Texas Pacific Land Corp (TPL) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”) is intended to help the reader understand the results of operations and financial condition of Texas Pacific Land Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements included in Part II, Item 8 of this Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including, but not limited to, those factors presented in Item 1A. “Risk Factors” and elsewhere in this Annual Report on Form 10-K. This section generally discusses the results of our operations for the year ended December 31, 2022 compared to the year ended December 31, 2021. For a discussion of the year ended December 31, 2021 compared to the year ended December 31, 2020, please refer to Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2021.
Overview
TPL was originally organized in 1888 as a business trust to hold title to extensive tracts of land in numerous counties in West Texas which were previously the property of the Texas and Pacific Railway Company. As discussed in Item 1. “Business — General — Corporate Reorganization,” on January 11, 2021, we completed our Corporate Reorganization from a business trust to a corporation changing our name from Texas Pacific Land Trust to Texas Pacific Land Corporation.
For an overview of our business and discussion of our business segments, see Item 1. “Business — General.”
Our business activity is generated from our surface and royalty interest ownership in West Texas, primarily in the Permian Basin. Our revenues are derived from oil, gas and produced water royalties, sales of water and land, easements and commercial leases. Due to the nature of our operations and concentration of our ownership in one geographic location, our revenue and net income are subject to substantial fluctuations from quarter to quarter and year to year. In addition to fluctuations in response to changes in the market price for oil and gas, our financial results are also subject to decisions by the owners and operators of not only the oil and gas wells to which our oil and gas royalty interests relate, but also to other owners and operators in the Permian Basin as it relates to our other revenue streams, principally water sales, easements and other surface-related revenue.
Market Conditions
Global Oil and Natural Gas Market Impact in 2022
Average oil and gas prices during 2022 were strong compared to average prices in previous years over the last decade. Oil prices were impacted by continued oil supply cuts by OPEC+, an uneven global demand recovery, and Russia’s incursion into Ukraine, among other factors. In response to high oil prices during 2022, the United States (“US”) implemented various measures to help mitigate potential supply shortfalls and high oil prices, most notably by releasing millions of barrels of crude oil from its Strategic Petroleum Reserve. The confluence of these major events has contributed to fluctuations in oil prices during 2022. Global and domestic natural gas markets have also experienced volatility due to macroeconomic conditions, infrastructure and logistical constraints, and geopolitical issues, among other factors. US natural gas prices at Henry Hub, located in Erath, Louisiana, have strengthened in 2021 and 2022 due in part to liquified natural gas prices (“LNG”) exports and local demand for power, heating, and industrial activity. In 2022, the Waha Hub located in Pecos County, Texas, at times experienced significant negative price differentials relative to Henry Hub due in part to growing local Permian natural gas production gas and limited natural gas pipeline takeaway capacity. Inflation remains elevated and continues to significantly impact current labor costs and supplies. Changes in macro-economic conditions, including rising interest rates and lower global economic activity, could result in additional shifts in demand and supply in future periods. Although our revenues are directly and indirectly impacted by changes in oil prices, we believe our royalty interests (which require no capital expenditures or operating expense burden from us for well development), strong balance sheet, and liquidity position will help us navigate through potential oil price volatility.
COVID-19 Pandemic
We continue to monitor the COVID-19 pandemic. We are following local government mandates, where applicable, and will continue to revise and refine our on-site work to ensure business continuity and the safety and well-being of our employees. The full extent to which the pandemic impacts our business will depend on future developments that are highly
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uncertain and cannot be predicted, including new information that may emerge concerning the severity, and new variants, of the virus.
Permian Basin Activity
The Permian Basin is one of the oldest and most well-known hydrocarbon-producing areas and currently accounts for a substantial portion of oil and gas production in the United States, covering approximately 86,000 square miles in 52 counties across southeastern New Mexico and western Texas. Exploration and production (“E&P”) companies active in the Permian have generally increased their drilling and development activity in 2022 compared to recent prior year activity levels. Per the U.S. Energy Information Administration (“EIA”), Permian production is currently in excess of five million barrels per day, which is higher than the average daily production of any year prior to 2022. Despite record Permian production volumes, E&P companies continue to experience challenges with labor and supply chains related to drilling and completion activities, which could negatively impact overall production.
