SM Energy Company — 2016 Form 10-K
Business context and reporting period. SM Energy is an independent onshore North American oil and gas exploration and production company. This filing covers the fiscal year ended December 31, 2016; quarterly figures below identify the fourth quarter where relevant. The company shifted its portfolio toward operated Midland Basin and Eagle Ford assets, acquiring approximately 62,000 net Midland Basin acres for about $2.6 billion in cash and stock while divesting non-core properties.
Financial and operating performance
- Revenue and earnings: 2016 total operating revenue and other income was $1.217 billion, down 22% from $1.557 billion in 2015. Net loss widened to $757.7 million, or $9.90 per diluted share, from a $447.7 million loss, or $6.61 per share. Operating loss was $1.059 billion.
- Fourth quarter: Revenue and other income was $379.9 million and net loss was $200.9 million, or $2.20 per share. In Q4 2015, these were $303.7 million and a $340.3 million net loss, or $5.01 per share.
- Production and pricing: Production fell 14% to 55.3 MMBOE (151.0 MBOE/day). Average realized prices before derivative settlements were $36.85/Bbl oil, $2.30/Mcf gas and $16.16/Bbl NGLs; blended realized price was $21.32/BOE, down 9% year over year. Derivative cash settlements added $329.5 million, or $5.96/BOE.
- Costs and margins: Production expense was $597.6 million, down 17%; lease operating expense declined to $3.51/BOE, while transportation cost was $6.16/BOE. DD&A was $790.7 million. The filing does not provide a single headline operating-margin figure; the reported operating loss reflects substantial impairments, DD&A and derivative mark-to-market expense.
- Cash flow and investment: Operating cash flow was $552.8 million, down 43%. Investing cash outflow was $1.871 billion, including $2.184 billion for property acquisitions, partly offset by $946.1 million of divestiture proceeds. Adjusted EBITDAX, a non-GAAP measure, was $790.8 million versus $1.125 billion in 2015.
- Debt and liquidity: Year-end cash was $9.4 million; working capital was a $190.5 million deficit. Principal long-term debt was approximately $2.976 billion; the revolver had no year-end borrowings and approximately $1.165 billion of available capacity, subject to borrowing conditions. Debt was 54% of book capitalization. The borrowing base and lender commitments had fallen to $1.17 billion, with a further reduction expected after the Eagle Ford sale and reserve changes.
- Reserves: Proved reserves declined 16% to 395.8 MMBOE, including 187.1 MMBOE proved undeveloped. Standardized measure of discounted future net cash flows fell to $1.152 billion from $1.791 billion. Reserve changes included 108.2 MMBOE added through drilling, 47.7 MMBOE sold and 96.2 MMBOE of negative revisions.
Material changes versus 2015
- Production revenue declined 21%, reflecting both lower production volumes and lower realized prices. Average daily production decreased 14%, mainly due to reduced drilling and divestitures.
- Net loss increased by $310.0 million. A $250.6 million net derivative loss in 2016 contrasted with a $408.8 million gain in 2015; proved and unproved property impairments totaled $435.0 million.
- The company acquired the Rock Oil and QStar Midland Basin properties, funded through equity issuance, debt and asset-sale proceeds. Public equity offerings generated $934.1 million net, and approximately 13.4 million shares were also issued as acquisition consideration.
- Operating cash flow decreased from $978.4 million. Senior Notes and convertible debt increased, while the company repaid its $202.0 million year-end 2015 credit-facility balance.
Outlook, commentary and risks
- Management planned approximately $875 million of 2017 capital spending, excluding acquisitions, focused on operated Midland Basin and Eagle Ford acreage. It intended to increase Midland Basin activity to six rigs, run one to two Eagle Ford rigs, and reduce debt.
- Management expected 2017 total production to decrease versus 2016 because of completed and planned divestitures, partly offset by higher Midland Basin activity. It expected 2017 funding from operating cash flow and asset-sale proceeds, while retaining debt and equity financing as possible alternatives.
- The outside-operated Eagle Ford sale was under definitive agreement for $800 million gross, with closing expected in Q1 2017. The company also announced plans to sell its remaining Divide County, North Dakota assets by mid-2017; it estimated a related Q1 2017 impairment of $200–$400 million.
- Commodity prices, reserve estimates, acquisition execution, access to capital and future borrowing-base redeterminations are key uncertainties. The company had $970.9 million of potential undiscounted deficiency payments under long-term delivery commitments if no product were delivered; management said it did not expect material shortfalls. The Eagle Ford sale was expected to remove $501.9 million of those potential payments.
- Other significant risks include debt service and restrictive covenants, derivative counterparty performance and price limits, third-party-operated assets, infrastructure constraints, drilling and completion execution, and environmental and regulatory requirements. The company reported compliance with its credit covenants through the filing date.
Important facts for investors to verify
- Whether the $800 million Eagle Ford transaction closed on expected terms and how the proceeds were allocated between debt reduction and investment.
- Whether the planned Divide County sale closed and whether the estimated $200–$400 million impairment was recorded.
- The outcome of the April 2017 borrowing-base redetermination, available revolver capacity and compliance with debt covenants.
- Production, costs and reserve additions from the acquired Midland Basin acreage, including whether development converts unproven acreage into economic reserves.
- How commodity prices and derivative settlements affect realized cash flows, reserve values and further impairment risk.
- The dilution and capital-allocation effects of 2016 equity issuance, alongside the company’s debt-reduction plans and dividend policy.