SM Energy Company — Q3 2016 Form 10-Q
Business context and reporting period. Independent onshore North American oil, gas, and NGL producer. This unaudited filing covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods unless noted. Management’s strategy was to concentrate investment in higher-return Permian, operated Eagle Ford, and Bakken/Three Forks assets.
Financial and operating performance
- Revenue: Q3 production revenue was $329.2 million, down 10%; nine-month production revenue was $832.1 million, down 31%. Lower production volumes and, year to date, weaker realized prices contributed to the decline.
- Profit and impairment: Q3 net loss was $40.9 million ($0.52 per diluted share), versus net income of $3.1 million ($0.05 per share). Nine-month net loss was $556.8 million ($7.78 per share), versus a $107.5 million loss. Nine-month proved-property impairment was $277.8 million, primarily related to outside-operated Eagle Ford assets. Income tax benefits were $23.7 million for Q3 and $314.5 million year to date.
- Operating costs and margins: Q3 production expense was $152.5 million, down 17%; lease operating expense was $3.29 per BOE, down 15%. Realized production price before derivative settlements was $23.25 per BOE versus $22.84. DD&A was $194.0 million in Q3 and $619.2 million year to date. The filing does not provide a single GAAP operating-margin figure.
- Production: Q3 average production was 153.9 MBOE/day, down 12%; nine-month average was 152.9 MBOE/day, down 15%. Management attributed declines mainly to reduced drilling and completion activity and, year to date, the prior Mid-Continent divestiture.
- Cash flow: Q3 cash from operations was $158.1 million versus $235.3 million; nine-month operating cash flow was $415.0 million versus $784.8 million. Nine-month investing cash use was $361.8 million; financing provided $927.5 million. The cash balance at September 30 was $980.7 million, including $49.0 million restricted for the Rock Oil purchase deposit.
- Debt and liquidity: At September 30, the revolving credit facility had no balance; senior notes and convertible notes had net carrying values of $2.765 billion and $128.9 million, respectively. The company reported $1.107 billion of available facility capacity at September 30; the post-acquisition capacity reported at October 26 was $1.250 billion. The September 30 borrowing base was $1.1 billion, subsequently increased to $1.35 billion effective upon the Rock Oil closing. The company reported compliance with debt covenants through the filing date.
- Capital and shareholder financing: Nine-month capital expenditures and property acquisitions totaled $514.6 million. The company raised $530.9 million net through an 18.4 million-share offering, $166.7 million net from 1.50% convertible notes, and $491.6 million net from 6.75% notes due 2026. Shares outstanding increased to 86.9 million from 68.1 million at year-end 2015. Quarterly dividend was $0.05 per share.
Material changes, outlook, and risks
- Portfolio transactions: Q3 divestitures generated $165.2 million net proceeds. The $991.0 million adjusted Rock Oil acquisition closed October 4, 2016, after quarter-end. Subsequent to quarter-end, SM Energy agreed to sell Raven/Bear Den assets for $785 million gross, subject to adjustments and closing conditions, and entered into QStar/RRP acquisition agreements for $1.1 billion cash plus approximately $500 million of stock (about 13.4 million shares). QStar was expected to close in mid-December 2016; the filing cautions that pending transactions may not close as planned.
- Guidance: Management expected 2016 capital spending of approximately $700 million, excluding acquisitions, with about 85% directed to drilling and completion. It expected Q4 production to decline from Q3, partly offset by Rock Oil production. Management expected full-year 2016 LOE per BOE and G&A per BOE to be below 2015 levels, and did not expect material Q4 impairments based on then-current price assumptions.
- Commodity outlook and hedging: Management expected prices to remain near then-current levels for the rest of 2016 and increase in 2017, while emphasizing volatility and uncertainty. Derivatives partly mitigated near-term price exposure; the net derivative asset was $61.1 million at quarter-end. Nine-month derivative results included a $121.1 million mark-to-market loss, while cash settlements remained an important operating-cash source.
- Risks and commitments: Commodity-price weakness could reduce cash flow, borrowing capacity, reserves, and asset values; further price declines or changed drilling plans could trigger impairments. The filing identifies acquisition integration, reserve and production estimates, funding, covenant, and transaction-closing risks. Minimum gathering, processing, and transportation commitments totaled approximately $1.0 billion of potential undiscounted deficiency payments if no volumes were delivered; management did not expect material shortfalls. A new Eagle Ford water-disposal agreement could entail approximately $23 million of deficiency payments if no water were delivered. A workforce reduction and Billings office closure were expected to involve about $8 million of exit costs; a subsequent lease termination agreement required a $3.2 million fee.
Important facts for investors to verify
- Whether the Raven/Bear Den divestiture and QStar/RRP acquisitions closed on expected terms, and the resulting net proceeds, adjustments, liabilities, and funding needs.
- Post-Rock Oil cash, debt, borrowing-base availability, covenant headroom, and the effect of planned credit-facility borrowing for QStar.
- Acquired-property reserves, production, development economics, and integration results, particularly given the substantial undeveloped acreage and incomplete purchase accounting.
- Production trends, realized prices, hedge coverage and settlements, and sensitivity of cash flows and impairments to commodity-price changes.
- Progress against the approximately $700 million 2016 capital plan and management’s expected production and cost trends.