With our ownership concentration in the Permian Basin, our revenues are directly impacted by oil and gas pricing and drilling activity in the Permian Basin. Below are metrics for the years ended December 31, 2022 and 2021:
| Years Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2022 | 2021 | ||||||
| Oil and Gas Pricing Metrics:(1) | |||||||
| WTI Cushing average price per bbl | $ | 94.90 | $ | 68.14 | |||
| Henry Hub average price per mmbtu | $ | 6.45 | $ | 3.89 | |||
| Activity Metrics specific to the Permian Basin:(1)(2) | |||||||
| Average monthly horizontal permits | 627 | 549 | |||||
| Average monthly horizontal wells drilled | 511 | 399 | |||||
| Average weekly horizontal rig count | 318 | 231 | |||||
| DUCs as of December 31 for each applicable year | 4,526 | 4,513 | |||||
| Total Average US weekly horizontal rig count (2) | 659 | 431 |
(1) Commonly used definitions in the oil and gas industry provided in the table above are defined as follows: WTI Cushing represents West Texas Intermediate. Bbl represents one barrel of 42 U.S. gallons of oil. Mmbtu represents one million British thermal units, a measurement used for natural gas. DUCs represent drilled but uncompleted wells.
(2) Permian Basin specific information per Enverus analytics. US weekly horizontal rig counts per Baker Hughes United States Rotary Rig Count for horizontal rigs. Statistics for similar data are also available from other sources. The comparability between these other sources and the sources used by the Company may differ.
The metrics above show selected domestic benchmark oil and natural gas prices and approximate activity levels in the
Permian Basin for the years ended December 31, 2022 and 2021. Our oil and gas royalties are impacted by both oil and gas prices as well as production levels. Oil and gas prices in 2022 have significantly increased compared to the comparable period in 2021. Although E&P companies broadly continue to deploy capital at a measured pace, drilling and development activities across the Permian have generally improved in 2022 compared to the prior year. As we are a significant landowner in the Permian Basin and not an oil and gas producer, our revenue is affected by the development decisions made by companies that operate in the areas where we own royalty interests and land. Accordingly, these decisions made by others affect not only our production and produced water disposal volumes, but also directly impact our surface-related income and water sales.
Liquidity and Capital Resources
Overview
Our principal sources of liquidity are cash and cash flows generated from our operations. Our primary liquidity and capital requirements are for capital expenditures related to our Water Services and Operations segment (the extent and timing of which are under our control), working capital and general corporate needs.
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We continuously review our liquidity and capital resources. If market conditions were to change and our revenues were to decline significantly or operating costs were to increase significantly, our cash flows and liquidity could be reduced. Should this occur, we could seek alternative sources of funding. We have no debt or credit facilities, nor any off-balance sheet arrangements as of December 31, 2022.
As of December 31, 2022, we had cash and cash equivalents of $510.8 million that we expect to utilize, along with cash flow from operations, to provide capital to support the growth of our business, to repurchase our Common Stock subject to market conditions, to pay dividends subject to the discretion of our Board and for general corporate purposes. For the year ended December 31, 2022, we repurchased $87.9 million of our Common Stock (including share repurchases not yet settled), and we paid $247.3 million in dividends to our stockholders. We believe that cash from operations, together with our cash and cash equivalents balances, will be sufficient to meet ongoing capital expenditures, working capital requirements and other cash needs for the foreseeable future.
During the year ended December 31, 2022, we invested approximately $18.6 million in Texas Pacific Water Resources LLC (“TPWR”) projects to maintain and/or enhance water sourcing assets, of which $6.9 million related to electrifying our water sourcing infrastructure.
