Epsilon Energy .(EPSN) - 2023 Q2 - Quarterly Report

FORWARD-LOOKING STATEMENTS This section cautions that forward-looking statements are subject to risks and uncertainties, and actual results may vary - The report contains forward-looking statements based on reasonable assumptions, but actual results may differ due to known and unknown risks and uncertainties. These statements are made as of the report date, and the company undertakes no obligation to update them, except as required by law[13] PART I - FINANCIAL INFORMATION This section provides Epsilon Energy Ltd.'s unaudited condensed consolidated financial statements and management's analysis for the period ended June 30, 2023 ITEM 1. FINANCIAL STATEMENTS This section presents the unaudited condensed consolidated financial statements of Epsilon Energy Ltd. for the period ended June 30, 2023, including balance sheets, statements of operations, changes in shareholders' equity, and cash flows, along with detailed notes explaining the company's business, accounting policies, and significant financial activities Unaudited Condensed Consolidated Balance Sheets This section presents the company's financial position, detailing assets, liabilities, and equity at specific reporting dates Condensed Consolidated Balance Sheet Highlights | Metric | June 30, 2023 | December 31, 2022 | | :-------------------------------- | :-------------- | :------------------ | | Total current assets | $43,558,398 | $55,463,691 | | Total non-current assets | $77,595,506 | $68,398,552 | | Total assets | $121,153,904| $123,862,243 | | Total current liabilities | $4,375,421 | $6,219,407 | | Total non-current liabilities | $14,145,220 | $13,397,631 | | Total liabilities | $18,520,641 | $19,617,038 | | Total shareholders' equity | $102,633,263 | $104,245,205 | - Total assets decreased by approximately $2.7 million from December 31, 2022, to June 30, 2023, primarily driven by a significant reduction in cash and cash equivalents, partially offset by an increase in short-term investments and property and equipment[17] Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) This section details the company's financial performance, including revenues, expenses, and net income over specific periods Condensed Consolidated Statements of Operations Highlights | Metric | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | | :--------------------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Total revenue | $6,500,136 | $19,903,004 | $15,856,412 | $33,503,102 | | Operating income (loss) | $(353,292) | $13,866,083 | $2,970,837 | $22,831,277 | | Net income | $430,589 | $10,582,988 | $3,960,416 | $16,388,876 | | Net income per share, basic | $0.02 | $0.45 | $0.17 | $0.69 | | Net income per share, diluted | $0.02 | $0.44 | $0.17 | $0.69 | - Total revenue for the six months ended June 30, 2023, decreased by 53% year-over-year, primarily due to lower natural gas, oil, and NGL prices. Net income for the six months ended June 30, 2023, also saw a significant decline of 75.8% compared to the same period in 2022[18] Unaudited Condensed Consolidated Statements of Changes in Shareholders' Equity This section outlines the movements in the company's equity accounts, reflecting net income, dividends, and share transactions Changes in Shareholders' Equity (Six Months Ended June 30, 2023) | Item | Balance at Jan 1, 2023 | Net Income | Dividends Paid | Stock-based Comp. | Buyback of Shares | Retirement of Shares | Other Comp. Loss | Balance at Jun 30, 2023 | | :----------------------- | :--------------------- | :--------- | :------------- | :---------------- | :---------------- | :------------------- | :--------------- | :---------------------- | | Common Shares (Amount) | $123,904,965 | — | — | — | — | $(2,556,961) | — | $121,348,004 | | Treasury Shares (Amount) | — | — | — | — | $(3,054,775) | $2,556,961 | — | $(497,814) | | Additional Paid-in Capital | $9,856,229 | — | — | $359,496 | — | — | — | $10,215,725 | | Accumulated Deficit | $(39,290,540) | $3,960,416 | $(2,828,602) | — | — | — | — | $(38,158,726) | | Total Shareholders' Equity | $104,245,205 | $3,960,416 | $(2,828,602) | $359,496 | $(3,054,775) | — | $(48,477) | $102,633,263 | - Total shareholders' equity decreased by approximately $1.6 million from January 1, 2023, to June 30, 2023, primarily due to dividends paid and share buybacks, partially offset by net income and stock-based compensation[21] Unaudited Condensed Consolidated Statements of Cash Flows This section summarizes the cash inflows and outflows from operating, investing, and financing activities Condensed Consolidated Statements of Cash Flows Highlights (Six Months Ended June 30) | Cash Flow Activity | 2023 | 2022 | | :----------------- | :------------ | :------------ | | Operating activities | $10,201,727 | $15,762,534 | | Investing activities | $(40,000,732) | $(4,981,904) | | Financing activities | $(6,023,377) | $(6,317,293) | | End of period cash, cash equivalents, and restricted cash | $9,983,094| $31,515,012 | - Net cash provided by operating activities decreased by 35% in the first six months of 2023 compared to 2022. Cash used in investing activities significantly increased to $40.0 million in 2023, primarily due to substantial investments in U.S. Treasury Bills and leasehold/development costs[25] Notes to the Unaudited Condensed Consolidated Financial Statements This section provides detailed explanations of the company's accounting policies, significant transactions, and financial statement line items 1. Description of Business This note describes Epsilon Energy Ltd.'s core operations as an independent natural gas and oil company in North America - Epsilon Energy Ltd. 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. The company trades on the NASDAQ Global Market under the symbol "EPSN"[28] 2. Basis of Preparation This note details the accounting principles, consolidation methods, significant estimates, and new accounting standards adopted for the financial statements - The financial statements are prepared in accordance with GAAP for interim financial information and SEC rules, with certain information condensed or omitted. The company consolidates its wholly-owned subsidiaries and uses proportionate consolidation for its undivided interest in the gathering system[29][30] - Significant estimates include proved natural gas and oil reserves, asset retirement obligations, and valuation of commodity derivative instruments. Epsilon, as an emerging growth company, has elected to defer adoption of certain new accounting standards[31][33] - The company adopted ASU 2016-13 (Credit Losses) and ASU 2020-04 (Reference Rate Reform) as of January 1, 2023, with no impact from their adoption[35][36] 3. Cash, Cash Equivalents, and Restricted Cash This note provides a breakdown of the company's cash, cash equivalents, and restricted cash balances Cash, Cash Equivalents, and Restricted Cash | Category | June 30, 2023 | December 31, 2022 | | :-------------------------------------------------- | :-------------- | :------------------ | | Cash and cash equivalents | $9,488,094 | $45,236,584 | | Restricted cash included in other assets | $495,000 | $570,363 | | Total cash, cash equivalents, and restricted cash | $9,983,094 | $45,806,947 | - Restricted cash is for potential well liabilities and is presented with cash and cash equivalents in the Consolidated Statements of Cash Flows[38] 4. Short Term Investments This note details the composition and reclassification of short-term investments, primarily US Treasury Bills, and related gains - Short-term investments consist of US Treasury Bills. In May 2023, the company reclassified all held-to-maturity short-term investments to available-for-sale due to a change in business strategy, resulting in an unrealized loss of $5,666 recorded in accumulated other comprehensive income[39] Available-for-Sale Short Term Investments (June 30, 2023) | Investment | Amortized Cost | Unrealized Losses | Fair Value | | :----------------- | :------------- | :---------------- | :--------- | | U.S. Treasury Bills | $26,851,488 | $(47,006) | $26,804,482| - During the three and six months ended June 30, 2023, the company sold securities with a carrying amount of $6,304,814 for total proceeds of $6,352,473, realizing gains of $47,659 to fund capital expenditures[42] 5. Property and Equipment This note details the company's property and equipment, including oil and gas properties, gathering systems, and recent acquisitions and dispositions Property and Equipment, Net | Category | June 30, 2023 | December 31, 2022 | | :------------------------------------ | :-------------- | :------------------ | | Total oil and gas properties, net | $68,007,294 | $58,766,129 | | Total gathering system, net | $7,646,776 | $8,138,261 | | Land | $637,764 | $637,764 | | Buildings and other property and equipment, net | $312,830 | $286,035 | | Total property and equipment, net | $76,604,664 | $67,828,189 | - During Q2 2023, Epsilon made three acquisitions totaling $12.1 million: a 10% interest in two New Mexico wellbores ($2.1 million), a 25% working interest in 1,297 gross acres in Ector County, Texas ($3.7 million with $1.6 million completion commitment), and a 25% working interest in 11,067 gross acres in Ector County, Texas ($6.3 million)[44][45] - The company sold two Oklahoma wellbore-only assets for $12,498 during Q2 2023, resulting in a $1.45 million loss, compared to a $0.22 million gain from a similar sale in Q2 2022[45] 6. Revolving Line of Credit This note describes the new revolving credit