Epsilon Energy Ltd. 2022 Q2 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 and gathering. Its principal assets are in Pennsylvania’s Marcellus shale and Oklahoma’s NW Anadarko basin. Epsilon also 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, 2022, compared with the corresponding 2021 periods. As of August 11, 2022, 22,975,512 common shares were outstanding.
Financial performance and key metrics
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Total revenue | $19.9 million | $7.1 million | $33.5 million | $15.5 million |
| Operating income | $13.9 million | $1.2 million | $22.8 million | $4.6 million |
| Net income (loss) | $10.6 million | $(0.5) million | $16.4 million | $2.3 million |
| Adjusted EBITDA | $15.6 million | $3.0 million | $24.9 million | $8.4 million |
| Cash flow from operations | $8.1 million | $2.4 million | $15.8 million | $8.0 million |
| Capital expenditures | Approximately $2.1 million | Approximately $1.2 million | $5.0 million | $1.7 million |
Q2 operating margin was approximately 69.7%, compared with 16.8% in Q2 2021. Six-month operating margin was approximately 68.1%, compared with 29.8% in the prior-year period. Q2 net margin was approximately 53.2%; six-month net margin was approximately 48.9%.
- Natural gas revenue increased 213% in Q2 and 133% for the first six months, primarily from substantially higher realized prices despite lower Pennsylvania production.
- Q2 natural gas volume was 2.324 Bcf versus 2.548 Bcf in the prior-year quarter; six-month volume was 4.675 Bcf versus 5.014 Bcf.
- Average natural gas price was $6.88/Mcf in Q2 versus $2.00/Mcf and $5.71/Mcf for the first six months versus $2.28/Mcf.
- Oil and other liquids revenue increased to $1.9 million in Q2 and $2.7 million for the first six months, reflecting new Oklahoma production and higher prices.
- Gathering system revenue increased 7% to $2.0 million in Q2 and 7% to $4.1 million for the first six months.
- Lease operating costs increased 47% in Q2 and 30% for the first six months, reflecting higher service costs. Operating cost per upstream Mcfe increased to $1.05 in Q2 and $0.89 for the first six months.
- General and administrative expense declined 27% in Q2 and 22% for the first six months, mainly because of lower legal fees related to the Chesapeake litigation.
Financial position, cash flow and liquidity
- Cash and cash equivalents were $30.9 million at June 30, 2022, or $31.5 million including restricted cash, compared with $27.1 million at December 31, 2021.
- Working capital surplus was $33.3 million at June 30, 2022, versus $24.1 million at year-end 2021.
- Total assets were $110.8 million and shareholders’ equity was $89.1 million at June 30, 2022.
- The company had no borrowings under its senior secured revolving facility. The current borrowing base was $14 million within a total commitment of up to $100 million; the facility matures March 1, 2024.
- Management stated that cash on hand, operating cash flow and available liquidity should fund requirements for at least the next 12 months. The company was in compliance with its credit covenants and expected to remain compliant.
- Six-month financing cash uses included $3.0 million of dividends and approximately $4.0 million of share repurchases. The company repurchased 697,100 shares at an average price of $6.53 and had 486,310 shares remaining under the program at June 30.
Material changes, outlook and unusual items
- Revenue, operating income, net income, Adjusted EBITDA and operating cash flow increased sharply year over year, primarily because of higher commodity prices and increased Oklahoma liquids production.
- Commodity derivatives produced a $0.8 million gain in Q2 2022 versus a $1.8 million loss in Q2 2021, but generated a $0.2 million loss for the first six months versus a $1.4 million loss in the prior-year period. Six-month cash settlements paid were $1.4 million.
- At June 30, derivatives covered approximately 1.53 million MMBtu, with a net fair value asset of $0.9 million. Approximately 15% of anticipated remaining 2022 production was hedged, and no contracts extended beyond December 31, 2022.
- The company recognized a $0.2 million gain on the sale of oil and gas properties in the first six months. No impairment was recorded.
- Management reported no formal production or financial guidance in the filing, but expects to continue funding operations and development through operating cash flow and cash on hand. The company had approximately $1.5 million of capital expenditure commitments at June 30.
- Effective July 1, 2022, Jason Stabell became CEO and Andrew Williamson became CFO. Former CEO Mike Raleigh resigned effective June 30, and former CFO Lane Bond moved to a transitional consulting role.
Risks, contingencies and controls
- Commodity prices remain the principal market risk; lower natural gas and oil prices could reduce revenue, cash flow, asset values and gathering-system throughput. Hedging reduces downside exposure but also limits benefits from higher prices.
- The Auburn gathering system uses a cost-of-service model through 2026. Gathering rates are recalculated based on throughput, costs and projected capital, creating potential variability in future gathering revenue.
- Epsilon is pursuing litigation against Chesapeake regarding alleged breaches of settlement and operating agreements and alleged interference with Auburn development. An appeal and cross-appeal were pending, and a newly filed complaint was subject to Chesapeake’s motion to stay. The filing states that an appellate decision was not expected until early to mid-2023.
- Contractual obligations totaled approximately $9.2 million, including $7.4 million of undiscounted asset retirement obligations, $1.5 million of capital commitments and $0.2 million of derivative liabilities.
- Management concluded that disclosure controls and procedures were effective as of June 30, 2022, and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether elevated natural gas and liquids prices and Oklahoma production levels persist, given Pennsylvania production declines and commodity volatility.
- The effect of derivative settlements and the expiration of all current hedges after December 31, 2022.
- The status and potential operational or financial impact of the Chesapeake litigation and related Auburn development restrictions.
- Whether the $14 million borrowing base remains available after subsequent redeterminations and whether covenant compliance changes if debt is drawn.
- The capital allocation balance among dividends, share repurchases, development spending and potential acquisitions.
- The financial and operational effects of the July 2022 CEO and CFO transition.