The accompanying notes are an integral part of these consolidated financial statements.
Magnolia Oil & Gas Corporation
Notes to Consolidated Financial Statements
(Unaudited)
1. Description of Business and Basis of Presentation
Organization and GeneralNature of Operations
Magnolia Oil & Gas Corporation (formerly TPG Pace Energy Holdings Corp.) (the “Company” or “Magnolia”) was incorporated in Delaware onFebruary 14, 2017 (“Inception”).
On March 15, 2018, the Company formed three wholly owned subsidiaries: Magnolia Oil & Gas Parent LLC (“Magnolia LLC”), Magnolia Oil & Gas Intermediate LLC (“Magnolia Intermediate”), and Magnolia Oil & Gas Operating LLC (“Magnolia Operating”), all of which are Delaware limited liability companies formed in contemplation of the Business Combination (as defined herein).
Business Combination
On July 31, 2018 (the “Closing Date”), the Company and Magnolia LLC, consummated the acquisition of the following:
certain right, title and interest in certain oil and natural gas assets located primarily in the Karnes County portion of the Eagle Ford Shale in South Texas (the “Karnes County Assets” and, such business the “Karnes County Business”) pursuant to that certain Contribution and Merger Agreement (as subsequently amended, the “Karnes County Contribution Agreement”), by and among the Company, Magnolia LLC and certain affiliates (the “Karnes County Contributors”) of EnerVest Ltd. (“EnerVest”);
certain right, title and interest in certain oil and natural gas assets located primarily in the Giddings Field of the Austin Chalk (the “Giddings Assets”) pursuant to that certain Purchase and Sale Agreement (the “Giddings Purchase Agreement”) by and among Magnolia LLC and certain affiliates of EnerVest (the “Giddings Sellers”); and
a 35% membership interest (the “Ironwood Interests”) in Ironwood Eagle Ford Midstream, LLC (“Ironwood”), a Texas limited liability company, which owns an Eagle Ford gathering system, pursuant to that certain Membership Interest Purchase Agreement (together with the transactions contemplated by the Karnes County Contribution Agreement and the Giddings Purchase Agreement, the “Business Combination Agreements” and the transactions contemplated thereby, the “Business Combination”), by and among Magnolia LLC and certain affiliates of EnerVest (the “Ironwood Sellers”).
The Company consummated the Business Combination for aggregate consideration of approximately $1.2 billion in cash, 31.8 million shares of the Company’s Class A Common Stock, par value $0.0001 per share (the “Class A Common Stock”), and 83.9 million shares of the Company’s Class B Common Stock, par value $0.0001 per share (the “Class B Common Stock”), and a corresponding number of units in Magnolia LLC (the “Magnolia LLC Units”), as well as certain earnout rights payable in a combination of cash and additional equity securities in the Company. In connection with the Business Combination, Magnolia issued and sold 35.5 million shares of Class A Common Stock in a private placement to certain qualified institutional buyers and accredited investors for gross proceeds of $355.0 million (the “PIPE Investment”). In addition, Magnolia Operating and Magnolia Oil & Gas Finance Corp., a wholly owned subsidiary of Magnolia Operating (“Finance Corp.” and, together with Magnolia Operating, the “Issuers”), issued and sold $400.0 million aggregate principal amount of 6.0% Senior Notes due 2026 (the “2026 Senior Notes”). The proceeds of the PIPE Investment and the offering of 2026 Senior Notes were used to fund a portion of the cash consideration required to effect the Business Combination.
Business Operations and Strategy
Magnolia is an independent oil and natural gas company engaged in the acquisition, development, exploration, and production of oil, natural gas, and NGLnatural gas liquid (“NGL”) reserves. The Company’s oil and natural gas properties are located primarily in Karnes County and the Giddings Field in South Texas where the Company targets the Eagle Ford Shale and 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.
Basis of Presentation
InThe accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles generally accepted in the United States of America (“GAAP”), the Company is the acquirer in the Business Combination for accounting purposes and the Karnes County Business, the Giddings Assets, and the Ironwood Interests are the acquirees. The Karnes County Business, including as applicable, its ownership of the Ironwood Interests, was deemed the “Predecessor” for periods prior to the Business Combination, and does not include the consolidation of the Company and the Giddings Assets. Although the Karnes County Contributors are not under common control, each are managed by the same managing general partner, EnerVest, and as such, these Predecessor financial statements have been presented on a combined basis for financial reporting purposes.
For the period on or after the Business Combination, the Company, including the combination of the Karnes County Business, the Giddings Assets, and the Ironwood Interests, is the “Successor.” The financial statements and certain footnote presentations separate the Company’s presentations into two distinct periods, the period before the consummation of the Business Combination, which includes the three months ended March 31, 2018 (the “Predecessor Period”) and the period after the Business Combination (the “Successor Period”), which includes the three months ended March 31, 2019. The Business Combination was accounted for using the acquisition method of accounting and the Successor financial statements reflect a new basis of accounting that is based on the fair value of assets acquired and liabilities assumed. As a result of the inclusion of the Giddings Assets, the new basis of accounting, and certain other items that affect comparability, the Company’s financial information prior to the Business Combination is not comparable to its financial information subsequent to the Business Combination.
The assets, liabilities, revenues, expenses and cash flows related to the Karnes County Business were not previously separately accounted for as a standalone legal entity and have been carved out of the overall assets, liabilities, revenues, expenses and cash flows from the Karnes County Contributors as appropriate. In addition, Parents’ Net Investment represents the Karnes County Contributors’ interest in the recorded net assets of the Karnes County Business and represents the cumulative net investment of the Karnes County Contributors’ in the Karnes County Business through the dates presented, inclusive of cumulative operating results.
The Karnes County Contributors utilize EnerVest’s centralized processes and systems for its treasury services and the Karnes County Business’ cash activity was commingled with other oil and gas assets that were not part of the Business Combination. As such, the net results of the cash transactions between the Karnes County Business and the Karnes County Contributors are reflected as Parents’ Net Investment in the accompanying Predecessor balance sheet.
The Predecessor financial statements also include a portion of indirect costs for salaries and benefits, rent, accounting, legal services and other expenses. In addition to the allocation of indirect costs, the financial statements reflect certain agreements executed by the Karnes County Contributors for the benefit of the Karnes County Business, including price risk management instruments. The allocations methodologies for significant allocated items include:
Corporate G&A - EnerVest, as managing general partner of the Karnes County Contributors, provides management, accounting, and advisory services to the Karnes County Contributors in exchange for a quarterly management fee based on the Karnes County Contributors’ investor commitments, which were used, in part, to acquire the Karnes County Business as well as other oil and natural properties that were not part of the Business Combination. As such, the management fee was allocated to the Karnes County Business using a ratio of asset acquisitions value to total asset acquisitions completed by the Karnes County Contributors, for the Predecessor Period.
Derivatives - Certain Karnes County Contributors entered into financial instruments to manage the Karnes County Business’ exposure to changes in commodity prices for the Karnes County Business as well as other oil and natural gas properties that were not part of the Business Combination, on a combined basis. The commodity derivative activity was allocated to the Karnes County Business using a ratio of expected crude oil and condensate, natural gas liquids (“NGLs”), and natural gas volumes produced, on an equivalents basis, by the Karnes County Business to the Karnes County Contributors’ total expected crude oil and condensate, NGLs, and natural gas produced, on an equivalents basis, for the Predecessor Period.
Indebtedness - The Karnes County Business’ did not historically have outstanding indebtedness, but its oil and natural gas properties were collateral to various credit facilities held by the Karnes County Contributors/EnerVest. Amounts outstanding on these credit facilities have not been allocated to the Karnes County Business as they were not directly attributable to the Karnes County Business.
Management believes the allocation methodologies used are reasonable and result in an allocation of the indirect costs and other items to operate the Karnes County Business as if it were a stand-alone entity. These allocations, however, may not be indicative of the cost of future operations or the amount of future allocations. Direct costs were included at the historical amounts related to each reported period.
The accompanying unaudited interim consolidated and combined financial statements have been prepared in accordance with GAAP and in accordance with the rules and regulations of the SEC.Securities and Exchange Commission (“SEC”) for interim financial reporting. Accordingly, certain information and disclosures normally included in annual financial statements prepared in accordance with GAAPan Annual Report on Form 10-K have been condensed or omitted. In the opinion of management, all adjustments, consisting of only normal recurring adjustments, considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of results for the full year or any future periods. The unaudited interim consolidated financial statements including the Predecessor financial statements,and related notes included in this Quarterly Report should be read in conjunction with the informationCompany’s consolidated and combined financial statements and related notes included in or incorporated by reference from the Company’s Annual Report on Form 10-K for the fiscal yearperiod ended December 31, 2018.2019. Except as disclosed herein, there have been no material changes to the information disclosed in the notes to the consolidated and combined financial statements included in the Company’s Annual Report on Form 10-K for the period ended December 31, 2019.
In the opinion of management, all normal, recurring adjustments and accruals considered necessary to present fairly, in all material respects, the Company’s interim financial results, have been included. Operating results for the periods presented are not necessarily indicative of expected results for the full year.
Certain reclassifications of prior period financial statements have been made to conform to current reporting practices. The consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of intercompany transactions and balances. The Company’s interests in oil and natural gas exploration and production ventures and partnerships are proportionately consolidated. The Company reflects a noncontrolling interest representing primarily the interest owned by the Karnes County Contributors through their ownership of Magnolia LLC Units in the consolidated financial statements. The noncontrolling interest is presented as a component of equity. See Note 11—Stockholders’ Equity for further discussion of the noncontrolling interest.
2. Summary of Significant Accounting Policies
As of March 31, 2019,2020, the Company’s significant accounting policies are consistent with those discussed in Note 2 - Summary of Significant Accounting Policies of its consolidated and combined financial statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018,2019, with the exception of Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842)” Accounts Receivable and Allowance for Expected Credit Losses.
