Company Quick10K Filing
Epsilon Energy
Price3.78 EPS0
Shares27 P/E16
MCap104 P/FCF9
Net Debt-19 EBIT10
TEV85 TEV/EBIT9
TTM 2019-09-30, in MM, except price, ratios
10-Q 2020-06-30 Filed 2020-08-13
10-Q 2020-03-31 Filed 2020-05-13
10-K 2019-12-31 Filed 2020-03-18
10-Q 2019-09-30 Filed 2019-11-13
10-Q 2019-06-30 Filed 2019-08-16
10-Q 2019-03-31 Filed 2019-05-14
10-K 2018-12-31 Filed 2019-03-29
8-K 2020-09-01 Officers, Amend Bylaw, Shareholder Vote, Exhibits
8-K 2020-07-22 Officers
8-K 2020-07-22
8-K 2020-07-07
8-K 2020-02-27
8-K 2019-06-19
8-K 2019-05-20

EPSN 10Q Quarterly Report

Part I - Financial Information
Item 1. Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. - Exhibits
EX-31.1 epsn-20200630ex31193f71f.htm
EX-31.2 epsn-20200630ex312cac37b.htm
EX-32.1 epsn-20200630ex32193c269.htm
EX-32.2 epsn-20200630ex3224425dc.htm

Epsilon Energy Earnings 2020-06-30

Balance SheetIncome StatementCash Flow
1008060402002018201820192020
Assets, Equity
10.08.06.04.02.00.02018201820192020
Rev, G Profit, Net Income
10.07.24.41.5-1.3-4.12018201820192020
Ops, Inv, Fin

10-Q 1 epsn-20200630x10q.htm 10-Q

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 June 30, 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 1610

Houston, Texas 77060

(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 August 7, 2020 there were 23,796,637 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

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

10

Interim Financial Statements

10

Principles of Consolidation

10

Use of Estimates

10

Recently Issued Accounting Standards

10

3.

Cash, Cash Equivalents, and Restricted Cash

11

4.

Property and Equipment

12

Property Additions and Acquisitions

12

Property Impairment

12

5.

Revolving Line of Credit

12

6.

Shareholders’ Equity

14

7.

Revenue Recognition

16

8.

Accumulated Other Comprehensive Income (Loss)

17

9.

Income Taxes

18

10.

Commitments and Contingencies

18

Litigation

18

11.

Net Income Per Share

19

12.

Operating Segments

19

13.

Risk Management Activities

22

Commodity Price Risks

22

Commodity Derivative Contracts

23

14.

Asset Retirement Obligations

24

15.

Fair Value Measurements

24

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

25

Overview

25

Business Strategy

25

Operational Highlights

27

Non-GAAP Financial Measures-Adjusted EBITDA

28

Net Operating Revenues

29

Operating Costs

30

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

30

General and Administrative

31

Interest Expense

31

Net Gain (Loss) on Commodity Contracts

32


Miscellaneous Income (Expense)

32

Capital Resources and Liquidity

32

Cash Flow

32

Credit Agreement

33

Derivative Transactions

34

Contractual Obligations

34

Off-Balance Sheet Arrangements

35

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

35

Gathering System Revenue Risk

35

Interest Rate Risk

35

Commodity Contracts

35

ITEM 4. CONTROLS AND PROCEDURES

35

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

35

Changes in Internal Control Over Financial Reporting

36

PART II OTHER INFORMATION

36

ITEM 1. LEGAL PROCEEDINGS

36

ITEM 1A. RISK FACTORS

36

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

38

SIGNATURES

38


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 the 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 and quarterly report on Form 10-Q for the quarter ended March 31, 2020 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

    

June 30, 

    

December 31, 

2020

2019

ASSETS

Current assets

Cash and cash equivalents

$

16,305,204

$

14,052,417

Accounts receivable, net of allowance for doubtful accounts of $819,000 at June 30, 2020 and nil at December 31, 2019

