EMPIRE PETROLEUM CORP - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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or

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EMPIRE PETROLEUM CORPORATION

(Exact name of registrant as specified in its charter)

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(539) 444-8002

(Registrant’s telephone number, including area code)

(Former name or former address and former fiscal year, if changed since last report)

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Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒ 

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  ☐    No  ☐

APPLICABLE ONLY TO CORPORATE ISSUERS

The number of shares of the registrant's common stock, $0.001 par value, outstanding as of September 30, 2020 was 24,892,277. 

EMPIRE PETROLEUM CORPORATION

INDEX TO FORM 10-Q

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

EMPIRE PETROLEUM CORPORATION

CONSOLIDATED BALANCE SHEETS

See accompanying notes to unaudited consolidated financial statements 

EMPIRE PETROLEUM CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

See accompanying notes to unaudited consolidated financial statements

EMPIRE PETROLEUM CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT

For the Nine Months Ended September 30, 2020 and 2019

(UNAUDITED)

See accompanying notes to unaudited consolidated financial statements

EMPIRE PETROLEUM CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

See accompanying notes to unaudited consolidated financial statements

EMPIRE PETROLEUM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

September 30, 2020

(UNAUDITED)

1.       BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited consolidated financial statements of Empire Petroleum Corporation ("Empire" or the "Company") have been prepared in accordance with United States generally accepted accounting principles for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, the results of operations, and the cash flows for the interim period are included. All adjustments are of a normal, recurring nature. Operating results for the interim period are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.

The information contained in this Form 10-Q should be read in conjunction with the audited financial statements and related notes for the year ended December 31, 2019 which are contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") on March 30, 2020.

The Company has incurred significant losses in recent years. The continuation of the Company as a going concern is dependent upon the ability of the Company to attain future profitable operations and/or additional debt or equity financing until profitable operations are achieved. These financial statements have been prepared on the basis of United States generally accepted accounting principles applicable to a company with continuing operations, which assume that the Company will continue in operation for the foreseeable future and will be able to realize its assets and discharge its obligations in the normal course of operations. Management believes the going concern assumption to be appropriate for these financial statements. If the going concern assumption were not appropriate for these financial statements, then adjustments might be necessary to adjust the carrying value of assets and liabilities and reported expenses.

The Company’s impairment assessment of proved and unproved mineral properties is based on several factors including oil and gas spot market prices and estimated futures prices that existed at September 30, 2020. In2020, crude oil prices in both the spot market and futures market experienced significant volatility. For the nine months ended September 30, 2020 the Company recorded an impairment expense of $800,452 as a result of the decline in oil prices (See Note 3). Further, the effect of lower crude oil prices on the Company’s future financial position or results of operations is not currently determinable due to broader economic and industry uncertainties, including the impact to the operators and other working interest owners of the properties in which the Company owns mineral interests.

In the event crude oil or natural gas prices remain low, there is the risk that, among other things:

The occurrence of certain of these events may have a material adverse effect on the Company's business, results of operations and financial condition.

In early March 2020 there was a global outbreak of COVID-19 that continued into the second and third quarters and has resulted in changes in global supply and demand of certain mineral and energy products. These changes, including the magnitude and length of the economic downturn and any potential resulting direct and indirect negative impact to the Company cannot be determined, but they could have a prospective material impact to the Company’s acquisition and project development activities, and cash flows and liquidity.

Reclassification of prior year presentation. Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations. An adjustment has been made to the Consolidated Balance Sheet for the year ended December 31, 2019 to reclassify certain utility and other deposits in the amount of $118,177 which had previously been included in prepaids.

The continuation of the Company is dependent upon the ability of the Company to raise capital and attain future profitable operations. The ultimate recoverability of the Company's investment in oil and natural gas interests is dependent upon the existence and discovery of economically recoverable oil and natural gas reserves, the ability of the Company to obtain necessary financing to further develop the interests, and the ability of the Company to attain future profitable production.

As of September 30, 2020, the Company had $134,374 of cash and working capital deficit of $10,140,110, which includes the net balance of the Senior Revolver Loan Agreement of $8,368,000 which matures March 27, 2021. The Company has proved reserves which have been acquired within the last two years. The Company plans to continue to look for oil and natural gas investments and will use a combination of debt and equity financing to fund the acquisitions. The Company expects to also incur costs related to evaluating and acquiring oil and natural gas acquisitions for the foreseeable future. It is expected that management will attempt to raise additional capital for future investment and working capital opportunities.

