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 Empire 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 Empire’s failure to secure short and long-term financing necessary to sustain and grow its operations, increased competition, changes in the markets in which Empire participates and the technology utilized by Empire and new legislation regarding environmental matters. These risks and other risks that could affect Empire's business are more fully described in reports Empire files with the SEC, including its Annual Report on Form 10-K for the year ended December 31, 2023. Actual results may vary materially from the forward-looking statements. Empire undertakes no duty to update any of the forward-looking statements in this Form 10-Q. Overview Our primary business is the optimization and development of oil and gas interests. In 2022 we had net income from operations but have incurred losses from operations in 2023 and 2024 and in years prior to 2022. There is no assurance that we will be profitable or obtain funds necessary to finance our future operations. We seek to increase shareholder value by growing reserves, production, revenues, and cash flow from operating activities by executing our mission to use highly-skilled personnel to thoughtfully and expertly spend capital to realize reserves on producing properties as well as further develop fields. Management places emphasis on operating cash flow in managing our business, as operating cash flow considers the cash expenses incurred during the period and excludes non-cash expenditures not related directly to our operations. Business Strategy Our business strategy is to obtain long-term growth in reserves and cash flow on a cost-effective basis. Management regularly evaluates potential acquisitions of properties that would enhance current core areas of operation. Critical Accounting Policies The preparation of financial statements in conformity with GAAP requires management to use judgment to make estimates and assumptions that affect certain amounts reported in the consolidated 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. Management periodically updates the estimates used in the preparation of the financial statements based on management’s latest assessment of the current and projected business and general economic environment. There have been no significant changes to Empire’s critical accounting policies during the nine months ended September 30, 2024. LIQUIDITY AND CAPITAL RESOURCES General Empire’s primary sources of short-term liquidity are cash and cash equivalents, net cash provided by operating activities, and issuance of debt or equity securities. Empire’s short- and long-term liquidity requirements consist primarily of capital expenditures, acquisitions of oil and natural gas properties, payments of contractual obligations, and working capital obligations. Funding for these requirements may be provided by any combination of Empire’s sources of liquidity. Although Empire expects that its sources of funding will be adequate to fund its liquidity requirements, no assurance can be given that such funding sources will be adequate to meet Empire’s future needs. 18 Liquidity As noted below, our working capital is negative as of September 30, 2024, which is primarily the result of a higher level of payables related to capital spending as part of our Starbuck Drilling Program in North Dakota. In addition, Empire was not in compliance with the current ratio covenant under the Revolver as of September 30, 2024; however, Empire obtained a compliance waiver from the lender for September 30, 2024. As of September 30, 2024, we had approximately $3.1 million in cash on hand and approximately $0.2 million available on the Revolver. Empire will require additional funds to be in compliance with debt covenants and satisfy the payables discussed above which are greater than estimated cash flows from operations over the next 12 months. Phil Mulacek and Energy Evolution Master Fund, Ltd, both related parties of Empire and our largest two shareholders, owning 20.3% and 31.4%, respectively, of the common shares outstanding as of September 30, 2024, have indicated that they will, and have the ability to, provide sufficient support to sustain the operating, investing, and financing activities of Empire, as necessary. In addition to the November Rights Offering, discussed elsewhere in this document, management continues to seek additional sources of capital via the debt or equity markets to improve liquidity going forward. See the liquidity and going concern discussion included in notes to unaudited interim condensed consolidated financial statements, presented elsewhere in this document, for further discussion of management’s plans. Empire expects to continue to incur costs related to drilling activities in core areas as well as future oil and natural gas acquisitions in core areas. As of September 30, 2024, Empire has incurred approximately $38.3 