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Epsilon Energy Ltd. - Quarter Report: 2020 March (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

☐     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from    to

Commission file number: 001-38770

EPSILON ENERGY LTD.

(Exact name of registrant as specified in its charter)

 

 

 

Alberta, Canada

  

98-1476367

(State or other jurisdiction of incorporation or organization)

 

(I.R.S Employer Identification No.) 

 

 

16945 Northchase Drive, Suite 161095

Houston, Texas 77060

(281) 670‑0002

(Address of principal executive offices including zip code and

telephone number, including area code)

16701 Greenspoint Park Drive, Suite 195

Houston, Texas 77060

(281) 670‑0002

(former address)

 

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

 

 

 

 

Title of each class

Trading Symbol   

Name of each exchange on which registered

Common Shares, no par value

“EPSN”

NASDAQ Global Market

 

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

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

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

Large accelerated filer ☐

Accelerated filer ☐

Non-accelerated filer ☒

Smaller reporting company ☒

Emerging growth company ☒

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes ☐ No ☒

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

 

As of March 31, 2020 there were 26,302,956 Common Shares outstanding.

 

 

 

 

 

Table of Contents

Table of Contents

 

 

 

 

 

Contents

    

 

 

 

 

FORWARD-LOOKING STATEMENTS 

 

4

PART I-FINANCIAL INFORMATION 

 

5

ITEM 1. FINANCIAL STATEMENTS 

 

5

Unaudited Condensed Consolidated Balance Sheets 

 

5

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income 

 

6

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity 

 

7

Unaudited Condensed Consolidated Statements of Cash Flows 

 

8

Notes to the Unaudited Condensed Consolidated Financial Statements 

 

9

1. 

Description of Business

 

9

2. 

Basis of Preparation

 

9

 

Interim Financial Statements

 

9

 

Principles of Consolidation

 

9

 

Use of Estimates

 

9

 

Recently Issued Accounting Standards

 

10

3. 

Cash, Cash Equivalents, and Restricted Cash

 

11

4. 

Property and Equipment

 

11

 

Property Additions and Acquisitions

 

11

 

Property Impairment

 

11

5. 

Revolving Line of Credit

 

12

6. 

Shareholders’ Equity

 

13

7. 

Revenue Recognition

 

15

8. 

Accumulated Other Comprehensive Income (Loss)

 

16

9. 

Income Taxes

 

16

10. 

Commitments and Contingencies

 

17

 

Litigation

 

17

11. 

Net Income Per Share

 

17

12. 

Operating Segments

 

18

13. 

Risk Management Activities

 

20

 

Commodity Price Risks

 

20

 

Commodity Derivative Contracts

 

20

14. 

Asset Retirement Obligations

 

21

15. 

Fair Value Measurements

 

22

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

 

23

 

Overview

 

23

 

Business Strategy

 

23

 

Operational Highlights

 

25

 

Non-GAAP Financial Measures-Adjusted EBITDA

 

25

 

Net Operating Revenues

 

26

 

Operating Costs

 

27

 

Depletion, Depreciation, Amortization and Accretion (“DD&A”)

 

28

 

General and Administrative

 

28

 

Interest Expense

 

29

 

Net Gain (Loss) on Commodity Contracts

 

29

Table of Contents

 

Miscellaneous Income (Expense)

 

29

 

Capital Resources and Liquidity

 

29

 

Cash Flow

 

29

 

Credit Agreement

 

30

 

Derivative Transactions

 

31

 

Contractual Obligations

 

31

 

Off-Balance Sheet Arrangements

 

32

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 

 

32

 

Gathering System Revenue Risk

 

32

 

Interest Rate Risk

 

32

 

Commodity Contracts

 

32

ITEM 4. CONTROLS AND PROCEDURES 

 

32

 

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

 

32

 

Changes in Internal Control Over Financial Reporting

 

33

PART II OTHER INFORMATION 

 

33

ITEM 1. LEGAL PROCEEDINGS 

 

33

ITEM 1A. RISK FACTORS 

 

33

ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS 

 

34

ITEM 3. DEFAULTS UPON SENIOR SECURITIES 

 

34

ITEM 4. MINE SAFETY DISCLOSURES 

 

34

ITEM 5. OTHER INFORMATION 

 

35

ITEM 6. EXHIBITS 

 

36

SIGNATURES 

 

36

 

 

 

 

Table of Contents

FORWARD-LOOKING STATEMENTS

Certain statements contained in this report constitute forward-looking statements. The use of any of the words ‘‘anticipate,’’ ‘‘continue,’’ ‘‘estimate,’’ ‘‘expect,’’ ‘‘may,’’ ‘‘will,’’ ‘‘project,’’ ‘‘should,’’ ‘‘believe,’’ and similar expressions and statements relating to matters that are not historical facts constitute ‘‘forward looking information’’ within the meaning of applicable securities laws. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated. Such forward-looking statements are based on reasonable assumptions, but no assurance can be given that these expectations will prove to be correct and the forward-looking statements included in this report should not be unduly relied upon. These statements are made only as of the date of this report. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future — including statements relating to natural gas and oil production rates, commodity prices for crude oil or natural gas, supply and demand for natural gas and oil; the estimated quantity of natural gas and oil reserves, including reserve life; future development and production costs, and statements expressing general views about future operating results — are forward-looking statements. Management believes that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in our Annual Report on Form 10-K for the year ended December 31, 2019, and those described from time to time in our future reports filed with the Securities and Exchange Commission. You should consider carefully the statements under Item 1A. Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2019 and in this quarterly report on Form 10-Q for the quarter ended March 31, 2020, which describe factors that could cause our actual results to differ from those set forth in the forward-looking statements. Our Annual Report on Form 10-K for the year ended December 31, 2019 is available on our website at www.epsilonenergyltd.com.

 

 

4

Table of Contents

PART I-FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

 

2020

 

2019

ASSETS

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

15,410,599

 

$

14,052,417

Accounts receivable

 

 

3,766,761

 

 

4,296,917

Fair value of derivatives

 

 

2,374,878

 

 

1,999,802

Prepaid income taxes

 

 

1,250,912

 

 

1,641,501

Other current assets

 

 

345,736

 

 

433,687

Total current assets

 

 

23,148,886

 

 

22,424,324

Non-current assets

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

 

Oil and gas properties, successful efforts method

 

 

 

 

 

 

Proved properties

 

 

131,965,089

 

 

130,819,256

Unproved properties

 

 

21,109,490

 

 

21,047,512

Accumulated depletion, depreciation, amortization and impairment

 

 

(92,842,748)

 

 

(89,255,035)

Total oil and gas properties, net

 

 

60,231,831

 

 

62,611,733

Gathering system

 

 

41,525,671

 

 

41,445,225

Accumulated depletion, depreciation, amortization and impairment

 

 

(30,493,041)

 

 

(29,961,690)

Total gathering system, net

 

 

11,032,630

 

 

11,483,535

Land

 

 

375,314

 

 

375,314

Buildings and other property and equipment, net

 

 

352,302

 

 

211,879

Total property and equipment, net

 

 

71,992,077

 

 

74,682,461

Other assets:

 

 

 

 

 

 

Restricted cash

 

 

562,647

 

 

561,294

Prepaid drilling costs

 

 

880

 

 

1,124

Total non-current assets

 

 

72,555,604

 

 

75,244,879

Total assets

 

$

95,704,490

 

$

97,669,203

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Accounts payable trade

 

$

2,820,603

 

$

2,828,495

Royalties payable

 

 

1,102,167

 

 

1,306,922

Accrued capital expenditures

 

 

93,930

 

 

627,356

Accrued gathering fees

 

 

476,448

 

 

373,929

Other accrued liabilities

 

 

567,958

 

 

858,188

Asset retirement obligation

 

 

1,529,313

 

 

1,503,978

Total current liabilities

 

 

6,590,419

 

 

7,498,868

Non-current liabilities

 

 

 

 

 

 

Asset retirement obligation

 

 

1,434,573

 

 

1,405,877

Deferred income taxes

 

 

12,331,986

 

 

12,401,464

Total non-current liabilities

 

 

13,766,559

 

 

13,807,341

Total liabilities

 

 

20,356,978

 

 

21,306,209

Commitments and contingencies (Note 10)

 

 

 

 

 

 

Shareholders' equity

 

 

 

 

 

 

Common shares, no par value, unlimited shares authorized and 26,790,985 issued and 26,302,956 shares outstanding at March 31, 2020 and 26,790,985 shares issued and outstanding at December 31, 2019.

 

 

140,808,923

 

 

140,808,923

Treasury shares, 488,029 at March 31, 2020

 

 

(1,499,586)

 

 

 —

Additional paid-in capital

 

 

7,203,407

 

 

7,029,488

Accumulated deficit

 

 

(80,975,596)

 

 

(81,285,895)

Accumulated other comprehensive income

 

 

9,810,364

 

 

9,810,478

Total shareholders' equity

 

 

75,347,512

 

 

76,362,994

Total liabilities and shareholders' equity

 

$

95,704,490

 

$

97,669,203

 

 

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements

 

5

Table of Contents

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Revenues from contracts with customers:

 

 

 

 

 

 

Gas, oil, NGLs and condensate revenue

 

$

4,111,144

 

$

5,507,663

Gas gathering and compression revenue

 

 

2,316,702

 

 

2,438,351

Total revenue

 

 

6,427,846

 

 

7,946,014

 

 

 

 

 

 

 

Operating costs and expenses:

 

 

 

 

 

 

Lease operating expenses

 

 

2,047,767

 

 

1,718,293

Gathering system operating expenses

 

 

97,778

 

 

312,787

Development geological and geophysical expenses

 

 

2,629

 

 

 —

Depletion, depreciation, amortization, and accretion

 

 

2,414,376

 

 

1,825,731

Impairment of proved properties

 

 

1,760,000

 

 

 —

General and administrative expenses:

 

 

 

 

 

 

Stock based compensation expense

 

 

173,919

 

 

133,720

Other general and administrative expenses

 

 

1,008,113

 

 

1,339,562

Total operating costs and expenses

 

 

7,504,582

 

 

5,330,093

Operating income

 

 

(1,076,736)

 

 

2,615,921

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

Interest income

 

 

21,529

 

 

42,691

Interest expense

 

 

(28,006)

 

 

(27,609)

Gain (loss) on derivative contracts

 

 

1,721,018

 

 

(510,754)

Other income (expense)

 

 

(2,225)

 

 

23

Other income (expense), net

 

 

1,712,316

 

 

(495,649)

 

 

 

 

 

 

 

Income before income tax expense

 

 

635,580

 

 

2,120,272

Income tax expense

 

 

325,281

 

 

746,596

NET INCOME

 

$

310,299

 

$

1,373,676

Currency translation adjustments

 

 

(114)

 

 

10,792

NET COMPREHENSIVE INCOME

 

$

310,185

 

$

1,384,468

 

 

 

 

 

 

 

Net income per share, basic

 

$

0.01

 

$

0.05

Net income per share, diluted

 

$

0.01

 

$

0.05

Weighted average number of shares outstanding, basic

 

 

26,565,084

 

 

27,392,755

Weighted average number of shares outstanding, diluted

 

 

26,565,084

 

 

27,408,374

 

