Riley Exploration Permian, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of the Company’s condensed consolidated financial statements and related notes thereto presented in this report as well as the Company's audited consolidated financial statements and related notes included in the Company's Annual Report for the fiscal year ended December 31, 2022. The following discussion contains “forward-looking statements” that reflect the Company’s future plans, estimates, beliefs and expected performance. The Company’s actual results could differ materially from those discussed in these forward-looking statements. See "Cautionary Statement Regarding Forward-Looking Statements" and "Part II. Item 1A. Risk Factors" below and the information set forth in the Risk Factors under Part I. Item 1A of the Company's Annual Report for the fiscal year ended December 31, 2022. Overview We operate in the upstream segment of the oil and natural gas industry and are focused on steadily growing conventional reserves, production and cash flow through the acquisition, exploration, development and production of oil, natural gas and NGLs primarily in the Permian Basin in West Texas. The Company’s activities are primarily focused on the San Andres Formation, a shelf margin deposit on the Northwest Shelf of the Permian Basin. We intend to continue to develop our reserves and increase production through development drilling and exploration activities and through acquisitions that meet our strategic and financial objectives. Financial and Operating Highlights Financial and operating results reflect the following: • Increased total net equivalent production by 34% to 13.2 MBoe/d for the three months ended March 31, 2023, as compared to the three months ended March 31, 2022 • During the three months ended March 31, 2023, 7 gross (5.3 net) horizontal wells brought online to production • Realized average combined price on production sold of $56.04 per Boe, before derivative settlements, during the three months ended March 31, 2023, including $72.76 per barrel for oil • Generated cash flow from operations of $33.0 million for the three months ended March 31, 2023 • Incurred total accrual (activity based) capital expenditures before acquisitions of $41.9 million for the three months ended March 31, 2023 • Paid cash dividends on common shares of $6.8 million during the three months ended March 31, 2023, and announced latest dividend of $0.34 per share with a record date of April 25, 2023, to be paid on May 9, 2023, for a total of $6.9 million • Exited the quarter with $2.3 million in cash and $89.0 million drawn on our revolving credit facility 25 . Table of Contents Recent Developments Market Conditions, Commodity Prices and Interest Rates U.S. and global markets have experienced heightened volatility following impactful geopolitical events, consistent evidence of widespread inflation, as well as increased fears of an economic recession. Recent measures have been taken by the U.S. Federal Reserve to combat persistent inflation by increasing interest rates throughout 2022 and into the first quarter of 2023. The global banking sector has experienced material disruptions which has also contributed to market volatility. Further, the full-scale military invasion of Ukraine by Russian troops has continued unabated since February 2022 coupled with related economic sanctions imposed on Russia further exacerbating supply shortages, leading to disruptions in the credit and capital markets, including significant uncertainty in commodity prices, during 2022 and into 2023. Prices for oil and natural gas are determined primarily by prevailing market conditions, which have been and could continue to be volatile. However, OPEC+ recently cut output in an attempt to create a floor for oil prices, causing an increase in the oil price per barrel. The combination of geopolitical events, inflation and the rising rate environment has led to increasing forecasts of a U.S. or global recession. Any such recession could prolong market volatility or cause a decline in commodity prices, among other potential impacts. The Company cannot estimate the length or gravity of the future impact these events will have on the Company's results of operations, financial position, liquidity and the value of oil and natural gas reserves. New Mexico Acquisition On April 3, 2023, the Company closed on the New Mexico Acquisition. The aggregate purchase price of the New Mexico Acquisition was $330 million, subject to customary purchase price adjustments pursuant to the Purchase Agreement, and was funded through a combination of borrowings under the Company's revolving credit facility and proceeds from the issuance of $200 million of Senior Notes. Power Joint Venture In January 2023, the Company entered into an agreement to form a joint venture created for the purpose of constructing a new power infrastructure for onsite power generation using produced natural gas. The Company has an initial 30% investment in the joint venture company, RPC Power, and is committed to providing its portion of capital expenditures. Construction on phase 1 of the project is expected to be completed in June 2023 with Phase 2 of the project expected to be operational by late 2023 or early 2024. 