million of additions to oil and natural gas properties, primarily related to the drilling program in the Starbuck field of North Dakota. It is expected that Empire will use a combination of debt or equity issuances, cash on hand, and cash flows from operations to fund capital programs, ongoing operations, and any potential acquisitions. Working Capital Working capital, presented below, decreased by approximately $9.0 million between December 31, 2023, and September 30, 2024. This change was primarily driven by payables related to the Starbuck Drilling Program in North Dakota and a lower cash balance at September 30, 2024. September 30, 2024 December 31, 2023 Current Assets $ 11,731,003 $ 18,744,904 Current Liabilities (26,993,885 ) (25,049,572 ) Working Capital $ (15,262,882 ) $ (6,304,668 ) Cash Flows Nine Months Ended September 30, 2024 2023 Variance Cash Flows Provided By (Used In): Operating Activities $ 14,917,374 $ (5,957,231 ) $ 20,874,605 Investing Activities (49,274,023 ) (5,519,179 ) (43,754,844 ) Financing Activities 29,713,857 10,566,802 19,147,055 Cash Flows from Operating Activities The impact of higher oil production and lower workover expenses in 2024 compared to 2023 contributed to the increase in cash flows from operating activities. Cash Flows from Investing Activities Cash flows from investing activities in the first nine months of 2024 include approximately $48.8 million of additions to oil and natural gas properties primarily due to the development of our operations as part of our Starbuck Drilling Program in North Dakota. Cash Flows from Financing Activities Cash flow from financing activities in 2024 includes net proceeds from the April Rights Offering of approximately $20.5 million (see Note 10). In addition, cash flows from financing activities in 2024 includes $5.0 million from a promissory note issued to Empire by a related party and approximately $4.0 million borrowed on Empire’s Revolver (see Note 8). 19 Capital Resources Capital Expenditures For the nine months ended September 30, 2024, Empire incurred approximately $38.3 million of additions to oil and natural gas properties which primarily reflects continued drilling and completions activity related to our Starbuck Drilling Program in North Dakota. Production and Operating Data The following table sets forth a summary of Empire’s production and operating data for the three and nine months ended September 30, 2024 and 2023. Because of normal production declines, increased or decreased production due to future acquisitions, divestitures, and development, and fluctuations in commodity prices, the historical information presented below should not be interpreted as being indicative of future results. Three Months Ended September 30, Nine Months Ended September 30, 2024 2023 2024 2023 Production and Operating Data: Net Production Volumes: Oil (Bbl) 144,674 120,177 435,717 368,847 Natural Gas (Mcf) 255,195 195,908 708,258 638,419 Natural Gas Liquids (Bbl) 39,137 35,568 113,534 106,002 Total (Boe) 226,344 188,396 667,294 581,252 Average Price per Unit: Oil (Bbl) $ 71.48 $ 78.98 $ 73.60 $ 74.77 Natural Gas (Mcf) $ 0.03 $ 2.10 $ 0.38 $ 2.06 Natural Gas Liquids (Bbl) $ 13.84 $ 11.57 $ 13.87 $ 12.06 Total (Boe) $ 48.12 $ 54.75 $ 50.83 $ 51.91 Operating Costs and Expenses per Boe: Lease Operating Expense $ 29.75 $ 37.42 $ 32.47 $ 35.56 Production and Ad Valorem Taxes $ 4.35 $ 4.21 $ 4.32 $ 3.91 Depreciation, Depletion, Amortization and Accretion $ 13.72 $ 6.36 $ 12.36 $ 5.74 General and Administrative Expense: General and Administrative Expense $ 16.06 $ 13.70 $ 13.29 $ 12.90 Stock-Based Compensation $ 1.48 $ 0.84 $ 2.45 $ 3.94 Total General and Administrative Expense $ 17.54 $ 14.54 $ 15.74 $ 16.84 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. 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. 20 Three Months Ended September 30, 2024 and 2023 Results of Operations The following table reflects Empire’s 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 September 30, 2024 2023 Variance Variance % Oil Revenues $ 10,341,280 $ 9,492,127 $ 849,153 9% Natural Gas Revenues 8,547 411,217 (402,670 ) -98% NGL Revenues 541,755 411,624 130,131 32% Total Product Revenues 10,891,582 10,314,968 Lease Operating Expense (Including Workovers) 6,733,611 7,050,054 (316,443 ) -4% Production and Ad Valorem Taxes 984,075 792,241 191,834 24% Depreciation, Depletion, Amortization and Accretion 3,105,491 1,198,448 1,907,043 159% General and Administrative Expense: General and Administrative Expense 3,635,917 2,580,464 1,055,453 41% Stock-based Compensation 335,077 158,792 176,285 111% Total General and Administrative Expense 3,970,994 2,739,256 1,231,738 45% Interest Expense 196,306 249,796 (53,490 ) -21% Operating Loss (3,416,603 ) (2,633,902 ) (782,701 ) 30% Net Loss (3,639,614 ) (2,747,628 ) (891,986 ) 32% Revenues Revenues for the three months ended September 30, 2024, increased slightly compared to the prior year primarily due to higher