EMPIRE PETROLEUM CORP 10-Q

Item 1. FINANCIAL STATEMENTS EMPIRE PETROLEUM CORPORATION CONSOLIDATED BALANCE SHEETS September 30, 2020 December 31, 2019 (UNAUDITED) ASSETS Current Assets: Cash $ 134,374 $ — Accounts Receivable 1,047,092 982,814 Unrealized Gain on Derivative Instruments 456,447 — Acquisition Deposit Receivable (see Note 4) 50,000 — Inventory 588,648 476,305 Prepaids 218,015 129,541 Total Current Assets 2,494,576 1,588,660 Property and equipment: Oil and Natural Gas Properties, Successful Efforts 24,678,466 12,660,457 Less: Accumulated Depreciation, Depletion and Impairment (5,172,137 ) (3,365,340 ) 19,506,329 9,295,117 Other Property and Equipment, net of $4,184 and $1,830 Accumulated Depreciation, respectively 10,272 12,626 Total Property and Equipment, net 19,516,601 9,307,743 Utility and Other Deposits 747,739 118,177 Total Assets $ 22,758,916 $ 11,014,580 LIABILITIES AND STOCKHOLDERS' DEFICIT Current Liabilities: Accounts Payable $ 1,536,484 $ 1,025,585 Accrued Expenses 2,262,844 1,103,916 Unrealized Loss on Derivative Instruments — 11,861 Current Portion of Long-term Notes Payable 8,835,358 96,704 Total Current Liabilities 12,634,686 2,238,066 Long Term Portion of Unrealized Loss on Derivative Instruments — 211,771 Long-Term Notes Payable 141,384 7,715,118 Contingent Payments (see Note 5) 985,820 — Asset Retirement Obligations 15,928,473 5,788,280 Total Liabilities 29,690,363 15,953,235 Stockholders' Deficit: Common Stock - $.001 Par Value 150,000,000 Shares Authorized, 24,892,277 and 20,367,277 Shares Issued and Outstanding, Respectively 24,892 20,367 Additional Paid-in Capital 19,853,151 18,823,926 Accumulated Deficit (26,809,490 ) (23,782,948 ) Total Stockholders' Deficit (6,931,447 ) (4,938,655 ) Total Liabilities and Stockholders' Deficit $ 22,758,916 $ 11,014,580 See accompanying notes to unaudited consolidated financial statements - 4 - EMPIRE PETROLEUM CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Revenue: Oil and Gas Sales $ 1,645,403 $ 1,695,264 $ 3,954,332 $ 4,016,232 Net realized and unrealized Gain (Loss) on Derivatives (103,166 ) 492,862 2,003,505 925,231 Total Revenue 1,542,237 2,188,126 5,957,837 4,941,463 Costs and Expenses: Operating 1,286,598 1,577,437 3,476,088 2,971,308 Taxes - Production 88,630 109,878 233,158 259,351 Depletion, Depreciation & Amortization 254,114 769,372 1,008,699 1,649,578 Impairment of Oil and Natural Gas Properties — — 800,452 — Accretion of Asset Retirement Obligation 275,713 63,255 631,710 133,082 General and Administrative 1,278,667 469,792 3,722,057 3,126,403 Total Cost and Expenses 3,183,722 2,989,734 9,872,164 8,139,722 Operating Loss (1,641,485 ) (801,608 ) (3,914,327 ) (3,198,259 ) Other Income and (Expense): Gain on Sale of Assets 125,000 — 1,268,760 — Interest Expense (124,887 ) (145,345 ) (380,975 ) (342,256 ) Net Loss $ (1,641,372 ) $ (946,953 ) $ (3,026,542 ) $ (3,540,515 ) Net Loss per Common Share, Basic & Diluted $ (0.07 ) $ (0.05 ) $ (0.14 ) $ (0.19 ) Weighted Average Number of Common Shares Outstanding, Basic & Diluted 23,469,200 19,867,277 21,971,947 19,020,236 See accompanying notes to unaudited consolidated financial statements - 5 - EMPIRE PETROLEUM CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT F or the Nine Months Ended September 30, 2020 and 2019 (UNAUDITED) Additional Common Stock Paid-In Accumulated Shares Par Value Capital Deficit Total Balances, December 31, 2019 20,367,277 $ 20,367 $ 18,823,926 $ (23,782,948 ) $ (4,938,655 ) Net Income — — — 1,588,015 1,588,015 Shares, Options, Warrants and Conversion Features Issued 1,025,000 1,025 101,475 — 102,500 Balances, March 31, 2020 21,392,277 $ 21,392 $ 18,925,401 $ (22,194,933 ) $ (3,248,140 ) Net Loss — — — (2,973,185 ) (2,973,185 ) Shares, Options, Warrants and Conversion Features Issued — — 406,250 — 406,250 Balances, June 30, 2020 21,392,277 21,392 19,331,651 (25,168,118 ) (5,815,075 ) Net Loss — — — (1,641,372 ) (1,641,372 ) Shares, Options, Warrants and Conversion Features Issued 3,500,000 3,500 521,500 — 525,000 Balances, September 30, 2020 24,892,277 $ 24,892 $ 19,853,151 $ (26,809,490 ) $ (6,931,447 ) Additional Common Stock Paid-In Accumulated Shares Par Value Capital Deficit Total Balances, December 31, 2018 17,345,609 $ 17,345 $ 16,960,818 $ (17,128,346 ) $ (150,183 ) Net Loss — — — (587,502 ) (587,502 ) Shares, Options, Warrants and Conversion Features Issued 1,446,668 1,447 215,553 — 217,000 Balances, March 31, 2019 18,792,277 $ 18,792 $ 17,176,371 $ (17,715,848 ) $ (520,685 ) Net Loss — — — (2,006,060 ) (2,006,060 ) Shares, Options, Warrants and Conversion Features Issued 1,075,000 1,075 1,598,055 — 1,599,130 Balances, June 30, 2019 19,867,277 19,867 18,774,426 (19,721,908 ) (927,615 ) Net Loss — — — (946,953 ) (946,953 ) Balances, September 30, 2019 19,867,277 $ 19,867 $ 18,774,426 $ (20,668,861 ) $ (1,874,568 ) See accompanying notes to unaudited consolidated financial statements - 6 - EMPIRE PETROLEUM CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended September 30, 2020 2019 Cash Flows From Operating Activities: Net Loss $ (3,026,542 ) $ (3,540,515 ) Adjustments to Reconcile Net Loss to Net Cash Provided by (used in) Operating Activities: Gain on Sales of Assets (1,268,760 ) — Value of warrants and options granted 406,250 1,491,630 Amortization of Warrant Value and Conversion Feature on Convertible Notes — 4,447 Amortization of Loan Issue Costs 43,758 29,072 Depreciation, Depletion and Amortization 1,008,699 1,649,578 Impairment of Oil and Natural Gas Properties 800,452 — Accretion of Asset Retirement Obligation 631,710 133,082 Cash paid to Ovintiv (see Note 4) (850,000 ) — Loss relating to Ovintiv Purchase Deposit (see Note 4) 800,000 — Change in Operating Assets and Liabilities: Accounts Receivable (64,278 ) (1,039,252 ) Unrealized Gain on Derivative Instruments (680,079 ) (663,350 ) Inventory 34,954 (33,703 ) Prepaids, Current (88,474 ) (96,283 ) Utility Deposits (181,600 ) — Accounts Payable 490,443 457,242 Accrued Expenses (26,659 ) 607,344 Net Cash Used In Operating Activities (1,970,126 ) (1,000,708 ) Cash Flows from Investing Activities: Acquisition of Oil and Natural Gas Properties (506,000 ) (6,033,135 ) Purchase of Other Fixed Assets — (14,456 ) Proceeds From Sale of Oil and Natural Gas Properties 1,309,800 — Net Cash Used in Investing Activities 803,800 (6,047,591 ) Cash Flows from Financing Activities: Proceeds from Debt Issued 925,700 7,879,744 Principal Payments of Debt (150,000 ) (1,065,000 ) Proceeds from Stock and Warrant Issuance 525,000 167,000 Net Cash Provided by Financing Activities 1,300,700 6,981,744 Net Change in Cash 134,374 (66,555 ) Cash - Beginning of Period — 84,631 Cash - End of Period $ 134,374 $ 18,076 Supplemental Cash Flow Information: Cash Paid for Interest $ 442,299 $ 316,809 Non-cash Investing and Financing Activities: Non-cash Additions to Asset Retirement Obligations $ 9,508,483 $ 3,400,770 Common Stock Issued in Exchange for Outstanding Notes Payable $ 102,500 $ 157,500 Purchases of oil and natural gas properties and deposits in accounts and notes payable, royalty suspense, and contingent payable to seller $ 2,569,863 $ — Note payable issued - PIE Agreement (see Note 8) $ 