Compensation of Officers and Employees

As of September 30, 2020, the Company had twelve employees. No independent Board members received compensation from the Company in the first nine months of 2020 or 2019. For the nine months ended September 30, 2020, the Company paid its officers, Mr. Morrisett and Mr. Pritchard, $249,417 each for services rendered. For the nine months ended September 30, 2019, the Company paid Mr. Morrisett $179,950 and Mr. Pritchard $183,950 for services rendered excluding the value of options awarded. In addition, as of September 30, 2020 Mr. Pritchard has outstanding advances of $28,828.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation. The consolidated financial statements of the Company include the accounts of the Company and its wholly owned subsidiaries, Empire Louisiana, LLC ("Empire Louisiana"), Empire North Dakota, LLC ("Empire North Dakota"), and Empire Texas, LLC (“Empire Texas”). All material intercompany balances and transactions have been eliminated.

Use of estimates in the preparation of financial statements. Preparation of financial statements in conformity with generally accepted accounting principles in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. Depletion of oil and natural gas properties is determined using estimates of proved oil and natural gas reserves. There are numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. Similarly, evaluations for impairment of proved and unproved oil and natural gas properties are subject to numerous uncertainties including, among others, estimates of future recoverable reserves, commodity price outlooks and prevailing market rates of other sources of income and costs. Other significant estimates include, but are not limited to, asset retirement obligations, fair value of assets purchased in acquisitions, and taxes.

Interim financial statements. The accompanying consolidated financial statements of the Company have not been audited by the Company's independent registered public accounting firm. In preparing the accompanying consolidated financial statements, management has made certain estimates and assumptions that affect reported amounts in the consolidated financial statements and disclosures of contingencies. Actual results may differ from those estimates. The results for interim periods are not necessarily indicative of annual results.

Certain disclosures have been condensed in or omitted from these consolidated financial statements. Accordingly, these condensed notes to the consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

Inventory Inventory consists of oil in tanks which has not been delivered and is valued at the contract price to the buyer and pipe which has not yet been put into production.

Revenue recognition. The Company recognizes revenues from the sales of oil and natural gas to its customers and presents them aggregated on the Company's consolidated statements of operations. The Company enters into contracts with customers to sell its oil and natural gas production. Revenue on these contracts is recognized in accordance with the five-step revenue recognition model prescribed in ASC 606. Specifically, revenue is recognized when the Company's performance obligations under these contracts are satisfied, which generally occurs with the transfer of control of the oil and natural gas to the purchaser. Control is generally considered transferred when the following criteria are met: (i) transfer of physical custody, (ii) transfer of title, (iii) transfer of risk of loss and (iv) relinquishment of any repurchase rights or other similar rights. Given the nature of the products sold, revenue is recognized at a point in time based on the amount of consideration the Company expects to receive in accordance with the price specified in the contract. Consideration under the oil and natural gas marketing contracts is typically received from the purchaser one to two months after production. At September 30, 2020, the Company had receivables related to contracts with customers of approximately $610,000.

Fair value measurements. The Financial Accounting Standards Board ("FASB") fair value measurement standards define fair value, establish a consistent framework for measuring fair value and establish a fair value hierarchy based on the observability of inputs used to measure fair value.

Convertible debt - The carrying value of the convertible debt approximate fair value as of December 31, 2019. As of September 30, 2020 all of the convertible debt had been converted to shares of the Company’s common stock. Management's estimates are based on the assessment of qualitative factors that are considered Level 3 measurements in the fair value hierarchy as required by FASB ASC 820.

Oil and natural gas properties - The fair value of proved and unproved oil and natural gas properties was measured using valuation techniques that convert the future cash flows to a single discounted amount. Significant inputs to the valuation of proved and unproved oil and natural gas properties include estimates of: (i) recoverable reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices; and (v) a market-based weighted average costs of capital. The Company utilized a combination of the New York Mercantile Exchange ("NYMEX") strip pricing and consensus pricing to value the reserves, then applied various discount rates depending on the classification of reserves and other risk characteristics. For significant purchases, management utilized the assistance of a third-party valuation expert to estimate the value of the oil and natural gas properties acquired.

The fair value of asset retirement obligations is included in proved oil and natural gas properties with a corresponding liability in the table above. The fair value was determined based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount rate, inflation rate and timing associated with the incurrence of these costs.

The inputs used to value oil and natural gas properties for impairments and asset retirement obligations require significant judgment and estimates made by management and represent Level 3 inputs.

Financial instruments and other- The fair values determined for accounts receivable, accrued expenses and other current liabilities were equivalent to the carrying value due to their short-term nature.

3.       PROPERTY AND EQUIPMENT

In March 2019, the Company, through its subsidiary, Empire North Dakota, LLC, purchased oil and natural gas properties in Montana and North Dakota (See Note 7).