Cash Flows from Operating Activities
For the years ended December 31, 2022 and 2021, net cash provided by operating activities was $447.1 million and $265.2 million, respectively. Our cash flow provided by operating activities is primarily from oil, gas and produced water royalties, water and land sales, and easements and other surface-related income. Cash flow used in operations generally consists of operating expenses associated with our revenue streams, general and administrative expenses and income taxes.
The increase in cash flows provided by operating activities for the years ended December 31, 2022 compared to the same period of 2021, was primarily related to increased prices and volumes of oil and gas production and was partially offset by increased income tax payments.
Cash Flows Used in Investing Activities
For the years ended December 31, 2022 and 2021, net cash used in investing activities was $21.4 million and $15.0 million, respectively. Our cash flows used in investing activities are primarily related to capital expenditures related to our water services and operations segment and acquisitions of royalty interests.
Capital expenditures increased $3.7 million for the year ended December 31, 2022 compared to the same period of 2021. Acquisitions of royalty interests increased approximately $1.7 million for the years ended December 31, 2022 compared to the same period 2021.
Cash Flows Used in Financing Activities
For the years ended December 31, 2022 and 2021, net cash used in financing activities was $336.8 million and $104.9 million, respectively. Our cash flows used in financing principally consist of activities which return capital to our stockholders such as payment of dividends and repurchases of our Common Stock.
During the year ended December 31, 2022, we paid total dividends of $247.3 million, consisting of cumulative paid cash dividends of $12.00 per share and special dividends of $20.00 per share. During the year ended December 31, 2021, we paid total dividends of $85.3 million consisting of cumulative cash dividends of $11.00 per share. We repurchased $87.9 million and $19.9 million of our Common Stock (including share repurchases not yet settled) during the years ended December 31, 2022 and 2021, respectively.
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Results of Operations - Consolidated
The following table shows our consolidated results of operations for the years ended December 31, 2022, 2021, and 2020 (in thousands):
| Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2020 | ||||||||
| Revenues: | ||||||||||
| Oil and gas royalties | $ | 452,434 | $ | 286,468 | $ | 137,948 | ||||
| Water sales | 84,725 | 67,766 | 54,862 | |||||||
| Produced water royalties | 72,234 | 58,081 | 50,640 | |||||||
| Easements and other surface-related income | 48,057 | 37,616 | 41,398 | |||||||
| Land sales and other operating revenue | 9,972 | 1,027 | 17,716 | |||||||
| Total revenues | 667,422 | 450,958 | 302,564 | |||||||
| Expenses: | ||||||||||
| Salaries and related employee expenses | 41,402 | 40,012 | 32,173 | |||||||
| Water service-related expenses | 17,463 | 13,233 | 14,233 | |||||||
| General and administrative expenses | 13,350 | 11,782 | 9,751 | |||||||
| Legal and professional fees | 8,735 | 7,281 | 10,778 | |||||||
| Ad valorem taxes | 8,734 | — | — | |||||||
| Land sales expenses | 55 | — | 3,973 | |||||||
| Depreciation, depletion and amortization | 15,376 | 16,257 | 14,395 | |||||||
| Total operating expenses | 105,115 | 88,565 | 85,303 | |||||||
| Operating income | 562,307 | 362,393 | 217,261 | |||||||
| Other income, net | 6,548 | 624 | 2,401 | |||||||
| Income before income taxes | 568,855 | 363,017 | 219,662 | |||||||
| Income tax expense (benefit): | ||||||||||
| Current | 121,230 | 93,265 | 46,002 | |||||||
| Deferred | 1,263 | (228) | (2,389) | |||||||
| Total income tax expense | 122,493 | 93,037 | 43,613 | |||||||
| Net income | $ | 446,362 | $ | 269,980 | $ | 176,049 |
Year Ended December 31, 2022 Compared to Year Ended December 31, 2021
Consolidated Revenues and Net Income:
Total revenues increased $216.5 million, or 48.0%, to $667.4 million for the year ended December 31, 2022 compared to $451.0 million for the year ended December 31, 2021. This increase was principally due to the $166.0 million increase in oil and gas royalties and the combined increase of $31.1 million in water sales and produced water royalties over the same period. Net income of $446.4 million for the year ended December 31, 2022 was 65.3% higher than the comparable period of 2021. The increase in net income was driven by the 55.2% increase in operating income resulting from the 48.0% increase in total revenues and the 3.9% improvement in operating margin to 84.3% for the year ended December 31, 2022 compared to the prior year. Individual revenue line items are discussed below under “Segment Results of Operations.”