26 . Table of Contents Results of Operations Comparison for the three months ended March 31, 2023 and 2022. The following table sets forth selected operating data for the three months ended March 31, 2023 and 2022: Three Months Ended March 31, 2023 2022 Revenues (in thousands): Oil sales $ 64,974 $ 62,376 Natural gas sales 523 1,789 Natural gas liquids sales 915 2,480 Oil and natural gas sales, net $ 66,412 $ 66,645 Production Data, net: Oil (MBbls) 893 675 Natural gas (MMcf) 949 682 Natural gas liquids (MBbls) 134 93 Total (MBoe) 1,185 881 Daily combined volumes (Boe/d) 13,169 9,791 Daily oil volumes (Bbls/d) 9,922 7,497 Average Realized Prices: Oil ($ per Bbl) $ 72.76 $ 92.44 Natural gas ($ per Mcf) 0.55 2.62 Natural gas liquids ($ per Bbl) 6.83 26.71 Combined ($ per Boe) $ 56.04 $ 75.63 Average Realized Prices, including derivative settlements: (1) Oil ($ per Bbl) $ 67.06 $ 66.60 Natural gas ($ per Mcf) 0.55 1.25 Natural gas liquids ($ per Bbl) 6.83 26.71 Combined ($ per Boe) $ 51.74 $ 54.78 _____________________ (1) The Company's calculation of the effects of derivative settlements includes losses on the settlement of its commodity derivative contracts. These losses are included under other income (expense) on the Company’s condensed consolidated statements of operations. 27 . Table of Contents Oil and Natural Gas Revenues Our revenues are derived from the sale of our oil and natural gas production, including the sale of NGLs that are extracted from our natural gas during processing. Revenues from product sales are a function of the volumes produced, product quality, market prices, and gas Btu content. Our revenues from oil, natural gas and NGL sales do not include the effects of derivatives. Our revenues may vary significantly from period to period as a result of changes in volumes of production sold or changes in commodity prices. The Company’s total oil and natural gas revenue, net decreased $0.2 million, or 0.3%, for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The Company’s realized average combined price on its production for the three months ended March 31, 2023 decreased by $19.59 per Boe, or 26% compared to the three months ended March 31, 2022. Oil revenues • For the three months ended March 31, 2023, oil revenues increased by $2.6 million, or 4%, compared to the three months ended March 31, 2022. Of the increase, $20.2 million was attributable to an increase in volume, partially offset by a $17.6 million decrease in our realized price. Volumes increased by 32%, while realized prices decreased by 21% compared to the three months ended March 31, 2022. • Oil volumes increased during the three months ended March 31, 2023 due to production from new wells and workovers performed on existing wells. During the three months ended March 31, 2023, we brought online 7 gross (5.3 net) horizontal wells. • The average WTI price decreased by $19.25 per Bbl during the three months ended March 31, 2023 when compared to the three months ended March 31, 2022, respectively. Natural gas revenues • For the three months ended March 31, 2023, natural gas revenues decreased by $1.3 million, compared to the three months ended March 31, 2022. Of the decrease, $2 million was attributable to a decrease in realized prices, partially offset by $0.7 million attributable to an increase in volume. Volumes increased by 39%, while realized prices decreased by 79%. • The average Henry Hub price decreased by $2.03 per Mcf during the three months ended March 31, 2023 compared to the three months ended March 31, 2022. Natural gas liquids revenues • For the three months ended March 31, 2023, NGL revenues decreased by $1.6 million compared to the three months ended March 31, 2022. Of the decrease, $2.7 million was attributable to a decrease in realized price, partially offset by $1.1 million attributable to an increase in volume. Volumes increased by 44%, while realized prices decreased by 74%. Contract Services - Related Party The following table presents the Company's revenue and costs associated with its contract services - related party transactions: Three Months Ended March 31, 2023 2022 (In thousands) Contract services - related parties (1) $ 600 $ 600 Cost of contract services - related parties (2) 110 85 Gross profit from contract services $ 490 $ 515 _____________________ (1) The Company’s contract services - related parties revenue is derived from master service agreements with related parties to provide certain administrative support services. (2) The Company's cost of contract services - related parties represents costs specifically attributable to the master service agreements the Company has in place with the respective related parties. 28 . Table of Contents Costs and Expenses The following table presents the Company's operating costs and expenses and other (income) expenses: Three Months Ended March 31, 2023 2022 Costs and Expenses: (In thousands) Lease operating expenses $ 8,875 $ 6,830 Production and ad valorem taxes $ 4,110 $ 3,502 Exploration costs $ 332 $ 1,498 Depletion, depreciation, amortization and accretion $ 9,083 $ 6,633 Administrative costs $ 5,467 $ 4,014 Share-based compensation 1,114 1,017 General and administrative expense $ 6,581 $ 5,031 Transaction costs $ 1,887 $ 2,638 Interest expense, net $ 1,016 $ 678 (Gain) loss on derivatives $ (5,755) $ 49,632 Loss from equity method investment $ 232 $ — Income tax expense (benefit) $ 8,690 $ (2,114) Lease Operating Expenses ("LOE") LOE are the costs incurred in the operation and