Epsilon Energy Ltd. — Form 10-Q Summary
Business Context and Reporting Period
Epsilon Energy Ltd. is a North American onshore natural gas and oil company engaged in acquisition, development, production, gathering and compression activities. Its operations are concentrated in Pennsylvania, Oklahoma, New Mexico and Texas. The filing covers the unaudited quarter and nine months ended September 30, 2023, with comparisons to the same periods in 2022.
- Key assets include 5,098 net Pennsylvania acres, 7,228 net Oklahoma acres, 3,093 net Texas acres, New Mexico wellbore interests and a 35% interest in the Auburn Gas Gathering System.
- Common shares outstanding at September 30, 2023: 22,126,800; shares outstanding as of November 8, 2023: 22,160,439.
Financial Performance and Key Metrics
| Metric | Q3 2023 | Q3 2022 | 9M 2023 | 9M 2022 |
|---|---|---|---|---|
| Total revenue | $6.3 million | $21.2 million | $22.2 million | $54.7 million |
| Operating income | $0.7 million | $14.4 million | $3.7 million | $37.2 million |
| Net income | $0.4 million | $9.6 million | $4.3 million | $26.0 million |
| Diluted EPS | $0.02 | $0.41 | $0.19 | $1.11 |
| Adjusted EBITDA | $3.9 million | $16.5 million | $13.7 million | $41.2 million |
| Cash flow from operations | Not separately provided | Not separately provided | $14.4 million | $29.4 million |
- Q3 operating margin was approximately 11.8%, net margin approximately 6.2% and Adjusted EBITDA margin approximately 62.2%. Nine-month operating margin was approximately 16.8%, net margin approximately 19.6% and Adjusted EBITDA margin approximately 61.9%.
- Natural gas, oil, NGL and condensate revenue was $3.2 million in Q3 and $14.5 million for the nine months. Gas gathering and compression revenue was $3.1 million in Q3 and $7.7 million for the nine months.
- Cash and cash equivalents were $12.5 million at September 30, 2023. Short-term U.S. Treasury investments were $18.9 million, and restricted cash was $0.5 million.
- Working capital surplus was $32.5 million at September 30, 2023, compared with $49.2 million at December 31, 2022.
- Total liabilities were $20.3 million and shareholders’ equity was $99.5 million at September 30, 2023.
- The company had no borrowings under its $35 million revolving credit facility. Interest is based on Daily Simple SOFR plus 3.25%.
Cash Flow, Capital Allocation and Liquidity
- Operating activities provided $14.4 million during the first nine months of 2023, down 51% from $29.4 million in the comparable 2022 period.
- Investing activities used $37.1 million, including $18.3 million of net purchases of U.S. Treasury Bills and approximately $18.8 million of leasehold, drilling and well costs.
- Financing activities used $10.1 million, including $5.7 million for share repurchases and $4.2 million for dividends.
- The company paid quarterly dividends of $0.0625 per share, or $0.25 per share annualized, during 2023.
- During the nine months, Epsilon repurchased 1,087,975 shares at an average price of $5.21 per share under two consecutive repurchase programs.
- Management stated that cash, short-term investments, available borrowings and operating cash flow should be sufficient to meet cash requirements for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Revenue declined 70% in Q3 and 60% for the nine months, primarily because of sharply lower natural gas prices and lower production volumes.
- Pennsylvania realized natural gas prices decreased 85% in Q3 to $1.07 per Mcf and 72% for the nine months to $1.74 per Mcf. Pennsylvania gas production declined 26% in Q3 and 10% for the nine months.
- Oklahoma realized prices declined 48% in Q3 and 39% for the nine months, while Oklahoma production declined 40% and 32%, respectively.
- Gathering system revenue increased 48% in Q3 and 24% for the nine months, benefiting from higher anchor-shipper volumes and a one-time compressor fee adjustment.
- Operating costs decreased 23% for both Q3 and the nine months, partly reflecting lower production and unusually high plugging and abandonment costs in the 2022 period.
- General and administrative expense decreased 21% in Q3 but increased 9% for the nine months, primarily due to compensation, director fees and service costs.
- Derivative contracts produced a $1.7 million gain for the nine months versus a $1.1 million loss in the comparable 2022 period, including $3.0 million of cash settlements received in 2023.
- The company recorded a $1.45 million loss on Oklahoma asset sales in 2023 compared with a $0.22 million gain in 2022.
Acquisitions, Outlook, Risks and Unusual Items
- During 2023, Epsilon acquired a 10% interest in two New Mexico wellbores for $2.1 million, a 25% interest in 1,297 gross Texas acres and related drilling activity, and a 25% interest in 11,067 gross Texas acres.
- Two Texas wells were drilled and were undergoing completion, with first production expected in early Q4 2023. Initial plans called for four wells on the larger Texas position during the first half of 2024.
- At September 30, 2023, the company had three gross, or 0.47 net, Pennsylvania wells being drilled and two gross, or 0.50 net, Texas wells awaiting flowback.
- Outstanding commodity contracts covered approximately 2.9 Bcf for November 2023 through October 2024. The contracts reduce downside exposure to gas prices but also limit benefits from higher prices.
- Asset retirement obligations were $2.8 million on a discounted basis and approximately $7.4 million on an undiscounted basis.
- The company’s lawsuit against Chesapeake was dismissed without prejudice in September 2023 following remand from the Third Circuit. The filing does not provide a quantified financial impact.
- Management identified commodity prices, production volumes, transportation and gathering conditions, reserve estimates, interest rates, counterparty performance and development execution as key risks. The filing states that there were no material changes to previously disclosed risk factors.
- No impairment was recorded during the three or nine months ended September 30, 2023.
Important Facts for Investors to Verify
- Whether low natural gas prices and declining Pennsylvania and Oklahoma production persist, and their effect on operating cash flow.
- Completion timing, production rates and capital requirements for the Texas wells and planned 2024 drilling program.
- The December 1, 2023 borrowing-base redetermination and continued compliance with credit facility covenants.
- Remaining authorization and future execution under the share repurchase program, including the 1,395,369 shares remaining at September 30, 2023.
- Realized results and settlement exposure under the 2023–2024 gas derivative contracts.
- The sustainability of dividends and share repurchases relative to cash flow after capital expenditures.
- Customer concentration, as one customer represented 20% of nine-month revenue and two customers represented 36% and 24% of Q3 revenue.