Consolidated Expenses:
Salaries and related employee expenses. Salaries and related employee expenses were $41.4 million for the year ended December 31, 2022 compared to $40.0 million for the comparable period of 2021. Stock compensation expense for the
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year ended December 31, 2022 was $7.6 million. As noted in Note 2, “Summary of Significant Accounting Policies — Share-Based Compensation,” the Company recognizes share-based compensation expense using the graded-vesting method which impacts the timing of the recognition of stock compensation expense for stock awards with vesting periods in excess of one year. Prior to December 2021, the Company did not have an equity incentive plan and did not pay compensation in equity. Salaries and related employee expenses for the year ended December 31, 2021 included $6.7 million of severance costs.
Water service-related expenses. Water service-related expenses increased $4.2 million to $17.5 million for the year ended December 31, 2022 compared to the same period of 2021. Transfer and treatment expenses for the year ended December 31, 2022 increased primarily due to heightened sales activity compared to the same period of 2021. Since the beginning of 2021, we have invested $13.3 million of capital in electrifying our water-related infrastructure to minimize our reliance on diesel-powered generators. Electricity expense for the year ended December 31, 2022 increased principally due to increased usage of our electrified infrastructure and rising electricity costs compared to the same period of 2021. This increase in electricity expense was partially offset by decreases in fuel and equipment rental expenses during the same time period.
General and administrative expenses. General and administrative expenses increased $1.6 million to $13.4 million for the year ended December 31, 2022 from $11.8 million for the same period of 2021. The increase in general and administrative expenses during the year ended December 31, 2022 compared to the same period of 2021 was principally related to increases in charitable contributions, corporate insurance and board expenses due to the expansion of our board to 10 directors.
Legal and professional fees. Legal and professional fees were $8.7 million for the year ended December 31, 2022 compared to $7.3 million for the comparable period of 2021. The increase is principally related to legal expenses associated with stockholder matters.
Ad valorem taxes. For the year ended December 31, 2022, the Company recorded an expense of $8.7 million for ad valorem taxes. Prior to January 1, 2022, ad valorem taxes with respect to our historical royalty interests were paid directly by certain third parties pursuant to an existing arrangement. Since the completion of our Corporate Reorganization on January 11, 2021, we have received notice from one such third party that they no longer intend to pay the ad valorem taxes related to such historical royalty interests. While we continue to believe the obligation to pay these ad valorem taxes should belong to the third party, we have accrued an estimate of such taxes and intend to pay the taxes when they become due in order to protect the royalty interests from any potential tax liens for nonpayment of future ad valorem taxes. While we intend to seek reimbursement from the third party following payment of such taxes, we are unable to determine the likelihood of such reimbursement, and accordingly, have not recorded a loss recovery receivable as of December 31, 2022.
Other income, net. Other income, net was $6.5 million and $0.6 million for the years ended December 31, 2022 and 2021, respectively. Interest income earned on our cash balances increased as interest yields rose during 2022.
Total income tax expense. Total income tax expense was $122.5 million and $93.0 million for the years ended December 31, 2022 and 2021, respectively. The increase in income tax expense is primarily related to increased operating income resulting from increased revenues from oil and gas royalties and water sales.
Segment Results of Operations
We operate our business in two reportable segments: Land and Resource Management and Water Services and Operations. We eliminate any inter-segment revenues and expenses upon consolidation.