 

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements

 

6

Table of Contents

 

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

 

    

 

 

    

 

    

Accumulated

    

 

    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

Total

 

 

Common Shares Issued

 

Treasury Shares

 

Additional

 

Comprehensive

 

Accumulated

 

Shareholders'

 

 

Shares

 

Amount

 

Shares

 

Amount

 

paid-in Capital

 

Income

 

Deficit

 

Equity

Balance at December 31, 2019

 

26,790,985

 

$

140,808,923

 

 —

 

$

 —

 

$

7,029,488

 

$

9,810,478

 

$

(81,285,895)

 

$

76,362,994

Net income

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

310,299

 

 

310,299

Stock-based compensation expenses

 

 —

 

 

 —

 

 —

 

 

 —

 

 

173,919

 

 

 —

 

 

 —

 

 

173,919

Buyback of common shares

 

 —

 

 

 —

 

(488,029)

 

 

(1,499,586)

 

 

 —

 

 

 —

 

 

 —

 

 

(1,499,586)

Other comprehensive income

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(114)

 

 

 —

 

 

(114)

Balance at March 31, 2020

 

26,790,985

 

$

140,808,923

 

(488,029)

 

$

(1,499,586)

 

$

7,203,407

 

$

9,810,364

 

$

(80,975,596)

 

$

75,347,512

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

 

    

 

 

    

 

    

Accumulated

    

 

    

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

Total

 

 

Common Shares Issued

 

Treasury Shares

 

Additional

 

Comprehensive

 

Accumulated

 

Shareholders'

 

 

Shares

 

Amount

 

Shares

 

Amount

 

paid-in Capital

 

Income

 

Deficit

 

Equity

Balance at December 31, 2018

 

27,439,300

 

$

143,705,441

 

(26,953)

 

$

(94,418)

 

$

6,519,028

 

$

9,797,930

 

$

(89,983,894)

 

$

69,944,087

Net income

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

1,373,676

 

 

1,373,676

Stock-based compensation expenses

 

 —

 

 

 —

 

 —

 

 

 —

 

 

133,720

 

 

 —

 

 

 —

 

 

133,720

Retirement of treasury shares

 

(26,953)

 

 

(94,418)

 

26,953

 

 

94,418

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Buyback and retirement of common shares

 

(57,100)

 

 

(248,381)

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(248,381)

Other comprehensive loss

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

10,792

 

 

 —

 

 

10,792

Balance at March 31, 2019

 

27,355,247

 

$

143,362,642

 

 —

 

$

 —

 

$

6,652,748

 

$

9,808,722

 

$

(88,610,218)

 

$

71,213,894

 

 

 

 

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements

 

7

Table of Contents

 

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

310,299

 

$

1,373,676

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

Depletion, depreciation, amortization, and accretion

 

 

2,414,376

 

 

1,825,731

Impairment of proved properties

 

 

1,760,000

 

 

 —

(Gain) loss on derivative contracts

 

 

(1,721,018)

 

 

510,754

Cash received from (paid for) settlements of derivative contracts

 

 

1,345,942

 

 

(184,244)

Stock-based compensation expense

 

 

173,919

 

 

133,720

Deferred income tax expense (benefit)

 

 

(69,478)

 

 

746,596

Changes in assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

530,156

 

 

1,060,359

Prepaid income taxes and other current assets

 

 

478,540

 

 

(754,996)

Accounts payable, royalties payable and other accrued liabilities

 

 

(9,215)

 

 

(772,879)

Net cash provided by operating activities

 

 

5,213,521

 

 

3,938,717

Cash flows from investing activities:

 

 

 

 

 

 

Acquisition of unproved oil and gas properties

 

 

 —

 

 

(596,500)

Additions to unproved oil and gas properties

 

 

(61,978)

 

 

(262,107)

Additions to proved oil and gas properties

 

 

(2,045,440)

 

 

(586,815)

Additions to gathering system properties

 

 

(101,472)

 

 

(65,296)

Additions to land, buildings and property and equipment

 

 

(145,640)

 

 

 —

Prepaid drilling costs

 

 

244

 

 

 —

Net cash used in investing activities

 

 

(2,354,286)

 

 

(1,510,718)

Cash flows from financing activities:

 

 

 

 

 

 

Buyback of common shares

 

 

(1,499,586)

 

 

(248,381)

Net cash used in financing activities

 

 

(1,499,586)

 

 

(248,381)

Effect of currency rates on cash, cash equivalents and restricted cash

 

 

(114)

 

 

10,792

Increase in cash, cash equivalents and restricted cash

 

 

1,359,535

 

 

2,190,410

Cash, cash equivalents and restricted cash, beginning of period

 

 

14,613,711

 

 

14,959,518

Cash, cash equivalents and restricted cash, end of period

 

$

15,973,246

 

$

17,149,928

 

 

 

 

 

 

 

Supplemental cash flow disclosures:

 

 

 

 

 

 

Income taxes paid

 

$

 —

 

$

580,000

Interest paid

 

$

28,006

 

$

31,391

 

 

 

 

 

 

 

Non-cash investing activities:

 

 

 

 

 

 

Change in proved properties accrued in accounts payable and accrued liabilities

 

$

(903,544)

 

$

741,406

Change in gathering system accrued in accounts payable and accrued liabilities

 

$

(21,026)

 

$

(40,187)

Asset retirement obligation asset additions and adjustments

 

$

3,937

 

$

 2

 

 

 

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements

 

8

Table of Contents

Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

1.    Description of Business

Epsilon Energy Ltd. (the “Company” or “Epsilon” or “we”) was incorporated under the laws of the Province of Alberta, Canada on March 14, 2005. On October 24, 2007, the Company became a publicly traded entity trading on the Toronto Stock Exchange (“TSX”) in Canada. On February 14, 2019, Epsilon’s registration statement on Form 10 was declared effective by the United States Securities and Exchange Commission and on February 19, 2019, the Company began trading in the United States on the NASDAQ Global Market under the trading symbol “EPSN.” Effective as of the close of trading on March 15, 2019, Epsilon voluntarily delisted its common shares from the TSX. The Company is engaged in the acquisition, development, gathering and production of primarily natural gas reserves in the United States.

Recent Developments

 

The significant demand declines caused by the global response to the coronavirus 2019 pandemic (“COVID-19”) as well as the actions taken by a number of global oil producers has contributed to steep declines in the demand and pricing for oil, natural gas and NGLs, negatively impacting U.S. producers. The commodity price environment is expected to remain depressed based on over-supply, decreased demand and a potential global economic recession. While Epsilon did not incur significant disruptions to operations during the three months ended March 31, 2020 as a result of the COVID-19 pandemic, the Company did need to recognize an impairment on its legacy Oklahoma producing assets due to the historically low commodity prices. Additionally, the Company is unable to predict the impact that the COVID-19 pandemic will have on it, including our financial position, operating results, liquidity and ability to obtain financing in future reporting periods, due to numerous uncertainties.

 

The federal government has passed a series of relief and stimulus packages, including the CAREs Act, for the country but Epsilon has not and will not need to avail itself of them and as such, these programs have no effect on Epsilon’s financial statements.

 

2.    Basis of Preparation

Interim Financial Statements

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the appropriate rules and regulations of the SEC. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. All adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented have been included. The interim financial information and notes hereto should be read in conjunction with the Company’s consolidated financial statements as of and for the years ended December 31, 2019 and 2018. The results of operations for interim periods are not necessarily indicative of results to be expected for a full fiscal year.

Principles of Consolidation

 

The Company’s unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Epsilon Energy USA, Inc. and its wholly owned subsidiaries, Epsilon Midstream, LLC, Dewey Energy GP, LLC, and Dewey Energy Holdings, LLC. With regard to the gathering system, in which Epsilon owns an undivided interest in the asset, proportionate consolidation accounting is used. All inter-company transactions have been eliminated.

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted 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 and disclosure of contingent assets and liabilities at the date of the financial statements and the

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

reported amounts of revenues and expenses during the reporting period. The most significant estimates pertain to proved natural gas and oil reserves and related cash flow estimates used in impairment tests of natural gas and oil, and gathering system properties, asset retirement obligations, accrued natural gas and oil revenues and operating expenses, accrued gathering system revenues and operating expenses, as well as the valuation of commodity derivative instruments. Actual results could differ from those estimates.

Recently Issued Accounting Standards

 

The Company, an emerging growth company (“EGC”), has elected to take advantage of the benefits of the extended transition period provided for in Section 7(a)(2)(B) of the Securities Act, for complying with new or revised accounting standards which allows the Company to defer adoption of certain accounting standards until those standards would otherwise apply to private companies.

In March 2020, the FASB issued ASU No. 2020-04 - Reference Rate Reform (Topic 848), codified as ASC 848 (“ASC 848”). The purpose of ASC 848 is to provide optional guidance to ease the potential effects on financial reporting of the market-wide migration away from Interbank Offered Rates (“IBORs”) to alternative reference rates. ASC 848 applies only to contracts, hedging relationships, and other transactions that reference a reference rate expected to be discontinued because of reference rate reform. The guidance may be applied upon issuance of ASC 848 through December 31, 2022. The Company is currently assessing the impact of adopting this new guidance.

In December 2019, the Financial Accounting Standards Board ( “FASB” ) issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes,” which simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740, Income Taxes. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted.

In June 2016 the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument’s contractual life. ASU 2016-13 is effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years, and must be applied retrospectively. Early adoption is permitted. Epsilon will adopt ASU 2016-13 as of January 1, 2023.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (ASU 2016-02), which significantly changes accounting for leases by requiring that lessees recognize a right of use asset and a related lease liability representing the obligation to make lease payments, for all lease transactions with terms greater than one year. Additional disclosures about an entity’s lease transactions will also be required. ASU 2016-02 defines a lease as “a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.” ASU 2016-02 is effective for the Company for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. In July, the FASB voted to extend the adoption date by one year for private and non-profit companies, and thus emerging growth companies as well. As an emerging growth company, Epsilon plans to defer adoption of ASU 2016-02 until the fiscal year beginning after December 15, 2021. Lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented in the financial statements using a modified retrospective approach. Epsilon is reviewing the provisions of ASU 2016-02 to determine the impact on its consolidated financial statements and related disclosures. Epsilon is evaluating the impact of the adoption of ASU 2016-02 on the financial statements. 

