# Texas Pacific Land Corp (TPL) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Texas Pacific Land Corp's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1811074/000181107424000015/tpl-20231231.htm
Accession: 0001811074-24-000015
Filing date: 2024-02-21
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/TPL/
All MD&A years: /company/TPL/mda/
Previous year: /company/TPL/mda/fy2022/ (FY 2022)
Next year: /company/TPL/mda/fy2024/ (FY 2024)

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, 2023 compared to the year ended December 31, 2022. For a discussion of the year ended December 31, 2022 compared to the year ended December 31, 2021, 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, 2022.

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 primarily 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 2023

Average oil and gas prices during 2023 have declined compared to average prices during 2022. Oil prices continue to be impacted by certain actions by OPEC+, geopolitical factors, and evolving global supply and demand trends, among other factors. Global and domestic natural gas markets have experienced volatility due to macroeconomic conditions, infrastructure and logistical constraints, weather, and geopolitical issues, among other factors. In 2023, domestic natural gas prices have declined in part to growing supply. Since mid-2022, the Waha Hub located in Pecos County, Texas has at times experienced significant negative price differentials relative to Henry Hub, located in Erath, Louisiana, due in part to growing local Permian natural gas production and limited natural gas pipeline takeaway capacity. Midstream infrastructure is currently under construction by operators to provide additional takeaway capacity, though the impact on future basis differentials will be dependent on future natural gas production and other factors. Changes in macro-economic conditions, including rising interest rates and lower global economic activity, could result in additional shifts in oil and gas supply and demand in future periods. Although our revenues are directly and indirectly impacted by changes in oil and natural gas 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 commodity price volatility.

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 2023 compared to recent prior year activity levels. Per the U.S. Energy Information Administration (“EIA”), Permian production is approximately six million barrels per day, which is higher than the average daily production of any year prior to 2023.

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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, 2023 and 2022:

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2023","","2022"],["Oil and Gas Pricing Metrics:(1)"],["WTI Cushing average price per bbl","","$","77.58","","","$","94.90"],["Henry Hub average price per mmbtu","","$","2.53","","","$","6.45"],["Activity Metrics specific to the Permian Basin:(1)(2)"],["Average monthly horizontal permits","","499","","627"],["Average monthly horizontal wells drilled","","422","","511"],["Average weekly horizontal rig count","","323","","318"],["DUCs as of December 31 for each applicable year","","4,656","","4,526"],["Total Average US weekly horizontal rig count (2)","","620","","659"]]
[[/GREPCENT_TABLE]]

(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. DUC classification is based on well data and date stamps provided by Enverus. DUCs is based on wells that have a drilled/spud date stamp but do not have a completed or first production date stamp. Excludes wells that have been labeled plugged and abandoned or permit expired and wells drilled/spud more than five years ago.

(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, 2023 and 2022. Our oil and gas royalties are impacted by both oil and gas prices as well as production levels. Oil and gas prices in 2023 have declined compared to the comparable period in 2022. Despite declining commodity prices, drilling and development activities across the Permian generally remained strong in 2023. 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.

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, 2023.

As of December 31, 2023, we had cash and cash equivalents of $725.2 million that we expect to utilize, along with cash flow from operations, to provide capital to support our business, to repurchase our Common Stock subject to market conditions, to pay dividends subject to the discretion of our Board, for potential acquisitions and for general corporate purposes. For the year ended December 31, 2023, we paid $100.0 million in dividends to our stockholders and repurchased $42.4 million of our Common Stock (including the share repurchases not settled at the end of the period).

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We acquired intangible assets of $21.4 million during the year ended December 31, 2023, consisting of a SWD easement and groundwater rights. Additionally, we invested approximately $15.2 million in TPWR projects to maintain and/or enhance our water sourcing assets, of which $3.1 million related to water wells and related infrastructure acquired in conjunction with the acquisition of groundwater rights during the year ended December 31, 2023. The SWD easement covers approximately 49,000 acres and provides us future disposal opportunities to service injection customers seeking disposal solutions located outside of core basins. The groundwater rights provide us access to additional water volumes outside of our existing surface footprint to assist in managing fluctuations in customer demand.