oil, natural gas and NGL sales volumes, substantially offset by lower realized oil and natural gas prices. Net oil sales volumes were approximately 145,000 Bbls for the three months ended September 30, 2024, an increase of approximately 20% over the same period in the prior year. Oil volumes in third-quarter 2024 increased primarily due to new wells completed in North Dakota during the period as well as the acquisition of additional working interest in New Mexico. Realized oil prices for the three months ended September 30, 2024, were $71.48 per barrel, while realized prices for the same period in the prior year were $78.98 per barrel, a decrease in price of approximately 9%. Realized natural gas prices for the three months ended September 30, 2024, were $0.03 per mcf, while realized prices for the same period in the prior year were $2.10 per mcf. This is primarily due to the depressed natural gas prices in the third quarter of 2024 in New Mexico. Realized NGL prices for the three months ended September 30, 2024, were $13.84 per barrel, while realized prices for the same period in the prior year were $11.57 per barrel, an increase in price of approximately 20%. Lease Operating Expense and Production Taxes Lease operating expense was lower for the three months ended September 30, 2024, compared to the same period in 2023 primarily due to lower workover costs. Lease operating expense includes approximately $1.4 million of workover expense for the three months ended September 30, 2024, as compared to $3.2 million for the same period in 2023. The higher workover expense in 2023 was primarily in New Mexico as Empire continued to work over wells in the region to enhance and maintain production. Production taxes were higher for the three months ended September 30, 2024, compared to the same period in 2023 as a result of the higher product revenues discussed above. 21 Depreciation, Depletion, Amortization and Accretion The higher DD&A for the three months ended September 30, 2024, compared to the same period in 2023 is due in part to the increase in production, the acquisition of additional working interest as well as the impact of the capitalized costs associated with the new drilling activity as part of our Starbuck Drilling Program in North Dakota. General and Administrative Expense General and administrative expense, excluding stock-based compensation, increased for the three months ended September 30, 2024, compared to the same period in 2023 primarily due to an increase in salaries and benefits period over period associated with an increase in employee headcount. Stock-based Compensation Empire utilizes stock-based compensation to compensate the Board, members of management, and retain talented personnel. Empire anticipates stock-based compensation to continue to be utilized in 2024 and beyond to attract and retain talented personnel and compensate Board members and consultants. Interest Expense Interest expense decreased for the three months ended September 30, 2024, compared to the same period in 2023 primarily due to lower cash interest expense from lower average debt balances in the third quarter of 2024 compared to third-quarter 2023. 22 Nine Months Ended September 30, 2024 and 2023 Results of Operations The following table reflects Empire’s 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. Nine Months Ended September 30, 2024 2023 Variance Variance % Oil Revenues $ 32,070,516 $ 27,578,453 $ 4,492,063 16% Natural Gas Revenues 269,844 1,315,938 (1,046,094 ) -79% NGL Revenues 1,574,995 1,278,759 296,236 23% Total Product Revenues 33,915,355 30,173,150 Lease Operating Expense (Including Workovers) 21,663,719 20,669,217 994,502 5% Production and Ad Valorem Taxes 2,883,240 2,271,630 611,610 27% Depreciation, Depletion, Amortization and Accretion 8,250,400 3,338,615 4,911,785 147% General and Administrative Expense: General and Administrative Expense 8,869,034 7,497,947 1,371,087 18% Stock-based Compensation 1,636,714 2,289,237 (652,523 ) -29% Total General and Administrative Expense 10,505,748 9,787,184 718,564 7% Interest Expense 1,246,575 671,982 574,593 86% Operating Loss (9,740,056 ) (7,158,122 ) (2,581,934 ) 36% Net Loss (12,004,581 ) (7,672,128 ) (4,332,453 ) 56% Revenues Revenues for the nine months ended September 30, 2024, increased compared to the prior year primarily due to higher oil, natural gas, and NGL sales volumes, partially offset by lower realized oil and natural gas prices. Net oil sales volumes were approximately 436,000 Bbls for the nine months ended September 30, 2024, an increase of approximately 18% over the same period in the prior year. Oil volumes in 2024 increased primarily due to new wells completed in North Dakota during the period as well as the acquisition of additional working interest in New Mexico. Realized oil prices for the nine months ended September 30, 2024, were $73.60 per barrel, while realized prices for the same period in the prior year were $74.77, a