NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2022
Note
1 - Organization and Basis of Presentation
Empire
Petroleum Corporation (“Empire” or the “Company”, collectively with its subsidiaries) is an independent energy
company operator engaged in optimizing developed production by employing field management methods to maximize reserve recovery while
minimizing costs. Empire has four wholly-owned subsidiaries in its areas of operations:
| • | Empire
North Dakota LLC (“Empire North Dakota”) |
| • | Empire
New Mexico, LLC (“Empire New Mexico”) |
| • | Empire
Texas (“Empire Texas”), consisting of the following entities: |
| ○ | Pardus
Oil & Gas Operating, LP (owned 1% by Empire Texas GP LLC and 99% by Empire Texas LLC) |
| ▪ | Empire
Texas Operating LLC |
| • | Empire
Louisiana LLC (“Empire Louisiana”) |
Empire
was incorporated in the State of Utah in August 1983 and subsequently in the State of Delaware in 1985. The consolidated financial statements
of Empire Petroleum Corporation and subsidiaries include the accounts of the Company and its wholly-owned subsidiaries.
The
accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with United States
generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q. Accordingly,
they do not include all of the information and footnotes required by GAAP 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, 2022.
All
intercompany accounts and transactions, including revenues and expenses, have been eliminated in consolidation.
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, 2021 which are contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission
(the "SEC") on March 31, 2022.
Note
2 – Summary of Significant Accounting Policies
Significant
Accounting Policies
There
have been no material changes to significant accounting policies and estimates from the information provided in the Form 10-K for the
year ended December 31, 2021.
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.
The
three-level fair value hierarchy for disclosure of fair value measurements defined by ASC Topic 820 is as follows:
Level
1 – Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets
or liabilities. An active market is defined as a market where transactions for the financial instrument occur with sufficient frequency
and volume to provide pricing information on an ongoing basis.
Level
2 – Inputs, other than quoted prices within Level 1, that are either directly or indirectly observable for the asset or liability
through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
Level
3 – Prices or valuations that require unobservable inputs that are both significant to the fair value measurement and unobservable.
Valuation under Level 3 generally involves a significant degree of judgment from management.
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. Where available, fair value is based on observable market prices or parameters or derived from such prices or
parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some
level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market
and the instrument’s complexity. The Company reflects transfers between the three levels at the beginning of the reporting period
in which the availability of observable inputs no longer justifies classification in the original level. There were no transfers between
fair value hierarchy levels for the quarter ended March 31, 2022.
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.
Derivatives
– Derivative financial instruments are carried at fair value and measured on a recurring basis. The Company’s commodity
price hedges are valued based on discounted future cash flow models that are primarily based on published forward commodity price curves;
thus, these inputs are designated as Level 2 within the valuation hierarchy.
The
fair values of derivative instruments in asset positions include measures of counterparty nonperformance risk, and the fair values of
derivative instruments in liability positions include measures of the Company’s nonperformance risk. These measurements were not
material to the Consolidated Financial Statements.
Fair
Value on a Nonrecurring Basis
The
Company applies the provisions of fair value measurement on a non-recurring basis to its non-financial assets and liabilities, including
oil and gas properties and asset retirement obligations. These assets and liabilities are not measured at fair value on an ongoing basis
but are subject to fair value adjustments if events or changes in certain circumstances indicate that adjustments may be necessary. No
triggering events that require assessment of such items were observed during the three months ended March 31, 2022.
Related
Party Transactions
Transactions
between related parties are considered to be related party transactions even though they may not be given accounting recognition. FASB
ASC 850, Related Party Disclosures (“FASB ASC 850”) requires that transactions with related parties that
would have influence in decision making shall be disclosed so that users of the financial statements can evaluate their significance.
Related party transactions typically occur within the context of the following relationships: affiliates of the entity; entities for
which investments in their equity securities is typically accounted for under the equity method by the investing entity; trusts for the
benefit of employees; principal owners of the entity and members of their immediate families; management of the entity and members of
their immediate families; and other parties that can significantly influence the management or operating policies of the transacting
parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully
pursuing its own separate interests.
Recently
Issued Accounting Pronouncements
FASB
periodically issues new accounting standards in a continuing effort to improve standards of financial accounting and reporting. The Company
has reviewed the recently issued pronouncements and concluded that the following new accounting standards are applicable:
In
August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts
in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.
