Magnolia Oil & Gas Corp 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts included or incorporated by reference in this report, including, without limitation, statements regarding the Company’s future financial position, business strategy, budgets, projected revenues, projected costs, and plans and objectives of management for future operations, are forward-looking statements. Such forward-looking statements are based on the beliefs of management, as well as assumptions made by, and information currently available to, the Company’s management. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “could,” “expect,” “intend,” “project,” “estimate,” “anticipate,” “plan,” “believe,” or “continue” or similar terminology. Although Magnolia believes that the expectations reflected in such forward-looking statements are reasonable, the Company can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the Company’s expectations include, but are not limited to, Magnolia’s assumptions about: • the length, scope, and severity of the ongoing coronavirus disease 2019 (“COVID-19”) pandemic, including the effects of related public health concerns and the impact of continued actions taken by governmental authorities and other third parties in response to the pandemic and its impact on commodity prices, and supply and demand considerations; • legislative, regulatory, or policy changes, including those following the change in presidential administrations; • the market prices of oil, natural gas, natural gas liquids (“NGLs”), and other products or services; • the supply and demand for oil, natural gas, NGLs, and other products or services; • production and reserve levels; • drilling risks; • economic and competitive conditions; • the availability of capital resources; • capital expenditures and other contractual obligations; • weather conditions; • inflation rates; • the availability of goods and services; • cyber attacks; • the occurrence of property acquisitions or divestitures; • the integration of acquisitions; and 15 • the securities or capital markets and related risks such as general credit, liquidity, market, and interest-rate risks. All of Magnolia’s forward-looking information is subject to risks and uncertainties that could cause actual results to differ materially from the results expected. Although it is not possible to identify all factors, these risks and uncertainties include the risk factors and the timing of any of those risk factors identified in this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the period ended December 31, 2020 (the “2020 Form 10-K”). Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Company’s unaudited consolidated financial statements and the related notes thereto. Overview Magnolia Oil & Gas Corporation (the “Company” or “Magnolia”) is an independent oil and natural gas company engaged in the acquisition, development, exploration, and production of oil, natural gas, and NGL reserves that operates in one reportable segment located in the United States. The Company’s oil and natural gas properties are located primarily in Karnes County and the Giddings area in South Texas, where the Company primarily targets the Eagle Ford Shale and the Austin Chalk formations. Magnolia’s objective is to generate stock market value over the long-term through consistent organic production growth, high full cycle operating margins, an efficient capital program with short economic paybacks, significant free cash flow after capital expenditures, and effective reinvestment of free cash flow. Magnolia’s business model prioritizes free cash flow, financial stability, and prudent capital allocation, and is designed to withstand challenging environments such as the one the Company is currently experiencing. COVID-19 Pandemic and Market Conditions Update In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. Governments have tried to slow the spread of the virus by imposing social distancing guidelines, travel restrictions, and stay-at-home orders, which have caused a significant decrease in activity in the global economy and the demand for oil and natural gas. The implications of the decrease in global demand for, coupled with the general oversupply of, oil may have further negative effects on the Company’s business. Demand and pricing may again decline if there is a resurgence of the outbreak across the U.S. and other locations across the world or as a result of the related social distancing guidelines, travel restrictions, and stay-at-home orders. The extent of any further impact of the pandemic on Magnolia’s industry and business cannot be reasonably predicted at this time. Magnolia’s business model prioritizes free cash flow, financial stability, and prudent capital allocation, and is designed to withstand challenging environments. The Company’s ongoing plan is to spend within cash flow on drilling and completing wells while maintaining low leverage. In the first quarter of 2021, Magnolia operated one rig in the Giddings area. The Company is well positioned to reduce or increase operations given the significant flexibility within its capital program, as its operated drilling rig is on a short-term contract and the Company has no long-term service obligations. Moreover, Magnolia does not have any contractual drilling obligations and nearly all of the Company’s acreage is held by production. In order to protect the health and safety of its workers, Magnolia and its contractors have implemented protocols to reduce the risk of an outbreak within the Company’s operations, and these protocols have not reduced production or efficiency in a significant manner. Magnolia's board of directors is continuing to monitor the