LeasesAccounts Receivable and Allowance for Expected Credit Losses
In FebruaryJune 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2016-02, Leases, which requires lessees to recognize a right of use asset and a lease liability on their balance sheet for all leases, including operating leases, with a term of greater than 12 months. In July 2018, the FASB issued ASU 2018-11, which adds a transition option permitting2016-13, Financial Instruments-Credit Losses (Topic 326): “Measurement of Credit Losses on Financial Instruments.” For public business entities, to apply the provisions of the new standard at its adoption date instead of the earliest comparative period presented in the consolidated financial statements. Under this transition option, comparativebecame effective for annual reporting would not be required, and the provisions of the standard would be applied prospectively to leases in effect at the date of adoption. The Company elected the package of transition practical expedients provided by the new standardperiods beginning after December 15, 2019, including interim periods within that allow the Company to not reassess under the new standard its prior conclusions about lease identification, classification related to contracts that commenced prior to adoption, and to apply the standard prospectively to all new or modified land easements and rights-of-way. The Company has also elected a policy to not recognize right of use assets and lease liabilities related to short-term leases. The Company has lease agreements with lease and non-lease components, which are generally accounted for as a single lease component.
reporting period. Magnolia adopted this standard on January 1, 2019 and recognized right of use2020. The standard changes the impairment model for most financial assets and lease liabilitiescertain other instruments, including trade and other receivables, and requires entities to use a new forward-looking expected loss model that will result in earlier recognition of allowance for certain commitmentslosses. The Company’s receivables consist mainly of trade receivables from commodity sales and joint interest billings due from owners on properties the Company operates. The majority of these receivables have payment terms of 30 days or less. For receivables due from joint interest owners, the Company generally has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. From an evaluation of the Company’s existing credit portfolio, historical credit losses have been de minimis and are expected to remain so in the future assuming no substantial changes to the business or creditworthiness of Magnolia’s business partners. As expected, there was no material impact on the Company’s unaudited consolidated financial statements or disclosures upon adoption of this ASU.
3. Revenue Recognition
Magnolia’s revenues include the sale of crude oil, natural gas, and NGLs. Oil, natural gas, and NGL sales are recognized as revenue when production is sold to a customer in fulfillment of performance obligations under the terms of agreed contracts. Performance obligations primarily relatedcomprise delivery of oil, natural gas, or NGLs at a delivery point, as negotiated within each contract. Each barrel of oil, million Btu of natural gas, gallon of NGLs, or other unit of measure is separately identifiable and represents a distinct performance obligation to real estate, vehicles,which the transaction price is allocated.
The Company’s oil production is primarily sold under market-sensitive contracts that are typically priced at a differential to the New York Mercantile Exchange (“NYMEX”) price or at purchaser posted prices for the producing area. For oil contracts, the Company generally records sales based on the net amount received.
For natural gas contracts, the Company generally records wet gas sales (which consists of natural gas and field equipment, while prior reporting periods are presented in accordanceNGLs based on end products after processing) at the wellhead or inlet of the gas processing plant (i.e., the point of control transfer) as revenues net of gathering, transportation, and processing expenses if the processor is the customer and there is no redelivery of commodities to the Company at the tailgate of the plant. Conversely, the Company generally records residual natural gas and NGL sales at the tailgate of the plant (i.e., the point of control transfer) on a gross basis along with historical accounting treatment under ASC Topic 840, Leases (“ASC 840”).the associated gathering, transportation, and processing expenses if the processor is a service provider and there is redelivery of one or several commodities to the Company at the tailgate of the plant. The Company determines iffacts and circumstances of an arrangement are considered and judgment is often required in making this determination. For processing contracts that require noncash consideration in exchange for processing services, the Company recognizes revenue and an equal gathering, transportation, and processing expense for commodities transferred to the service provider.
Customers are invoiced once the Company’s performance obligations have been satisfied. Payment terms and conditions vary by contract type, although terms generally include a lease at inception. Operating leasesrequirement of payment within 30 days. There are included in other long-termno judgments that significantly affect the amount or timing of revenue from contracts with customers. Accordingly, the Company’s product sales contracts do not give rise to material contract assets other current liabilities,or contract liabilities.
The Company’s receivables consist mainly of trade receivables from commodity sales and other long-term liabilities in Magnolia’s consolidated balance sheetjoint interest billings due from owners on properties the Company operates. Receivables from contracts with customers totaled $68.7 million as of March 31, 2020 and $100.4 million as of December 31, 2019. Operating lease right-of-use (“ROU”) assets representSee Note 2 - Summary of Significant Accounting Policies for more information on the Company’s allowance for expected credit losses policy.
The Company has concluded that disaggregating revenue by product type appropriately depicts how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors and has reflected this disaggregation of revenue on the Company’s consolidated statements of operations for all periods presented.
Performance obligations are satisfied at a point in time once control of the product has been transferred to the customer. The Company considers a variety of facts and circumstances in assessing the point of control transfer, including but not limited to: whether the purchaser can direct the use of the hydrocarbons, the transfer of significant risks and rewards, the Company’s right to use an underlying asset forpayment, and transfer of legal title.
The Company does not disclose the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments overunsatisfied performance obligations for contracts as all contracts have either an original expected length of one year or less, or the lease term. Magnolia’s lease terms may include optionsentire future consideration is variable and allocated entirely to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expenses for lease payments are recognized on a straight-line basis over the lease term. For more information, refer to Note 10 - Leases.wholly unsatisfied performance obligation.
3.4. Acquisitions
2020 Acquisitions
On February 21, 2020, the Company completed the acquisition of certain non-operated oil and natural gas assets located in Karnes and DeWitt Counties, Texas, for approximately $71.3 million in cash, subject to customary closing adjustments. The transaction was accounted for as an asset acquisition.
2019 Acquisitions
On May 31, 2019, the Company completed the acquisition of certain oil and natural gas assets located in the Company’s Karnes County Assets for approximately $36.3 million in cash and approximately 3.1 million shares of the Company’s Class A Common Stock. The transaction was accounted for as an asset acquisition.
Acquisitions (Successor)
Highlander Acquisition
In the first quarter ofOn February 5, 2019, Magnolia Operating formed a joint venture, Highlander Oil & Gas Holdings LLC (“Highlander”), to complete the acquisition of a 72% working interest in the Eocene-Tuscaloosa Zone, Ultra Deep Structure gas well located in St. Martin Parish, Louisiana (“Highlander Well”) and 31.1 million royalty trust units in the Gulf Coast Ultra Deep Royalty Trust from McMoRan Oil & Gas, LLC. Highlander paid cash consideration of approximately $51.9$50.9 million net of customary closing adjustments, for such interests. MGY Louisiana LLC, a wholly owned subsidiary of Magnolia Operating, holds approximately 85% of the units in Highlander. The transaction was accounted for as an asset acquisition.
EnerVest Business Combination
As discussed in Note 1 - Description of Business and Basis of Presentation, on July 31, 2018, the Company consummated the Business Combination contemplated by the Business Combination Agreements. The Business Combination Agreements and the Business Combination were approved by the Company’s stockholders on July 17, 2018. At the closing of the Business Combination, the Karnes County Contributors received 83.9 million shares of the Company’s Class B Common Stock and an equivalent number of Magnolia LLC
Units, which, together, are exchangeable on a one-for-one basis for shares of the Company’s Class A Common Stock, subject to certain conditions; 31.8 million shares of Class A Common Stock; and approximately $911.5 million in cash. The Giddings Sellers received approximately $282.7 million in cash, after customary purchase price adjustments. The Ironwood Sellers received $25.0 million in cash in exchange for the Ironwood Interests. On March 29, 2019, Magnolia and EnerVest consummated the final settlement pursuant to the Contribution and Merger Agreement and as otherwise agreed to by the parties, with Magnolia receiving a net cash payment of $4.3 million and the Karnes County Contributors forfeiting 0.5 million shares of Class A Common Stock, 1.6 million shares of Class B Common Stock to Magnolia, and a corresponding number of Magnolia LLC Units.
The Business Combination has been accounted for using the acquisition method. The acquisition method of accounting is based on ASC 805 “Business Combinations,” and uses the fair value concepts defined in ASC 820. ASC 805 requires, among other things, that the assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date by the Company.
Contingent Consideration
Pursuant to the Karnes County Contribution Agreement, for a period of five years following the Closing Date, the Karnes County Contributors were entitled to receive an aggregate of up to 13.0 million additional shares of Class A Common Stock or shares of Class B Common Stock (and a corresponding number of Magnolia LLC Units) based on certain EBITDA and free cash flow or stock price thresholds. As of December 31, 2018, the Company had met the defined stock price thresholds and, as a result, the Company had issued an aggregate of 3.6 million additional shares of Class A Common Stock and 9.4 million additional shares of Class B Common Stock to the Karnes County Contributors and Magnolia LLC issued an additional 9.4 million Magnolia LLC Units to the Karnes County Contributors.
Pursuant to the Giddings Purchase Agreement, until December 31, 2021, the Giddings Sellers were entitled to receive an aggregate of up to $47.0 million in cash earnout payments based on certain net revenue thresholds. On September 28, 2018, the Company paid the Giddings Sellers a cash payment of $26.0 million to fully settle the earnout obligation.
The purchase consideration for the Business Combination was as follows:
|
| | | | |
| (in thousands) |
|
|
| Purchase Consideration: |
|
|
| Cash consideration |
| $ | 1,214,966 |
|
Stock consideration (1) |
| 1,398,238 |
|
Fair value of contingent earnout purchase consideration (2) |
| 169,000 |
|
| Total purchase price consideration |
| $ | 2,782,204 |
|
| |
(1) | At closing of the Business Combination, the Karnes County Contributors received 83.9 million shares of Class B Common Stock and 31.8 million shares of Class A Common Stock (and a corresponding number of Magnolia LLC Units). On March 29, 2019, Magnolia and EnerVest consummated the final settlement pursuant to the Contribution and Merger Agreement as agreed to by the parties, with the Karnes County Contributors forfeiting 2.1 million shares of Class A and Class B Common Stock to Magnolia (and a corresponding number of Magnolia LLC Units). |
| |
(2) | Pursuant to ASC 805, ASC 480, “Distinguishing Liabilities from Equity” and ASC 815, “Derivatives and Hedging,” the Karnes County earnout consideration was valued at fair value as of the Closing Date and was classified in stockholders’ equity. The Giddings earnout was valued at fair value as of the Closing Date and was classified as a liability. The fair value of the earnouts was determined using the Monte Carlo simulation valuation method based on Level 3 inputs in the fair value hierarchy. |
The following table summarizes the allocation of the purchase consideration to the assets and liabilities assumed on the acquisition date:
|
| | | | |
| (in thousands) | | |
Fair value of assets acquired (1) | | |
| Accounts receivable | | $ | 61,790 |
|
| Other current assets | | 2,853 |
|
Oil and natural gas properties (2) | | 2,813,140 |
|
| Ironwood equity investment | | 18,100 |
|
| Total fair value of assets acquired | | 2,895,883 |
|
| Fair value of liabilities assumed | | |
| Accounts payable and other current liabilities | | (65,908 | ) |
| Asset retirement obligations | | (34,132 | ) |
| Deferred tax liability | | (13,639 | ) |
| Fair value of net assets acquired | | $ | 2,782,204 |
|
| |
(1) | The total purchase consideration allocation above is preliminary. Any changes within the measurement period, including working capital adjustments, may change the allocation of the purchase consideration. The allocation of the purchase consideration and related tax impact assessments are to be completed within twelve months of the Closing Date and could impact on the components of the purchase consideration allocation. |
| |
(2) | The fair value measurements of oil and natural gas properties and asset retirement obligations are based on inputs that are not observable in the market and therefore represent Level 3 inputs. The fair values of oil and natural gas properties and asset retirement obligations were measured using valuation techniques that convert future cash flows to a single discounted amount. Significant inputs to the valuation of oil and natural gas properties included estimates of: (i) recoverable reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices; and (v) a market-based weighted average cost of capital rate. |
The Company incurred $25.0 million in transaction costs associated with the Business Combination. The Company also incurred a total of $23.5 million of debt issuance costs in connection with the consummation of the Business Combination related to the establishment of the RBL Facility (as defined herein) and the issuance of the 2026 Senior Notes.
