SM Energy Company — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; unaudited. SM Energy is an independent onshore North American oil, gas, and NGL exploration and production company, focused on oil and liquids-rich plays. Results are not necessarily indicative of full-year performance.
Financial and operating performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total operating revenue | $632.7 million | $484.2 million | Up 31% |
| Income from operations | $128.6 million | $46.2 million | Up 178% |
| Net income | $65.6 million | $16.7 million | Up 292% |
| Diluted EPS | $0.96 | $0.25 | Up 284% |
| Net cash provided by operating activities | $299.7 million | $282.3 million | Up 6% |
| Capital expenditures | $351.7 million | $381.2 million | Down 8% |
| EBITDAX (non-GAAP) | $398.9 million | $328.8 million | Up 21% |
Oil, gas, and NGL production revenue was $623.1 million. Average daily production rose 21% to 138.6 MBOE, driven mainly by Eagle Ford development. Reported production was 3.7 million barrels of oil, 35.5 Bcf of gas, and 2.9 million barrels of NGLs. Realized price per BOE increased 10% to $49.96, primarily reflecting higher gas prices. Derived from reported totals, operating margin was approximately 20% of revenue versus 10% in Q1 2013; net margin was approximately 10% versus 3%.
Production expense increased 30% to $163.7 million, including transportation costs up 67% to $79.2 million. Transportation costs rose to $6.35 per BOE, partly because Eagle Ford production carries higher transportation expense. DD&A and asset-retirement accretion declined 11% to $177.2 million, and impairment expense fell to $2.8 million from $21.5 million. Derivative loss increased to $97.7 million, comprising $28.9 million of cash-settlement losses and a $68.7 million unfavorable fair-value change; this materially reduced reported earnings.
Cash, debt, and liquidity
Cash and cash equivalents were $236.4 million at March 31, 2014, down from $282.2 million at year-end. Operating cash flow was less than capital spending; the reported figures imply a roughly $52 million shortfall before other investing activity and financing. Net cash used in investing was $345.5 million. The company had no revolving-credit borrowings and $1.6 billion of fixed-rate Senior Notes outstanding. Available borrowing capacity was approximately $1.299 billion, after letters of credit. The credit facility borrowing base was reaffirmed at $2.2 billion; the company reported compliance with covenants, a debt-to-trailing-EBITDAX ratio of 1.0, and an adjusted current ratio of 4.1.
Current assets were $577.3 million and current liabilities were $515.3 million. The balance sheet also showed a net derivative liability of approximately $47.2 million, compared with a net derivative asset of approximately $21.5 million at December 31, 2013. The quarterly dividend was $0.05 per share.
Outlook, risks, and notable items
- Management expected a 2014 capital budget of $1.9 billion, including approximately $1.7 billion for drilling and completions; about 85% of the drilling budget was expected to go to Eagle Ford, Bakken/Three Forks, and Permian programs. Funding was expected from operating cash flow and divestiture proceeds, with credit-facility borrowing or other capital sources available if needed.
- Management expected production to continue increasing on retained properties. It anticipated stable recurring LOE per BOE, but rising company-wide transportation cost per BOE as Eagle Ford becomes a larger share of production.
- The Mitsui carry on substantially all costs for the company’s interest in a non-operated Eagle Ford program was expected to end in Q2 2014; the company planned approximately $250 million of un-carried spending in that program during 2014.
- After quarter-end, the company agreed to acquire approximately 7,000 net Rocky Mountain acres for about $100 million cash. Closing was expected in Q2, subject to conditions; completion was not assured.
- Commodity-price volatility is a principal risk. Derivatives covered production through Q2 2018 and reduced some price exposure, but can also limit upside and produce losses. Management noted regulatory uncertainty over potential margin and collateral requirements for derivatives.
- Other risks include the uncertain outcome of the Chieftain Oklahoma royalty class-action matter, for which the company could not estimate financial impact; an IRS dispute over $4.6 million of R&D tax credits; and execution, service-cost, transportation, and funding risks associated with the drilling program. The company settled its Endeavour litigation on April 16, 2014, for cash and other consideration; the filing does not provide a clear value for the settlement.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material changes to previously disclosed risk factors were reported.
Most important facts for investors to verify
- Whether production growth and realized prices support the planned $1.9 billion capital program, particularly after the Mitsui carry ends.
- The cash impact of capital spending, divestitures, and any resulting revolver use; Q1 operating cash flow was below capital expenditures.
- The drivers and future cash effects of derivative losses, the net derivative liability, and the company’s hedge volumes and contract prices.
- Whether transportation costs continue rising as Eagle Ford production grows, and whether operating efficiencies offset that increase.
- Closing and economics of the approximately $100 million post-quarter acreage acquisitions, and the eventual value of the Endeavour settlement.
- Developments in the Chieftain royalty litigation and IRS R&D-credit appeal, including any change in estimated exposure.