EMPIRE PETROLEUM CORP 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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, which 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 distinct 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 Annual Report on Form 10-K for the year ended December 31, 2021. 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. Overview 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 sustained 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 condensed consolidated statement of operations and a deferred asset on the condensed consolidated balance sheet. However, because of the current uncertainty as to the Company’s ability to achieve sustained profitability, a valuation reserve has been established that offsets the amount of any tax benefit available for each period presented in the condensed consolidated statements of operations. Critical Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to use our judgment to make estimates and assumptions that affect certain amounts reported in our financial statements. As additional information becomes available, these estimates and assumptions are subject to change and thus impact amounts reported in the future. Critical accounting policies are those accounting policies that involve judgment and uncertainties affecting the application of those policies and the likelihood that materially different amounts would be reported under different conditions or using differing assumptions. We periodically update our estimates used in the preparation of the financial statements based on our latest assessment of the current and projected business and general economic environment. There have been no significant changes to our critical accounting policies during the three months ended March 31, 2022. Production and Operating Data The following table sets forth a summary of our production and operating data for the three-month periods ended March 31, 2022 and 2021. Because of normal production declines, increased or decreased production due to future acquisitions, divestitures, and development, 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. - 17 - Three Months Ended March 31, 2022 Three Months Ended March 31, 2021 Production and operating data: Net production volumes: Oil (Bbl) 114,255 39,926 Natural gas (Mcf) 213,945 41,004 Natural gas liquids (gal) 1,686,375 — * Total (Boe) 190,064 46,760 Average price per unit: Oil (a) $ 91.17 $ 48.35 Natural gas (a) $ 4.61 $ 6.27 Natural gas liquids $ 1.03 $ — * Total (Boe) $ 68.51 $ 46.78 Operating costs and expenses per Boe: Oil and natural gas production $ 27.31 $ 30.32 Production and ad valorem taxes $ 4.74 $ 3.63 Depreciation, depletion, amortization and accretion $ 4.02 $ 9.94 General & administrative $ 12.92 $ 19.38 (a) Includes the effect of net cash receipts (payments on) derivatives, as applicable contracts are in place. Bbl – One stock tank barrel, of 42 U.S. gallons liquid volume, used herein in reference to oil, condensate, or natural gas liquids. Mcf – One thousand cubic feet of natural gas Gal – One gallon of natural gas liquid Boe – One barrel of oil equivalent, a standard convention used to express oil and natural gas volumes on a comparable oil equivalent basis. Natural gas equivalents are determined under the relative energy content method by using the ratio of 6.0 Mcf of natural gas to 1.0 Bbl of oil or condensate. * Prior to the acquisition of the New Mexico properties, natural gas liquids production was minimal and included as a component of natural gas on the financial statements. - 18 - Results of Operations The following table reflects our summary operating information. Because of normal production declines, increased or decreased drilling activity and the effects of acquisitions, the historical information presented below should not be interpreted as indicative of future results. Three Months Ended March 31, 2022 2021 Variance Variance % Oil revenues $ 10,416,422 $ 2,058,479 8,357,943 406% Natural gas revenues 985,423 376,549 608,874 162% NGL revenues 1,732,518 — 1,732,518 100% Total revenues from product sales 13,134,363 2,435,028 Lease operating expense 5,190,946 1,418,010 3,772,936 266% Production and ad valorem taxes 901,238 169,832 731,406 431% Depreciation, depletion, amortization and accretion 764,446 465,005 299,441 64% General and administrative expense (excluding stock-based compensation) 2,079,102 906,048 1,173,054 129% Stock-based compensation 376,278 — 376,278 100% Interest expense 110,648 136,828 (26,180 ) -19% Operating Income (Loss) 3,734,075 (860,352 ) 4,594,427 534% Net Income (Loss) 3,623,427 (997,180 ) 4,620,607 463% Revenues Revenues increased as a result of more volumes produced from legacy assets due to successful execution of the Company’s mission to cost-effectively produce more volumes paired with the XTO acquisition’s revenues and volumes brought online from efforts to make the field produce more volumes combined with favorable pricing environments in the Company’s core operating areas. Approximately $5.7 million in oil revenues, $740,000 in gas revenue, and $1.6 million in NGL revenue was attributed to production acquired with the XTO acquisition in the current quarter for a total revenue impact of the XTO assets of approximately $8.1 million of the total revenue variance between periods. Lease Operating Expense and Taxes Lease operating expense