Epsilon Energy Ltd. — 2019 Q3 Form 10-Q Summary
Business Context and Reporting Period
Epsilon Energy Ltd. is a Canada-incorporated independent oil and gas company focused on acquiring, developing, producing and gathering primarily natural gas in the United States, with core assets in Pennsylvania’s Marcellus Shale and Oklahoma’s Anadarko Basin. The filing covers the three and nine months ended September 30, 2019; financial statements are unaudited and prepared under U.S. GAAP. Epsilon began trading on NASDAQ under “EPSN” in February 2019 and delisted from the TSX in March 2019.
Financial and Operating Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Total revenue | $5.2 million | $7.3 million | $19.9 million | $21.2 million |
| Operating income | $0.7 million | $2.0 million | $6.1 million | $6.6 million |
| Net income | $1.5 million | $2.5 million | $6.7 million | $5.2 million |
| Diluted EPS | $0.05 | $0.09 | $0.24 | $0.19 |
| Adjusted EBITDA | $3.9 million | $3.8 million | $13.5 million | $12.2 million |
| Operating cash flow | $2.9 million | $3.8 million | $11.8 million | $8.3 million |
Revenue comprised $13.0 million of oil, gas, NGL and condensate revenue and $6.9 million of gas gathering and compression revenue for the first nine months. Approximate operating margins were 13.7% in Q3 2019 versus 27.9% in Q3 2018, and 30.7% for the first nine months versus 31.2% in the prior-year period. Approximate net margins were 27.8% and 34.7% for the respective third quarters, and 33.4% and 24.7% for the respective nine-month periods.
- Cash and cash equivalents were $18.7 million at September 30, 2019, compared with $14.4 million at December 31, 2018.
- Working capital surplus was $16.7 million, up from $13.6 million at year-end 2018.
- The revolving credit facility had no outstanding balance, a $23.0 million borrowing base and a maturity date of March 1, 2022. The company was in compliance with its covenants.
- Net property and equipment was $70.2 million, compared with $67.4 million at December 31, 2018. No impairment was recorded.
- Capital expenditures and property investments used $5.8 million of investing cash during the first nine months, while share repurchases used $1.7 million of financing cash.
- Net derivative fair value was an asset of $1.9 million at September 30, 2019, compared with a $0.4 million liability at September 30, 2018.
Material Changes Versus the Prior Comparable Period
- Q3 revenue declined 28.0%, primarily because upstream natural gas revenue fell 38.1% as production and realized prices decreased. Nine-month revenue declined 6.0%.
- Q3 realized natural gas price decreased to $1.64/Mcf from $2.34/Mcf, while nine-month realized price was $2.29/Mcf versus $2.28/Mcf.
- Q3 natural gas production decreased to approximately 1.75 Bcf from 1.95 Bcf; nine-month production decreased to 5.38 Bcf from 5.52 Bcf.
- Oklahoma production and realized pricing weakened materially: Q3 production declined 47.4% and realized price declined 43.2%; nine-month production declined 24.5% and realized price declined 17.4%.
- Despite lower revenue, nine-month net income increased 27.2%, principally because derivative results shifted from a $0.8 million loss in 2018 to a $3.5 million gain in 2019, and cash operating flows increased 42.6%.
- General and administrative expense increased 15.9% for the nine-month period because of costs associated with the NASDAQ listing, TSX delisting, U.S. reporting requirements and credit facility renewal; Q3 G&A declined 26.7% as listing-related costs ceased.
- The company repurchased 363,530 shares during the nine months. Its NASDAQ repurchase program authorized purchases of up to 1,367,762 shares for an aggregate price of up to $2.5 million; 1,004,232 shares remained available under the program at September 30.
Guidance, Outlook, Risks and Unusual Items
No formal production or financial guidance is provided. Management expects to grow modestly within cash flow in the current commodity-price environment, subject to attractive returns, while continuing to invest in the Marcellus and evaluating opportunities in other U.S. basins. Management believes cash from operations, cash on hand and available credit will fund liquidity needs for the next 12 months and beyond.
- Natural gas prices remain the principal risk; regional supply growth and transportation constraints have pressured Appalachian pricing and differentials.
- Commodity derivatives reduced exposure to price declines but limit upside from higher prices. At September 30, outstanding swaps covered 1.07 million MMBtu for 2019 and 4.58 million MMBtu for 2020, with a reported net fair value of $1.85 million.
- The credit facility requires commodity hedging and compliance with interest coverage, current-ratio and leverage covenants. The borrowing base is subject to lender redetermination based partly on reserve values.
- The Auburn Gas Gathering System operating arrangement expires in 2026, after which rates will be renegotiated. Gathering revenue and rates are affected by throughput and capital spending.
- Future commitments included $13.2 million of undiscounted asset retirement obligations and $0.34 million of operating lease payments. No capital expenditure commitments, litigation or off-balance-sheet arrangements were reported.
- The company corrected an immaterial $0.9 million presentation error relating to a property-sale gain in the June 30, 2019 comparative interim information.
- The company plans to adopt revenue-recognition guidance in the fourth quarter of 2019 and restricted-cash cash-flow guidance retrospectively; the expected financial impact was not clearly quantified.
Most Important Facts for Investors to Verify
- Whether sustained low natural gas prices and lower Oklahoma and Pennsylvania production reduce operating cash flow after current derivative protection expires.
- The assumptions, timing and reserve support underlying the $23.0 million borrowing base and required hedge percentages.
- The extent to which the $3.5 million nine-month derivative gain, including unrealized mark-to-market gains, affects reported earnings versus recurring cash generation.
- Throughput trends, rate-setting mechanics and renewal economics for the Auburn Gas Gathering System before its 2026 contract expiration.
- The impact of continued share repurchases and planned accounting-standard adoption on future liquidity, equity and reported revenue disclosures.