We evaluate the performance of our operating segments separately to monitor the different factors affecting financial results. The reportable segments presented are consistent with our reportable segments discussed in Note 12, “Business Segment Reporting” in Item 8. “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. We monitor our reporting segments based upon revenue and net income calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
Our results of operations for the year ended December 31, 2022 have benefited directly and indirectly from a rebound in oil and gas activity in the Permian Basin and increases in commodity prices compared to 2021. Our oil and gas royalties have increased due to increased royalty production and higher commodity prices during this time period. Additionally, revenues derived from easements and other surface-related income, water sales, and produced water royalties have also generally been positively impacted by ongoing development activity in the Permian Basin.
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Year Ended December 31, 2022 Compared to Year Ended December 31, 2021
The following is an analysis of our operating results for the comparable periods by reportable segment (dollars in thousands):
| Years Ended December 31, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | ||||||||||||
| Revenues: | |||||||||||||
| Land and resource management: | |||||||||||||
| Oil and gas royalties | $ | 452,434 | 68 | % | $ | 286,468 | 64 | % | |||||
| Easements and other surface-related income | 44,569 | 7 | % | 32,892 | 7 | % | |||||||
| Land sales and other operating revenue | 9,972 | 1 | % | 1,027 | — | % | |||||||
| Total Land and resource management | 506,975 | 76 | % | 320,387 | 71 | % | |||||||
| Water services and operations: | |||||||||||||
| Water sales | 84,725 | 13 | % | 67,766 | 15 | % | |||||||
| Produced water royalties | 72,234 | 11 | % | 58,081 | 13 | % | |||||||
| Easements and other surface-related income | 3,488 | — | % | 4,724 | 1 | % | |||||||
| Total Water services and operations | 160,447 | 24 | % | 130,571 | 29 | % | |||||||
| Total consolidated revenues | $ | 667,422 | 100 | % | $ | 450,958 | 100 | % | |||||
| Net income: | |||||||||||||
| Land and resource management | $ | 365,041 | 82 | % | $ | 208,897 | 77 | % | |||||
| Water services and operations | 81,321 | 18 | % | 61,083 | 23 | % | |||||||
| Total consolidated net income | $ | 446,362 | 100 | % | $ | 269,980 | 100 | % |
Land and Resource Management
Land and Resource Management segment revenues increased $186.6 million, or 58.2%, to $507.0 million for the year ended December 31, 2022 as compared with revenues of $320.4 million for the comparable period of 2021. The increase in Land and Resource Management segment revenues is principally due to the $166.0 million increase in oil and gas royalties for the year ended December 31, 2022 compared to the comparable period of 2021.
Oil and gas royalties. Oil and gas royalties were $452.4 million for the year ended December 31, 2022 compared to $286.5 million for the year ended December 31, 2021, an increase of 57.9%.
The table below provides financial and operational data by royalty stream for the years ended December 31, 2022 and 2021:
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| Years Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2022 | 2021 | ||||||
| Our share of production volumes(1): | |||||||
| Oil (MBbls) | 3,401 | 3,076 | |||||
| Natural gas (MMcf) | 13,086 | 12,082 | |||||
| NGL (MBbls) | 2,208 | 1,705 | |||||
| Equivalents (MBoe) | 7,791 | 6,795 | |||||
| Equivalents per day (MBoe/d) | 21.3 | 18.6 | |||||
| Oil and gas royalties (in thousands): | |||||||
| Oil royalties | $ | 307,606 | $ | 195,710 | |||
| Natural gas royalties | 74,866 | 40,964 | |||||
| NGL royalties | 69,962 | 49,794 | |||||
| Total oil and gas royalties | $ | 452,434 | $ | 286,468 | |||
| Realized prices: | |||||||
| Oil ($/Bbl) | $ | 94.69 | $ | 66.62 | |||
| Natural gas ($/Mcf) | $ | 6.19 | $ | 3.67 | |||
| NGL ($/Bbl) | $ | 34.25 | $ | 31.56 | |||
| Equivalents ($/Boe) | $ | 60.81 | $ | 44.14 |
(1) Commonly used definitions in the oil and gas industry not previously defined: Boe represents barrels of oil equivalent. MBbls represents one thousand barrels of crude oil, condensate or NGLs. Mcf represents one thousand cubic feet of natural gas. MMcf represents one million cubic feet of natural gas. MBoe represents one thousand Boe. MBoe/d represents one thousand Boe per day.