The amendments in this ASU affect entities that issue convertible instruments and/or contracts in an entity’s own equity. The amendments
in this ASU primarily affect convertible instruments issued with beneficial conversion features or cash conversion features because the
accounting models for those specific features are removed. However, all entities that issue convertible instruments are affected by the
amendments to the disclosure requirements of this ASU. For contracts in an entity’s own equity, the contracts primarily affected
are freestanding instruments and embedded features that are accounted for as derivatives under the current guidance because of failure
to meet the settlement conditions of the derivatives scope exception related to certain requirements of the settlement assessment. Also
affected is the assessment of whether an embedded conversion feature in a convertible instrument qualifies for the derivatives scope
exception. Additionally, the amendments in this ASU affect the diluted EPS calculation for instruments that may be settled in cash or
shares and for convertible instruments. The amendments in this ASU are effective for public business entities, excluding entities eligible
to be smaller reporting companies, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal
years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods
within those fiscal years. The Board specified that an entity should adopt the guidance as of the beginning of its annual fiscal year.
The Board decided to allow entities to adopt the guidance through either a modified retrospective method of transition or a fully retrospective
method of transition. The Company is analyzing the effect that adoption will have but does not expect a material impact as a result of
adopting these standards.
Note
3 – Property
The
Company follows the successful efforts method of accounting for its oil and natural gas properties. Under this method, costs to acquire
oil and natural gas properties and costs incurred to drill and equip development and exploratory wells are capitalized. Exploration costs
are charged to operations as incurred. Upon sale or retirement of oil and natural gas properties, the costs and related accumulated depreciation,
depletion and amortization are eliminated from the accounts and the resulting gain or loss is recognized.
Costs
incurred to maintain wells and related equipment and lease and well operating costs are charged to expense as incurred.
Depletion
is calculated on a units-of-production basis at the field level based on total proved developed reserves.
Proved
Properties and Impairments
Proved
oil and natural gas properties are reviewed for impairment at least annually, or as indicators of impairment arise. There were no indicators
of impairment in the current quarter or for the same quarter in the previous period.
In
May 2021 the Company purchased oil and natural gas properties in New Mexico (see Note 4).
The
aggregate capitalized costs of oil and natural gas properties as of March 31, 2022 are as follows:
Proved producing wells | |
$ | 20,977,026 | |
Proved undeveloped | |
| 2,724,966 | |
Lease and well equipment | |
| 5,448,952 | |
Asset retirement obligation | |
| 18,188,033 | |
Gross capitalized costs | |
| 47,338,977 | |
Accumulated Depreciation, Depletion, Amortization | |
| | |
and Impairment | |
| (17,926,748 | ) |
Net capitalized costs | |
$ | 29,412,229 | |
Other
property and equipment consists of operating lease assets, vehicles, office furniture, and equipment with lives ranging from three to
five years.
| |
| | |
Other property and equipment, at cost | |
$ | 1,559,064 | |
Less: accumulated depreciation | |
| (334,745 | ) |
Other property and equipment, net | |
$ | 1,224,319 | |
Note
4 – Acquisition of XTO Properties
On
March 12, 2021 the Company, through its wholly owned subsidiary Empire New Mexico, entered into a purchase and sale agreement with XTO
Holdings, LLC (a subsidiary of ExxonMobil) (the “Seller’) to acquire, among other things, certain oil and natural gas properties
in New Mexico. The purchase price was $17,800,000 subject to customary adjustments. The transaction closed on May 14, 2021 with an effective
date of January 1, 2021.
The
XTO acquisition has been assessed under the screen test for business combinations under FASB ASC 805, Business Combinations (“ASC
805”). The XTO acquisition met the screen test and has been accounted for as an asset acquisition using the acquisition method
of accounting. Under the accounting for asset acquisitions, the acquisition is recorded using a cost accumulation and allocation model
under which the cost of the acquisition is allocated on a relative fair value basis to the assets acquired and liabilities assumed. Acquisition-related
transaction costs are capitalized as a component of the cost of the assets acquired.
As
a condition of the sale, the Company purchased a $5,000,000 performance bond for the benefit of the seller for proper plugging, abandonment
and restoration of the purchased properties. The performance bond is collateralized with a letter of credit in the amount of $3,750,000.