On January 27, 2020, the Company, through its wholly owned subsidiary, Empire North Dakota, LLC, entered into a Bill of Sale and Assignment to purchase lease interests in approximately 4,936 acres in Montana for $500,000.

On February 10, 2020, the Company, through its wholly owned subsidiary, Empire North Dakota, LLC, sold overriding royalty interests for leases it owned in Montana for up to $325,000 to a consultant of the Company, $200,000 of which was purchased in the first quarter of 2020 and the final $125,000 was purchased in the third quarter of 2020.

On February 17, 2020 the Company, through its wholly owned subsidiary, Empire North Dakota, LLC, sold all of its interest in leases of approximately 337 acres in Montana for $1,010,400.

On April 6, 2020 the Company, through its wholly owned subsidiary, Empire Texas, LLC, purchased oil and natural gas properties in Texas (see Note 5).

During the nine months ended September 30, 2020, NYMEX strip prices experienced significant volatility, resulting in a significant decrease in value of the Company’s economically recoverable proved oil and natural gas reserves. As such, the carrying amount of the Company’s proved oil and natural gas properties exceeded the expected undiscounted future net cash flows for certain leases, resulting in impairment charges against earnings of $800,452 for the quarter ended March 31, 2020. These impairment charges are included in impairments of long-lived assets on the consolidated statement of operations for the nine months ended September 30, 2020. The Company did not recognize an impairment of proved oil and natural gas properties during the nine months ended September 30, 2019.

The aggregate capitalized costs of oil and natural gas properties as of September 30, 2020, are as follows:

Other property and equipment consists of office furniture and equipment.

4.       OVINTIV OIL AND NATURAL GAS PROPERTIES

On March 3, 2020 the Company, through its wholly owned subsidiary, Empire North Dakota, LLC, entered into a Purchase and Sale Agreement (“the Agreement”) with Ovintiv USA, Inc. and several related companies to purchase certain oil and natural gas properties in Montana and North Dakota comprising 26,600 net acres with 94 active wells. The purchase price was $8,500,000, subject to adjustments with an effective date of January 1, 2020 and a closing date of April 30, 2020.

The Company made an $850,000 deposit relating to the purchase. Due to the COVID pandemic and governmental state of emergency orders related thereto, the Company was unable to meet with and obtain financing to complete the purchase from its lenders. The Agreement has been terminated and the parties have agreed to settle with Empire receiving a $50,000 return of its deposit. The Company had estimated a loss on the deposit of $725,000 in the quarter ending June 30, 2020. The remainder of the loss has been recorded in the quarter ending September 30, 2020.

5.       ACQUISITION OF PARDUS OIL AND NATURAL GAS PROPERTIES

On April 6, 2020 the Company, through its wholly owned subsidiary, Empire Texas, LLC, entered into a Purchase and Sale Agreement (“the Agreement”) with Pardus Oil & Gas, LLC and Pardus Oil & Gas Operating GP, LLC (collectively “the Seller”) to purchase certain oil and natural gas properties in Texas comprising 139 gross wells and approximately 30,000 net acres, 77.3 miles of gathering lines and pipelines and related facilities and equipment, and all general and limited partner interest in Pardus Oil & Gas Operating, LP. The purchase price included the assumption of certain obligations and a contingent payment not to exceed $2,000,000 reduced by certain revenue suspense amounts. The contingent payment is based on monthly oil production in excess of a specified level from the purchased properties and an average monthly realized oil price of $40 or more per barrel of oil through December 31, 2022. The transaction closed on April 7, 2020.

The following table sets forth the Company's purchase price allocation:

The fair values of assets acquired and liabilities assumed were based on the following key inputs:

Oil and natural gas properties

The fair value of proved oil and natural gas properties was measured using valuation techniques that convert the future cash flows to a single discounted amount. Significant inputs to the valuation of proved oil and natural gas properties include estimates of: (i) recoverable reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices; and (v) a market-based weighted average costs of capital. The Company utilized a combination of the New York Mercantile Exchange ("NYMEX") strip pricing and consensus pricing to value the reserves, then applied various discount rates depending on the classification of reserves and other risk characteristics. Management utilized the assistance of a third-party valuation expert to estimate the value of the oil and natural gas properties acquired.

The fair value of asset retirement obligations totaled $9,508,484 and is included with a corresponding liability in the table above. The fair value was determined based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount rate, inflation rate and timing associated with the incurrence of these costs.

The total consideration consists of a contingent payment to the seller which is due based on monthly production of oil and natural gas through December 31, 2022 and a monthly average price of $40 or higher per barrel.

