Epsilon Energy Ltd. (NASDAQ:EPSN) Q4 2022 Earnings Call Transcript March 24, 2023
Operator: Good morning. And welcome to the Epsilon Energy 2022 Year End Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Andrew Williamson, Chief Financial Officer. Please go ahead.
Andrew Williamson: Thank you, Operator. And on behalf of the management team, I would like to welcome all of you to today’s conference call to review Epsilon’s fourth quarter and full year 2022 financial and operational results. Before we begin, I would like to remind you that our comments may include forward-looking statements. It should be noted that a variety of factors could cause Epsilon’s actual results to differ materially from the anticipated results or expectations expressed in these forward-looking statements. Today’s call may also contain certain non-GAAP financial measures. Please refer to the earnings release that we issued yesterday for disclosures on forward-looking statements and reconciliations of non-GAAP measures. With that, I’d like to turn the call over to Jason Stabell, our Chief Executive Officer.
Jason Stabell: Thank you, Andrew. Good morning to everyone and thank you for participating in our conference call. Joining me today are Andrew Williamson, our CFO; and Henry Clanton, our COO. We will be available to answer questions later in the call. I’m pleased to report that we delivered record profitability in 2022 and the company sits on a very solid foundation moving forward. Our positive results are largely due to the hard work of our team and I want to thank them for all their contributions. Here are some key highlights from 2022. Net revenue interest production was 27.3 MMcfe per day, down 6% year-over-year. We generated net income of $35.4 million, representing $1.51 per diluted share. Adjusted EBITDA grew 120% year-over-year to $53.1 million.
Free cash flow before changes in working capital increased by 139% year-over-year to $35 million. We increased our cash balance year-over-year by 69% to $45.8 million, including restricted cash, representing $1.96 per diluted share. We returned $12.1 million to shareholders during the year through our quarterly dividend and share repurchases. We have a debt free balance sheet with a growing cash position. Currently, we have available liquidity of approximately $75 million, comprised of $45 million in cash as of year-end and $30 million of undrawn borrowing availability under our revolving credit facility as of February this year. In 2022, we were largely unhedged, and as a result, we were able to capitalize on higher commodity prices during the year.
Our average realized price for the year, including hedges, was $6.09 per Mcfe. Realized prices were significantly higher year-over-year with natural gas realizations nearly doubling. The combination of sustained production and increased pricing resulted in a record adjusted EBITDA and free cash flow. This year’s $53 million of adjusted EBITDA compares to $40 million for the full year of 2021 and 2020 combined. We generated over $20 million in incremental free cash flow before changes in working capital over last year. Moving on to our assets. In Pennsylvania, five gross wells, 0.05 net were drilled and four gross wells, 0.21 net were completed during the year. The most notable was the Koromlan 107HC, which came online in August 2022. The well has produced strongly with cumulative production of 5.9 Bcf in just over four months in 2022.
Photo by Chris LeBoutillier on Unsplash
We have a 16% net revenue interest in the well. The Koromlan is a long lateral, nearly 14,000 feet completed in the Lower Marcellus and demonstrates the potential of our remaining drilling inventory in Auburn. We incurred $3 million in capital expenditures related to our Marcellus upstream assets, primarily attributable to the Koromlan well. While we do not operate, we will continue to work with the operator to develop the substantial remaining inventory. In Oklahoma, production was up to 2.6 MMcfe per day, a 30% increase over last year as we participated in the drilling of two gross wells, 0.26 net and the completion of three gross wells, 0.7 net for a total capital cost of $4 million net to Epsilon. One of the wells drilled in 2022 is awaiting completion in the first half of this year.
Our Oklahoma assets accounted for 13% of our upstream revenues during the year. These assets remain solid contributors with a mix of natural gas, oil and natural gas liquids. Our Auburn Gas Gathering System provides us with a steady stream of revenue and cash flow. Throughput in the system was up 5% compared to the prior year, which contributed to higher midstream revenues, up 3% year-over-year. Our midstream earnings growth potential is highly leveraged to incremental development in the Auburn area. Turning to our year-end reserve results. I would like to point out that we do not operate our upstream assets, and as a result, we often have limited visibility on future development plans. We use best estimates based on the information from operators and our team’s view on the optimized development plan for returns.
In the latest reserve report, we reduced estimated near-term capital expenditures based on discussions with our operators. This change resulted in a portion of our prior PUDs shifting outside the five-year SEC window required for proved classification. However, our total resource estimates did not change. We believe the current assumed pace of development will likely eliminate the need for any similar downward adjustments in future years. We continue to believe that our acreage is the highest quality, as demonstrated by our 2022 results and we will continue to work constructively with our partners to best realize the value of our assets. For year-end 2022, we reported SEC proved reserves of 94.3 Bcfe, which included an increase of 7.2 Bcfe improved developed producing reserves, comprised of 9.9 Bcfe of positive performance revisions and an increase of 7.3 Bcfe due to the new wells completed.
