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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 September 30, 2023

  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.)

500 Dallas Street, Suite 1250

Houston, Texas 77002

(281) 670-0002

(Address of principal executive offices including zip code and

telephone number, including area code)

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 November 8, 2023, there were 22,160,439 Common Shares outstanding.

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 (Loss)

5

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity

7

Unaudited Condensed Consolidated Statements of Cash Flows

9

Notes to the Unaudited Condensed Consolidated Financial Statements

1.

Description of Business

10

2.

Basis of Preparation

10

Interim Financial Statements

10

Principles of Consolidation

10

Use of Estimates

10

Reclassification

10

Recently Issued Accounting Standards

10

3.

Cash, Cash Equivalents, and Restricted Cash

11

4.

Short Term Investments

11

5.

Property and Equipment

12

Property Impairment

13

6.

Revolving Line of Credit

13

7.

Shareholders’ Equity

13

8.

Revenue Recognition

17

9.

Income Taxes

18

10.

Commitments and Contingencies

18

Litigation

19

11.

Leases

19

12.

Net Income Per Share

20

13.

Operating Segments

21

14.

Commodity Risk Management Activities

24

Commodity Price Risks

24

Commodity Derivative Contracts

24

15.

Asset Retirement Obligations

25

16.

Fair Value Measurements

26

17.

Current Expected Credit Loss

26

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

27

Overview

27

Business Strategy

27

Operational Highlights

28

Non-GAAP Financial Measures-Adjusted EBITDA

28

Net Operating Revenues

30

Operating Costs

31

Depletion, Depreciation, Amortization and Accretion

31

General and Administrative

32

Loss on Derivative Contracts

33

Capital Resources and Liquidity

33

Cash Flow

33

Credit Agreement

33

Repurchase Transactions

34

Derivative Transactions

34

Contractual Obligations

35

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

35

Gathering System Revenue Risk

35

Interest Rate Risk

35

Derivative Contracts

35

ITEM 4. CONTROLS AND PROCEDURES

36

Disclosure Controls and Procedures

36

Changes in Internal Control Over Financial Reporting

36

Inherent Limitations on Effectiveness of Controls

36

PART II OTHER INFORMATION

36

ITEM 1. LEGAL PROCEEDINGS

36

ITEM 1A. RISK FACTORS

37

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

37

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

37

ITEM 4. MINE SAFETY DISCLOSURES

37

ITEM 5. OTHER INFORMATION

37

ITEM 6. EXHIBITS

39

SIGNATURES

39

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, 2022, 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, 2022. Our Annual Report on Form 10-K for the year ended December 31, 2022 is available on our website at www.epsilonenergyltd.com.

4

PART I-FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Balance Sheets

    

September 30, 

    

December 31, 

2023

2022

ASSETS

Current assets

Cash and cash equivalents

$

12,498,051

$

45,236,584

Accounts receivable

4,006,278

7,201,386

Short term investments

18,870,468

Fair value of derivatives

1,222,090

Prepaid income taxes

1,954,788

1,140,094

Other current assets

920,224

632,154

Operating lease right-of-use assets

31,383

Total current assets

38,249,809

55,463,691

Non-current assets

Property and equipment:

Oil and gas properties, successful efforts method

Proved properties

154,190,226

148,326,265

Unproved properties

26,185,843

18,169,157

Accumulated depletion, depreciation, amortization and impairment

(111,142,288)

(107,729,293)

Total oil and gas properties, net

69,233,781

58,766,129

Gathering system

42,694,512

42,639,001

Accumulated depletion, depreciation, amortization and impairment

(35,241,595)

(34,500,740)

Total gathering system, net

7,452,917

8,138,261

Land

637,764

637,764

Buildings and other property and equipment, net

303,211

286,035

Total property and equipment, net

77,627,673

67,828,189

Other assets:

Operating lease right-of-use assets, long term

468,833

Restricted cash

495,000

570,363

Fair value of derivatives, long term

42,005

Prepaid drilling costs

2,891,250

Total non-current assets

81,524,761

68,398,552

Total assets

$

119,774,570

$

123,862,243

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities

Accounts payable trade

$

1,855,591

$

1,695,353

Gathering fees payable

556,437

935,012

Royalties payable

1,241,533

2,223,043

Accrued capital expenditures

195,917

41,694

Accrued compensation

631,646

598,351

Other accrued liabilities

556,814

690,655

Fair value of derivatives

126,508

Operating lease liabilities

55,656

35,299

Total current liabilities

5,220,102

6,219,407

Non-current liabilities

Asset retirement obligations

2,794,743

2,780,237

Deferred income taxes

11,805,453

10,617,394

Operating lease liabilities, long term

498,155

Total non-current liabilities

15,098,351

13,397,631

Total liabilities

20,318,453

19,617,038

Commitments and contingencies (Note 10)