The inputs used to value oil and natural gas properties and asset retirement obligations require significant judgment and estimates made by management and represent Level 3 inputs.

Financial instruments and other

The fair values determined for accounts payable - trade were equivalent to the carrying value due to their short-term nature.

Accounts payable - trade includes $20,456 of liabilities primarily related to well activity prior to close.

6.       ACQUISITION OF WARHORSE OIL AND NATURAL GAS PROPERTIES

On September 10, 2019, the Company received a process verbal and related sheriff's deed dated as of May 29, 2019 (the "Sheriff's Deed") pertaining to two wells in St. Landry Parish purchased from Business First Bancshares, Inc. d/b/a Business First Bank ("Business First").

Pursuant to the Sheriff's Deed, the Company acquired certain oil and natural gas properties located in St. Landry Parish, Louisiana, including operated working interest in two producing wells. The Company purchased Business First's position as the superior lienholder and seizing creditor of such oil and natural gas properties, which were owned by Warhorse Oil & Gas, LLC, for $450,000 plus $16,993 sheriff fees. The payment was paid from loan proceeds under the loan agreement with CrossFirst Bank (see Note 9).

The Company treated the acquisition as an asset purchase. An amount equal to $73,968 was allocated to lease and well equipment and $378,110 was allocated to producing properties. An asset retirement obligation of $19,732 was recorded in conjunction with the purchase.

7.       ACQUISITION OF ENERGYQUEST II ASSETS

On March 28, 2019, the Company purchased oil producing properties from EnergyQuest II, LLC ("EnergyQuest") for a purchase price of $5,600,000. The effective date of the transaction was January 1, 2019. After certain adjustments related to the effective date, the total proceeds paid to EnergyQuest were $5,646,126.  Such proceeds were paid from borrowing on notes payable and sales of unregistered securities of the Company.

The following table sets forth the Company's purchase price allocation:

The fair values of assets acquired and liabilities assumed were based on the following key inputs:

Oil and natural gas properties

The fair value of proved oil and natural gas properties was measured using valuation techniques that convert the future cash flows to a single discounted amount. Significant inputs to the valuation of proved oil and natural gas properties include estimates of: (i) recoverable reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices; and (v) a market-based weighted average costs of capital. The Company utilized a combination of the New York Mercantile Exchange ("NYMEX") strip pricing and consensus pricing to value the reserves, then applied various discount rates depending on the classification of reserves and other risk characteristics. Management utilized the assistance of a third-party valuation expert to estimate the value of the oil and natural gas properties acquired.

The fair value of asset retirement obligations totaled $5,117,939 and is included in proved oil and natural gas properties with a corresponding liability in the table above. The fair value was determined based on a discounted cash flow model, which included assumptions of the estimated current abandonment costs, discount rate, inflation rate and timing associated with the incurrence of these costs.

The inputs used to value oil and natural gas properties and asset retirement obligations require significant judgment and estimates made by management and represent Level 3 inputs.

Financial instruments and other

The fair values determined for accounts receivable and accounts payable - trade were equivalent to the carrying value due to their short-term nature.

Accounts payable - trade includes $1,861,433 of liabilities primarily related to well activity prior to close.

8.       JOINT DEVELOPMENT AGREEMENT

On August 6, 2020 the Company, through its wholly owned subsidiary, Empire Texas, LLC (“ET”), entered into a joint development agreement (the “Agreement”) with Petroleum & Independent Exploration, LLC and related entities (“PIE”) dated August 1, 2020. Under the terms of the Agreement, PIE will perform recompletion or workover on specified mutually agreed upon wells (“Workover Wells”) owned by ET. To fund the work, PIE entered into a term loan agreement with ET 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. As of September 30, 2020 approximately $70,000 has been advanced from the loan. As part of the Agreement, ET will assign to PIE a combined 85% working and revenue interest in the Workover Wells; an assignment was completed in October 2020 for the initial three 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 ET in each of the Workover Wells and retain a 50% working and revenue interest (See Note 10).

In addition, PIE and Empire entered into a Securities Purchase Agreement (“Securities Agreement”) whereby PIE purchased for $525,000 (a) 3,500,000 shares of Empire common stock, (b) warrants to purchase 2,625,000 shares of Empire common stock at an exercise price of $0.20 per share, (c) warrants to purchase 1,800,000 shares of Empire common stock at an exercise price of $0.25 per share, (d) warrants to purchase 8,136,518 shares of Empire common stock at an exercise price of $0.10 per share, and (e) warrants to purchase up to 11,066,667 shares of Empire common stock at an exercise price of $0.141 per share. PIE is obligated to exercise the $0.20 warrants within 45 days of when 3 month trailing average production from the Empire Texas properties have increased by 20% over the trailing 3 month trailing average production as of July 2020. PIE can only exercise the $0.25 warrants once all existing non-PIE outstanding warrants to purchase Empire common stock have been exercised or lapsed. For the $0.141 warrants, PIE may initially acquire 7,533,333 shares of Empire common stock, however the amount may be increased if any existing non-PIE warrants are exercised prior to December 31, 2020 (See Note 11).

