Diamondback Energy, Inc. annual report, FY2014

Diamondback Energy, Inc. — FY 2014 Form 10-K

Reporting period: Fiscal year ended December 31, 2014. The filing also reports fourth-quarter results; this is an annual filing, not a standalone Q4 filing. Financial amounts below are U.S. dollars unless stated otherwise.

Business context and reporting period

Diamondback is an independent oil and gas producer focused on the Permian Basin in West Texas, primarily developing the Wolfberry play. At year-end it held approximately 85,369 net leasehold acres and, through Viper Energy Partners, mineral interests underlying approximately 15,948 net acres. Diamondback owned approximately 88% of Viper and consolidated it in its financial statements.

Key financial and operating metrics

Metric	FY 2014	FY 2013
Revenue	$495.7 million	$208.0 million
Income from operations	$212.7 million	$95.2 million
Net income attributable to Diamondback	$193.8 million	$54.6 million
Diluted earnings per share	$3.64	$1.29
Net cash from operating activities	$356.4 million	$155.8 million
Net cash used in investing activities	$1,482.0 million	$940.1 million
Adjusted EBITDA, non-GAAP	$392.2 million	$164.8 million

Average production increased 166% to 19,474 BOE/d; FY 2014 production was 76% oil, 14% natural gas liquids and 10% natural gas. Oil, NGL and gas sales were 91%, 6% and 3% of revenue, respectively.
Average realized price before derivatives was $69.74/BOE, down from $77.84/BOE. Oil averaged $83.48/barrel versus $93.32; NGL averaged $28.39/barrel versus $36.00. After derivatives, realized oil and combined prices were $85.42/barrel and $71.21/BOE.
Lease operating expense was $7.79/BOE, versus $7.92; DD&A was $23.92/BOE, versus $24.92. Operating income was approximately 42.9% of revenue; this measure does not adjust for derivative gains reported below operating income.
Net income included a $127.5 million net derivative gain, comprising a $117.1 million gain in fair value of open contracts and $10.4 million of settlement gains. Derivatives were not designated as accounting hedges; fair-value changes therefore ran through earnings.
Operating cash flow was substantially below investing outlays. The company funded its large acquisition and development program with equity offerings, Viper unit offerings and net revolver borrowings.
Year-end cash was $30.2 million; current assets were $251.7 million and current liabilities were $266.7 million. Total debt was $673.5 million: $450.0 million of 7.625% senior notes due 2021 and $223.5 million drawn on the revolver.
The company’s revolver had a $750 million borrowing base, but a $500 million elected commitment; $276.5 million was available at year-end. Viper had a $110 million borrowing base and no borrowings. Diamondback reported compliance with its financial covenants.
Proved reserves were 112.8 million BOE, up from 63.6 million BOE; 58.9% were proved developed. The standardized measure of discounted future net cash flows was $2.045 billion, a reserve-accounting estimate rather than current market value.

Material changes versus the prior comparable period

Revenue rose 138%, driven primarily by higher production volumes from drilling and acquisitions; lower average commodity prices reduced revenue by approximately $58.2 million, partly offsetting an estimated $346.0 million volume contribution.
Operating cash flow more than doubled, while investing cash use increased to $1.482 billion. FY 2014 investment included approximately $499.8 million for drilling and infrastructure and $845.8 million for leasehold interests.
Debt increased from $460.0 million to $673.5 million, principally reflecting higher revolver borrowings; the $450 million senior notes were unchanged.
Diamondback completed two major leasehold acquisitions for approximately $292.2 million and $523.3 million, and Viper completed its IPO and follow-on offering. Diamondback also issued common stock offerings that generated net proceeds of approximately $208.4 million and $485.0 million.
Proved developed reserves increased to 66.5 million BOE from 30.0 million BOE. PUD reserves increased to 46.3 million BOE from 33.6 million BOE, including 29.9 million BOE of extensions and discoveries; technical revisions reduced PUDs by 6.6 million BOE, largely after downgrading vertical locations as the company shifted toward horizontal development.

Outlook, management commentary, risks and unusual items

For 2015, management budgeted $400–$450 million of capital spending, including $285–$315 million for horizontal drilling and completions, and expected to drill 50–60 gross horizontal wells. It expected 7,500-foot lateral well costs of $6.2–$6.7 million and said completions could be deferred if service costs did not fall sufficiently.
Management planned to release two horizontal rigs and its vertical rig in February 2015, retaining three horizontal rigs. It cited the sharp oil-price decline and a goal of prioritizing returns and limiting debt. The filing reported WTI below $50/barrel in February 2015, following a decline from over $105 in June 2014.
Approximately 10,700 barrels per day of estimated 2015 production were hedged at an average $88.14/barrel through WTI, LLS and Brent swaps. The filing cautions that future production may not be hedgeable at comparable prices and that derivatives carry counterparty and volume risks.
Management believed operating cash flow and revolver capacity would fund operations through year-end 2015 under its price and production expectations; this depends on commodity prices, production, borrowing-base redeterminations and access to financing. The budget excludes land acquisitions.
Key risks include commodity-price volatility, a single-basin and formation concentration, substantial capital needs and leverage, reserve and PUD uncertainty, acreage expirations, water availability, infrastructure and service constraints, customer concentration, and environmental, hydraulic-fracturing and other regulatory requirements. Shell Trading and Enterprise Crude Oil accounted for 64% and 16% of FY 2014 revenue, respectively.
Other notable matters: the company recorded no proved-property impairment in 2014; routine litigation was not expected by management to have a material adverse effect. A $500,000 escrow deposit was disputed and deposited with a court pending determination. The company reported effective disclosure controls and internal control over financial reporting, with unqualified audit opinions.

Most important facts for investors to verify

Whether FY 2014 earnings and cash generation are sustainable after separating derivative fair-value gains from operating performance, and how realized prices evolved after year-end.
Whether the 2015 capital budget, production plan and well-cost assumptions remain achievable, and whether cash flow plus available borrowing capacity can fund them without further financing.
Current borrowing-base availability and covenant headroom following lower commodity prices, including any effect on reserve values and liquidity.
Production performance, development timing and economics of PUDs and newly acquired acreage, including reserve revisions and the proportion of reserves that remains undeveloped.
Hedge volumes, settlement exposure and counterparty credit, alongside the concentration of sales with Shell Trading and Enterprise Crude Oil.
Potential effects of lease expirations, water and infrastructure constraints, regulatory changes, and related-party arrangements with Wexford-affiliated entities.