To effect the letter of credit, the Company entered into a Promissory Note Agreement with Bank of Oklahoma, NA in the amount of $3,750,000
which is due on demand with an interest rate established by the Bank, currently at 4%. The Promissory Note, and associated letter of
credit, is collateralized with a bank certificate of deposit in a corresponding amount. In addition, the Company is required to deposit
$100,000 per month, up to $1,250,000, into a sinking fund to be held by the surety. Subsequent amendments increased the monthly payment
amounts to $160,000 in response to additional bonding requested by the State of New Mexico.
The
following table sets forth the Company's purchase price allocation:
Preliminary Fair Value of Assets Acquired | |
| |
Oil and natural gas properties | |
$ | 17,662,402 | |
Inventory of oil in tanks | |
| 318,546 | |
Vehicles | |
| 179,156 | |
Asset retirement obligations | |
| 6,117,709 | |
Total preliminary assets acquired | |
| 24,277,813 | |
| |
| | |
Preliminary Fair Value of Liabilities Assumed | |
| | |
Royalty suspense | |
| 290,325 | |
Asset retirement obligations | |
| 6,117,709 | |
Total preliminary liabilities assumed | |
| 6,408,034 | |
| |
| | |
Purchase Price | |
| 17,869,779 | |
The
value of oil and gas properties was based on an allocation of the purchase price which included assignment of values to the other identifiable
assets acquired and liabilities assumed. The value of inventory, vehicles, and royalty suspense was based on their relative fair values
as described above.
The
fair value of asset retirement obligations are 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
Company has approximately $400,000 recorded as a final settlement receivable from the seller as of March 31, 2022. On April 25, 2022,
the Company entered into an amendment to the Purchase and Sale Agreement which defined certain assets and liabilities which were included
in and excluded from the acquisition. The Company anticipates final settlement to occur in 2022 and anticipates fully collecting the outstanding
receivable at that time.
Note
5 – Joint Development Agreement
On
August 6, 2020 the Company, through its wholly owned subsidiary, Empire Texas, entered into a joint development agreement (the “JDA”)
with Petroleum & Independent Exploration, LLC and related entities (“PIE”), a related party (See Note 13), dated August
1, 2020. Under the terms of the JDA, PIE will perform recompletion or workover on specified mutually agreed upon wells (“Workover
Wells”) owned by Empire Texas. To fund the work, PIE entered into a term loan agreement with Empire Texas 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.
Proceeds of the loan will be used for recompletion or workover of the Workover Wells. Refer to Note 8 for the amount advanced on the
loan as of period-end. As part of the JDA, Empire Texas will assign to PIE a combined 85% working and revenue interest in the Workover
Wells. Of the assigned interest, 70% working and revenue interest will be used to repay the obligations under the term loan agreement.
Once the term loan is repaid, PIE will reassign a 35% working and revenue interest to Empire Texas in each of the Workover Wells and
retain a 50% working and revenue interest. To the extent the cash flows from the revenue interest
are insufficient to repay the obligations under the term loan, the Company remains required to repay the obligation and the activity
resulting from the JDA is being treated as a carried interest with a corresponding term loan.
In
addition, PIE and Empire entered into a Securities Purchase Agreement (“Securities Agreement”) whereby PIE purchased
for $525,000 (a) 875,000 shares of Empire common stock, (b) warrants to purchase 656,250 shares of Empire common stock at an exercise
price of $0.80 per share, (c) warrants to purchase 450,000 shares of Empire common stock at an exercise price of $1.00 per share, (d)
warrants to purchase 2,034,129 shares of Empire common stock at an exercise price of $0.40 per share, and (e) warrants to purchase up
to 2,766,666 shares of Empire common stock at an exercise price of $0.564 per share, pursuant to various vesting provisions as detailed
in the Securities Agreement. On March 11, 2021 the Company amended the Securities Agreement to remove the vesting provisions for
the warrants and PIE exercised all of its warrants for an aggregate exercise price of $3,349,052.
Note
6 - Asset Retirement Obligations
The
Company’s asset retirement obligations represent the estimated present value of the estimated cash flows the Company will incur
to plug, abandon and remediate its producing properties at the end of their productive lives, in accordance with applicable state laws.
Market risk premiums associated with asset retirement obligations are estimated to represent a component of the Company’s credit-adjusted
risk-free rate that is utilized in the calculations of asset retirement obligations.
