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: • 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, including impacts of actions taken by OPEC and other state-controlled oil companies; • production and reserve levels; • the timing and extent of the Company’s success in discovering, developing, producing and estimating reserves; • 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, 2022 (the “2022 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. 16 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. The Company’s allocation of capital prioritizes reinvesting in its business to achieve moderate and predictable annual volume growth, balanced with returning capital to its shareholders through dividends and share repurchases. Magnolia’s business model prioritizes free cash flow, financial stability, and prudent capital allocation. The Company’s ongoing plan is to spend within cash flow on drilling and completing wells while maintaining low leverage. Market Conditions Update After Magnolia experienced record operating margins during 2022, natural gas and NGL prices have significantly declined and oil prices have weakened, while material and labor costs remained elevated. This has resulted in lower revenue and lower operating margins. As a result, Magnolia took actions to reduce its operating and capital spending to better reflect the current cost and commodity environment. The capital spending level is in line with the principles of Magnolia’s business model and is expected to provide the Company more operational and financial flexibility going forward. Business Overview As of September 30, 2023, Magnolia’s assets in South Texas included 42,451 gross (22,785 net) acres in the Karnes area, and 663,327 gross (475,543 net) acres in the Giddings area. As of September 30, 2023, Magnolia held an interest in approximately 2,307 gross (1,519 net) wells, with total production of 82.7 thousand and 81.3 thousand barrels of oil equivalent per day for the three and nine months ended September 30, 2023. Magnolia recognized net income attributable to Class A Common Stock of $102.0 million and $289.9 million, or $0.54 and $1.51 per diluted common share, for the three and nine months ended September 30, 2023. Magnolia recognized net income of $117.5 million and $328.7 million, which includes a noncontrolling interest of $15.4 million and $38.9 million related to the Magnolia LLC Units (and corresponding shares of Class B Common Stock) held by certain affiliates of EnerVest, for the three and nine months ended September 30, 2023. During the nine months ended September 30, 2023, the Company declared cash dividends to holders of its Class A Common Stock totaling $66.3 million. As of September 30, 2023, the Company’s board of directors had authorized a share repurchase program of up to 40.0 million shares of Class A Common Stock. The program does not require purchases to be made within a particular time frame. The Company had repurchased 28.3 million shares under the program at a cost of $470.8 million and had 11.7 million shares of Class A Common Stock remaining under its share repurchase authorization as of September 30, 2023. As of September 30, 2023, Magnolia owned approximately 89.5% of the interest in Magnolia LLC and the noncontrolling interest was approximately 10.5%. 17 Results of Operations Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022 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 realized 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) September 30, 2023 September 30, 2022 Production: Oil (MBbls) 3,024 3,381 Natural gas (MMcf) 14,406 13,364 NGLs (MBbls) 2,179 1,892 Total (Mboe) 7,604 7,500 Average daily production: Oil (Bbls/d) 32,867 36,751 Natural gas (Mcf/d) 156,585 145,257 NGLs (Bbls/d) 23,686 20,568 Total (boe/d) 82,651 81,529 Revenues: Oil revenues $ 243,588 $ 317,243 Natural gas revenues 27,069 100,124 Natural gas liquids revenues 45,021 65,596 Total revenues $ 315,678 $ 482,963 Average Price: Oil (per barrel) $ 80.56 $ 93.83 Natural gas (per Mcf) 1.88 7.49 NGLs (per barrel) 20.66 34.66 Oil revenues were 77% and 66% of the Company’s total revenues for the three months ended September 30, 2023 and 2022, respectively. Oil production was 40% and 45% of total production volume for the three months ended September 30, 2023 and 2022, respectively. Oil revenues for the three months ended September 30, 2023 were $73.7 million lower than for the three months ended September 30, 2022. A 14% decrease in average price decreased third quarter 2023 revenues by $44.9 million compared to the same period in the prior year while an 11% decrease in oil production decreased revenues by $28.8 million. Natural gas revenues were 9% and 20% of the Company’s total revenues for the three months ended September 30, 2023 and 2022, respectively. Natural gas production was 31% and 30% of total production volume for the three months ended September 30, 2023 and 2022, respectively. Natural gas revenues for the three months ended September 30, 2023 were $73.1 million lower than the three months ended September 30, 2022. A 75% decrease in average price decreased third quarter 2023 revenues by $75.0 million compared to the same period in the prior year, partially offset by an 8% increase in natural gas production which increased revenues by $1.9 million. NGL revenues were 14% of the Company’s total revenues for each of the three months ended September 30, 2023 and 2022. NGL production was 29% and 25% of total production volume for the three months ended September 30, 2023 and 2022, respectively. NGL revenues for the three months ended September 30, 2023 were $20.6 million lower than the three months ended September 30, 2022. A 40% decrease in average price decreased third quarter 2023 revenues by $26.5 million compared to the same period in the prior year, partially offset by a 15% increase in NGL production which increased revenues by $5.9 million. 