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 financial condition and results of operations should be read in conjunction with 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 September 30, 2021. 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" . 24 . 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 Central Basin Platform and Northwest Shelf. We intend to continue to develop our reserves and increase production through development drilling and exploration activities on our multi-year inventory of identified potential drilling locations 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 31% to 9.9 MBoe/d for the three months ended December 31, 2021, as compared to the same period in 2020 • During the three months ended December 31, 2021, 5 gross (4.1 net) horizontal wells brought online to production • Realized average combined price on production sold of $61.94 per Boe, before derivative settlements, during the three months ended December 31, 2021, including $75.67 per barrel for oil • Generated cash flow from operations of $21.7 million for the three months ended December 31, 2021 • Total accrued capital expenditures of $20.7 million for the three months ended December 31, 2021 • Paid cash dividends on common shares of $6.1 million during the three months ended December 31, 2021, and announced latest dividend of $0.31 per share with a record date of January 26, 2022, which was paid on February 9, 2022, for a total of $6.1 million • Exited the first quarter with $8.3 million in cash and $65.0 million drawn on our revolving credit facility 25 . Results of Operations Comparison for the three months ended December 31, 2021 and 2020 The following table sets forth selected operating data for the three months ended December 31, 2021 and 2020: Three Months Ended December 31, 2021 2020 Revenues (in thousands): Oil sales $ 50,623 $ 22,107 Natural gas sales 2,705 119 Natural gas liquids sales 3,322 188 Oil and natural gas sales, net $ 56,650 $ 22,414 Production Data, net: Oil (MBbls) 669 547 Natural gas (MMcf) 844 461 Natural gas liquids (MBbls) 105 74 Total (MBoe) 915 698 Daily combined volumes (Boe/d) 9,940 7,583 Daily oil volumes (Bbls/d) 7,271 5,945 Average Realized Prices: Oil ($ per Bbl) $ 75.67 $ 40.41 Natural gas ($ per Mcf) 3.20 0.26 Natural gas liquids ($ per Bbl) 31.64 2.54 Combined ($ per Boe) $ 61.94 $ 32.12 Average Realized Prices, including derivative settlements: (1) Oil ($ per Bbl) $ 54.05 $ 49.87 Natural gas ($ per MMBtu) 1.37 0.26 Natural gas liquids ($ per Bbl) 31.64 2.54 Combined ($ per Boe) $ 44.43 $ 39.53 _____________________ (1) The Company's calculation of the effects of derivative settlements includes gains (losses) on the settlement of its commodity derivative contracts. These gains (losses) are included under other income and expense on the Company’s condensed consolidated statements of operations. 26 . 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 increased $34.2 million, or 153%, for the three months ended December 31, 2021 compared to the same period in 2020. The Company’s realized average combined price on its production for the three months ended December 31, 2021 increased by $29.82 or 93%, respectively, compared to the same period of 2020. Oil revenues • For the three months ended December 31, 2021, oil revenues increased by $28.5 million, or 129%, compared to the same period in 2020. Of the increase, $23.6 million was attributable to an increase in our realized price and $4.9 million was attributable to an increase in volume. Volumes increased by 22% while prices increased by 87% compared to the same period in 2020. • Oil volumes increased during the three months ended December 31, 2021 due to production from new wells and workovers performed on existing wells. During the three months ended December 31, 2021, we brought online 5 new gross (4.1 net) wells. Natural gas revenues • For the three months ended December 31, 2021, natural gas revenues increased by $2.6 million, compared to the same period in 2020, to $2.7 million from $0.1 million. Volumes increased by 83% and realized prices increased by $2.94 per Mcf from realized prices in 2020. • Natural gas sales volumes increased during the three months ended December 31, 2021 due to increased production from new wells brought online and increased gas processing capacity available from the Company's midstream gathering and processing partner. Natural gas liquids revenues • For the three months ended December 31, 2021, NGL revenues increased by $3.1 million, compared to the same period in 2020, to $3.3 million from $0.2 million. Volumes increased by 42% and realized prices increased by $29.10 per Bbl from realized prices in 2020. • NGL sales volumes increased during the three months ended December 31, 2021 due to increased production from new wells brought online and increased gas processing capacity available from the Company's midstream gathering and processing partner. Contract Services - Related Party Revenue The following tables present the Company's revenue and costs associated with its related party transactions: Three Months Ended December 31, 2021 2020 (In thousands) Contract services – related parties (1) $ 600 $ 600 Cost of contract services - related parties (2) 150 148 Gross profit - related parties $ 450 $ 452 _____________________ (1) The Company’s contract services – related parties revenue is derived from master services 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. 27 . The following table presents the Company's operating costs and expenses and other (income) expenses: Three Months Ended December 31, 2021 2020 Costs and Expenses: (In thousands) Lease operating expenses $ 7,419 $ 4,568 Production and ad valorem taxes $ 3,005 $ 1,289 Exploration costs $ 611 $ 424 Depletion, depreciation, amortization and accretion $ 6,867 $ 5,990 Administrative costs $ 3,633 $ 2,445 Equity-based compensation 951 413 General and administrative expense $ 4,584 $ 2,858 Transaction costs $ 1,258 $ 1,049 Interest expense $ 896 $ 1,235 Loss on derivatives $ 5,193 $ 13,909 Income tax expense (benefit) $ 5,869 $ (515) Lease Operating Expenses Lease operating expenses ("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 salt water 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 $2.9 million for the three months ended December 31, 2021 compared to the same period in 2020. For the three months ended December 31, 2021, $1.4 million of the increase was attributable to an increase in variable LOE costs as production volumes increased and $1.1 million of the increase was due to higher workover expense. 