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.

Cash Flows from Operating Activities

For the years ended December 31, 2023 and 2022, net cash provided by operating activities was $418.3 million and $447.1 million, respectively. Our cash flow provided by operating activities is primarily from oil, gas and produced water royalties, water and land sales, 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 decrease in cash flows provided by operating activities for the year ended December 31, 2023 compared to the same period of 2022, was primarily related to changes in working capital requirements over the same time period.

Cash Flows Used in Investing Activities

For the years ended December 31, 2023 and 2022, net cash used in investing activities was $60.3 million and $21.4 million, respectively. Our cash flows used in investing activities are primarily related to land acquisitions, intangible assets such as subsurface easements, and capital expenditures related to our water services and operations segment.

Acquisitions of intangible assets and land increased $21.4 million and $19.7 million, respectively, for the year ended December 31, 2023 compared to the same period of 2022 and were partially offset by a decrease of $4.2 million in capital expenditures during the same time period.

Cash Flows Used in Financing Activities

For the years ended December 31, 2023 and 2022, net cash used in financing activities was $144.6 million and $336.8 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, 2023, we paid total dividends of $100.0 million, consisting of cumulative paid cash dividends of $13.00 per share. During the year ended December 31, 2022, we paid total dividends of $247.3 million consisting of cumulative cash dividends of $12.00 per share and a special dividend of $20.00 per share. We repurchased $42.4 million and $87.9 million of our Common Stock (including share repurchases not settled at the end of the period) during the years ended December 31, 2023 and 2022, respectively.

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Results of Operations - Consolidated

The following table shows our consolidated results of operations for the years ended December 31, 2023, 2022, and 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2023","","2022","","2021"],["Revenues:"],["Oil and gas royalties","$","357,394","","","$","452,434","","","$","286,468"],["Water sales","112,203","","","84,725","","","67,766"],["Produced water royalties","84,260","","","72,234","","","58,081"],["Easements and other surface-related income","70,932","","","48,057","","","37,616"],["Land sales and other operating revenue","6,806","","","9,972","","","1,027"],["Total revenues","631,595","","","667,422","","","450,958"],["Expenses:"],["Salaries and related employee expenses","43,384","","","41,402","","","40,012"],["Water service-related expenses","33,566","","","17,463","","","13,233"],["General and administrative expenses","14,928","","","13,285","","","11,638"],["Legal and professional fees","31,522","","","8,735","","","7,281"],["Ad valorem and other taxes","7,385","","","8,854","","","144"],["Depreciation, depletion and amortization","14,757","","","15,376","","","16,257"],["Total operating expenses","145,542","","","105,115","","","88,565"],["Operating income","486,053","","","562,307","","","362,393"],["Other income, net","31,508","","","6,548","","","624"],["Income before income taxes","517,561","","","568,855","","","363,017"],["Income tax expense (benefit):"],["Current","110,517","","","121,230","","","93,265"],["Deferred","1,399","","","1,263","","","(228)"],["Total income tax expense","111,916","","","122,493","","","93,037"],["Net income","$","405,645","","","$","446,362","","","$","269,980"]]
[[/GREPCENT_TABLE]]

Year Ended December 31, 2023 Compared to Year Ended December 31, 2022

Consolidated Revenues and Net Income:

Total revenues decreased $35.8 million, or 5.4%, to $631.6 million for the year ended December 31, 2023 compared to $667.4 million for the year ended December 31, 2022. This decrease was principally due to the $95.0 million decrease in oil and gas royalty revenue and was partially offset by the combined increase of $39.5 million in water sales and produced water royalties, and the $22.9 million increase in easements and other surface-related income, over the same period. Individual revenue line items are discussed below under “Segment Results of Operations.” Net income of $405.6 million for the year ended December 31, 2023 was 9.1% lower than the comparable period of 2022, principally as a result of both the decrease in revenues discussed above and the increase in operating expenses discussed further below under “Consolidated Expenses.”