facility, its terms, security, and financial covenants - Epsilon closed a new senior secured reserve-based revolving credit facility with Frost Bank on June 28, 2023, replacing its previous facility. The initial commitment and borrowing base is $35 million, with interest at Daily Simple SOFR plus 3.25%[48][51] - The facility is secured by assets of Epsilon Energy USA and requires adherence to financial covenants: a current ratio of 1.0 to 1.0 and a leverage ratio of less than 2.5 to 1.0. The company was in compliance as of June 30, 2023, with no current borrowings[49][50] 7. Shareholders' Equity This note details share repurchase programs, stock-based compensation expenses, and dividend declarations impacting shareholders' equity - The Board authorized a new share repurchase program on March 9, 2023, to buy back up to 2,292,644 common shares (10% of outstanding) for up to $15.0 million. As of June 30, 2023, 372,275 shares were repurchased under this new plan at an average price of $5.19 per share[53][54] - For the six months ended June 30, 2023, Epsilon repurchased a total of 562,975 shares at an average price of $5.40 per share under two consecutive repurchase programs[56] Stock-Based Compensation Expense (Six Months Ended June 30) | Award Type | 2023 | 2022 | | :-------------------- | :---------- | :---------- | | Restricted Stock | $330,128 | $241,972 | | Performance Share Units | $29,368 | $94,380 | | Total | $359,496| $336,352| - The company declared quarterly dividends of $0.0625 per common share (annualized $0.25) on March 3, 2023, and June 6, 2023, totaling approximately $2.8 million for the six months ended June 30, 2023[71] 8. Revenue Recognition This note explains the company's revenue sources and recognition policies for product sales and gathering services - Revenues are derived from sales of natural gas, oil, and NGLs, and from the company's ownership interest in the Auburn gas gathering system. Product sales revenue is recognized when control transfers to the purchaser, while gathering and compression revenue is recognized over time using an output method[72][73][76][78] Operating Revenue Breakdown (Six Months Ended June 30) | Revenue Source | 2023 | 2022 | | :--------------------- | :------------ | :------------ | | Natural gas | $9,262,873 | $26,687,432 | | Natural gas liquids | $441,283 | $1,002,825 | | Oil and condensate | $1,563,497 | $1,704,904 | | Gathering and compression fees | $4,588,759 | $4,107,941 | | Total operating revenue | $15,856,412 | $33,503,102 | Accounts Receivable Breakdown (June 30, 2023 vs. December 31, 2022) | Category | June 30, 2023 | December 31, 2022 | | :-------------------------- | :-------------- | :------------------ | | Natural gas and oil sales | $2,238,717 | $5,696,419 | | Gathering and compression fees | $1,604,093 | $1,483,956 | | Total accounts receivable | $4,355,076 | $7,201,386 | 9. Income Taxes This note details the company's income tax expense, effective tax rate, and potential dividend withholding tax implications Income Tax Expense (Six Months Ended June 30) | Category | 2023 | 2022 | | :-------------------- | :------------ | :------------ | | Total current income tax expense | $1,342,737 | $5,882,148 | | Total deferred tax expense | $230,327 | $319,326 | | Income tax expense| $1,573,064| $6,201,474| - The effective tax rate for the six months ended June 30, 2023, was higher than the statutory federal rate due to state income taxes and a valuation allowance against the Canadian net operating loss[85] - Starting in 2023, distributions of Epsilon Energy USA Inc. earnings to Epsilon Energy Ltd. are expected to incur a 5% U.S. dividend withholding tax, subject to treaty eligibility[86] 10. Commitments and Contingencies This note outlines the company's capital expenditure commitments and ongoing legal proceedings - As of June 30, 2023, the company had commitments of $1.6 million for capital expenditures[87] - Epsilon is involved in ongoing litigation against Chesapeake Appalachia, LLC, alleging breach of settlement and operating agreements related to the Auburn Development. The matter is currently stayed pending a decision on appeal from the Third Circuit[88][91] 11. Leases This note details the company's operating lease assets, liabilities, costs, and future minimum lease payment obligations Operating Lease Assets and Liabilities | Category | June 30, 2023 | December 31, 2022 | | :------------------------------------ | :-------------- | :------------------ | | Total operating lease right-of-use assets | $495,842 | $31,383 | | Total operating lease liabilities | $544,400 | $35,299 | | Operating lease costs | $71,652 | $32,097 | - The company commenced a new 70-month office lease on March 1, 2023, with estimated future lease payments of approximately $0.85 