9.       DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments to manage its exposure to commodity price fluctuations. Commodity derivative instruments are used to reduce the effect of volatility of price changes on the oil and natural gas the Company produces and sells. The Company’s derivative financial instruments consist of oil gas swaps.

The Company does not enter into derivative financial instruments for speculative or trading purposes.

The Company does not designate its derivative instruments to qualify for hedge accounting. Accordingly, the Company reflects changes in the fair value of its derivative instruments in its consolidated statements of operations as they occur. Unrealized gains and losses related to the swap contracts are recognized and recorded as an asset or liability on the Company’s balance sheet.

The following table summarizes the net realized and unrealized amounts reported in earnings related to the commodity derivative instruments for the three and nine months ended September 30, 2020 and 2019:

The following represents the Company’s net cash receipts from derivatives for the three and nine months ended September 30, 2020 and 2019:

The following table sets forth the Company’s outstanding derivative contracts at September 30, 2020. The Company has no outstanding natural gas derivatives. All of the Company’s derivatives are expected to settle by October 2021:

10.     NOTES PAYABLE

In February 2019, the Company entered into five unsecured promissory note agreements with accredited investors totaling $90,000. The notes were due May 1, 2019, and accrued interest at 8%. One of the notes, in the amount of $15,000 was issued to Michael R. Morrisett, the Company's President. These notes and the related interest were paid in May 2019.

On September 20, 2018 the Company entered into a Senior Revolver Loan Agreement (“the Agreement”) with CrossFirst Bank (“CrossFirst”). The Agreement was amended March 27, 2019 and September 30, 2020 (effective as of June 30, 2020) (the “Amended Agreement”). The Amended Agreement commitment amount is $8,700,000 which is reduced by $180,000 per calendar quarter ($8,520,000 at September 30, 2020) and the maximum amount that can be advanced under the Agreement is $20,000,000 and includes interest at Wall Street Journal Prime plus 150 basis points (4.75% as of September 30, 2020). The Agreement matures on March 27, 2021. Collateral for the loan is a lien on all of the assets of the Company’s wholly owned subsidiaries, Empire Louisiana and Empire North Dakota, and a first priority mortgage lien, pledge of and security interest in not less than 80% of Empire Louisiana’s and Empire North Dakota’s producing oil, gas and other leasehold and mineral interests. The Agreement requires Empire Louisiana, beginning December 31, 2018 to maintain certain covenants including an EBITDAX to interest expense of at least 3:1 and funded debt to EBITDAX of 4:1 on a trailing twelve month basis. The Company is not in compliance with these covenants of the Agreement at September 30, 2020. As of September 30, 2020, the Company has an outstanding loan balance of $8,397,000 under the Agreement.

In January 2020 three of the Senior Unsecured Promissory Note investors exercised the conversion feature and converted their $102,500 notes for 1,025,000 shares of the Company's common stock. All of the Senior Unsecured Promissory Notes have been converted to common stock of the Company as of March 31, 2020.

On April 1, 2020, in conjunction with the purchase of assets from Pardus Oil & Gas, LLC (see Note 5), the Company entered into a unsecured promissory note agreement with the seller in the amount of $378,000. The note is payable in one installment on April 1, 2021 and bears interest at the one-year LIBOR rate (1% as of September 30, 2020).

On May 5, 2020, the Company, through its wholly owned subsidiary, Pardus Oil & Gas Operating, LP, received an SBA Payroll Protection Plan (“PPP”) loan for $160,700. The loan matures on May 5, 2022 and has an interest rate of 1%. There are no payments due until ten months after the covered period which ended October 20, 2020, at which time the payment amount will be determined based on the portion of the loan which has not been forgiven under criteria established by the SBA, using an eighteen-month amortization. The Company expects that the majority of the loan amount will be forgiven based on currently published guidelines of the United States Small Business Administration.

In August 2020, concurrent with the Joint Development Agreement with Petroleum and Independent Exploration, LLC (“PIE”), 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. In addition, the Company assigned a 70% working and revenue interest to PIE in the designated wells which will be applied to repayment of the loan. As of September 30, 2020, approximately $70,000 has been advanced from the loan (See Note 8).

