Magnolia Oil & Gas Corp annual report, FY2018

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Magnolia Oil & Gas Corporation — 2018 Form 10-K

Reporting period: Fiscal year ended December 31, 2018; this is an annual filing, not a standalone Q4 report. Magnolia completed its business combination on July 31, 2018, so results are divided between a Successor period (July 31–December 31) and Predecessor periods. The accounting basis and asset scope differ, making direct year-over-year comparisons unreliable.

Business context and reporting period

Magnolia is an independent oil and gas producer focused on the Eagle Ford Shale in Karnes County and the Austin Chalk in the Giddings Field, South Texas. The July 31 business combination acquired these assets and a 35% interest in Ironwood Eagle Ford Midstream. Magnolia also acquired Harvest’s South Texas assets on August 31 for approximately $191.5 million in cash and stock. At year-end, Magnolia held 455,964 net acres and reported fourth-quarter production of 61.9 Mboe/d.

Financial and operating performance

  • Successor period, July 31–December 31: Revenue was $433.2 million; operating income was $114.0 million; net income was $82.4 million, including $43.4 million attributable to noncontrolling interests. Net income attributable to Class A common stock was $39.1 million, or $0.25 per diluted share.
  • Fourth quarter: Revenue was $255.1 million, operating income $74.1 million, and net income $57.8 million. After $24.9 million attributable to noncontrolling interests, Class A net income was $32.9 million, or $0.21 per share.
  • Successor-period production and pricing: Production totaled 9.3 MMboe, averaging 60.7 Mboe/d. Realized prices averaged $67.37/bbl for oil, $3.04/Mcf for natural gas, and $25.93/bbl for NGLs. Average lease operating expense was $3.31/boe.
  • Cash flow: Successor-period operating cash flow was $305.5 million; investing cash flow was negative $877.6 million; financing cash flow was $707.9 million. These figures reflect substantial acquisition and combination-related activity.
  • Year-end liquidity and debt: Cash was $135.8 million. Magnolia had $400 million principal amount of 6.0% senior notes due 2026 and no RBL borrowings. The RBL borrowing base was $550 million; reported liquidity was $685.8 million. The company said it was in compliance with debt covenants.
  • Reserves: Year-end proved reserves were 100.5 MMboe, of which 76.5 MMboe were proved developed and 24.0 MMboe proved undeveloped. The standardized measure of discounted future net cash flows was $1.88 billion; the filing cautions that this is not an estimate of fair value.

Material changes versus prior periods

Magnolia’s scale expanded substantially through the business combination and Harvest acquisition. Successor-period revenue and expenses include the acquired Giddings assets and a new fair-value accounting basis; Predecessor results principally reflect the Karnes County Business and do not include Giddings. For context, Predecessor revenue was $449.2 million for January 1–July 30, 2018, while 2017 Predecessor revenue was $403.2 million, but these are not like-for-like company comparisons.

Successor-period costs included $24.6 million of transaction-related expense, approximately $11.0 million of one-time seismic-license exploration expense, $6.0 million of intangible amortization, and $12.5 million of interest expense. The new acquisition basis also contributed to higher DD&A per boe. The predecessor’s commodity derivative contracts were terminated in July 2018; Magnolia reported no hedging arrangements during the Successor period.

Unaudited pro forma information, assuming the business combination and related transactions occurred January 1, 2017, showed revenue of $978.4 million for 2018 versus $555.7 million for 2017, and Class A net income of $188.9 million versus $70.5 million. These hypothetical figures exclude specified one-time items and are not a forecast or actual reported result.

Outlook, risks, contingencies and unusual items

  • Management stated that cash, operating cash flow, and available RBL capacity were expected to fund the capital budget and short-term liquidity needs. Magnolia planned to average one rig in Karnes County and one in Giddings during 2019; no specific production or earnings guidance was provided.
  • Magnolia’s strategy emphasizes organic production growth, capital discipline, free cash flow, and low leverage. The company had not established a multi-year development plan comparable to the predecessor’s plan; most Successor proved undeveloped reserves were planned for development within one year.
  • Commodity prices are the principal market risk. Magnolia had no hedges and disclosed that an annualized $1/bbl oil-price change would affect revenue by approximately $12.2 million, while a $0.10/Mcf gas-price change would affect revenue by approximately $3.4 million.
  • Two customers generated 61.3% of Successor-period revenue. Other key risks include concentration in South Texas, reliance on third-party transport and processing, drilling and reserve-estimation uncertainty, environmental and regulatory obligations, and dependence on EVOC as contract operator under a services agreement that can be terminated after two years.
  • Contractual commitments totaled $652.7 million, including $400 million of note principal and $201.6 million of estimated interest payments. The EVOC services-fee commitment was $37.3 million; the agreement provides for an approximately $23.6 million annual fee, subject to specified adjustments.
  • Management did not expect ordinary-course legal matters to materially affect the financial statements; a predecessor-related lawsuit’s exposure was not reasonably estimable, and the Karnes County Contributors retained that liability. No proved-property impairment was recorded for the periods presented.
  • Disclosure controls were deemed effective, but management did not assess internal control over financial reporting for year-end 2018, citing the significant post-combination design and implementation work required.

Most important facts for investors to verify

  • Review the full-year and Q4 financial statements alongside the Successor/Predecessor basis changes; do not treat the periods as directly comparable.
  • Verify the latest production, realized pricing, capital spending, reserve revisions, and pace of conversion of the 24.0 MMboe of proved undeveloped reserves.
  • Check current cash, RBL borrowing-base availability and redeterminations, covenant compliance, and the company’s ability to fund development and debt service.
  • Assess exposure to unhedged commodity prices and customer concentration, including the consequences of losing a major purchaser.
  • Review acquisition accounting and purchase-price adjustments, contingent consideration, the EVOC services arrangement, and the development of internal financial controls.