unfolding COVID-19 pandemic very closely. Magnolia has been able to maintain a consistent level of effectiveness, including maintaining day-to-day operations, financial reporting systems, and internal control over financial reporting. Business Overview As of March 31, 2021, Magnolia’s assets in South Texas included 42,970 gross (23,512 net) acres in the Karnes area, and 634,210 gross (436,585 net) acres in the Giddings area. As of March 31, 2021, Magnolia held an interest in approximately 1,841 gross (1,174 net) wells, with total production of 62.3 thousand barrels of oil equivalent per day (“Mboe/d”) for the three months ended March 31, 2021. In the first quarter of 2021, Magnolia operated one rig in the Giddings area. Magnolia recognized net income attributable to Class A Common Stock of $63.2 million, or $0.37 per diluted common share, for the three months ended March 31, 2021. Magnolia recognized net income of $91.5 million, which includes a noncontrolling interest of $28.2 million related to the Magnolia LLC Units (and corresponding Class B Common Stock) held by certain affiliates of EnerVest for the three months ended March 31, 2021. 16 The Company’s board of directors has authorized a share repurchase program of up to 20.0 million shares. The program does not require purchases to be made within a particular timeframe. As of March 31, 2021, the Company had repurchased 7.4 million shares under the plan at an aggregate cost of $59.2 million. On March 5, 2021, Magnolia LLC repurchased and subsequently canceled 5.0 million Magnolia LLC Units with an equal number of shares of corresponding Class B Common Stock for $50.8 million of cash consideration (the “Class B Common Stock Repurchase”). In addition, EnerVest redeemed 14.2 million shares of Class B Common Stock for Class A Common Stock and subsequently sold the stock as part of the secondary offering completed on March 5, 2021. Magnolia did not receive any proceeds from the sale of shares of Class A Common Stock by EnerVest. Magnolia funded the Class B Common Stock Repurchase with cash on hand. As of March 31, 2021, Magnolia owned approximately 72.6% of the interest in Magnolia LLC and the noncontrolling interest was 27.4%. Results of Operations Three Months Ended March 31, 2021 Compared to the Three Months Ended March 31, 2020 Oil, Natural Gas and NGL Sales Revenues. The following table provides the components of Magnolia’s revenues for the periods indicated, as well as each period’s respective average prices and production volumes. This table shows production on a boe basis in which natural gas is converted to an equivalent barrel of oil based on a ratio of six Mcf to one barrel. This ratio may not be reflective of the current price ratio between the two products. Three Months Ended (In thousands, except per unit data) March 31, 2021 March 31, 2020 Production: Oil (MBbls) 2,593 3,391 Natural gas (MMcf) 10,240 10,053 NGLs (MBbls) 1,304 1,155 Total (Mboe) 5,604 6,222 Average daily production: Oil (Bbls/d) 28,808 37,259 Natural gas (Mcf/d) 113,783 110,475 NGLs (Bbls/d) 14,490 12,688 Total (boe/d) 62,262 68,360 Revenues: Oil revenues $ 146,413 $ 154,686 Natural gas revenues 34,764 16,175 Natural gas liquids revenues 26,486 10,504 Total revenues $ 207,663 $ 181,365 Average Price: Oil (per barrel) $ 56.47 $ 45.62 Natural gas (per Mcf) 3.39 1.61 NGLs (per barrel) 20.31 9.09 Oil revenues were 71% and 85% of the Company’s total revenues for the three months ended March 31, 2021 and 2020, respectively. Oil production was 46% and 55% of total production volume for the three months ended March 31, 2021 and 2020, respectively. Oil revenues for the three months ended March 31, 2021 were $8.3 million lower than the three months ended March 31, 2020. A 24% decrease in oil production reduced revenues by $45.1 million compared to the same period in the prior year, while a 24% increase in average prices increased first quarter 2021 revenues by $36.8 million. The decrease in oil production was the result of the Company bringing fewer wells online in the three months ended March 31, 2021. 17 Natural gas revenues were 17% and 9% of the Company's total revenues for the three months ended March 31, 2021 and 2020, respectively. Natural gas production was 30% and 27% of total production volume for the three months ended March 31, 2021 and 2020, respectively. Natural gas revenues for the three months ended March 31, 2021 were $18.6 million higher than the three months ended March 31, 2020. A 111% increase in average prices increased first quarter 2021 revenues by $18.0 million compared to the same period in the prior year, while a 2% increase in natural gas production increased revenues by $0.6 million. NGL revenues were 13% and 6% of the Company’s total revenues for the three months ended March 31, 2021 and 2020, respectively. NGL production was 23% and 19% of total production volume for the three months ended March 31, 2021 and 2020, respectively. NGL revenues for the three months ended March 31, 2021 were $16.0 million higher than the three months ended March 31, 2020. A 123% increase in average prices increased first quarter 2021 revenues by $13.0 million compared to the same period in the prior year, while a 13% increase in NGL production increased revenues by $3.0 million. Operating Expenses and Other Income (Expense) . The following table summarizes the Company’s operating expenses and other income (expense) for the periods indicated. Three Months Ended (In thousands, except per unit data) March 31, 2021 March 31, 2020 Operating Expenses: Lease operating expenses $ 19,392 $ 24,163 Gathering, transportation and processing 8,799 8,020 Taxes other than income 10,762 10,018 Exploration expenses 