3,306,646

4,296,917

Fair value of derivatives

1,257,702

1,999,802

Prepaid income taxes

1,515,952

1,641,501

Other current assets

199,441

433,687

Total current assets

22,584,945

22,424,324

Non-current assets

Property and equipment:

Oil and gas properties, successful efforts method

Proved properties

132,997,655

130,819,256

Unproved properties

21,175,910

21,047,512

Accumulated depletion, depreciation, amortization and impairment

(94,789,633)

(89,255,035)

Total oil and gas properties, net

59,383,932

62,611,733

Gathering system

41,587,171

41,445,225

Accumulated depletion, depreciation, amortization and impairment

(31,064,707)

(29,961,690)

Total gathering system, net

10,522,464

11,483,535

Land

375,314

375,314

Buildings and other property and equipment, net

350,270

211,879

Total property and equipment, net

70,631,980

74,682,461

Other assets:

Restricted cash

564,248

561,294

Prepaid drilling costs

2,425

1,124

Total non-current assets

71,198,653

75,244,879

Total assets

$

93,783,598

$

97,669,203

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities

Accounts payable trade

$

1,542,637

$

2,828,495

Royalties payable

1,095,343

1,306,922

Accrued capital expenditures

197,158

627,356

Accrued gathering fees

615,548

373,929

Other accrued liabilities

386,686

858,188

Asset retirement obligation

1,555,075

1,503,978

Total current liabilities

5,392,447

7,498,868

Non-current liabilities

Asset retirement obligation

1,459,838

1,405,877

Deferred income taxes

12,399,263

12,401,464

Total non-current liabilities

13,859,101

13,807,341

Total liabilities

19,251,548

21,306,209

Commitments and contingencies (Note 10)

Shareholders' equity

Common shares, no par value, unlimited shares authorized and 26,790,985 issued and 26,133,671 shares outstanding at June 30, 2020 and 26,790,985 shares issued and outstanding at December 31, 2019.

140,808,923

140,808,923

Treasury shares, 657,314 at June 30, 2020

(1,927,198)

Additional paid-in capital

7,375,459

7,029,488

Accumulated deficit

(81,541,630)

(81,285,895)

Accumulated other comprehensive income

9,816,496

9,810,478

Total shareholders' equity

74,532,050

76,362,994

Total liabilities and shareholders' equity

$

93,783,598

$

97,669,203

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 June 30, 

Six months ended June 30, 

    

2020

    

2019

    

2020

    

2019

Revenues from contracts with customers:

Gas, oil, NGLs and condensate revenue

$

4,015,047

$

4,498,478

$

8,126,191

$

10,006,141

Gas gathering and compression revenue

2,263,740

2,265,094

4,580,442

4,703,445

Total revenue

6,278,787

6,763,572

12,706,633

14,709,586

Operating costs and expenses:

Lease operating expenses

2,034,120

1,583,895

4,081,887

3,302,188

Gathering system operating expenses

79,702

238,886

177,480

551,673

Development geological and geophysical expenses

2,273

83,748

4,902

83,748

Depletion, depreciation, amortization, and accretion

2,577,770

1,953,171

4,992,146

3,778,903

Impairment of proved properties

1,760,000

Gain on sale of property

(929,827)

(929,827)

Bad debt expense

819,000

819,000

General and administrative expenses:

Stock based compensation expense

172,052

133,721

345,971

267,441

Other general and administrative expenses

1,236,729

921,307

2,244,842

2,260,868

Total operating costs and expenses

6,921,646

3,984,901

14,426,228

9,314,994

Operating income (loss)

(642,859)

2,778,671

(1,719,595)

5,394,592

Other income (expense):

Interest income

13,041

46,598

34,570

89,289

Interest expense

(28,317)

(29,010)

(56,323)

(56,619)

Gain (loss) on derivative contracts

(85,348)

2,734,988

1,635,669

2,224,234

Other income (expense)

(3)

431

(2,227)

454

Other income (expense), net

(100,627)

2,753,007

1,611,689

2,257,358

Income (loss) before income tax expense

(743,486)

5,531,678

(107,906)

7,651,950

Income tax expense (recovery)