Shareholders' equity

Preferred shares, no par value, unlimited shares authorized, none issued or outstanding

Common shares, no par value, unlimited shares authorized and 22,126,800 shares issued and outstanding at September 30, 2023 and 23,117,144 issued and outstanding at December 31, 2022

118,209,690

123,904,965

Additional paid-in capital

10,655,378

9,856,229

Accumulated deficit

(39,158,820)

(39,290,540)

Accumulated other comprehensive income

9,749,869

9,774,551

Total shareholders' equity

99,456,117

104,245,205

Total liabilities and shareholders' equity

$

119,774,570

$

123,862,243

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

5

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income

Three months ended September 30, 

Nine months ended September 30, 

    

2023

    

2022

    

2023

    

2022

Revenues from contracts with customers:

Gas, oil, NGL, and condensate revenue

$

3,241,531

$

19,171,121

$

14,509,184

$

48,566,282

Gas gathering and compression revenue

3,068,996

2,072,806

7,657,755

6,180,747

Total revenue

6,310,527

21,243,927

22,166,939

54,747,029

Operating costs and expenses:

Lease operating expenses

1,559,957

2,024,229

4,404,757

5,681,736

Gathering system operating expenses

631,725

600,672

1,854,000

1,666,275

Development geological and geophysical expenses

2,387

7,159

Depletion, depreciation, amortization, and accretion

1,392,032

1,706,030

4,780,766

4,898,988

Loss (gain) on sale of oil and gas properties

1,449,871

(221,642)

General and administrative expenses:

Stock based compensation expense

439,653

500,597

799,149

836,949

Other general and administrative expenses

1,540,358

2,015,272

5,160,757

4,651,547

Total operating costs and expenses

5,563,725

6,849,187

18,449,300

17,521,012

Operating income

746,802

14,394,740

3,717,639

37,226,017

Other income (expense):

Interest income

384,732

89,638

1,308,695

126,804

Interest expense

(8,760)

(17,501)

(71,619)

(33,565)

(Loss) gain on derivative contracts

(24,303)

(929,637)

1,672,535

(1,124,547)

Other income (expense), net

468

(32,777)

5,169

(99,896)

Other income (expense), net

352,137

(890,277)

2,914,780

(1,131,204)

Net income before income tax expense

1,098,939

13,504,463

6,632,419

36,094,813

Income tax expense

710,164

3,896,010

2,283,228

10,097,484

NET INCOME

$

388,775

$

9,608,453

$

4,349,191

$

25,997,329

Currency translation adjustments

(846)

(34,524)

(2,317)

(48,272)

Unrealized gain (loss) on securities

24,641

(22,365)

NET COMPREHENSIVE INCOME

$

412,570

$

9,573,929

$

4,324,509

$

25,949,057

Net income per share, basic

$

0.02

$

0.42

$

0.19

$

1.11

Net income per share, diluted

$

0.02

$

0.41

$

0.19

$

1.11

Weighted average number of shares outstanding, basic

22,118,984

23,011,729

22,616,539

23,419,666

Weighted average number of shares outstanding, diluted

22,178,686

23,169,658

22,631,550

23,524,574

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

6

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 January 1, 2023

23,117,144

$

123,904,965

$

$

9,856,229

$

9,774,551

$

(39,290,540)

$

104,245,205

Net income

3,529,827

3,529,827

Dividends paid

(1,412,455)

(1,412,455)

Stock-based compensation expense

179,748

179,748

Buyback of common shares

(237,920)

(1,367,425)

(1,367,425)

Retirement of treasury shares

(190,700)

(1,115,306)

190,700

1,115,306

Other comprehensive loss

(2,600)

(2,600)

Balance at March 31, 2023

22,926,444

$

122,789,659

(47,220)

$

(252,119)

$

10,035,977

$

9,771,951

$

(37,173,168)