11.     EQUITY

Diluted Earnings per Share ("EPS") gives effect to all dilutive potential common shares outstanding during the period. The computation of Diluted EPS does not assume conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on losses. As a result, if there is a loss from continuing operations, Diluted EPS is computed in the same manner as Basic EPS. At September 30, 2020 and 2019, the Company had 5,004,167 and 4,167 respectively, options outstanding that were not included in the calculation of earnings per share for the periods then ended. Such financial instruments may become dilutive and would then need to be included in future calculations of Diluted EPS. At September 30, 2020 and 2019, the outstanding options were considered anti-dilutive since the strike prices were above the market price and since the Company has incurred losses year to date.

In March 2019, 1,446,668 outstanding $0.15 warrants were converted to shares of common stock of the Company. Proceeds received from the conversion was $217,000 including $50,000 of notes payable conversion by Mr. Kamin, a board member.

During May 2019, the Company issued warrants to purchase 300,000 shares of its common stock for $0.17 per share which expire on December 31, 2021 to a former employee for business assistance provided. The value allocated to the warrants was the fair value determined using the Black-Scholes option valuation with the following assumptions:  no dividend yield, expected annual volatility of 217%, risk free interest rate of 1.92% and an expected useful life of 31 months. The fair value of the warrants of $58,380 was recorded as compensation expense and allocated to Paid in Capital.

On April 3, 2019, the Board of Directors of the Company adopted the Empire Petroleum Corporation 2019 Stock Option Plan (the "Stock Option Plan"). The total number of shares of common stock that may be issued pursuant to stock options under the Stock Option Plan is 10,000,000. Further, on April 3, 2019 the Company granted Mr. Pritchard and Mr. Morrissett each, options to purchase 2,500,000 shares of common stock of the Company at an exercise price of $0.33 per share. The options vest in three installments with 1,250,000 vesting immediately and 625,000 vesting each in April 2020 and April 2021. All of the options expire in April, 2029. The value allocated to the vested options was the fair value determined using the Black-Scholes option valuation with the following assumptions:  no dividend yield, expected annual volatility of 213%, risk free interest rate of 2.32% and an expected useful life of 5.375 years. The fair value of the vested options of $812,500 was recorded as compensation expense and allocated to Paid in Capital in 2019. In 2020, the fair value of the options which vested in April 2020 of $406,250 was recorded as compensation expense and allocated to Paid in Capital. The fair of the remaining unvested options is $406,250 as of September 30, 2020.

On April 3, 2019 the Board of Directors of the Company amended certain warrant certificates which had been issued to Mr. Kamin covering 3,000,000 warrants to purchase common stock of the Company. The original warrants expired on December 31, 2021 and had exercise prices of $0.15 and $0.25 for 500,000 and 2,500,000 shares, respectively. The warrants were extended to expire on April 2, 2029. The value allocated to the warrants was the fair value determined using the Black-Scholes option valuation with the following assumptions:  no dividend yield, expected annual volatility of 213%, risk free interest rate of 2.32% and an expected useful life of 5 years. The fair value of the warrants of $620,750 was recorded as compensation expense and allocated to Paid in Capital.

On August 7, 2020 concurrently with the Joint Development Agreement with Petroleum & Independent Exploration, LLC and related entities (“PIE”), the companies entered into a Securities Purchase Agreement (“Securities Agreement”) whereby PIE purchased for $525,000 (a) 3,500,000 shares of Empire common stock, (b) warrants to purchase 2,625,000 shares of Empire common stock at an exercise price of $0.20 per share, (c) warrants to purchase 1,800,000 shares of Empire common stock at an exercise price of $0.25 per share, (d) warrants to purchase 8,136,518 shares of Empire common stock at an exercise price of $0.10 per share, and (e) warrants to purchase up to 11,066,667 shares of Empire common stock at an exercise price of $0.141 per share. PIE is obligated to exercise the $0.20 warrants within 45 days of when 3 month trailing average production from the Empire Texas properties have increased by 20% over the trailing 3 month trailing average production as of July 2020. PIE can only exercise the $0.25 warrants once all existing non-PIE outstanding warrants to purchase Empire common stock have been exercised or lapsed. For the $0.141 warrants, PIE may initially acquire 7,533,333 shares of Empire common stock, however the amount may be increased if any existing non-PIE warrants are exercised prior to December 31, 2020. 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 147%, risk free interest rate of .19% and an expected useful life of 4 years. The fair value of the warrants of $450,848 was allocated to Paid in Capital (See Note 8).

12.    SUBSEQUENT EVENTS

On October 1, 2020 the Company entered into a new office lease agreement. The term of the lease is 63 months commencing October 1, 2020 through December 31, 2025 with lease rates ranging from $0 per month for the first three months to $13,038 per month for the final year. The Company is accounting for the lease as an operating lease.

