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Morgan EP, LLC

6 Months Ended

Jun. 30, 2023

(9) Morgan E&P, LLC

Morgan E&P, LLC (“Morgan”) was organized by the Fund on April 3, 2023 as a Delaware limited liability company and a wholly-owned subsidiary of the Fund. On May 22, 2023, Morgan completed the acquisition of 4,747.52 net acres, in the Bakken/Three Forks formation in the Williston Basin of North Dakota, with additional acreage to be acquired over the coming months of up to 6,705.52 net acres. The acreage and associated mineral rights were acquired from Pro Energy I LLC (“Pro Energy”), a company whose principals have decades of oil and gas experience and who have themselves drilled over 1,800 horizontal wells in the Williston Basin over a 10-year period.

Under the terms of the Purchase and Sale Agreement entered into by Morgan and Pro Energy, Morgan is required to drill and complete a minimum of six wells within 18 months of receiving the first drilling permits. The average cost of drilling a new horizontal well is approximately $8.2 million. Morgan will receive an average net revenue interest (“NRI”) of 80% in the production of any wells drilled, and after operating expenses are deducted from the NRI, Pro Energy shall receive a carried interest for 20% of these net cash flows.

In May 2023, we entered into an agreement with Morgan to provide it up to $10.0 million in senior debt financing, subject to a schedule of disbursements and draws that we determine. As of June 30, 2023, Morgan had drawn $0.75 million under this facility.

Going-Concern—The accompanying unaudited condensed consolidated financial statements of Morgan have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities and other commitments in the normal course of business. As such, the unaudited condensed consolidated financial statements do not include adjustments relating to the recoverability and classification of assets and their carrying amount, or the amount and classification of liabilities that may result should Morgan be unable to continue as a going concern. However, Equus Total Return, Inc. has agreed to and will continue to provide financial support to Morgan for at least one year and one day past the date of this report and Equus Total Return has the ability and intent to provide the financial support. As such, in connection with continued support from Equus Total Return, management concluded this plan alleviates the substantial doubt that was raised about the ability of Morgan Energy to continue as a going concern for at least twelve months from the date the financial statements were issued.

We do not consolidate the financial results of Morgan with the financial results of the Fund and, accordingly, only the value of our investment in Morgan is included on our balance sheets. Our investment in Morgan is valued in accordance with our normal valuation procedures and is based in part on a reserve report prepared for Morgan by Cawley, Gillespie, & Associates, Inc., an independent petroleum engineering firm, the transactions and values of comparable companies in this sector, and the estimated value of leasehold mineral interests associated with the acreage held by Morgan. A valuation of Morgan was performed by a third-party valuation firm, who recommended a value range of Morgan consistent with the fair value determined by our Management (See Schedule of Investments).

Below is summarized unaudited condensed consolidated financial information for Morgan E&P, LLC as of June 30, 2023 and for the period from inception (April 3, 2023) through June 30, 2023 (in thousands):

MORGAN E&P, LLC

Unaudited Condensed Consolidated Balance Sheet

	June 30,
	2023

Assets
Current assets:
Cash and cash equivalents	$	123
Total current assets		123
Oil and gas properties		500
Other non-current assets:
Fixed Assets		12
Total other non-current assets, net		12

Total assets	$	635

Liabilities and member's deficit
Current liabilities:
Accrued interest payable	$	8
Due to Parent		13
Total current liabilities		21

NON CURRENT LIABILITIES:
Notes Payable		750
Total non-current liabilities		750
Total liabilities		771

Total member's deficit		(136	)

Total liabilities and member's deficit	$	635

	From inception (April 3, 2023) through
	June 30, 2023

Operating revenue	$	—
Other expense
General and administrative		128
Interest expense		8
Total other expense		136
Net loss	$	(136	)

MORGAN E&P, LLC

Unaudited Condensed Consolidated Statement of Cash Flows

	From inception (April 3, 2023) through
	June 30, 2023

Cash flows from operating activities:
Net loss	$	(136	)
Changes in operating assets and liabilites:
Prepaid expenses and other current assets		(12	)
Accounts payable and other		8
Due to Parent		13
Net cash used in operating activities		(127	)

Cash flows from investing activities:
Investment in oil & gas properties		(500	)
Net cash used in investing activities		(500	)

Cash flows from financing activities:
Due to Parent		750
Net cash provided by investing activities		750
Net increase in cash		123
Cash and cash equivalents at beginning of period		—
Cash and cash equivalents at end of period	$	123

Critical Accounting Policies for Morgan

Acquisitions—Morgan evaluates each acquisition of oil and gas properties to determine whether each should be accounted for as an acquisition of assets or business in accordance with Accounting Standards Update No. 2017-01: Business Combinations (Topic 805) Clarifying the Definition of a Business (“ASU 2017-01”).

Asset acquisitions are recorded at the cost of acquiring the property. The results of operations of the oil and gas properties acquired in the Company’s acquisitions have been included in the consolidated financial statements since the closing dates of the respective acquisitions. A business combination may result in the recognition of a bargain purchase gain or goodwill based on the measurement of the fair value of the assets and liabilities acquired at the acquisition date as compared to the fair value of consideration transferred, adjusted for purchase price adjustments. The initial accounting for business combinations may not be complete and adjustments to provisional amounts, or recognition of additional assets acquired or liabilities assumed, may occur as more detailed analyses are completed and additional information is obtained about the facts and circumstances that existed as of the acquisition dates.