Non-Compete
On the Closing Date, the Company and EnerVest, separate and apart from the Business Combination, entered into a non-compete agreement (the “Non-Compete”) restricting EnerVest and certain of its affiliates from competing with the Company in certain counties comprising the Eagle Ford Shale following the Closing Date. An affiliate of EnerVest will have the right to receive 4.0 million shares of Class A Common Stock issuable in two tranches of 2.0 million shares in two and one half and four years from the Closing Date, respectively, provided EnerVest does not compete with Magnolia in the Eagle Ford Shale until the later of July 31, 2022 or the date the Services Agreement is terminated. For more discussion on the Non-Compete, refer to Note 6 - Intangible Assets.
Harvest Acquisition
On August 31, 2018, the Company completed the acquisition of substantially all of Harvest Oil & Gas Corporation’s South Texas assets for approximately $133.3 million in cash and 4.2 million newly issued shares of the Company’s Class A Common Stock for a total consideration of $191.5 million, net of customary closing adjustments. The acquisition added an undivided working interest across a portion of Magnolia’s existing Karnes County Assets and all of the Company’s existing Giddings Assets. On March 14, 2019, Magnolia consummated the final settlement with Harvest receiving a cash payment of $1.4 million.
The following table summarizes the allocation of the purchase consideration to the assets and liabilities assumed:
|
| | | | |
| (in thousands) | | |
| Fair value of assets acquired | | |
| Other current assets | | $ | 1,290 |
|
Oil and natural gas properties (1) | | 201,337 |
|
| Total fair value of assets acquired | | 202,627 |
|
| Fair value of liabilities assumed | | |
| Asset retirement obligations and other current liabilities | | (9,666 | ) |
| Fair value of net assets acquired | | $ | 192,961 |
|
| |
(1) | The fair value measurements of oil and natural gas properties and asset retirement obligations are based on inputs that are not observable in the market and therefore represent Level 3 inputs. The fair values of oil and natural gas properties and asset retirement obligations were measured using valuation techniques that convert future cash flows to a single discounted amount. Significant inputs to the valuation of oil and natural gas properties included estimates of: (i) recoverable reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices; and (v) a market-based weighted average cost of capital rate. These inputs required significant judgments and estimates by management at the time of the valuation. |
Acquisitions (Predecessor)
Subsequent GulfTex Acquisition
On March 1, 2018, the Predecessor acquired certain oil and natural gas properties located in the Eagle Ford Shale from GulfTex Energy III, L.P. and GulfTex Energy IV, L.P. for an adjusted purchase price of approximately $150.1 million, net of customary closing adjustments (the “Subsequent GulfTex Acquisition”).
The recognized fair value of identifiable assets and acquired liabilities assumed in connection with the Subsequent GulfTex Acquisition, is as follows:
|
| | | | |
| (in thousands) | | |
| Purchase price allocation: | | |
| Accounts receivable | | $ | 10,501 |
|
| Proved oil and natural gas properties | | 118,572 |
|
| Unproved oil and natural gas properties | | 22,802 |
|
| Accounts payable and accrued liabilities | | (1,679 | ) |
| Asset retirement obligations | | (57 | ) |
| | | $ | 150,139 |
|
4. Derivative Instruments and Hedging Activities (Predecessor)
The Company’s activities expose it to risks associated with changes in the market price of oil, natural gas, and NGLs. As such, future earnings are subject to fluctuation due to changes in the market price of oil, natural gas, and NGLs. The Company has not engaged in any hedging activities and does not expect to engage in any hedging activities with respect to the market risk to which the Company is exposed. The Karnes County Contributors, on behalf of the Predecessor, used derivatives to reduce the risk of volatility in the prices of oil, natural gas, and NGLs and their policies did not permit the use of derivatives for speculative purposes.
The Predecessor elected not to designate any of its derivatives as hedging instruments. Accordingly, changes in the fair value of the Predecessor's derivatives were recorded immediately to earnings as “Loss on derivatives, net” in the combined statements of operations. During the quarter ended March 31, 2018, the Predecessor incurred a loss on derivatives of $7.2 million.
5. Fair Value Measurements
Certain of the Company’s assets and liabilities are carried at fair value and measured either on a recurring or non-recurringnonrecurring basis. The Company’s fair value measurements are based either on actual market data or assumptions that other market participants would use in pricing an asset or liability in an orderly transaction, using the valuation hierarchy prescribed by GAAP under ASC 820.
The three levels of the fair value hierarchy under ASC 820 are as follows:
Level I - Quoted prices (unadjusted) in active markets for identical investments at the measurement date are used.
Level II - Pricing inputs are other than quoted prices included within Level I that are observable for the investment, either directly or indirectly. Level II pricing inputs include quoted prices for similar investments in active markets, quoted prices for identical or similar investments in markets that are not active, inputs other than quoted prices that are observable for the investment, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level III - Pricing inputs are unobservable and include situations where there is little, if any, market activity for the investment. The inputs used in determination of fair value require significant judgment and estimation.
Fair Values - Recurring (Predecessor)Value of Financial Instruments
Debt Obligations
The Predecessor’s derivatives consisted of over-the-counter contracts that were not traded on a public exchange. As thecarrying value and fair value of these derivatives was based on inputs using market prices obtained from independent brokers or determined using quantitative modelsthe financial instrument that used as their basis readily observable market parameters that are actively quoted and can be validated through external sources, including third-party pricing services, brokers and market transactions, the Predecessor categorized these derivatives as Level 2. The Predecessor valued these derivatives using the income approach using inputs such as the forward curve for commodity prices based on quoted market prices and prospective volatility factors related to changes in the forward curves. Estimates of fair value have been determined at discrete points in time based on relevant market data. Furthermore, fair values are adjusted to reflect the credit risk inherent in the transaction, which may have included amounts to reflect counterparty credit quality and/or the effect of the Predecessor’s creditworthiness.
Fair Values - Nonrecurring
The fair value measurements of assets acquired and liabilities assumed in a business combination are measured on a nonrecurring basis on the acquisition date using an income valuation technique based on inputs that are not observable in the market, and therefore, represent Level 3 inputs. Significant inputs to the valuation of acquired oil and gas properties includes estimates of: (i) reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices, including price differentials; (v) future cash flows; and (vi) a market participant-based weighted average cost of capital rate. These inputs require significant judgments and estimates by the Company’s management at the time of the valuation. Refer to Note 3 - Acquisitions for additional information.
Debt Obligations
Carrying values and fair values of financial instruments that areis not carried at fair value in the accompanying consolidated balance sheet as ofat March 31, 2020 and December 31, 2019 is as follows:
|
| | | | | | | | | | | | | | | |
| | March 31, 2020 | | December 31, 2019 |
| (In thousands) | Carrying Value | | Fair Value | | Carrying Value | | Fair Value |
| Long-term debt | $ | 390,147 |
| | $ | 228,000 |
| | $ | 389,835 |
| | $ | 412,000 |
|
|
| | | | | | | | |
| | | March 31, 2019 |
| (In thousands) | | Carrying Value | | Fair Value |
| Long-term debt | | $ | 388,928 |
| | $ | 404,000 |
|
The fair value of the 2026 Senior Notes at March 31, 2020 and December 31, 2019 was based on unadjusted quoted prices in an active market, which are considered a Level 1 input in the fair value hierarchy.
The Company has other financial instruments consisting primarily of receivables, payables, and other current assets and liabilities that approximate fair value due to the nature of the instrument and their relatively short maturities. Non-financial assets and liabilities initially measured at fair value include assets acquired and liabilities assumed in the Business Combinationbusiness combinations and asset retirement obligations.
Nonrecurring Fair Value Measurements
The Company applies the provisions of the fair value measurement standard on a nonrecurring basis to its non-financial assets and liabilities, including oil and natural gas properties. These assets and liabilities are not measured at fair value on a recurring basis but are subject to fair value adjustments when facts and circumstances arise that indicate a need for remeasurement.
During the first quarter of 2020, Magnolia recorded impairments of $1.9 billion related to proved and unproved properties as a result of the sharp decline in commodity prices. Proved property impairment of $1.4 billion is included in “Impairment of oil and natural gas properties” and unproved property impairment of $0.6 billion is included in “Exploration expense” on the Company’s consolidated statement of operations for the three months ended March 31, 2020. Proved and unproved properties that were impaired had aggregate fair values as of the most recent date of impairment for the three months ended March 31, 2020, of $0.8 billion and $0.3 billion, respectively. The fair values of oil and natural gas properties were measured using the income approach based on inputs that are not observable in the market, and therefore, represent Level 3 inputs. The Company calculated the estimated fair values of its oil and natural gas properties using a discounted future cash flow model. Significant inputs associated with the calculation of discounted future net cash flows include estimates of future commodity prices based on NYMEX strip pricing adjusted for price differentials, estimates of proved oil and natural gas reserves and risk adjusted probable and possible reserves, estimates of future expected operating and capital costs, and a market participant based weighted average cost of capital of 10% for proved property impairments and 12% for unproved property impairments.
6. Intangible Assets
Non-Compete Agreement
On the Closing Date,July 31, 2018, the Company and EnerVest, separate and apart from the Business Combination, entered into the Non-Compete,a non-compete agreement (the “Non-Compete”), which prohibits EnerVest and certain of its affiliates from competing with the Company in the Eagle Ford Shale (the “Market Area”) until the later of July 31, 2022 or the date the Services Agreement is terminated. Under the Non-Compete, an affiliate of EnerVest will have the right to receive 4.0 million shares of Class A Common Stock in two2 tranches of 2.0 million shares in two and one half and four years from the Closing Date, respectively,July 31, 2018 provided EnerVest does not compete in the Market Area.