maintenance of producing properties. Expenses for compression, direct labor, saltwater disposal and materials and supplies comprise the most significant portion of our lease operating expenses. Certain operating cost components, such as direct labor and materials and supplies, generally remain relatively fixed across broad production volume ranges, but can fluctuate depending on activities performed during a specific period. For instance, repairs to our pumping equipment or surface facilities or subsurface maintenance result in increased production expenses in periods during which they are performed. Certain operating cost components, such as compression and saltwater disposal associated with completion water, are variable and increase or decrease as hydrocarbon production levels and the volume of completion water disposal increases or decreases. The Company’s LOE increased by $2.0 million for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. For the three months ended March 31, 2023, the increase was driven by a $2.3 million increase due to higher production and a $1.1 million increase due to higher workover expense. These increases were partially offset by a $1.4 million decrease in LOE expense due to efficiencies related to utility rates, field payroll, and saltwater disposal charges. Production and Ad Valorem Tax Expense Production taxes are paid on produced oil, natural gas and NGLs based on a percentage of revenues at fixed rates established by federal, state or local taxing authorities. In general, the production taxes we pay correlate to changes in our oil, natural gas and NGL revenues. We are also subject to ad valorem taxes in the counties where our production is located. Ad valorem taxes are generally based on the valuation of our oil and natural gas properties, which also trend with oil and natural gas prices and vary across the different counties in which we operate. Production and ad valorem taxes increased by $0.6 million for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. Ad valorem taxes increased for the three months ended March 31, 2023 based on higher estimated property values for the current taxable period, which was partially offset by a decrease in production taxes of approximately $0.1 million. 29 . Table of Contents Exploration Expense Exploration expense consists of expiration of unproved leasehold and geological and geophysical costs which include seismic survey costs. The following table presents exploration expense by area for the three months ended March 31, 2023 and the three months ended March 31, 2022: Three Months Ended March 31, 2023 2022 (In thousands, except acreage data) Exploration expense (1) $ 332 $ 1,465 Geological and geophysical costs — 33 Total exploration expense $ 332 $ 1,498 Expired net acres - Texas 157 626 Expired net acres - New Mexico — 518 Net acres renewed after expiration (2) — 8 _____________________ (1) For the three months ended March 31, 2023, exploration expense includes $0.3 million and zero related to expiration of unproved leasehold costs in Texas and New Mexico, respectively. For the three months ended March 31, 2022, exploration expense included $1.3 million and $0.2 million related to expiration of unproved leasehold costs in Texas and New Mexico, respectively. (2) The Company did not renew any net acreage after expiration in New Mexico during the three months ended March 31, 2023 and 2022. Depletion, Depreciation, Amortization and Accretion Expense Depletion, depreciation and amortization is the systematic expensing of the capitalized costs incurred to acquire, explore and develop oil, natural gas and NGLs. All costs incurred in the acquisition, exploration and development of properties (excluding costs of surrendered and abandoned leaseholds, delay lease rentals, dry holes and overhead related to exploration activities) are capitalized. Capitalized costs are depleted using the units of production method. Accretion expense relates to ARO. We record the fair value of the liability for ARO in the period in which the liability is incurred (at the time the wells are drilled or acquired) with the offset to property cost. The liability accretes each period until it is settled or the well is sold, at which time the liability is removed. Depletion, depreciation, amortization and accretion expense increased by $2.5 million for the three months ended March 31, 2023, respectively, compared to the three months ended March 31, 2022. The increase for the three months ended March 31, 2023 was primarily due to higher production. General and Administrative Expense ("G&A") G&A expenses include corporate overhead such as payroll and benefits for our corporate staff, share-based compensation expense, office rent for our headquarters, audit and other fees for professional services and legal compliance. G&A expenses are reported net of overhead recoveries. Total G&A expense increased by $1.6 million for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. Administrative costs, which include payroll, benefits and non-payroll costs, increased by $1.5 million for the three months ended March 31, 2023 compared to the three months ended March 31, 2022, primarily due to increased employee count, professional services, insurance, and technology costs. Transaction Costs Transaction costs represent costs incurred on successful or unsuccessful business combinations or unsuccessful property acquisitions. The transaction costs of $1.9 million for the three months ended March 31, 2023 primarily relate to the New Mexico Acquisition that closed April 3, 2023. During the three months ended March 31, 2022, the transaction costs of $2.6 million primarily relate to a potential business combination and related financing that the Company pursued but ultimately chose not to consummate due to changing market conditions. 