NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
June 30, 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 eight wholly-owned subsidiaries
in four areas of operations:
| · | Empire
North Dakota LLC (“Empire North Dakota”) |
| o | Empire
North Dakota Acquisition LLC (“Empire NDA”) |
| · | Empire
New Mexico LLC d/b/a Green Tree New Mexico (“Empire New Mexico”) |
| · | Empire
Texas (“Empire Texas”), consisting of the following entities: |
| o | Empire
Texas Operating LLC |
| o | Pardus
Oil & Gas Operating, LP (owned 1% by Empire Texas GP LLC and 99% by Empire Texas LLC) |
| · | Empire
Louisiana LLC (“Empire Louisiana”) |
Empire was incorporated in the State of Delaware
in 1985. The consolidated financial statements of Empire include the accounts of the Company and its wholly-owned subsidiaries. All intercompany
accounts and transactions, including revenues and expenses, have been eliminated in consolidation.
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.
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 a degree 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 period ended
June 30, 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- or six-months ended June 30, 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.
Concentrations of Credit Risk
The Company’s accounts receivable
are primarily receivables from oil and natural gas purchasers and joint interest owners. The purchasers of the Company’s oil and
natural gas production consist primarily of independent marketers, major oil and natural gas companies and gas pipeline companies. Historically,
the Company has not experienced any significant losses from uncollectible accounts from its oil and natural gas purchasers. The Company
operates a substantial portion of its oil and natural gas properties. As the operator of a property, the Company makes full payments
for costs associated with the property and seeks reimbursement from the other working interest owners in the property for their share
of those costs. Joint operating agreements govern the operations of an oil or natural gas well and, in most instances, provide for offsetting
of amounts payable or receivable between the Company and its joint interest owners. The Company’s joint interest partners consist
primarily of independent oil and natural gas producers. If the oil and natural gas exploration and production industry in general was
adversely affected, the ability of the Company’s joint interest partners to reimburse the Company could be adversely affected.
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 Accounting Standards
Update (“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 have been no indicators of impairment in any period disclosed in these
financial statements.
In May 2021, the Company purchased oil and natural gas properties
in New Mexico (see Note 4).
In April 2022, the Company purchased working
interests of oil and natural gas properties primarily located in the Landa field in North Dakota through its wholly owned subsidiary
Empire NDA and assumed the role of operator. The Company paid approximately $1.4 million for eight producing properties, two properties
with behind-pipe reserves, and related lease and well equipment. The Company allocated 80% of the acquisition cost to leasehold costs
and the remaining 20% to related lease and well equipment. Non-cash asset retirement obligations were assumed of $233,659. The acquisition
was accounted for as an asset acquisition.
Aggregate capitalized costs of oil and natural
gas properties as of June 30, 2022 are as follows:
Proved producing wells | |
$ | 23,172,667 | |
Proved undeveloped | |
| 2,777,634 | |
Lease and well equipment | |
| 6,207,868 | |
Asset retirement obligation | |
| 18,268,308 | |
Gross capitalized costs | |
| 50,426,477 | |
Accumulated depreciation, depletion, amortization and impairment | |
| (18,202,939 | ) |
Net capitalized costs | |
$ | 32,223,538 | |
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 | |
$ | 1,731,485 | |
Less: accumulated depreciation | |
| (409,162 | ) |
Other property and equipment, net | |
$ | 1,322,323 | |
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 (“PSA”) 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 was 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 that increased the letter of credit requirement to $5.45 million. Payments on the sinking fund were
made through April 2022 and no additional collateral deposits were required as of June 2022.