Oil & Gas Properties—The method of accounting for oil and natural gas properties determines what costs are capitalized and how these costs are ultimately matched with revenue and expenses. Morgan uses the full cost method of accounting for oil and natural gas properties. Under the full cost method, all direct costs and certain indirect costs associated with the acquisition, exploration, and development of oil and natural gas properties are capitalized.

Oil and gas properties include costs that are excluded from costs being depleted or amortized. Oil and natural gas property costs excluded represent investments in unproved properties and include non-producing leasehold, geological and geophysical costs associated with leasehold or drilling interests and exploration costs. The Company excludes these costs until the project is evaluated and proved reserves are established or impairment is determined. Excluded costs are reviewed at least annually to determine if impairment has occurred. The amount of any evaluated or impaired oil and natural gas properties is transferred to capitalized costs being amortized. For the period from inception (April 3, 2023) through June 30, 2023, the Company did not transfer any costs to the full cost pool.

Oil and natural gas properties are depleted using the units-of-production method. The depletion expense is significantly affected by the unamortized historical and future development costs and the estimated proved oil and natural gas reserves. Estimation of proved oil and natural gas reserves relies on professional judgment and the use of factors that cannot be precisely determined. Holding all other factors constant, if proved oil and natural gas reserves were revised upward or downward, earnings would increase or decrease, respectively. Subsequent proved reserve estimates that are materially different from those reported would change the depletion expense recognized during the future reporting period. Proceeds from the sales or disposition of oil and natural gas of proved and unproved properties are accounted for as a reduction of capitalized costs with no gain or loss recognized, unless such reduction would significantly alter the relationship between capitalized costs and proved reserves, in which case the gain or loss is recognized in the statement of income. In general, a significant alteration occurs when the deferral of gains or losses will result in an amortization rate materially different from the amortization rate calculated upon recognition of gains or losses. Abandonments of properties are accounted for as adjustments of capitalized costs with no loss recognized.

Under the full cost accounting rules, total capitalized costs are limited to a ceiling equal to the present value of future net revenue, discounted at 10% per annum, plus the lower of cost or fair value of unevaluated properties less income tax effects (the “ceiling limitation”). Future net revenue used to calculate the ceiling do not include cash outflows associated with settling asset retirement obligations. Morgan performs an annual ceiling test to evaluate whether the net book value of the full cost pool exceeds the ceiling limitation. If capitalized costs (net of accumulated depreciation, depletion, and amortization) are greater than the discounted future net revenue or ceiling limitation, a write-down or impairment of the full cost pool is required. A write-down of the carrying value of the full cost pool is a non-cash charge that reduces earnings and impacts members’ equity in the period of occurrence and typically results in lower depreciation, depletion, and amortization expense in future periods. Once incurred, a write-down is not reversible at a later date. The risk that Morgan will be required to write-down the carrying value of oil and natural gas properties increases during a period when oil or gas prices are depressed. In addition, a write-down may occur if estimates of proved reserves are substantially reduced or estimates of future development costs increase significantly.

Income Taxes—A limited liability company is not subject to the payment of federal income taxes as components of its income and expenses flow through directly to the members. However, Morgan may be subject to certain state income taxes, inasmuch as it maintains a registered office in Texas. Texas margin tax applies to legal entities conducting business in Texas. The margin tax is based on our Texas sourced taxable margin. The tax is calculated by applying a tax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. Taxable Subsidiaries may generate income tax expense because of the Taxable Subsidiaries’ ownership of the portfolio companies. We reflect any such income tax expense on our Statements of Operations. Morgan had no federal income tax expense since inception.

Asset Retirement Obligations—The fair value of asset retirement obligations are recorded in the period in which they are incurred if a reasonable estimate of fair value can be made, and the corresponding cost is capitalized as part of the carrying amount of the related long-lived asset. The fair value of the asset retirement obligation is measured using expected future cash outflows discounted at Morgan’s credit- adjusted risk-free interest rate. Fair value, to the extent possible, should include a market risk premium for unforeseeable circumstances. No market risk premium was included in Morgan’s asset retirement obligation fair value estimate since a reasonable estimate could not be made. The liability is accreted to its then present value each period, and the capitalized cost is depleted or amortized over the estimated recoverable reserves using the units-of-production method. If the obligation is settled for other than the carrying amount of the liability, the Company will record the difference to the full cost pool.

Environmental Matters

We do not believe the existence of current environmental laws or interpretations thereof will materially hinder or adversely affect Morgan’s business operations; however, there can be no assurances of future effects on Morgan of new laws or interpretations thereof.

Environmental Contingencies

Morgan’s activities are subject to local, state, and federal laws and regulations governing environmental quality and pollution control in the United States. The exploration, drilling and production from wells, natural gas facilities, including the operation and construction of pipelines, plants and other facilities for transporting, processing, treating, or storing natural gas and other products, are subject to stringent environmental regulation by state and federal authorities, including the Environmental Protection Agency (“EPA”). Such regulation can increase the cost of planning, designing, installing, and operating such facilities.