The
Company’s asset retirement obligation activity is as follows for the quarter ended March 31, 2022:
| |
| | |
Asset retirement obligations, beginning of period | |
$ | 20,640,599 | |
Accretion expense | |
| 330,000 | |
Asset retirement obligation, end of period | |
$ | 20,970,599 | |
Note
7 – Commodity 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 does
not enter into derivative financial instruments for speculative or trading purposes. The Company’s derivative financial instruments
consist of put options.
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 contracts are recognized and recorded as an asset or liability on the Company’s consolidated balance sheets.
The
following table summarizes the net realized and unrealized losses reported in earnings related to the commodity derivative instruments
for the three months ended March 31, 2022 and 2021:
| |
Three Months Ended March 31, | |
| |
2022 | | |
2021 | |
Loss on derivatives: | |
| | | |
| | |
Oil derivatives | |
$ | (112,321 | ) | |
$ | (357,915 | ) |
The
following represents the Company’s net cash payments on derivatives for the three months ended March 31, 2022 and 2021:
| |
Three Months Ended March 31, | |
| |
2022 | | |
2021 | |
| |
| | | |
| | |
Oil derivatives | |
$ | (83,260 | ) | |
$ | (127,944 | ) |
The
following table sets forth the Company’s outstanding derivative contracts at March 31, 2022:
|
|
|
2nd
Quarter |
|
3rd
Quarter |
|
4th
Quarter |
2022 |
|
|
|
|
|
|
|
WTI Index Put Options: |
|
|
|
|
|
|
|
Quarterly volume (MBbl) |
|
|
20.43 |
|
20.32 |
|
15.72 |
Floor Price (Bbl) |
|
|
$40.00 |
|
$40.00 |
|
$40.00 |
|
|
|
|
|
|
|
|
Quarterly volume (MBbl) |
|
|
|
|
|
|
2.00 |
Floor Price (Bbl) |
|
|
|
|
|
|
$70.00 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1st
Quarter |
|
2nd Quarter |
|
3rd
Quarter |
|
4th
Quarter |
2023 |
|
|
|
|
|
|
|
WTI Index Put Options: |
|
|
|
|
|
|
|
Quarterly volume (MBbl) |
13.40 |
|
15.34 |
|
10.86 |
|
6.00 |
Floor Price (Bbl) |
$40.00 |
|
$55.00 |
|
$55.00 |
|
$60.00 |
|
|
|
|
|
|
|
|
Quarterly volume (MBbl) |
6.00 |
|
|
|
|
|
|
Floor Price (Bbl) |
$67.50 |
|
|
|
|
|
|
Note
8 - Debt
The
following table represents the Company’s outstanding debt as of March 31, 2022:
Senior Revolver Loan Agreement | |
$ | 6,769,500 | |
| |
| | |
Term Loan – PIE, a related party | |
| 815,697 | |
| |
| | |
Equipment and vehicle notes, 0% to 6.99% interest rates, due in 2025 to 2027 with monthly
payments ranging from $400 to $1,400 per month | |
| 292,743 | |
| |
| | |
Note Payable to Insurance Provider, bears 3.63% interest, matures November 2022, monthly payments of
principal and interest of $50,083 | |
| 295,559 | |
| |
| | |
Total Debt | |
| 8,173,499 | |
Less Current Maturities | |
| 1,553,369 | |
Total Long-Term Debt | |
$ | 6,620,130 | |
On
July 7, 2021 the Company entered into the Fourth Amendment to its Senior Revolver Loan Agreement (“the Amended Agreement”)
with CrossFirst Bank (“CrossFirst”). The maximum amount that can be advanced under the Agreement is $20,000,000 and the existing
commitment amount is $7,680,000 which is reduced by $300,000 per calendar quarter beginning September 30, 2021 and includes interest
at Wall Street Journal Prime plus 150 basis points (% as of March 31, 2022). The Amended Agreement matures on March 27, 2024. Collateral
for the loan is a lien on all of the assets of Empire Louisiana and Empire North Dakota, wholly owned subsidiaries of the Company, 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 Amended Agreement requires the Company maintain commodity derivatives
at certain thresholds based on projected production and, beginning March 31, 2021, 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 amount of current maturities
related to the Amended Agreement is $1,200,000. The Company was in compliance with the loan covenants at March 31, 2022.