The Company recorded an estimated cost of $44.4 million for the Non-Compete as intangible assets on the Company’s consolidated balance sheet. These intangible assets have a definite life and are subject to amortization utilizing the straight-line method over their economic life, currently estimated to be two and one half to four years. The Company includes the amortization in “Amortization of intangible assets” on the Company’s consolidated statementstatements of operations.
|
| | | | | | | |
| (In thousands) | March 31, 2020 | | December 31, 2019 |
| Non-compete intangible assets | $ | 44,400 |
| | $ | 44,400 |
|
| Accumulated amortization | (24,175 | ) | | (20,549 | ) |
| Intangible assets, net | $ | 20,225 |
| | $ | 23,851 |
|
| Weighted average amortization period (in years) | 3.25 |
| | 3.25 |
|
|
| | | |
| (In thousands) | March 31, 2019 |
| Non-compete intangible assets | $ | 44,400 |
|
| Accumulated amortization | (9,670 | ) |
| Intangible assets, net | $ | 34,730 |
|
| Weighted average amortization (years) | 3.25 |
|
7.Asset Retirement Obligation Other Current Liabilities
The following table summarizes the changes inprovides detail of the Company’s asset retirement obligationsother current liabilities for the periods presented:
|
| | | | | | | | |
| (In thousands) | | March 31, 2020 | | December 31, 2019 |
| Accrued capital expenditures | | $ | 47,903 |
| | $ | 40,722 |
|
| Other | | 36,643 |
| | 55,058 |
|
| Total other current liabilities | | $ | 84,546 |
| | $ | 95,780 |
|
|
| | | | |
| (in thousands) | | For the Quarter Ended March 31, 2019 |
| Asset retirement obligations, beginning of period | | $ | 85,983 |
|
| Liabilities incurred and assumed | | 3,873 |
|
| Liabilities settled | | (837 | ) |
| Accretion expense | | 1,328 |
|
| Asset retirement obligations, end of period | | 90,347 |
|
| Less: Current portion | | 1,129 |
|
| Asset retirement obligation, long-term | | $ | 89,218 |
|
Asset retirement obligations (“ARO”) reflect the present value of the estimated future costs associated with the plugging and abandonment of oil and natural gas wells, removal of equipment and facilities from leased acreage and land restoration in accordance with applicable local, state and federal laws. Inherent in the fair value calculation of ARO are numerous assumptions and judgments, including the ultimate settlement amounts, inflation factors, credit adjusted discount rates and timing of settlement. To the extent future revisions to these assumptions impact the value of the existing ARO liability, a corresponding offsetting adjustment is made to the oil and natural gas property balance.
8. Income Taxes
The Company estimates its annual effective tax rate in recording its quarterly provision for income taxes in the various jurisdictions in which Magnolia and its subsidiaries operate. The tax effects of statutory rate changes, significant unusual or infrequent items, and certain changes in the assessment of the realizability of deferred tax assets are excluded from the determination of the Company’s annual effective tax rate as such items are recognized as discrete items in the period in which they occur.
Income tax expense recorded for the period is based on applying an estimated annual effective income tax rate to the net income from January 1, 2019 through March 31, 2019. There were no significant unusual or infrequently occurring items that are required to be recorded as discrete items as of March 31, 2019. The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the Company’s expected operating income for the year, projections of the proportion of income earned and taxed in various jurisdictions, the effect of noncontrolling interest, permanent and temporary differences, and the likelihood of recovering deferred tax assets in the current year. The accounting estimates used to compute the income tax expense may change as new events occur, more experience is obtained, additional information becomes known or as the tax environment changes. For the three months ended March 31, 2019, the Company incurred U.S. federal income tax expense of approximately $3.5 million. The Company’s annual effective tax rate as of March 31, 2019 was 14.2%. The primary differences between the annual effective tax rate and the statutory rate of 21.0% were income attributable to noncontrolling interest and state taxes.
The Company’s income tax provision (benefit) consists of the following components:
|
| | | | | | | | |
| | | Successor | | Predecessor |
| (In thousands) | | Three Months Ended March 31, 2019 | | Three Months Ended March 31, 2018 |
| Current: | | | | |
| Federal | | $ | 177 |
| | $ | — |
|
| State | | 183 |
| | 564 |
|
| | | 360 |
| | 564 |
|
| Deferred: | | | | |
| Federal | | 3,361 |
| | — |
|
| State | | 54 |
| | (118 | ) |
| | | 3,415 |
| | (118 | ) |
| Total provision | | $ | 3,775 |
| | $ | 446 |
|
The Company is subject to U.S. federal income tax, the margin tax in the state of Texas as well as Louisiana corporate income tax. No amounts have been accrued for income tax uncertainties or interest and penalties as of March 31, 2019. The Company is currently not aware of any issues under review that could result in significant payments, accruals, or material deviation from its position. The Company’s tax years since its formation remain subject to possible income tax examinations by its major taxing authorities for all periods.
9. Long Term Debt (Successor)
The Company’s debt is comprised of the following:
|
| | | | | | | | |
| (In thousands) | | March 31, 2020 | | December 31, 2019 |
| Revolving credit facility | | $ | — |
| | $ | — |
|
| 6.0% Senior Notes due 2026 | | 400,000 |
| | 400,000 |
|
| Total long-term debt | | 400,000 |
| | 400,000 |
|
| | | | | |
| Less: Unamortized deferred financing cost | | (9,853 | ) | | (10,165 | ) |
| Total debt, net | | $ | 390,147 |
| | $ | 389,835 |
|
|
| | | | |
| (In thousands) | | March 31, 2019 |
| Revolving credit facility | | $ | — |
|
| 6.0% Senior Notes due 2026 | | 400,000 |
|
| Total long-term debt | | 400,000 |
|
| | | |
| Less: unamortized deferred financing cost | | (11,072 | ) |
| Total debt, net | | $ | 388,928 |
|
Credit Facility
In connection with the consummation of the Business Combination, Magnolia Operating entered into a senior secured reserve-based revolving credit facility (the “RBL Facility”)the RBL Facility among Magnolia Operating, as borrower, Magnolia Intermediate, as its holding company, the banks, financial institutions, and other lending institutions from time to time party thereto, as lenders, the other parties from time to time party thereto and Citibank, N.A., as administrative agent, collateral agent, issuing bank, and swingline lender, providing for maximum commitments in an aggregate principal amount of $1.0 billion with a letter of credit facility with a $100.0 million sublimit. The borrowing base as of March 31, 20192020 was $550.0 million. In April 2020, the borrowing base capacity was reduced to $450.0 million. The RBL Facility is guaranteed by certain parent companies and subsidiaries of Magnolia LLC and is collateralized by certain of Magnolia Operating’s oil and natural gas properties and has a borrowing base subject to semi-annual redetermination.
Borrowings under the RBL Facility bear interest, at Magnolia Operating’s option, at a rate per annum equal to either the adjusted LIBOR rate or the alternative base rate plus the applicable margin. Additionally, Magnolia Operating is required to pay a commitment fee quarterly in arrears in respect of unused commitments under the RBL Facility. The applicable margin and the commitment fee rate are calculated based upon the utilization levels of the RBL Facility as a percentage of the borrowing base then in effect.
The RBL Facility contains certain affirmative and negative covenants customary for financings of this type, including compliance with a leverage ratio of less than 4.00 to 1.00 and, if the leverage ratio is in excess of 3.00 to 1.00, a current ratio of greater than 1.00 to 1.00. As of March 31, 2019,2020, the Company was in compliance with all covenants (including the financial covenants) under the RBL Facility.
Deferred financing costs incurred in connection with securing the RBL Facility were $11.7 million, which are amortized on a straight-line basis over a period of five years and included in “Interest expense”expense, net” in the Company’s consolidated statementstatements of operations.
During the period ended March 31, 2019, the The Company recognized interest expense of $1.1 million during the three months ended March 31, 2020 and 2019 related to the RBL Facility. The unamortized portion of the deferred financing costs are included in “Deferred financing costs, net” on the accompanying unaudited consolidated balance sheet as of March 31, 2019.2020.
The Company did not0t have any outstanding borrowings under its RBL Facility as of March 31, 2019.2020.
2026 Senior Notes
On the Closing Date,July 31, 2018, the Issuers issued and sold $400.0 million aggregate principal amount of 2026 Senior Notes. The 2026 Senior Notes were issued under the Indenture, dated as of the Closing DateJuly 31, 2018 (the “Indenture”), by and among the Issuers and Deutsche Bank Trust Company Americas, as trustee. The 2026 Senior Notes are guaranteed on a senior unsecured basis by the Company, Magnolia Operating, and Magnolia Intermediate and may be guaranteed by certain future subsidiaries of the Company.
The 2026 Senior Notes will mature on August 1, 2026. The 2026 Senior Notesand bear interest at the rate of 6.0% per annum, payable semi-annually in arrears on each February 1st and August 1st.annum.
At any time prior to August 1, 2021, the Issuers may, on any one or more occasions, redeem all or a part of the 2026 Senior Notes at a redemption price equal to 100% of the principal amount of the 2026 Senior Notes redeemed, plus a “make whole” premium on accrued and unpaid interest, if any, to, but excluding, the date of redemption. After August 1, 2021, the Issuers may redeem all or a part of the 2026 Senior Notes based on principal plus a set premium, as set forth in the Indenture, including any accrued and unpaid interest.
The Company incurred $11.8 million of deferred financing costs related to the issuance of the 2026 Senior Notes, which were capitalized,capitalized. These costs are amortized using the effective interest method over the term of the 2026 Senior Notes and are included in “Interest expense”expense, net” in the Company’s consolidated statementstatements of operations. The unamortized portion of the deferred financing costs is included as a reduction to the carrying value of the 2026 Senior Notes, which have been recorded as Long-term“Long-term debt, netnet” on the consolidated balance sheet as of March 31, 2019. During the three months ended March 31, 2019, the2020. The Company recognized interest expense of $6.3 million for the three months ended March 31, 2020 and 2019 related to the 2026 Senior Notes.
Affiliate Guarantors
Certain wholly-ownedThe Company, Magnolia LLC (together with the Company, the “Parent Guarantors”), and the direct parent company of Magnolia Operating and certain subsidiaries of the CompanyMagnolia Operating are guarantors under the terms of its 2026 Senior Notes and RBL Facility. The parent guaranteesParent Guarantors may be released upon the request of Magnolia Operating. Magnolia’s consolidated financial statements reflect the financial position of these subsidiary guarantors. As the parent company, Magnolia has no independent operations, assets, or liabilities.operations. The guarantees are full and unconditional (except for customary release provisions) and joint and several. There are restrictions on dividends, distributions, loans, or other transfers of funds from the subsidiary guarantors to the Company.
9. Commitments and Contingencies
Legal Matters
The Company is involved in disputes or legal actions in the ordinary course of business. For example, certain of the Karnes County Contributors and the Company have been named as defendants in a lawsuit where the plaintiffs claim to be entitled to a minority working interest in certain Karnes County Assets. The litigation is in the pre-trial stage. The exposure related to this litigation is currently not reasonably estimable. The Karnes County Contributors retained all such liability in connection with the Business Combination. At March 31, 2020, the Company does not believe the outcome of any such disputes or legal actions will have a material effect on its consolidated statements of operations, balance sheet, or cash flows. NaN amounts were accrued with respect to outstanding litigation at March 31, 2020 or March 31, 2019.