Our share of crude oil, natural gas and NGL production volumes was 21.3 thousand Boe per day for the year ended December 31, 2022 compared to 18.6 thousand Boe per day for the same period of 2021. The average realized prices were $94.69 per barrel of oil, $6.19 per Mcf of natural gas, and $34.25 per barrel of NGL, for a total equivalent price of $60.81 per Boe for the year ended December 31, 2022, an increase of $16.67 per Boe compared to the total equivalent price of $44.14 per Boe for the same period of 2021.
Easements and other surface-related income. Easements and other surface-related income was $44.6 million for the year ended December 31, 2022, an increase of 35.5% compared to $32.9 million for the year ended December 31, 2021. Easements and other surface-related income includes revenue related to the use and crossing of our land for oil and gas exploration and production, renewable energy, and agricultural operations. The increase in easements and other surface-related income is principally related to increases of $4.5 million in wellbore easements, $3.7 million in material sales, and $2.8 million in pipeline easement income for the year ended December 31, 2022 compared to the same period of 2021. Easements and other surface-related income is dependent on development decisions made by companies that operate in the areas where we own land and is, therefore, unpredictable and may vary significantly from period to period. See “Market Conditions” above for additional discussion of development activity in the Permian Basin during the year ended December 31, 2022.
Land sales and other operating revenue. Land sales and other operating revenue includes revenue generated from land sales and grazing leases and was $10.0 million and $1.0 million for the years ended December 31, 2022 and 2021, respectively. For the year ended December 31, 2022, we sold 6,392 acres of land for an aggregate sales price of $9.7 million or approximately $1,515 per acre. For the year ended December 31, 2021, we sold 30 acres of land for an aggregate sales price of approximately $0.7 million, or approximately $25,000 per acre.
Net income. Net income for the Land and Resource Management segment was $365.0 million for the year ended December 31, 2022 compared to $208.9 million for the year ended December 31, 2021. Expenses, including income tax expense, for the Land and Resource Management segment were $141.9 million and $111.5 million for the years ended December 31, 2022 and 2021, respectively. The increase in expenses during 2022 is principally related to a $24.0 million
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increase in income tax expense for the year ended December 31, 2022 compared to the same period of 2021. Expenses are discussed further above under “Results of Operations.”
Water Services and Operations
Water Services and Operations segment revenues increased 22.9%, to $160.4 million for the year ended December 31, 2022 as compared with revenues of $130.6 million for the comparable period of 2021. The increase in Water Services and Operations segment revenues is due to increases in water sales revenue and produced water royalties, which are discussed below. As discussed in “Market Conditions” above, our segment revenues are directly influenced by development decisions made by our customers and the overall activity level in the Permian Basin. Accordingly, our segment revenues and sales volumes, as further discussed below, will fluctuate from period to period based upon those decisions and activity levels.
Water sales. Water sales revenue increased $17.0 million, or 25.0% to $84.7 million for the year ended December 31, 2022 compared to the same period of 2021. The increase in water sales is principally due to an increase of approximately 10.3% in sourced and treated water sales volumes for the years ended December 31, 2022 compared to the year ended December 31, 2021.
Produced water royalties. Produced water royalties are received from the transfer or disposal of produced water on our land. Produced water royalties are contractual and not paid as a matter of right. We do not operate any salt water disposal wells. Produced water royalties were $72.2 million for the year ended December 31, 2022 compared to $58.1 million for the same period in 2021. This increase is principally due to increased produced water volumes for the year ended December 31, 2022 compared to the same period of 2021.
