SM Energy Company — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013. Financial statements are unaudited. SM Energy is an independent North American oil and gas producer focused on oil- and liquids-rich plays, including the Eagle Ford and Bakken/Three Forks.
Financial and operating performance
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Oil, gas and NGL production revenue | $469.6 million | $362.6 million |
| Total operating revenue | $484.2 million | $377.4 million |
| Income from operations | $46.2 million | $56.2 million |
| Net income | $16.7 million | $26.3 million |
| Diluted EPS | $0.25 | $0.39 |
| Net cash provided by operating activities | $282.3 million | $188.1 million |
| Capital expenditures, cash basis | $381.2 million | $335.0 million |
| Net cash used in investing activities | $378.9 million | $331.8 million |
| EBITDAX, non-GAAP | $328.8 million | $259.0 million |
Average production reached a record 115.0 MBOE/day, up 24% year over year. Oil and NGL volumes rose 26% and 60%, respectively; gas volumes increased 14%. Production revenue grew 30%, reflecting higher volumes and a 6% increase in realized revenue per BOE. Realized oil was $91.67/Bbl, gas $3.57/Mcf, and NGLs $36.65/Bbl; NGL realized price declined 18% year over year.
Operating margin was approximately 9.5% of revenue versus 14.9% in Q1 2012; net margin was approximately 3.5% versus 7.0%. These are calculated from reported results. Production expense increased 44% to $125.6 million, including higher lease operating and transportation costs. DD&A and asset-retirement accretion increased to $198.7 million. A $21.5 million property impairment and $30.6 million realized and unrealized derivative loss also weighed on earnings; the comparable derivative loss was $2.2 million in Q1 2012.
Liquidity, debt and balance sheet
At March 31, 2013, cash and cash equivalents were $0.1 million, restricted cash $106.8 million, and current assets $320.2 million against current liabilities of $510.2 million. The resulting reported working-capital deficit was approximately $190.0 million. Total debt was $1.53 billion: $430 million drawn on the revolver and $1.10 billion of senior notes. Operating cash flow less cash capital expenditures was approximately negative $98.9 million. The company funded the gap partly with $90 million of net revolver borrowings.
Subsequent to quarter-end, the company amended and extended its revolving credit facility: lender commitments increased to $1.3 billion, the borrowing base to $1.9 billion, and maturity to April 12, 2018. At April 25, $470 million was drawn and available borrowing capacity was $829.2 million. At March 31, the company reported covenant ratios of 1.4 debt to EBITDAX and 1.8 adjusted current ratio, and stated it was in compliance with covenants. Senior-note coupons range from 6.50% to 6.625%; Q1 weighted-average borrowing rate was 5.4%.
Material changes and management outlook
- Production growth, led by the Eagle Ford, drove higher revenue and operating cash flow, but earnings declined year over year amid derivative losses, impairment, and higher operating costs.
- Management budgeted a 2013 capital program of $1.5 billion, including $1.2 billion for drilling and completion; approximately 90% of that budget was designated for Eagle Ford, Bakken/Three Forks, and Permian programs. Management expected operating cash flow and revolver availability to fund the program, with a shortfall anticipated to be financed through borrowings; capital markets or asset divestitures were additional options.
- Management expected production to increase annually for the next several years. It expected lease operating costs per BOE to remain relatively stable in 2013, while transportation costs per BOE could rise as Eagle Ford becomes a larger share of production.
- Mitsui was carrying 90% of certain drilling and completion costs on the company’s remaining interest in non-operated Eagle Ford acreage, up to a $680 million commitment. Approximately $347.3 million had been spent by March 31; the remainder was expected to be used during 2013 and into 2014.
- Commodity derivatives covered portions of anticipated production through Q4 2015: 13.0 million barrels of oil, 119.0 million MMBtu of gas, and 1.5 million barrels of NGLs. Derivative fair value shifted from a net asset of $38.7 million at year-end 2012 to a net liability of $3.6 million at March 31, 2013.
Risks, contingencies and unusual items
- Oil, gas and NGL prices are volatile; management cited potential near-term NGL supply growth and continued uncertainty in gas markets. Lower prices could reduce cash flow, borrowing capacity and investment flexibility. Derivatives mitigate some price exposure but can generate losses or limit upside.
- The IRS issued an April 23, 2013 proposed adjustment disallowing R&D tax credits claimed for open audit years. The company intends to contest the position; the filing does not provide a clear estimate of potential exposure.
- A putative Oklahoma royalty class action alleges improper deductions of post-production costs. Proceedings were stayed pending appellate rulings in similar cases. The company denied the allegations and stated it could not estimate the action’s financial impact.
- The $21.5 million impairment related primarily to non-Eagle Ford dry-gas assets and a plugging-and-abandonment program. The Net Profits Plan liability is a Level 3 estimate sensitive to commodity-price assumptions; management estimated that a 5% change in prices would change the liability by approximately $7 million.
- Management noted possible future costs or collateral requirements from evolving derivatives regulation, as well as risks from drilling results, service and water-disposal costs, transportation capacity, reserve replacement, and access to capital.
Important facts for investors to verify
- Whether production growth and the $1.5 billion 2013 capital program convert into sustainable operating cash flow, particularly given cash capex exceeded operating cash flow in Q1.
- Current revolver utilization, borrowing-base availability and covenant headroom following the post-quarter-end facility amendment and future borrowing-base redeterminations.
- How much Q1 earnings volatility reflects non-cash derivative mark-to-market losses, and the effect of hedge settlements and coverage on future realized prices and cash flows.
- Potential tax exposure from the IRS R&D credit dispute and any developments in the Oklahoma royalty litigation.
- Whether rising transportation and operating costs, lower NGL prices, or impairment of other properties could offset production and revenue growth.