These additions were partially offset by 10 Bcfe of production. We saw the impact of the five-year SEC booking rule in our PUD reserves. We had a 23.5 Bcfe reduction from previous estimates due to the aforementioned change in our development timing assumptions. We anticipate reclassifying these reserves back to prove once we have line of sight on development timing. Despite the reclassification of these PUD reserves, we saw a significant increase in our overall PV10 value, driven by higher SEC pricing. The PV10 value of our SEC proved reserves at year-end 2022 increased by $85 million to $193 million. Approximately 95% of year-end 2022 SEC proved reserves were natural gas, 3% NGLs and 2% crude oil. The reserves were classified as 86% proved developed producing and 14% proved undeveloped.
We have a solid asset base that will continue to provide meaningful cash flow to our shareholders for many years. As we look ahead in 2023, we are focused on continuing to deliver strong results. We believe that Epsilon is well positioned for continued success in a variety of commodity price environments. In late December, we hedged over 1 Bcf of 2023 production for the April to October period at a net realized price of $3.96 MMcf. We remain focused on returning capital to our shareholders through our dividend and share buyback programs. To that end, yesterday, we announced a new buyback program, which will run for 12 months. We have increased the cap to 10% of shares outstanding or 2.3 million shares, our regulatory limit. Finally, our strong balance sheet positions us to actively pursue accretive business development opportunities.
Our initial focus has been in Appalachia, where our deep knowledge and long history in the basin distinguish us from other small to midsize companies. However, we will also consider opportunities in other basins, if attractive and consistent with our strategy. We believe that the recent volatility in commodity prices could help augment the number of attractive opportunities in the A&D and farm-out markets. We believe that our ability to quickly evaluate and execute on opportunities makes us an attractive counterparty. We are excited about the future and remain focused on creating value for our shareholders. This includes working closely with our operators on our existing assets, ongoing BD efforts and better highlighting the attractive value proposition of our shares to the investment community.
Operator, we can now open the lines for questions.
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Q&A Session
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Operator: Thank you. And the first question will be from Tom McIntyre from MFS . Please go ahead.
Unidentified Analyst: Good morning, all. Thank you for the update. I have two things. You mentioned looking at basins in the Marcellus, I think, you talked about it on the last call, but given the price of natural gas, and obviously, your hedging move was a good one. What’s your thinking about that I just don’t see how you can be and if you’re not the operator how you would want to risk more capital into this sort of market at this time and that’s one thing? And it kind of leads me to my second question would be, last year, as you reported, you spent $6 million or $7 million buying back stock, but the number of shares really didn’t fall hardly at all. This year is a larger buyback, and as a shareholder, I’m interested in seeing that share count fall.
So maybe you could address that, obviously, you had something to do with option expiration and I don’t know what the level and pace for that might be in the New Year. But the two in terms of capital allocation, whether investing in basins or buying your own shares seem to be somewhat related while we have natural gas at these prices? Thank you.
Jason Stabell: Hi, Tom. Thanks for joining and I appreciate the questions. So, for your first question on Marcellus investment opportunities, clearly, the rollover in nat gas prices has challenged a lot of different investment opportunities there. I think our view is, we’ve got a pretty disciplined approach on our cost of capital. We’re looking at stuff there and if the opportunity set meets those criteria, then I think we would consider it. For sure, there are less people probably out looking to move assets. So opportunities that may come to the fore for us probably are more on the farm-out side. I mean that’s a bit of speculation, but people that want to keep drilling rigs going. I think everybody’s of the view or a consensus view is we’re in a middling period here on that gas, but the medium- to long-term picture is still quite strong.
We are going to keep looking, and as we mentioned on today’s call, we’re also considering inbound investments. I think our balance sheet and ability to move pretty quickly. We get quite a few inbounds from other basins of investment or possible investment opportunities. So we’re staying busy. But you’re right. It it’s a more challenged environment on the nat gas side. On your buyback, I think, first, to address the year-over-year share count. I’d say probably the big driver last year on that is the management transition. There were a number of shares that accelerated. So that drove the issuance there. Otherwise, I think, we would have had a more meaningful year-over-year drop. And with the buyback in place for this year, yes, we’d expect — if we find attractive opportunities to buy the stock that we would drive down the overall shares outstanding.
