SM Energy Company — FY 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010. This is an annual filing, not a standalone fourth-quarter report; selected Q4 results are included below. SM Energy is a U.S. independent oil and gas exploration and production company focused on oil- and liquids-rich resource plays, particularly the Eagle Ford and Bakken/Three Forks.
Key financial and operating metrics
| Metric | FY 2010 | FY 2009 |
|---|---|---|
| Total operating revenues | $1.093 billion | $832.2 million |
| Net income (loss) | $196.8 million | ($99.4 million) |
| Diluted EPS | $3.04 | ($1.59) |
| Operating income (loss) | $338.8 million | ($130.8 million) |
| Net cash from operating activities | $497.1 million | $436.1 million |
| Net cash used in investing activities | $361.6 million | $304.1 million |
| Net cash used in financing activities | $141.1 million | $127.5 million |
| Oil and gas production | 110.0 BCFE; 301.4 MMCFE/day | 109.1 BCFE; 298.8 MMCFE/day |
| Year-end proved reserves | 984.5 BCFE | 772.2 BCFE |
| Year-end working capital | ($227.4 million) | ($87.6 million) |
| Long-term debt at year-end | $323.7 million | $454.9 million |
Operating and net margins, calculated from reported totals, were approximately 31% and 18%, respectively, in 2010. Cash capital expenditures were $668.3 million; accrued costs incurred for oil and gas activities were $877.4 million. Year-end cash was $5.1 million. At December 31, debt included $48.0 million drawn on the credit facility and $275.7 million of convertible notes, net of discount.
Average realized prices including hedging were $66.85 per barrel of oil and $6.05 per Mcf of gas; before hedging, they were $72.65 and $5.21, respectively. Production costs were $1.77 per MCFE, including lease operating expense of $1.10, transportation of $0.19, and production taxes of $0.48.
In Q4 2010, operating revenue was $294.1 million and net income was $37.1 million ($0.56 diluted EPS). Production was 31.6 BCFE.
Material changes versus the prior comparable period
- Revenue rose about 31% and the company moved from a $99.4 million loss to $196.8 million of net income. Higher commodity prices and $155.3 million of divestiture gains were significant contributors.
- Operating cash flow increased 14%. Production grew only 1% overall, but production from retained properties increased 12% after adjusting for divestitures.
- Proved reserves increased 27% to 984.5 BCFE. Drilling added 384.2 BCFE; reserve sales removed 86.8 BCFE. Reserve additions were concentrated in the Eagle Ford and Woodford plays. Proved undeveloped reserves rose to 30% of total reserves from 18%.
- Capital investment more than doubled from $419.0 million to $877.4 million of costs incurred, reflecting accelerated development, especially in the Eagle Ford.
- Production costs declined 6% in total and LOE per MCFE fell from $1.33 to $1.10, partly due to sales of higher-cost properties. DD&A increased 10% to $336.1 million; G&A rose 40% to $106.7 million.
- Proved-property impairment fell to $6.1 million from $174.8 million in 2009; unproved-property impairment fell to $2.0 million from $45.4 million.
Outlook, risks, contingencies and unusual items
- 2011 plan: Capital budget of approximately $1.0 billion, including about $830 million for drilling. Roughly 80% of drilling capital was planned for the Eagle Ford and Bakken/Three Forks. Management expected full-year production growth.
- Eagle Ford: The company planned to increase operated rigs from two to five or six and budgeted approximately $500 million for its total program. It was evaluating a 20%–30% acreage farm-down or joint venture to target net 2011 investment of about $500 million. Gathering capacity and service availability remained important execution constraints.
- Financing: In February 2011, SM Energy issued $350 million of 6.625% senior notes due 2019, receiving net proceeds of about $342.1 million. Proceeds were intended to repay credit-facility borrowings and support capital spending. The borrowing base was reduced from $1.1 billion to $1.0 billion; the facility commitment was $678 million. At February 18, 2011, there were no facility borrowings and approximately $677.5 million of availability, subject to borrowing conditions. The convertible notes and credit facility have key 2012 put/maturity dates.
- Hedging: 2010 realized hedge gains were $23.5 million, while the year-end net derivative fair-value liability was $52.3 million. Effective January 1, 2011, the company discontinued cash-flow hedge accounting prospectively, which may increase reported earnings volatility without changing the economic terms of its hedges.
- Commitments: Gas gathering agreements require delivery of an aggregate 607 Bcf through 2021; deficiency payments may apply if volumes fall short. A post-year-end hydraulic-fracturing services contract carries a $180 million two-year commitment, with early-termination liability capped at $24 million. The company also reported substantial drilling, gathering, lease and other contractual obligations.
- Legal matter: Plaintiffs in an Eagle Ford title/overriding-royalty dispute involving approximately 22,000 acres obtained summary judgment in February 2011. They sought approximately $6.6 million in damages and fees; the company intended to appeal, disputed the claim, and had recorded no loss accrual. Management did not expect an adverse result to materially affect the company as a whole, but the outcome was uncertain.
- Principal risks: Commodity-price volatility; reserve-estimation and drilling uncertainty; financing and borrowing-base sensitivity; infrastructure and takeaway constraints; service-cost inflation; counterparty and hedge risk; environmental and hydraulic-fracturing regulation; and climate, tax and derivatives regulatory changes. One customer represented 11% of 2010 oil and gas production revenue.
- Unusual items and controls: The $155.3 million divestiture gain and $34.4 million noncash benefit from remeasurement of the Net Profits Plan liability boosted results; the latter is sensitive to commodity prices and discount assumptions. Deloitte issued unqualified opinions on the financial statements and internal controls; management reported effective disclosure controls and financial-reporting controls.
Most important facts for investors to verify
- Whether Eagle Ford drilling, production growth and takeaway-capacity expansions met management’s 2011 schedule and budget, and whether the planned farm-down or joint venture occurred.
- How much of 2010 earnings and cash generation was recurring versus attributable to divestiture gains, hedge settlements and noncash Net Profits Plan remeasurement.
- Whether the $1.0 billion borrowing base, facility availability and 2012 refinancing or convertible-note settlement plans remained adequate as capital spending and commodity prices changed.
- Reserve quality and development execution: 30% of proved reserves were undeveloped, with estimated future development costs and reserve values dependent on prices, costs and timing.
- Final outcomes of the Eagle Ford royalty litigation, pending property-sale adjustments, gathering commitments and the $180 million fracturing-services contract.