 

 

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

3. Cash,  Cash Equivalents, and Restricted Cash

Cash and cash equivalents include cash on hand and short term, highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

Restricted cash consists of amounts deposited to back bonds or letters of credit for potential well liabilities. The Company presents restricted cash with cash and cash equivalents in the Consolidated Statements of Cash Flows. The following table provides a reconciliation of cash, cash equivalents and restricted cash reported in the Consolidated Balance Sheets to the total of the amounts in the Consolidated Statements of Cash Flows as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

 

2020

 

2019

Cash and cash equivalents

 

$

15,410,599

 

$

14,052,417

Restricted cash included in other assets

 

 

562,647

 

 

561,294

Cash, cash equivalents and restricted cash in the statement of cash flows

 

$

15,973,246

 

$

14,613,711

 

 

 

 

 

 

 

 

 

4.     Property and Equipment

The following table summarizes the Company’s property and equipment as at March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

 

2020

 

2019

Property and equipment:

 

 

 

 

 

 

Oil and gas properties, successful efforts method

 

 

 

 

 

 

Proved properties

 

$

131,965,089

 

$

130,819,256

Unproved properties

 

 

21,109,490

 

 

21,047,512

Accumulated depletion, depreciation, amortization and impairment

 

 

(92,842,748)

 

 

(89,255,035)

Total oil and gas properties, net

 

 

60,231,831

 

 

62,611,733

Gathering system

 

 

41,525,671

 

 

41,445,225

Accumulated depletion, depreciation, amortization and impairment

 

 

(30,493,041)

 

 

(29,961,690)

Total gathering system, net

 

 

11,032,630

 

 

11,483,535

Land

 

 

375,314

 

 

375,314

Buildings and other property and equipment, net

 

 

352,302

 

 

211,879

Total property and equipment, net

 

$

71,992,077

 

$

74,682,461

 

Property Additions and Acquisitions

 

No acquisitions were made during the three months ended March 31, 2020. During the year ended December 31, 2019,  the Company acquired additional acres in the Anadarko Basin for $596,500.

Property Sale

 

In June 2019, the Company completed the first part of a sale of undeveloped, stranded leases in Pennsylvania. At that time, the Company received $1.0 million. The sale was completed in July 2019 with a final payment of $0.4 million for a total of $1.4 million received for the stranded leases.

 

Property Impairment

 

Epsilon performs a quantitative impairment test quarterly or whenever events or changes in circumstances indicate that an asset group's carrying amount may not be recoverable, over proved properties using the published NYMEX forward prices, timing, methods and other assumptions consistent with historical periods. When indicators of impairment

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

are present, tests require that the Company first compare expected future undiscounted cash flows by asset group to their respective carrying values. If the carrying amount exceeds the estimated undiscounted future cash flows, a reduction of the carrying amount of the natural gas properties to their estimated fair values is required, which is determined based on discounted cash flow techniques using significant assumptions including projected revenues, future commodity prices, and a market-specific weighted average cost of capital which are affected by expectations about future market and economic conditions.

During the three months ended March 31, 2020, Epsilon recognized certain indicators of impairments specific to our Oklahoma assets related to historically low oil and NGL prices and determined that the carrying value of those assets was not recoverable, based on the current indicators. As a result of this assessment, a $1.76 million impairment was assessed on the Company’s Oklahoma assets at March 31, 2020. No impairment was required as of December 31, 2019.

 

 

5.    Revolving Line of Credit

Effective July 30, 2013, Epsilon Energy USA Inc., a wholly owned subsidiary of the Company, executed a three-year senior secured revolving credit facility with a bank (‘‘Credit Facility’’) for a total commitment of up to $100 million. Upon each advance, interest is charged at the rate of LIBOR plus an ‘‘applicable margin’’. The applicable margin ranges from 2.75 - 3.75% and is based on the percent of the line of credit utilized.

The terms “Borrowing Base” and “Mortgaged Properties” include the Company’s gathering system assets in addition to the natural gas and oil properties. The “Required Reserve Value” is the lesser of 90% of the recognized value of all proved natural gas and oil properties or 150% of the then current borrowing base.

On January 7, 2019, the maturity date of the Credit Facility was extended to March 1, 2022 and the borrowing base was increased from $13.5 million to $23 million. The borrowing base is subject to twice per annum redetermination by the lenders based on, among other things, their evaluation of the Company’s natural gas reserves. Additionally, the Company is required to maintain acceptable commodity hedging agreements covering at least 25% of projected production of natural gas for the succeeding calendar year, along with the 50% for the current calendar year.

On August 14, 2019 the borrowing base was reaffirmed at $23 million. Additionally, the commodity hedging requirements were updated. Currently, when the Company’s utilization exceeds 25%, the Company must have in place acceptable commodity hedging agreements covering at least 75% of projected production for the first full twelve months after such occurrence and 50% of projected production of natural gas for the succeeding six months.

On February 11, 2020 the borrowing base was reaffirmed at $23 million and hedging requirements remained unchanged.

The lender under the Credit Facility has a first priority security interest in the tangible and intangible assets, including the gathering system, of Epsilon Energy USA, Inc. to secure any outstanding amounts under the agreement. Under the terms of the agreement, the Company must maintain the following covenants:

Interest coverage ratio greater than 3 based on income adjusted for interest, taxes and non-cash amounts.

Current ratio, adjusted for line of credit amounts used and available and non-cash amounts, greater than 1.

Leverage ratio less than 3.5 based on income adjusted for interest, taxes and non-cash amounts.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

The Company was in compliance with the financial covenants of the Credit Facility as of March 31, 2020 and December 31, 2019 and Epsilon expects to be in compliance with the financial covenants for the next 12 months.

A commitment fee of 0.50% is assessed quarterly on the daily average unused borrowing base on the Credit Facility.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Balance at

    

Balance at

    

 

    

 

 

 

March 31, 

    

December 31, 

 

Current

 

Interest Rate

 

    

2020

 

2019

    

Borrowing Base

    

3 mo.

Revolving line of credit

 

$

 —

 

$

 —

 

$

23,000,000

 

 

LIBOR + 2.75% (1)


(1)

At March 31, 2020, the weighted average interest rate was 4.2%.

 

 

 

6.    Shareholders’ Equity

(a)Authorized shares

The Company is authorized to issue an unlimited number of Common Shares with no par value and an unlimited number of Preferred Shares with no par value.

(b)Purchases of Equity Shares

Prior to moving the Company listing from the TSX to the NASDAQ, and prior to the purchase of the equity shares on the NASDAQ shown below, the Company purchased shares through a normal-course issuer bid (“NCIB”) program with the TSX, which expired February 28, 2019. On the TSX the Company repurchased and retired 57,100 shares of common stock through the year ended December 31, 2019. The repurchased stock had an average price of $4.26 per share. The average share price (converted to US$ using a rate of Cdn$1.33 to US$1) on the TSX from January 1, 2019 through the last day of trading on the TSX, March 15, 2019, was $4.22. 

Commencing on May 20, 2019, the Company entered into a share repurchase program on the NASDAQ conducted in accordance with Rule 10b-18 promulgated under the Securities Exchange Act of 1934. The Company is authorized to repurchase up to 1,367,762 of its outstanding common shares, representing 5% of the outstanding common shares of Epsilon as of May 20, 2019, for an aggregate purchase price of not more than $5.0 million. The program will end on May 19, 2020 unless the maximum amount of common shares is purchased before then or Epsilon provides earlier notice of termination.

Repurchases may be made at management’s discretion from time to time through the facilities of the NASDAQ Global Market. The price paid for the common shares will be, subject to applicable securities laws, the prevailing market price of such common shares on the NASDAQ Global Market at the time of such purchase. The Company intends to fund the purchase out of available cash and does not expect to incur debt to fund the share repurchase program.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

The following table contains information about our acquisition of equity securities during the three months ended March 31, 2020:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

Total number

 

Maximum number

 

 

 

 

 

 

of shares

 

of shares that

 

 

 

 

 

 

purchased as

 

may yet be

 

 

Total number

 

Average price

 

part of publicly

 

purchased under

 

 

of shares

 

paid per

 

announced plans

 

the plans or

 

    

purchased

 

share

    

or programs

    

programs

Beginning balance at May 20, 2019

 

 

 

 

 

 

 

 

 

 

1,367,762

Shares purchased thru December 31, 2019

 

696,096

 

$

3.72

 

 

 

 

 

 

January 2020

 

102,051

 

$

2.95

 

 

 

 

 

 

February 2020

 

261,519

 

$

3.11

 

 

 

 

 

 

March 2020

 

124,459

 

$

2.98

 

 

 

 

 

 

Total as of March 31, 2020

 

1,184,125

 

$

3.44

 

 

1,184,125

 

 

183,637

 

(c)Stock Options

The Company maintains a stock option plan for directors, officers, employees and consultants of the Company and its subsidiaries.

Through March 31, 2020,  the Company had outstanding stock options covering 245,000 Common Shares at an overall average exercise price of $5.27 per Common Share to directors, officers, and employees of the Company and its subsidiaries. A maximum amount of 755,000 Common Shares is available for future issuances.

The following table summarizes stock option activity for the three months ended March 31, 2020 and the year ended December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Year ended

 

 

March 31, 2020

 

December 31, 2019

 

 

 

 

Weighted

 

 

 

Weighted

 

 

Number of

 

Average

 

Number of

 

Average

 

 

Options

 

Exercise

 

Options

 

Exercise

Exercise price in US$

    

Outstanding

    

Price (1)

    

Outstanding

    

Price (1)

Balance at beginning of period

 

245,000

 

$

5.27

 

 

290,750

 

$

5.02

Exercised

 

 —

 

 

 

 

 

(25,000)

 

 

2.17

Expired/Forfeited

 

 —

 

 

 

 

 

(20,750)

 

 

5.37

Balance at period-end

 

245,000

 

$

5.27

 

 

245,000

 

$

5.27

 

 

 

 

 

 

 

 

 

 

 

 

Exercisable at period-end

 

245,000

 

$

5.27

 

 

206,670

 

$

5.32


(1)

Exercise price has been converted to US$ using the rate of Cdn$1.33 to US$1, the rate on March 15, 2019, the date Epsilon Energy, Ltd was delisted from the TSX.

 

At March 31, 2020, using the Black Scholes model, the Company had unrecognized stock based compensation,  of nil (at December 31, 2019:  $1,867 over 0.08 years). The aggregate intrinsic value at March 31, 2020 was nil (at December 31, 2019:  nil). For the three months ended March 31, 2020, $1,867 of stock compensation expense was recognized (for the three months ended March 31, 2019,  $6,301).

During the three months ended March 31, 2020 and the year ended December 31, 2019,  the Company awarded no stock options.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

(d)Share Compensation Plan

A Share Compensation Plan (the “Plan”) was adopted by the Board on April 13, 2017 and approved by the shareholders at the Annual General Meeting in April 2017. The Plan provides that designated participants may, as determined by the Board, be issued Common Shares in an amount up to 100% of the participant’s compensation paid by the Company in consideration of the participant’s service for the current year divided by the market price of the Common Shares on the NASDAQ at the date of issuance of the Common Shares in the current year.

For the three months ended March 31, 2020, no shares of Restricted Stock were awarded. For the year ended December 31, 2019,  184,500 common shares of Restricted Stock were awarded to the Company’s officers, employees, and board of directors. These shares vest over a three-year period, with one-third of the shares being issued per period on the anniversary of the award resolution. The vesting of the shares is contingent on the individuals’ continued employment or service. The Company determined the fair value of the granted Restricted Stock based on the market price of the common shares of the Company on the date of grant. Stock compensation expense for the granted Restricted Stock is recognized over the vesting period. Stock compensation expense recognized during the three months ended March 31, 2020 was $172,052 (for the three months ended March 31, 2019, $127,419). 

At March 31, 2020, the Company had unrecognized stock based compensation related to these shares of $1,137,542 to be recognized over a weighted average period of 1.17 years (at December 31, 2019:  $1,309,594 over 1.34 years).

