Business context and reporting period
SM Energy Company is an independent onshore North American oil, natural gas, and NGL exploration and production company focused on oil- and NGL-rich plays. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods unless noted.
Third-quarter production reached a record 619.6 MMcfe per day, up 34%, primarily reflecting Eagle Ford growth and higher Bakken/Three Forks output.
Financial and operating highlights
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Oil, gas and NGL production revenue | $373.9 million | $325.2 million | $1,049.1 million | $935.5 million |
| Total operating revenues and other income | $379.0 million | $530.6 million | $1,060.8 million | $1,223.8 million |
| Income (loss) from operations | $(42.8) million | $372.8 million | $65.8 million | $564.5 million |
| Net income (loss) | $(38.3) million | $230.1 million | $12.9 million | $336.1 million |
| Diluted earnings (loss) per share | $(0.58) | $3.41 | $0.19 | $4.99 |
| EBITDAX, non-GAAP | $260.9 million | $215.5 million | $733.6 million | $635.9 million |
| Net production | 57.0 BCFE | 42.5 BCFE | 158.3 BCFE | 118.4 BCFE |
Quarterly production revenue increased 15% as equivalent volumes rose 34%, partly offset by a 14% decline in realized price per Mcfe. Nine-month production revenue rose 12% as volumes increased 34%, while realized price per Mcfe fell 16%. Q3 realized prices were $83.98/bbl oil, $3.05/Mcf gas, and $34.82/bbl NGLs.
Production expense was $102.4 million in Q3, up 32%; DD&A and asset-retirement accretion was $192.4 million, up 56%. Per Mcfe, lease operating expense was $0.82, transportation $0.65, production taxes $0.33, and DD&A/accretion $3.38. Transportation expense per Mcfe rose 16% year over year, reflecting Eagle Ford mix; DD&A per Mcfe rose 17%.
For the first nine months, operating cash flow was $653.6 million, investing cash outflow $1,083.7 million, and financing cash inflow $311.1 million. Capital expenditures were $1,126.8 million. Cash and cash equivalents were $0.2 million at September 30, versus $119.2 million at year-end 2011; restricted cash of $93.8 million was designated for development operations.
At September 30, total debt was approximately $1.328 billion: $228 million drawn on the credit facility and $1.1 billion of fixed-rate senior notes. The company reported $771.2 million of available credit-facility borrowing capacity, including the effect of letters of credit. Current assets were $325.9 million and current liabilities $499.9 million; the company’s adjusted current ratio under its credit agreement was 2.2. It reported a debt-to-EBITDAX covenant ratio of 1.3 and compliance with covenants.
Material changes versus the prior comparable period
- Q3 swung to a net loss from substantial prior-year income. The main unusual earnings drivers included a $55.9 million derivative loss in Q3 2012 versus a $128.4 million gain in Q3 2011, and an $8.5 million divestiture loss versus a $190.7 million divestiture gain in Q3 2011.
- Nine-month net income fell to $12.9 million from $336.1 million. The prior-year period included $245.7 million of divestiture gains; 2012 included $31.2 million of divestiture losses, including a $33.2 million non-cash loss on properties no longer actively marketed.
- Quarterly production rose 34%, with oil up 33%, gas up 21%, and NGLs up 109%. Lower gas and NGL realized prices partially offset volume growth.
- In June 2012, the company issued $400 million of 6.50% notes due 2023 and used $392.2 million of net proceeds to reduce credit-facility borrowings. It also redeemed/concluded settlement of its 3.50% convertible notes, paying $287.5 million in cash for principal and issuing shares for excess conversion value.
- The credit-facility borrowing base increased to $1.55 billion from $1.4 billion in August 2012. The company’s current lender commitments were $1.0 billion.
Outlook, commentary, risks and contingencies
Management expected 2012 capital spending of approximately $1.5 billion, including $1.1–$1.2 billion for drilling and completion; more than 95% of allocated drilling and completion capital was expected to target oil- and NGL-rich projects. The remaining capital program was expected to be funded by operating cash flow and credit-facility borrowings. Management anticipated production growth over the next several years and expected no federal income taxes for 2012 based on its third-quarter projections.
The company planned to maintain or adjust rig activity across the Eagle Ford, Bakken/Three Forks, Granite Wash, and Permian programs. Mitsui was carrying 90% of certain drilling and completion costs on the company’s non-operated Eagle Ford acreage until a $680 million carry was used; $201.3 million had been spent by September 30, leaving $478.7 million.
Management highlighted commodity-price volatility, service-cost and transportation-cost pressure, potential reductions in borrowing capacity, exploration and reserve-replacement uncertainty, and the possibility of impairments. The company had commodity derivatives outstanding through Q2 2015 covering 10.8 million barrels of oil, 79.3 million MMBtu of gas, and 1.5 million barrels of NGLs. Derivative fair value was a net asset of $36.1 million at quarter-end, but fair-value changes can materially affect reported earnings. Proposed Dodd-Frank requirements could increase derivative collateral or compliance costs; the company said the effect remained uncertain.
Unusual items included $38.5 million of nine-month proved-property impairments on Haynesville assets, $11.3 million of unproved-property abandonment and impairments, and $18.6 million of exploratory dry-hole expense. A Texas appellate court reversed a prior judgment over a claimed Eagle Ford overriding royalty interest; plaintiffs petitioned the Texas Supreme Court for review. Separately, SM Energy pursued a claim against Endeavour Operating Corporation relating to an agreed purchase of Pennsylvania assets; the company was remarketing the assets and may seek recovery of any sale-price shortfall and related costs.
The company said there were no material changes to previously disclosed risk factors. It concluded disclosure controls were effective at a reasonable assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts investors should verify
- Whether production growth and the planned 2012 capital program were achieved, and how spending was funded given minimal unrestricted cash at quarter-end.
- How commodity prices, hedge settlements, and derivative fair-value movements affect cash generation, reported earnings, and future hedging protection.
- Debt levels, credit-facility commitments and availability, borrowing-base redeterminations, and covenant compliance.
- Progress in using the Mitsui carry and any effect on production, reserves, and DD&A rates.
- Outcome of the Endeavour asset-sale litigation and the Texas royalty-interest appeal, along with potential proceeds, costs, or liabilities.
- Whether the company’s stated expectations for production growth, 2012 capital spending, and no federal income taxes remained valid; these are forward-looking statements, not guarantees.