Epsilon Energy Ltd. — Form 10-Q Summary
Business Context and Reporting Period
Epsilon Energy Ltd. is a North American independent oil and gas company focused primarily on natural gas acquisition, development, production, and gathering operations in Pennsylvania and Oklahoma. The filing covers the three and six months ended June 30, 2019. The company’s common shares trade on Nasdaq under “EPSN.” The filing was submitted on August 16, 2019 after a service-provider error prevented the report from being filed as instructed on August 6, 2019.
Financial Performance and Position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $6.8 million | $6.2 million | $14.7 million | $13.9 million |
| Operating income | $1.8 million | $1.8 million | $4.5 million | $4.6 million |
| Net income | $3.8 million | $0.6 million | $5.2 million | $2.7 million |
| Adjusted EBITDA | $5.2 million | $3.6 million | $9.6 million | $8.4 million |
| Net income per diluted share | $0.14 | $0.02 | $0.19 | $0.10 |
- Q2 revenue increased 9.7%; six-month revenue increased 5.5% year over year.
- Q2 operating margin was approximately 27.3%, versus 28.8% in the prior-year quarter. Six-month operating margin was approximately 30.4%, versus 33.0%.
- Q2 net margin was approximately 56.7%, versus 9.1%; six-month net margin was approximately 35.4%, versus 19.5%. The increase was substantially influenced by derivative gains and other income.
- Oil, gas, NGL, and condensate revenue increased to $4.5 million in Q2 and $10.0 million for the six months, while gas gathering and compression revenue declined to $2.3 million and $4.7 million, respectively.
- Natural gas production was 1.85 Bcf in Q2 and 3.63 Bcf for the six months, compared with 1.72 Bcf and 3.56 Bcf in the comparable periods. Realized natural gas prices increased to $2.26/Mcf in Q2 and $2.61/Mcf for the six months.
- Net cash provided by operating activities was $9.0 million for the six months, compared with $4.5 million in 2018. Investing cash use was $5.5 million, and financing cash use was $1.2 million, primarily for share repurchases.
- Cash and cash equivalents were $16.6 million at June 30, 2019, compared with $14.4 million at December 31, 2018. Working capital surplus was $17.5 million.
- The revolving credit facility had no outstanding balance and $23.0 million of borrowing capacity. The facility maturity was extended to March 1, 2022. Epsilon was in compliance with all financial covenants.
- Total assets were $92.9 million and shareholders’ equity was $74.2 million at June 30, 2019. Total liabilities were $18.7 million.
Material Changes Versus the Prior Comparable Period
- Upstream natural gas revenue increased 26.8% in Q2 and 18.2% for the six months, driven primarily by higher realized prices and modestly higher volumes.
- Gas gathering revenue decreased 11.7% in Q2 and 11.9% for the six months because of lower system throughput, partially offset by higher gathering and compression rates.
- Derivative contracts generated a $2.7 million Q2 gain and a $2.2 million six-month gain, compared with losses of $0.8 million and $0.5 million in the comparable 2018 periods. The six-month gain included only $0.2 million of cash settlements; the remainder was primarily mark-to-market.
- General and administrative expense increased 27.1% in Q2 and 54.4% for the six months, reflecting costs associated with the TSX delisting, Nasdaq listing, U.S. reporting requirements, legal expenses, insurance, and credit-facility renewal fees.
- Operating costs declined 2.9% in Q2 and 9.1% for the six months, partly because 2018 included environmental cleanup and remediation costs.
- The company repurchased 237,189 shares during Q2 at an average price of $4.13. The Nasdaq repurchase program authorizes purchases of up to 1,367,762 shares for an aggregate price of up to $2.5 million.
- Capital expenditures and property additions increased materially from the prior year, including Oklahoma and Pennsylvania leasehold, drilling, and development costs. The company had $12.9 million of capital expenditure commitments at June 30, 2019.
Outlook, Commentary, Risks, and Unusual Items
- Management expects cash generated from operations, cash on hand, and available credit to fund liquidity needs, operating and development activities, and contractual obligations for the next 12 months and beyond.
- No formal production, revenue, earnings, or capital-spending guidance is provided in the filing.
- Management intends to continue investing in the lower and upper Marcellus reservoirs, develop core Pennsylvania and Oklahoma assets, and evaluate opportunities in other U.S. petroleum basins.
- Management described the Pennsylvania operating environment as challenging because regional gas deliverability has outpaced infrastructure, creating weak local prices and large differentials to NYMEX Henry Hub. New infrastructure had begun to improve local pricing.
- Commodity prices remain the principal market risk. Hedging reduces downside exposure but also limits the benefit of higher prices. At June 30, 2019, outstanding natural gas swaps covered 2.7 million MMBtu for 2019 and 4.6 million MMBtu for 2020, with a reported net derivative fair value of $1.7 million.
- Customer concentration is significant: three customers represented 48%, 25%, and 16% of six-month revenue; two customers represented 46% and 45% of Q2 revenue.
- Total future commitments were $27.5 million, including $12.9 million of capital expenditure commitments and $14.1 million of undiscounted asset-retirement obligations.
- The company reported no current litigation, no off-balance-sheet arrangements, no material change to previously disclosed risk factors, and no impairment of oil and gas or gathering-system assets.
- Disclosure controls and procedures were deemed effective as of June 30, 2019, with no material changes to internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Separate recurring operating performance from the significant mark-to-market derivative gain included in 2019 earnings.
- Assess the sustainability of revenue and cash flow given lower gathering-system throughput, regional gas-price differentials, and customer concentration.
- Review the $12.9 million capital expenditure commitments against cash, operating cash flow, and the $23.0 million undrawn credit facility.
- Evaluate the impact of higher corporate costs following the Nasdaq listing and U.S. reporting transition.
- Verify hedge volumes, settlement terms, counterparty exposure, and the effect of hedges on future realized prices.
- Monitor credit-facility borrowing-base redeterminations, covenant compliance, and the requirement to maintain specified natural gas hedges.
- Confirm the timing and accounting impact of the pending revenue-recognition and lease standards discussed in the notes.