Environmental Matters
The Company, as an owner or lessee and operator of oil and natural gas properties, is subject to various federal, state, local laws, and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil and natural gas lease for the cost of pollution clean-up resulting from operations and subject the lessee to liability for pollution damages. In some instances, the Company may be directed to suspend or cease operations in the affected area. The Company maintains insurance coverage, which it believes is customary in the industry, although the Company is not fully insured against all environmental risks.
Risks and Uncertainties
The Company’s revenue, profitability, and future growth are substantially dependent upon the prevailing and future prices for oil and natural gas, which depend on numerous factors beyond the Company’s control such as overall oil and natural gas production and inventories in relevant markets, economic conditions, the global political environment, regulatory developments, and competition from other energy sources. Oil and natural gas prices historically have been volatile and may be subject to significant fluctuations in the future.
The coronavirus disease 2019 (“COVID-19”) pandemic and related economic repercussions have created significant volatility, uncertainty, and turmoil in the oil and natural gas industry. Oil demand has significantly deteriorated as a result of the virus outbreak and corresponding preventative measures taken around the world to mitigate the spread of the virus. Furthermore, in the midst of the ongoing COVID-19 pandemic, the competition between Russia and Saudi Arabia for crude oil market share caused a substantial increase in supply. The implications of these unprecedented events continue to unfold and may have further negative effects to the Company’s business, such as production curtailment, reduced storage capacity, and reductions to its operating plans.
10. LeasesIncome Taxes
The Company estimates its annual effective tax rate in recording its quarterly provision for income taxes in the various jurisdictions in which it operates. On March 27, 2020, the United States enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).The CARES Act includes several significant business tax provisions that, among other things, allow businesses to carry back net operating losses (“NOL”) arising in 2018, 2019, and 2020 to the five prior tax years. Applying the NOL carryback provision results in an income tax benefit of $1.2 million in the first quarter of 2020 and the difference in the U.S. federal rate of 35% in 2017 compared to 21% in 2018 and thereafter results in a discrete benefit to the tax provision of approximately $0.5 million for the period ended March 31, 2020.
The income tax expense or benefit recorded for the period is based on applying an estimated annual effective income tax rate to the net income or loss for the quarters ended March 31, 2020 and March 31, 2019. The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the Company’s expected operating income for the year, projections of the proportion of income earned and taxed in various jurisdictions, the effect of noncontrolling interest, permanent and temporary differences, and the likelihood of recovering deferred tax assets in the current year. The accounting estimates used to compute the income tax expense or benefit may change as new events occur, more experience is obtained, additional information becomes known, or as the tax environment changes. The Company’s annual effective tax rate for the three months ended March 31, 2020 and 2019 was 3.8% and 14.2%, respectively. The primary differences between the annual effective tax rate and the statutory rate of 21.0% are income attributable to noncontrolling interest, the recognition of a valuation allowance on federal and state deferred tax assets, and state taxes. During the first quarter of 2020, Magnolia’s effective tax rate was primarily impacted by the recognition of valuation allowances for its deferred tax assets from non-cash impairments of the carrying value of the Company’s oil and natural gas properties and the net deferred tax assets generated in this period.
During the first quarter of 2020, the Company moved from a net deferred tax liability position to an estimated net deferred tax asset position of $208.8 million resulting primarily from oil and natural gas impairments. Management assessed whether it is more-likely-than-not that it will generate sufficient taxable income to realize its deferred income tax assets, including the investment in partnership and net operating loss carryforwards. In making this determination, the Company considered all available positive and negative evidence and made certain assumptions. The Company considered, among other things, its deferred tax liabilities, the overall business environment, its historical earnings and losses, current industry trends, and its outlook for future years. As of March 31, 2020, the Company assessed the realizability of the deferred tax assets and recorded a full valuation allowance of $208.8 million.
Magnolia’s leases primarily consist of real estate, vehicles, and field equipment.
The Company’s leases have remaining lease termsincome tax provision consists of up to 9 years, some of which include options to renew or terminate the lease. The exercise of lease renewal options is at the Company’s sole discretion. Magnolia’s lease agreements do not contain any residual value guarantees or restrictive covenants.following components:
|
| | | | | | | |
| (In thousands) | Three Months Ended
March 31, 2020 | | Three Months Ended March 31, 2019 |
| Current: | | | |
| Federal | $ | (1,172 | ) | | $ | 177 |
|
| State | — |
| | 183 |
|
| | (1,172 | ) | | 360 |
|
| Deferred: | | | |
| Federal | (68,877 | ) | | 3,361 |
|
| State | (5,777 | ) | | 54 |
|
| | (74,654 | ) | | 3,415 |
|
| Total provision | $ | (75,826 | ) | | $ | 3,775 |
|
As most of Magnolia’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments.
The Company usedis subject to U.S. federal income tax, the incremental borrowing rate on January 1, 2019, for operating leases that commenced prior to that date.
|
| | | |
| (In thousands) | March 31, 2019 |
| Operating Leases | |
| Operating lease assets | $ | 2,039 |
|
| | |
| Operating lease liabilities - current | $ | 1,340 |
|
| Operating lease liabilities - long-term | 694 |
|
| Total operating lease liabilities | $ | 2,034 |
|
| | |
| Weighted Average Remaining Lease Term (in years) | 1.88 |
|
| Weighted Average Discount Rate | 4.4 | % |
For the quarter-ended March 31, 2019, the Company incurred $0.5 million of lease costs for operating leases included on the Company’s balance sheet, $9.3 million for short-term lease costs and $1.3 million for variable lease costs. Cash paid for amounts includedmargin tax in the measurementstate of lease liabilities in operating cash flows from operating leases is $0.5 million.
Maturities of lease liabilitiesTexas, and Louisiana corporate income tax. NaN amounts have been accrued for income tax uncertainties or interest and penalties as of March 31, 20192020. The Company is currently not aware of any issues under the scope of ASC 842 are as follows:review that could result in significant payments, accruals, or material deviation from its position. The Company’s tax years since its formation remain subject to possible income tax examinations by its major taxing authorities for all periods.
|
| | | |
| (In thousands) | |
Maturity of Lease Liabilities(1) | Operating Leases |
| 2019 (remaining) | $ | 1,393 |
|
| 2020 | 509 |
|
| 2021 | 136 |
|
| 2022 | 14 |
|
| 2023 | 15 |
|
| After 2023 | 53 |
|
| Total lease payments | $ | 2,120 |
|
| Less: interest | (86 | ) |
| Present value of lease liabilities | $ | 2,034 |
|
| |
(1) | As of December 31, 2018, minimum future contractual payments for long-term operating leases under the scope of ASC 840 were $881 thousand in 2019, $646 thousand in 2020, $198 thousand in 2021, $14 thousand in 2022, $15 thousand in 2023 and $63 thousand thereafter. |
11. Stockholders’ Equity
Class A Common Stock
In connection with the closing of the Business Combination, the Company increased the number of authorized shares of Class A Common Stock to 1.3 billion. At March 31, 2019,2020, there were 155.8168.5 million shares of Class A Common Stock issued and 166.5 million shares of Class A Common Stock outstanding. The holders of Class A Common Stock and Class B Common Stock vote together as a single class on all matters and are entitled one1 vote for each share held.
There is no cumulative voting with respect to the election of directors, which results in the holders of more than 50% of the shares being able to elect all of the directors, subject to voting obligations under the Stockholder Agreement (defined below)herein). In the event of a liquidation, dissolution, or winding up of the Company, the common stockholders are entitled to share ratably in all assets remaining available for distribution to them after payment of liabilities and after provision is made for each class of stock, if any, having preference over the common stock. The holders of the Class A Common Stock have no preemptive or other subscription rights, and there are no sinking fund provisions applicable to such shares.
Class B Common Stock
In connection with the closing of the Business Combination, the Company authorized 225.0 million shares of Class B Common Stock. At March 31, 2019,2020, there were 91.885.8 million shares of Class B Common Stock issued and outstanding. Holders of Class B Common Stock vote together as a single class with holders of Class A Common Stock on all matters properly submitted to a vote of the stockholders. The holders of Class B Common Stock generally have the right to exchange all or a portion of their Class B Common Stock, together with an equal number of Magnolia LLC Units, for the same number of shares of Class A Common Stock or, at Magnolia LLC’s option, an equivalent amount of cash. Upon the future redemption or exchange of Magnolia LLC Units held by any holder of Class B Common Stock, a corresponding number of shares of Class B Common Stock held by such holder of Class B Common Stock will be canceled. In the event of a liquidation, dissolution, or winding up of the Company, the common stockholders are entitled to share ratably in all assets remaining available for distribution to them after payment of liabilities and after provision is made for each class of stock, if any, having preference over the common stock. The holders of the Class B Common Stock have no preemptive or other subscription rights, and there are no sinking fund provisions applicable to such shares.
Share Repurchase Program
Warrants
On August 5, 2019, the Company’s board of directors authorized a share repurchase program of up to 10 million shares of Class A Common Stock. The program does not require purchases to be made within a particular timeframe. As of March 31, 2019,2020, the Company had 31.7repurchased 2.0 million warrants outstanding, consisting of 21.7 million public warrants originally sold as part ofshares under the units sold in the Company’s initial public offering (the “IPO”) and 10.0 million warrants (the “Private Placement Warrants”) sold in a private placement concurrently with the IPO to the TPG Pace Energy Sponsor LLC, a Delaware limited liability company (the “Sponsor”). Each whole warrant entitles the holder to purchase one whole share of Class A Common Stock for $11.50 per share. The warrants became exercisable on August 30, 2018 and will expire on July 31, 2023 or earlier upon redemption or liquidation. The Company may redeem the outstanding warrantsplan at a pricecost of $0.01 per existing warrant, if the last sale price of Magnolia’s Class A Common Stock equals or exceeds $18.00 per share for any 20 trading days within a 30 trading day period ending on the third business day before Magnolia sends the notice of redemption to the warrant holders. The Private Placement Warrants, however, are non-redeemable so long as they are held by the Sponsor or its permitted transferees.$16.8 million.
Noncontrolling Interest
Noncontrolling interest in Magnolia’s consolidated subsidiaries include amounts attributable to Magnolia LLC Units that were issued to the Karnes County Contributors in connection with the Business Combination. The noncontrolling interest percentage is affected by various equity transactions such as issuances of Class A Common Stock, exercise of warrants, and conversionthe exchange of Class B Common Stock to(and corresponding Magnolia LLC Units) for Class A Common Stock.Stock, or cancellation of Class B Common Stock (and corresponding Magnolia LLC Units). As of March 31, 2019,2020, Magnolia owned approximately 62.9%66% of the interest in Magnolia LLC and the noncontrolling interest was 37.1%34%. In the first quarter of 2019, Magnolia Operating formed Highlander as a joint venture in whichwhere MGY Louisiana LLC, a wholly owned subsidiary of Magnolia Operating, holds approximately 85% of the units in Highlander, with the remaining 15% attributable to noncontrolling interest.