million[93] Future Minimum Lease Payments (as of June 30, 2023) | Year | Operating Leases | | :--- | :--------------- | | 2023 | $0 | | 2024 | $134,750 | | 2025 | $173,550 | | 2026 | $177,021 | | 2027 | $180,492 | | Thereafter | $183,963 | | Total minimum lease payments | $849,776 | 12. Net Income Per Share This note provides the calculation of basic and diluted net income per share, including weighted-average shares and anti-dilutive exclusions Net Income and Weighted-Average Shares (Six Months Ended June 30) | Metric | 2023 | 2022 | | :------------------------------------ | :------------ | :------------ | | Net income | $3,960,416 | $16,388,876 | | Basic weighted-average shares outstanding | 22,869,440 | 23,627,015 | | Diluted weighted average shares outstanding | 22,904,922 | 23,796,166 | Anti-Dilutive Shares Excluded from EPS (Six Months Ended June 30) | Category | 2023 | 2022 | | :------------------------------------ | :------ | :------ | | Anti-dilutive options | 64,606 | 77,870 | | Anti-dilutive unvested time-based restricted shares | 275,872 | 169,127 | | Anti-dilutive unvested performance-based restricted shares | 8,083 | 41,319 | | Total Anti-dilutive shares | 348,561 | 288,316 | 13. Operating Segments This note describes the company's three reportable segments and provides their respective operating income and total assets - Epsilon operates through three reportable segments: Upstream (acquisition, development, production of oil/gas), Gas Gathering (operating a natural gas gathering system), and Corporate (G&A, interest income, corporate functions)[99] Segment Operating Income (Loss) (Six Months Ended June 30) | Segment | 2023 | 2022 | | :-------------- | :------------ | :------------ | | Upstream | $3,373,766 | $22,581,214 | | Gas Gathering | $3,576,936 | $3,222,690 | | Corporate | $(3,979,865) | $(2,972,627) | | Consolidated| $2,970,837| $22,831,277 | Segment Total Assets (June 30) | Segment | 2023 | 2022 | | :-------------- | :------------ | :------------ | | Upstream | $68,957,888 | $59,601,665 | | Gas Gathering | $7,646,776 | $8,571,168 | | Corporate | $44,549,240 | $42,627,454 | | Consolidated| $121,153,904| $110,800,287| 14. Commodity Risk Management Activities This note details the company's use of derivative instruments to manage commodity price risk and their financial impact - Epsilon uses commodity derivative instruments (NYMEX Henry Hub swaps and Tennessee Z4 basis swaps) to manage exposure to natural gas price fluctuations and protect operating revenues and cash flows, without designating them as accounting hedges[103][105][107] Gain (Loss) on Derivative Contracts (Six Months Ended June 30) | Metric | 2023 | 2022 | | :------------------------------------ | :------------ | :------------ | | Gain (loss) on derivative contracts | $1,696,838 | $(194,910) | | Cash received (paid) on settlements | $1,632,858 | $(1,375,287) | Net Fair Value of Derivatives | Category | June 30, 2023 | December 31, 2022 | | :-------------------- | :-------------- | :------------------ | | Net Fair Value of Derivatives | $1,286,070 | $1,222,090 | 15. Asset Retirement Obligations This note provides the estimated asset retirement obligations and the changes in these liabilities during the period - Epsilon's total asset retirement obligations were estimated at $2.8 million as of June 30, 2023, consistent with December 31, 2022, based on a net future undiscounted liability of approximately $7.4 million[110] Changes in Asset Retirement Obligations (Six Months Ended June 30, 2023) | Item | Amount | | :-------------------------- | :----- | | Balance beginning of period | $2,780,237 | | Liabilities acquired | $4,640 | | Liabilities disposed of | $(46,961)| | Accretion | $39,931 | | Balance end of period | $2,777,847 | 16. Fair Value Measurements This note explains the fair value hierarchy and measurement techniques applied to various financial assets and liabilities - Cash, cash equivalents, restricted cash, accounts receivable, and accounts payable are carried at cost, approximating fair value due to short-term maturity. The revolving line of credit's recorded value approximates fair value due to its variable interest rate[113] - U.S. Treasury Bills are classified as Level 1 in the fair value hierarchy, while commodity derivative instruments (NYMEX HH swap and basis swap contracts) are valued using a mark-to-market approach and classified as Level 2[114][115] Fair Value of Assets (June 30, 2023) | Asset | Level 1 | Level 2 | Net Fair Value | | :-------------------- | :------ | :------ | :------------- | | Derivative contracts | — | $1,286,070 | $1,286,070 | | Short term investments | $26,804,482 | — | $26,804,482 | 17. Current Expected Credit Loss This note details the company's assessment of credit losses on financial assets, which