2,062 556,427 Impairment of oil and natural gas properties — 1,381,258 Asset retirement obligations accretion 1,331 1,438 Depreciation, depletion and amortization 42,944 142,671 Amortization of intangible assets 2,113 3,626 General and administrative expenses 20,364 18,080 Total operating expenses $ 107,767 $ 2,145,701 Other Income (Expense): Income from equity method investee $ — $ 440 Interest expense, net (7,294) (6,757) Loss on derivatives, net (482) — Other expense, net (229) (472) Total other expense, net $ (8,005) $ (6,789) Average Operating Costs per boe: Lease operating expenses $ 3.46 $ 3.88 Gathering, transportation and processing 1.57 1.29 Taxes other than income 1.92 1.61 Exploration expense 0.37 89.43 Impairment of oil and natural gas properties — 222.00 Asset retirement obligations accretion 0.24 0.23 Depreciation, depletion and amortization 7.66 22.93 Amortization of intangible assets 0.38 0.58 General and administrative expenses 3.63 2.91 Lease operating expenses are costs incurred in the operation of producing properties, including expenses for utilities, direct labor, water disposal, workover rigs, workover expenses, materials, and supplies. Lease operating expenses for the three months ended March 31, 2021 were $4.8 million, or $0.42 per boe, lower compared to the corresponding 2020 period primarily due to a reduction of workover expenses associated with bringing fewer new wells online, resulting in lower production. Gathering, transportation and processing costs are costs incurred to deliver oil, natural gas, and NGLs to the market. These expenses can vary based on the volume of oil, natural gas, and NGLs produced as well as the cost of commodity processing. The 18 gathering, transportation and processing costs for the three months ended March 31, 2021 were $0.8 million, or $0.28 per boe, higher than the three months ended March 31, 2020 primarily due to higher natural gas production and prices. Taxes other than income include production and ad valorem taxes. These taxes are based on rates primarily established by state and local taxing authorities. Production taxes are based on the market value of production. Ad valorem taxes are based on the fair market value of the mineral interests or business assets. Taxes other than income for the three months ended March 31, 2021 were $0.7 million, or $0.31 per boe, higher compared to the three months ended March 31, 2020 primarily due to an increase in natural gas and NGL revenues. Exploration expenses are geological and geophysical costs that include unproved property impairments, seismic surveying costs, costs of expired or abandoned leases, and delay rentals. Exploration expenses for the three months ended March 31, 2021 were lower than the three months ended March 31, 2020 by $554.4 million, or $89.06 per boe, as a result of an impairment recorded for the quarter ended March 31, 2020 related to Magnolia’s unproved oil and natural gas properties due to the sharp decline in commodity prices primarily driven by the COVID-19 pandemic and oversupply by producers relating to oil price and production controls. For more information, please see Note 6—Fair Value Measurements in the Company’s Notes to Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. For the three months ended March 31, 2021, the Company did not recognize any impairments. For the three months ended March 31, 2020, the Company recognized $1.4 billion of impairment included in “Impairment of oil and natural gas properties” in the consolidated statement of operations related to its proved oil and natural gas properties. The impairment was driven by the sharp decline in commodity prices. For more information, please see Note 6—Fair Value Measurements in the Company’s Notes to Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Depreciation, depletion and amortization (“DD&A”) during the three months ended March 31, 2021 was $99.7 million, or $15.27 per boe, lower than the three months ended March 31, 2020, primarily as a result of lower oil and natural gas property balances associated with proved property impairments recorded in the first quarter of 2020. General and administrative (“G&A”) expenses during the three months ended March 31, 2021 were $2.3 million, or $0.72 per boe, higher than the three months ended March 31, 2020 primarily driven by costs associated with the termination of the Services Agreement and increased corporate payroll expenses related to increased employee headcount. Loss on derivatives, net was a $0.5 million unrealized loss related to the Company’s natural gas costless collar entered into during the third quarter of 2020. There was no derivative activity in the corresponding 2020 period. Liquidity and Capital Resources Magnolia’s primary source of liquidity and capital has been its cash flows from operations. The Company’s primary uses of cash have been for acquisitions of oil and natural gas properties and related assets, development of the Company’s oil and natural gas properties, share repurchases, and general working capital needs. The Company may also utilize borrowings under other various financing sources available to it, including its RBL Facility and the issuance of equity or debt securities through public offerings or private placements, to fund Magnolia’s acquisitions and long-term liquidity needs. Magnolia’s ability to complete future offerings of equity or debt securities and the timing of these offerings will depend upon various factors, including prevailing market conditions and the Company’s financial condition. The Company anticipates its current cash balance, cash flows from operations, and its available sources of liquidity to be sufficient to meet the Company’s