The following table summarizes Restricted Stock activity for the three months ended March 31, 2020, and the year ended December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Year ended

 

 

March 31, 2020

 

December 31, 2019

 

 

 

 

Weighted

 

 

 

Weighted

 

 

Number of

 

Average

 

Number of

 

Average

 

 

Shares

 

Remaining Life

 

Shares

 

Remaining Life

 

    

Outstanding

    

(years)

    

Outstanding

    

(years)

Balance non-vested Restricted Stock at beginning of period

 

346,499

 

1.67

 

282,833

 

2.56

Granted

 

 —

 

 —

 

184,500

 

3.00

Vested

 

 —

 

 —

 

(106,834)

 

 —

Forfeited

 

 —

 

 —

 

(14,000)

 

2.64

Balance non-vested Restricted Stock at end of period

 

346,499

 

1.42

 

346,499

 

1.67

 

 

 

 

7. Revenue Recognition

Revenues are comprised primarily of sales of natural gas along with the revenue generated from the Company’s ownership interest in the gas gathering system in the Auburn field in Northeastern Pennsylvania. Also included to a much lesser degree is natural gas, crude oil and NGLs from Oklahoma.

The following table details revenue for the three months ended March 31, 2020 and 2019.

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

 

2020

 

2019

Operating revenue

 

 

 

 

 

 

Natural gas

 

$

4,019,764

 

$

5,434,935

Natural gas liquids

 

 

31,658

 

 

13,491

Oil and condensate

 

 

59,722

 

 

59,237

Gathering and compression fees

 

 

2,316,702

 

 

2,438,351

Total operating revenue

 

$

6,427,846

 

$

7,946,014

 

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

Revenue is recorded in the month when contractual performance obligations are satisfied. However, settlement statements from the purchasers, and the related cash consideration are received within 30 days for natural gas, NGLs, oil, or condensate sold, and 60 days for gas gathering revenues. As a result, the Company must estimate the amount of production delivered to the customer and the consideration that will ultimately be received for sale of the natural gas, NGLs, oil, or condensate. Estimated revenue due to the Company is recorded within the receivables line item on the accompanying consolidated balance sheets until payment is received. The accounts receivable balances from contracts with customers within the accompanying balance sheets as of March 31, 2020 and December 31, 2019 were $2.0 million and $2.4 million, respectively.

The settlement statement from the operator of the Auburn GGS is received two months after transmission and compression has occurred. As a result, the Company must estimate the amount of production that was transmitted and compressed within the system. The accounts receivable balances from the operator of the Auburn GGS within the accompanying balance sheets as of March 31, 2020 and December 31, 2019 were $1.7 million and $1.9 million, respectively.

 

 

8.    Accumulated Other Comprehensive Income

Accumulated other comprehensive income (loss) includes certain transactions that have generally been reported in the condensed consolidated statements of changes in shareholders’ equity, including translation gains (losses) related to the convertible debentures that will remain frozen in accumulated other comprehensive income until such time Epsilon Energy Ltd. is liquidated. Activity within Accumulated other comprehensive income (loss) for the three months ended March 31, 2020 and 2019 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

 

 

2020

    

2019

 

Balance at beginning of period

 

$

9,810,478

 

$

9,797,930

 

Translation gain (loss) other

 

 

(114)

 

 

10,792

 

Balance at end of period

 

$

9,810,364

 

$

9,808,722

 

 

 

 

 

9.  Income Taxes

Income tax provisions for the three months ended March 31, 2020 and 2019 are as follows:

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Current:

 

 

 

 

 

 

Federal

 

$

297,863

 

$

 —

State 

 

 

96,896

 

 

 —

Total current income tax expense

 

 

394,759

 

 

 —

Deferred:

 

 

 

 

 

 

Federal

 

 

(131,081)

 

 

537,040

State 

 

 

61,603

 

 

209,556

Total deferred tax expense (benefit)

 

 

(69,478)

 

 

746,596

Income tax expense

 

$

325,281

 

$

746,596

 

The Company files federal income tax returns in the United States and Canada, and various returns in state and local jurisdictions.

The Company believes it has appropriate support for the income tax positions taken and to be taken on our tax returns and that the accruals for tax liabilities are adequate for all open years based on our assessment of various factors including past experience and interpretations of tax law applied to the facts of each matter. The Company's tax returns are

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

open to audit under the statute of limitations for the years ending December 31, 2016 through December 31, 2019. To the extent we utilize net operating losses generated in earlier years, such earlier years may also be subject to audit.

Our effective tax rate will typically differ from the statutory federal rate primarily as a result of state income taxes and the valuation allowance against the Canadian net operating loss. The effective tax rate for the three months ended March 31, 2020 was slightly higher than the statutory federal rate as a result of the state income taxes and the valuation allowance against the Canadian net operating loss.

 

10.    Commitments and Contingencies

The Company’s future minimum lease commitments as of March 31, 2020 are summarized in the following table:

 

 

 

 

Year ended

    

 

December 31, 

    

Payments

2020

 

 

75,441

2021

 

 

103,693

2022

 

 

107,419

2023

 

 

18,007

 

 

$

304,560

 

The Company enters into commitments for capital expenditures in advance of the expenditures being made. As of March 31, 2020, the Company had commitments of $3.15 million for capital expenditures. 

Litigation

The Company is not currently involved in any litigation. Management is of the opinion that the potential for litigation is remote.

 

11.    Net Income Per Share

Basic net income per share is computed on the basis of the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed based upon the weighted-average number of common shares outstanding during the period plus the assumed issuance of common shares for all potentially dilutive securities.

The net income used in the calculation of basic and diluted net income per share is as follows:

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Net income available to shareholders

 

$

310,299

 

$

1,373,676

 

In calculating the net income per share, basic and diluted, the following weighted-average shares were used:

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Basic weighted-average number of shares outstanding

 

26,565,084

 

27,392,755

Dilutive stock options

 

 —

 

12,204

Unvested restricted shares granted

 

 —

 

3,415

Diluted weighted average shares outstanding

 

26,565,084

 

27,408,374

 

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

The Company excluded the following shares from the diluted EPS because their inclusion would have been anti-dilutive.

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Anti-dilutive options

 

245,000

 

267,796

Anti-dilutive unvested restricted shares

 

346,499

 

279,418

Total Anti-dilutive shares

 

591,499

 

547,214

 

 

 

 

12.    Operating Segments

Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. The chief operating decision-maker, who is responsible for allocating resources and assessing performance of the operating segments, has been identified as executive management. Segment performance is evaluated based on operating profit or loss as shown in the table below. Interest income and expense, and income taxes are managed separately on a group basis.

The Company’s reportable segments are as follows:

a.

The Upstream segment activities include acquisition, development and production of oil, natural gas, and other liquid reserves on properties within the United States;

b.

The Gas Gathering segment partners with two other companies to operate a natural gas gathering system; and

c.

The Canada segment activities include corporate listing and governance functions of the Company.

 

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

Segment activity as of, and for the three months ended March 31, 2020 and 2019 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Upstream

    

Gas Gathering

    

Corporate

 

    

Elimination

    

Consolidated

As of and for the three months ended March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas

 

$

4,019,764

 

$

 —

 

$

 —

 

 

$

 —

 

$

4,019,764

Natural gas liquids

 

 

31,658

 

 

 —

 

 

 —

 

 

 

 —

 

 

31,658

Oil and condensate

 

 

59,722

 

 

 —

 

 

 —

 

 

 

 —

 

 

59,722

Gathering and compression fees

 

 

 —

 

 

2,736,138

 

 

 —

 

 

 

(419,436)

 

 

2,316,702

Total operating revenue

 

$

4,111,144

(1)

$

2,736,138

 

$

 —

 

 

$

(419,436)

 

 

6,427,846

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings for the period

 

$

(1,580,897)

 

$

1,686,193

 

$

205,003

 

(3)

$

 —

 

$

310,299

Operating costs

 

 

2,047,767

 

 

517,214

 

 

 —

 

 

 

(419,436)

 

 

2,145,545

Development geological and geophysical expenses

 

 

2,629

 

 

 —

 

 

 —

 

 

 

 —

 

 

2,629

Depletion, deprec., amortization and accretion

 

 

1,881,645

 

 

532,731

 

 

 —

 

 

 

 —

 

 

2,414,376

Impairment

 

 

1,760,000

 

 

 —

 

 

 —

 

 

 

 —

 

 

1,760,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment assets

 

$

80,725,283

 

$

14,907,581

 

$

71,626

 

 

$

 —

 

$

95,704,490

Capital expenditures(2)

 

 

1,349,514

 

 

80,446

 

 

 —

 

 

 

 —

 

 

1,429,960

Proved properties

 

 

39,122,341

 

 

 —

 

 

 —

 

 

 

 —

 

 

39,122,341

Unproved properties

 

 

21,109,490

 

 

 —

 

 

 —

 

 

 

 —

 

 

21,109,490

Gathering system

 

 

 —

 

 

11,032,630

 

 

 —

 

 

 

 —

 

 

11,032,630

Other property and equipment

 

 

727,616

 

 

 —

 

 

 —

 

 

 

 —

 

 

727,616

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of and for the three months ended March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas

 

$

5,434,935

 

$

 —

 

$

 —

 

 

$

 —

 

$

5,434,935

Natural gas liquids

 

 

13,491

 

 

 —

 

 

 —

 

 

 

 —

 

 

13,491

Oil and condensate

 

 

59,237

 

 

 —

 

 

 —

 

 

 

 —

 

 

59,237

Gathering and compression fees

 

 

 —

 

 

2,701,244

 

 

 —

 

 

 

(262,893)

 

 

2,438,351

Total operating revenue

 

$

5,507,663

(1)

$

2,701,244

 

$

 —

 

 

$

(262,893)

 

 

7,946,014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings for the period

 

$

2,435,906

 

$

1,653,297

 

$

(2,715,527)

 

(3)

$

 —

 

$

1,373,676

Operating costs

 

 

1,718,293

 

 

575,680

 

 

 —

 

 

 

(262,893)

 

 

2,031,080

Depletion, deprec., amortization and accretion

 

 

1,353,464

 

 

472,267

 

 

 —

 

 

 

 —

 

 

1,825,731

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment assets

 

$

75,381,033

 

$

14,813,978

 

$

194,166

 

 

$

 —

 

$

90,389,178

Capital expenditures(2)

 

 

2,186,828

 

 

25,109

 

 

 —

 

 

 

 —

 

 

2,211,937

Proved properties

 

 

35,048,675

 

 

 —

 

 

 —

 

 

 

 —

 

 

35,048,675

Unproved properties

 

 

20,357,273

 

 

 —

 

 

 —

 

 

 

 —

 

 

20,357,273

Gathering system

 

 

 —

 

 

12,456,159

 

 

 —

 

 

 

 —

 

 

12,456,159

 


(1)

Segment operating revenue represents revenues generated from the operations of the segment. Inter-segment sales during the three months ended March 31, 2020 and 2019 have been eliminated upon consolidation. For the three months ended March 31, 2020, Epsilon sold natural gas to 16 unique customers. The three customers over 10% comprised 62%,  13% and 12% of total revenue. For the three months ended March 31, 2019, Epsilon sold natural gas to 20 unique customers. The two customers over 10% comprised 53% and 34% of total revenue.