69,962 $ — See accompanying notes to unaudited consolidated financial statements - 7 - 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. In 2020, 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 Company’s revenues, cash flows and profitability may decline substantially, which could also indirectly impact expected production by reducing the amount of funds available to acquire future mineral interests; · reserves relating to the Company’s proved properties may become uneconomic to produce resulting in impairment of proved properties; and · operators and other working interest owners are unable to execute their drilling and exploration programs resulting in lower production or inability to prove reserves on unproved properties 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. - 8 - 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. - 9 - 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. - 10 - The aggregate capitalized costs of oil and natural gas properties as of September 30, 2020, are as follows: Proved producing wells $ 5,284,041 Proved undeveloped 2,232,458 Lease, well and gathering equipment 1,680,692 Asset retirement obligation 14,988,534 Unproved leasehold costs 492,741 Gross capitalized costs 24,678,466 Less: accumulated depreciation, depletion and impairment (5,172,138 ) $ 19,506,328 Other property and equipment consists of office furniture and equipment. Other property and equipment, at cost $ 14,456 Less: accumulated depreciation (4,184 ) Oher property and equipment, net $ 10,272 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: Fair Value of Assets Acquired Oil and natural gas properties $ 1,935,366 Inventory of oil in tanks 147,297 Deposits 378,000 Equipment and gathering lines 109,200 Asset retirement obligation asset 9,508,484 Total Assets Acquired $ 12,078,347 Fair Value of Liabilities Assumed Accounts payable, net $ 20,456 Note payable – current 378,000 Royalty suspense 1,185,587 Asset retirement obligations 9,508,484 Total liabilities assumed $ 11,092,527 Total consideration $ 985,820 - 11 - 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: Fair Value of Assets Acquired Accounts receivable $ 1,308,748 Inventory of oil in tanks 438,321 Oil properties 10,878,429 Total Assets Acquired $ 12,625,498 Fair Value of Liabilities Assumed Accounts payable – trade $ 1,861,433 Asset retirement obligations 5,117,939 Total liabilities assumed $ 6,979,372 Total consideration paid $ 5,646,126 - 12 - 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). - 13 - 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: Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019 Gain (loss) on derivatives: Oil derivatives $ (103,165 ) $ 492,530 $ 2,003,505 $ 917,482 Natural gas derivatives — 332 — 7,749 Total $ (103,165 ) $ 492,862 $ 2,003,505 $ 925,231 The following represents the Company’s net cash receipts from derivatives for the three and nine months ended September 30, 2020 and 2019: Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019 Net cash received from payments on derivatives Oil derivatives $ 279,533 $ 156,820 $ 1,323,427 $ 250,323 Natural gas derivatives — 6,846 — 11,557 Total $ 279,533 $ 163,666 $ 1,323,427 $ 261,880 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: 1 st Quarter 2 nd Quarter 3 rd Quarter 4 th Quarter 2020 Oil Swaps: Volume (MBbl) — — — 15.78 Price per Bbl — — — $ 55.18 2021 Oil Swaps: Volume (MBbl) 15.26 15.18 5.20 — Price per Bbl $ 49.40 $ 50.87 $ 38.25 — - 14 - 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. - 15 - 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). - 16 -