cash requirements. As of March 31, 2021, the Company had $400.0 million of principal debt related to the 2026 Senior Notes outstanding and no outstanding borrowings related to the RBL Facility. As of March 31, 2021, the Company had $628.2 million of liquidity comprised of the $450.0 million of borrowing base capacity of the RBL Facility, which was reaffirmed on April 12, 2021, and $178.2 million of cash and cash equivalents. Cash and Cash Equivalents At March 31, 2021, Magnolia had $178.2 million of cash and cash equivalents. The Company’s cash and cash equivalents are maintained with various financial institutions in the United States. Deposits with these institutions may exceed the amount of insurance provided on such deposits. However, the Company regularly monitors the financial stability of its financial institutions and believes that the Company is not exposed to any significant default risk. 19 Sources and Uses of Cash and Cash Equivalents The following table presents the sources and uses of the Company’s cash and cash equivalents for the periods presented: Three Months Ended (In thousands) March 31, 2021 March 31, 2020 Sources of cash and cash equivalents Net cash provided by operating activities $ 118,153 $ 134,878 Other — — $ 118,153 $ 134,878 Uses of cash and cash equivalents Acquisitions, other $ (558) $ (69,390) Additions to oil and natural gas properties (40,166) (101,391) Changes in working capital associated with additions to oil and natural gas properties (1,744) 7,181 Class A Common Stock repurchases (20,281) (6,483) Class B Common Stock purchase and cancellation (50,781) — Non-compete settlement (17,152) — Other (1,838) (936) (132,520) (171,019) Decrease in cash and cash equivalents $ (14,367) $ (36,141) Sources of Cash and Cash Equivalents Net Cash Provided by Operating Activities Operating cash flows are the Company’s primary source of liquidity and are impacted, in the short- and long-term, by oil and natural gas prices. The factors that determine operating cash flows are largely the same as those that affect net earnings or net losses, with the exception of certain non-cash expenses such as DD&A, the non-cash portion of exploration expense, impairment of oil and natural gas properties, asset retirement obligations accretion, and deferred income tax expense. Net cash provided by operating activities totaled $118.2 million and $134.9 million for the three months ended March 31, 2021 and 2020, respectively. During the three months ended March 31, 2021, cash provided by operating activities was negatively impacted by lower oil production, partially offset by positive impacts from increased oil and natural gas prices, and by a decrease in expenses associated with bringing fewer new wells online. Uses of Cash and Cash Equivalents Acquisitions During the three months ended March 31, 2020, the Company completed various leasehold and property acquisitions, primarily comprised of a $69.7 million acquisition of certain non-operated oil and natural gas assets located in Karnes and DeWitt Counties, Texas. There were no such acquisitions during the three months ended March 31, 2021. Additions to Oil and Natural Gas Properties The following table sets forth the Company’s capital expenditures for the three months ended March 31, 2021 and 2020: Three Months Ended (In thousands) March 31, 2021 March 31, 2020 Drilling and completion $ 38,850 $ 100,611 Leasehold acquisition costs 1,316 780 Total capital expenditures $ 40,166 $ 101,391 As of March 31, 2021, Magnolia was running a one-rig program for the Giddings Assets. The activity during the three months ended March 31, 2021 was largely driven by the number of operated and non-operated drilling rigs. The number of operated 20 drilling rigs is largely dependent on commodity prices and the Company’s strategy of maintaining spending to accommodate the Company’s business model. Capital Requirements The Company’s board of directors has authorized a share repurchase program of up to 20 million shares of Class A Common Stock. The program does not require purchases to be made within a particular timeframe and whether the Company undertakes these additional repurchases is ultimately subject to numerous considerations, market conditions, and other factors. During the three months ended March 31, 2021 and 2020, the Company repurchased 2.0 million and 1.0 million shares for a total cost of approximately $20.3 million and $6.5 million, respectively. On March 5, 2021, Magnolia LLC repurchased and subsequently canceled 5.0 million Magnolia LLC Units with an equal number of shares of corresponding Class B Common Stock for $50.8 million of cash consideration. Magnolia funded the Class B Common Stock Repurchase with cash on hand. As of March 31, 2021, Magnolia owned approximately 72.6% of the interest in Magnolia LLC and the noncontrolling interest was 27.4%. In January 2021, the Company amended the Non-Compete agreement such that, rather than delivering an aggregate of 4.0 million shares of Class A Common Stock upon the two and one-half year and the four year anniversaries of July 31, 2018 (the “Closing Date”), the Company would deliver (i) the cash value of approximately 2.0 million shares of Class A Common Stock and approximately 0.4 million shares of Class A Common Stock on the two and one-half year anniversary of the Closing Date and (ii) an aggregate of 1.6 million shares of Class A Common Stock on the four year anniversary of the Closing Date, in each case subject to the terms and conditions of the Non-Compete. On February 1, 2021, as consideration for compliance with the Non-Compete, the Company paid $17.2 million in cash and issued 0.4 million shares of Class A Common Stock.