.
The Company purchased Business First's position as the superior lienholder and seizing creditor of such oil and natural gas properties,
which were owned by Warhorse Oil & Gas, LLC, for $450,000 plus $16,993 sheriff fees. The payment was paid from loan proceeds
under the loan agreement with CrossFirst Bank (see Note 9).
The Company treated the acquisition
as an asset purchase. An amount equal to $73,968 was allocated to lease and well equipment and $378,110 was allocated to producing
properties. An asset retirement obligation of $19,732 was recorded in conjunction with the purchase.
7. ACQUISITION
OF ENERGYQUEST II ASSETS
On March 28, 2019, the Company purchased oil
producing properties from EnergyQuest II, LLC ("EnergyQuest") for a purchase price of $5,600,000. The effective date
of the transaction was January 1, 2019. After certain adjustments related to the effective date, the total proceeds paid to EnergyQuest
were $5,646,126. Such proceeds were paid from borrowing on notes payable and sales of unregistered securities of the Company.
The following table sets forth the
Company's purchase price allocation:
|
|
|
|
Fair Value of Assets Acquired
|
|
|
|
Accounts receivable
|
|
$
|
1,308,748
|
|
Inventory of oil in tanks
|
|
|
438,321
|
|
Oil properties
|
|
|
10,878,429
|
|
|
|
|
|
|
Total Assets Acquired
|
|
$
|
12,625,498
|
|
|
|
|
|
|
Fair Value of Liabilities Assumed
|
|
|
|
|
Accounts payable – trade
|
|
$
|
1,861,433
|
|
Asset retirement obligations
|
|
|
5,117,939
|
|
|
|
|
|
|
Total liabilities assumed
|
|
$
|
6,979,372
|
|
|
|
|
|
|
Total consideration paid
|
|
$
|
5,646,126
|
|
The fair values of assets acquired
and liabilities assumed were based on the following key inputs:
Oil and natural gas properties
The fair value of proved oil and natural
gas properties was measured using valuation techniques that convert the future cash flows to a single discounted amount. Significant
inputs to the valuation of proved oil and natural gas properties include estimates of: (i) recoverable reserves; (ii) production
rates; (iii) future operating and development costs; (iv) future commodity prices; and (v) a market-based weighted average
costs of capital. The Company utilized a combination of the New York Mercantile Exchange ("NYMEX") strip pricing and
consensus pricing to value the reserves, then applied various discount rates depending on the classification of reserves and other
risk characteristics. Management utilized the assistance of a third-party valuation expert to estimate the value of the oil and
natural gas properties acquired.
The fair value of asset retirement
obligations totaled $5,117,939 and is included in proved oil and natural gas properties with a corresponding liability in the table
above. The fair value was determined based on a discounted cash flow model, which included assumptions of the estimated current
abandonment costs, discount rate, inflation rate and timing associated with the incurrence of these costs.
The inputs used to value oil and natural
gas properties and asset retirement obligations require significant judgment and estimates made by management and represent Level
3 inputs.
Financial instruments and other
The fair values determined for accounts
receivable and accounts payable - trade were equivalent to the carrying value due to their short-term nature.
Accounts payable - trade includes $1,861,433
of liabilities primarily related to well activity prior to close.
8. DERIVATIVE
FINANCIAL INSTRUMENTS
The Company uses derivative financial instruments
to manage its exposure to commodity price fluctuations. Commodity derivative instruments are used to reduce the effect of volatility
of price changes on the oil and natural gas the Company produces and sells. The Company’s derivative financial instruments
consist of oil and natural gas swaps.
The Company does not enter into derivative
financial instruments for speculative or trading purposes.
The Company does not designate its derivative
instruments to qualify for hedge accounting. Accordingly, the Company reflects changes in the fair value of its derivative instruments
in its consolidated statements of operations as they occur. Unrealized gains and losses related to the swap contracts are recognized
and recorded as an asset or liability on the Company’s balance sheet.
