Epsilon Energy Ltd. — Q1 2023 Form 10-Q Summary
Business context and reporting period
Epsilon Energy Ltd. is a North American onshore natural gas and oil company engaged in acquisition, development, production, gathering and compression. Its principal assets are in Pennsylvania’s Marcellus shale and Oklahoma’s NW Anadarko basin. The company owns a 35% interest in the 52-mile Auburn Gas Gathering System in Pennsylvania. This unaudited Form 10-Q covers the three months ended March 31, 2023, compared with the three months ended March 31, 2022.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Total revenue | $9.4 million | $13.6 million | Down 31% |
| Operating income | $3.3 million | $9.0 million | Down 63% |
| Net income | $3.5 million | $5.8 million | Down 39% |
| Diluted EPS | $0.15 | $0.24 | Down $0.09 |
| Net cash from operating activities | $7.6 million | $7.7 million | Down 2% |
| Adjusted EBITDA | $5.6 million | $9.3 million | Down 39% |
| Adjusted EBITDA margin | 60.3% | 68.3% | Down 8.0 percentage points |
Operating margin was approximately 35.5% in Q1 2023 versus 65.9% in Q1 2022. Net margin was approximately 37.7% versus 42.7%.
- Pennsylvania natural gas revenue was $5.9 million, down 42%, primarily because the realized price declined to $2.56/Mcf from $4.47/Mcf; production increased to 2.5 Bcf from 2.4 Bcf.
- Gathering and compression revenue increased 13% to $2.4 million, supported by anchor shipper volumes increasing from 62% to 88% of throughput.
- Oklahoma revenue was $1.1 million, down 17%. Oklahoma production was approximately 0.17 Bcfe, essentially unchanged year over year.
- Lease operating costs were broadly stable at $1.4 million. Gathering system operating costs increased 24% to $0.7 million.
- General and administrative expense increased 68% to $2.2 million, including management-transition compensation, legal fees related to the Chesapeake litigation, and higher service and miscellaneous costs.
- The company recognized a $1.1 million gain on derivative contracts, compared with a $1.0 million loss in Q1 2022. The gain included $0.4 million of net cash settlements.
- Cash, cash equivalents and restricted cash totaled $19.7 million at March 31, 2023, compared with $45.8 million at December 31, 2022. The decrease primarily reflected a $30.1 million investment in U.S. Treasury notes, share repurchases and dividends.
- Short-term investments were $30.1 million and consisted of held-to-maturity U.S. Treasury notes. Working capital surplus was $50.8 million.
- The company had no borrowings under its senior secured revolving facility. The facility has a $30 million effective borrowing base within a $100 million total commitment and matures March 1, 2024. Epsilon was in compliance with its financial covenants.
- Capital expenditures were approximately $1.2 million in Q1 2023, compared with $2.6 million in Q1 2022. The company had $0.2 million of short-term capital commitments at quarter-end.
Material changes versus the prior comparable period
- Revenue and operating income declined substantially because of lower natural gas prices, despite modestly higher Pennsylvania production.
- Cash generation from operations remained comparatively resilient, declining only 2% year over year.
- Liquidity was reallocated from cash into $30.1 million of short-term Treasury investments.
- G&A expense rose materially because of management-transition costs, litigation-related legal fees and other professional expenses.
- The weighted-average basic share count declined to 23.0 million from 23.7 million. Epsilon repurchased and retired 190,700 shares under its prior program and repurchased an additional 47,220 shares at an average price of $5.32 under a new program.
- On March 9, 2023, the board authorized a new repurchase program for up to 2,292,644 shares, or 10% of outstanding shares, with an aggregate limit of $15.0 million. The program runs through March 26, 2024 unless terminated earlier.
- The quarterly dividend was $0.0625 per share, or $0.25 annualized, totaling approximately $1.4 million.
Guidance, outlook, risks and unusual items
Management did not provide formal production, revenue or earnings guidance in the filing. Management stated that current cash, operating cash flow and available liquidity are expected to meet requirements for the next twelve months and beyond, including operating, development, debt and dividend obligations.
- Management is pursuing high-return investments in existing assets and potential new North American oil and gas opportunities. At March 31, 2023, one gross, or 0.11 net, Oklahoma well was awaiting completion.
- At March 31, 2023, natural gas derivatives covered approximately 0.92 Bcf of NYMEX Henry Hub swaps and 0.92 Bcf of Tennessee Z4 basis swaps. The company had no derivative contracts extending beyond December 31, 2023.
- Commodity prices remain the principal operating risk. Hedging reduces downside exposure but also limits the benefit of higher prices and introduces counterparty and mark-to-market volatility.
- The company’s estimated asset retirement obligation was $2.8 million, based on approximately $7.5 million of undiscounted future costs.
- Epsilon is pursuing litigation against Chesapeake Appalachia concerning alleged breaches of settlement and operating agreements and alleged interference with Auburn development and permitting. The appeal had been argued in January 2023, and a decision was not expected until mid-2023; a related lawsuit was stayed pending the appeal.
- On April 13, 2023, the company divested two operated Oklahoma wells and 1,298 net acres, leaving 7,228 net Oklahoma acres.
- On May 9, 2023, Epsilon agreed to acquire a 10% interest in two New Mexico wellbores for estimated net capital expenditures of $2.1 million. The wells were in flow-back at the time of the agreement.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. The filing stated that there were no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether natural gas prices and Pennsylvania production volumes support management’s expected operating cash flow and liquidity outlook.
- The maturity, borrowing-base redeterminations and covenant terms of the revolving credit facility, particularly after March 1, 2024.
- The timing and potential financial or operational impact of the Chesapeake litigation and Auburn development permitting matters.
- The economics, completion status and funding requirements of the two New Mexico wellbores acquired after quarter-end.
- The pace and cash impact of the new $15.0 million share repurchase authorization alongside the quarterly dividend.
- The mark-to-market value, settlement profile and remaining exposure of the company’s commodity derivatives.
- The effect of management-transition costs and higher corporate expenses on recurring profitability.