In
August 2020, concurrent with the Joint Development Agreement with Petroleum and Independent Exploration, LLC (“PIE”), a related
party, the Company entered into a term loan agreement 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. The loan proceeds will be used for recompletion or workover
of certain designated wells. Refer to Note 5 for additional information regarding this arrangement.
Note
9 - Leases
As
a lessee, the Company leases its corporate office headquarters in Tulsa, Oklahoma and three field offices. The leases expire between
2024 and 2027. The corporate office has an option to renew for an additional five-year term. The option to renew the lease is generally
not considered reasonably certain to be exercised. Therefore, the period covered by such optional period is not included in the determination
of the term of the lease and the lease payments during these periods are similarly excluded from the calculation of right-of-use lease
asset and lease liability balances.
The
Company recognizes right-of-use lease expense on a straight-line basis, except for certain variable expenses that are recognized when
the variability is resolved, typically during the period in which they are paid. Variable right-of-use lease payments typically include
charges for property taxes, insurance, and variable payments related to non-lease components, including common area maintenance.
Right
of use lease expense was approximately $60,000 for the three months ended March 31, 2022.
Supplemental
balance sheet information related to the right of use leases is as follows as of March 31, 2022:
| |
| | |
Operating lease asset (included in Other Property and Equipment) | |
$ | 744,013 | |
| |
| | |
Current portion of lease liability | |
$ | 181,029 | |
Long-term lease liability | |
| 602,554 | |
Total right of use lease liabilities | |
$ | 783,583 | |
The
weighted average remaining term for the Company’s right of use leases is 3.7 years.
Maturities
of lease liabilities are as follows as of March 31, 2022:
| | |
| | |
2023 | | |
$ | 236,720 | |
2024 | | |
| 239,683 | |
2025 | | |
| 227,574 | |
2026 | | |
| 154,545 | |
2027 | | |
| 37,200 | |
Thereafter | | |
| 3,100 | |
Total lease payments | | |
| 898,822 | |
Less imputed interest | | |
| (115,239 | ) |
Total lease obligation | | |
$ | 783,583 | |
Note
10 – Common and Preferred Stock
As
a result of the Company’s Amended and Restated Certificate of Incorporation (“Charter”) that was effective in
March 2022, the total number of shares of all classes of stock that the Company has the authority to issue is 200,000,000,
consisting of 190,000,000
shares of common stock, par value $0.001
per share and 10,000,000
shares of preferred stock, par value $0.001
per share.
Preferred
Stock
Preferred
stock may be issued from time to time in one or more series at the direction of the board of directors and the directors also have
the ability to fix dividend rates and rights, liquidation preferences, voting rights, conversion rights, rights and terms of
redemption and other rights, preferences, privileges and restrictions as determined by the board of directors, subject to certain
limitations set forth in the Charter.
Series
A Voting Preferred Stock
On
March 8, 2022, the Company formalized the issuance of preferred stock as was required under the terms of the Company's May 2021 financing
agreements with Energy Evolution (Master Fund), Ltd. (the "Fund") and issued six shares of Series A Voting Preferred Stock.
The Series A Voting Preferred Stock was issued in connection with the strategic investment in the
Company by Energy Evolution (Master Fund), Ltd. (the “Fund”). For so long as the Series A Voting Preferred Stock is outstanding,
the Company’s board of directors will consist of six directors. Three of the directors are designated as the Series A Directors
and the three other directors (each, a “common director”) are elected by the holders of common stock and/or any preferred
stock (other than the Series A Voting Preferred Stock) granted the right to vote on the common directors. Any Series A Director may be
removed with or without cause but only by the affirmative vote of the holders of a majority of the Series A Voting Preferred Stock voting
separately and as a single class. The holders of the Series A Voting Preferred Stock have the exclusive right, voting separately and
as a single class, to vote on the election, removal and/or replacement of the Series A Directors. Holders of common stock or other preferred
stock have no right to vote on the Series A Directors. The approval of the holders of the Series A Voting Preferred Stock, voting separately
and as a single class, is required to authorize any resolution or other action to issue or modify the number, voting rights or any other
rights, privileges, benefits or characteristics of the Series A Voting Preferred Stock, including without limitation, any action to modify
the number, structure and/or composition of the Company’s current board of directors.