was determined to be nil - Under ASU 326, Epsilon assesses collectability of financial assets, primarily U.S. Treasury Bills and accounts receivable from oil/gas purchasers and gathering services. As of June 30, 2023, and December 31, 2022, the allowance for credit loss was determined to be nil[118] 18. Subsequent Events This note discloses a significant share repurchase transaction that occurred after the reporting period - On July 6, 2023, Epsilon repurchased 525,000 common shares at $5.00 per share, with 1,395,369 common shares remaining authorized for repurchase under the current program[119] ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section provides management's perspective on Epsilon Energy Ltd.'s financial condition and results of operations, highlighting key trends, business strategies, operational performance, and liquidity for the periods ended June 30, 2023, compared to 2022 Overview This section provides a high-level description of Epsilon Energy Ltd.'s operations, including its geographic focus and asset ownership - Epsilon Energy Ltd. is a North American onshore independent natural gas and oil company with operations in the Marcellus shale (Pennsylvania), NW Anadarko basin (Oklahoma), and Permian basin (New Mexico and Texas)[122] Net Acreage and Production by Region | Region | Net Acres | Net Production (as of June 30, 2023) | | :------------- | :-------- | :----------------------------------- | | Pennsylvania | 5,098 | 25 MMcf/d | | Oklahoma | 7,228 | 2.4 MMcfe/d | | Texas | 3,093 | N/A | | New Mexico | N/A | 204 BOE/d | - The company owns a 35% interest in the 52-mile Auburn Gas Gathering System in Pennsylvania[123] Business Strategy This section outlines Epsilon's capital allocation strategy, focusing on high-return investments and shareholder returns, including recent acquisitions - Epsilon focuses on high rate of return capital investments in onshore North American natural gas and oil basins, committed to disciplined capital allocation including shareholder returns via dividends and share buybacks[124] - Recent acquisitions in Q2 2023 include a 10% interest in two New Mexico wellbores for $2.1 million, a 25% working interest in 1,297 gross acres in Ector County, Texas for $3.7 million (with a $1.6 million completion commitment), and a 25% working interest in 11,067 gross acres in Ector County, Texas for $6.3 million[126][127][128] Operational Highlights This section presents key operational metrics and production data across the company's primary operating regions Marcellus Shale (Pennsylvania) Operational Highlights (Six Months Ended June 30) | Metric | 2023 | 2022 | Change (YoY) | | :------------------------------------ | :---------- | :---------- | :----------- | | Realized natural gas price ($/Mcf) | $2.01 | $5.68 | -65% | | Net revenue interest natural gas production (Bcf) | 4.5 | 4.6 | -2% | | Gathered and delivered (net to Epsilon, Bcf) | 11.2 | N/A | N/A | Anadarko (Oklahoma) Operational Highlights (Six Months Ended June 30) | Metric | 2023 | 2022 | Change (YoY) | | :------------------------------------ | :---------- | :---------- | :----------- | | Realized price for all production ($/Mcfe) | $5.59 | $8.47 | -34% | | Total net revenue interest production (Bcfe) | 0.35 | 0.49 | -29% | - In the Permian Basin, New Mexico production for the three and six months ended June 30, 2023, was 14.9 Mboe with a realized price of $47.45 per Boe. In Texas, the company acquired a 25% interest in 12,373 acres and drilled 1 gross (0.25 net) well, with another awaiting completion[132] Non-GAAP Financial Measures-Adjusted EBITDA This section defines Adjusted EBITDA, a non-GAAP measure, and provides its reconciliation to net income for performance assessment - Adjusted EBITDA is a non-GAAP measure defined as earnings before net interest expense, taxes, DD&A, impairments, non-cash stock compensation, gain/loss on asset sales, gain/loss on derivative contracts (net of cash settlement), and other income. It is used by management to assess debt servicing ability, fund capital expenditures, and compare operating performance[133][135] Adjusted EBITDA Reconciliation (Six Months Ended June 30) | Metric | 2023 | 2022 | | :------------------------------------ | :------------ | :------------ | | Net income | $3,960,416 | $16,388,876 | | Add Back: | | | | Interest (income) expense, net | $(861,104) | $(21,102) | | Income tax expense | $1,573,064 | $6,201,474 | | Depreciation, depletion, amortization, and accretion | $3,388,734 | $3,192,958 | | Stock based compensation expense | $359,496 | $336,352 | | Loss (gain) on sale of assets | $1,449,871 | $(221,642) | | Loss (gain) on derivative contracts net of cash received or paid on settlement | $(63,980) | $(1,180,377) | | Foreign currency translation loss | $(987) | $4,331 | | Adjusted EBITDA | $9,805,510| $24,700,870 | Net Operating Revenues This section analyzes the company's total operating revenues, highlighting changes driven by commodity prices and sales volumes - Total revenues for the six months ended June 30, 2023, decreased by $17.6 million (53%) to $15.9 million from $33.5 million in the same period of 2022[139] Revenue and Volume Statistics (Six Months Ended June 30) | Category | 2023 Revenue | 2022 Revenue | 2023 Volume | 2022 Volume | 2023 Avg. Price | 2022 Avg. Price | | :-------------------------- | :----------- | :----------- | :---------- | :---------- | :-------------- | :-------------- | | PA Natural gas | $8,609,038 | $25,220,340 | 4,290 MMcf | 4,439 MMcf | $2.01/Mcf | $5.68/Mcf | | PA Gathering system | $4,588,759 | $4,107,941 | N/A | N/A | N/A | N/A | | NM Total Revenues | $707,058 | — | 14.9 Mboe | — | $47.45/Boe | — | | OK Total Revenues | $1,951,557 | $4,174,821 | 0.35 Bcfe | 0.49 Bcfe | $5.59/Mcfe | $8.47/Mcfe | | Total Revenues | $15,856,412| $33,503,102| | | | | - Upstream natural gas revenue decreased by $17.4 million (65%) for the six months ended June 30, 2023, primarily due to lower natural gas prices ($16.4 million decrease) and lower sales volumes ($1.0 million decrease). Gathering system revenue increased by $0.5 million (12%) due to anchor shipper volumes increasing from 65% to 85% of total throughput[140][143] Operating Costs This section examines the company's operating expenses, detailing changes in lease operating costs and gathering system costs Operating Costs (Six Months Ended June 30) | Cost Category | 2023 | 2022 | Change (YoY) | | :-------------------------- | :------------ | :------------ | :----------- | | Lease operating costs | $2,844,800 | $3,657,507 | -22% | | Gathering system operating costs | $1,222,275 | $1,065,603 | +15% | | Total | $4,067,075| $4,723,110| -14% | - Upstream operating costs decreased by $0.8 million (22%) for the six months ended June 30, 2023, primarily due to extraordinary plugging and abandonment costs in 2022 that were not representative of typical operations[145] - Gathering system operating costs increased by $0.2 million (15%) for the six months ended June 30, 2023, driven by a CPI-U adjusted increase to G&A fees and compressor rentals[146] Depletion, Depreciation, Amortization and Accretion ("DD&A") This section reports the company's DD&A expense, noting its consistency compared to the prior year DD&A Expense (Six Months Ended June 30) | Metric | 2023 | 2022 | | :------------------------------------ | :------------ | :------------ | | Depletion, depreciation, amortization and accretion | $3,388,734 | $3,192,958 | - DD&A expense for the three and six months ended June 30, 2023, remained consistent compared to the same periods in 2022[149] Loss (gain) on sale of assets This section analyzes the loss or gain recognized from the sale of assets, highlighting the increase in losses due to specific asset dispositions Loss (Gain) on Sale of Assets (Six Months Ended June 30) | Metric | 2023 | 2022 | | :-------------------- | :------------ | :------------ | | Loss (gain) on sale of assets | $1,449,871 | $(221,642) | - Loss on sale of assets increased by $1.7 million for the six months ended June 30, 2023, compared to 2022, due to the sale of two Oklahoma assets in 2023 with a larger net book value than the one asset sold in 2022[150] General and Administrative ("G&A") This section details the increase in G&A expenses, attributing it to higher compensation, management transition costs, and service fees General and Administrative Expenses (Six Months Ended June 30) | Metric | 2023 | 2022 | | :-------------------- | :------------ | :------------ | | General and administrative | $3,979,895 | $2,972,627 | - G&A expenses increased by $1.0 million (35%) for the six months ended June 30, 2023, primarily due to a $0.7 million increase in compensation, $0.6 million from management transition, and $0.1 million from Board of Directors pay adjustment, along with a $0.3 million increase in other service fees[152] Interest Expense This section reports the increase in interest expense, linked to changes in the revolving credit facility's borrowing base Interest Expense (Six Months Ended June 30) | Metric | 2023 | 2022 | | :------------- | :---------- | :---------- | | Interest expense | $62,859 | $16,064 | - Interest expense increased for the three and six months ended June 30, 2023, compared to 2022, due to changes in the revolving credit facility's borrowing base[153] Gain (Loss) on Derivative Contracts This section discusses the gains and losses from derivative contracts, attributing the increase in realized gains to natural gas price movements Gain (Loss) on Derivative Contracts (Six Months Ended June 30) | Metric | 2023 | 2022 | | :------------------------------------ | :------------ | :------------ | | Gain (loss) on derivative contracts | $1,696,838 | $(194,910) | | Cash settlements received (paid) | $1,632,858 | $(1,375,287) | - Realized gains on derivative contracts increased for the six months ended June 30, 2023, primarily due to a decrease in NYMEX HH Natural Gas Futures prices, which increased the value of the NYMEX HH swaps. As of June 30, 2023, the company had no derivative contracts beyond October 2023[155] Capital Resources and Liquidity This section analyzes the company's sources and uses of cash, credit facilities, share repurchase activities, and contractual obligations Cash Flow This section details the company's cash flow from operating, investing, and financing activities, highlighting significant changes - The primary source of cash for Epsilon is funds generated from operations. For the six months ended June 30, 2023, cash provided by operating activities decreased by 35% to $10.2 million from $15.8 million in 2022[156][158] - Cash used in investing activities significantly increased to $40.0 million in 2023 (vs. $5.0 million in 2022), driven by a $26.5 million net investment in U.S. Treasury Bills and $13.5 million in leasehold and development costs[159] - Cash used in financing activities was $5.9 million in 2023 (vs. $6.3 million in 2022), primarily for dividend payments and common stock repurchases[160] Credit Agreement This section describes the terms and financial covenants of Epsilon's new revolving credit facility - Epsilon's new senior secured reserve-based revolving credit facility, closed June 28, 2023, has an initial commitment and borrowing base of $35 million, with interest at Daily Simple SOFR plus 3.25%. The facility is secured by Pennsylvania upstream assets[161] - Financial covenants include a current ratio of 1.0 to 1.0 and a leverage ratio of less than 2.5 to 1.0. If the leverage ratio exceeds 1.0 or borrowing base utilization is over 50%, the company must hedge 50% of anticipated PDP production for 24 months[162] Repurchase Transactions This section details the company's share repurchase programs, including authorized amounts and shares repurchased - A new share repurchase program authorized on March 9, 2023, allows for the repurchase of up to 2,292,644 common shares (10% outstanding) for up to $15.0 million. As of June 30, 2023, 372,275 shares were repurchased under this new plan at an average price of $5.19 per share[163] - For the six months ended June 30, 2023, a total of 562,975 shares were repurchased at an average price of $5.40 per share under two consecutive programs[165] Derivative Transactions This section explains the company's use of derivative instruments to manage commodity price risk and lists outstanding contracts - Epsilon uses hedging arrangements, including NYMEX Henry Hub swaps and Tennessee Z4 basis swaps, to reduce natural gas price volatility and stabilize cash flows, supporting its capital spending program[166][167] Outstanding Natural Gas Commodity Contracts (June 30, 2023) | Derivative Type | Volume (MMbtu) | Weighted Average Price ($/MMbtu) | Fair Value of Asset | | :-------------------- | :------------- | :------------------------------- | :------------------ | | NYMEX Henry Hub swap | 460,000 | $5.21 | $1,106,445 | | Tennessee Z4 basis swap | 460,000 | $(1.25) | $179,625 | | Total | 920,000 | | $1,286,070 | Contractual Obligations This section summarizes the company's capital expenditure commitments and asset retirement obligations - As of June 30, 2023, the company had short-term capital expenditure commitments of $1.6 million and long-term asset retirement obligations of $7.4 million[168] ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This section outlines Epsilon's exposure to various market risks, including commodity price fluctuations, risks related to its gas gathering system revenue, and interest rate changes, and how these risks are managed Gathering System Revenue Risk This section assesses the impact of commodity price fluctuations on the Auburn Gas Gathering System's revenue - The company believes that short-term low commodity prices will not significantly impact the revenue of its Auburn Gas Gathering System due to historically high levels of recoverable reserves and low production costs in the Marcellus Basin[170] Interest Rate Risk This section evaluates the company's exposure to interest rate fluctuations, noting no outstanding principal balance on its credit agreement - Market risk from interest rates is estimated by the change in fair value from a hypothetical 100 basis point change on the outstanding balance of the credit agreement. As of June 30, 2023, and 2022, the outstanding principal balance under the credit agreement