(2)

Capital expenditures for Upstream segment consist primarily of the acquisition of properties, and the drilling and completing of wells while Gas Gathering consists of expenditures relating to the expansion and completion of the gathering and compression facility.

(3)

Segment reporting for net earnings for the period does not include non-monetary compensation, general and administrative expense, interest income, interest expense, both gains and (losses) on derivative contracts, or income tax amounts as they are managed on a group basis and are instead included in the corporate column for reconciliation purposes.

 

 

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

 

13.    Commodity Risk Management Activities

Commodity Price Risks

 

Epsilon engages in price risk management activities from time to time. These activities are intended to manage Epsilon’s exposure to fluctuations in commodity prices for natural gas by securing fixed price contracts for a portion of expected sales volumes.

Inherent in the Company’s fixed price contracts, are certain business risks, including market risk and credit risk. Market risk is the risk that the price of natural gas and oil will change, either favorably or unfavorably, in response to changing market conditions. Credit risk is the risk of loss from nonperformance by the Company’s counterparty to a contract. The Company does not currently require collateral from any of its counterparties nor does its counterparties require collateral from the Company.

The Company enters into certain commodity derivative instruments to mitigate commodity price risk associated with a portion of its future natural gas production and related cash flows. The natural gas revenues and cash flows are affected by changes in commodity product prices, which are volatile and cannot be accurately predicted. The objective for holding these commodity derivatives is to protect the operating revenues and cash flows related to a portion of the future natural gas sales from the risk of significant declines in commodity prices, which helps ensure the Company’s ability to fund the capital budget.

Epsilon has historically elected not to designate any of its financial commodity derivative contracts as accounting hedges and, accordingly, accounts for these financial commodity derivative contracts using the mark-to-market accounting method. Under this accounting method, changes in the fair value of outstanding financial instruments are recognized as gains or losses in the period of change and are recorded as gain (loss) on derivative contracts on the condensed consolidated statements of operations and comprehensive income. The related cash flow impact is reflected in cash flows from operating activities. During the three months ended March 31, 2020, Epsilon recognized gains on commodity derivative contracts of $1,721,018. This amount included cash received on settlements of these contracts of $1,345,942. For the three months ended March 31, 2019, Epsilon recognized losses on financial commodity derivative contracts of $510,754. This amount included cash paid on settlements of these contracts of $184,244.

Commodity Derivative Contracts

 

Presented below is a summary of Epsilon’s natural gas price and basis swap contracts as of March 31, 2020.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted Average Price ($/MMbtu)

 

Fair Value

 

 

Volume

 

 

 

Basis

 

March 31, 

Derivative Type

    

(MMbtu)

    

 Swaps 

    

Differential

    

2020

2021

 

 

 

 

 

 

 

 

 

 

 

Fixed price swap

 

3,062,500

 

$

2.73

 

$

 —

 

 

2,134,184

Basis swap

 

4,902,500

 

$

 —

 

$

(0.46)

 

 

240,694

 

 

 

 

 

 

 

 

 

 

$

2,374,878

 

As of March 31, 2020 and 2019, all of the Company’s economic derivative hedge positions were with large financial institutions, which are not known to the Company to be in default on their derivative positions. The Company is exposed to credit risk to the extent of non-performance by the counterparties in the derivative contracts discussed above; however, the Company does not anticipate non-performance by such counterparties. None of the Company’s derivative instruments contains credit-risk related contingent features. Derivatives are net on the balance sheet as they are subject to the right to offset the liabilities with the assets.

 

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

The following tables summarize the gross fair values of our derivative instruments, presenting the impact of offsetting the derivative assets and liabilities on our condensed consolidated balance sheets as of the dates indicated below:

 

 

 

 

 

 

 

 

 

Fair Value of Derivative 
Assets

 

    

March 31, 

    

March 31, 

 

 

2020

 

2019

Current

 

 

  

 

 

  

Basis swap

 

$

342,998

 

$

34,781

Fixed price swap

 

 

2,134,184

 

 

260,239

Long-term

 

 

 

 

 

 

Basis swap

 

 

 —

 

 

67,677

Fixed price swap

 

 

 —

 

 

225,619

 

 

$

2,477,182

 

$

588,316

 

 

 

 

 

 

 

 

 

 

Fair Value of Derivative
 Liabilities

 

    

March 31, 

    

March 31, 

 

 

2020

 

2019

Current

 

 

  

 

 

  

Basis swap

 

$

(102,304)

 

$

(620,143)

Fixed price swap

 

 

 —

 

 

(488,838)

Long-term

 

 

 

 

 

 

Basis swap

 

 

 —

 

 

(76,138)

Fixed price swap

 

 

 —

 

 

(26,730)

 

 

$

(102,304)

 

$

(1,211,849)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Fair Value of Derivatives

 

$

2,374,878

 

$

(623,533)

 

The following table presents the changes in the fair value of Epsilon’s commodity derivatives for the periods indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Fair value of asset (liability), beginning of year

 

$

1,999,802

 

$

(297,023)

Gains (losses) on derivative contracts included in earnings

 

 

1,721,018

 

 

(510,754)

Settlement of commodity derivative contracts

 

 

(1,345,942)

 

 

184,244

Fair value of asset (liability), end of year

 

$

2,374,878

 

$

(623,533)

 

 

 

 

 

 

 

14.    Asset Retirement Obligations

Asset retirement obligations were estimated by management based on Epsilon’s net ownership interest in all wells and the gathering system, estimated costs to reclaim and abandon such assets and the estimated timing of the costs to be incurred in future periods.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

The following tables summarize the changes in asset retirement obligations for the periods indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Year ended

 

 

 

March 31, 

 

 

December 31, 

 

 

2020

    

2019

Balance beginning of period

 

$

2,909,855

 

$

1,625,154

Liabilities from drilling of new wells

 

 

1,756

 

 

16,163

Change in estimates

 

 

2,181

 

 

1,153,740

Accretion

 

 

50,094

 

 

114,798

Balance end of period

 

$

2,963,886

 

$

2,909,855

 

 

 

 

15.    Fair Value Measurements

The methodologies used to determine the fair value of our financial assets and liabilities at March 31, 2020 were the same as those used at December 31, 2019.  

Cash, cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities are carried at cost, which approximates their fair value because of the short-term maturity of these instruments. The Company’s revolving line of credit has a recorded value that approximates its fair value since its variable interest rate is tied to current market rates and the applicable margins represent market rates.

Commodity derivative instruments consist of fixed-price swaps and basis swap contracts for natural gas. The Company’s derivative contracts are valued based on an income approach. The model considers various assumptions, such as quoted forward prices for commodities, time value and volatility factors. These assumptions are observable in the marketplace throughout the full term of the contract, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace, and are therefore designated as Level 2 within the valuation hierarchy. The Company utilizes its counterparties’ valuations to assess the reasonableness of its own valuations.

 

 

 

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in the understanding of trends and significant changes in or results of operations and the financial condition of Epsilon Energy Ltd. and its subsidiaries for the periods presented. The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and notes thereto presented in this report, including the unaudited condensed consolidated financial statements as of March 31, 2020 and 2019 and for the three months then ended together with accompanying notes, as well as our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2019. The following discussion contains “forward-looking statements” that reflect our future plans, estimates, beliefs, and expected performance. Actual results and the timing of events may differ materially from those contained in these forward- looking statements due to a number of factors. See “Part II. Item 1A. Risk Factors” and “Forward-Looking Statements.”

Overview

 

Epsilon Energy Ltd. (the “Company”) is a North American onshore focused independent natural gas and oil company engaged in the acquisition, development, gathering and production of natural gas and oil reserves. Our primary areas of operation are Pennsylvania and Oklahoma. Our assets are concentrated in areas with known hydrocarbon resources, which are conducive to multi well, repeatable drilling programs.

Substantially all of the production from our Pennsylvania acreage (4,130 net) is dedicated to the Auburn Gas Gathering System, or the Auburn GGS, located in Susquehanna County, Pennsylvania for a 15 year term expiring in 2026 under an operating agreement whereby the Auburn GGS owners receive a fixed percentage rate of return on the total capital invested in the construction of the system. Epsilon owns a 35% interest in the system which is operated by a subsidiary of Williams Partners, LP. In the three months ended March 31, 2020,  Epsilon paid $0.42 million to the Auburn GGS to gather and treat our 2.7 Bcf of natural gas production in Pennsylvania ($0.26 million to the Auburn GGS to gather and treat our 1.8 Bcf of natural gas in the three months ended March 31, 2019).

Epsilon realized  net income of $0.3 million during the three months ended March 31, 2020 as compared to net income of $1.4 million for the three months ended March 31, 2019.

Our common shares trade on the NASDAQ Global Market under the ticker symbol “EPSN.”

Business Strategy

 

Our business strategy is to manage the cash flow generated from our producing leasehold and midstream assets in a manner where the risked capital allocation provides attractive rates of return. Our remaining inventory of drillable locations within existing leasehold is sufficient to maintain this cash flow for several years at capital expenditure levels well within the yearly free cash flow generated from these assets. In addition, the Company seeks to identify attractive onshore natural gas and oil properties in the United States, to acquire a leasehold interest and to develop the leasehold interest with the goal of deploying capital at attractive rates.

The core Marcellus Shale is one of the most attractive dry gas resources in the lower United States and has attracted significant development capital. Well productivity has improved dramatically for many years resulting in increasing initial production rates and gas recoveries. The resulting supply of natural gas has at times stressed the transportation infrastructure of the Northeast US and exacerbated the local price discount to Henry Hub. In many other basins throughout the US, the increase in natural gas production has outpaced demand. This market condition has resulted in historically weaker natural gas prices for the benchmark index Henry Hub.

The operating environment remains challenging in Northeast Pennsylvania. In the Marcellus, the Company implemented a number of initiatives to enhance the value of our core assets in the Marcellus including a comprehensive review of well spacing and completion productivity for both the Lower and Upper Marcellus, and Epsilon is working with our well operators to increase operating efficiency. In addition, Epsilon continues to work closely with our gathering system partners in order to enhance operational safety and to preserve and grow the long-term value of our gathering system assets.

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The major producers in the Appalachian region are under tremendous pressure from capital markets to demonstrate capital discipline and control costs. Several major producers have announced reduced capital programs to balance the supply-demand for the commodity. Accordingly, the Company expects local production to decline modestly throughout the second half of 2020. The Company cannot, however, predict the duration of the current global market conditions that may lead to a global recession and its impact on oil and gas demand and commodity prices. Our target is to maintain our current production level or grow modestly, but only if natural gas prices improve and the capital deployed can achieve our internal rate of return.

In the longer term, Epsilon believes natural gas prices will become more constructive due to a moderating of supply and incremental demand from LNG exports, exports to Mexico and further coal to gas switching for domestic electrical power generation. Specifically, LNG export capacity is expected to more than double from the current ~ 8.5 Bcf/d to 17 Bcf/d by 2024 based only on facilities currently commissioning or under construction.

In the Northwest STACK, the Company chooses to not deploy capital due to depressed natural gas liquids and natural gas pricing. However, the leases are held by production which provides a long-term right to develop additional sales when commodity prices appear attractive. In the interim, the Company intends to monitor development activities from offset operators in our area very closely in an effort to further appraise our leasehold interest without risking capital.

