EPSN - NASDAQ

Good morning. And welcome to the Epsilon Energy 2022 Year End Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] 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.

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.

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. 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.

Thank you. [Operator Instructions] And the first question will be from Tom McIntyre from MFS [ph]. Please go ahead.

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.

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.

Thanks. Could I also ask, I think, I was waiting, I don’t know if anybody else was to see whether new management would continue or change the dividend policy, and in your press release, you kind of, A, you did do that; and B, in the press release, you kind of you kind of trumpet it a little bit as if it was part of your -- of a steady outlook in terms of the companies going forward in terms of your capital allocation. Is that a fair reading of the point you were trying to get across in the press release?

I’d say this, the Board is very comfortable with the dividend where it is, and obviously, that’s something we continue to evaluate, but we feel real strong about where we are on the dividend going forward.

Okay.

That’s our imagination.

Thanks very much.

Tom, this is Andrew. That dividend is underwritten by our earnings from the midstream system. That’s how we think about it.

Yeah. I just didn’t know…

It’s not affected where the price…

… would revisit the whole concept of a company like you folks paying a dividend, but so I was curious as to what you’re and then you trumped, like said in the press release, so I thought that put on sounder footing. But I just wanted to ask.

Thanks.

Thank you.

[Operator Instructions] The next question is from Nat Stewart from N.A.S. Capital. Please go ahead.

Good morning, guys.

Hi, Nat.

I just had a few questions. One is just a little accounting change, I noticed on the gathering system. I was curious why you did that. It looks like you allocated some of the kind of cost that nets out from the upstream to the gathering system, is that correct? I mean, I think, I saw that. I was just curious if there is a reason for that or what that was about?

Yeah. Nat, thank you for the question. This is Andrew. Yeah. That’s correct. We changed the way we do that elimination for the gathering fees that we pay to Epsilon’s ownership and the gathering system. The appropriate way to do that is it’s a net of gathering system revenue and its upstream operating costs, because it’s a gathering fee...

Okay.

Previously that had been netted out of upstream operating costs rather than gathering system operating costs, so.

Okay.

This is a new mechanism.

So if I…

This is appropriate way to do it. Yeah.

Okay.

Yeah.

So if I was just considering it, let’s say, you own, let’s say, you didn’t have the upstream, right? And it was just a partial ownership in this pipeline. How would I think about the revenue and costs attached to that absent kind of the various netting effects? Am I correct, it would be -- the revenue would be $9.6 million and then you deduct I’m not sure some amount for the expenses attached to that?

Yeah. There’s $1.5 million in additional gathering revenue.

Okay. And on the cost side, would that…

From 8.1% to the 9.6% as you point out.

And then what would the cost part look like?

The cost part would be the same because…

Okay.

… we’re now netting that out of upstream costs.

Okay. All right.

On the gathering system OpEx would be the same.

Okay. Now in terms of your investment outlook, I guess, I had that pretty well covered. Are you looking at kind of all size deals, because you have a pretty substantial capacity here? I assume if something substantial came up, you could have a pretty good capacity relative to your current asset base to buy something. Are you looking at kind of all sized deals or are you looking at, how does the ability to put a decent amount of money to work look?

It will depend on the opportunity. But, yeah, I think, we’re…

Okay.

There aren’t many advantages to being a small cap energy company. But for us, that balance sheet and having the flexibility that it provides, I think, is an advantage for us in considering a variety of different opportunities large and small. Small things move the needle for us, but we’re certainly open to larger opportunities that make sense for the shareholders.

Yeah. I agree with that. And I think really to succeed as a public company, building that kind of operating leverage with some substantial investments would make a big difference. In terms of hedging, is there anything you’ve done since December that wasn’t mentioned or is that your full hedge position?

That’s the full hedge position. We -- back in December, I thought there was some softness potentially over the summer. It’s hard when you’ve got our balance sheet…

Yeah. Yeah.

… to think aggressively about hedging. But we thought the risk reward, it was about a 525 Henry Hub, the risk reward versus what we saw as some of the downside potential in price made sense to put the hedges on in retrospect.

Yeah.

I would have loved if we’ve done more, but things fell apart pretty fast right after...

Yeah. Right. I think that...

Yeah.

That must have caught a lot of people by surprise, obviously. So, yeah, that sounds great. Keep it up and I look forward to seeing what you guys come up with. Thanks for answering my questions.

Thanks, Nat.

Thanks, Nat.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Jason Stabell for any closing remarks.

Thanks, Chad. On behalf of the company, I want to thank everybody for their interest in Epsilon. If you have any additional questions, feel free to contact us. And I’d also like to highlight we have a refresh website that we launched today and we expect in the early part of the second quarter to be posting an updated corporate presentation on the website as well. So look out for that, and again, everybody have a great weekend. Thank you.