Diamondback Energy, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Diamondback is an independent oil and gas company focused on the Permian Basin in West Texas. The unaudited consolidated statements include Viper Energy Partners LP, in which Diamondback owned approximately 88% at quarter-end.
Financial and operating results
| Metric | Q3 2014 | Q3 2013 | Change |
|---|---|---|---|
| Total revenue | $139.1 million | $57.8 million | Up 141% |
| Income from operations | $63.5 million | $29.4 million | Up 116% |
| Net income attributable to Diamondback | $43.7 million | $14.6 million | Up 200% |
| Diluted EPS | $0.79 | $0.33 | Up |
| Average production | 20,636 BOE/d | 7,419 BOE/d | Up 178% |
For the nine months, revenue was $364.1 million versus $132.1 million; income from operations was $174.8 million versus $57.5 million; and net income attributable to Diamondback was $95.1 million versus $34.5 million. Diluted EPS was $1.83 versus $0.85. Average production rose 177% to 17,367 BOE/d. Production was about 75% oil in Q3.
Q3 operating margin was approximately 45.7% of revenue, compared with 50.9% a year earlier; net income attributable to Diamondback was approximately 31.4% of revenue versus 25.3%. Results included a $14.9 million derivative gain in Q3 2014, versus a $4.9 million loss in Q3 2013; much of the 2014 gain was non-cash. The filing does not provide a clear EBITDA value.
- Cash flow, nine months: Operating cash flow was $252.0 million, up from $91.6 million. Investing outflow was $1,289.1 million, primarily for drilling, infrastructure and acquisitions. Financing inflow was $1,062.2 million. Cash increased $25.1 million to $40.6 million.
- Balance sheet at September 30: Total assets were $2,820.6 million; current assets $143.3 million; current liabilities $196.3 million; and equity $1,885.8 million. The simple current ratio was approximately 0.73.
- Debt and liquidity: Debt totaled $590.0 million: $450.0 million of 7.625% senior notes due 2021 and $140.0 million drawn on Diamondback’s revolving facility. Its $350.0 million borrowing base left $210.0 million available. A subsequent borrowing-base increase to $750.0 million was approved, but Diamondback elected to cap aggregate lender commitments at $500.0 million. Viper had a separate $110.0 million borrowing base and no borrowings. Diamondback reported compliance with financial covenants.
- Capital and dilution: February and July common-stock offerings generated approximately $208.4 million and $485.0 million net, respectively. Shares issued and outstanding increased from 47.1 million at year-end 2013 to approximately 56.7 million at September 30, 2014.
Material changes and management commentary
- Revenue and production growth primarily reflected increased drilling and acquisitions; lower oil and NGL prices partially offset volume gains. Q3 realized oil price was $88.63/Bbl versus $103.11; average realized price across products was $73.28/BOE versus $84.67.
- Q3 LOE per BOE was unchanged at $7.27; nine-month LOE per BOE improved to $6.79 from $8.97. Nine-month DD&A per BOE declined to $24.54 from $25.09.
- Diamondback acquired about 12,967 net acres in September for approximately $523.3 million and acquired additional leasehold and surface interests earlier in 2014. It reported about 84,746 net Permian acres at quarter-end.
- Viper completed its IPO in June and a further unit offering in September. Diamondback received a $148.8 million distribution from Viper and retained approximately 88% ownership at quarter-end.
- Management reported oil prices falling from over $105/Bbl in June to below $80/Bbl at the time of the filing, with service costs increasing. It intended to enter 2015 operating five horizontal rigs, but said it could drill fewer wells than initially anticipated if prices did not improve or service costs did not decline; it expected to continue two rigs on Spanish Trail acreage. Management emphasized returns on capital and limiting debt.
- The 2014 drilling and infrastructure budget was $425 million–$475 million; $313.9 million had been spent through September. Management believed operating cash flow and revolver capacity would fund operations through year-end 2014 under its then-current price and production expectations, but noted capital needs and funding availability remained uncertain.
Risks, contingencies and unusual items
- Commodity-price volatility is a major risk. Open oil swaps at September 30 covered 644,000 barrels for October–December 2014 at $98.64/Bbl and 331,000 barrels for January–April 2015 at $99.71/Bbl. These derivatives were not designated as accounting hedges, so fair-value changes affected reported earnings.
- After quarter-end, Diamondback entered additional oil swaps covering periods from late 2014 through early 2016. The filing lists prices and volumes; these contracts may limit upside as well as reduce downside exposure.
- Customer concentration is notable: Shell Trading represented 66% and Enterprise Crude Oil 17% of revenue for the nine months. Receivables also carried customer concentration risk.
- The company’s debt includes floating-rate revolver borrowings, secured by substantially all assets of Diamondback and specified subsidiaries; the senior notes contain restrictive covenants. Lower prices or borrowing-base changes could pressure liquidity and spending.
- Related-party arrangements include gas sales to a Wexford-affiliated processor, advisory agreements with Wexford, and leases and service relationships with affiliated entities. Assess terms, oversight and potential conflicts.
- A previously disclosed Minnesota litigation matter was effectively concluded in March 2014 after summary judgment; management said routine pending claims were not expected to have a material adverse effect. No material change in risk factors was reported.
- Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. The company was evaluating the impact of the new revenue-recognition standard.
Investor verification priorities
- Separate production-driven growth from acquisition contributions and verify the sustainability and returns of the acquired acreage and drilling program.
- Assess sensitivity to lower oil prices, including realized pricing, swap coverage and the impact of non-cash derivative marks on earnings.
- Reconcile capital spending and acquisition outlays with operating cash flow, equity issuance, revolver availability and year-end liquidity expectations.
- Review borrowing-base and covenant headroom, senior-note restrictions, and the effect of Diamondback’s decision to cap lender commitments at $500 million.
- Evaluate purchaser concentration, related-party transactions, and Diamondback’s retained ownership and control of Viper.