Recent Developments

 

On March 11, 2020, the World Health Organization characterized the global outbreak of the novel strain of coronavirus, COVID-19, as a “pandemic.” To limit the spread of COVID-19, governments have taken various actions including the issuance of stay-at-home orders and social distancing guidelines, causing some businesses to suspend operations and a reduction in demand for many products from direct or ultimate customers. Such actions have resulted in a swift and unprecedented reduction in international and U.S. economic activity which, in turn, has adversely affected the demand for oil and natural gas and caused significant volatility and disruption of the financial markets.

Epsilon is closely monitoring the current and potential impacts of COVID-19 on all aspects of our business and geographies, including how it has impacted, and may in the future impact our operations, financial results, liquidity, contractors, customers, employees and vendors. The Company continue to monitor a number of factors that may cause actual results of operations to differ from our historical results or current expectations. Mentioned above, these factors include: the impact of the COVID-19 pandemic and the related economic downturn, the historically low natural gas liquids prices, and ramifications of the crude oil price war between the Organization of Petroleum Exporting Countries ("OPEC") /Saudi Arabia and Russia that occurred in March. While OPEC agreed in April to cut production, downward pressure on prices has continued and could continue for the foreseeable future, particularly given concerns over available storage capacity for refined products such as crude, and refinery inputs including condensate and NGL’s. These and other factors could affect the Company’s oil and gas properties, operations, earnings and cash flows for some period and could cause such results to not be comparable to those of the same period in previous years. Commodity prices are expected to continue to be volatile as a result of the changes in oil and natural gas production, inventories and demand, as well as national and international economic pressure. The Company cannot predict when prices will improve and stabilize. The results presented in this Form 10-Q are not necessarily indicative of future operating results. 

While Epsilon did not incur significant disruptions to operations during the three months ended March 31, 2020 as a result of the COVID-19 pandemic, the Company did recognize an impairment on its legacy Oklahoma producing assets due to the historically low commodity prices. Additionally, the Company is unable to predict the impact that the COVID-19 pandemic will have on us, including our financial position, operating results, liquidity and ability to obtain financing in future reporting periods, due to numerous uncertainties. These uncertainties include the severity of the virus, the duration of the outbreak, governmental or other actions taken to combat the virus (which could include limitations on our operations or the operations of our customers and vendors), and the effect that the COVID-19 pandemic and the current oil price wars have on the demand for natural gas and natural gas liquids. The situation surrounding COVID-19 remains fluid and unpredictable, and Epsilon is actively managing our response and assessing potential impacts to our financial position and operating results, as well as any adverse developments that could impact our business. However, at this point, Epsilon does not anticipate any prolonged negative financial consequences to our financial position. Epsilon has no debt and has $15 million of cash on hand to fund planned operating activities and to potentially weather a prolonged depressed economic environment.

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   The federal government has passed a series of relief and stimulus packages, including the CAREs Act, for the country but Epsilon has not and will not need to avail itself of them and as such, these programs have no effect on Epsilon’s financial statements.

Epsilon has also taken, and is continuing to take, proactive steps to manage any disruption in our business caused by COVID-19. For instance, the Company was an early adopter in employing a work-from-home system, even before any government mandate on non-essential businesses was enacted. Epsilon increased its technology platform, infrastructure and security to allow for a work-from-home environment ahead of the actual need, and therefore, once the hypothetical became a reality, the Company believes it was ahead of many companies in this respect. Epsilon has also deployed additional layered safety protocols at our office in order to keep our employees safe and to keep our operations running without material disruption. 

Three Months ended March 31, 2020 Highlights

Operational Highlights

 

Marcellus Shale – Pennsylvania

During the three months ended March 31, 2020, Epsilon’s realized natural gas price was $1.46 per Mcf, a 51%  decrease over the three months ended March 31, 2019.

Total three months ended March 31, 2020 natural gas production of 2.67 Bcf, as compared to 1.78 Bcf during the same period in 2019. 

Marcellus working interest (WI) gas averaged 33.79 MMcf/d for the three months ended March 31, 2020.

Gathered and delivered 23.3 Bcf gross (8.1 Bcf net to Epsilon’s interest) during the three months ended March 31, 2020 through the Auburn System which represents approximately 77% of maximum throughput. 

Anadarko, NW Stack Trend – Oklahoma

During the three months ended March 31, 2020, Epsilon’s realized price for all Oklahoma production was $2.75 per Mcfe, a 30.0% decrease over the three months ended March 31, 2019.

Total production for the three months ended March 31, 2020 included natural gas, oil, and associated liquids and was 0.070 Bcfe, a 17.0% increase over the same period in 2019.

Non-GAAP Financial Measures-Adjusted EBITDA

 

Epsilon defines Adjusted EBITDA as earnings before (1) net interest expense, (2) taxes, (3) depreciation, depletion, amortization and accretion expense, (4) impairments of natural gas and oil properties, (5) non-cash stock compensation expense, (6) gain or loss on derivative contracts net of cash received or paid on settlement, and (7) other income. Adjusted EBITDA is not a measure of financial performance as determined under U.S. GAAP and should not be considered in isolation from or as a substitute for net income or cash flow measures prepared in accordance with U.S. GAAP or as a measure of profitability or liquidity.

Additionally, Adjusted EBITDA may not be comparable to other similarly titled measures of other companies. Epsilon has included Adjusted EBITDA as a supplemental disclosure because its management believes that EBITDA provides useful information regarding its ability to service debt and to fund capital expenditures. It further provides investors a helpful measure for comparing operating performance on a "normalized" or recurring basis with the performance of other companies, without giving effect to certain non-cash expenses and other items. This provides management, investors and analysts with comparative information for evaluating the Company in relation to other natural gas and oil companies providing corresponding non-U.S. GAAP financial measures or that have different financing and

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capital structures or tax rates. These non-U.S. GAAP financial measures should be considered in addition to, but not as a substitute for, measures for financial performance prepared in accordance with U.S. GAAP. The table below sets forth a reconciliation of net income to Adjusted EBITDA for the three months ended March 31, 2020 and 2019, which is the most directly comparable measure of financial performance calculated under U.S. GAAP and should be reviewed carefully.

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Net income

 

$

310,299

 

$

1,373,676

Add Back:

 

 

 

 

 

 

Net interest (income) expense

 

 

6,477

 

 

(15,082)

Income tax expense

 

 

325,281

 

 

746,596

Depreciation, depletion, amortization, and accretion

 

 

2,414,376

 

 

1,825,731

Impairment expense

 

 

1,760,000

 

 

 —

Stock based compensation expense

 

 

173,919

 

 

133,720

(Gain) loss on derivative contracts net of cash received or paid on settlement

 

 

(375,076)

 

 

326,510

Foreign currency translation (gain) loss

 

 

2,225

 

 

(23)

Adjusted EBITDA

 

$

4,617,501

 

$

4,391,128

 

 

Results of Operations

 

Net Operating Revenues

 

During the three months ended March 31, 2020 revenues decreased $1.5 million, or 19.1%, to $6.4 million from $7.9 million during the same period of 2019. 

Revenue and volume statistics for the three months ended March 31, 2020 and 2019 were as follows:

 

 

 

 

 

 

 

 

 

Three months ended

 

 

March 31, 

 

    

2020

    

2019

Revenues

 

 

 

 

 

 

Natural gas revenue

 

$

4,019,764

 

$

5,434,935

Volume (MMcf)

 

 

2,727

 

 

1,823

Avg. Price ($/Mcf)

 

$

1.47

 

$

2.98

PA Exit Rate (MMcfpd)

 

 

33.1

 

 

24.6

Oil and other liquids revenue

 

$

91,380

 

$

72,728

Volume (MBO)

 

 

3.1

 

 

3.1

Avg. Price ($/Bbl)

 

$

29.22

 

$

23.81

Gathering system revenue

 

$

2,316,702

 

$

2,438,351

Total Revenues

 

$

6,427,846

 

$

7,946,014

 

We earn gathering system revenue as a 35% owner of the Auburn Gas Gathering system. This revenue consists of fees paid by Anchor Shippers  (parties listed in Anchor Shipper Gas Gathering Agreement for Northern Pennsylvania, including Epsilon Midstream, LLC)  and third-party customers of the system to transport gas from the wellhead to the compression facility, and then to the delivery meter at the Tennessee Gas Pipeline. For the three months ended March 31, 2020, approximately 87% of the Auburn GGS revenues earned were gathering fees, while 13%  were  compression fees. Gathering revenues from third-party customers represented approximately 11% of revenues and third-party compression revenues represented 5% of revenues. For the three months ended March 31, 2019, approximately 85% of the Auburn GGS revenues earned were gathering fees, while 15% were compression fees. Gathering revenues from third-party customers represented approximately 18% of revenues and third-party compression revenues represented 7% of revenues. 

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Revenues derived from Epsilon’s production which have been eliminated from gathering system revenues amounted to $0.42 million for the three months ended March 31, 2020 and $0.26 million for the three months ended March 31, 2019.

Upstream natural gas revenue for the three months ended March 31, 2020 decreased by $1.4 million, or 26%, over the same period in 2019. This was a result of lower natural gas prices; however, this was offset by higher volumes being produced. 

The Company’s share of gathering system revenue remained generally consistent, decreasing by only $0.1 million, or 5.0%, during the three months ended March 31, 2020 over the same period in 2019. However, total upstream gathering fees increased due to increased production from Epsilon, which resulted in an increase in the amount of revenues eliminated from the consolidated operating statements. This increased elimination entry resulted in a net decrease in gathering system revenue to Epsilon. The Auburn GGS is subject to a cost of service model, whereby the Anchor Shippers dedicate acreage and reserves to the Auburn GGS. In exchange for this dedication, the owners of the Auburn system agree to a fixed rate of return on capital invested which cannot be exceeded. Therefore, rather than being subject to a fixed gathering rate, the Shippers are subject to a fluctuating gathering rate which is re determined annually in order to produce the contractual return on capital to the Auburn GGS owners. The term of the model is fixed from 2012 to 2026. Each year, actual throughput, revenue, operating expenses and capital are captured in the model, and the remaining years are forecasted. The model then iterates for a gathering rate that yields the contractual rate of return. All else being equal, to the extent that throughput is higher or capital is lower than the preceding year’s forecast, the gathering rate will decline.

Operating Costs

 

The following table presents total cost and cost per unit of production (Mcfe), including ad valorem, severance, and production taxes for the three months ended March 31, 2020 and 2019:

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Lease operating costs

 

$

2,047,767

 

$

1,718,293

Gathering system operating costs

 

 

97,778

 

 

312,787

 

 

$

2,145,545

 

$

2,031,080

 

 

 

 

 

 

 

Upstream operating costs—Total $/Mcfe

 

 

0.75

 

 

0.93

Gathering system operating costs  $ / Mcf

 

 

0.04

 

 

0.11

 

Upstream operating costs consist of lease operating expenses necessary to extract natural gas and oil, including gathering and treating the natural gas and oil to ready it for sale.