The following table sets forth the
Company’s preliminary purchase price allocation:
Fair Value of Assets Acquired | |
| |
Oil and natural gas properties | |
$ | 17,662,402 | |
Inventory - Oil in tanks | |
| 318,546 | |
Vehicles | |
| 179,156 | |
Asset retirement obligations | |
| 6,117,709 | |
Total assets acquired | |
| 24,277,813 | |
| |
| | |
Fair Value of Liabilities Assumed | |
| | |
Royalty suspense | |
| 290,325 | |
Asset retirement obligations | |
| 6,117,709 | |
Total 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 June 30, 2022. On April 25, 2022, the Company entered into an amendment
to the PSA 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 full collection of 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 the current 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 ( the “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 related 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 six months ended June 30, 2022:
| |
| | |
Asset retirement obligations, beginning of period | |
$ | 20,640,599 | |
Additions | |
| 233,659 | |
Liabilities settled | |
| (160,958 | ) |
Accretion expense | |
| 666,488 | |
Asset retirement obligation, end of period | |
$ | 21,379,788 | |
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 in such
a way that would 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- and six-months ended June 30, 2022 and 2021:
| |
Three Months Ended June 30, | | |
Six Months Ended June 30, | |
| |
2022 | | |
2021 | | |
2022 | | |
2021 | |
Loss on Derivatives: | |
| | | |
| | | |
| | | |
| | |
Oil derivatives | |
$ | (23,893 | ) | |
$ | (182,034 | ) | |
$ | (136,214 | ) | |
$ | (539,949 | ) |
The following represents the Company’s net cash payments on
derivatives for the three- and six-months ended June 30, 2022 and 2021:
| |
Three Months Ended June 30, | | |
Six Months Ended June 30, | |
| |
2022 | | |
2021 | | |
2022 | | |
2021 | |
| |
| | | |
| | | |
| | | |
| | |
Oil derivatives | |
$ | (77,631 | ) | |
$ | (230,279 | ) | |
$ | (160,891 | ) | |
$ | (358,224 | ) |
The following table sets forth the Company’s outstanding derivative
contracts at June 30, 2022:
|
|
|
|
|
3rd Quarter |
|
4th Quarter |
2022 |
|
|
|
|
|
|
|
WTI Index Put Options: |
|
|
|
|
|
|
|
Quarterly volume (MBbls) |
|
|
|
|
26.32 |
|
25.72 |
Floor price (Bbl) |
|
|
|
|
$48.74 |
|
$51.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1st Quarter |
|
2nd Quarter |
|
3rd Quarter |
|
4th Quarter |
2023 |
|
|
|
|
|
|
|
WTI Index Put Options: |
|
|
|
|
|
|
|
Quarterly volume (MBbls) |
35.40 |
|
15.34 |
|
10.86 |
|
6.00 |
Floor price (Bbl) |
$56.36 |
|
$55.00 |
|
$55.00 |
|
$60.00 |
Note 8 - Debt
The following table represents the Company’s
outstanding debt as of June 30, 2022:
Senior Revolver Loan Agreement | |
$ | 6,469,500 | |
| |
| | |
Term Loan – PIE, a related party | |
| 1,316,759 | |
| |
| | |
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 | |
| 275,762 | |
| |
| | |
Note Payable to Insurance Provider, bears 3.63% interest, matures November 2022, monthly payments of principal and interest of $50,083 | |
| 150,103 | |
| |
| | |
Total Notes Payable | |
| 8,212,124 | |
Less: Current Maturities | |
| 1,406,081 | |
Total Long-Term Notes Payable | |
$ | 6,806,043 | |
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 at the current period-end
is $7,080,000 which is reduced by $300,000 per calendar quarter and includes interest at Wall Street Journal Prime plus 150 basis points
(% as of June 30, 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, both of which are 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 that the Company maintain commodity derivatives at certain
thresholds based on projected production and to maintain certain covenants including an EBITDAX to interest expense of at least 4.5:1
and funded debt to EBITDAX of 4:1 on a trailing twelve-month basis. Current maturities of debt related to the Amended Agreement is $1,200,000.
The Company was in compliance with its loan covenants at June 30, 2022. The Company paid $600,000 in principal during the six months
ended June 30, 2022.
