Epsilon Energy .(EPSN) - 2021 Q3 - Quarterly Report

PART I - FINANCIAL INFORMATION Item 1. Financial Statements The company's assets grew to $96.2M, with net income turning positive to $3.65M for the nine-month period Condensed Consolidated Balance Sheet Highlights (Unaudited) | Account | September 30, 2021 | December 31, 2020 | | :--- | :--- | :--- | | Cash and cash equivalents | $20,592,298 | $13,270,913 | | Total current assets | $28,664,894 | $17,778,069 | | Total property and equipment, net | $66,959,550 | $68,331,878 | | Total assets | $96,192,178 | $86,676,184 | | Total current liabilities | $12,628,525 | $4,510,380 | | Total liabilities | $25,165,376 | $17,656,741 | | Total shareholders' equity | $71,026,802 | $69,019,443 | Condensed Consolidated Statements of Operations Highlights (Unaudited) | Metric | Nine Months Ended Sep 30, 2021 | Nine Months Ended Sep 30, 2020 | | :--- | :--- | :--- | | Total revenue | $28,632,220 | $18,517,244 | | Operating income (loss) | $11,723,863 | $(2,442,113) | | Net income (loss) | $3,647,008 | $(548,518) | | Net income (loss) per share, diluted | $0.15 | $(0.02) | Condensed Consolidated Statements of Cash Flows Highlights (Unaudited) | Cash Flow Activity | Nine Months Ended Sep 30, 2021 | Nine Months Ended Sep 30, 2020 | | :--- | :--- | :--- | | Net cash provided by operating activities | $13,526,750 | $12,093,463 | | Net cash used in investing activities | $(3,825,051) | $(5,491,616) | | Net cash used in financing activities | $(2,377,181) | $(9,078,522) | | Increase (decrease) in cash | $7,323,261 | $(2,468,384) | Note 1. Description of Business Epsilon Energy is a US-based natural gas acquisition, development, and production company - The Company is engaged in the acquisition, development, gathering and production of primarily natural gas reserves in the United States[23] Note 5. Revolving Line of Credit The credit facility maturity was extended to 2024, with the borrowing base reduced to $14M and no outstanding debt - On April 6, 2021, the credit agreement was amended to extend the maturity date to March 1, 2024, and the borrowing base was decreased from $23 million to $18 million[46] - On June 28, 2021, the borrowing base was further decreased from $18 million to $14 million[47] - As of September 30, 2021, there were no borrowings under the revolving line of credit and the company was in compliance with all financial covenants[49][51] Note 6. Shareholders' Equity The company repurchased 525,615 shares for $2.38M and recorded $738,789 in stock compensation expense Share Repurchase Activity (Jan 1, 2021 - Sep 30, 2021) | Period | Shares Purchased | Average Price Paid | | :--- | :--- | :--- | | Total YTD | 525,615 | $4.52 | - The company's 2020 Equity Incentive Plan authorizes the issuance of up to 2,000,000 Common Shares for compensation in the form of stock options, restricted stock, PSUs, and other awards[61] - Stock compensation expense for the nine months ended September 30, 2021, was $738,789, comprising $402,247 for Restricted Stock and $336,542 for PSUs[63][75] Note 7. Revenue Recognition Total operating revenue grew to $28.6M for the nine-month period, driven by a sharp rise in natural gas revenue Operating Revenue Breakdown (Nine Months Ended) | Revenue Source | September 30, 2021 | September 30, 2020 | | :--- | :--- | :--- | | Natural gas | $20,950,378 | $11,470,012 | | Natural gas liquids | $588,685 | $56,705 | | Oil and condensate | $1,201,289 | $190,180 | | Gathering and compression fees | $5,891,868 | $6,800,347 | | Total operating revenue | $28,632,220 | $18,517,244 | Note 9. Commitments and Contingencies The company has $1.8M in capital commitments and is involved in ongoing litigation with Chesapeake Appalachia - As of September 30, 2021, the Company had commitments of $1.8 million for capital expenditures[98] - On March 10, 2021, Epsilon filed a complaint against Chesapeake Appalachia, LLC, claiming breach of settlement and operating agreements concerning the Auburn Development in Pennsylvania[99] Note 11. Operating Segments The Upstream segment drove performance with $13.0M in net earnings, while the Gas Gathering segment contributed $4.3M Segment Performance (Nine Months Ended Sep 30, 2021) | Segment | Operating Revenue | Net Earnings (Loss) | | :--- | :--- | :--- | | Upstream | $22,740,352 | $12,965,907 | | Gas Gathering | $7,088,836 | $4,333,909 | | Corporate | $0 | $(13,652,808) | - The company's reportable segments are Upstream (oil and gas production), Gas Gathering (midstream operations), and Corporate[107] Note 12. Risk Management Activities The company recognized a $6.4M net loss on commodity derivative contracts used to manage price risk - For the nine months ended September 30, 2021, Epsilon recognized losses on commodity derivative contracts of $6,417,123, which included cash settlements of $2,488,702[119] Outstanding Derivative Contracts as of September 30, 2021 | Derivative Type | Volume (MMbtu) | Period | Fair Value (Liability) | | :--- | :--- | :--- | :--- | | Two-way costless collar | 610,000 | 2021 | $(1,589,765) | | Two-way costless collar | 900,000 | 2022 | $(2,338,656) | | Total | 1,510,000 | | $(3,928,421) | Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Higher commodity prices drove a 55% revenue increase and a return to profitability, with strong liquidity Overview & Business Strategy The company focuses on managing cash flow from its North American onshore assets to generate attractive returns - The company's business strategy