decrease in price of approximately 2%. Realized natural gas prices for the nine months ended September 30, 2024, were $0.38 per mcf, while realized prices for the same period in the prior year were $2.06, a decrease in price of approximately 72%. The lower prices in 2024 are primarily due to depressed natural gas prices in New Mexico during the period. Realized NGL prices for the nine months ended September 30, 2024, were approximately $13.87 per barrel, while realized prices for the same period in the prior year were approximately $12.06 per barrel, an increase in price of approximately 15%. Lease Operating Expense and Production Taxes The increase in lease operating expense for the nine months ended September 30, 2024, was primarily associated with an increase in production, partially offset by lower workover expenses year over year. Lease operating expense includes approximately $5.3 million of workover expense for the nine months ended September 30, 2024, as compared to $8.9 million for the same period in 2023. The higher workover expense in 2023 was primarily in New Mexico as Empire continued to work over wells in the region to enhance and maintain production. Production taxes were higher for the nine months ended September 30, 2024, compared to the same period in 2023 as a result of the higher product revenues discussed above. 23 Depreciation, Depletion, Amortization and Accretion The higher DD&A in 2024 is due in part to the increase in production, the acquisition of additional working interest in New Mexico as well as the impact of the capitalized costs associated with drilling activity associated with our Starbuck Drilling Program in North Dakota. General and Administrative Expense General and administrative expense, excluding stock-based compensation, increased for the nine months ended September 30, 2024, compared to the same period in 2023 primarily due to an increase in salaries and benefits period over period associated with an increase in employee headcount. Stock-based Compensation Empire utilizes stock-based compensation to compensate members of the Board, management, and retain talented personnel. Empire anticipates stock-based compensation to continue to be utilized in 2024 and beyond to attract and retain talented personnel and compensate Board members and consultants. The decrease year over year is primarily due to Board of Directors awards in 2023. Interest Expense Interest expense increased in 2024 compared to the same period in 2023 primarily due to higher cash interest expense and the amortization of the debt discount both associated with the Promissory Note that was issued in 2024 (see Note 8). 24 Item 3.         QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. Item 4.         CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this report, Empire carried out an evaluation under the supervision and participation of Empire’s Principal Executive Officer and Principal Financial Officer, along with our management, of the effectiveness of the design and operation of Empire’s disclosure controls and procedures as defined in Securities Exchange Act Rule 13a-15(e). Based on this evaluation, Empire’s Principal Executive Officer and Principal Financial Officer concluded that the disclosure controls and procedures were effective, as of the end of the period covered by this report, in ensuring the information required to be disclosed by Empire in the reports it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including Empire’s Chief Executive Officer (principal executive officer and principal financial officer) to allow timely decisions regarding required disclosure. Changes in Internal Control Over Financial Reporting While we continue to implement design enhancements to our internal control procedures, there were no changes to our internal control over financial reporting during the three months ended September 30, 2024, which were identified in connection with the evaluation that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. It is management’s expectation that Empire will implement enhanced controls throughout 2024 with additional controls implemented as they are identified by management. Management will continue to diligently and rigorously review the financial reporting controls and procedures on an ongoing basis. Inherent Limitations on Effectiveness of Controls Empire’s disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their desired objectives. Management recognizes that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of their inherent limitations, disclosure controls and procedures and internal control over financial reporting may not prevent or detect all errors or misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. 25 PART II. OTHER INFORMATION Item 1. Legal Proceedings For information regarding legal proceedings, see Note 15 of the Unaudited Interim Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q. Item 1A. Risk Factors Not applicable.