18 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) September 30, 2023 September 30, 2022 Operating Expenses: Lease operating expenses $ 35,893 $ 34,709 Gathering, transportation and processing 10,297 19,297 Taxes other than income 14,823 26,623 Exploration expenses 5,128 1,173 Asset retirement obligations accretion 875 814 Depreciation, depletion and amortization 81,158 68,972 General and administrative expenses 19,371 19,625 Total operating expenses $ 167,545 $ 171,213 Other Income (Expense): Interest income (expense), net $ 1,034 $ (5,263) Other expense, net (479) (166) Total other income (expense), net $ 555 $ (5,429) Average Operating Costs per boe: Lease operating expenses $ 4.72 $ 4.63 Gathering, transportation and processing 1.35 2.57 Taxes other than income 1.95 3.55 Exploration expenses 0.67 0.16 Asset retirement obligations accretion 0.12 0.11 Depreciation, depletion and amortization 10.67 9.20 General and administrative expenses 2.55 2.62 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 September 30, 2023 were $1.2 million, or $0.09 per boe, higher compared to the corresponding 2022 period, due to an increase in costs, including chemicals, compression, and operating and maintenance costs. 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 September 30, 2023 were $9.0 million, or $1.22 per boe, lower than the three months ended September 30, 2022, primarily due to lower natural gas and NGL prices which resulted in lower processing costs. Taxes other than income is comprised of production, ad valorem, and franchise 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 September 30, 2023 were $11.8 million, or $1.60 per boe, lower compared to the three months ended September 30, 2022, primarily due to a decrease in production taxes as a result of the decrease in oil, natural gas, and NGL revenues. Exploration expenses are geological and geophysical costs that include seismic surveying costs, costs of expired or abandoned leases, and delay rentals. The exploration expenses for the three months ended September 30, 2023 were $4.0 million, or $0.51 per boe, higher than the three months ended September 30, 2022, due to increased spending on seismic licenses. Depreciation, depletion and amortization (“DD&A”) during the three months ended September 30, 2023 was $12.2 million, or $1.47 per boe, higher than the three months ended September 30, 2022, due to increased production and a higher depreciable cost basis. 19 The Company recognized interest income, net, during the three months ended September 30, 2023 as compared to interest expense, net during the three months ended September 30, 2022. This $6.3 million change was driven by higher interest income realized during 2023 as a result of higher interest rates. Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022 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 realized 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. Nine Months Ended (In thousands, except per unit data) September 30, 2023 September 30, 2022 Production: Oil (MBbls) 9,345 9,216 Natural gas (MMcf) 40,839 38,205 NGLs (MBbls) 6,045 5,134 Total (Mboe) 22,196 20,718 Average daily production: Oil (Bbls/d) 34,229 33,760 Natural gas (Mcf/d) 149,594 139,947 NGLs (Bbls/d) 22,142 18,806 Total (boe/d) 81,303 75,890 Revenues: Oil revenues $ 705,857 $ 912,702 Natural gas revenues 75,687 242,049 Natural gas liquids revenues 122,807 190,700 Total revenues $ 904,351 $ 1,345,451 Average Price: Oil (per barrel) $ 75.54 $ 99.03 Natural gas (per Mcf) 1.85 6.34 NGLs (per barrel) 20.32 37.14 Oil revenues were 78% and 68% of the Company’s total revenues for the nine months ended September 30, 2023 and 2022, respectively. Oil production was 42% and 44% of total production volume for the nine months ended September 30, 2023 and 2022, respectively. Oil revenues for the nine months ended September 30, 2023 were $206.8 million lower than for the nine months ended September 30, 2022. A 24% decrease in average price decreased revenues by $216.5 million during the nine months ended September 30, 2023 compared to the same period in the prior year, partially offset by a 1% increase in oil production which increased revenues by $9.7 million. Natural gas revenues were 8% and 18% of the Company’s total revenues for the nine months ended September 30, 2023 and 2022, respectively. Natural gas production was 31% of total production volume for each of the nine months ended September 30, 2023 and 2022. Natural gas revenues for the nine months ended September 30, 2023 were $166.4 million lower than the nine months ended September 30, 2022. A 71% decrease in average price decreased revenues by $171.3 million during the nine months ended September 30, 2023 compared to the same period in the prior year, partially offset by a 7% increase in natural gas production which increased revenues by $4.9 million. NGL revenues