12. Stock Based Compensation
On October 8, 2018, the Company’s board of directors adopted the “Magnolia Oil & Gas Corporation Long Term Incentive Plan” (the “Plan”), effective as of July 17, 2018. A total of 11.8 million shares of Class A Common Stock have been authorized for issuance under the Plan. The Company granted employeesgrants stock based compensation awards in the form of restricted stock units (“RSUs”) and performance stock units (“PSUs”) to eligible employees and directors to enhance the Company and its affiliates’ ability to attract, retain, and motivate persons who make important contributions to the Company and its affiliates by providing these individuals with equity ownership opportunities. Shares issued as a result of awards granted under the Plan are generally new shares of Class A Common Stock.
Stock based compensation expense is recognized net of forfeitures within general“General and administrative expenseexpenses” on the consolidated statementstatements of operations.operations and was $2.9 million and $2.4 million for the three months ended March 31, 2020 and 2019, respectively. The Company has elected to account for forfeitures of awards granted under the Plan as they occur in determining compensation expense.
Restricted Stock Units
The Company grants service-based RSU awards to employees and non-employee directors, which generally vest ratably over a three-year service period.period, in the case of awards to employees, and vest in full after one year, in the case of awards to directors. RSUs represent the right to receive shares of Class A Common Stock at the end of the vesting period equal to the number of RSUs granted.that vest. RSUs are subject to restrictions on transfer and are generally subject to a risk of forfeiture if the award recipient is no longerceases to be an employee or director of the Company for any reason prior to vesting of the award. Compensation expense for the service-based RSU awards is based upon the grant date market value of the award and such costs are recorded on a straight-line basis over the requisite service period the vesting period, for each separately vesting portion of the award, as if the award was, in-substance, multiple awards. Unrecognized compensation expense related to unvested restricted sharesRSUs at March 31, 20192020 was $14.1$13.6 million, which the Company expectedexpects to recognize over a weighted average period of 1.52.2 years.
The table below summarizes restricted stock unitRSU activity for the three months ended March 31, 2019.2020:
|
| | | | | | |
| | Restricted Stock Units | | Weighted Average Grant Date Fair Value |
| Unvested RSUs, beginning of period | 1,099,901 |
| | $ | 12.97 |
|
| Granted | 686,345 |
| | 7.45 |
|
| Vested | (213,846 | ) | | 12.68 |
|
| Forfeited | — |
| | — |
|
| Unvested RSUs, end of period | 1,572,400 |
| | $ | 10.60 |
|
|
| | | | | |
| | Restricted Stock Units | Weighted Average Grant Date Fair Value |
| Unvested restricted stock units, beginning of period | 807,431 |
| $ | 13.97 |
|
| Granted | 438,261 |
| $ | 12.52 |
|
| Vested | — |
| — |
|
| Forfeited | — |
| — |
|
| Unvested restricted stock units, end of period | 1,245,692 |
| $ | 13.46 |
|
Performance Stock Units
During the three months ended March 31, 2019,2020, the Company granted PSUs to employees with eachcertain employees. Each PSU, representingto the extent earned, represents the contingent right to receive one1 share of Class A Common Stock. However,Stock and the number of shares of Class A Common Stock issuable upon vesting ranges from zero toawardee may earn between 0 and 150% of the target number of PSUs granted based on the total shareholder return (“TSR”) of the Class A Common Stock relative to the TSR achieved by a specific industry peer group over an approximatea three-year performance period, the last day of which is also the vesting date. In addition to the TSR conditions, vesting of the PSUs is subject to the awardee’s continued employment through the date of settlement of the PSUs, which will occur within 60 days following the end of the performance period. Unrecognized compensation expense related to unvested PSUs at March 31, 20192020 was $8.9$7.5 million, which the Company expectedexpects to recognize over a weighted average period of 2.32.0 years.
The table below summarizes performance stock award and unitPSU activity for the three months ended March 31, 2019.2020:
|
| | | | | | |
| | Performance Stock Units | | Weighted Average Grant Date Fair Value |
| Unvested PSUs, beginning of period | 701,128 |
| | $ | 14.31 |
|
| Granted | 401,958 |
| | 6.14 |
|
| Vested | (8,334 | ) | | 14.58 |
|
| Forfeited | — |
| | — |
|
| Unvested PSUs, end of period | 1,094,752 |
| | $ | 11.31 |
|
|
| | | | | |
| | Performance Stock Units | Weighted Average Grant Date Fair Value |
| Unvested performance stock units, beginning of period | 475,313 |
| $ | 14.58 |
|
| Granted | 260,720 |
| $ | 13.84 |
|
| Vested | — |
| — |
|
| Forfeited | — |
| — |
|
| Unvested performance stock units, end of period | 736,033 |
| $ | 14.32 |
|
The grant date fair value of the PSUs granted during the three months ended March 31, 2020 and 2019 was $2.5 million and $3.6 million, respectively, calculated using thea Monte Carlo simulation was $3.6 million.simulation. The following table summarizes the assumptions used to calculate the grant date fair value of the PSUs granted February 25, 2019.
these PSUs.
|
| | | |
| Grant Date Fair Value Assumptions | Three Months Ended March 31, 2020 | | Three Months Ended March 31, 2019 |
| Expected term (in years) | 2.85 | | 2.85 |
| Expected volatility | 33.50% | | 33.61% |
| Risk-free interest rate | 1.16% | | 2.48% |
|
| | |
| As of February 25, 2019
Grant Date Fair Value Assumptions
|
Expected term (in years) | 2.85 |
|
Expected volatility | 33.61 | % |
Risk-free interest rate | 2.48 | % |
13. Earnings (Loss) Per Share
A reconciliation of the numerators and denominators of the basic and diluted per share computations follows. No such computation is necessary for the Predecessor periods as the Predecessor was not previously accounted for as a standalone legal entity and did not have publicly traded securities.follows:
|
| | | | | | | | |
| (In thousands, except per share data) | | Three Months Ended March 31, 2020 | | Three Months Ended March 31, 2019 |
| Basic: | | | | |
| Net income (loss) attributable to Class A Common Stock | | $ | (1,227,010 | ) | | $ | 13,026 |
|
| Weighted average number of common shares outstanding during the period - basic | | 167,149 |
| | 156,322 |
|
| Net income (loss) per share of Class A Common Stock - basic | | $ | (7.34 | ) | | $ | 0.08 |
|
| | | | | |
| Diluted: | | | | |
| Net income (loss) attributable to Class A Common Stock | | $ | (1,227,010 | ) | | $ | 13,026 |
|
| Weighted average number of common shares outstanding during the period - basic | | 167,149 |
| | 156,322 |
|
| Add: Dilutive effect warrants, stock based compensation, and other | | — |
| | 1,818 |
|
| Weighted average number of common shares outstanding during the period - diluted | | 167,149 |
| | 158,140 |
|
| Net income (loss) per share of Class A Common Stock - diluted | | $ | (7.34 | ) | | $ | 0.08 |
|
|
| | | | |
| (in thousands) | | For the three months ended March 31, 2019
|
| Basic: | | |
| Net Income attributable to Class A Common Stock | | $ | 13,026 |
|
| Weighted average number of common shares outstanding during the period | | 156,322 |
|
| Net income per common share - basic | | $ | 0.08 |
|
| | | |
| Diluted: | | |
| Net Income attributable to Class A Common Stock | | $ | 13,026 |
|
| Basic weighted average number of common shares outstanding during the period | | 156,322 |
|
| Add: Dilutive effect of warrants and stock based compensation | | 1,818 |
|
| Diluted weighted average number of common shares outstanding during the period | | 158,140 |
|
| Net income per common share - diluted | | $ | 0.08 |
|
The calculation for weighted average shares reflects shares outstanding over the reporting period based on the actual number of days the shares were outstanding. For the period presented, theThe Company excluded 93.3the following from the computation of diluted earnings or loss per share because the effect was anti-dilutive as a result of the net loss for the quarter ended March 31, 2020: (i) 85.8 million weighted average shares of Class A Common Stock issuable upon conversionexchange of the Class B Common Stock (and the corresponding Magnolia LLC Units), (ii) 4.0 million contingent shares of Class A Common Stock issuable to EnerVest, provided EnerVest does not compete in the Market Area, and (iii) 0.3 million RSUs and PSUs. For the quarter ended March 31, 2019, the Company excluded 93.3 million weighted average shares of Class A Common Stock issuable upon the exchange of the Class B Common Stock (and the corresponding Magnolia LLC Units) as the effect was anti-dilutive.
14. Related Party Transactions
As of March 31, 2019,2020, EnerVest Energy Institutional Fund XIV-A, L.P., a Delaware limited partnership, and EnerVest Energy Institutional Fund XIV-C, L.P., a Delaware limited partnership, both of which are part of the Karnes County Contributors, each held more
than 10% of the Company’s common stock and qualified as principal owners of the Company, as defined in ASC 850, “Related Party Disclosures.”
Amended and Restated Limited Liability Company Agreement of Magnolia LLC
On the Closing Date, the Company, Magnolia LLC and certain of the Karnes County Contributors entered into Magnolia LLC’s amended and restated limited liability company agreement, which sets forth, among other things, the rights and obligations of the holders of units in Magnolia LLC. Under the Magnolia LLC Agreement, the Company is the sole managing member of Magnolia LLC.
Registration Rights Agreement
At the closing of the Business Combination, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) with the Karnes County Contributors, the Sponsor, and the Company’s four independent directors prior to the Business Combination (collectively, the “Holders”), pursuant to which the Company is obligated, subject to the terms thereof and in the manner contemplated thereby, to register for resale under the Securities Act all or any portion of the shares of Class A Common Stock that the Holders hold as of July 31, 2018 and that they may acquire thereafter, including upon conversion, exchange or redemption of any other security therefor. Under the Registration Rights Agreement, Holders also have “piggyback” registration rights exercisable at any time that allow them to include the shares of Class A Common Stock that they own in certain registrations initiated by the Company.
Pursuant to the Registration Rights Agreement, on August 30, 2018, the Securities and Exchange Commission declared the Company’s registration statement on Form S-3 effective, which registered the offering by the Holders of the shares of Class A Common Stock included therein.
On December 21, 2018, the Sponsor completed a distribution of shares of the Company’s Class A Common Stock and warrants (the “Distribution”) by the Sponsor to TPG Pace Energy Sponsor Successor, LLC (“Sponsor Successor”) and certain other of its members, including Stephen Chazen and Michael MacDougall (the “Specified Members”). Related to that Distribution, on February 25, 2019, the Company entered into the First Amendment to the Registration Rights Agreement with the Karnes County Contributors, Sponsor Successor and the Specified Members, pursuant to which Sponsor Successor would become a party to the Registration Rights Agreement with the same rights and obligations that the Sponsor had under the Registration Rights Agreement. The Specified Members and any future recipients of the Company’s common stock and warrants in a distribution by Sponsor Successor or any successor entity that become signatories to the Registration Rights Agreement were also provided with certain rights and obligations that are a subset of the rights the Sponsor had under the Registration Rights Agreement prior to the Distribution.
