Chesapeake Energy Corporation — Q3 2012 Form 10-Q
Filing identity: The supplied filing is Chesapeake Energy Corporation’s unaudited Form 10-Q for the quarter ended September 30, 2012; it does not identify Expand Energy Corp. Financial figures below are in millions of dollars unless stated otherwise.
Business context and reporting period
Chesapeake explored and produced natural gas, oil and natural gas liquids (NGL), with related marketing, gathering and compression, and oilfield-services businesses. Management described a strategic shift from a gas-focused portfolio toward liquids production, alongside asset sales intended to reduce debt and fund capital spending. Comparisons are to the three and nine months ended September 30, 2011.
Key financial metrics
| Metric | Q3 2012 | Nine months 2012 | Comparable 2011 |
|---|---|---|---|
| Total revenue | $2,970 | $8,778 | $3,977 Q3; $8,908 nine months |
| Net income (loss) | $(1,971) | $(938) | $922 Q3; $1,269 nine months |
| Net income (loss) attributable to Chesapeake | $(2,012) | $(1,069) | $922 Q3; $1,269 nine months |
| Loss per common share, diluted | $(3.19) | $(1.86) | $1.23 Q3; $1.69 nine months |
| Cash from operating activities | Not separately stated for quarter | $1,978 | $3,724 nine months |
| Cash used in investing activities | Not separately stated for quarter | $(8,154) | $(3,715) nine months |
| Cash from financing activities | Not separately stated for quarter | $5,981 | $0 nine months |
| Cash and cash equivalents | $142 at September 30 | $351 at December 31, 2011 | |
| Total debt, net of discounts and stated adjustments | $16,218 at September 30 | $10,626 at December 31, 2011 |
Q3 operating loss was $3,194, including a $3,315 non-cash impairment of natural gas and oil properties. Nine-month operating loss was $2,450. The nine-month period also included a $1,061 gain on sales of investments, principally the sale of Chesapeake’s Access Midstream Partners interest. Interest expense was $63 for the nine months, versus $37 in 2011; reported expense was reduced by capitalized interest.
At September 30, current assets were $3,611 and current liabilities were $6,456, a working-capital deficit of about $2,845 before considering management’s separately stated cash-availability measure. Management reported approximately $2.5 billion of cash availability and negative working capital of approximately $466 million when including cash availability. The filing does not provide a simple reconciliation of those two measures in the supplied text.
Material changes versus the prior comparable period
- Nine-month revenue was broadly level, but net income swung to a $938 loss from $1,269 income. Q3 revenue fell to $2,970 from $3,977, and the quarter changed from $922 income to a $1,971 net loss.
- Production grew: nine-month production was 1,060.5 bcfe, up from 863.3 bcfe. Oil production rose to 22.3 million barrels from 11.7 million; natural-gas production rose to 848.6 bcf from 731.9 bcf.
- Despite higher volumes, realized nine-month prices excluding unrealized derivative effects fell: natural gas to $2.06/mcf from $5.10/mcf and NGL to $30.17/barrel from $39.10. Oil realized price increased to $91.55/barrel from $85.45. The resulting lower realized gas price was a major factor in reduced operating cash flow.
- Nine-month operating cash flow declined to $1,978 from $3,724. Capital spending and acquisitions outpaced operating cash generation, while investing outflows increased substantially.
- Debt rose materially during the period, and the company amended its revolving-credit covenant after management said it otherwise would not have met the September 30 leverage requirement. Chesapeake’s reported indebtedness-to-EBITDA ratio was approximately 4.83 to 1.00.
Outlook, management commentary, risks and unusual items
- Capital and production outlook: Management budgeted 2013 drilling and completion spending of $5.75–$6.25 billion, new leasehold spending of about $500 million, and midstream, oilfield-services and other investment of $850 million–$1.1 billion. It projected 2013 operating cash flow before working-capital changes of $4.25–$5.25 billion, based on stated commodity-price assumptions. Management projected a 7% decline in natural-gas production in 2013 and targeted liquids production of about 170,000 barrels per day in 2013 and 250,000 in 2015.
- Asset sales and debt: The company expected $17–$19 billion of asset-sale proceeds in 2012–2013 and reported $8.4 billion of 2012 sales completed through November 7. Management said sales, operating cash flow and borrowing were intended to fund investment and bring long-term debt to no more than $9.5 billion in 2013. Not all planned sales had binding agreements. After quarter-end, Chesapeake reported $2.715 billion of net proceeds from Delaware Basin sales and a November 9 $2 billion term-loan facility; proceeds were used to repay the May 2012 term loans and reduce revolving-credit borrowings.
- Liquidity and covenant risk: Management said capital expenditures would continue to exceed operating cash flow through 2013, although the gap was expected to narrow. The amended corporate revolver leverage limits step down from 6.00:1 at September 30, 2012 to 4.25:1 at September 30, 2013, then return to 4.00:1 at December 31, 2013. Failure to comply could trigger acceleration and cross-defaults. Forecast compliance depended in part on commodity prices, spending flexibility and asset-sale timing and proceeds.
- Commodity and reserve exposure: About 70% of estimated proved reserves at September 30 were natural gas. The SEC trailing-average gas price used for reserves fell 31%, to $2.83/mcf from $4.12; proved reserves declined to 16.222 tcfe from 18.789 tcfe at the start of 2012, primarily due to downward price revisions. Chesapeake warned that further price declines could cause additional impairment. Its open commodity derivatives had a net fair-value liability of about $1.034 billion, and 2013 natural-gas production was unhedged at the reporting date.
- Legal, regulatory and environmental matters: The filing describes securities, derivative, executive-compensation, ERISA and other shareholder litigation, and SEC and other agency inquiries. The company said it could not estimate potential losses in certain cases. A subsidiary agreed to plead guilty to three Clean Water Act misdemeanors, with $600,000 in fines and a proposed two-year probation term subject to court approval; related civil matters remained ongoing.
- Other unusual items: Chesapeake recorded the $3.315 billion property impairment, $286 million of fixed-asset sale and impairment losses for the nine months, and $25 million of drilling-rig early-termination costs. It also recorded a $1.032 billion gain from selling its Access Midstream investment. A Barnett Shale acreage-maintenance shortfall could lead to an approximately $36 million cash payment to Total in 2013.
- Controls and dividends: Management concluded disclosure controls were effective as of September 30, 2012, with no material change in internal control reported for the quarter. The common dividend declared was $0.0875 per share for Q3; preferred dividends also remained payable.
Most important facts for investors to verify
- Whether announced and pending asset sales closed on schedule and at expected proceeds, and how much debt was actually repaid afterward.
- Current debt, available revolver capacity, covenant headroom and compliance under the amended leverage schedule.
- Whether operating cash flow and planned capital spending track management’s 2013 assumptions, especially if gas prices remain low.
- Subsequent reserve revisions, ceiling-test impairments, production trends and the economics of the liquids-focused shift.
- How unhedged 2013 gas exposure and the large derivative liability affect realized prices, cash flow and collateral requirements.
- Developments in material litigation, regulatory inquiries and environmental proceedings, including any loss estimates or sanctions.