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 $1.7 million for the three months ended December 31, 2021 compared to the same period in 2020, primarily due to increases in our production sold resulting from additional wells brought online, workovers performed on existing wells that increased production and significantly higher commodity prices. Also contributing to the increase is higher ad valorem taxes based on the increase in property values during the three months ended December 31, 2021. Exploration Expense Exploration expense, which consists of expiration of unproved leasehold and geological and geophysical costs that include seismic survey costs, increased by $0.2 million, or 44%, for the three months ended December 31, 2021, as compared to the same period in 2020. For the three months ended December 31, 2021, the Company incurred higher exploration expense compared to the same period in 2020 primarily driven by higher acreage expirations in New Mexico. 28 . The following table presents exploration expense by area for the three months ended December 31, 2021 and 2020: Three Months Ended December 31, 2021 2020 (In thousands, except acreage data) Exploration expense (1) $ 588 $ 424 Geological and geophysical costs 23 — Total exploration expense $ 611 $ 424 Expired net acres - Texas 91 99 Expired net acres - New Mexico 1,146 905 Net acres renewed after expiration (2) 89 100 _____________________ (1) As of December 31, 2021, exploration expense includes $187 thousand and $401 thousand related to expiration of unproved leasehold costs in Texas and New Mexico, respectively. As of December 31, 2020, exploration expense includes $225 thousand and $199 thousand 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 December 31, 2021 and 2020. Depletion, Depreciation, Amortization and Accretion Expense Depreciation, depletion, 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 legal liability for ARO in the period in which the liability is incurred (at the time the wells are drilled or acquired) at the asset’s inception, with the offsetting increase 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 $0.9 million for the three months ended December 31, 2021, respectively, compared to the same period for 2020. The increase for the three months ended December 31, 2021 was due to higher production, partially offset by a lower depletion rate. The depletion rate is a function of capitalized cost and related underlying reserves. The lower depletion rate was primarily driven by an increase in reserves as a result of improved commodity prices. General and Administrative Expense ("G&A") G&A expenses include corporate overhead such as payroll and benefits for our corporate staff, equity-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 from other owners in properties operated by us. Total G&A expense increased by $1.7 million, for the three months ended December 31, 2021, compared to the same period for 2020. Administrative costs, which includes payroll, benefits and non-payroll costs, increased by $1.2 million, for the three months ended December 31, 2021, compared to the same period for 2020. The increase in administrative costs was primarily attributable to increased professional services, insurance, technology and investor relations costs. Equity compensation expense increased by $0.5 million for the three months ended December 31, 2021, compared to the same period in 2020. The increase is primarily attributable to restricted shares awarded to employees in October 2021 and restricted shares awarded to certain employees following completion of the Merger. Interest Expense Interest expense was $0.9 million and $1.2 million for the three months ended December 31, 2021 and 2020, respectively. Interest expense decreased due to a lower outstanding average balance on the Company's revolving credit facility during the three months ended December 31, 2021 when compared to the same period for 2020. 29 . 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 (expenses) on its condensed consolidated statement 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 December 31, 2021 and 2020: Three Months Ended December 31, 2021 2020 (In thousands) Settlements on derivatives $ (16,014) $ 5,173 Non-cash gain (loss) on derivatives 10,821 (19,082) Loss on derivatives $ (5,193) $ (13,909) Our earnings are affected by the changes in value of our derivatives 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 to the extent future commodity price outlook increases between measurement periods, we will have mark-to-market losses. Income Tax Expense The Company became a taxable entity as a result of its Merger with Tengasco on February 26, 2021. See further discussion in Note 4 - Acquisitions and Divestitures to the Company's consolidated financial statements included herein. While REP LLC was organized as a limited liability company, taxable income passed through to its unit holders. Accordingly, a provision for federal and state corporate income taxes has been made for the operations of REP LLC only from February 27, 2021 through December 31, 2021 in the accompanying consolidated financial statements. 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. Upon consummation of the Merger, the Company established a $13.6 million provision for deferred income taxes with the conversion to a C-corporation. The majority of this deferred tax liability was established by a change in tax status which primarily was attributable to the oil and natural gas properties. See Note 11 - Income Taxes to the Company's consolidated financial statements included herein for further discussion of income taxes. Three Months Ended December 31, 2021 2020 (In thousands) Current expense $ 113 $ — Deferred expense (benefit) 5,756 (515) Total expense (benefit) $ 5,869 $ (515) Effective income tax rate 21.5 % 2.0 % 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 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. 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. 30 . 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 our ability to 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 instance, during the fiscal second quarter of 2022, the Company is expecting an impact to its natural gas and NGL sales due to its primary midstream gas gathering and processing partner curtailing volume capacity as work continues on their overall capacity expansion project. While the Company expects volumes to be impacted only for the months of February through April, the Company cannot estimate the full impact this will have on its results of operations. For more information on conditions impacting our liquidity and capital resources. 