Stockholder Agreement
On the Closing Date, the Company, the Sponsor, and the Karnes County Contributors entered into the Stockholder Agreement (the “Stockholder Agreement”), under which the Karnes County Contributors are entitled to nominate two directors, one of whom shall be independent under the listing rules of the New York Stock Exchange, the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Sarbanes-Oxley Act of 2002, for appointment to the board of directors of the Company (the “Board”) so long as they collectively own at least 15% of the outstanding shares of Class A Common Stock and Class B Common Stock, (on a fully diluted basis, including equity securities exercisable into common stock, and on a combined basis), and one director so long as they owned at least 2% of the outstanding shares of Class A Common Stock and Class B Common Stock (on a fully diluted basis, including equity securities exercisable into common stock, and on a combined basis). The Sponsor is entitled to nominate two directors for appointment to the Board so long as it owns at least 60% of the voting common stock that it owned at the Closing Date (including any shares of common stock issuable upon the exercise of any Private Placement Warrants held by the Sponsor), and one director so long as it owns at least 25% of the voting common stock that it owned at the Closing Date (including any shares of common stock issuable upon the exercise of any Private Placement Warrants held by the Sponsor). The Karnes County Contributors and the Sponsor are each entitled to appoint one director to each committee of the Board (subject to applicable laws and stock exchange rules). In connection with the Distribution, Sponsor Successor also joined the Stockholder Agreement, agreeing to be bound by the terms of the Stockholder Agreement applicable to the Sponsor.
Contingent Consideration
Pursuant to the Karnes County Contribution Agreement, for a period of five years following the Closing Date, the Company agreed to issue to the Karnes County Contributors up to 13.0 million additional shares of the Company’s stock upon satisfaction of certain EBITDA and free cash flow or stock price thresholds in three tranches. As of March 31, 2019, the Company had met the defined stock price thresholds and had issued an aggregate of 3.6 million additional shares of Class A Common Stock and 9.4 million additional shares of Class B Common Stock to the Karnes County Contributors.
Predecessor Transactions
EnerVest, as managing general partner of the Karnes County Contributors, provided management, accounting and advisory services to the Karnes County Contributors in exchange for a quarterly management fee based on the Karnes County Contributors' investor commitments. The management fees incurred were allocated to the Predecessor using a ratio of asset acquisitions value to total asset acquisitions completed by the Karnes County Contributors. The management fees and other costs allocated to the Predecessor and included in "General and administrative expenses" in the combined statements of operations were $5.8 million for the three months ended March 31, 2018.
The Karnes County Contributors also entered into operating agreements with EnerVest Operating, LLC (“EVOC”), a wholly-owned subsidiary of EnerVest, to act as contract operator of the Predecessor’s oil and natural gas wells. The Predecessor reimbursed EVOC for direct expenses incurred. A majority of such expenses were charged on an actual basis (i.e., no mark-up or subsidy to EVOC). These costs are included in “Lease operating expenses” in the combined statements of operations in the Predecessor period. Additionally, in its role as contract operator, EVOC collected proceeds from oil, natural gas, and NGL sales and distributed them to the Predecessor and other working interest owners.
15. Commitments and Contingencies
Legal Matters
The Company is involved in disputes or legal actions in the ordinary course of business. For example, certain of the Karnes County Contributors and the Company have been named as defendants in a lawsuit where the plaintiffs claim to be entitled to a minority working interest in certain Karnes County Business properties. The litigation is in the discovery stage. The exposure related to this litigation is currently not reasonably estimable. The Karnes County Contributors retained all such liability in connection with the Business Combination. At March 31, 2019, the Company does not believe the outcome of any such disputes or legal actions will have a material effect on its consolidated statement of operations, balance sheet or cash flows.
Environmental Matters
The Company, as an owner or lessee and operator of oil and gas properties, is subject to various federal, state, local laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil and gas lease for the cost of pollution clean-up resulting from operations and subject the lessee to liability for pollution damages. In some instances, the Company may be directed to suspend or cease operations in the affected area. The Company maintains insurance coverage, which it believes is customary in the industry, although the Company is not fully insured against all environmental risks.
Risks and Uncertainties
The Company’s revenue, profitability and future growth are substantially dependent upon the prevailing and future prices for oil and natural gas, which depend on numerous factors beyond the Company’s control such as overall oil and natural gas production and inventories in relevant markets, economic conditions, the global political environment, regulatory developments and competition from other energy sources. Oil and natural gas prices historically have been volatile, and may be subject to significant fluctuations in the future.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.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. 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 recent coronavirus disease 2019 (“COVID-19”) pandemic, and the impacts of the competition between Russia and Saudi Arabia for crude oil market share, including the effects of related public health concerns and the impact of actions taken by governmental authorities and other third parties in response to the pandemic and its impact on commodity prices, supply and demand considerations, and storage capacity;
the market prices of oil, natural gas, natural gas liquids (“NGLs”), and other products or services;
the supply and demand for oil, natural gas, NGLs, and other products or services;
production and reserve levels;
drilling risks;
economic and competitive conditions;
the availability of capital resources;
capital expenditureexpenditures and other contractual obligations;
currency exchange rates;
weather conditions;
inflation rates;
the availability of goods and services;
legislative, regulatory, or policy changes;
cyber attacks;
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 this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 20182019 filed with the SEC on February 27, 2019.26, 2020.
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with ourthe Company’s unaudited consolidated financial statements and the related notes thereto.
Overview
Overview
Magnolia Oil & Gas Corporation (the "Company"“Company” or "Magnolia"“Magnolia”) is a Delaware corporation formed in February 2017 as a special purpose acquisition company under the name TPG Pace Energy Holdings Corp. for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination with one or more businesses.
Magnolia’s business model was designed with a primary objective to generate stock market value over the long term. The Company’s strategy is to establish a company whose characteristics would demonstrate a certain basic set of criteria that appeal to generalist investors and to generate growing earnings per share over time, high operating and full cycle margins, and maintain a very strong balance sheet with a low amount of leverage.
On July 31, 2018, the Company and Magnolia Oil & Gas Parent LLC (“Magnolia LLC”), as applicable, consummated the acquisition of: (i) certain right, title and interest in certainan independent oil and natural gas assets located primarily in the Karnes County portion of the Eagle Ford Shale in South Texas (the "Karnes County Assets") pursuant to that certain Contribution and Merger Agreement (as subsequently amended, the "Karnes County Contribution Agreement"), by and among the Company, Magnolia LLC and certain affiliates (the "Karnes County Contributors") of EnerVest Ltd. ("EnerVest"); (ii) certain right, title and interest in certain oil and natural gas assets located primarily in the Giddings Field of the Austin Chalk (the "Giddings Assets") pursuant to that certain Purchase and Sale Agreement (the "Giddings Purchase Agreement") by and among Magnolia LLC and certain affiliates of EnerVest (the "Giddings Sellers"); and (iii) a 35% membership interest (the “Ironwood Interests”) in Ironwood Eagle Ford Midstream, LLC, a Texas limited liability company which
owns an Eagle Ford gathering system, pursuant to that certain Membership Interest Purchase Agreement, by and among Magnolia LLC and certain affiliates of EnerVest (the "Ironwood Sellers") (collectively, the “Business Combination”).
In connection with the consummation of the Business Combination, on July 31, 2018, the Karnes County Contributors received 83.9 million shares of Class B Common Stock, par value $0.0001 per share (“Class B Common Stock”), 31.8 million shares of Class A Common Stock, par value $0.0001 per share (“Class A Common Stock”), and approximately $911.5 million in cash; the Giddings Sellers received approximately $282.7 million in cash; and the Ironwood Sellers received $25.0 million in cash. On March 29, 2019, Magnolia and EnerVest consummated the final settlement of the Business Combination, with Magnolia LLC receiving a net cash payment of $4.3 million in cash and the Karnes County Contributors forfeiting 0.5 million shares of Class A Common Stock and 1.6 million shares of Class B Common Stock to Magnolia, and a corresponding number of Magnolia LLC Units to Magnolia LLC.
In accordance with accounting principles generally accepted in the United States of America (“GAAP”), the Company has been identified as the acquirer in the Business Combination for accounting purposes and the Karnes County Business was deemed to be the accounting “Predecessor”. The Business Combination was accounted for using the acquisition method of accounting and the Successor financial statements reflect a new basis of accounting based on the fair value of net assets acquired. As a result of the application of the acquisition method of accounting, the Company’s consolidated and combined financial statements and certain presentations are separated into two distinct periods to indicate the different ownership and accounting basis between the periods presented, the period before the consummation of the Business Combination, which includes the period from January 1, 2018 to March 31, 2018 (the “Predecessor Period”) and the period after the consummation of the Business Combination which includes January 1, 2019 to March 31, 2019 (the “Successor Period”).
The Company operates in one reportable segment engaged in the acquisition, development, exploration, and production of oil, natural gas, and natural gas propertiesliquid (“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 Field in South Texas, where the Company primarily targets the Eagle Ford Shale and the Austin Chalk formation.formations.
Magnolia’s objective is to generate stock market value over the long term through consistent organic production growth, high full cycle operating margins, an efficient capital program with short economic paybacks, significant free cash flow after capital expenditures, and effective reinvestment of free cash flow. Magnolia’s business model prioritizes free cash flow, financial stability, and prudent capital allocation, and is designed to withstand challenging environments such as the one the Company is currently experiencing.
COVID-19 Pandemic and Market Conditions Update
In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. Governments have tried to slow the spread of the virus by imposing social distancing guidelines, travel restrictions, and stay-at-home orders, which have caused a significant decrease in activity in the global economy and the demand for oil and natural gas. Furthermore, in the midst of the ongoing COVID-19 pandemic, the competition between Russia and Saudi Arabia for crude oil market share caused a substantial increase in supply. As a result, the price of oil has remained extremely depressed and available storage and transportation capacity for production is increasingly limited and may be completely unavailable in the near future. The imbalance between the supply of and demand for oil, lack of available storage, as well as the uncertainty around the extent and timing of an economic recovery, have caused extreme market volatility and a substantial adverse effect on commodity prices.
Magnolia’s business, like many oil and natural gas producers, has been, and is expected to continue to be, negatively affected by the crisis described above, which is ongoing and evolving. The Company has not entered into any hedging arrangements with respect to the commodity price risk to which the Company is exposed and the prices ultimately realized for oil, natural gas, and NGLs are based on a number of variables, including prevailing index prices attributable to the Company’s production and certain differentials to those index prices. Magnolia is unable to reasonably predict when, or to what extent, commodity prices and the overall markets and global economy will stabilize, and the pace of any subsequent recovery for the oil and gas industry. Further, the ultimate impact that these events will have on Magnolia’s business, liquidity, financial condition, and results of operations is highly uncertain and dependent on numerous evolving factors that cannot be predicted, including the duration of the pandemic.
