EMPIRE PETROLEUM CORP quarterly report, Q1 FY2019

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Empire Petroleum Corporation — Form 10-Q Summary

Business Context and Reporting Period

Empire Petroleum Corporation explores, develops, acquires and operates oil and natural gas properties. This unaudited quarterly report covers the three months ended March 31, 2019, with comparable results for the three months ended March 31, 2018. The company had three employees and reported 18,792,277 common shares outstanding at March 31, 2019.

Financial Results and Key Metrics

  • Revenue: Oil and gas sales were $343,965, compared with no revenue in the prior-year quarter. Total revenue, after an $88,114 unrealized derivative loss, was $255,851.
  • Operating costs: Operating expenses, production taxes, depreciation, depletion and amortization, and asset-retirement accretion totaled $196,821. General and administrative expense was $612,589, up from $226,677.
  • Profitability: Operating loss was $553,559, compared with $226,677 in the prior-year quarter. Net loss was $587,502, or $0.03 per basic and diluted share, versus a net loss of $246,305, or $0.02 per share. Based on reported total revenue, net margin was approximately negative 230%.
  • Production: Net production totaled 6,835 BOE, consisting of 5,038 barrels of oil and 1,796 Mcf of natural gas. Average prices were $59.92 per barrel, $2.83 per Mcf and $48.63 per BOE.
  • Cash flow: Cash used in operations was $113,560, compared with $143,542 in the prior-year quarter. Investing cash flow was negative $5,187,882, primarily for the EnergyQuest II asset acquisition. Financing cash flow was positive $5,246,744, including $5,079,744 of debt proceeds and $167,000 of stock proceeds.
  • Liquidity: Cash declined from $84,631 at December 31, 2018 to $29,933 at March 31, 2019. Working capital was negative $6,877,951.
  • Assets and liabilities: Total assets were $10,668,384, including $9,861,895 of net oil and gas properties. Total liabilities were $11,189,069, resulting in a stockholders’ deficit of $520,685.
  • Debt: Current notes payable totaled $6,486,217, and no long-term notes payable were reported. The CrossFirst Bank senior revolver commitment was increased to $9 million and its maturity extended to March 27, 2021. The company was not in compliance with certain debt covenants at March 31, 2019, and classified the entire revolver balance as current because a waiver had not been obtained.

Material Changes Versus the Prior Comparable Period

  • The company began generating oil and gas revenue following property acquisitions in 2018 and 2019; it had no production before August 2018.
  • On March 28, 2019, the company acquired EnergyQuest II oil-producing properties for consideration of $5,187,882. The acquired assets included 184 wells in Montana and North Dakota, with approximately 375 BOE per day of stated production; Empire expected to operate 139 wells.
  • Oil and gas properties increased from $1,629,770 net at December 31, 2018 to $9,861,895 at March 31, 2019. The acquisition also added $3,267,380 of asset-retirement obligations.
  • Net loss increased $341,197, or 139%, primarily because of higher general and administrative costs, new operating costs, derivative losses and interest expense.
  • General and administrative expense increased $385,912, or 170%, to $612,589, driven primarily by compensation, insurance, travel, professional fees and acquisition and capital-raising activities.
  • In March 2019, 1,446,668 warrants were converted into common shares, generating $217,000 of proceeds, including conversion of $50,000 of notes payable. Shares outstanding increased from 17,345,609 at December 31, 2018 to 18,792,277 at March 31, 2019.

Guidance, Outlook, Risks and Unusual Items

  • Going concern: Management stated that continued operations depend on achieving profitability and/or obtaining additional debt or equity financing. The company expects to seek additional capital for acquisitions and working capital.
  • Acquisition strategy: Management is actively pursuing additional operated and non-operated oil and gas properties, expected to be financed through debt or equity transactions.
  • Commodity exposure: The company uses oil and natural gas swaps to reduce price volatility. Outstanding contracts were expected to settle by October 31, 2019, including oil swaps at $65.85 per barrel and natural gas swaps at $2.875 per Mcf.
  • Debt covenant risk: The revolver requires specified EBITDAX-to-interest and funded-debt-to-EBITDAX ratios. The company was not compliant with certain covenants at quarter-end.
  • Reserve and valuation risk: Reported asset values depend on estimates of recoverable reserves, production rates, commodity prices, operating costs, discount rates and abandonment costs. These are Level 3 estimates and actual results may differ materially.
  • Asset retirement obligations: The company recorded a $3,267,380 non-cash addition related to assumed abandonment obligations in the EnergyQuest II acquisition; total asset-retirement obligations were $3,504,629 at March 31, 2019.
  • Subsequent events: On April 3, 2019, the company adopted a 10 million-share stock option plan and granted 2.5 million options each to the CEO and president at an exercise price of $0.33 per share. On April 10, 2019, $37,500 of convertible notes were converted into 375,000 common shares.
  • Other risks: The filing identifies financing needs, competition, commodity markets, environmental legislation and the company’s history of operating losses as material risks. No legal proceedings were reported.

Important Facts for Investors to Verify

  • Confirm the company’s ability to raise sufficient capital to fund operations, acquisitions and working capital given $29,933 of cash and materially negative working capital.
  • Verify the status of the CrossFirst Bank covenant compliance, any required waivers, and the terms and repayment requirements of the current debt.
  • Assess whether the EnergyQuest II properties can sustain stated production levels and generate sufficient cash flow to service debt and fund operations.
  • Reconcile the derivative disclosures: the statements report an $88,114 unrealized derivative loss, while the derivative note reports a total derivative loss of $68,359; the MD&A also contains an apparent reference to a 12-month period.
  • Evaluate the reasonableness of reserve estimates and the $3.5 million asset-retirement obligation, including sensitivity to commodity prices and abandonment costs.
  • Review dilution from the 2019 stock option plan, outstanding warrants, convertible notes and subsequent equity conversions.