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 emergence and spread of variant strains of COVID-19, including the effects of related public health concerns and the impact of continued or new 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; • geopolitical and business conditions in key regions of the world; • 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 • 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 the reports that we have filed and may file with the Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K for the period ended December 31, 2021 (the “2021 Form 10-K”). 16 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. The Company’s ongoing plan is to spend within cash flow on drilling and completing wells while maintaining low leverage. As of March 31, 2022, Magnolia operated one rig exclusively in the Giddings area, and one rig in both the Karnes and Giddings areas. The Company is well positioned to reduce or increase operations given the significant flexibility within its capital program as the Company has no long-term service obligations. COVID-19 Pandemic and Market Conditions Update The COVID-19 pandemic and related economic repercussions have created significant volatility, uncertainty, and turmoil in the oil and natural gas industry. As the global economy continues to recover from the effects of the COVID-19 pandemic, economic indicators have continued to strengthen. However, the economy has begun to experience elevated inflation levels as a result of global supply and demand imbalances. Inflationary pressures and labor shortages could result in increases to our operating and capital costs. Business Overview As of March 31, 2022, Magnolia’s assets in South Texas included 43,518 gross (23,793 net) acres in the Karnes area, and 638,830 gross (447,415 net) acres in the Giddings area. As of March 31, 2022, Magnolia held an interest in approximately 2,020 gross (1,292 net) wells, with total production of 71.8 thousand barrels of oil equivalent per day for the three months ended March 31, 2022. During the first quarter of 2022, Magnolia was running a two-rig program. One rig drilled multi-well development pads exclusively in the Giddings area. The second rig drilled a mix of wells in both the Karnes and Giddings areas. Magnolia recognized net income attributable to Class A Common Stock of $166.0 million, or $0.90 per diluted common share, for the three months ended March 31, 2022. Magnolia recognized net income of $208.6 million, which includes a noncontrolling interest of $42.6 million related to the Magnolia LLC Units (and corresponding shares of Class B Common Stock) held by certain affiliates of EnerVest, for the three months ended March 31, 2022. On February 3, 2022, the Company’s board of directors declared a semi-annual cash dividend of $0.20 per share of Class A Common Stock totaling approximately $37.3 million. The dividend was paid on March 1, 2022 to shareholders of record as of the close of business on February 14, 2022. The Company’s board of directors has authorized a share repurchase program of up to 30.0 million shares. The program does not require purchases to be made within a particular time frame. As of March 31, 2022, the Company had repurchased 15.7 million shares under the program at a cost of $197.9 million. During the three months ended March 31, 2022, the Company also repurchased 0.6 million shares of Class A Common Stock for $11.6 million from EnerVest Energy Institutional Fund XIV-C, L.P. outside of the share repurchase program. During the three months ended March 31, 2022, Magnolia LLC repurchased and subsequently canceled 3.9 million Magnolia LLC Units with an equal number of shares of corresponding Class B Common Stock for $84.7 million of cash consideration (the “Class B Common Stock Repurchases”). Magnolia funded the Class B Common Stock Repurchases with cash on hand. During the same period, the Magnolia LLC Unit Holders redeemed 9.7 million Magnolia LLC Units (and a corresponding number of shares of Class B Common Stock) for an equivalent number of shares of Class A Common Stock and subsequently sold these shares to the public. Magnolia did not receive any proceeds from the sale of shares of Class A Common Stock by the Magnolia LLC Unit Holders. As of March 31, 2022, Magnolia owned approximately 84.0% of the interest in Magnolia LLC and the noncontrolling interest was approximately 16.0%. 17 Results of Operations Factors Affecting the Comparability of the Historical Financial Results Magnolia’s historical financial condition and results of operations for the periods presented may not be comparable, either from period to period or going forward, as a result of the following factors: • On February 16, 2022, Magnolia Operating, as borrower, amended and restated the RBL Facility (“Amended and Restated RBL Facility”) in its entirety, which will now mature in February 2026. • During the second quarter of 2021, the Company amended the term of the Services Agreement to end on June 30, 2021. • During the second quarter of 2021, the Company amended the Non-Compete (the “Second Non-Compete Amendment”), which modified the term of the Non-Compete to end on June 30, 2021. • The 2026 Senior Notes issued under the Indenture, dated as of July 31, 2018, were amended on April 5, 2021. This debt modification included approximately $1.1 million of one-time transaction fees which were expensed and $5.0 million in fees paid to holders of the 2026 Senior Notes, which were reflected as deferred financing costs reducing Long-term debt and will be amortized over the remaining term of the 2026 Senior Notes. As a result of the factors listed above, the historical results of operations and period-to-period comparisons of these results and certain financial data may not be comparable or indicative of future results. 