Chesapeake Energy Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; comparative periods ended September 30, 2017. The supplied filing is for Chesapeake Energy Corporation, not a filing under the name Expand Energy Corp. Financial amounts below are in U.S. dollars; unless stated otherwise, amounts are in millions.
Business context and reporting period
Chesapeake was an independent U.S. oil and gas exploration and production company, with operations spanning the Eagle Ford, Marcellus, Haynesville, Utica, Mid-Continent and Powder River Basin. Management’s priorities were debt reduction, funding capital spending with operating cash flow, and improving margins. The statements are unaudited.
Financial results and liquidity
- Q3 revenue: $2,418, up 24% from $1,943. Oil, natural gas and NGL revenue was $1,199 versus $979; marketing revenue was $1,219 versus $964. Marketing revenue and expense largely offset, with a Q3 marketing gross loss of $19.
- Q3 earnings: Operating income was $280 versus $94, an operating margin of approximately 11.6% versus 4.8%. Net income attributable to Chesapeake was $84 versus a loss of $18. Income available to common stockholders was $60, or $0.07 per diluted share, versus a loss available to common stockholders of $41, or $0.05 per share.
- Nine-month results: Revenue was $7,162 versus $6,977; operating income was $588 versus $734; and net income attributable to Chesapeake was $360 versus $616. Diluted EPS was $0.32 versus $0.56. Income available to common stockholders was $288 versus $506.
- Production and pricing: Q3 production averaged 537 mboe/day, down 1%; adjusted for assets sold, production averaged 536 mboe/day, up 5%. Average sales price was $26.92/boe, up 28%. For the nine months, total production averaged 540 mboe/day, up 2%, and the average price was $26.59/boe, up 18%.
- Cash flow and spending: Nine-month operating cash flow was $1,595 versus $273 in 2017. Investing cash outflow was $1,192 and financing cash outflow was $404. Drilling and completion costs were $1,481; total oil and gas expenditures, including acquisitions and capitalized interest, were $1,725. Cash ended at $4.
- Debt and liquidity: September 30 debt principal was $9,862, down 1% from $9,981 at year-end 2017; carrying value was $9,812. Cash was $4, and working capital deficit was $1,741 versus $831 at year-end. The $3.0 billion revolving facility had $645 drawn, $182 in letters of credit, and reported available capacity of $2,173. Chesapeake reported compliance with applicable covenants; its leverage ratio was approximately 3.82:1.
- Margins and costs: Q3 production expense was $2.68/boe versus $3.03; gathering, processing and transportation expense was $7.36/boe versus $7.40. Nine-month DD&A rose to $813 from $627, or $5.51/boe from $4.31, reflecting a higher depletion rate and production.
Material changes and unusual items
- Oil, gas and NGL sales before derivative effects rose 27% in Q3 and 20% for the nine months. However, nine-month reported oil, gas and NGL revenue fell to $3,424 from $3,727 after derivative results; derivative losses were $500 versus gains of $452 in the prior-year period.
- ASC 606 adoption changed certain marketing contracts from gross to net presentation. For the nine months, it reduced both reported marketing revenue and marketing expense by $582 and $567, respectively, without affecting operating income, EPS or cash flow; comparisons of reported revenue therefore require care.
- Q3 included a $65 loss on repayment of the secured term loan and a further $3 loss on credit-facility amendment costs. The nine-month period also included $139 of FTS International investment gains, a $61 gain on extinguishing the Utica overriding-royalty obligation, $38 of workforce-restructuring costs and $51 of impairments.
- In September, Chesapeake issued $850 of 7.00% notes due 2024 and $400 of 7.50% notes due 2026, using proceeds and other funding to repay its $1,233 secured term loan. The revolving facility was amended to mature in September 2023.
Outlook, risks and contingencies
- Management forecast 2018 capital expenditures, including capitalized interest, of $2.2–$2.5 billion, below 2017 spending of $2.5 billion, and expected modest production growth adjusted for asset sales. Its stated 2018 objective was to reduce debt by $2–$3 billion.
- After quarter-end, Chesapeake completed the sale of its Ohio assets to Encino on October 29 for $1.868 billion net cash proceeds, with up to $100 million of contingent payments tied to specified gas-price conditions. Chesapeake gave notice to redeem all $1.416 billion principal of its 8.00% second-lien notes, with redemption funded from sale proceeds.
- On October 30, Chesapeake announced a definitive agreement to acquire WildHorse in a transaction valued at approximately $3.977 billion, including WildHorse net debt of $930 million. The transaction, expected to close in the first half of 2019, was subject to shareholder, regulatory and other approvals. Consideration could include substantial Chesapeake share issuance and cash funded through the revolver; risks include dilution, financing, integration, deal costs and failure to close.
- Management expected available cash, operating cash flow and revolver capacity to fund planned spending and obligations for the next 12 months, but cautioned that liquidity beyond that period was not assured. Commodity-price volatility, refinancing and covenant capacity, access to capital, and possible additional collateral demands are key risks. As of October 26, the company reported $222 million of collateral posted and possible additional requests of approximately $441 million.
- Open gathering, processing and transportation commitments totaled $8.444 billion undiscounted. Legal matters included OOGC arbitration seeking unspecified potentially material relief and HOOPP arbitration seeking rescission or $215 million in damages, plus other relief. Chesapeake said it intended to defend both claims. The full valuation allowance against deferred tax assets also reflects uncertainty about future realization.
Important facts for investors to verify
- Whether the Ohio sale proceeds were applied as planned to redeem the second-lien notes, and the resulting debt, interest expense and liquidity position.
- Whether the WildHorse acquisition closed on its stated terms, including actual cash needs, share issuance, dilution, debt assumed and expected synergies.
- Underlying operating cash generation and capital requirements, separating commodity-price effects, derivative settlements and one-time or noncash gains and charges.
- Available revolver capacity after letters of credit, collateral requirements, debt maturities and covenant tests; reconcile the filing’s stated working-capital deficit with current debt maturities.
- Outcomes and potential financial exposure from the OOGC and HOOPP arbitrations, and the effect of long-term midstream commitments and commodity hedges.