The
Series A Voting Preferred Stock is held by Phil Mulacek, co-chairman of the board of directors and one of the principals of the Fund,
as the Fund’s designee (the “Initial Holder”). The Series A Voting Preferred Stock may be transferred only to certain
controlled affiliates of the Initial Holder (“Permitted Transferees”), and the voting rights of the Series A Voting Preferred
Stock are contingent upon the Initial Holder and Permitted Transferees (collectively, the “Series A Holders”) holding together
at least 3,000,000 shares of the Company’s outstanding common stock.
The
Series A Voting Preferred Stock is not entitled to receive any dividends or distributions of cash or other property except in the event
of any liquidation, dissolution or winding up of the Company’s affairs. In such event, before any amount is paid to the holders
of the Company’s common stock but after any amount is paid to the holders of the Company’s senior securities, the holders
of the Series A Voting Preferred Stock will be entitled to receive an amount per share equal to $1.00.
Except
as discussed above or as otherwise set forth in the certificate of designation of the Series A Voting Preferred Stock, the holders of
the Series A Voting Preferred Stock have no voting rights.
The
Series A Voting Preferred Stock is not redeemable at the Company’s election or the election of any holder, except the Company may
elect to redeem the Series A Voting Preferred Stock for $1.00 per share following satisfaction of its notice and cure requirements in
the event that:
|
• |
any
or all shares of Series A Voting Preferred Stock are held by anyone other than the Initial Holder or a Permitted Transferee; or |
|
• |
the
Series A Holders together hold less than 3,000,000 shares of the Company’s outstanding common stock. |
The
Series A Voting Preferred Stock is not convertible into common stock or any other security.
Common
Stock
The
holders of shares of common stock are entitled to one vote per share for all matters on which common stockholders are authorized to vote
on. Examples of matters that common stockholders are entitled to vote on include, but are not limited to, election of three of the six
directors and other common voting situations afforded to common stockholders.
Note
11 - Equity
On
August 27, 2021 the Company’s Board of Directors approved a one for four reverse stock split such that every holder of the Company’s
common stock shall receive one share of common stock for every four shares owned. The reverse stock split was made effective on March
7, 2022, simultaneous with the Company’s listing of its common stock on the NYSE American. All share amounts have retrospectively
been stated at post-reverse split amounts and pricing.
During
February and March 2021, the Company issued to a group of accredited investors 2,248,464 shares of its common stock and warrants to purchase
2,248,464 shares of its common stock for $2.00 per share which expire on December 31, 2022. Proceeds from the sale were $3,147,850.
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 180%, risk free interest rate of .14% and an expected useful life of 21 months. The
fair value of the warrants of $2,350,407 was allocated to Additional Paid-in Capital. During the quarter ended March 31, 2022, 48,750
shares of common stock were issued as a result of warrant exercises. As of March 31, 2022, warrants for 749,464 shares of common stock
have been exercised.
Note
12 – Stock-Based Compensation
Stock
Options
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 2,500,000.
Further, on April 3, 2019 the Company granted Mr. Pritchard and Mr. Morrisett each, options to purchase 625,000
shares of common stock of the Company at an exercise price of $1.32
per share. Each
option vested in three installments with 312,500
vesting immediately and 156,250
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. As a result of the adoption of a 2021 plan, the board of directors and management have determined that there would be no
further issuances from the Stock Option Plan. As of March 31, 2022, there were 1,178,200
unexercised options under the Stock Option Plan.
On August 27, 2021, the Board of Directors of
the Company adopted the Empire Petroleum Corporation 2021 Stock and Incentive Compensation Plan (the “Incentive Plan”).
The total number of shares of common stock that may be issued pursuant to the Incentive Plan is 750,000.
Four grants were made in 2021 that amounted to 187,500
options. Two of the grants were for a cumulative amount of 62,500
options and vested immediately upon grant in November 2021. Valuation was calculated using the Black-Scholes option valuation model
with the following assumptions: no dividend yield, expected annual volatility of 229%,
risk free interest rate of .81%,
and expected useful life of 3
years. The
third grant was for 62,500 options and the valuation used the following inputs: no dividend yield, expected annual volatility of
277%, risk free interest rate of .99%, and expected useful life of 4 years. The
fourth grant was for 250,000 options and inputs used to value the grant included no dividend yield, expected annual volatility of
335%, risk free interest rate of 1.16%, and expected useful life of 5 years.