were 14% of the Company’s total revenues for each of the nine months ended September 30, 2023 and 2022. NGL production was 27% and 25% of total production volume for the nine months ended September 30, 2023 and 2022, respectively. NGL revenues for the nine months ended September 30, 2023 were $67.9 million lower than the nine months ended September 30, 2022. A 45% decrease in average price decreased revenues by $86.4 million during the nine months ended September 30, 2023 20 compared to the same period in the prior year, partially offset by an 18% increase in NGL production which increased revenues by $18.5 million. Operating Expenses and Other Income (Expense) . The following table summarizes the Company’s operating expenses and other income (expense) for the periods indicated. Nine Months Ended (In thousands, except per unit data) September 30, 2023 September 30, 2022 Operating Expenses: Lease operating expenses $ 115,060 $ 96,057 Gathering, transportation and processing 33,419 51,518 Taxes other than income 49,331 74,917 Exploration expenses 5,139 10,119 Asset retirement obligations accretion 2,539 2,404 Depreciation, depletion and amortization 228,868 179,331 Impairment of oil and natural gas properties 15,735 — General and administrative expenses 57,863 55,226 Total operating expenses $ 507,954 $ 469,572 Other Income (Expense): Interest income (expense), net $ 372 $ (21,637) Other income, net 7,643 6,579 Total other income (expense), net $ 8,015 $ (15,058) Average Operating Costs per boe: Lease operating expenses $ 5.18 $ 4.64 Gathering, transportation and processing 1.51 2.49 Taxes other than income 2.22 3.62 Exploration expenses 0.23 0.49 Asset retirement obligations accretion 0.11 0.12 Depreciation, depletion and amortization 10.31 8.66 Impairment of oil and natural gas properties 0.71 — General and administrative expenses 2.61 2.67 Lease operating expenses for the nine months ended September 30, 2023 were $19.0 million, or $0.54 per boe, higher compared to the corresponding 2022 period, due to increased activity, including workover activity, and an increase in costs, including chemicals, compression, and operating and maintenance costs. Gathering, transportation and processing costs for the nine months ended September 30, 2023 were $18.1 million, or $0.98 per boe, lower than the nine months ended September 30, 2022, primarily due to lower natural gas and NGL prices which resulted in lower processing costs. Taxes other than income for the nine months ended September 30, 2023 were $25.6 million, or $1.40 per boe, lower compared to the nine months ended September 30, 2022, primarily due to a decrease in production taxes as a result of the decrease in oil, natural gas, and NGL revenues. Exploration expenses for the nine months ended September 30, 2023 were $5.0 million, or $0.26 per boe, lower than the nine months ended September 30, 2022, due to decreased spending on seismic licenses. DD&A during the nine months ended September 30, 2023 was $49.5 million, or $1.65 per boe, higher than the nine months ended September 30, 2022 due to increased production and a higher depreciable cost basis. During the nine months ended September 30, 2023, the Company recognized a $15.7 million proved property impairment related to the Highlander property. 21 General and administrative expenses during the nine months ended September 30, 2023 were $2.6 million higher, but $0.06 per boe lower, than the nine months ended September 30, 2022. General and administrative expenses were higher year over year primarily due to higher corporate payroll expenses, but lower on a per boe basis because of increased production. The Company recognized interest income, net, during the nine months ended September 30, 2023 as compared to interest expense, net during the nine months ended September 30, 2022. This $22.0 million change was driven by higher interest income realized during 2023 as a result of a higher average cash balance and higher interest rates. Income tax expense. The following table summarizes the Company’s income tax expense for the periods indicated. Three Months Ended Nine Months Ended (In thousands) September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Current income tax expense $ 19,262 $ 19,358 $ 27,450 $ 65,333 Deferred income tax expense 11,949 — 48,213 — Income tax expense $ 31,211 $ 19,358 $ 75,663 $ 65,333 For the three months ended September 30, 2023, income tax expense was $11.9 million higher than the three months ended September 30, 2022, comprised of movements in both current and deferred income taxes. This was primarily driven by $11.9 million of deferred income tax expense recognized in 2023 which was not recognized in 2022 due to the existence of a full valuation allowance against net deferred tax assets. For the nine months ended September 30, 2023, income tax expense was $10.3 million higher than the nine months ended September 30, 2022, comprised of movements in both current and deferred income taxes. This was primarily driven by $48.2 million of deferred income tax expense recognized in 2023 which was not recognized in 2022 due to the existence of a full valuation allowance against net deferred tax assets. This was partially offset by a $37.9 million decrease in current income tax expense due to lower taxable income primarily as a result of the decline in commodity prices. As of December 31, 2022, the Company released the valuation allowance against net deferred tax assets. As of September 30, 2023, the Company’s total deferred tax assets were $122.5 million. The Company considered, among other things, the overall business environment, its historical earnings and losses, current industry trends, and its outlook for future years. As of September 30, 2023, the Company assessed the realizability of the deferred tax assets and recorded a valuation allowance of $3.8 million to offset the deferred tax asset created by the capital loss attributable to the sale of the Company’s interest in Highlander. See Note 9— Income Taxes in the Notes to the Company’s consolidated financial statements included in this Quarterly Report on Form 10-Q for further detail. 