SM Energy Company — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. SM Energy is an onshore North American oil, gas, and NGL producer, focused on its Midland Basin and Eagle Ford assets. The unaudited interim statements are prepared under U.S. GAAP.
Financial results and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Oil, gas, and NGL production revenue | $402.6 million | $284.9 million | $785.4 million | $618.1 million |
| Net income (loss) | $17.2 million | $(119.9) million | $334.6 million | $(45.5) million |
| Diluted earnings (loss) per share | $0.15 | $(1.08) | $2.95 | $(0.41) |
| Cash from operating activities | $171.4 million | $107.1 million | $311.5 million | $242.1 million |
| Adjusted EBITDAX (non-GAAP) | $225.0 million | $154.0 million | $435.1 million | $326.0 million |
- Q2 operating income was $56.1 million, compared with an operating loss of $147.3 million a year earlier. Q2 included a $39.5 million divestiture gain and a $63.7 million net derivative loss. First-half results included a $424.9 million divestiture gain and a $71.3 million net derivative loss.
- At June 30, cash was $615.9 million; available borrowing capacity was $999.8 million, with no revolver borrowings. The company reported $1.6 billion of liquidity.
- Senior Notes had $2.801 billion aggregate principal outstanding and Senior Convertible Notes had $172.5 million principal outstanding at June 30. The 2021 Senior Notes were classified as current; they were redeemed on July 16 for $355.9 million, including accrued interest. The company expected to record a $9.8 million extinguishment loss in Q3.
- Six-month capital expenditures and unproved-property acquisitions totaled $747.9 million. Cash proceeds from oil and gas property sales were $742.2 million.
Material changes versus comparable periods
- Production revenue rose 41% in Q2 and 27% in the first half, primarily reflecting higher realized prices and strong Midland Basin growth. Average daily production fell 8% in Q2 and 12% in the first half, mainly due to prior and current-period divestitures and declines in retained assets.
- Permian production increased 110% in Q2 and 106% in the first half year over year; oil production became a larger share of the mix. The company sold its Powder River Basin, Divide County, and Halff East assets during the first half, and expected no Rocky Mountain production after Q2.
- Realized prices before derivative settlements increased 53% per BOE in Q2 and 44% in the first half. Q2 oil, gas, and NGL production expense declined 6%, while lease operating expense per BOE increased 13% and transportation cost per BOE decreased 22%.
- Operating cash flow improved year over year. Investing cash flow was a $5.7 million use in the first half versus $311.4 million provided in 2017, reflecting higher capital spending and lower divestiture proceeds.
Outlook, risks, and unusual items
- Management forecast a 2018 capital program of approximately $1.31 billion, excluding acquisitions, with more than 80% directed to drilling and completions and approximately 86% of drilling and completion capital allocated to the Midland Basin. The budget was increased by $40 million, mainly for higher Midland Basin working interests.
- Management expected full-year 2018 production to be in line with 2017, with Midland Basin growth offsetting divestitures and declines elsewhere. It cited stronger-than-expected Midland Basin well results and planned to average seven operated rigs and four completion crews there.
- Management warned that Permian takeaway capacity could remain tight through mid-to-late 2019, potentially increasing basis differentials. Commodity prices remain volatile; derivatives partially mitigate price and basis exposure but can limit realized prices and generate losses. The company reported a net derivative liability of $149.4 million at June 30.
- Management said liquidity was adequate to execute its plan and expected operating cash flow and divestiture proceeds to fund the 2018 program and subsequent note redemption. Credit covenants were met. The next borrowing-base redetermination was scheduled for October 1, 2018.
- Gathering, processing, transportation, and purchase commitments could entail approximately $360.6 million of undiscounted deficiency payments if minimum volumes are not met; management did not expect material shortfalls. Drilling and completion contracts totaled $103.1 million, with $40.4 million of immediate termination penalties.
- Quarterly correction: Q2 included $18.9 million of noncash, after-tax adjustments relating to Q1—$17.7 million of divestiture loss and $6.7 million of additional DD&A expense. Management said the corrections were immaterial to either quarter and fiscal 2018; they overstated Q1 income and understated Q2 income by approximately $18.9 million, with no effect on first-half statements.
- Management expected higher 2018 LOE, DD&A, and ad valorem taxes per BOE, while total G&A was expected to remain broadly flat. No material changes to previously disclosed risk factors were reported; ordinary-course litigation was not expected to have a material effect.
Important facts for investors to verify
- How realized oil prices, Midland Basin production growth, and Permian takeaway constraints affect cash generation and the 2018 production outlook.
- Whether the $1.31 billion capital program is funded as expected after the $355.9 million note redemption, and how remaining debt and covenant headroom evolve.
- The final purchase-price adjustments and realized proceeds/gains from the three 2018 asset sales, and the effect of exiting Rocky Mountain production.
- Derivative settlements, fair-value changes, and hedge coverage—including their effect on realized prices and the reported derivative liability.
- Whether production and purchase commitments are met and whether any deficiency payments or drilling-contract termination costs arise.
- The implications of the disclosed Q1/Q2 noncash correction and the expected Q3 debt-extinguishment loss for period-to-period comparisons.