18 Three Months Ended March 31, 2022 Compared to the Three Months Ended March 31, 2021 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, 2022 March 31, 2021 Production: Oil (MBbls) 2,816 2,593 Natural gas (MMcf) 12,378 10,240 NGLs (MBbls) 1,586 1,304 Total (Mboe) 6,465 5,604 Average daily production: Oil (Bbls/d) 31,289 28,808 Natural gas (Mcf/d) 137,532 113,783 NGLs (Bbls/d) 17,624 14,490 Total (boe/d) 71,835 62,262 Revenues: Oil revenues $ 262,667 $ 146,958 Natural gas revenues 56,580 35,663 Natural gas liquids revenues 58,592 26,486 Total revenues $ 377,839 $ 209,107 Average Price: Oil (per barrel) $ 93.28 $ 56.68 Natural gas (per Mcf) 4.57 3.48 NGLs (per barrel) 36.94 20.31 Oil revenues were 70% of the Company’s total revenues for each of the three months ended March 31, 2022 and 2021. Oil production was 44% and 46% of total production volume for the three months ended March 31, 2022 and 2021, respectively. Oil revenues for the three months ended March 31, 2022 were $115.7 million higher than the three months ended March 31, 2021. A 65% increase in average prices increased first quarter 2022 revenues by $94.9 million, while a 9% increase in oil production increased revenues by $20.8 million compared to the same period in the prior year. Natural gas revenues were 14% and 17% of the Company’s total revenues for the three months ended March 31, 2022 and 2021, respectively. Natural gas production was 32% and 30% of total production volume for the three months ended March 31, 2022 and 2021, respectively. Natural gas revenues for the three months ended March 31, 2022 were $20.9 million higher than the three months ended March 31, 2021. A 31% increase in average prices increased first quarter 2022 revenues by $11.1 million compared to the same period in the prior year, while a 21% increase in natural gas production increased revenues by $9.8 million. NGL revenues were 16% and 13% of the Company’s total revenues for the three months ended March 31, 2022 and 2021, respectively. NGL production was 24% and 23% of total production volume for the three months ended March 31, 2022 and 2021, respectively. NGL revenues for the three months ended March 31, 2022 were $32.1 million higher than the three months ended March 31, 2021. An 82% increase in average prices increased first quarter 2022 revenues by $21.7 million compared to the same period in the prior year, while a 22% increase in NGL production increased revenues by $10.4 million. 19 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, 2022 March 31, 2021 Operating Expenses: Lease operating expenses $ 28,744 $ 19,392 Gathering, transportation and processing 15,840 10,243 Taxes other than income 20,882 10,762 Exploration expenses 5,538 2,062 Asset retirement obligations accretion 789 1,331 Depreciation, depletion and amortization 53,106 42,944 Amortization of intangible assets — 2,113 General and administrative expenses 17,070 20,364 Total operating expenses $ 141,969 $ 109,211 Other Income (Expense): Interest expense, net $ (9,357) $ (7,294) Loss on derivatives, net — (482) Other income (expense), net 207 (229) Total other expense, net $ (9,150) $ (8,005) Average Operating Costs per boe: Lease operating expenses $ 4.45 $ 3.46 Gathering, transportation and processing 2.45 1.83 Taxes other than income 3.23 1.92 Exploration expenses 0.86 0.37 Asset retirement obligations accretion 0.12 0.24 Depreciation, depletion and amortization 8.21 7.66 Amortization of intangible assets — 0.38 General and administrative expenses 2.64 3.63 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, 2022 were $9.4 million, or $0.99 per boe, higher compared to the corresponding 2021 period, due to an increase in costs including operating and maintenance costs, workover activities and additional non-operated activities. 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 gathering, transportation and processing costs for the three months ended March 31, 2022 were $5.6 million, or $0.62 per boe, higher than the three months ended March 31, 2021, primarily due to increased natural gas production and higher 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, 2022 were $10.1 million, or $1.31 per boe, higher compared to the three months ended March 31, 2021, primarily due to an increase in oil, natural gas, and NGL revenues. Exploration expenses are geological and geophysical costs that include seismic surveying costs, costs of unsuccessful exploratory dry wells, costs of expired or abandoned leases, and delay rentals. The exploration expenses for the three months ended March 31, 2022 were $3.5 million, or $0.49 per boe, higher than the three months ended March 31, 2021, due to increased seismic surveying costs. Depreciation, depletion and amortization (“DD&A”) during the three months ended March 31, 2022 was $10.2 million, or $0.55 per boe, higher than the three months ended March 31, 2021 due to increased production and a higher depreciable cost basis. 