Epsilon Energy Ltd. — Form 10-Q Summary
Business Context and Reporting Period
Epsilon Energy Ltd. is a U.S.-focused natural gas and oil acquisition, development, production and gathering company. Its primary assets are Pennsylvania Marcellus properties and a 35% interest in the Auburn Gas Gathering System. The filing covers the three and nine months ended September 30, 2020, with comparative periods ended September 30, 2019. The financial statements are unaudited and prepared under U.S. GAAP.
Key Financial Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Total revenue | $5.81 million | $5.22 million | $18.52 million | $19.93 million |
| Operating income (loss) | $(0.72) million | $0.72 million | $(2.44) million | $6.11 million |
| Net income (loss) | $(0.29) million | $1.45 million | $(0.55) million | $6.66 million |
| Adjusted EBITDA | $3.94 million | $3.86 million | $11.70 million | $13.49 million |
| Net cash from operations | Not separately stated in the cash-flow statement | Not separately stated | $12.09 million | $11.83 million |
Q3 operating margin was approximately negative 12.4% and net margin was approximately negative 5.0%. Nine-month operating margin was approximately negative 13.2% and net margin was approximately negative 3.0%. Adjusted EBITDA margin was approximately 67.9% for Q3 and 63.2% for the nine-month period; Adjusted EBITDA is a non-GAAP measure and is not a substitute for GAAP earnings or cash flow.
- Natural gas, oil, NGL and condensate revenue was $3.59 million in Q3 and $11.72 million for nine months. Gas gathering and compression revenue was $2.22 million in Q3 and $6.80 million for nine months.
- Natural gas production increased to 3.0 Bcf in Q3 and 8.5 Bcf for nine months, versus 1.8 Bcf and 5.4 Bcf, respectively, in the prior-year periods.
- Realized natural gas prices declined to $1.18/Mcf in Q3 and $1.33/Mcf for nine months, compared with $1.64/Mcf and $2.29/Mcf, respectively, in 2019.
- Cash and cash equivalents were $11.58 million at September 30, 2020, compared with $14.05 million at December 31, 2019. Including restricted cash, cash available for cash-flow presentation was $12.15 million.
- Working capital surplus was approximately $11.5 million, down from $14.9 million at December 31, 2019.
- The company had no borrowings under its revolving credit facility. The facility had a $23 million borrowing base, a March 1, 2022 maturity date and approximately $23 million of available capacity, subject to lender redetermination and covenants.
- Total assets were $87.34 million and shareholders’ equity was $67.33 million at September 30, 2020.
Material Changes Versus the Prior Comparable Period
- Q3 revenue increased 11.3%, primarily because higher natural gas volumes more than offset lower realized prices. Nine-month revenue decreased 7.1% because price declines outweighed production growth.
- The company moved from net income of $1.45 million in Q3 2019 to a net loss of $0.29 million in Q3 2020, and from nine-month net income of $6.66 million to a nine-month net loss of $0.55 million.
- Lease operating expense increased 38.7% in Q3 and 28.4% for nine months, reflecting higher production and costs associated with new wells. DD&A increased 50.0% in Q3 and 37.9% for nine months.
- General and administrative expense increased 44.5% in Q3 and 15.1% for nine months, largely due to tender-offer, legal, administrative and stock-based compensation costs.
- The company recognized a $1.76 million impairment of Oklahoma producing assets in Q1 2020 due to historically low oil and NGL prices. No additional impairment was recorded in Q3.
- Cash flow from operations increased modestly to $12.09 million for the nine months, but cash declined by $2.47 million after $5.49 million of investing outflows and $9.08 million of share repurchases.
- The company repurchased and canceled 2,337,034 shares through a tender offer for $7.15 million, or $3.06 per share. Total nine-month share repurchases were approximately $9.08 million according to the cash-flow statement.
Guidance, Outlook, Risks and Unusual Items
- Management expects current cash, operating cash flow and available credit capacity to fund operating and development requirements for the next 12 months and beyond, but notes that sustained commodity-price deterioration could require additional liquidity measures.
- Management intends to maintain current production or grow modestly only if natural gas prices and expected returns support additional capital deployment. Local Appalachian production is expected to remain flat or decline modestly during the remainder of 2020.
- The COVID-19 pandemic, depressed commodity prices and industry oversupply created substantial uncertainty. Management stated that it could not estimate the future effect on financial condition, liquidity or results of operations.
- Chesapeake Energy Corporation filed for Chapter 11 bankruptcy. Epsilon recorded an $819,000 allowance for its 35% share of unpaid May and June 2020 Auburn gathering fees. Post-petition amounts were being paid at the filing date, but recovery of pre-petition amounts remains uncertain.
- Outstanding commodity contracts covered 762,500 MMBtu of fixed-price swaps at $2.73/MMBtu and 762,500 MMBtu of basis swaps at a $0.44/MMBtu differential. Net derivative fair value was an asset of $20,258 at September 30, 2020.
- Commodity derivatives generated a $2.06 million gain and $4.04 million of cash settlements during the nine months. Derivative gains are volatile and may not recur at the same level.
- Contractual obligations totaled approximately $12.00 million, including $2.63 million of capital expenditure commitments and $8.95 million of undiscounted asset retirement obligations.
- The company reported no litigation and no off-balance-sheet arrangements. It was in compliance with credit-facility covenants.
- Disclosure controls were effective at September 30, 2020. Management reported that a prior material weakness related to the oil and gas impairment calculation had been remediated, subject to testing.
Facts Investors Should Verify
- Whether low natural gas, oil and NGL prices persist and trigger additional property impairments or reduce operating cash flow.
- The ultimate recovery of Epsilon’s pre-petition gathering receivables related to Chesapeake’s bankruptcy.
- Actual production, realized prices, gathering volumes and derivative settlements in subsequent quarters.
- Whether cash balances and operating cash flow remain sufficient after capital commitments, asset retirement obligations and any further share repurchases.
- The outcome of testing and continued effectiveness of the remediation for the impairment-related internal-control weakness.
- The company’s ability to maintain credit-facility covenant compliance and the borrowing base if commodity prices or reserve estimates deteriorate.