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 are 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 December 31, 2021, we had a working capital deficit of $32.8 million compared to working capital deficit of $46.9 million as of September 30, 2021. The working capital deficit at December 31, 2021 reflects $31.0 million in current derivative liabilities compared to $42.1 million in current derivative liabilities at September 30, 2021. We utilize our revolving credit facility and cash on hand to manage the timing of cash flows and fund short-term working capital deficits. Cash Flows The following table summarizes the Company’s cash flows from continuing operations: Three Months Ended December 31, 2021 2020 (In thousands) Statement of Cash Flows Data from Continuing Operations: Net cash provided by operating activities $ 21,727 $ 17,193 Net cash used in investing activities $ (29,128) $ (9,707) Net cash used in financing activities $ (1,349) $ (7,269) Operating Activities The Company’s net cash provided by operating activities increased by $4.5 million or 26% to $21.7 million for the three months ended December 31, 2021 from $17.2 million for the same period in 2020. The increase was primarily driven by an increase in revenues of $34.2 million, partially offset by a $21.2 million decrease in net cash received for settlements of commodity derivative contracts and an increase in operating expenses of $6.0 million, which excludes non-cash expenses such as equity based compensation, expiration of unproved leasehold costs, and depreciation, depletion, accretion, and amortization expense. Investing Activities The Company's cash flows used in investing activities increased by $19.4 million or 200% to $29.1 million for the three months ended December 31, 2021 from $9.7 million for the same period in 2020. The increase was primarily due to higher capital spending of $19.6 million primarily related to the Company's drilling and completion activity and EOR project in 2021. Financing Activities Net cash flow used in financing activities decreased by $5.9 million or 81% to $1.3 million for the three months ended December 31, 2021 from $7.3 million for the same period in 2020. During the three months ended December 31, 2021, the Company utilized proceeds from its revolving credit facility to fund capital expenditures. For the same period in 2020, the Company had a net paydown on its revolving credit facility of $3.5 million based on decreased drilling and completion activity during this period. In addition, the Company distributed an additional $2.3 million of dividends on common stock during the three months ended December 31, 2021 compared to the same period in 2020. 31 . Revolving Credit Facility The Company's borrowing base was $175 million with outstanding borrowings of $65 million on December 31, 2021, representing available borrowing capacity of $110 million. See further discussion in Note 9 — Revolving Credit Facility to the Company's consolidated financial statements included herein. Distributions For the three months ended December 31, 2021, the Company authorized and declared a quarterly dividend totaling approximately $6.1 million, with $6.0 million paid in cash and $0.1 million payable to restricted shareholders upon vesting. Contractual Obligations In July 2021, as part of a planned expansion of the primary gas processing plant owned by the Company's primary midstream partner, Stakeholder, the Company committed to annually drill, complete and connect a minimum number of wells or deliver an annual target volume to Stakeholder's gathering system. While the minimum number of wells is below our planned development activity, there are financial penalties if the minimum activity levels are not met. The annual well or volume target is for each of five years beginning January 2022. The additional capacity from the gas processing plant expansion is expected to lead to increased natural gas sales and decreased gas flaring for the Company. In August 2021, the Company entered into a purchase agreement for supplies for its EOR project. Under the agreement, the Company has remaining commitments to purchasing supplies totaling approximately $0.8 million and $2.6 million by January 2022 and April 2022, respectively. On October 7, 2021, the Company executed two agreements related to its EOR project. The first agreement is a CO 2 purchase agreement with Kinder Morgan CO 2 Company, LLC and the second agreement is a connection agreement that also established a delivery point for the purchased CO 2 with the Cortez Pipeline Company. Critical Accounting Estimates The discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s unaudited condensed consolidated financial statements and accompanying notes included herein, which have been prepared in accordance with U.S. GAAP. The preparation of financial statements requires the Company to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. These estimates and assumptions may also affect disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Changes in facts and assumptions or the discovery of new information may result in revised estimates. Actual results could differ from these estimates and assumptions used in preparation of the Company’s unaudited condensed consolidated financial statements and it is at least reasonably possible these estimates could be revised in the near term and these revisions could be material. Certain accounting policies involve judgments and uncertainties to such an extent that there is reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. The Company evaluates its estimates and assumptions on a regular basis. The Company bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Significant areas requiring the use of assumptions, judgments and estimates include (i) oil and natural gas reserves; (ii) cash flow estimates used in impairment testing of oil and natural gas properties; (iii) depreciation, depletion, amortization and accretion, or DD&A; (iv) ARO; (v) assigning fair value and allocating purchase price in connection with business combinations; (vi) valuation of commodity derivative instruments; (vii) income tax provisions; (viii) carrying value of goodwill; and (ix) accrued amounts. Actual results may differ from these estimates and assumptions used in preparation of the Company’s unaudited condensed consolidated financial statements included herein. Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable. 32 .