(177,452)

1,693,820

147,829

2,440,416

NET INCOME (LOSS)

$

(566,034)

$

3,837,858

$

(255,735)

$

5,211,534

Currency translation adjustments

6,132

1,052

6,018

11,844

NET COMPREHENSIVE INCOME (LOSS)

$

(559,902)

$

3,838,910

$

(249,717)

$

5,223,378

Net income (loss) per share, basic

$

(0.02)

$

0.14

$

(0.01)

$

0.19

Net income (loss) per share, diluted

$

(0.02)

$

0.14

$

(0.01)

$

0.19

Weighted average number of shares outstanding, basic

26,147,403

27,172,896

26,356,244

27,207,467

Weighted average number of shares outstanding, diluted

26,147,403

27,215,258

26,356,244

27,236,364

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, 2020

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 loss

(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

Net loss

(566,034)

(566,034)

Stock-based compensation expenses

172,052

172,052

Buyback of common shares

(169,285)

(427,612)

(427,612)

Other comprehensive income

6,132

6,132

Balance at June 30, 2020

26,790,985

$

140,808,923

(657,314)

$

(1,927,198)

$

7,375,459

$

9,816,496

$

(81,541,630)

$

74,532,050

    

  

  

  

  

  

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, 2019

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 income

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

Net income

3,837,858

3,837,858

Stock-based compensation expenses

133,721

133,721

Buyback of common shares

(237,189)

(985,264)

(985,264)

Other comprehensive income

1,052

1,052

Balance at June 30, 2019

27,355,247

$

143,362,642

(237,189)

$

(985,264)

$

6,786,469

$

9,809,774

$

(84,772,360)

$

74,201,261

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

7


EPSILON ENERGY LTD.

Unaudited Condensed Consolidated Statements of Cash Flows

Six months ended June 30, 

    

2020

    

2019

Cash flows from operating activities:

Net income (loss)

$

(255,735)

$

5,211,534

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

Depletion, depreciation, amortization, and accretion

4,992,146

3,778,903

Impairment of proved properties

1,760,000

Bad debt expense

819,000

Gain on sale/disposal of properties

(929,827)

Gain on derivative contracts

(1,635,669)

(2,224,234)

Cash received from (paid for) settlements of derivative contracts

2,377,769

187,420

Stock-based compensation expense

345,971

267,441

Deferred income tax expense (benefit)

(2,201)

2,393,228

Changes in assets and liabilities:

Accounts receivable

171,271

1,473,287

Prepaid income taxes and other current assets

359,795

(595,604)

Accounts payable, royalties payable and other accrued liabilities

(630,262)

(1,526,708)

Net cash provided by operating activities

8,302,085

8,035,440

Cash flows from investing activities:

Acquisition of unproved oil and gas properties

(596,500)

Additions to unproved oil and gas properties

(128,398)

(822,006)

Additions to proved oil and gas properties

(3,691,409)

(1,846,040)

Additions to gathering system properties

(152,256)

(163,075)

Additions to land, buildings and property and equipment

(151,800)

Prepaid drilling costs

(1,301)

(2,101,510)

Proceeds from sale of leases

929,827

Net cash used in investing activities

(4,125,164)

(4,599,304)

Cash flows from financing activities:

Buyback of common shares

(1,927,198)

(1,233,645)

Net cash used in financing activities

(1,927,198)

(1,233,645)

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

6,018

11,844

Increase in cash, cash equivalents and restricted cash

2,255,741

2,214,335

Cash, cash equivalents and restricted cash, beginning of period

14,613,711

14,959,518

Cash, cash equivalents and restricted cash, end of period

$

16,869,452

$

17,173,853

Supplemental cash flow disclosures:

Income taxes paid

$

$

733,200

Interest paid

$

56,323

$

60,401

Non-cash investing activities:

Change in proved properties accrued in accounts payable and accrued liabilities

$

(1,516,946)

$

12,198

Change in gathering system accrued in accounts payable and accrued liabilities

$

(10,310)