rose with the XTO acquisition and in response to the Company’s execution of its mission to increase production in its legacy assets. The Company has worked to cost-effectively increase production throughout its asset base utilizing experienced personnel and third-party service providers. Production and ad valorem taxes have increased as a direct result of the XTO acquisition’s properties and increased volumes produced and sold. The acquisition of New Mexico assets accounted for approximately $2.7 million of the increase in lease operating expenses and $655,000 of the increase in production and ad valorem taxes. Depreciation, Depletion, Amortization and Accretion and Impairment There were no indicators of impairment on the Company’s properties at period-end. The addition of PDP reserves and producing volumes in New Mexico served as the primary driver of the change in this line item period over period. General and Administrative Expense The Company’s headcount increased as a result of the New Mexico acquisition, including administrative personnel. Increase in salaries period-over-period was approximately $170,000. Addition of the New Mexico assets resulted in additional costs for accounting and other professional services of approximately $300,000. The Company also accrued for a loss contingency related to a Texas sales tax audit for which the initial assessment was received in April 2022. The Company accrued $650,000 related to that contingency based on currently available information. The Company intends to seek redetermination of this assessment. The final payment related to this sales tax audit may be more or less than the accrued amount. The Company utilizes stock-based compensation to compensate members of management and retain talented personnel. The Company anticipates stock-based compensation to continue to be utilized in 2022 and beyond to attract and retain talented personnel. Interest Expense Cash-based interest expense declined with a corresponding decrease in the Company’s Credit Facility. - 19 - Liquidity As of March 31, 2022, the Company had approximately $5.4 million cash on hand and approximately $300,000 available on its Credit Facility. The Company expects to incur costs related to future oil and natural gas acquisitions for the foreseeable future. It is expected that management will use a combination of cash flows from operations as well as seeking additional debt and equity funding for these acquisitions and to fund ongoing operations. Working Capital Working capital (presented below) was approximately $4.7 million as of March 31, 2022 compared to approximately $1.1 million as of December 31, 2021, resulting in an increase of approximately $3.7 million. This change is primarily a result of a consistently strong pricing environment in the first quarter of 2022 that increased the Company’s cash balance by approximately $1.7 million. Drilling on the four non-operated properties that had begun in the fourth quarter of 2021 was completed in early 2022, which was a primary reason for the decrease in accounts payable of approximately $1.7 million between period ends. March 31, December 31, 2022 2021 Current Assets 15,440,677 13,118,020 Current Liabilities 10,694,151 12,054,487 Working Capital 4,746,526 1,063,533 Cash Flows Three Months Ended March 31, Cash flows provided by (used in): 2022 2021 Variance Operating activities $ 3,060,704 $ (626,106 ) $ 3,686,810 Investing activities (956,514 ) (1,961,973 ) 1,005,459 Financing activities (362,452 ) 6,345,062 (6,707,514 ) Cash Flows from Operating Activities The Company closed on its New Mexico properties in May 2021 (See Note 4). These properties significantly increased the volume produced by the Company, and the Company was also able to capitalize on higher pricing in the first quarter of 2022 compared to that in the first quarter of 2021. The Company had net income in the first three months of 2022 compared to the same period in 2021, further increasing cash provided by operating activities compared to the cash used in operating activities for the same period last year. Cash Flows from Investing Activities For the three months ended March 31, 2021, the Company deposited approximately $1.8 million in an escrow account ahead of the New Mexico acquisition (See Note 4). This cash outflow was the primary driver for the net cash used in investing activities in the prior year. In the current period, there were no similar cash outflows and additions to oil and natural gas properties was minimal in comparison, totaling approximately $425,000 for the three months ended March 31, 2022. Cash Flows from Financing Activities For the three months ended March 31, 2022, the Company made principal payments on debt of approximately $460,000 that was offset by approximately $98,000 of cash received for warrant exercises. During the same period in the prior year, the Company received cash totaling approximately $6.5 million related to stock and warrant issuances and exercises. Capital Resources Capital Expenditures For the three months ended March 31, 2022, the Company spent approximately $425,000 on additions to oil and natural gas properties, primarily as a result of non-operated drilling. The Company anticipates additional capital expenditures in the coming quarters that will be funded with cash flows from operations. - 20 - Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.