30 . Table of Contents Interest Expense Interest expense increased by $0.3 million during the three months ended March 31, 2023 when compared to the three months ended March 31, 2022. The Company had a higher outstanding average balance on the revolving credit facility as well as an increase in interest rates, during the three months ended March 31, 2023 when compared to the three months ended March 31, 2022. Gain/Loss on Derivatives The Company recognizes settlements and changes in the fair value of its derivative contracts as a single component within other income (expense) on its condensed consolidated statements of operations. We have oil and natural gas derivative contracts, including fixed price swaps, basis swaps and collars, that settle against various indices. The following table presents the components of the Company's gain (loss) on derivatives for the three months ended March 31, 2023 and 2022: Three Months Ended March 31, 2023 2022 (In thousands) Settlements on derivative contracts $ (5,088) $ (18,375) Non-cash gain (loss) on derivatives 10,843 (31,257) Gain (loss) on derivatives $ 5,755 $ (49,632) Our earnings are affected by the changes in value of our derivative portfolio between periods and the related cash received or paid upon settlement of our derivatives. To the extent the future commodity price outlook declines between periods, we will have mark-to-market gains, while future commodity price increases between measurement periods result in mark-to-market losses. The gain (loss) on derivatives for the three months ended March 31, 2023 and 2022 was $5.8 million and $(49.6) million, respectively. The non-cash gain on derivatives for the three months ended March 31, 2023 was driven by new contracts entered into during the quarter and higher contract pricing when compared to forward pricing at March 31, 2023. The non-cash loss on derivatives for the three months ended March 31, 2022 was driven by lower contract pricing when compared to forward pricing at March 31, 2022. The decrease in the loss on settlements on derivatives was due to the decrease in oil and natural gas prices for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. Income Tax Expense (Benefit) Deferred income taxes are provided to reflect the future tax consequences or benefits of differences between the tax basis of assets and liabilities and their reported amounts in the financial statements using enacted tax rates. See Note 10 - Income Taxes to the Company's consolidated financial statements included herein for further discussion of income taxes. Three Months Ended March 31, 2023 2022 (In thousands) Current income tax expense $ 3,407 $ 779 Deferred income tax expense (benefit) 5,283 (2,893) Total income tax expense (benefit) $ 8,690 $ (2,114) Effective income tax rate 21.4 % 22.9 % Liquidity and Capital Resources The business of exploring for, developing and producing oil and natural gas is capital intensive. Because oil, natural gas and NGL reserves are a depleting resource, like all upstream operators, we must make capital investments to grow and even sustain production. The Company’s principal liquidity requirements are to finance its operations, fund capital expenditures and 31 . Table of Contents acquisitions, make cash distributions and satisfy any indebtedness obligations. Cash flows are subject to a number of variables, including the level of oil and natural gas production and prices, and the significant capital expenditures required to more fully develop the Company’s oil and natural gas properties. Historically, our primary sources of capital funding and liquidity have been our cash on hand, cash flow from operations and borrowings under our revolving credit facility. At times and as needed, we may also issue debt or equity securities, including through transactions under our shelf registration statement filed with the SEC. In April 2023, the Company amended its Credit Facility to increase the borrowing base and issued Senior Notes to fund the New Mexico Acquisition. We estimate the combination of the sources of capital discussed above will continue to be adequate to meet our short and long-term liquidity needs. Cash on hand and operating cash flow can be subject to fluctuations due to trends and uncertainties that are beyond our control. Likewise, our ability to issue equity and obtain credit facilities on favorable terms may be impacted by a variety of market factors as well as fluctuations in our results of operations. For further discussion of risks related to our liquidity and capital resources, see "Item 1A. Risk Factors." Working Capital Working capital is the difference in our current assets and our current liabilities. Working capital is an indication of liquidity and potential need for short-term funding. The change in our working capital requirements is driven generally by changes in accounts receivable, accounts payable, commodity prices, credit extended to, and the