$

82,550

Asset retirement obligation asset additions and adjustments

$

3,937

$

7,975

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.” 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 drastic global economic downturn. While Epsilon did not incur significant disruptions to operations during the six months ended June 30, 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. The full impact of the COVID-19 pandemic continues to evolve as of the date of this report. As such, the full magnitude that the pandemic will have on the Company’s financial condition, liquidity, and future results of operations is uncertain. Management is actively monitoring the impact of the COVID-19 pandemic on the Company's financial condition, liquidity, operations, suppliers, industry and ability to obtain financing in future reporting periods. Given the daily evolution of the COVID-19 pandemic and the global responses to curb its spread, the Company is currently not able to estimate the effects of the COVID-19 pandemic on its results of operations, financial condition, or liquidity for fiscal year 2020. However, if the pandemic and the low oil price environment continue, it may have a material adverse effect on the Company’s operating cash flows, liquidity, and future development plans.

The federal government has passed a series of relief and stimulus packages, including the CARES Act, for the country, but Epsilon has not and does not anticipate that it will apply for assistance under such programs. Accordingly, these programs have no effect on Epsilon’s financial statements

On June 28, 2020, Chesapeake Energy Corporation (“CHK”) filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code (“Petition”). Chesapeake Energy Marketing, Inc. is one of the Anchor Shippers under the Anchor Ship Gas Gathering Agreement (“ASGGA”) for the Auburn GGS with a 43.8750% voting percentage. The Williams Companies Inc. (“Williams”), including its subsidiary Appalachia Midstream Services, L.L.C. (“AMS”), is listed in the petition as a top 30 creditor of CHK, with an amount due by CHK under the ASGGA. On June 28, 2020 unpaid fees attributable to CHK for the ASGA for May and June 2020 gathering fees were $1.1 million and $1.3 million respectively. As of June 30, 2020, Epsilon has recorded an allowance for doubtful accounts for the Company’s 35% share of these payments for a total bad debt expense of $0.8 million. Epsilon is a 35% owner in the ASGGA. Whether and when these pre-petition amounts are paid depends on how the bankruptcy proceeding unfolds related to the ASGGA. Pre-petition amounts are handled differently than post-petition amounts (amounts for services related to CHK’s production after June 28, 2020).  The general rule post-petition is that, if CHK wants to receive the continued provision of services under the ASGGA, Williams is required to continue to perform under the ASGGA provided that Williams is paid for such performance.  Currently, CHK continues to produce into the gathering system, and drill and complete wells in the areas covered by the ASGGA. In addition, certain wells that we have interests in are scheduled to begin production in October 2020.

The Company is unable to predict the impact that the COVID-19 pandemic and the CHK bankruptcy will have on it, including our financial position, operating results, liquidity and ability to obtain financing in future reporting periods, due to numerous uncertainties.

9


Table of Contents

Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated 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 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. The Company is currently assessing the impact of adopting this new guidance.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

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. The Company is currently assessing the impact of adopting this new guidance.

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.

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 June 30, 2020 and December 31, 2019:

    

June 30, 

    

December 31, 

2020

2019

Cash and cash equivalents

$

16,305,204

$

14,052,417

Restricted cash included in other assets

564,248

561,294

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

$

16,869,452

$

14,613,711

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

4.  Property and Equipment

The following table summarizes the Company’s property and equipment as at June 30, 2020 and December 31, 2019:

    

June 30, 

    

December 31, 

2020

2019

Property and equipment:

Oil and gas properties, successful efforts method

Proved properties

$

132,997,655

$

130,819,256

Unproved properties

21,175,910

21,047,512

Accumulated depletion, depreciation, amortization and impairment

(94,789,633)

(89,255,035)

Total oil and gas properties, net

59,383,932

62,611,733

Gathering system

41,587,171

41,445,225

Accumulated depletion, depreciation, amortization and impairment

(31,064,707)

(29,961,690)

Total gathering system, net

10,522,464

11,483,535

Land

375,314

375,314

Buildings and other property and equipment, net

350,270

211,879

Total property and equipment, net

$

70,631,980

$

74,682,461

Property Additions and Acquisitions

No acquisitions were made during the six months ended June 30, 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. No subsequent sales have occurred.

