Epsilon Energy Ltd. — Q1 2021 Form 10-Q Summary
Business context and reporting period
Epsilon Energy Ltd. is a U.S.-focused independent oil and natural gas company engaged in acquisition, development, production and gathering operations, primarily in Pennsylvania, with additional assets in Oklahoma. The company owns a 35% interest in the Auburn Gas Gathering System in northeastern Pennsylvania. This unaudited filing covers the three months ended March 31, 2021, compared with the three months ended March 31, 2020.
Financial performance and liquidity
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Total revenue | $8.44 million | $6.43 million | +31.3% |
| Operating income | $3.43 million | $(1.08) million | Improved by $4.51 million |
| Net income | $2.74 million | $0.31 million | +781.2% |
| Net income margin | 32.4% | 4.8% | Improved |
| Adjusted EBITDA | $5.38 million | $4.62 million | +16.6% |
| Adjusted EBITDA margin | 63.8% | 71.8% | Lower |
| Operating cash flow | $5.62 million | $5.21 million | +7.9% |
| Capital expenditures | $0.55 million | $2.35 million | Lower by $1.80 million |
| Cash used for share repurchases | $0.49 million | $1.50 million | Lower |
- Natural gas, oil, NGL and condensate revenue was $6.44 million, up from $4.11 million. Natural gas revenue increased 58%, primarily from higher realized prices.
- Gathering and compression revenue declined 13.6% to $2.00 million, reflecting lower throughput.
- Realized natural gas price increased to approximately $2.57 per Mcf from $1.47 per Mcf, while natural gas production declined to 2.466 Bcf from 2.727 Bcf.
- Total operating costs and expenses declined to $5.01 million from $7.50 million. The prior-year period included a $1.76 million impairment of Oklahoma proved properties; no impairment was recorded in Q1 2021.
- Lease operating expenses fell 22.2% to $1.59 million, while general and administrative expense increased 29.4% to $1.53 million, primarily due to legal fees, added executive compensation and higher stock-based compensation.
- Net derivative gains were $0.47 million versus $1.72 million in the prior-year period. Cash received from derivative settlements was $0.06 million versus $1.35 million.
- Cash and cash equivalents were $17.85 million at March 31, 2021; cash, cash equivalents and restricted cash totaled $18.42 million. Working capital surplus was approximately $17.3 million.
- The company had no borrowings under its revolving credit facility. Total assets were $90.2 million and total liabilities were $18.7 million at March 31, 2021.
Material changes versus the prior comparable period
- Higher natural gas prices more than offset lower Pennsylvania production, driving the increase in upstream revenue and profitability.
- Auburn Gas Gathering System throughput fell 25% to 17.5 Bcf gross, or 6.1 Bcf net to Epsilon, due to reduced crossflow volumes and lower capacity at the Auburn compression facility.
- Operating results benefited from the absence of the $1.76 million Oklahoma impairment recorded in Q1 2020 and from lower depletion, depreciation, amortization and accretion expense, which declined 30% to $1.68 million.
- Weighted-average basic shares declined to 23.95 million from 26.57 million, reflecting prior share repurchases. During Q1 2021, Epsilon repurchased 123,200 shares for $0.49 million at an average price of $4.00 per share.
- On April 6, 2021, after quarter-end, the credit agreement was amended to extend maturity to March 1, 2024, reduce the borrowing base from $23 million to $18 million, increase applicable margins to 3.25%-4.25%, add a 0.25% LIBOR floor and tighten the leverage covenant to less than 3.0.
Outlook, commentary, risks and unusual items
- Management expects cash on hand, operating cash flow and available credit capacity to satisfy operating, development and contractual requirements for the next 12 months and beyond. It expects to maintain current production or grow modestly only when commodity prices and returns support additional capital deployment.
- Management expects Appalachian production in 2021 to be broadly flat with 2020 and continues to pursue operating efficiencies, well-spacing and completion reviews, and optimization of the Auburn gathering system.
- Management cited potential longer-term support for natural gas prices from LNG exports, Mexican exports and coal-to-gas switching, while noting continued Northeast transportation constraints, local price discounts and broader commodity-price volatility.
- Outstanding commodity derivatives covered approximately 3.96 million MMBtu for 2021 and 2022, with a net fair value asset of $0.40 million at March 31, 2021. Hedging limits downside exposure but also limits benefits from higher prices.
- Epsilon filed litigation against Chesapeake Appalachia on March 10, 2021, alleging breaches of a settlement agreement and operating agreements related to development of the Auburn Development. Epsilon requested a preliminary injunction, with a hearing expected in summer 2021. The filing does not provide a quantified potential recovery or loss.
- Capital expenditure commitments were $1.49 million. Total future commitments, including derivative liabilities, asset retirement obligations and operating leases, were reported at $10.86 million.
- The company identified no material changes to previously disclosed risk factors, but remains exposed to natural gas and oil prices, production and throughput levels, transportation constraints, counterparty performance, litigation, reserve estimates, COVID-19 effects and regulatory or financing risks.
- Disclosure controls and procedures were determined to be effective as of March 31, 2021, and no material changes to internal control over financial reporting were reported.
Investor verification priorities
- Verify whether higher natural gas prices persist and whether Pennsylvania production and Auburn system throughput recover from Q1 levels.
- Review the April 2021 credit agreement amendment, including the lower borrowing base, higher margins and tighter leverage covenant.
- Monitor the Chesapeake litigation, preliminary-injunction proceedings and any effect on Auburn development plans or cash flows.
- Assess the sensitivity of cash flow and asset values to commodity prices, reserve revisions and future impairment testing.
- Reconcile Adjusted EBITDA to GAAP cash flow and net income, particularly the impact of derivative mark-to-market gains, stock-based compensation and non-cash charges.
- Track remaining share repurchase authorization of 1,069,800 shares and its effect on liquidity and share count.