In October 2020 the Company entered into a $306,000 Letter of Credit agreement, utilizing the commitment under its Senior Revolver Loan Agreement (see Note 10).

GENERAL TO ALL PERIODS

RESULTS OF OPERATIONS

The Company's primary business is the exploration and development of oil and natural gas interests. The Company has incurred significant losses from operations, and there is no assurance that it will achieve profitability or obtain the funds necessary to finance its operations. For all periods presented, the Company's effective tax rate is 0%. The Company has generated net operating losses since inception, which would normally reflect a tax benefit in the statement of operations and a deferred asset on the balance sheet. However, because of the current uncertainty as to the Company's ability to achieve profitability, a valuation reserve has been established that offsets the amount of any tax benefit available for each period presented in the statements of operations.

The following table sets forth a summary of our production and operating data for the three and nine month periods ended September 30, 2020. Because of normal production declines, increased or decreased drilling activities, fluctuations in commodity prices and the effects of acquisitions or divestitures, the historical information presented below should not be interpreted as being indicative of future results.

THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2020 COMPARED TO THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2019.

For the three months ended September 30, 2020 and 2019, revenues from oil and natural gas sales were $ 1,645,403 and $1,695,264 respectively. In 2020, due to COVID and other economic factors, prices of oil and natural gas declined, resulting in the Company reducing volumes produced.

Operating expenses, production taxes, depreciation and depletion and amortization and accretion decreased to $1,905,055 cumulatively for the three months ended September 30, 2020 from $2,519,942 for the same period in 2019. The decrease was due to a decrease in costs associated with oil and natural gas production, which was constrained during the period due to management’s reduction of production in response to lower prices.

Net realized and unrealized gain (loss) on derivatives decreased to $(103,166) for the three months ended September 30, 2020, from $492,862 in the same period 2019 due primarily to decreases in oil prices since June 30, 2020 and increases in oil prices during the same period in 2019, respectively, for those contracts in existence at that date.

General and administrative expenses increased by $808,875 to $1,278,667 for the three months ended September 30, 2020, from $469,792 for the same period in 2019. The increase was primarily due to an increased number of employees and professional fees related to the Pardus acquisition. For the three month period in 2020, expenses included the $75,000 loss for the acquisition deposit on the Ovintiv properties.

Interest expense was $124,887 and $145,345 for the three months ended September 30, 2020 and 2019, respectively. The decrease in interest expense of $20,458 resulted primarily from lower interest rates in 2020.

For the reasons discussed above, the previous period net loss increased by $694,419 from $(946,953) for the three months ended September 30, 2019 to net loss of $(1,641,372) for the three months ended September 30, 2020.

NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2020 COMPARED TO NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2019

For the nine months ended September 30, 2020 and 2019, revenues from oil and natural gas sales were $ 3,954,332 and $4,016,232 respectively.  The Company purchased significant oil and natural gas properties in the second quarter of 2019 which were not included in 2019 revenues. In the second and third quarter of 2020, due to COVID and other economic factors, prices of oil and natural gas declined, resulting in the Company reducing volumes produced.

Operating expenses, production taxes, depreciation and depletion and amortization and accretion, excluding impairment, increased to $5,349,655 cumulatively for the nine months ended September 30, 2020 from $5,013,319 for the same period in 2019. The increase was due primarily to only a partial period of production in 2019 because of the EnergyQuest acquisition March 2019 and lower production volumes in 2020.

Impairment of oil and natural gas properties expense increased to $800,452 for the nine months ended September 30, 2020 from $0 for the same period in 2019. The increase was due to the change in market prices for oil and natural gas in 2020.

Net realized and unrealized gain on derivatives increased to $2,003,505 for the nine months ended September 30, 2020, from $925,231 in the same period 2019 due to decrease in oil prices since the agreements were entered into or since December 31, 2020 and 2019 respectively, for those contracts in existence at that date, to the date of maturity or the balance sheet date.

General and administrative expenses increased by $595,654 to $3,722,057 for the nine months ended September 30, 2020, from $3,126,403 for the same period in 2019. The increase was primarily due to $800,000 allowance for the acquisition deposit on the Ovintiv properties in 2020 offset by options and warrants issued and professional fees and travel related to the acquisition of oil and natural gas properties in 2019.

Interest expense was $380,975 and $342.256 for the nine months ended September 30, 2020 and 2019, respectively. The increase in interest expense of $38,719 resulted primarily from the debt issued to acquire oil and natural gas properties in the second quarter of 2019 and lower interest rates in 2020.

