Epsilon Energy Ltd. — Q1 2022 Form 10-Q Summary
Business Context and Reporting Period
Epsilon Energy Ltd. is a North American independent oil and natural gas company focused primarily on acquiring, developing, gathering and producing U.S. natural gas reserves. Its principal operations are in Pennsylvania, including a 35% interest in the Auburn Gas Gathering System, with additional production in Oklahoma. The filing covers the unaudited three months ended March 31, 2022, compared with the three months ended March 31, 2021.
Key Financial Metrics
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Total revenue | $13.6 million | $8.4 million | +61% |
| Operating income | $9.0 million | $3.4 million | +161% |
| Net income | $5.8 million | $2.7 million | +112% |
| Diluted EPS | $0.24 | $0.11 | +118% |
| Net cash from operations | $7.7 million | $5.6 million | +38% |
| Adjusted EBITDA | $9.3 million | $5.4 million | +72% |
| Cash, cash equivalents and restricted cash | $30.6 million | $18.4 million | +66% |
Natural gas, oil, NGL and condensate revenue was $11.5 million, up from $6.4 million, while gathering and compression revenue was $2.1 million, up from $2.0 million. Natural gas revenue benefited primarily from higher realized prices: $4.55/Mcf versus $2.57/Mcf, partly offset by lower Pennsylvania production volumes of 2.351 Bcf versus 2.466 Bcf. Oklahoma production increased 141% to 0.17 Bcfe, with an average realized price of $7.71/Mcfe.
Operating costs and expenses declined to $4.6 million from $5.0 million. DD&A declined 20% to $1.4 million, and general and administrative expense declined 14% to $1.3 million. The net income margin was approximately 42.7%, compared with 32.4% in Q1 2021. The filing does not present a separately defined GAAP operating margin; operating income as a percentage of revenue was approximately 65.9% versus 40.7%.
Cash Flow, Liquidity and Capital Structure
- Operating cash flow was $7.7 million. Investing cash outflows were $2.9 million, primarily for proved and unproved oil and gas properties. Financing cash outflows were $1.3 million, primarily for a $1.5 million dividend.
- Cash, cash equivalents and restricted cash increased by $3.6 million during the quarter to $30.6 million. Working capital surplus was $27.6 million at March 31, 2022, compared with $24.1 million at December 31, 2021.
- The company had no borrowings under its senior secured revolving credit facility. The facility has a total commitment of up to $100 million, with a current borrowing base of $14 million and maturity in March 2024.
- Total liabilities were $22.1 million and shareholders’ equity was $83.9 million at March 31, 2022. Current liabilities included $3.3 million of income taxes payable.
- The Board declared and paid a quarterly dividend of $0.0625 per share, or $0.25 annualized. No shares were repurchased during Q1 2022, although the company authorized a 2022 repurchase program for up to 1,183,410 shares and $8 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven mainly by a 77% increase in realized Pennsylvania natural gas prices and increased Oklahoma oil and liquids production and pricing.
- Commodity derivatives produced a $971,904 loss in Q1 2022 versus a $465,341 gain in Q1 2021. The Q1 2022 loss included $1.2 million of cash settlements. No derivative contracts remained outstanding at March 31, 2022.
- Capital expenditures increased to $2.9 million from $0.6 million, reflecting increased development spending in Pennsylvania and Oklahoma.
- The company retired 534,015 treasury shares repurchased during 2021. It also issued 38,750 shares upon exercise of stock options.
- Accounts receivable increased to $6.5 million from $4.6 million, while income taxes payable increased to $3.3 million from $1.1 million.
Guidance, Outlook, Risks and Unusual Items
- Management expects 2022 local Appalachian production to be broadly flat versus 2021. Its target is to maintain or modestly grow production only when natural gas prices and expected returns justify additional capital.
- Management believes cash on hand, operating cash flow and available credit will be sufficient for at least the next twelve months and beyond. The company expects to remain compliant with its credit-facility covenants.
- Subsequent to quarter-end, the company hedged approximately 15% of anticipated remaining 2022 production using NYMEX costless collars. Hedging reduces downside exposure but limits benefits from higher commodity prices.
- Material commitments included $1.03 million of capital expenditure commitments, $0.2 million of operating lease obligations and $7.5 million of undiscounted asset retirement obligations, primarily due after three years.
- Epsilon is pursuing litigation and related appellate proceedings against Chesapeake Appalachia concerning alleged breaches of settlement and operating agreements and alleged obstruction of Auburn Development activities. The initial amended complaint was dismissed on a narrow issue without prejudice; Epsilon appealed and refiled a complaint on May 9, 2022. The filing does not provide a quantified potential recovery or loss.
- Key risks include commodity-price volatility, production declines, gathering-system throughput and rate changes, counterparty and derivative risk, reserve and impairment estimates, regulatory and permitting matters, and concentration of revenue among significant customers. Three customers represented 37%, 13% and 12% of Q1 2022 revenue.
- No impairment of oil and gas properties was required in Q1 2022. The company reported effective disclosure controls and no material changes in internal control over financial reporting.
Investor Verification Priorities
- Verify whether elevated natural gas and Oklahoma liquids prices are sustainable and how subsequent price movements affect realized revenue and cash flow.
- Review production trends, reserve updates and the timing and returns of Pennsylvania and Oklahoma development expenditures.
- Assess the cash impact and accounting volatility of derivative settlements, including the new 2022 hedges.
- Monitor the Chesapeake litigation, appeal and refiled complaint, including any effects on Auburn Development permitting and future production.
- Confirm the borrowing-base redetermination, credit-facility covenants and liquidity after dividends, capital spending and any share repurchases.
- Evaluate customer concentration and the cost-of-service mechanics of the Auburn Gas Gathering System through its 2026 operating term.