Gathering system operating costs consist primarily of rental payments for the natural gas fueled compression units. Other significant gathering system operating costs include chemicals (to prevent corrosion and to reduce water vapor in the gas stream), saltwater disposal, measurement equipment / calibration and general project management. The gathering system operating costs and the associated $/Mcf reported include the effects of elimination entries to remove the gas gathering fees billed by the gas gathering system operator to Epsilon’s upstream operations, and the volume associated with those fees. The elimination entries amounted to $0.42 million and $0.26 million for the three months ended March 31, 2020 and 2019, respectively (see Note 12,  ‘‘Operating Segments,’’ of the Notes to Unaudited Condensed Consolidated Financial Statements).

Upstream operating costs for the three months ended March 31, 2020 increased  $0.3 million, or 19.2%, from the same period in 2019. The increase in total cost was due to the increase in volumes produced and the cost of operating four new wells that went online in October of 2019. Gathering system costs for the three months ended March 31, 2020 decreased $0.2 million over the same period in 2019. The Company’s share of total gathering system costs remained consistent; however, due to increased production from Epsilon the resulting increase in the elimination entry in costs eliminated from the consolidated operating statements resulted in the large decrease in gathering system operating costs reported, and a very low cost per Mcf.

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Depletion, Depreciation, Amortization and Accretion (“DD&A”)

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Depletion, depreciation, amortization and accretion

 

$

2,414,376

 

$

1,825,731

 

Natural gas and oil and gathering system assets are depleted and depreciated using the units of production method aggregating properties on a field basis. For leasehold acquisition costs and the cost to acquire proved and unproved properties, the reserve base used to calculate depreciation and depletion is total proved reserves. At this time, the Company has only minimal leasehold acquisition costs, and only in Oklahoma. For natural gas and oil development and gathering system costs, the reserve base used to calculate depletion and depreciation is proved developed reserves. A reserve report is prepared as of December 31, each year. The depletion for the first three quarters of the next year is normally based on the reserve report prepared at the end of the previous year, taking into consideration the limited development of the reserves over these time periods. The fourth quarter depletion is calculated using the reserve volumes from the reserve report prepared as of December 31 of the current year. However, for the three months ended March 31, 2020, due to the historically low commodity prices, the December 31, 2019 reserves report volumes were updated based on relevant March 31, 2020 prices and the depletion and depreciation were calculated using the lower volumes due to the lower prices because of the COVID-19 pandemic.

Depreciation expense includes primarily amounts pertaining to our office furniture and fixtures, leasehold improvements, and computer hardware. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 7 years. Also included in depreciation expense is an amount pertaining to buildings owned by the Company. Depreciation for the buildings is calculated using the straight-line method over an estimated useful life of 30 years.

Accretion expense is related to the asset retirement obligations.  

As discussed above, DD&A expense for the first three quarters is calculated based on the reserve report from the prior year. DD&A expense increased $0.6 million, or 32% for the three months ended March 31, 2020 compared to the same period in 2019 mainly due to the addition of four new wells which resulted in increased production volumes.

Impairment

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Impairment

 

$

1,760,000

 

$

 —

 

Epsilon performs a quantitative impairment test quarterly or whenever events or changes in circumstances indicate that an asset group's carrying amount may not be recoverable, over proved properties using the published NYMEX forward prices, timing, methods and other assumptions consistent with historical periods. When indicators of impairment are present, tests require that the Company first compare expected future undiscounted cash flows by asset group to their respective carrying values. If the carrying amount exceeds the estimated undiscounted future cash flows, a reduction of the carrying amount of the natural gas properties to their estimated fair values is required.

During the three months ended March 31, 2020, the Company recognized certain indicators of impairments specific to our Oklahoma assets and determined that carrying value of those assets was not recoverable based on the current indicators. As a result of this assessment, a $1.76 million impairment was assessed on the Company’s Oklahoma assets at March 31, 2020. No impairment was required as of March 31, 2019.

General and Administrative

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

General and administrative

 

$

1,182,032

 

$

1,473,282

 

G&A expenses consist of general corporate expenses such as compensation, legal, accounting and professional fees, consulting services, travel and other related corporate costs such as stock options and restricted stock granted and the related non-cash compensation.

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G&A expenses decreased by $0.3 million, or 19.8%, during the three months ended March 31, 2020 compared to the same period in 2019,  mainly due to decreased costs required during the process of delisting from the TSX and listing on the NASDAQ. 

Interest Expense

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Interest expense

 

$

28,006

 

$

27,609

 

Interest expense relates to the commitment fees paid on the revolving line of credit.

Interest expense remained consistent during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019. Interest expense for the periods consists primarily of commitment fees as Epsilon did not access our line of credit during this time.

Gain (Loss) on Derivative  Contracts

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Gain (loss) on derivative contracts

 

$

1,721,018

 

$

(510,754)

 

For the three months ended March 31, 2020 and 2019,  Epsilon entered into fixed price swap and basis swap derivative contracts. During the three months ended March 31, 2020 we received net cash settlements of $1,345,942 and during the three months ended March 31, 2019 Epsilon paid $184,244 on the settlement of contracts.

The realized losses during the three months ended March 31, 2019 were entirely due to basis swaps that settled out-of-the-money as regional prices moved higher throughout the quarter, offset by modest gains in NYMEX HH swaps. At March 31, 2019, the unrealized losses in the derivative contracts were almost entirely attributable to out-of-the-money basis swaps. In January, February, March, April and October of 2019, the Company added Henry Hub (1.575 Bcf) and basis swaps (1.575 Bcf) with expirations during the three months ended March 31, 2020. NYMEX HH prices generally declined throughout the three months ended March 31, 2020 resulting in large realized gains.

Furthermore, by March 31, 2020, substantially all of the gains in the unsettled contracts held were due to in-the-money NYMEX HH swaps. These NYMEX HH swaps (3.063 Bcf) and basis swaps (4.903 Bcf) were added to the hedge portfolio throughout year ended December 31, 2019 and in January 2020.

Other Income (Expense)

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2020

    

2019

Interest income and other income (expense)

 

$

19,304

 

$

42,714

 

For the three months ended March 31, 2020 and 2019 other income consisted primarily of interest income.

Capital Resources and Liquidity

Cash Flow

 

The primary source of cash for Epsilon during the three months ended March 31, 2020 and 2019 was funds generated from operations. In addition to operations, the primary uses of cash for the three months ended March 31, 2020 were development of natural gas properties, and the repurchase of shares of common stock. For the three months ended March 31, 2019 cash was used for income tax pre-payments, and acquisitions and development of oil and gas properties.

At March 31, 2020, we had a working capital surplus of $16.6 million, an increase of $1.70 million over the $14.9 million surplus at December 31,  2019. The surplus increased over the last year because of the cash that is continually being generated by operations and cash received from the settlement of derivative contracts. The Company anticipates its current cash balance, cash flows from operations, and available sources of liquidity to be sufficient to meet its cash requirements. However, as the impact of recent declines in worldwide crude oil and natural gas prices and the impact of COVID-19 on

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the economy evolves, Epsilon will continue to assess its liquidity needs. In the event of a sustained market deterioration, the Company may need additional liquidity, which would require it to evaluate available alternatives and take appropriate actions.

Three months ended March 31, 2020 compared to 2019

During the three months ended March 31, 2020, $5.2 million was provided by the Company’s operating activities, compared to $3.9 million provided during the same period in 2019, a $1.3 million, and 32.3%  increase.  The increase was mainly due to cash received on the settlement of derivative contracts and a decrease in spending and thereby reducing payable balances. 

The Company used $2.4 million of cash for investing activities during the three months ended March 31, 2020. This was spent primarily on leasehold and development costs targeting increasing production in Pennsylvania. For the three months ended March 31, 2019,  the Company used  $1.5 million, mainly on leasehold costs in Oklahoma and Pennsylvania, and the acquisition of unproved properties in Oklahoma. 

The $1.5 million and $0.2 million of cash used for financing activity during the three months ended March 31, 2020 and 2019, respectively, was related to the repurchase of common shares of the Company.

Credit Agreement

 

In addition, the Company has a senior secured credit facility which includes a total commitment of up to $100 million. The current effective borrowing base is $23 million, which is subject to semi-annual redetermination. There are currently no borrowings under the facility. If Epsilon decided to access the facility, depending on the level of borrowing, the Company might need to increase its hedging activity. Borrowings from the Facility may be used for the acquisition and development of oil and gas properties, investments in cash flow generating assets complimentary to the production of oil and gas, and for letters of credit and other general corporate purposes. Upon each advance, interest is charged at the highest of a) rate of LIBOR plus an applicable margin (2.75%-3.75% based on the percent of the line of credit utilized), b) the Prime Rate, or c) the sum of the Federal Funds Rate plus 0.5%. Effective January 7, 2019 the agreement was amended to extend the maturity date to March 1, 2022.

The bank has a first priority security interest in the tangible and intangible assets of Epsilon Energy USA to secure any outstanding amounts under the agreement. Under the terms of the agreement, the Company must maintain the following covenants:

Interest coverage ratio greater than 3 based on income adjusted for interest, taxes and non-cash amounts.

 

Current ratio, adjusted for line of credit amounts used and available and non-cash amounts, greater than 1.

 

Leverage ratio less than 3.5 based on income adjusted for interest, taxes and non-cash amounts.

Epsilon was in compliance with the financial covenants of the agreement as of March 31, 2020 and December 31, 2019 and expect to be in compliance for the next 12 months. We expect to remain in compliance as we currently have no borrowings under the facility and funded all operations for 2019 out of operating cash flow and cash on hand and expect to continue to do so through 2020.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at

 

Balance at

 

 

 

 

 

 

 

March 31, 

 

December 31, 

 

Borrowing Base

 

Interest

 

    

2020

    

2019

    

March 31, 2020

    

Rate

Revolving line of credit

 

$

 —

 

$

 —

 

$

23,000,000

 

3 mo. LIBOR + 2.75%

 

Available borrowing capacity under the credit agreement is $23 million was reaffirmed on February 11, 2020.

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Repurchase Transactions

 

Since May 20, 2019, Epsilon has conducted a normal course issuer bid (“NCIB”) to repurchase our issued and outstanding common shares, when doing so has been accretive to management's estimates of intrinsic value per share. The NCIB will end on May 19, 2020. Since the commencement of the NCIB on May 20, 2019, Epsilon has strengthened its financial position and overhead costs. With sufficient cash flow from operations, it used discretionary cash to fund these repurchases. Since May 20, 2019, Epsilon has repurchased 1,353,410 common shares of the authorized 1,367,762 purchase amount. During the three months ended March 31, 2020, the Company spent $1,499,586 under the NCIB. For the three months ended March 31, 2019, Epsilon spent $248,381 to repurchase common shares.

Derivative Transactions

 

The Company has entered into hedging arrangements to reduce the impact of natural gas price volatility on operations. By removing the price volatility from a significant portion of natural gas production, the potential effects of changing prices on operating cash flows have been mitigated, but not eliminated. While mitigating the negative effects of falling commodity prices, these derivative contracts also limit the benefits we might otherwise receive from increases in commodity prices.