On February 28, 2022, management issued a
combination of stock options and restricted stock units under the Incentive Plan. 249,000
stock options were granted to employees and members of management with three
year vesting terms and expirations of August
2025 and 2026. Stock option values were calculated using a Black-Scholes option valuation with the following
assumptions: no dividend yield, expected annual volatility of 56%
as calculated by utilizing the stock price from the date of the XTO acquisition through grant date, risk free interest rate of 1.62%
and 1.67%
for the 2025 and 2026 options, respectively, and expected useful lives of 2.75
and 3.75
years for the 2025 and 2026 options, respectively. Total fair value of the stock option grants was approximately $1.2
million. The value of these options are being recognized to expense in a straight-line method from date of grant through expiration
date.
Restricted
Stock Units
The
Incentive Plan allows for the grant of restricted stock units (“RSUs”). Any RSU grants
fall under the total grants available to be made under the Incentive Plan of 750,000 shares of common stock.
Each
RSU represents the contingent right to receive one share of common stock. The holders of outstanding RSUs do not receive dividends
or have voting rights prior to vesting and settlement. The Company determines the fair value of granted RSUs based on the market price
of the common stock on the date of the grant. Compensation expense for granted RSUs is recognized on a straight-line basis over the vesting
and is net of forfeitures, as incurred. Stock-based compensation is included in General and Administrative expense in the Condensed Consolidated
Statements of Operations and is recorded with a corresponding increase in Additional Paid-in Capital within the Condensed Consolidated
Balance Sheets.
RSUs
were granted on February 28, 2022 with 12- and 13-month service periods. Total value assigned to the RSUs based on grant date approximated
$585,000. For the three months ended March 31, 2022, approximately $45,000 of compensation expense related to RSUs was recognized, leaving
approximately $540,000 of unrecognized compensation expense which will be recognized on a straight-line basis depending on the service
period of each grant.
Note
13 – Related Party Transactions
The
Energy Evolution (Master Fund), Ltd. (“Energy Evolution”) is a related party of the Company as it beneficially owns approximately
27% of the Company’s outstanding shares of common stock as of March 31, 2022. Additionally, a board member of Energy Evolution
was appointed to the Company’s board in October 2021 as the board co-chairman. This board member separately beneficially owns approximately
17% of the Company’s outstanding shares of common stock as of March 31, 2022 and held all of the outstanding shares of preferred
stock at March 31, 2022. The board member also is a majority owner of Petroleum & Independent Exploration, LLC and related entities
(“PIE”). In October 2021 another Energy Evolution member was appointed to the Company’s board of directors and has
an ownership percentage of approximately 3%.
The
Company has a joint development agreement with PIE to perform recompletion or workover on specified mutually agreed upon wells (See Note
5). This joint development agreement has a note payable whose balance increases as work is performed until payout terms have been reached
per the agreement (See Note 8).
Note
14 – Commitments and Contingencies
From
time to time, the Company is subject to various legal proceedings arising in the ordinary course of business, including proceedings for
which the Company may not have insurance coverage. While many of these matters involve inherent uncertainty, as of the date hereof, the
Company does not currently believe that any such legal proceedings will have a material adverse effect on the Company’s business,
financial position, results of operations or liquidity.
The
Company is subject to extensive federal, state, and local environmental laws and regulations. These laws, among other things, regulate
the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal
or release of petroleum or chemical substances at various sites. Management believes no materially significant liabilities
of this nature existed as of the balance sheet date.
The
Company has undergone a sales tax audit related to its Texas entity and received the initial assessment notice in April 2022. The maximum
exposure of this sales tax assessment is approximately $1.3 million though the Company is confident that the final assessment will be
less than the maximum as previously stated. The Company has accrued $650,000 for this contingency for the quarter ended March 31, 2022.
Note
15 – Subsequent Events
In
February 2022, the Company entered into a Purchase and Sale Agreement with a third party to purchase certain oil and gas properties located
in North Dakota for a preliminary purchase price of $1.5 million. The acquisition closed in April 2022 for approximately $1.4 million.
In April 2022, Anthony Kamin, co-chairman of the
board, resigned his position. Vice Admiral Andrew Lewis joined the board upon Mr. Kamin’s departure.