The following table summarizes the net realized
and unrealized amounts reported in earnings related to the commodity derivative instruments for the three and six months ended
June 30, 2020 and 2019:
|
|
Three months ended June 30,
|
|
|
Six months ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Gain (loss) on derivatives:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil derivatives
|
|
$
|
(402,374
|
)
|
|
$
|
492,548
|
|
|
$
|
2,106,671
|
|
|
$
|
424,952
|
|
Natural gas derivatives
|
|
|
—
|
|
|
|
8,180
|
|
|
|
—
|
|
|
|
7,417
|
|
Total
|
|
$
|
(402,374
|
)
|
|
$
|
500,728
|
|
|
$
|
2,106,671
|
|
|
$
|
432,369
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following represents the Company’s
net cash receipts from derivatives for the three and six months ended June 30, 2020 and 2019:
|
|
Three months ended June 30,
|
|
|
Nine months ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Net cash received from payments on derivatives
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil derivatives
|
|
$
|
510,609
|
|
|
$
|
74,154
|
|
|
$
|
1,043,894
|
|
|
$
|
93,503
|
|
Natural gas derivatives
|
|
|
—
|
|
|
|
4,305
|
|
|
|
—
|
|
|
|
4,711
|
|
Total
|
|
$
|
510,609
|
|
|
$
|
78,459
|
|
|
$
|
1,043,894
|
|
|
$
|
98,214
|
|
The following table sets forth the Company’s
outstanding derivative contracts at June 30, 2020. The Company has no outstanding natural gas derivatives. All of the Company’s
derivatives are expected to settle by October 2021:
|
|
1st Quarter
|
|
|
2nd Quarter
|
|
|
3rd Quarter
|
|
|
4th Quarter
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil Swaps:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Volume (MBbl)
|
|
|
—
|
|
|
|
—
|
|
|
|
16.02
|
|
|
|
15.78
|
|
Price per Bbl
|
|
|
—
|
|
|
|
—
|
|
|
$
|
58.39
|
|
|
$
|
55.18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2021
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil Swaps:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Volume (MBbl)
|
|
|
15.26
|
|
|
|
15.18
|
|
|
|
5.20
|
|
|
|
—
|
|
Price per Bbl
|
|
$
|
49.40
|
|
|
$
|
50.87
|
|
|
$
|
38.25
|
|
|
|
—
|
|
9. NOTES
PAYABLE
In February 2019, the Company entered into
five unsecured promissory note agreements with accredited investors totaling $90,000. The notes were due May 1, 2019, and accrued
interest at 8%. One of the notes, in the amount of $15,000 was issued to Michael R. Morrisett, the Company's President. These notes
and the related interest were paid in May 2019.
On September 20, 2018 the Company entered into
a Senior Revolver Loan Agreement (“the Agreement”) with CrossFirst Bank (“CrossFirst”). The Agreement was
amended March 27, 2019 (the “Amended Agreement”). The Amended Agreement commitment amount is $9,000,000 which is reduced
by $150,000 per calendar quarter ($8,400,000 at June 30, 2020) and the maximum amount that can be advanced under the Agreement
is $20,000,000 and includes interest at Wall Street Journal Prime plus 150 basis points (4.75% as of June 30, 2020). The Agreement
matures on March 27, 2021. Collateral for the loan is a lien on all of the assets of the Company’s wholly owned subsidiaries,
Empire Louisiana and Empire North Dakota, and a first priority mortgage lien, pledge of and security interest in not less than
80% of Empire Louisiana’s and Empire North Dakota’s producing oil, gas and other leasehold and mineral interests. The
Agreement requires Empire Louisiana, beginning December 31, 2018 to maintain certain covenants including an EBITDAX to interest
expense of at least 3:1 and funded debt to EBITDAX of 4:1 on a trailing twelve month basis. The Company is not in compliance with
the funded debt to EBITDAX covenant of the Agreement at June 30, 2020. As of June 30, 2020, the Company has an outstanding loan
balance of $8,397,253 under the Agreement.
In January 2020 three of the Senior Unsecured
Promissory Note investors exercised the conversion feature and converted their $102,500 notes for 1,025,000 shares of the Company's
common stock. All of the Senior Unsecured Promissory Notes have been converted to common stock of the Company as of March 31, 2020.
On April 1, 2020, in conjunction with the purchase
of assets from Pardus Oil & Gas, LLC (see Note 5), the Company entered into a unsecured promissory note agreement with the
seller in the amount of $378,000. The note is payable in one installment on April 1, 2021 and bears interest at the one-year LIBOR
rate (1% as of June 30, 2020).
On May 5, 2020, the Company, through its wholly
owned subsidiary, Pardus Oil & Gas Operating, LP, received an SBA Payroll Protection Plan (“PPP”) loan for $160,700.
The loan matures on May 5, 2022 and has an interest rate of 1%. There are no payments due until November 5, 2020 at which time
the payment amount will be determined based on the portion of the loan which has not been forgiven under criteria established by
the SBA, using an eighteen-month amortization. The Company expects that the majority of the loan amount will be forgiven based
on currently published guidelines of the United States Small Business Administration.
10. EQUITY
Diluted Earnings per Share ("EPS")
gives effect to all dilutive potential common shares outstanding during the period. The computation of Diluted EPS does not assume
conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on losses. As a result, if there
is a loss from continuing operations, Diluted EPS is computed in the same manner as Basic EPS. At March 31, 2020 and 2019, the
Company had 5,004,167 and 4,167 respectively, options outstanding that were not included in the calculation of earnings per share
for the periods then ended. Such financial instruments may become dilutive and would then need to be included in future calculations
of Diluted EPS. At June 30, 2020 and 2019, the outstanding options were considered anti-dilutive since the strike prices were above
the market price and since the Company has incurred losses year to date.