Consolidated Expenses:

Salaries and related employee expenses. Salaries and related employee expenses were $43.4 million for the year ended December 31, 2023 compared to $41.4 million for the comparable period of 2022. The increase in salaries and related employee expenses is principally related to market compensation adjustments.

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Water service-related expenses. Water service-related expenses increased $16.1 million to $33.6 million for the year ended December 31, 2023 compared to the same period of 2022. Certain types of water service-related expenses, including, but not limited to, transfer, treatment, and water purchases, will vary from period to period as our customers’ needs and requirements change. Water sales, which increased 32.4% during 2023, were impacted not only by increased customer volumes, but also by higher demand within shorter time commitments and resulted in increased water purchase, treatment and transfer expenses. While these dynamics in demand resulted in a 92.2% increase in water service-related expenses for the year ended December 31, 2023 compared to the same period of 2022, the operational decision to meet these demands resulted in increased revenues and operating income over the same time period.

General and administrative expenses. General and administrative expenses increased $1.6 million to $14.9 million for the year ended December 31, 2023 from $13.3 million for the same period of 2022. The increase in general and administrative expenses during the year ended December 31, 2023 compared to the same period of 2022 was principally related to increased expenses for technology applications and increased board fees due to the expansion of our board to 10 directors in April 2022.

Legal and professional fees. Legal and professional fees were $31.5 million for the year ended December 31, 2023 compared to $8.7 million for the comparable period of 2022. The increase is principally related to legal expenses associated with stockholder matters. See further discussion in Part I - Item 3. Legal Proceedings.

Ad valorem and other taxes. Ad valorem and other taxes were $7.4 million for the year ended December 31, 2023, compared to $8.9 million for the comparable period of 2022. Ad valorem taxes for the year ended December 31, 2022 included payments for prior year ad valorem tax liabilities which had not been paid by the third party responsible for those ad valorem taxes. Prior to January 1, 2022, the ad valorem taxes with respect to our historical royalty interests were paid directly by third parties pursuant to an existing arrangement. Since the completion of our Corporate Reorganization on January 11, 2021, we have received notice from a third party that it no longer intends 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 and/or paid an estimate of such taxes in order to protect the royalty interests from any potential tax liens for nonpayment of ad valorem taxes. While we intend to seek reimbursement from the third party following payment of such taxes, we are unable to determine the amount and/or likelihood of such reimbursement, and accordingly, have not recorded a loss recovery receivable as of December 31, 2023.

Other income, net. Other income, net was $31.5 million and $6.5 million for the years ended December 31, 2023 and 2022, respectively. The increase in other income, net is primarily related to increased interest income earned on our cash balances during 2023. Higher cash balances and interest yields during this period contributed to the increase in interest income.

Total income tax expense. Total income tax expense was $111.9 million and $122.5 million for the years ended December 31, 2023 and 2022, respectively. The decrease in income tax expense is primarily related to decreased operating income resulting from decreased oil and gas royalty revenue and increased operating expenses.

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 14, “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 oil and gas royalty revenue, and, in turn, our results of operations for the year ended December 31, 2023 have been impacted by lower average commodity prices compared to 2022. The decline in oil and gas royalty revenues has been partially offset by increases in revenues derived from water sales, easements and other surface-related income, and produced water royalties which have been positively impacted by ongoing development activity in the Permian Basin.

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Year Ended December 31, 2023 Compared to Year Ended December 31, 2022

The following is an analysis of our operating results for the comparable periods by reportable segment (dollars presented in thousands):

