Epsilon Energy Ltd. — Q2 2023 Form 10-Q Summary
Business Context and Reporting Period
Epsilon Energy Ltd. is a North American onshore natural gas and oil company focused on acquisition, development, production, gathering and compression. Operations span Pennsylvania, Oklahoma, New Mexico and Texas. The company owns a 35% interest in the Auburn Gas Gathering System in Pennsylvania. This unaudited Form 10-Q covers the three and six months ended June 30, 2023, compared with the respective 2022 periods.
Key Financial Metrics
| Metric | Q2 2023 | Q2 2022 | Six Months 2023 | Six Months 2022 |
|---|---|---|---|---|
| Revenue | $6.5 million | $19.9 million | $15.9 million | $33.5 million |
| Operating income (loss) | $(0.4) million | $13.9 million | $3.0 million | $22.8 million |
| Net income | $0.4 million | $10.6 million | $4.0 million | $16.4 million |
| Adjusted EBITDA | $4.2 million | $15.4 million | $9.8 million | $24.7 million |
| Net cash from operating activities | Not separately provided | Not separately provided | $10.2 million | $15.8 million |
| Capital expenditures and property additions | $12.5 million | $1.5 million | $13.6 million | $5.2 million |
| Net income per diluted share | $0.02 | $0.44 | $0.17 | $0.69 |
Q2 operating margin was approximately negative 5.4%, compared with approximately 69.7% in Q2 2022. Six-month operating margin was approximately 18.7%, compared with approximately 68.1% in the prior-year period. Net margin was approximately 6.6% in Q2 and 25.0% for the six months. Adjusted EBITDA margin was approximately 64.1% in Q2 and 61.8% for the six months.
At June 30, 2023, cash and cash equivalents were $9.5 million, restricted cash was $0.5 million and short-term U.S. Treasury investments were $26.8 million. Total current assets were $43.6 million against current liabilities of $4.4 million, producing working capital of approximately $39.2 million. Total liabilities were $18.5 million, including $10.8 million of deferred taxes and $2.8 million of asset retirement obligations. There were no borrowings outstanding.
Material Changes Versus the Prior Comparable Period
- Revenue declined 67% in Q2 and 53% for the six months, primarily because of substantially lower natural gas prices and lower production volumes. Pennsylvania realized natural gas prices fell 80% in Q2 and 65% for the six months.
- Six-month Pennsylvania natural gas production declined 2% to 4.5 Bcf; Oklahoma production declined 29% to 0.35 Bcfe. Gathering revenue increased 12% for the six months as anchor shipper volumes increased.
- Net income declined 96% in Q2 and 76% for the six months. Results were also affected by a $1.45 million loss on the sale of Oklahoma assets, compared with a $0.22 million gain in the 2022 periods.
- Adjusted EBITDA declined 73% in Q2 and 60% for the six months, reflecting lower commodity revenue. Derivative gains were $0.6 million in Q2 and $1.7 million for the six months, compared with $0.8 million and a $0.2 million loss, respectively, in the prior-year periods.
- General and administrative expense increased 35% for the six months, primarily due to higher compensation, management transition costs, board compensation and service fees.
- Operating cash flow declined 35% to $10.2 million. Investing cash outflows increased to $40.0 million, including a net $26.5 million investment in U.S. Treasury Bills and $13.5 million of leasehold and development spending.
- The company acquired a 10% interest in two New Mexico wellbores for $2.1 million and 25% interests in Texas acreage for $10.0 million, plus a $1.6 million completion commitment for one well.
- The company repurchased 562,975 shares during the six months for approximately $3.1 million and paid approximately $2.8 million of dividends. A new repurchase program authorizes purchases of up to 2,292,644 shares for up to $15.0 million through March 26, 2024.
- Shares outstanding decreased from 23.1 million at December 31, 2022 to 22.6 million at June 30, 2023, excluding 95,121 shares held in treasury.
Guidance, Outlook, Risks and Unusual Items
- No formal production, revenue or earnings guidance is provided in the filing. Management expects current cash, short-term investments, available borrowings and operating cash flow to meet requirements for at least the next twelve months.
- Management is pursuing high-return capital investments, continued development of Pennsylvania assets and selective opportunities in other North American basins. First production from two Texas wells is estimated for the fourth quarter of 2023; two to four wells are currently planned for the Texas acreage in 2024.
- A new senior secured reserve-based revolving facility provides a $35 million borrowing base, matures in June 2027 or earlier upon termination, and bears interest at Daily Simple SOFR plus 3.25%. The facility is subject to semiannual redeterminations, with the next scheduled for October 1, 2023.
- The facility requires a minimum 1.0-to-1.0 current ratio and leverage below 2.5-to-1.0. The company was in compliance at June 30, 2023. Hedging of 50% of anticipated PDP production for 24 months may be required if leverage exceeds 1.0-to-1.0 or borrowing-base utilization exceeds 50%.
- At June 30, 2023, natural gas derivatives covered 0.46 Bcf of NYMEX Henry Hub swaps and 0.46 Bcf of Tennessee Z4 basis swaps, with net fair value of $1.3 million. No derivative contracts extended beyond October 2023.
- Commodity prices, production declines, transportation and gathering conditions, interest rates, reserve estimates and counterparty performance are significant risks. The filing states that there were no material changes to the risk factors in the 2022 Form 10-K.
- Epsilon is pursuing litigation against Chesapeake Appalachia concerning alleged failures to cooperate in development of the Auburn Development. An appeal was awaiting decision, and a related action was stayed pending the appeal.
- The company had $1.6 million of short-term capital commitments and approximately $7.4 million of undiscounted asset retirement obligations at June 30, 2023.
- On July 6, 2023, after quarter-end, Epsilon repurchased 525,000 additional shares at $5.00 per share, leaving 1,395,369 shares authorized for repurchase under the current program.
Most Important Facts for Investors to Verify
- Whether natural gas prices and Pennsylvania production stabilize or continue to decline, given the company’s significant exposure to natural gas revenue.
- The borrowing-base outcome at the October 1, 2023 redetermination and compliance with the new credit facility covenants.
- Timing, costs and production results from the Texas and New Mexico investments, including the $1.6 million Texas completion commitment.
- The sustainability of dividends and share repurchases after the substantial increase in capital expenditures and decline in operating cash flow.
- The duration and cash-flow impact of current derivatives, including the absence of contracts beyond October 2023.
- The status and potential operational implications of the Chesapeake litigation and Auburn Development permitting matters.