SM Energy Co quarterly report, Q2 FY2014

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SM Energy Company — Q2 2014 Form 10-Q

Reporting period: Three and six months ended June 30, 2014. Unaudited results; comparisons are with the corresponding 2013 periods unless stated otherwise. SM Energy is an independent onshore oil, gas and NGL producer focused on liquids-rich plays.

Financial and operating performance

  • Q2 revenue: Oil, gas and NGL production revenue was $654.7 million, up 22%; total operating revenue was $675.0 million, up 21%.
  • Q2 earnings: Operating income was $121.7 million versus $144.3 million; net income was $59.8 million versus $76.5 million. Diluted EPS was $0.88 versus $1.13. The decrease primarily reflects a $126.5 million derivative loss, compared with an $85.2 million derivative gain in Q2 2013.
  • Six-month results: Production revenue was $1.278 billion, up 27%; operating income was $250.4 million versus $190.5 million; net income was $125.4 million versus $93.2 million. Diluted EPS was $1.84 versus $1.38.
  • Production: Q2 equivalent production reached a quarterly record of 147.0 MBOE/day, up 12%. Six-month average production was 142.8 MBOE/day, up 16%. Growth was led by the Eagle Ford; Q2 oil and NGL volumes rose 21% and 41%, respectively, while gas volumes declined 3%.
  • Costs and prices: Q2 production expense increased 19% to $177.6 million, including higher transportation costs. Production cost per BOE rose 10% to $48.93. Realized price per BOE before derivative settlements rose 10% to $48.93; derivative cash settlements reduced Q2 realized oil price by $5.18/Bbl and gas price by $0.36/Mcf. DD&A per BOE fell 25% to $14.03.
  • Cash flow and investment: Six-month operating cash flow was $715.2 million, up 20%. Investing cash use was $832.6 million, including $778.6 million of capital expenditures and $98.6 million of property acquisitions, partly offset by $46.8 million of sale proceeds. Cash declined by $118.5 million to $163.8 million. Capital expenditures alone exceeded operating cash flow by about $63.4 million.
  • Debt and liquidity: Senior Notes totaled $1.6 billion; no revolving-credit borrowings or floating-rate debt were outstanding at June 30. Available credit capacity was approximately $1.299 billion, with a $2.2 billion borrowing base and $1.3 billion lender commitments. The company reported covenant compliance; debt/adjusted EBITDAX was 1.0 and adjusted current ratio was 3.0.

Material changes and notable items

  • Six-month derivative results swung to a $224.1 million loss from a $54.6 million gain in 2013. The 2014 loss included $62.6 million of cash-settlement losses and a $161.5 million decline in derivative fair value. Net derivative fair value was a $140.0 million liability at June 30, versus a $21.5 million asset at year-end 2013.
  • Production revenue growth reflected higher volumes and a 10% increase in realized price per BOE for the six-month period. Higher Eagle Ford activity also increased transportation expense; management expects company-wide transportation cost per BOE to rise as Eagle Ford becomes a larger share of production.
  • Q2 included $10.7 million of income from the Endeavour litigation settlement and $50.2 million of proceeds from divesting non-strategic Williston Basin assets; the estimated net divestiture gain was $27.8 million and remained subject to post-closing adjustments. Other operating revenues also reflected losses on certain assets held for sale.
  • No proved-property impairments were recorded in the first half, compared with $55.8 million in the first half of 2013. Exploration expense rose 26% to $45.6 million, including higher seismic and overhead costs.

Outlook, risks and contingencies

  • Management expected production to continue increasing and recurring LOE per BOE to remain stable for the rest of 2014. No numerical full-year production or capital-spending guidance is stated in the supplied filing text.
  • The remaining 2014 capital program was expected to be funded by operating cash flow and divestiture proceeds, with credit-facility borrowing or capital-market access available if needed. The Mitsui carry on certain non-operated Eagle Ford costs was exhausted in Q2, so SM Energy began funding its full share.
  • Operations included continued Eagle Ford and Bakken/Three Forks development, Powder River Basin delineation and a planned fourth operated rig there in Q3, and East Texas testing. After quarter-end, the company entered into Rocky Mountain property-acquisition agreements totaling approximately $345 million, including an agreement described for about 61,000 net acres adjacent to Gooseneck for approximately $330 million.
  • Commodity prices, production performance, transportation and service costs, access to capital, borrowing-base redeterminations, derivative outcomes and regulatory changes are key risks. The company cautioned that derivatives can produce losses and limit realized prices; additional Dodd-Frank margin requirements could increase cash-collateral needs.
  • Chieftain royalty litigation in Oklahoma remains unresolved; the company said it could not estimate the potential impact and expected a renewed class-certification motion in the first half of 2015. The IRS had proposed disallowing $4.6 million of R&D credits for 2007–2010; the company was appealing. Management stated other pending claims were not expected to have a material effect.
  • Rig contracts had $71.2 million of future minimum commitments at June 30, with an additional $18.1 million entered into after quarter-end. The company reported effective disclosure controls and no material changes to internal control over financial reporting.

Investor verification priorities

  1. Assess how much reported earnings and cash flow depend on derivative settlements, fair-value movements and the current hedge book; confirm hedge volumes, prices and exposure after subsequent contracts.
  2. Reconcile the capital program, acquisitions and divestiture proceeds with operating cash flow, cash balances and available credit—especially the post-quarter acquisitions and their funding.
  3. Track production growth and unit-cost trends, particularly Eagle Ford transportation costs and the impact of the expired Mitsui carry.
  4. Review the outcome and potential exposure of the Chieftain royalty case and the IRS R&D-credit appeal.
  5. Confirm post-closing adjustments to the Williston divestiture and monitor borrowing-base redetermination, covenant headroom and commodity-price sensitivity.