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 development of the Company’s oil and natural gas properties, returning capital to shareholders, bolt-on acquisitions of oil and natural gas properties, 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 September 30, 2023, 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 September 30, 2023, the Company had $1.1 billion of liquidity comprised of the $450.0 million of borrowing base capacity of the RBL Facility, and $618.5 million of cash and cash equivalents. Cash and Cash Equivalents At September 30, 2023, Magnolia had $618.5 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. 22 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: Nine Months Ended (In thousands) September 30, 2023 September 30, 2022 SOURCES OF CASH AND CASH EQUIVALENTS Net cash provided by operating activities $ 608,907 $ 1,028,685 USES OF CASH AND CASH EQUIVALENTS Acquisitions $ (53,812) $ (11,749) Deposits for acquisitions of oil and natural gas properties (22,503) — Additions to oil and natural gas properties (332,055) (323,510) Changes in working capital associated with additions to oil and natural gas properties (21,688) 14,152 Class A Common Stock repurchases (151,696) (153,138) Class B Common Stock purchases and cancellations — (138,753) Dividends paid (66,480) (56,220) Distributions to noncontrolling interest owners (9,946) (23,852) Other (7,702) (13,058) Net uses of cash and cash equivalents (665,882) (706,128) NET CHANGE IN CASH AND CASH EQUIVALENTS $ (56,975) $ 322,557 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, stock based compensation, amortization of deferred financing costs, gain on sale of assets, impairment of oil and natural gas properties, non-cash exploration expenses, asset retirement obligations accretion, and deferred income tax expense. Net cash provided by operating activities totaled $608.9 million and $1.0 billion for the nine months ended September 30, 2023 and 2022, respectively. During the nine months ended September 30, 2023, cash provided by operating activities was negatively impacted by a decrease in realized oil and natural gas prices and net changes in operating assets and liabilities. Uses of Cash and Cash Equivalents Acquisitions During the nine months ended September 30, 2023, the Company paid $53.8 million for acquisitions, primarily comprised of a $40.0 million acquisition in the Giddings area. In addition, Magnolia paid a $22.5 million deposit for an acquisition in the Giddings area expected to close in the fourth quarter of 2023. The remaining consideration for this acquisition will be funded with cash on hand. 23 Additions to Oil and Natural Gas Properties The following table sets forth the Company’s capital expenditures for the periods presented: Three Months Ended Nine Months Ended (In thousands) September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Drilling and completion $ 104,310 $ 114,468 $ 330,147 $ 319,843 Leasehold acquisition costs 2,358 1,582 1,908 3,667 Total capital expenditures $ 106,668 $ 116,050 $ 332,055 $ 323,510 During the third quarter of 2023, Magnolia was running a two-rig program. 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 As of September 30, 2023 the Company’s board of directors had authorized a share repurchase program of up to 40.0 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 nine months ended September 30, 2023 and 2022, the Company repurchased 7.1 million and 6.6 million shares for a total cost of approximately $152.9 million and $144.0 million, respectively. During the nine months ended September 30, 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 nine months ended September 30, 2022, Magnolia LLC repurchased and subsequently canceled 5.9 million Magnolia LLC Units with an equal number of shares of corresponding Class B Common Stock for $138.8 million of cash consideration, respectively. As of September 30, 2023, Magnolia owned approximately 89.5% of the interest in Magnolia LLC and the noncontrolling interest was approximately 10.5%. During the nine months ended September 30, 2023, the Company declared cash dividends to holders of its Class A Common Stock totaling $66.3 million. During the same time period, cash paid for dividends was $66.5 million, inclusive of dividends on vested non-participating securities. Additionally, $7.5 million was distributed to the Magnolia LLC Unit Holders. During the nine months ended September 30, 2022, the Company declared cash dividends to holders of its Class A Common Stock totaling $56.4 million, of which $56.2 million was paid as of September 30, 2022. Additionally, $11.4 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.