SM Energy Company — Q3 2018 Form 10-Q
Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2018. SM Energy produces oil, gas and NGLs in onshore North America and is now focused on its Midland Basin and Eagle Ford assets following non-core asset sales.
Financial and operating performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Oil, gas and NGL production revenue | $458.4m | $294.5m | $1,243.8m | $912.6m |
| Net income (loss) | $(135.9)m | $(89.1)m | $198.7m | $(134.6)m |
| Diluted EPS | $(1.21) | $(0.80) | $1.75 | $(1.21) |
| Net cash from operating activities | $229.7m | $128.5m | $541.2m | $370.6m |
| Adjusted EBITDAX (non-GAAP) | $256.1m | $164.3m | $691.2m | $490.4m |
- Q3 average production was 130.2 MBOE/d, up 12%; Permian volumes doubled year over year. Nine-month average production was 119.4 MBOE/d, down 4%, reflecting divestitures and lower Eagle Ford output.
- Q3 realized price before derivative settlements rose 39% per BOE year over year to $38.26. Production expense was $127.6m in Q3 and $365.9m for nine months.
- Q3 operating loss was $108.6m. The $178.0m net derivative loss and $26.7m debt-extinguishment loss contributed to the quarterly net loss. Nine-month income included a $425.7m net gain on divestitures.
- Nine-month capital expenditures were $1.033bn; net investing cash outflow was $314.0m. Cash declined $137.1m from year-end to $176.8m.
- At September 30, cash was $176.8m and available credit capacity was $999.8m, for reported liquidity of approximately $1.2bn. No revolver borrowings were outstanding. Senior-note principal was $2.477bn and convertible-note principal $172.5m; total principal debt was approximately $2.649bn.
- Quarterly dividend was $0.05 per share. Current assets were $453.1m versus current liabilities of $733.9m; derivative liabilities are included in current liabilities.
Material changes versus prior comparable period
- Production revenue increased 56% in Q3 and 36% year to date, reflecting stronger realized prices and higher Permian production. Q3 production rose 12%, while nine-month production fell 4%.
- Q3 net loss widened to $135.9m from $89.1m, despite higher production revenue. The main reported pressures included derivative losses, higher DD&A, and debt-refinancing costs.
- Nine-month net income swung from a $134.6m loss to $198.7m income, principally because 2018 included $425.7m of net divestiture gains, whereas 2017 included substantial asset write-downs.
- Operating cash flow increased to $541.2m from $370.6m; investing activity shifted from $66.0m provided to $314.0m used, largely as capital spending rose.
Outlook, risks and unusual items
- Management expected full-year 2018 capital spending of approximately $1.31bn, excluding acquisitions, with about 86% allocated to the Midland Basin and 14% to the Eagle Ford. Full-year production was expected to be in line with 2017, with a higher oil share on retained assets.
- Management cited commodity-price volatility and tight Permian takeaway capacity through mid-to-late 2019 as risks; hedges were intended to mitigate price and basis exposure. At September 30, commodity derivatives were a net liability of $286.7m.
- Management stated it expected sufficient liquidity to execute its plan and no material shortfalls on gathering, transportation and other volume commitments. Potential undiscounted deficiency payments were approximately $342.2m if minimum delivery or purchase obligations were missed.
- The company refinanced debt in Q3: issued $500m of 6.625% notes due 2027 and retired all 2021 and 2023 notes plus $85m principal of 2022 notes. The transactions generated a $26.7m extinguishment loss. The new revolver has $1.0bn of lender commitments; covenant compliance was reported at quarter-end.
- Q3 DD&A included an $11.8m non-cash prior-period correction, which management deemed immaterial; it reduced nine-month net income by $9.0m after tax and increased the Q3 net loss by $9.0m after tax.
- Other noted items: $9.1m Q3 and $26.6m year-to-date unproved-property abandonment and impairment expense; no material pending litigation was expected by management. The company planned to adopt lease accounting guidance on January 1, 2019, expecting higher recognized lease assets and liabilities, with the full impact still under evaluation.
Investor verification points
- Reconcile Q3 and year-to-date results for the non-cash derivative mark-to-market losses, cash derivative settlements, and divestiture gains.
- Review the $11.8m prior-period DD&A correction and its reported-period effects.
- Assess debt maturities, refinancing economics, covenant thresholds and the April 2019 borrowing-base redetermination.
- Test the assumptions behind the $1.31bn capital program, production outlook and expected liquidity against commodity prices, Permian takeaway capacity and operating costs.
- Review derivative coverage and the $286.7m net derivative liability, as well as the volume commitments and potential deficiency payments.