Easements and other surface-related income. Easements and other surface-related income was $3.5 million for the year ended December 31, 2022, a decrease of $1.2 million compared to $4.7 million for the year ended December 31, 2021. The decrease in easements and other surface-related income relates to a decrease in temporary permits for sourced water lines for the year ended December 31, 2022 compared to the same period in 2021.
Net income. Net income for the Water Services and Operations segment was $81.3 million for the year ended December 31, 2022 compared to $61.1 million for the year ended December 31, 2021. As discussed above, revenues for the Water Services and Operations segment increased 22.9% for the year ended December 31, 2022 compared to the same period of 2021. Expenses, including income tax expense, for the Water Services and Operations segment were $79.1 million for the year ended December 31, 2022 as compared to $69.5 million for the year ended December 31, 2021. The overall increase in segment expenses during 2022 is principally related to a $5.4 million increase in income tax expense and a $4.2 million increase in water service-related expenses resulting from increased segment revenue and operating income during the same time period. Expenses are discussed further above under “Results of Operations.”
Non-GAAP Performance Measures
In addition to amounts presented in accordance with GAAP, we also present certain supplemental non-GAAP measurements. These measurements are not to be considered more relevant or accurate than the measurements presented in accordance with GAAP. In compliance with the requirements of the SEC, our non-GAAP measurements are reconciled to net income, the most directly comparable GAAP performance measure. For all non-GAAP measurements, neither the SEC nor any other regulatory body has passed judgment on these non-GAAP measurements.
EBITDA and Adjusted EBITDA
EBITDA is a non-GAAP financial measurement of earnings before interest, taxes, depreciation, depletion and amortization. Its purpose is to highlight earnings without finance, taxes, and depreciation, depletion and amortization expense, and its use is limited to specialized analysis. We calculate Adjusted EBITDA as EBITDA excluding employee share-based compensation, conversion costs related to our Corporate Reorganization, and severance costs. Its purpose is to highlight earnings without non-cash activity such as share-based compensation and/or other non-recurring or unusual items such as conversion and severance costs. We have presented EBITDA and Adjusted EBITDA because we believe that both are useful supplements to net income in analyzing operating performance.
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The following table presents a reconciliation of net income to EBITDA and Adjusted EBITDA for the years ended December 31, 2022, 2021, and 2020 (in thousands):
| Years Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2020 | |||||||||
| Net income | $ | 446,362 | $ | 269,980 | $ | 176,049 | |||||
| Add: | |||||||||||
| Income tax expense | 122,493 | 93,037 | 43,613 | ||||||||
| Depreciation, depletion and amortization | 15,376 | 16,257 | 14,395 | ||||||||
| EBITDA | 584,231 | 379,274 | 234,057 | ||||||||
| Add: | |||||||||||
| Employee share-based compensation | 7,583 | — | — | ||||||||
| Severance costs | — | 6,680 | — | ||||||||
| Conversion costs related to corporate reorganization | — | 2,026 | 5,050 | ||||||||
| Adjusted EBITDA | $ | 591,814 | $ | 387,980 | $ | 239,107 |
Off-Balance Sheet Arrangements
The Company has not engaged in any off-balance sheet arrangements.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements. It is our opinion that we fully disclose our significant accounting policies in the Notes to the Consolidated Financial Statements. Consistent with our disclosure policies, we include the following discussion related to what we believe to be our most critical accounting policies that require our most difficult, subjective or complex judgment.
Accrual of Oil and Gas Royalties
The Company accrues oil and gas royalties. An accrual is necessary due to the time lag between the production of oil and gas and generation of the actual payment by operators. The oil and gas royalty accrual is based upon historical production volumes, estimates of the timing of future payments and recent market prices for oil and gas.
New Accounting Pronouncements
For further information regarding recently issued accounting pronouncements, see Note 2, “Summary of Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data.”