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2023","","2022"],["Revenues:"],["Land and resource management:"],["Oil and gas royalties","$","357,394","","","57","%","","$","452,434","","","68","%"],["Easements and other surface-related income","67,905","","","11","%","","44,569","","","7","%"],["Land sales and other operating revenue","6,806","","","1","%","","9,972","","","1","%"],["Total Land and resource management","432,105","","","69","%","","506,975","","","76","%"],["Water services and operations:"],["Water sales","112,203","","","18","%","","84,725","","","13","%"],["Produced water royalties","84,260","","","13","%","","72,234","","","11","%"],["Easements and other surface-related income","3,027","","","\u2014","%","","3,488","","","\u2014","%"],["Total Water services and operations","199,490","","","31","%","","160,447","","","24","%"],["Total consolidated revenues","$","631,595","","","100","%","","$","667,422","","","100","%"],["Net income:"],["Land and resource management","$","306,706","","","76","%","","$","365,041","","","82","%"],["Water services and operations","98,939","","","24","%","","81,321","","","18","%"],["Total consolidated net income","$","405,645","","","100","%","","$","446,362","","","100","%"]]
[[/GREPCENT_TABLE]]

Land and Resource Management

Land and Resource Management segment revenues decreased $74.9 million, or 14.8%, to $432.1 million for the year ended December 31, 2023 as compared to the same period of 2022. The decrease in Land and Resource Management segment revenues is due to a $95.0 million decrease in oil and gas royalties for the year ended December 31, 2023 compared to the same period of 2022. The decrease in oil and gas royalty revenue was partially offset by a $23.3 million increase in easements and other surface-related income over the same time period.

Oil and gas royalties. Oil and gas royalty revenue was $357.4 million for the year ended December 31, 2023 compared to $452.4 million for the year ended December 31, 2022, a decrease of 21.0%. Oil and gas royalties for the year ended December 31, 2023 included an $8.7 million recovery, discussed further in the following paragraph. Excluding the $8.7 million recovery, oil and gas royalties decreased $103.7 million due to lower average commodity prices during the year ended December 31, 2023 compared to the same period of 2022. The average realized prices declined 30.0% to $42.58 per Boe for the year ended December 31, 2023 from $60.81 per Boe for the same period of 2022. Our share of crude oil, natural gas and NGL production volumes was 23.5 thousand Boe per day for the year ended December 31, 2023 compared to 21.3 thousand Boe per day for the same period of 2022.

As part of an ongoing arbitration between TPL and an operator with respect to underpayment of oil and gas royalties resulting from improper deductions of post-production costs by the operator for production periods before and through June 2023, the operator has agreed to pay $10.1 million to TPL, comprised of $8.7 million of unpaid oil and gas royalties, $0.9 million of interest and $0.5 million of damages (the “O&G Settlement”). The full amount of $10.1 million has been recorded as a receivable, $8.7 million has been included in oil and gas royalty revenue and the remaining $1.4 million has been recorded as other income in the consolidated financial statements for the year ended December 31, 2023. The Company received payment from the operator for the full amount in January 2024.

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The table below provides financial and operational data by royalty stream for the years ended December 31, 2023 and 2022 and excludes the O&G Settlement discussed above:

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2023","","2022"],["Our share of production volumes (1) (2):"],["Oil (MBbls)","","3,701","","","3,401"],["Natural gas (MMcf)","","14,528","","","13,086"],["NGL (MBbls)","","2,453","","","2,208"],["Equivalents (MBoe)","","8,575","","","7,791"],["Equivalents per day (MBoe/d)","","23.5","","","21.3"],["Oil and gas royalties (in thousands) (2):"],["Oil royalties","","$","273,304","","","$","307,606"],["Natural gas royalties","","29,915","","","74,866"],["NGL royalties","","45,510","","","69,962"],["Total oil and gas royalties","","$","348,729","","","$","452,434"],["Realized prices (2):"],["Oil ($/Bbl)","","$","77.33","","","$","94.69"],["Natural gas ($/Mcf)","","$","2.23","","","$","6.19"],["NGL ($/Bbl)","","$","20.05","","","$","34.25"],["Equivalents ($/Boe)","","$","42.58","","","$","60.81"]]
[[/GREPCENT_TABLE]]

(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.

(2)    The metrics provided exclude the impact of the $8.7 million of oil and gas royalties from the O&G Settlement discussed above.