is to manage cash flow from its producing leasehold and midstream assets to provide attractive rates of return[132] - Epsilon's primary area of operation is Pennsylvania, with assets concentrated in areas conducive to multi-well, repeatable drilling programs[129] Operational Highlights Q3 2021 saw significant realized price increases in both the Marcellus Shale (191%) and Anadarko Basin (511%) - Marcellus Shale (Pennsylvania): Realized natural gas price was $3.43 per Mcf in Q3 2021, a 191% increase over Q3 2020, while natural gas production was 2.6 Bcf[139][140] - Anadarko (Oklahoma): Realized price for all production was $6.17 per Mcfe in Q3 2021, a 511% increase over Q3 2020, with total production increasing 444% to 0.37 Bcfe[142][144] Non-GAAP Financial Measures-Adjusted EBITDA Adjusted EBITDA for the nine-month period increased to $15.2M from $11.7M year-over-year Reconciliation of Net Income to Adjusted EBITDA | Period | Net Income (Loss) | Adjusted EBITDA | | :--- | :--- | :--- | | Nine Months 2021 | $3,647,008 | $15,152,089 | | Nine Months 2020 | $(548,518) | $11,699,423 | | Three Months 2021 | $1,396,466 | $6,787,384 | | Three Months 2020 | $(292,783) | $3,943,131 | Results of Operations Revenue rose 55% to $28.6M due to higher prices, while operating costs decreased and G&A expenses increased - For the nine months ended September 30, 2021, revenues increased $10.1 million, or 55%, to $28.6 million, primarily due to increased commodity prices[150] - Upstream operating costs for the nine months decreased by $0.6 million (9.8%) due to a reduction in the PA impact fee and lower discretionary maintenance spending[157] - DD&A expense decreased by $2.59 million (33%) for the nine months, mainly due to an increase in reported reserves and lower production volumes[166] - G&A expenses for the nine months increased by $1.4 million (34%) due to higher legal fees, CEO compensation, and stock-based compensation[171] Capital Resources and Liquidity The company maintained strong liquidity with a $16.0M working capital surplus and no debt - At September 30, 2021, the company had a working capital surplus of $16.0 million, an increase of $2.7 million from December 31, 2020[180] - For the nine months ended September 30, 2021, cash provided by operating activities was $13.5 million, a 12% increase from the prior year[181] - Since January 1, 2021, Epsilon has repurchased 525,615 common shares for $2,377,181 under its share repurchase program[191] - The company has a senior secured credit facility with a current borrowing base of $14 million and no outstanding borrowings[184][190] Item 3. Quantitative and Qualitative Disclosures About Market Risk The company is primarily exposed to commodity price risk, which it mitigates through derivative hedging contracts - The company's earnings and cash flow are significantly affected by changes in the market price of commodities like natural gas and oil[199] - Epsilon has established a hedging strategy and enters into derivative financial instruments to manage the risk associated with changes in commodity prices and stabilize cash flows[204] - Interest rate risk is minimal as the outstanding principal balance under the credit agreement was nil at September 30, 2021[203] Item 4. Controls and Procedures Disclosure controls were deemed ineffective due to a material weakness in recording realized hedge losses - Management concluded that as of September 30, 2021, disclosure controls and procedures were not effective[206] - The ineffectiveness was due to a material weakness in internal control over financial reporting related to the accounts payable/accrual function regarding the recording of realized hedge losses[206] - Management is developing a remediation plan which is expected to include incremental training and enhanced review of transactions and account reconciliations[208] PART II - OTHER INFORMATION Item 1. Legal Proceedings The company is in an ongoing legal dispute with Chesapeake Appalachia over development agreements - On March 10, 2021, Epsilon filed a complaint against Chesapeake Appalachia, LLC, claiming breach of settlement and operating agreements related to the Auburn Development in North-Central Pennsylvania[213] - The court granted Chesapeake's motion to dismiss on a narrow issue, but Epsilon has filed a motion for reconsideration, which was expected to be fully briefed by November 1, 2021[214] Item 1A. Risk Factors No material changes to risk factors were reported since the company's 2020 Annual Report on Form 10-K - There have been no material changes from the risk factors disclosed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2020[215] Item 2. Unregistered Sale of Equity Securities and Use of Proceeds The company repurchased 525,615 common shares for $2.38M as part of its ongoing share buyback program Share Repurchase Summary (YTD as of Sep 30, 2021) | Metric | Value | | :--- | :--- | | Total shares purchased | 525,615 | | Average price per share | $4.52 | | Maximum shares remaining for purchase | 667,385 | - The share repurchase program commenced on January 1, 2021, and will end on December 31, 2021, unless terminated earlier, with purchases funded out of available cash[217] Other Items (3, 4, 5, 6) Items 3, 4, and 5 were not applicable, while Item 6 lists the exhibits filed with the report - Items 3, 4, and 5 are noted as 'Not applicable'[218][219] - Item 6 lists the exhibits filed with the 10-Q, including SOX 302 and 906 certifications and Inline XBRL documents[221]