Epsilon Energy Ltd. 2022 Q3 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, gathering and production. Operations are concentrated in the Marcellus shale in Pennsylvania and the NW Anadarko basin in Oklahoma. Epsilon also owns a 35% interest in the Auburn Gas Gathering System in Pennsylvania.
This unaudited Form 10-Q covers the three and nine months ended September 30, 2022, compared with the corresponding 2021 periods. The filing was dated November 10, 2022. Epsilon reported 23,027,441 common shares outstanding as of November 10, 2022.
Financial Performance and Key Metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Total revenue | $21.2 million | $13.1 million | $54.7 million | $28.6 million |
| Operating income | $14.4 million | $7.1 million | $37.2 million | $11.7 million |
| Net income | $9.6 million | $1.4 million | $26.0 million | $3.6 million |
| Adjusted EBITDA | $16.5 million | $6.8 million | $41.5 million | $15.2 million |
| Operating cash flow | $13.7 million | $5.5 million | $29.4 million | $13.5 million |
| Basic EPS | $0.42 | $0.06 | $1.11 | $0.15 |
Q3 operating margin was approximately 67.8% and net margin was approximately 45.2%. For the nine months, operating margin was approximately 68.0% and net margin was approximately 47.5%.
- Gas, oil, NGL and condensate revenue was $19.2 million in Q3 and $48.6 million for the nine months. Gas gathering and compression revenue was $2.1 million in Q3 and $6.2 million for the nine months.
- Q3 natural gas revenue increased 88% year over year, primarily from a 114% increase in average realized gas price to $7.40/Mcf, partly offset by a 12% production decline to 2,419 MMcf.
- Nine-month natural gas revenue increased 113%, with average realized gas price rising 133% to $6.28/Mcf while production declined 9% to 7,094 MMcf.
- Q3 Oklahoma realized pricing increased 53% to $9.42/Mcfe; nine-month pricing increased 54% to $8.82/Mcfe.
- Operating expenses were $6.8 million in Q3 and $17.5 million for the nine months. Lease operating expenses increased 21% year over year for the nine months, reflecting higher service costs and increased per-unit costs.
- Losses on derivative contracts were $0.9 million in Q3 and $1.1 million for the nine months, compared with losses of $5.1 million and $6.4 million in the respective 2021 periods.
Balance Sheet, Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $40.3 million at September 30, 2022, compared with $26.5 million at December 31, 2021. Cash, cash equivalents and restricted cash totaled $40.8 million.
- Working capital surplus was approximately $40.6 million, up from $24.1 million at year-end 2021.
- Total assets were $119.8 million and shareholders’ equity was $96.1 million at September 30, 2022.
- The company had no borrowings under its senior secured revolving credit facility. The facility provides for total commitments of up to $100 million, with a current borrowing base of $14 million, subject to semiannual redetermination. Maturity is March 1, 2024.
- Capital expenditures were $5.7 million for the nine months, primarily for Pennsylvania and Oklahoma development.
- Financing uses included $6.2 million for share repurchases and $4.4 million for dividends. The company paid quarterly dividends of $0.0625 per share, or $0.25 annualized.
- Management stated that cash on hand, operating cash flow and available liquidity are sufficient for expected requirements for the next twelve months and beyond.
Material Changes Versus the Prior Comparable Period
- Revenue increased 62% in Q3 and 91% for the nine months, driven primarily by higher natural gas prices.
- Net income increased by $8.2 million in Q3 and $22.4 million for the nine months.
- Adjusted EBITDA increased 144% in Q3 and 174% for the nine months.
- Operating cash flow increased 149% in Q3 and 117% for the nine months.
- Production declines in Pennsylvania and Q3 Oklahoma were partly offset by higher realized prices and additional Oklahoma wells placed into service during the nine months.
- Epsilon repurchased 982,500 shares for $6.2 million during the nine months, at an average price of $6.32 per share. The program had 200,910 shares remaining as of September 30, 2022.
- The company initiated dividend payments in 2022, distributing approximately $4.4 million during the nine months.
- Derivative losses declined materially from 2021, although hedging continued to limit some benefit from higher commodity prices.
Guidance, Outlook, Risks and Unusual Items
- Management expects to fund operations and development through operating cash flow and cash on hand and expects continued compliance with credit facility covenants.
- No derivative contracts extended beyond December 31, 2022. Outstanding September 30 contracts covered 610,000 MMBtu in aggregate, including a 305,000 MMBtu basis swap and a 305,000 MMBtu two-way collar with an $8.20 ceiling and $6.50 floor.
- Commodity prices remain the principal market risk. Lower natural gas and oil prices could reduce revenue, asset values, operating cash flow and gathering system activity.
- Natural production declines are reducing Pennsylvania volumes and affected Q3 Oklahoma volumes. Management expects development activity and new wells to influence future production.
- The Auburn Gas Gathering System operates under a cost-of-service model through 2026. Gathering rates are recalculated annually and may decline if throughput increases or capital spending is lower than forecast.
- Epsilon is pursuing litigation against Chesapeake Appalachia concerning alleged breaches of settlement and operating agreements and alleged obstruction of Auburn Development activities. The appeal and cross-appeal were fully briefed, with a decision not expected until early to mid-2023. A related refiled complaint is stayed pending the appeal.
- Capital expenditure commitments were approximately $0.4 million, with asset retirement obligations of approximately $7.4 million reported in the MD&A.
- No material changes were reported to the risk factors in the 2021 Form 10-K, and management concluded that disclosure controls were effective as of September 30, 2022.
Important Facts for Investors to Verify
- Whether elevated natural gas prices persist and how pricing affects revenue after existing hedges expire.
- The pace of natural production declines in Pennsylvania and Oklahoma and the timing and economics of new wells.
- Future borrowing-base redeterminations, covenant compliance and the March 2024 credit facility maturity.
- The outcome and timing of the Chesapeake litigation and any effect on Auburn Development plans.
- The sustainability of dividends and share repurchases relative to operating cash flow and development needs.
- Derivative positions after December 31, 2022 and the resulting exposure to commodity price volatility.
- Potential future cash obligations for asset retirement, capital commitments and the adoption of lease accounting requirements.