Magnolia has taken steps and continues to actively work to mitigate the evolving challenges and growing impact of both the COVID-19 pandemic and the industry downturn on its operations, financial condition, and people. 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. Magnolia currently expects its drilling and completion capital outlays for the remainder of the year to be less than those in the first quarter of 2020. As a result, the Company has reduced its rig count to one rig in the Giddings assets. If the current commodity price environment persists, Magnolia expects to cease its remaining drilling and completion activity across its asset base. The Company is well positioned to reduce operations given the significant flexibility within its capital program, as its operated drilling rig is on a short-term contract and the Company has no long-term service obligations. Moreover, Magnolia does not have any contractual drilling obligations and nearly all the Company’s acreage is held by production. In response to the COVID-19 pandemic and industry downturn, Magnolia has initiated a corporate-wide cost reduction program to help decrease costs throughout every aspect of the Company. The Company has made reductions in general and administrative expense by reducing corporate salaries by approximately ten percent, renegotiating the fees with the Services Agreement, and continues to work with many of its other vendors and suppliers to reduce the cost of their services in order to improve the Company’s margins. Magnolia believes these measures, taken together with its significant liquidity and lack of near term debt maturities, will provide additional flexibility in navigating the current volatile environment; however, given the tremendous uncertainty and turmoil, there is no certainty that the measures Magnolia takes will be sufficient.
As a producer of oil and natural gas, Magnolia is recognized as an essential business and has continued to operate while taking steps to protect the health and safety of its workers. Magnolia and its contractors have implemented protocols to reduce the risk of an outbreak within its operations, and these protocols have not reduced production or efficiency in a significant manner. Magnolia’s non-field level employees have the option to temporarily work remotely, and Magnolia has been able to maintain a consistent level of effectiveness through these arrangements, including maintaining day-to-day operations, financial reporting systems, and internal control over financial reporting.
Business Overview
As of March 31, 2019,2020, Magnolia’s assets in South Texas included 17,330 net42,968 gross (23,535 net) acres in Karnes, Gonzales, DeWitt, and Atascosa countiesCounties, Texas, and 439,342 net630,787 gross (428,778 net) acres in the Giddings Field. As of March 31, 2019,2020, Magnolia hadheld an interest in approximately 1,4771,792 gross (1,181 net) wells, (1,061 net), with total production of 62.4 68.4 thousand barrels of oil equivalent per day (“Mboe/dd”) for the three months ended March 31, 2019.2020. In the first quarter of 2019,2020, Magnolia operated three drilling rigs across its acreage; endinga one-rig program for the quarter with two drilling rigs, one rig in Karnes County Assets and one rig ina one-rig program for the Giddings Field, and brought 18 gross operated horizontal wells on production.Assets.
Magnolia recognized a net incomeloss attributable to Class A Common Stock of $13.0 million,$1.2 billion, or $0.08$7.34 per diluted common share, for the Successor Period.three months ended March 31, 2020. Magnolia also recognized a net incomeloss of $22.7 million,$1.9 billion, which includes noncontrolling interest of $9.7 million$0.7 billion related to the Magnolia LLC Units (and corresponding Class B Common StockStock) held by certain affiliates of EnerVest.EnerVest for the three months ended March 31, 2020.
On August 5, 2019, the Company’s board of directors authorized a share repurchase program of up to 10 million shares of Class A Common Stock. The program does not require purchases to be made within a particular timeframe. As of March 31, 2020, the Company had repurchased 2.0 million shares under the plan at a cost of $16.8 million, 1.0 million of which were repurchased in the first quarter of 2020 at a cost of $6.5 million.
As a result of the sharp decline in commodity prices during the first quarter of 2020, Magnolia recorded impairments of $1.9 billion related to proved and unproved properties. Proved property impairment of $1.4 billion is included in “Impairment of oil and natural gas properties” and unproved property impairment of $0.6 billion is included in “Exploration expense” on the Company’s consolidated statement of operations for the three months ended March 31, 2020.
Results of Operations
Factors Affecting the Comparability of the Historical Financial Results
The Successor PeriodMagnolia’s historical financial statements reflect a new basiscondition and results of accountingoperations for the assets and liabilities acquired by the Company in the Business Combination that is based on the fair value of the assets acquired and liabilities assumed. As a result, the statement of operations subsequent to the Business Combination includes depreciation and amortization expense on Magnolia’s property, plant, and equipment balances made under the new basis of accounting. Therefore, the Company’s financial information prior to the Business Combinationperiods presented may not be comparable, either from period to its financial information subsequent to the Business Combination. Certain other items of income and expense may not be comparableperiod or going forward, as a result of the following factors:
ForThe Company incurred a net loss of $1.9 billion for the quarter ended March 31, 2018, the results2020 compared to net income of operations reflect the results of solely the Predecessor, which, as described above, consists of only the results of the Karnes County Business, including, as applicable, its ownership of the Ironwood Interest, when the Predecessor was not owned by the Company, and do not include the results of the Giddings Assets;
The results of operations of the Predecessor were not previously accounted for as the results of operations of a stand-alone legal entity, and accordingly have been carved out, as appropriate,$22.7 million for the periods presented.quarter ended March 31, 2019. The resultsnet loss was primarily a result of operationsimpairments of the Predecessor therefore include a portion of indirect costs for salaries$1.9 billion related to proved and benefits, depreciation, rent, accounting, legal services,unproved oil and other expenses. In addition to the allocation of indirect costs, the results of operations reflect certain agreements executed by the Karnes County Contributorsnatural gas properties for the benefit ofquarter ended March 31, 2020;
On February 21, 2020, the Predecessor, including price risk management instruments. For more information, please refer to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018. These allocations may not be indicative of the cost of future operations or the amount of future allocations;
The PredecessorCompany completed the acquisition of the Subsequent GulfTex Assets from GulfTex Energy III, L.P.certain non-operated oil and GulfTex Energy IV, L.P. on March 1, 2018 during the Predecessor Period,natural gas assets located in Karnes and accordingly the results of operations of the Predecessor reflect the impact of the assets acquiredDeWitt Counties, Texas, for approximately $71.3 million in that acquisition only from their respective acquisition date;cash, subject to customary closing adjustments;
As a corporation,On May 31, 2019, the Company is subject to U.S. federal income taxes at a statutory ratecompleted the acquisition of 21% of pretax earnings whereascertain oil and natural gas assets located in the Company’s Karnes County Contributors were treated as partnerships for income tax purposes. As a result, items of income, expense, gains and losses flowed through to the owners of the Karnes County Contributors and were taxed at the owner level. Accordingly, no U.S. tax provision for federal income taxes is included in the financial statements of the Predecessor;
On August 31, 2018, the Company acquired substantially all of the South Texas assets of Harvest Oil & Gas Corporation (the “Harvest Acquisition”)Assets for approximately $133.3$36.3 million in cash and 4.2approximately 3.1 million newly issued shares of the Company’s Class A Common Stock. Stock; and
On March 14,February 5, 2019, Magnolia consummated the final settlement with Harvest receivingOperating formed a cash payment of $1.4 million. The Harvest Acquisition added an undivided working interest across a portion of the Karnes County Assets and all of the Giddings Assets;
In the first quarter of 2019,joint venture, Highlander Oil & Gas Holdings LLC (“Highlander”), which the Company indirectly holds an 85% membership interest in, completedto complete the acquisition of a 72% working interest in the Eocene-Tuscaloosa Zone, Ultra Deep Structure gas well located in St. Martin Parish, Louisiana (“Highlander(the “Highlander Well”) and 31.1 million royalty trust, in which MGY Louisiana LLC, a wholly owned subsidiary of Magnolia Operating, holds approximately 85% of the units, inwith the Gulf Coast Ultra Deep Royalty Trust from McMoRan Oil & Gas, LLC. Highlander paid cash consideration of approximately $51.9 million, net of customary closing adjustments, for such interests.remaining 15% attributable to noncontrolling interest.
As a result of the factors listed above, the combined 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.
Three Months Ended March 31, 20192020 Compared to the Three Months Ended March 31, 20182019
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 6six Mcf to 1one barrel. This ratio ismay not be reflective of the current price ratio between the two products.
| | | | | Successor | | Predecessor | | | | | |
| (In thousands, except per unit data) | | Three Months Ended March 31, 2019 | | Three Months Ended March 31, 2018 | | Three Months Ended March 31, 2020 | | Three Months Ended
March 31, 2019 |
| PRODUCTION VOLUMES: | | | | | |
| Production: | | | | | |
| Oil (MBbls) | | 2,906 |
| | 2,362 |
| | 3,391 |
| | 2,906 |
|
| Natural gas (MMcf) | | 9,763 |
| | 2,888 |
| | 10,053 |
| | 9,763 |
|
| NGLs (MBbls) | | 1,084 |
| | 420 |
| | 1,155 |
| | 1,084 |
|
| Total (Mboe) | | 5,617 |
| | 3,263 |
| | 6,222 |
| | 5,617 |
|
| | | | | | | | | |
| Average daily production volume: | | | | | |
| Average daily production: | | | | | |
| Oil (Bbls/d) | | 32,289 |
| | 26,244 |
| | 37,259 |
| | 32,289 |
|
| Natural gas (Mcf/d) | | 108,478 |
| | 32,089 |
| | 110,475 |
| | 108,478 |
|
| NGLs (Bbls/d) | | 12,044 |
| | 4,667 |
| | 12,688 |
| | 12,044 |
|
| Total (boe/d) | | 62,413 |
| | 36,256 |
| | 68,360 |
| | 62,413 |
|
| | | | | | | | | |
| REVENUES: | | | | | |
| Revenues: | | | | | |
| Oil revenues | | $ | 171,654 |
| | $ | 154,156 |
| | $ | 154,686 |
| | $ | 171,654 |
|
| Natural gas revenues | | 27,375 |
| | 8,374 |
| | 16,175 |
| | 27,375 |
|
| Natural gas liquids revenues | | 19,645 |
| | 9,782 |
| | 10,504 |
| | 19,645 |
|
| Total revenues | | $ | 218,674 |
| | $ | 172,312 |
| | $ | 181,365 |
| | $ | 218,674 |
|
| | | | | | | | | |
| AVERAGE PRICE: | | | | | |
| Average Price: | | | | | |
| Oil (per barrel) | | $ | 59.07 |
| | $ | 65.27 |
| | $ | 45.62 |
| | $ | 59.07 |
|
| Natural gas (per Mcf) | | 2.80 |
| | 2.90 |
| | 1.61 |
| | 2.80 |
|
| NGLs (per barrel) | | 18.12 |
| | 23.29 |
| | 9.09 |
| | 18.12 |
|