In March 2019, 1,446,668 outstanding $0.15
warrants were converted to shares of common stock of the Company. Proceeds received from the conversion was $217,000 including
$50,000 of notes payable conversion by Mr. Kamin, a board member.
During May 2019, the Company issued warrants
to purchase 300,000 shares of its common stock for $0.17 per share which expire on December 31, 2021 to a former employee for business
assistance provided. The value allocated to the warrants was the fair value determined using the Black-Scholes option valuation
with the following assumptions: no dividend yield, expected annual volatility of 217%, risk free interest rate of 1.92% and
an expected useful life of 31 months. The fair value of the warrants of $58,380 was recorded as compensation expense and allocated
to Paid in Capital.
On April 3, 2019, the Board of Directors of
the Company adopted the Empire Petroleum Corporation 2019 Stock Option Plan (the "Stock Option Plan"). The total number
of shares of common stock that may be issued pursuant to stock options under the Stock Option Plan is 10,000,000. Further, on April
3, 2019 the Company granted Mr. Pritchard and Mr. Morrissett each, options to purchase 2,500,000 shares of common stock of the
Company at an exercise price of $0.33 per share. The options vest in three installments with 1,250,000 vesting immediately and
625,000 vesting each in April 2020 and April 2021. All of the options expire in April, 2029. The value allocated to the vested
options was the fair value determined using the Black-Scholes option valuation with the following assumptions: no dividend
yield, expected annual volatility of 213%, risk free interest rate of 2.32% and an expected useful life of 5.375 years. The fair
value of the vested options of $812,500 was recorded as compensation expense and allocated to Paid in Capital in 2019. In 2020,
the fair value of the options which vested in April 2020 of $406,250 was recorded as compensation expense and allocated to Paid
in Capital. The fair of the remaining unvested options is $406,250 as of June 30, 2020.
On April 3, 2019 the Board of Directors of
the Company amended certain warrant certificates which had been issued to Mr. Kamin covering 3,000,000 warrants to purchase common
stock of the Company. The original warrants expired on December 31, 2021 and had exercise prices of $0.15 and $0.25 for 500,000
and 2,500,000 shares, respectively. The warrants were extended to expire on April 2, 2029. The value allocated to the warrants
was the fair value determined using the Black-Scholes option valuation with the following assumptions: no dividend yield,
expected annual volatility of 213%, risk free interest rate of 2.32% and an expected useful life of 5 years. The fair value of
the warrants of $620,750 was recorded as compensation expense and allocated to Paid in Capital.
11. SUBSEQUENT
EVENTS
On August 6, 2020 the Company, through its
wholly owned subsidiary, Empire Texas, LLC, entered into a joint development agreement (the “Agreement”) with Petroleum
& Independent Exploration, LLC and related entities (“PIE”) dated August 1, 2020. Under the terms of the Agreement,
PIE will perform recompletion and workover on specified wells owned by Empire. To fund the work, PIE entered into a term loan agreement
with Empire dated August 1, 2020, whereby PIE will loan up to $2,000,000, at an interest rate of 6% per annum, maturing August
7, 2024 unless terminated earlier by PIE. On August 7, 2020, $150,000 was advanced to Empire from the loan. As part of the Agreement,
Empire will assign to PIE a combined 85% working and revenue interest in the affected wells. Of the assigned interest, 70% will
be used to repay the obligations under the term loan agreement. Once the term loan is repaid, PIE will assign a 35% working and
revenue interest to Empire and retain a 50% working and revenue interest. In addition, PIE and Empire entered into a Securities
Purchase Agreement (“Securities Agreement”) whereby PIE has agreed to purchase for $525,000 (a) 3,500,000 shares of
Empire common stock, (b) warrants to purchase 2,625,000 shares of Empire common stock at an exercise price of $0.20 per share,
(c) warrants to purchase 1,800,000 shares of Empire common stock at an exercise price of $0.25 per share, (d) warrants to purchase
8,136,518 shares of Empire common stock at an exercise price of $0.10 per share, and (e) warrants to purchase up to 11,066,667
shares of Empire common stock at an exercise price of $0.141 per share. PIE is obligated to exercise the $0.20 warrants within
45 days of when 3 month trailing average production from the Empire Texas properties have increased by 20% over the trailing 3
month trailing average production as of July 2020. PIE can only exercise the $0.25 warrants once all existing non-PIE outstanding
warrants to purchase Empire common stock have been exercised or lapsed. For the $0.141 warrants, PIE may initially acquire 7,533,333
shares of Empire common stock, however the amount may be increased if any existing non-PIE warrants are exercised prior to December
31, 2020.