In August 2020, concurrent with the JDA with
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
The Company leases its corporate office headquarters
in Tulsa, Oklahoma and three field offices whose terms expire between 2024 and 2027. The corporate office has an option to renew for
an additional five-year term; however, 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 $122,000 for the six
months ended June 30, 2022.
Supplemental balance sheet information related to the right of use
leases is as follows as of June 30, 2022:
| |
| | |
Net operating lease asset (included in Other Property and Equipment) | |
$ | 770,371 | |
| |
| | |
Current portion of lease liability | |
$ | 209,320 | |
Long-term lease liability | |
| 591,412 | |
Total right of use lease liabilities | |
$ | 800,732 | |
The weighted average remaining term for the Company’s right-of-use
leases is 3.6 years.
Maturities of lease liabilities are as follows as of June 30, 2022:
| | |
| | |
2023 | | |
$ | 264,047 | |
2024 | | |
| 267,025 | |
2025 | | |
| 237,663 | |
2026 | | |
| 115,430 | |
2027 | | |
| 31,000 | |
Total lease payments | | |
| 915,165 | |
Less imputed interest | | |
| (114,433 | ) |
Total lease obligation | | |
$ | 800,732 | |
Note 10 – Common and Preferred Stock
Pursuant to the Company’s Amended and
Restated Certificate of Incorporation (“Charter”), effective as of March 4, 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 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 do not have the 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, 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 would receive one share of common
stock for every four shares owned. The reverse stock split was effective as of 6:00 p.m. Eastern Time on March 7, 2022, immediately prior
to 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 with an original expiration date of December 31, 2022 that would be accelerated should certain performance criteria
be met. 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 0.14% and a term of 21 months. The fair value of the warrants of $2,350,407 was allocated to Additional Paid-in Capital. The performance
criteria triggering early maturity occurred in April 2022, accelerating the warrant maturity date to July 2022. During the six months
ended June 30, 2022, 1,367,645 shares of common stock were issued as a result of warrant exercises. As of July 10, 2022, all warrants
were fully 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 a term 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. During the three months ended June 30, 2022, Mr.
Pritchard exercised options to purchase 235,000 shares of common stock and as of June 30, 2022, there were 2,018,200 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 0.81%, and term 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 0.99%, and term of 4 years. The fourth grant
was for 62,500 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 a term 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 grants of RSUs are made in accordance with the terms of the Incentive Plan that allows
a maximum of 750,000 shares of common stock to be issued.
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 six months ended June 30, 2022, approximately $186,000 of compensation expense related to RSUs was recognized, leaving
approximately $398,000 of unrecognized compensation expense which will be recognized on a straight-line basis depending on the service
period of each grant.
On
May 22, 2022, RSUs were granted to Board members with 13-month service periods. Total value assigned to the RSUs based on grant date
was $1,545,000. Compensation expense of approximately $139,000 was recognized in the second quarter related to these grants and unrecognized
compensation expense to be recognized on a straight-line basis over the remaining service period approximated $1,406,000 at June 30,
2022.
Note 13 – Related Party Transactions
The Fund is a related party of the Company as it
beneficially owns approximately 25% of the Company’s outstanding shares of common stock as of June 30, 2022. Additionally, a board
member of the Fund was appointed to the Company’s Board of Directors in October 2021 as the Board co-chairman. This Board member
separately beneficially owns approximately 16% of the Company’s outstanding shares of common stock and held all outstanding shares
of preferred stock at June 30, 2022. The Board member also is a majority owner of PIE. In October 2021 another board member of the Fund
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 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 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 as of June 30, 2022.
Note 15 – Subsequent Events
Subsequent to the end of the current quarter, all remaining outstanding
warrants to purchase approximately 202,000 shares of common stock at $2 per share were exercised. See Note 11 for additional information.
A former director exercised 75,000 of his stock options granted under
the 2019 Stock Option Plan on July 5, 2022.