Business context and reporting period
Chesapeake Energy Corporation’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2014, compared with the same periods in 2013. The filing is for Chesapeake Energy Corporation, notwithstanding the different company name in the request metadata. Chesapeake reported average production of approximately 695,000 boe per day in Q2 and completed the spin-off of its oilfield services business, Seventy Seven Energy (SSE), on June 30.
Financial performance and position
Unless otherwise indicated, amounts are in U.S. dollars.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $5.152 billion | $4.675 billion | $10.198 billion | $8.098 billion |
| Operating income | $610 million | $1.167 billion | $1.343 billion | $1.384 billion |
| Net income | $230 million | $625 million | $696 million | $728 million |
| Net income available to common stockholders | $145 million | $457 million | $518 million | $473 million |
| Diluted EPS | $0.22 | $0.66 | $0.78 | $0.72 |
| Cash from operations | Not separately presented by quarter | $2.643 billion | $2.205 billion |
- Q2 operating margin was approximately 11.8%, compared with 25.0% a year earlier. Six-month operating margin was approximately 13.2%, compared with 17.1%.
- Q2 natural gas, oil and NGL sales were $1.704 billion, down from $2.406 billion, chiefly reflecting a swing in derivative results: a $213 million net revenue reduction in 2014 versus a $537 million increase in 2013. Excluding derivative effects, Q2 commodity sales were $1.917 billion versus $1.869 billion.
- Six-month production was 124.0 mmboe, up from 121.2 mmboe. Liquids production grew, while natural gas production declined; the company cited asset sales as a factor in gas declines. The six-month unhedged realized price rose to $32.79/boe from $28.57/boe.
- Six-month investing cash outflow was $1.780 billion and financing cash outflow was $238 million. Cash increased to $1.462 billion from $837 million at year-end 2013.
- At June 30, long-term debt, net, was $11.549 billion, down from $12.886 billion at year-end; cash availability, defined by the company as cash plus available corporate revolver capacity, was $5.442 billion. The $4.0 billion corporate revolver was undrawn except for $20 million of letters of credit. Working capital remained negative at $1.422 billion.
- Q2 common dividend was $0.0875 per share; six-month declared dividends were $0.1750 per share.
Material changes versus the prior comparable period
- Q2 total revenue increased about 10%, largely due to higher marketing, gathering and compression revenue. That business generated only $1 million of Q2 net margin before depreciation, versus $29 million a year earlier.
- Despite higher total revenue, Q2 operating income and net income fell substantially. Management attributed the net-income decline primarily to lower unrealized gains on natural gas and oil derivatives. Six-month net income also declined, while diluted EPS increased, reflecting changes in the per-share calculation.
- Q2 production was 63.2 mmboe versus 61.6 mmboe; liquids were 28% of production, up from 25%. Lower production costs and general and administrative costs per boe reflected operating efficiencies and cost reductions.
- Capital spending was reduced: six-month drilling and completion costs were $1.996 billion in the cash flow statement versus $3.145 billion a year earlier. Management reported a lower average operated rig count and improved capital efficiency.
- The June 30 SSE spin-off removed its assets and liabilities from Chesapeake’s consolidated balance sheet, including approximately $1.572 billion of debt, and eliminated the oilfield services segment going forward. Historical pre-spin results remain included in continuing operations.
- In April, Chesapeake issued $3.0 billion of senior notes and used proceeds and cash on hand to repay its $2.0 billion term loan and redeem or repurchase high-coupon notes. Debt-extinguishment losses contributed to the period’s unusual charges.
Outlook, commentary, risks and unusual items
- Management projected 2014 total capital expenditures of $5.0–$5.4 billion, approximately 24% below 2013 spending. It cited flexibility to adjust discretionary spending and expected covenant compliance under its plans.
- Management expected more than $700 million of proceeds from second-half 2014 asset sales that had closed, been announced or were underway. These were expectations, not guaranteed proceeds.
- At June 30, downside price protection covered approximately 69% of estimated remaining 2014 natural gas production at an average $4.12/mcf and 65% of estimated remaining 2014 oil production at $94.25/bbl. Commodity derivative fair value was a net liability of approximately $755 million.
- Subsequent to quarter-end, Chesapeake agreed to pay $450 million in a Powder River Basin property exchange, subject to closing conditions. It also repurchased all third-party CHK Utica preferred shares for approximately $1.26 billion, eliminating about $75 million in annual cash dividends.
- Significant commitments include $16.634 billion of undiscounted gathering, processing and transportation obligations and approximately $501 million of minimum future drilling-service payments. SSE agreements include approximately $283 million of minimum pressure-pumping payments and $393 million of minimum drilling payments.
- Risks include commodity-price volatility, derivative and counterparty exposure, debt and liquidity needs, transportation and gathering constraints, reserve and production uncertainty, and possible impairment charges. The filing describes DOJ and state investigations into leasing practices, Michigan criminal proceedings, royalty-underpayment claims and other litigation; potential losses in some matters could not be estimated clearly.
- Unusual items included $195 million of Q2 losses on debt purchases, $33 million of restructuring and termination costs, and $40 million of fixed-asset impairments and other charges. Management cautioned that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- How much of reported earnings and cash generation reflects commodity operations versus derivative mark-to-market movements, divestitures and other nonrecurring items.
- Whether the projected 2014 capital budget, production profile and second-half asset-sale proceeds are achieved, and how the post-quarter Utica repurchase and Powder River Basin transaction affect liquidity and leverage.
- The level, timing and economic impact of gathering, transportation, drilling and SSE-related contractual commitments, including whether asset sales or production changes alter their burden.
- Progress and potential exposure in Michigan antitrust proceedings, royalty litigation and other regulatory matters for which the filing does not provide a clear loss estimate.
- Debt maturities, covenant headroom and the sustainability of the dividend in light of negative working capital, commodity-price sensitivity and ongoing capital requirements.