SM Energy Company — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. SM Energy is an independent North American oil and gas producer focused on oil- and liquids-rich resource plays, including the Eagle Ford and Bakken/Three Forks. Financial statements are unaudited.
Financial and operating results
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Oil, gas and NGL production revenue | $333.9m | $175.9m | $610.2m | $388.8m |
| Total operating revenues and other income | $377.9m | $211.7m | $693.2m | $571.8m |
| Income from operations | $211.7m | $36.8m | $191.7m | $244.5m |
| Net income | $124.5m | $18.1m | $106.0m | $144.2m |
| Diluted EPS | $1.86 | $0.28 | $1.59 | $2.24 |
| Operating cash flow | — | — | $370.0m | $270.2m |
| Capital expenditures, cash basis | — | — | $662.4m | $304.6m |
- Q2 average production rose 58% to 436.9 MMCFE/day; first-half average production rose 49% to 419.3 MMCFE/day. Q2 realized oil price was $97.51/Bbl, gas $4.63/Mcf, and NGLs $54.02/Bbl. Reported NGL production and revenue were not presented for 2010 under the prior reporting method.
- Q2 production revenue increased 90%, reflecting higher production and oil prices. First-half production revenue rose 57%, but first-half net income declined 27%, principally amid lower divestiture gains and a change in derivative and Net Profits Plan effects.
- Q2 production expense was $53.3m, up 18%; expense per MCFE declined 25% to $1.34. Transportation cost per MCFE increased as Eagle Ford production grew. Management noted severance-tax incentives reduced production taxes.
- First-half cash flow from operations increased 37%. Investing used $566.8m, while financing provided $292.8m; cash increased to $101.1m from $5.1m at year-end 2010.
Balance sheet, debt and liquidity
- At June 30, cash was $101.1m, current assets $346.1m, current liabilities $483.1m, total assets $3.220bn and stockholders’ equity $1.349bn.
- No revolving-credit borrowings were outstanding. The amended facility had $1.0bn of lender commitments, a $1.3bn borrowing base and $999.4m of available capacity; it matures May 27, 2016. The company reported compliance with covenants. Its credit-agreement-defined debt/EBITDAX and current ratios were 0.86 and 3.19, respectively.
- Debt included $350m of 6.625% senior notes due 2019 and 3.50% convertible notes with $280.3m carrying value, net of discount. The company reported $630.3m of fixed-rate debt, net of discount. The new senior notes’ net proceeds of approximately $341.4m were used partly to repay the revolver and support capital spending.
- Interest expense was $14.6m for Q2 and $24.3m for the first half. The convertible notes could be put to the company beginning April 2012; holders did not convert in Q2.
Material developments, outlook and risks
- Management increased its 2011 capital budget to approximately $1.6bn from $1.1bn, mainly due to continued Eagle Ford and Haynesville investment. Preliminary 2012 capital spending was estimated at $1.4–$1.5bn. Funding was expected from operating cash flow, note proceeds, divestitures and/or joint ventures, with the revolver available for any remaining need.
- Management planned to increase operated Eagle Ford rigs toward five or six by year-end, add a third Bakken/Three Forks rig in Q3, and continue Haynesville development. Eagle Ford production had been constrained by third-party takeaway limits; management expected capacity to exceed 200 MMcf/day by year-end and reach about 460 MMcf/day in the second half of 2014.
- After quarter-end, SM Energy sold operated LaSalle County and adjacent Eagle Ford assets for $227.4m cash; the estimated gain was $196.1m, subject to adjustments. It also agreed to sell Pennsylvania Marcellus assets for $80m, subject to closing conditions. A Mitsui agreement would transfer a 12.5% working interest in about 39,000 Eagle Ford acres in return for a 90% carry of specified drilling and completion costs until $680m was spent on the company’s behalf.
- Commodity derivatives had a net fair-value liability of $68.7m. The company discontinued cash-flow hedge accounting prospectively from January 1, 2011, so subsequent fair-value changes flow through earnings; this contributed to period-to-period earnings volatility. Management cited commodity-price volatility, potential borrowing-base reductions, service-cost pressure, and gathering/transportation availability as risks.
- Two gas gathering agreements carry up to ten-year throughput commitments; deficiency payments could total about $729.4m if no gas were delivered. A hydraulic-fracturing services contract committed $180m over two years, with early-termination liability capped at $24m.
- In Eagle Ford overriding-royalty litigation, a court entered a July 2011 judgment of about $5.2m in plaintiffs’ favor concerning a claimed 7.46875% interest over roughly 22,000 net acres. SM Energy intended to appeal, disputed the ruling, and recorded no accrual because it did not consider an unfavorable ultimate outcome probable.
- Management said existing environmental compliance had not materially affected results, but noted uncertainty about future regulation, including hydraulic fracturing and greenhouse-gas rules. The filing reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Closing proceeds, final sale prices and gains for the Eagle Ford and Marcellus transactions, and completion of the Mitsui agreement.
- Whether production growth and takeaway capacity meet management’s expectations, and whether the increased 2011 and preliminary 2012 capital budgets remain adequately funded.
- Derivative settlements, fair-value movements and hedge-related earnings effects; compare cash operating performance with reported net income.
- Credit-facility availability and covenant compliance after spending, divestitures and any borrowing-base redetermination; assess the 2012 convertible-note put exposure.
- Gas gathering throughput commitments, the Eagle Ford royalty litigation and the outcome of post-closing adjustments or other contingent obligations.