For the reasons discussed above, the previous period net loss decreased by $513,973 from $(3,540,515) for the nine months ended September 30, 2019 to net loss of $(3,026,542) for the nine months ended September 30, 2020.

LIQUIDITY AND CAPITAL RESOURCES

GENERAL

As of September 30, 2020, the Company had $134,374 of cash. The Company expects to incur costs related to future oil and natural gas acquisitions for the foreseeable future. It is expected that management will attempt to raise additional capital for future investment and working capital opportunities.

OUTLOOK

See Notes 3 through 8 to the financial statements for information regarding the purchase and development agreements the Company entered into in 2019 and 2020 to purchase and develop existing oil and natural gas properties and mineral interests. The Company is also actively pursuing the acquisition of other operated and non-operated oil and natural gas properties. It is anticipated that such acquisitions will be financed through equity or debt transactions.

Lower oil and natural gas prices present challenges to our industry and our Company. The economic impact of the COVID-19 pandemic have caused oil price volatility in 2020. In the first three quarters of 2020, gains on settled derivatives offset a large portion of the impact of the recent decline in prices and slower production, and we currently have derivative positions in place for a substantial amount of our expected remaining 2020 production. There can be no assurance that we will be able to add derivative positions to cover the remainder of our expected production at favorable prices.

The Impact of COVID-19 on Our Business

During the first three quarters of 2020, we did not experience any material impact to our ability to operate or market our production due to the direct or indirect impacts of the COVID-19 pandemic. The Cybersecurity and Infrastructure Security Agency in the U.S. Department of Homeland Security classifies individuals engaged in and supporting exploration for and production of natural gas, oil and NGLs as “essential critical infrastructure workforce,” and to date, state and local governments where our wells are located have followed this guidance and exempted these activities from business closures. Should this situation change, our access to supplies or workers to drill, complete and operate wells could be materially and adversely affected.

However, as decreased transportation, manufacturing and general economic activity levels prompted by COVID-19 and related governmental and societal actions have reduced the demand for oil-based products such as gasoline, jet fuel and other refined products, space to store oil and condensate production is reaching or may reach capacity in some areas, which is prompting purchasers of oil and condensate to reduce future purchase levels and, in some cases, to claim force majeure for purchases already contracted. These situations may lead to production greater than storage capacity later in the year, depending on weather and other seasonal factors. In addition, commodity pricing challenges may cause our production costs to exceed the revenues associated with such production. To the extent that this decreased demand for our commodities continues and our margins are not at acceptable levels or storage for our production is not available, we may have to reduce production from or completely shut in portions of our currently producing wells. The inability to sell our production or the decision to potentially reduce or shut in our production could materially and adversely affect our operating results and our ability to comply with the financial covenants under our credit facility.

There is uncertainty around the extent and duration of the disruption. The degree to which the COVID-19 pandemic or any other public health crisis adversely impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, its impact on the economy and market conditions, and how quickly and to what extent normal economic and operating conditions can resume. Therefore, while we expect this matter will likely disrupt our operations, the degree of the adverse financial impact cannot be reasonably estimated at this time.

FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-Q, including this section, includes certain statements that may be deemed "forward-looking statements" within the meaning of federal securities laws. All statements, other than statements of historical facts, that address activities, events or developments that the Company expects, believes or anticipates will or may occur in the future, including future sources of financing and other possible business developments, are forward-looking statements. Such statements are subject to a number of assumptions, risks and uncertainties and could be affected by a number of different factors, including the Company's failure to secure short and long-term financing necessary to sustain and grow its operations, increased competition, changes in the markets in which the Company participates and the technology utilized by the Company and new legislation regarding environmental matters. These risks and other risks that could affect the Company's business are more fully described in reports the Company files with the SEC, including its Form 10-K for the year ended December 31, 2019. Actual results may vary materially from the forward-looking statements.

The Company undertakes no duty to update any of the forward-looking statements in this Form 10-Q.

MATERIAL RISKS

The Company has incurred significant losses from operations and there is no assurance that it will achieve profitability or obtain the funds necessary to finance continued operations. For other material risks, see the Company's Form 10-K for the year ended December 31, 2019, which was filed on March 30, 2020.

Not applicable.

As of the end of the period covered by this report, the Company carried out an evaluation under the supervision of the Company's President (and principal financial officer) of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Securities Exchange Act Rules 13a - 15(e) and 15d - 15(e). Based on this evaluation, the Company's President (and principal financial officer) has concluded that the disclosure controls and procedures as of the end of the period covered by this report are effective.

PART II. OTHER INFORMATION

None.

Not applicable.

None.

None.

Not applicable.

None.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

EXHIBIT INDEX

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