Easements and other surface-related income. Easements and other surface-related income was $67.9 million for the year ended December 31, 2023, an increase of 52.4% compared to $44.6 million for the year ended December 31, 2022. 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 $13.6 million in pipeline easements and $5.3 million in material sales (caliche and sand) for the year ended December 31, 2023 compared to the same period of 2022. The amount of income derived from pipeline easements is a function of the term of the easement, the size of the easement and the number of easements entered into for any given period. 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, 2023.

Land sales and other operating revenue. Land sales and other operating revenue was $6.8 million and $10.0 million for the years ended December 31, 2023 and 2022, respectively. For the year ended December 31, 2023, we sold 18,061 acres of land for an aggregate sales price of $6.8 million. For the year ended December 31, 2022, we sold 6,392 acres of land for an aggregate sales price of approximately $9.7 million.

Net income. Net income for the Land and Resource Management segment decreased 16.0% to $306.7 million for the year ended December 31, 2023 compared to $365.0 million for the comparable period in 2022. Segment operating income decreased $98.2 million for the year ended December 31, 2023 compared to the same period of 2022, largely driven by the $95.0 million decrease in oil and gas royalty revenue. Expenses are discussed further above under “Results of Operations.”

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Water Services and Operations

Water Services and Operations segment revenues increased 24.3%, to $199.5 million for the year ended December 31, 2023 as compared with $160.4 million for the comparable period of 2022. The increase in Water Services and Operations segment revenues is principally 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 $27.5 million, or 32.4% to $112.2 million for the year ended December 31, 2023 compared to the same period of 2022. The growth in water sales is principally due to an increase of 21.8% in water sales volumes for the years ended December 31, 2023 compared to the year ended December 31, 2022.

Produced water royalties. Produced water royalties are royalties 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 $84.3 million for the year ended December 31, 2023 compared to $72.2 million for the same period in 2022. This increase is principally due to increased produced water volumes for the year ended December 31, 2023 compared to the same period of 2022.

Net income. Net income for the Water Services and Operations segment was $98.9 million for the year ended December 31, 2023 compared to $81.3 million for the year ended December 31, 2022. Segment operating income increased $22.0 million for the year ended December 31, 2023 compared to the same period of 2022. The increase is principally due to the $39.0 million increase in segment revenues which were partially offset by the $16.1 million increase in water service-related expenses and the $5.4 million increase in income tax expense. 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 performance 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, Adjusted EBITDA and Free Cash Flow

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. Its purpose is to highlight earnings without non-cash activity such as share-based compensation and/or other non-recurring or unusual items. We calculate Free Cash Flow as Adjusted EBITDA less current income tax expense and capital expenditures. Its purpose is to provide an additional measure of operating performance. We have presented EBITDA, Adjusted EBITDA and Free Cash Flow because we believe that these metrics are useful supplements to net income in analyzing the Company's operating performance. Our definitions of Adjusted EBITDA and Free Cash Flow may differ from computations of similarly titled measures of other companies.

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The following table presents a reconciliation of net income to EBITDA, Adjusted EBITDA and Free Cash Flow for the years ended December 31, 2023, 2022, and 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2023","","2022","","2021"],["Net income","","$","405,645","","","$","446,362","","","$","269,980"],["Add:"],["Income tax expense","","111,916","","","122,493","","","93,037"],["Depreciation, depletion and amortization","","14,757","","","15,376","","","16,257"],["EBITDA","","532,318","","","584,231","","","379,274"],["Add:"],["Employee share-based compensation","","9,124","","","7,583","","","\u2014"],["Severance costs","","\u2014","","","\u2014","","","6,680"],["Conversion costs related to corporate reorganization","","\u2014","","","\u2014","","","2,026"],["Adjusted EBITDA","","541,442","","","591,814","","","387,980"],["Less:"],["Current income tax expense","","(110,517)","","","(121,230)","","","(93,265)"],["Capital expenditures","","(15,431)","","","(18,967)","","","(16,415)"],["Free Cash Flow","","$","415,494","","","$","451,617","","","$","278,300"]]
[[/GREPCENT_TABLE]]

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 removal of crude oil and natural gas products from the respective mineral reserve locations 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.”