timing of collections from customers, the level and timing of spending for expansion activity, and the timing of debt maturities. As of March 31, 2023, we had a working capital deficit of $32.9 million compared to a deficit of $25.3 million as of December 31, 2022. The working capital deficit at March 31, 2023 reflects $8.0 million in current derivative liabilities compared to $16.5 million in current derivative liabilities at December 31, 2022. As of March 31, 2023, our accounts payable increased by $13.1 million primarily due to increased capital activity. We utilize our Credit Facility and cash on hand to manage the timing of cash flows and fund short-term working capital deficits. Our current derivative assets and liabilities represent the mark-to-market value as of March 31, 2023 of future commodity production which will settle on a monthly basis through the end of their contractual terms. This aligns with the receipt of oil and natural gas revenues on a monthly basis. Cash Flows The following table summarizes the Company’s cash flows from continuing operations: Three Months Ended March 31, 2023 2022 (In thousands) Statement of Cash Flows Data from Continuing Operations: Net cash provided by operating activities $ 32,970 $ 29,995 Net cash used in investing activities $ (69,935) $ (10,199) Net cash provided by (used in) financing activities $ 25,939 $ (8,504) Operating Activities The Company’s net cash provided by operating activities was relatively flat at $33.0 million for the three months ended March 31, 2023 from $30.0 million for the three months ended March 31, 2022. Investing Activities The Company's cash flows used in investing activities increased by $59.7 million to $69.9 million for the three months ended March 31, 2023 from $10.2 million for the three months ended March 31, 2022. The increase was primarily due to funds held in escrow associated with the Company's New Mexico Acquisition of $33.0 million for the three months ended March 31, 2023, with no comparable item for the three months ended March 31, 2022. Additionally, the Company incurred higher capital spending of $24.8 million related to increased activity during the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The Company also contributed 1.8 million to its equity method investment in RPC Power. Financing Activities Net cash flow provided by financing activities were $25.9 million for the three months ended March 31, 2023 compared to net cash flow used in financing activities of $8.5 million for the three months ended March 31, 2022. During the three months 32 . Table of Contents ended March 31, 2023, the Company had a draw on its revolving credit facility of $33.0 million, used to fund the escrow for the New Mexico Acquisition, which compares to a net paydown of $2.0 million for the same period in 2022. Revolving Credit Facility The Company's borrowing base was $225 million with outstanding borrowings of $89 million on March 31, 2023, representing available borrowing capacity of $136 million. See further discussion in Note 8 - Long-Term Debt to the Company's condensed consolidated financial statements included herein. On February 22, 2023, the Company amended its Credit Facility to, among other things, allow for the issuance of Senior Notes of up to $200 million. On April 3, 2023, the Company amended its Credit Facility to, among other things, increase the borrowing base from $225 million to $325 million. For more information on the amended Credit Facility and the issuance of the Senior Notes, see Note 13 - Subsequent Events. Distributions For the three months ended March 31, 2023, the Company authorized and declared a quarterly dividend totaling approximately $6.9 million, with $6.7 million paid in cash and $0.2 million payable to restricted shareholders upon vesting. Contractual Obligations In January 2023, the Company entered into an agreement to form a joint venture with Conduit Power LLC. The Company is committed to contribute its portion of capital expenditures into the joint venture company, RPC Power. In conjunction with the formation of the joint venture, the Company entered into additional agreements with RPC Power or one of its subsidiaries. These agreements include RPC Power providing operational expertise on the implementation and management of the power generation for a monthly fee of $20 thousand and the Company committing to provide the natural gas needed to fuel the onsite power generators through 2028. See Note 12 - Commitments and Contingencies in our notes to the condensed consolidated financial statements. Critical Accounting Estimates The Company's critical accounting policies and estimates are described in "Critical Accounting Estimates" within "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 1 of the Notes to the Consolidated Financial Statements in Riley Permian's Annual Report on Form 10-K for the year ended December 31, 2022. The accounting estimates used in preparing our interim condensed consolidated financial statements for the three months ended March 31, 2023 are the same as those described in Riley Permian's Annual Report. See Note 3 - Summary of Significant Accounting Policies in the Company's consolidated financial statements in "Item 15. Exhibits and Financial Statement Schedules" for a full discussion of our significant accounting policies. Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.