Empire Petroleum Corporation — Form 10-Q Summary
Business Context and Reporting Period
Empire Petroleum Corporation is an oil and gas exploration, development and production company. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, with comparable periods in 2017. The company was a smaller reporting company and had 17,345,609 common shares outstanding at September 30, 2018.
During 2018, Empire acquired producing properties in Louisiana, materially expanding its asset base and beginning oil and gas sales. The company reported approximately 35 BOE per day from four Cardinal wells and approximately 135 BOE per day from eight Exodus wells at acquisition.
Key Financial Metrics
| Metric | Three Months Ended September 30, 2018 | Nine Months Ended September 30, 2018 | Comparable 2017 Period |
|---|---|---|---|
| Petroleum sales | $24,277 | $24,277 | $0 |
| Operating loss | $(211,542) | $(648,621) | $(51,250) and $(164,260), respectively |
| Net loss | $(233,574) | $(710,126) | $(68,649) and $(216,573), respectively |
| Basic and diluted loss per share | $(0.02) | $(0.06) | $(0.01) and $(0.02), respectively |
| Net cash used in operating activities | Not separately reported | $(538,586) | $(167,100) |
| Capital expenditures for oil and gas properties | Not separately reported | $1,160,866 | $0 |
| Cash at period end | Not separately reported | $58,348 | $14,143 |
Based on the statement of operations, the third-quarter gross loss before general and administrative expense was $6,145, or approximately 25.3% of petroleum sales. The operating loss margin was approximately 871.4% negative and the net loss margin was approximately 962.3% negative. These margins reflect very limited revenue relative to operating and corporate expenses.
At September 30, 2018, total assets were $1.72 million, including $1.34 million of net oil and natural gas properties and a $300,000 investment in Masterson West II. Current assets were $79,585, including $58,348 of cash and $21,237 of oil sales receivables. Current liabilities were $294,980, including $178,266 of current convertible notes, $25,000 of demand notes and $91,714 of accounts payable and accrued liabilities.
Debt included $232,327 of net convertible notes, $25,000 of demand notes payable and $867,520 outstanding under a CrossFirst Bank revolver. The revolver has a $1.35 million initial commitment, a maximum borrowing capacity of $5 million, bears interest at Wall Street Journal Prime plus 1.50%, and matures September 20, 2020. An asset retirement obligation of $184,013 was also recorded.
Financing activities provided $1,680,020 during the first nine months, consisting principally of $867,520 of bank borrowings, $25,000 of demand-note proceeds and $787,500 from stock and warrant issuance. Cash declined by $19,432 during the period because operating and investing uses exceeded financing inflows.
Material Changes Versus the Prior Comparable Period
- Petroleum sales increased from zero to $24,277 in both the quarter and year-to-date period following the 2018 property acquisitions.
- Production and operating expense increased to $26,128 for the quarter and year to date; severance taxes were $3,040.
- General and administrative expense increased 301% year to date, from $164,260 to $642,476, primarily due to warrants, professional fees, due diligence and asset-purchase costs.
- Interest expense increased from $52,313 to $61,505 for the first nine months, reflecting additional convertible notes and other financing.
- Year-to-date net loss increased from $216,573 to $710,126.
- Net oil and gas property assets increased from zero at December 31, 2017 to $1,343,625 at September 30, 2018, principally from the Cardinal and Exodus acquisitions.
- Shares outstanding increased from 8,803,942 at December 31, 2017 to 17,345,609 at September 30, 2018, with additional warrants and equity-linked securities issued during the period.
Guidance, Outlook, Risks and Unusual Items
Management provided no formal earnings or production guidance. It stated that it is pursuing additional operated and non-operated oil and gas acquisitions and expects acquisitions to be financed through equity or debt transactions.
The company disclosed substantial doubt-related risks surrounding its ability to continue operations. It has incurred significant historical losses and stated that continued operations depend on achieving profitable operations and/or obtaining additional debt or equity financing. Management also stated that it had no employees at September 30, 2018 and continues to seek partners and financing.
The CrossFirst revolver requires Empire Louisiana, beginning December 31, 2018, to maintain minimum trailing-twelve-month EBITDAX-to-interest expense of 3:1 and funded-debt-to-EBITDAX of 4:1. The filing text does not provide a clear assessment of whether these covenants will be met.
The Masterson West II transaction had not reached its scheduled April 1, 2017 closing date, but neither party had terminated the agreement as of the filing. The company expected the agreement or related LLC agreement to be amended, replaced or terminated in 2018.
The Cardinal acquisition closed August 28, 2018 for stated consideration of $323,000, with $293,966 paid after adjustments. The Exodus acquisition closed September 20, 2018 for a stated purchase price of $864,901. Both acquisitions involved significant Level 3 valuation estimates, including reserves, production rates, commodity prices, costs and discount rates.
On October 25, 2018, after quarter-end, Empire Louisiana agreed to acquire non-operating interests in four producing wells and two saltwater disposal wells for $205,000.
The interim financial statements were unaudited and condensed. The company stated that actual results may differ from estimates, including estimates related to reserves, asset retirement obligations, acquisition valuations and impairment. The filing identified no legal proceedings and stated that market-risk disclosures were not applicable.
Important Facts for Investors to Verify
- Whether the company can obtain sufficient financing to fund operations, satisfy obligations and pursue acquisitions.
- Whether newly acquired properties can generate production and cash flow sufficient to offset operating, corporate and financing costs.
- Compliance with the CrossFirst revolver’s financial covenants beginning December 31, 2018.
- The maturity, conversion terms and refinancing or repayment requirements of the $232,327 net convertible-note balance.
- The valuation, reserves and production assumptions supporting the $1.34 million carrying value of oil and gas properties.
- The status and ultimate outcome of the unresolved Masterson West II agreement.
- The effect of additional shares, warrants, convertible notes and other equity-linked instruments on future dilution.
- The amount and timing of asset retirement obligations and other liabilities associated with the acquired wells.