20 For the three months ended March 31, 2022, the Company did not recognize any amortization of intangible assets, because the intangible assets were fully amortized in June 2021 as a result of the termination of the Non-Compete. During the three months ended March 31, 2021, the Company recognized $2.1 million of amortization of intangible assets. General and administrative expenses during the three months ended March 31, 2022 were $3.3 million, or $0.99 per boe, lower than the three months ended March 31, 2021, primarily driven by the reduction in costs due to the termination of the Services Agreement in June 2021, partially offset by higher corporate payroll expenses related to increased employee headcount. Interest expense, net, during the three months ended March 31, 2022 was $2.1 million higher than the three months ended March 31, 2021, primarily driven by the write-off of previously capitalized deferred financing costs in connection with the amendment to the RBL Facility during the first quarter of 2022. 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 Amended and Restated 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, 2022, the Company had $400.0 million of principal debt related to the 2026 Senior Notes outstanding and no outstanding borrowings related to the Amended and Restated RBL Facility. As of March 31, 2022, the Company had $796.4 million of liquidity comprised of the $450.0 million of borrowing base capacity of the Amended and Restated RBL Facility, and $346.4 million of cash and cash equivalents. Cash and Cash Equivalents At March 31, 2022, Magnolia had $346.4 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 such financial institutions and believes that the Company is not exposed to any significant default risk. 21 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, 2022 March 31, 2021 Sources of cash and cash equivalents Net cash provided by operating activities $ 238,869 $ 118,153 Uses of cash and cash equivalents Acquisitions $ (1,055) $ (558) Additions to oil and natural gas properties (84,230) (40,166) Changes in working capital associated with additions to oil and natural gas properties 13,946 (1,744) Class A Common Stock repurchases (43,486) (20,281) Class B Common Stock purchases and cancellations (84,733) (50,781) Non-compete settlement — (17,152) Dividends paid (37,174) — Distributions to noncontrolling interest owners (11,637) (155) Other (11,086) (1,683) (259,455) (132,520) Decrease in cash and cash equivalents $ (20,586) $ (14,367) 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, with the exception of certain non-cash expenses such as DD&A, the non-cash portion of exploration expenses, asset retirement obligations accretion, and deferred income tax expense. Net cash provided by operating activities totaled $238.9 million and $118.2 million for the three months ended March 31, 2022 and 2021, respectively. During the three months ended March 31, 2022, cash provided by operating activities was positively impacted by increased oil, natural gas, and NGL prices, partially offset by higher operating expenses and income tax payments. Uses of Cash and Cash Equivalents Acquisitions The Company made individually insignificant bolt-on acquisitions during each of the three months ended March 31, 2022 and 2021. 22 Additions to Oil and Natural Gas Properties The following table sets forth the Company’s capital expenditures for the three months ended March 31, 2022 and 2021: Three Months Ended (In thousands) March 31, 2022 March 31, 2021 Drilling and completion $ 83,357 $ 38,850 Leasehold acquisition costs 873 1,316 Total capital expenditures $ 84,230 $ 40,166 During the first quarter of 2022, Magnolia was running a two-rig program. One rig drilled multi-well development pads in the Giddings area. The second rig drilled a mix of wells in both the Karnes and Giddings areas. The number of operated 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 30.0 million shares of Class A Common Stock. The program does not require purchases to be made within a particular time frame 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, 2022 and 2021, the Company repurchased 1.5 million and 2.0 million shares for a total cost of approximately $33.3 million and $20.3 million, respectively. During the three months ended March 31, 2022, the Company also repurchased 0.6 million shares of Class A Common Stock for $11.6 million from EnerVest Energy Institutional Fund XIV-C, L.P. outside of the share repurchase program. During the three months ended March 31, 2022 and 2021, Magnolia LLC repurchased and subsequently canceled 3.9 million and 5.0 million Magnolia LLC Units with an equal number of shares of corresponding Class B Common Stock for $84.7 million and $50.8 million of cash consideration, respectively. As of March 31, 2022, Magnolia owned approximately 84.0% of the interest in Magnolia LLC and the noncontrolling interest was approximately 16.0%. In January 2021, the Company amended the Non-Compete 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. On June 30, 2021, as part of the Second Non-Compete Amendment, the Company paid $24.9 million in cash in lieu of delivering the remaining 1.6 million shares of Class A Common Stock. On February 3, 2022, the Company’s board of directors declared a cash dividend of $0.20 per share of Class A Common Stock totaling $37.3 million, of which $37.2 million was paid as of March 31, 2022. In addition, $8.6 million was distributed to the Magnolia LLC Unit Holders. The amount and frequency of future dividends is subject to the discretion of the Company’s board of directors and primarily depends on earnings, capital expenditures, debt covenants, and various other factors.