At March 31, 2020, Epsilon’s outstanding natural gas commodity swap contracts consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted Average Price ($/MMbtu)

 

 

 

 

 

Volume

 

 

 

 

Basis

 

Fair Value of Asset

Derivative Type

    

(MMbtu)

    

 Swaps 

    

Differential

    

March 31, 2020

2020

 

 

 

 

 

 

 

 

 

 

 

Fixed price swap

 

3,062,500

 

$

2.73

 

$

 —

 

 

2,134,184

Basis swap

 

4,902,500

 

$

 —

 

$

(0.46)

 

 

240,694

 

 

7,965,000

 

 

 

 

 

 

 

$

2,374,878

 

Contractual Obligations

 

The following table summarizes Epsilon’s contractual obligations at March 31, 2020:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payments Due by Period

 

 

 

 

 

Less than

 

1 – 3

 

Greater than

 

    

Total

    

1 Year

    

Years

    

3 Years

Derivative liabilities(1)

 

 

102,304

 

 

102,304

 

 

 —

 

 

 —

Asset retirement obligation, undiscounted

 

 

8,925,484

 

 

1,608,499

 

 

 —

 

 

7,316,985

Capital expenditure commitments

 

 

3,149,153

 

 

1,284,571

 

 

1,864,582

 

 

 —

Operating leases

 

 

304,560

 

 

75,441

 

 

211,112

 

 

18,007

Total future commitments

 

$

12,481,501

 

$

3,070,815

 

$

2,075,694

 

$

7,334,992

________________________

(1)

The liability balance shown represents the gross mark-to-market liability balance of derivative contracts before being offset by contracts in an asset position.

 

We enter into commitments for capital expenditures in advance of the expenditures being made. At a given point in time, it is estimated that we have committed to capital expenditures equal to approximately one quarter of our capital budget by means of giving the necessary authorizations to the asset operator to incur the expenditures in a future period. Current commitments have been included in the contractual obligations table above.

Based on current natural gas prices and anticipated levels of production, we believe that the estimated net cash generated from operations, together with cash on hand and amounts available under our credit agreement, will be adequate to meet liquidity needs for the next 12 months and beyond, including satisfying our financial obligations and funding our operating and development activities.

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Off-Balance Sheet Arrangements

 

As of March 31, 2020,  the Company had no off-balance sheet arrangements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our earnings and cash flow are significantly affected by changes in the market price of commodities. The prices of natural gas and oil can fluctuate widely and are influenced by numerous factors such as demand, production levels, world political and economic events, and the strength of the US dollar relative to other currencies. Should the price of natural gas and oil decline substantially, the value of our assets could fall dramatically, impacting our future operations and exploration and development activities, along with our gas gathering system revenues. In addition, our operations are exposed to market risks in the ordinary course of our business, including interest rate and certain exposure as well as risks relating to changes in the general economic conditions in the United States.

Gathering System Revenue Risk

 

The Auburn Gas Gathering System lies within the Marcellus Basin with historically high levels of recoverable reserves and low cost of production. We believe that a short-term low commodity price environment will not significantly impact the reserves produced and thus the revenue of our gas gathering system.

Interest Rate Risk

 

Market risk is estimated as the change in fair value resulting from a hypothetical 100 basis point change in the interest rate on the outstanding balance under our credit agreement. The credit agreement allows us to fix the interest rate for all or a portion of the principal balance for a period up to three months. To the extent that the interest rate is fixed, interest rate changes affect the instrument’s fair market value but do not affect results of operations or cash flows. Conversely, for the portion of the credit agreement that has a floating interest rate, interest rate changes will not affect the fair market value but will affect future results of operations and cash flows.

At March 31, 2020 and 2019, the outstanding principal balance under the credit agreement was nil.

Derivative Contracts

 

The Company’s financial results and condition depend on the prices received for natural gas production. Natural gas prices have fluctuated widely and are determined by economic and political factors. Supply and demand factors, including weather, general economic conditions, the ability to transport the gas to other regions, as well as conditions in other natural gas regions, impact prices. Epsilon has established a hedging strategy and may manage the risk associated with changes in commodity prices by entering into various derivative financial instrument agreements and physical contracts. Although these commodity price risk management activities could expose Epsilon to losses or gains, entering into these contracts helps to stabilize cash flows and support the Company’s capital spending program.

 

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

 

As required by Rule 13a-15(b) under the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.

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Based upon such evaluation, we have concluded that as of March 31, 2020 our disclosure controls and procedures were not effective as of such date as a result of a material weakness in our internal control over financial reporting related to the preparation of our oil and gas properties impairment calculation in accordance with the relevant accounting literature and the related review control as of March 31, 2020.

The effect of the error that resulted from the material weakness discussed above was corrected as part of the 10-Q reporting process, and management has concluded that the consolidated financial statements included in this report fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.

Management’s Remediation Plan

 

Our management is in the process of developing its remediation plan to address the material weakness identified in the first quarter of 2020, which we expect to include incremental training and additional accounting research subscriptions.

Changes in Internal Control over Financial Reporting

 

There were no changes to our internal control over financial reporting (as defined in Rules 13a- 15(f) and 15d- 15(f) of the Exchange Act) during the quarter ended March 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

 

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that of limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, the risk.

 

 

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is not currently involved in any litigation.

 

ITEM 1A. RISK FACTORS

There have been no material changes from the risk factors disclosed in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2019, other than the following:

The COVID-19 pandemic and recent developments in the global crude oil markets have had, and may continue to have, material adverse consequences for the global economy, which have impacted our planned operational activities, and may have a material adverse impact on our financial condition, results of operations and cash flows.

The responses of governmental authorities and companies across the world to reduce the spread of the COVID-19 pandemic have significantly reduced global economic activity. Various containment measures, which have included business closures, work stoppages, shuttering of public spaces and events and/or severe restrictions of global and regional travel, among others, while aiding in the prevention of further spread of the virus, have resulted in the slowing of economic growth, reduced demand for crude oil and natural gas and the disruption of global manufacturing supply chains. The longevity and severity of the impact of COVID-19 on the oil and gas industry, including the reduced demand for crude oil and natural gas commodities and its resulting impact on commodity prices, may continue until a vaccine or alternative

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treatment is made widely available across the globe. We are unable to predict when, and if, an effective vaccine for COVID-19 will become available.

 

Additionally, in March 2020, OPEC and non-OPEC producers failed to agree to production cuts, causing a significant drop in crude oil prices. Also, Saudi Arabia recently reduced its export prices to certain markets, while increasing its prices in others. Subsequently, in April 2020, members of OPEC and certain non-OPEC producers agreed to production cuts through first quarter 2022. While these production cuts are expected to reduce excess global crude oil inventories in 2021, they are unlikely to be sufficient to offset the sharp demand decreases caused by COVID-19 in the near-term.

Collectively, these factors have contributed to significant negative global economic impacts, including a significant drop in demand for hydrocarbon products, potentially causing the US and other global economies to fall into a recession that could extend throughout 2020 and beyond. A recession could likely extend the time for the current crude oil markets to absorb excess supplies, resulting in suppressed crude oil prices for a number of future quarters.

Our profitability could be significantly affected by this decreased demand and lower commodity price environment. The decline in commodity prices and our future estimated production levels could lead to additional material impairments of our long-lived assets, intangible assets, equity method investments and right-of-use assets. It is likely additional impairments could be triggered if the COVID-19 pandemic leads to a continued and sustained reduction in global economic activity and demand for energy.

The COVID-19 pandemic could potentially further impact our global workforce and operations. The infection of key personnel, and/or the infection of a significant portion of our workforce, could result in business continuity and productivity disruptions.

Further, containment measures have been implemented to mitigate the spread of COVID-19, there is the risk that reduced demand could continue should there be wide-spread and sustained adoption of certain behavioral changes, such as reduced travel and work from home policies, among others. Such behavioral changes, and perceived benefits to the environment, have recently been cited by groups opposing the oil and gas industry as cause for future long-term global adoption. We could be negatively impacted should there be wide-spread and sustained changes in consumer behavioral patterns that result in reduced demand for and consumption of energy commodities.

The impacts of COVID-19 and the significant drop in commodity prices have had an unprecedented impact on the global economy. Impacts of the COVID-19 pandemic and/or any worsening of the global business and economic environment, may heighten or exacerbate many of the other risks disclosed in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2019. We are unable to predict all potential impacts to our business, the severity of such impacts or the duration. These risks could have a material adverse impact on our financial position, results of operations and cash flows.

 

ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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ITEM 5. OTHER INFORMATION

Due to the COVID-19 pandemic, the Company will schedule its 2020 annual meeting of stockholders (the “2020 Annual Meeting”) for a future date later in the year. Because the date of the 2020 Annual Meeting will represent a change of more than 30 days from the anniversary of the Company’s 2019 annual meeting of stockholders, in accordance with Rule 14a-5(f) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company is informing stockholders of this change.

The time and location of the 2020 Annual Meeting will be specified in the Company’s proxy statement for the 2020 Annual Meeting. Because the date of the 2020 Annual Meeting has been changed by more than 30 days from the anniversary of the 2019 annual meeting, new deadlines have been set for submission of proposals by stockholders intended to be included in the Company’s proxy statement for the 2020 Annual Meeting.

Pursuant to Rule 14a-8 under the Exchange Act, a stockholder intending to present a proposal to be included in the proxy statement for the 2020 Annual Meeting must deliver a proposal in writing to our principal executive offices no later than a reasonable time before we begin to print and mail the proxy materials for the 2020 Annual Meeting. Such proposal must also comply with the applicable requirements as to form and substance established by the Securities and Exchange Commission if those proposals are to be included in the proxy statement and form of proxy. Accordingly, the new deadline for submission of proposals to be included in the proxy statement for the 2020 Annual Meeting will be determined when the date of the meeting is set. 

The Company’s Bylaws set forth advance notice procedures with regard to other stockholder proposals, including nominations for the election of directors and business proposals to be brought before an annual meeting of stockholders by any stockholder (other than matters included in our proxy materials in accordance with Rule 14a-8 under the Exchange Act). With respect to the 2020 Annual Meeting, dates of such notice will be set when the date of the annual meeting is set.

 

 

 

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Table of Contents

ITEM 6. —EXHIBITS

 

 

 

 

 

 

 

 

Exhibit

No.

 

Description of Exhibit

 

 

 

31.1

 

Sarbanes-Oxley Section 302 certification of Principal Executive Officer.

 

 

31.2 

 

Sarbanes-Oxley Section 302 certification of Principal Financial Officer.

 

 

32.1 

 

Sarbanes-Oxley Section 906 certification of Principal Executive Officer.

 

 

32.2 

 

Sarbanes-Oxley Section 906 certification of Principal Financial Officer.

 

 

101.INS

 

XBRL Instance Document.

 

 

101.SCH

 

XBRL Schema Document.

 

 

101.CAL

 

XBRL Calculation Linkbase Document.

 

 

101.DEF

 

XBRL Definition Linkbase Document.

 

 

101.LAB

 

XBRL Labels Linkbase Document.

 

 

101.PRE

 

XBRL Presentation Linkbase Document.

 

 

 

 

 

 

 

SIGNATURES

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

 

 

 

 

Epsilon Energy Ltd.

  

 

(Registrant)

 

 

 

 

 

Date: May 13, 2020

 

By:

/s/ B. Lane Bond

 

 

 

B. Lane Bond

 

 

 

Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)

 

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