SM Energy Company — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; balance-sheet figures are as of March 31, 2011. SM Energy is an independent North American oil and gas producer focused on resource plays, including the Eagle Ford and Bakken/Three Forks.
Key financial and operating metrics
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Oil, gas and NGL production revenue | $276.3 million | $212.9 million |
| Total operating revenues and other income | $315.3 million | $360.1 million |
| Operating income (loss) | $(20.0) million | $207.8 million |
| Net income (loss) | $(18.5) million; $(0.29) per diluted share | $126.2 million; $1.96 per diluted share |
| Cash from operating activities | $156.7 million | $153.9 million |
| Capital expenditures | $309.7 million | $132.4 million |
| Production | 401.4 MMCFE/day | 285.8 MMCFE/day |
Production revenue rose 30%, supported by a 40% increase in equivalent production. Total operating revenues declined because the prior-year period included a much larger divestiture gain ($121.0 million versus $24.9 million). Q1 2011 results included an $88.4 million realized and unrealized derivative loss, including an $82.0 million noncash mark-to-market loss. The company ended the quarter with $191.3 million cash, $489.9 million current liabilities, and no credit-facility borrowings. It had $677.5 million available under the facility. Debt included $350 million of 6.625% senior notes and $287.5 million principal of 3.50% convertible notes; the latter were carried net of discount at $277.9 million.
Average realized prices were $85.79/Bbl for oil, $4.35/Mcf for gas and $46.65/Bbl for NGLs. Realized equivalent price was $7.65/MCFE, versus $8.28/MCFE a year earlier. Operating profit including derivative cash settlements was $4.89/MCFE, versus $5.59/MCFE. The reported GAAP current ratio is not stated; the company reported a 2.79 current ratio under its credit agreement.
Material changes and management commentary
- Production increased sharply, led by Eagle Ford development; South Texas and Gulf Coast supplied 37% of Q1 equivalent production. Oil and gas volumes rose 17% and 31%, respectively; NGL volumes were reported separately for the first time, so prior-period NGL comparisons are not directly comparable.
- The company discontinued cash-flow hedge accounting prospectively from January 1, 2011. Subsequent derivative fair-value changes are recorded immediately in earnings, contributing to quarter-to-quarter earnings volatility. Net derivative liabilities were $132.9 million at quarter-end.
- Q1 costs incurred for oil and gas activities were $290.7 million, up 112% year over year. The 2011 capital budget was approximately $1.0 billion, with about 80% of drilling capital allocated to Eagle Ford and Bakken/Three Forks.
- Management expected operating cash flow, note proceeds and anticipated divestiture or joint-venture proceeds to fund most of the 2011 program, with the credit facility available for any remaining need. Management said it did not anticipate near-term additional debt or equity issuance, but could consider financing alternatives.
- The company issued $350 million of 6.625% senior notes due 2019, using part of the net proceeds to repay its credit facility. The notes limit common dividends to $6.5 million annually during their term. Holders of the convertible notes obtained a right to convert during Q2 2011 after the share-price trigger was met; the company may settle in cash, shares or a combination.
- Management planned to increase operated Eagle Ford rigs to six by year-end and expected gas takeaway capacity to rise from about 100 MMcf/day to 230 MMcf/day by year-end 2011. It also planned to market or joint-venture approximately 20%–30% of its roughly 72,000 net Eagle Ford acres; bids were expected in Q2.
Risks, commitments and unusual items
- Commodity-price volatility, derivative valuation changes and hedges that can limit realized prices remain significant. Proposed derivatives rules could increase collateral requirements or costs; the ultimate effect was uncertain.
- Infrastructure constraints in the Eagle Ford could restrict takeaway, particularly for gas and condensate. A subsequent 10-year gathering agreement includes minimum-throughput commitments; if no gas is delivered, aggregate deficiency payments could total approximately $513.4 million over the term.
- A hydraulic-fracturing services contract creates a $180 million commitment over two years, with early-termination liability capped at $24 million.
- In an Eagle Ford overriding-royalty dispute affecting less than 1% of net acreage, a court granted plaintiffs’ summary judgment motion. The company intended to appeal; it recorded no loss accrual and did not consider an adverse outcome probable.
- The $122.8 million of assets held for sale included Pennsylvania/Mid-Continent assets and South Texas gathering assets. The January Rocky Mountain sale generated $44.4 million cash before costs and plan payments; final proceeds remained subject to adjustment.
- The company cited possible cost and operating impacts from environmental regulation, hydraulic-fracturing rules, greenhouse-gas requirements, and proposed changes to tax deductions relevant to oil and gas producers.
Important facts for investors to verify
- Whether Eagle Ford development, takeaway capacity and planned acreage farm-downs progress as expected, and how much capital or production they require.
- How much of the reported loss reflects noncash derivative remeasurement, and the effects of the new hedge-accounting presentation on future reported earnings.
- Whether the 2011 capital program is funded as planned, including the timing and value of expected asset sales or joint ventures and the status of the credit-facility renewal.
- The economic exposure under the gathering agreement’s minimum-volume commitments and the circumstances that could trigger deficiency payments.
- Convertible-note conversion or repurchase decisions, and compliance with debt, dividend and other covenants.