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 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 further impairment was required at June 30, 2020 and 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.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

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 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.

The Company was in compliance with the financial covenants of the Credit Facility as of June 30, 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

    

    

June 30, 

    

December 31, 

Current

Interest Rate

    

2020

2019

    

Borrowing Base

    

3 mo.

Revolving line of credit

$

$

$

23,000,000

LIBOR + 2.75% (1)


(1)At June 30, 2020, the weighted average interest rate was 3.05%.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

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.

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 was 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 ended on May 19, 2020, but Epsilon’s final repurchase under this program occurred on May 8, 2020.

Repurchases were made at management’s discretion from time to time through the facilities of the NASDAQ Global Market. The price paid for the common shares was, 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 funded the purchase out of available cash and did not incur debt to fund the share repurchase program.

The following table contains information about our acquisition of equity securities during the six months ended June 30, 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 through December 31, 2019 (1)

696,096

$

3.72

January 2020

102,051

$

2.95

February 2020

261,519

$

3.11

March 2020

124,459

$

2.98

April 2020

156,585

$

2.48

May 2020

12,700

$

2.91

Total as of June 30, 2020

1,353,410

$

3.33

1,353,410

14,352


(1)Shares purchased through December 31, 2019 were cancelled prior to the year ended December 31, 2019.

(c)

Stock Options

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

Through June 30, 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

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

subsidiaries. A maximum amount of 755,000 Common Shares is available for future issuances. These 245,000 options have a weighted average expected remaining term of approximately 3.0 years.

The following table summarizes stock option activity for the six months ended June 30, 2020 and the year ended December 31, 2019:

Six months ended

Year ended

June 30, 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 June 30, 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 June 30, 2020 was nil (at December 31, 2019: nil). For the three and six months ended June 30, 2020, nil and $1,867, respectively, of stock compensation expense was recognized (for the three and six months ended June 30, 2019, $6,301 and $12,602, respectively).

During the six months ended June 30, 2020 and the year ended December 31, 2019, the Company awarded no stock options.

(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 six months ended June 30, 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 and six months ended June 30, 2020 was $172,052 and $344,104, respectively (for the three and six months ended June 30, 2019, $127,420 and $254,839, respectively).

At June 30, 2020, the Company had unrecognized stock based compensation related to these shares of $965,491 to be recognized over a weighted average period of 1.09 years (at December 31, 2019: $1,309,594 over 1.34 years).

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

The following table summarizes Restricted Stock activity for the six months ended June 30, 2020, and the year ended December 31, 2019:

Six months ended

Year ended

June 30, 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

1.17

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.

Overall, product sales revenue generally is recorded in the month when contractual delivery obligations are satisfied, which occurs when control is transferred to the Company’s customers at delivery based on contractual terms and conditions. In addition, gathering and compression revenue generally is recorded in the month when contractual service obligations are satisfied, which occurs as control of those services is transferred to the Company’s customers.

The following table details revenue for the three and six months ended June 30, 2020 and 2019.

    

Three months ended June 30, 

Six Months Ended June 30, 

2020

    

2019

    

2020

    

2019

Operating revenue

Natural gas

$

3,876,340

$

4,330,013

$

7,896,104

$

9,764,948

Natural gas liquids

10,204

50,860

41,862

64,351

Oil and condensate

128,503

117,605

188,225

176,842

Gathering and compression fees

2,263,740

2,265,094

4,580,442

4,703,445

Total operating revenue

$

6,278,787

$

6,763,572

$

12,706,633

$

14,709,586

Product Sales Revenue

The Company enters into contracts with third party purchasers to sell its natural gas, oil, NGLs and condensate production. Under these product sales arrangements, the sale of each unit of product represents a distinct performance obligation. Product sales revenue is recognized at the point in time that control of the product transfers to the purchaser based on contractual terms which reflect prevailing commodity market prices. To the extent that marketing costs are incurred by the Company prior to the transfer of control of the product, those costs are included in lease operating expenses on the Company’s consolidated statements of operations.