was nil[171][172] Derivative Contracts This section explains the company's use of derivative instruments to manage commodity price risk and stabilize cash flows - Epsilon uses derivative financial instruments and physical contracts to manage commodity price risk, which helps stabilize cash flows and support capital spending, although it also limits benefits from price increases[173] ITEM 4. CONTROLS AND PROCEDURES This section details management's evaluation of the effectiveness of the company's disclosure controls and procedures and internal control over financial reporting, including any changes or inherent limitations Disclosure Controls and Procedures This section confirms management's assessment of the effectiveness of the company's disclosure controls and procedures - Management, including the principal executive and financial officers, concluded that Epsilon's disclosure controls and procedures were effective at a reasonable assurance level as of June 30, 2023[174] Changes in Internal Control Over Financial Reporting This section states that no material changes occurred in the company's internal control over financial reporting during the quarter - No changes in internal control over financial reporting occurred during the quarter ended June 30, 2023, that have materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting[175] Inherent Limitations on Effectiveness of Controls This section acknowledges that internal controls have inherent limitations, preventing absolute assurance against material misstatements - Internal control over financial reporting cannot provide absolute assurance due to inherent limitations, including human judgment lapses, failures, collusion, or improper management override, which may lead to material misstatements not being prevented or detected timely[176] PART II - OTHER INFORMATION This section covers legal proceedings, risk factors, equity security sales, and other miscellaneous disclosures ITEM 1. LEGAL PROCEEDINGS This section provides an update on the ongoing legal dispute between Epsilon and Chesapeake Appalachia, LLC, concerning alleged breaches of agreements and obstruction of development efforts Litigation This section details the ongoing legal dispute with Chesapeake Appalachia, LLC, regarding alleged breaches of agreements - Epsilon filed a complaint against Chesapeake Appalachia, LLC, on March 10, 2021, alleging breach of a settlement agreement and operating agreements related to the Auburn Development. An appeal is pending a decision from the Third Circuit, and a re-filed complaint is stayed[178][180][181] ITEM 1A. RISK FACTORS This section states that there have been no new material changes to the risk factors previously disclosed in the company's Annual Report on Form 10-K - There have been no material changes from the risk factors disclosed in Item 1A. Risk Factors of the Annual Report on Form 10-K for the year ended December 31, 2022[182] ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS This section provides details on the company's equity security repurchase activities during the six months ended June 30, 2023, under its normal course issuer bid programs Purchases of Equity Securities by Epsilon Energy Ltd. This section details the company's share repurchase activities under its issuer bid programs, including shares purchased and remaining authorizations Equity Securities Repurchased (Six Months Ended June 30, 2023) | Program | Shares Purchased | Average Price Paid per Share | | :------------------------------------ | :--------------- | :--------------------------- | | 2022-2023 (terminated March 7, 2023) | 190,700 | $5.82 | | 2023-2024 (commenced March 27, 2023) | 372,275 | $5.11 | | Total as of June 30, 2023 | 562,975 | $5.40 | - Under the 2023-2024 program, 1,920,369 shares remained to be purchased as of June 30, 2023[184] ITEM 3. DEFAULTS UPON SENIOR SECURITIES This item is not applicable to the company for the reporting period - Not applicable[185] ITEM 4. MINE SAFETY DISCLOSURES This item is not applicable to the company for the reporting period - Not applicable[186] ITEM 5. OTHER INFORMATION This item is not applicable to the company for the reporting period - Not applicable[187] ITEM 6. EXHIBITS This section lists all exhibits filed as part of the Form 10-Q, including certifications and XBRL data files List of 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 | Inline XBRL Instance Document | | 104 | Cover Page Interactive Data File (embedded within the Inline XBRL document) | SIGNATURES This section confirms the official authorization and signing of the report by the designated financial officer - The report was duly authorized and signed on August 10, 2023, by J. Andrew Williamson, Chief Financial Officer and Principal Financial Officer[191]