$

105,172,300

Net income

430,589

430,589

Dividends paid

(1,416,147)

(1,416,147)

Stock-based compensation expense

179,748

179,748

Buyback of common shares

(325,055)

(1,687,350)

(1,687,350)

Retirement of treasury shares

(277,154)

(1,441,655)

277,154

1,441,655

Other comprehensive loss

(45,877)

(45,877)

Balance at June 30, 2023

22,649,290

$

121,348,004

(95,121)

$

(497,814)

$

10,215,725

$

9,726,074

$

(38,158,726)

$

102,633,263

Net income

388,775

388,775

Dividends paid

(1,388,869)

(1,388,869)

Stock-based compensation expense

439,653

439,653

Buyback of common shares

(525,000)

(2,640,500)

(2,640,500)

Retirement of treasury shares

(620,121)

(3,138,314)

620,121

3,138,314

Vesting of shares of restricted stock

97,631

Other comprehensive income

23,795

23,795

Balance at September 30, 2023

22,126,800

$

118,209,690

$

$

10,655,378

$

9,749,869

$

(39,158,820)

$

99,456,117

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

7

    

  

  

  

  

  

Accumulated

  

  

Other

Total

Common Shares Issued

Treasury Shares

Additional

Comprehensive

Accumulated

Shareholders'

Shares

Amount

Shares

Amount

paid-in Capital

Income

Deficit

Equity

Balance at January 1, 2022

24,202,218

$

131,815,739

(534,015)

$

(2,423,007)

$

8,835,203

$

9,818,605

$

(68,783,207)

$

79,263,333

Net income

5,805,888

5,805,888

Dividends paid

(1,483,027)

(1,483,027)

Stock-based compensation expense

142,302

142,302

Exercise of stock options

38,750

209,312

209,312

Retirement of treasury shares

(534,015)

(2,423,007)

534,015

2,423,007

Other comprehensive income

5,402

5,402

Balance at March 31, 2022

23,706,953

$

129,602,044

$

$

8,977,505

$

9,824,007

$

(64,460,346)

$

83,943,210

Net income

10,582,988

10,582,988

Dividends paid

(1,486,650)

(1,486,650)

Stock-based compensation expense

194,050

194,050

Exercise of stock options

72,500

399,475

399,475

Buyback of common shares

(697,100)

(4,554,822)

(4,554,822)

Retirement of treasury shares

(423,000)

(2,907,999)

423,000

2,907,999

Other comprehensive loss

(19,150)

(19,150)

Balance at June 30, 2022

23,356,453

$

127,093,520

(274,100)

$

(1,646,823)

$

9,171,555

$

9,804,857

$

(55,364,008)

$

89,059,101

Net income

9,608,453

9,608,453

Dividends paid

(1,453,043)

(1,453,043)

Stock-based compensation expense

500,597

500,597

Exercise of stock options

27,500

138,325

138,325

Buyback of common shares

(285,400)

(1,680,057)

(1,680,057)

Vesting of shares of restricted stock

187,155

Other comprehensive loss

(34,524)

(34,524)

Balance at September 30, 2022

23,571,108

$

127,231,845

(559,500)

$

(3,326,880)

$

9,672,152

$

9,770,333

$

(47,208,598)

$

96,138,852

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

8

EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Cash Flows

Nine months ended September 30, 

    

2023

    

2022

Cash flows from operating activities:

Net income

$

4,349,191

$

25,997,329

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

Depletion, depreciation, amortization, and accretion

4,780,766

4,898,988

Accretion of discount on available for sale securities

(574,341)

Gain on available for sale securities

(60,494)

Loss (gain) on sale of oil and gas properties

1,449,871

(221,642)

(Gain) loss on derivative contracts

(1,672,535)

1,124,547

Settlement received (paid) on derivative contracts

2,979,128

(1,396,698)

Settlement of asset retirement obligation

(3,482)

(118,259)

Stock-based compensation expense

799,149

836,949

Deferred income tax expense (benefit)

1,188,059

439,857

Changes in assets and liabilities:

Accounts receivable

3,195,108

(5,472,585)

Prepaid income taxes

(814,694)

Other assets and liabilities

(67,008)

(205,717)

Accounts payable, royalties payable and other accrued liabilities

(1,191,558)

1,511,652

Income taxes payable

2,021,246

Net cash provided by operating activities