Settlement statements for product sales, and the related cash consideration, are received from the purchaser within 30 days. 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, oil, NGLs, 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.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

Gas Gathering and Compression Revenue

The Company also provides natural gas gathering and compression services through its ownership interest in the gas gathering system in the Auburn field. For the provision of gas gathering and compression services, the Company collects its share of the gathering and compression fees per unit of gas serviced and recognizes gathering revenue over time using an output method based on units of gas gathered.

The settlement statement from the operator of the Auburn Gas Gathering System 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. Estimated revenue due to the Company is recorded within the receivables line item on the accompanying consolidated balance sheets until payment is received.

Allowance for Doubtful Accounts

The Company records an allowance for doubtful accounts on a case by case basis once there is evidence that collection is not probable. Due to the bankruptcy filed by Chesapeake Energy Corporation on June 28, 2020, the Company recorded an allowance for possible uncollectable fees. Unpaid fees attributable to CHK for May and June 2020 gathering system fees were $1.1 million and $1.3 million respectively. As of June 30, 2020, Epsilon has recorded an allowance for doubtful accounts for the Company’s 35% share of these payments for a total bad debt expense of $0.8 million.

The following table details accounts receivable net of allowance for doubtful accounts as at June 30, 2020 and December 31, 2019.

    

June 30, 

    

December 31, 

2020

2019

Accounts receivable

Natural gas and oil sales

$

2,286,937

$

2,293,044

Joint interest billing

56,544

59,127

Gathering and compression fees

1,778,289

1,940,308

Other

3,876

4,438

Total accounts receivable

4,125,646

4,296,917

Less: allowance for doubtful accounts

(819,000)

Total accounts receivable, net of allowance for doubtful accounts

$

3,306,646

$

4,296,917

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 for the three and six months ended June 30, 2020 and 2019 consisted of the following:

    

Three months ended June 30, 

Six Months Ended June 30, 

2020

    

2019

    

2020

    

2019

Balance at beginning of period

$

9,810,364

$

9,808,722

$

9,810,478

$

9,797,930

Translation gain other

6,132

1,052

6,018

11,844

Balance at end of period

$

9,816,496

$

9,809,774

$

9,816,496

$

9,809,774

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

9. Income Taxes

Income tax provisions for the three and six months ended June 30, 2020 and 2019 are as follows:

Three months ended June 30, 

Six months ended June 30, 

    

2020

    

2019

    

2020

    

2019

Current:

Federal

$

(185,473)

$

$

112,390

$

State

(59,256)

47,188

37,640

47,188

Total current income tax expense

(244,729)

47,188

150,030

47,188

Deferred:

Federal

64,367

1,228,821

(66,714)

1,765,861

State

2,910

417,811

64,513

627,367

Total deferred tax expense (benefit)

67,277

1,646,632

(2,201)

2,393,228

Income tax expense

$

(177,452)

$

1,693,820

$

147,829

$

2,440,416

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 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 six months ended June 30, 2020 was 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 June 30, 2020 are summarized in the following table:

Year ended

    

December 31, 

    

Payments

2020

50,294

2021

103,073

2022

106,797

2023

36,013

$

296,177

The Company enters into commitments for capital expenditures in advance of the expenditures being made. As of June 30, 2020, the Company had commitments of $2.52 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.

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Epsilon Energy Ltd.

Notes to the Unaudited Condensed Consolidated Financial Statements

11. Net Income (Loss) Per Share

Basic net income (loss) per share is computed on the basis of the weighted-average number of common shares outstanding during the period. Diluted net income (loss) 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 (loss) used in the calculation of basic and diluted net income (loss) per share is as follows:

Three months ended June 30, 

Six months ended June 30, 

    

2020

    

2019

    

2020

    

2019

Net income (loss) available to shareholders

$

(566,034)

$

3,837,858

$

(255,735)

$

5,211,534

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