Business context and reporting period
Diamondback Energy, Inc. is an independent oil and gas producer focused on the Permian Basin. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Diamondback consolidates Viper Energy Partners and owned approximately 59% of its units at quarter-end.
Financial and operating performance
| Metric | Q3 2018 | Q3 2017 |
|---|---|---|
| Total revenue | $538.0 million | $301.3 million |
| Income from operations | $266.9 million | $142.6 million |
| Net income attributable to Diamondback | $157.1 million | $73.0 million |
| Diluted earnings per share | $1.59 | $0.74 |
| Average daily production | 122,975 BOE | 85,029 BOE |
- Q3 revenue rose 79%, operating income 87%, and Diamondback-attributable net income 115% year over year. Average daily production increased 44.6%.
- Q3 operating margin was approximately 49.6%, versus 47.4% in the prior-year quarter. Realized oil price rose to $55.99/bbl from $45.62; however, the oil differential to NYMEX widened to $13.70/bbl from $2.56.
- For the first nine months, revenue was $1.544 billion, operating income $815.8 million, and Diamondback-attributable net income $539.0 million, compared with $805.9 million, $391.4 million, and $367.7 million, respectively, in 2017. Average daily production grew 51% to 112,799 BOE.
- Nine-month cash from operations was $1.152 billion, compared with $638.0 million. Investing used $1.819 billion, including $1.010 billion for oil and gas property development; financing provided $1.063 billion. Cash increased by $396.0 million to $508.4 million.
- At September 30, consolidated debt was $2.332 billion and cash was $508.4 million. Current assets of $795.7 million exceeded current liabilities of $721.8 million. Diamondback had no borrowings on its $1.0 billion elected revolver commitment; Viper had $296.5 million drawn and $178.5 million available under its borrowing base.
- Quarter-end debt included $1.25 billion principal of 4.750% notes due 2024, $800 million of 5.375% notes due 2025, and $296.5 million of Viper revolver borrowings. The September note issuance increased 2024 notes by $750 million; total interest expense rose year over year.
Material changes and notable items
- Growth reflected higher production from drilling and acquisitions, as well as improved oil and NGL prices. Q3 operating costs included higher lease operating expense, production taxes, midstream expense, and DD&A; management cited workover charges, higher commodity prices and volumes, and a larger asset base.
- Derivative losses were significant: $48.4 million in Q3 and $139.3 million for the first nine months, including cash settlement losses of $38.5 million and $115.7 million, respectively. Derivatives are not designated as accounting hedges, so fair-value changes affect reported earnings.
- Income tax expense was $42.3 million in Q3 and $82.8 million for the nine months. Viper’s May 2018 change from pass-through to taxable-entity status affected tax accounting; the filing also reports a $72.7 million discrete deferred-tax benefit related to that change for the nine-month period.
- Subsequent to quarter-end, Ajax and ExL/EnergyQuest acquisitions closed on October 31 for a combined stated cash consideration of approximately $1.213 billion, plus about 2.6 million Diamondback shares for Ajax. The company also sold mineral interests to Viper for $175 million in August.
- The proposed all-stock Energen merger was valued at approximately $9.2 billion, including Energen net debt of $831 million as of June 30. Closing was subject to customary conditions and was expected at the end of November 2018; Diamondback agreed to assume Energen’s debt.
Outlook, risks and contingencies
- Management’s 2018 drilling and infrastructure capital budget was approximately $1.5–$1.6 billion, excluding leasehold and mineral acquisitions. The company expected to drill and complete 170–175 gross operated horizontal wells and said current-price operating cash flow, cash on hand and revolver access were expected to fund operations through year-end.
- Management reported Q3 cash operating margins above 80% per BOE and emphasized low-cost execution. It cited positive early results from two Second Bone Spring wells and planned an average of 14 rigs for the remainder of 2018 after the Ajax closing.
- Management identified commodity-price volatility, weaker regional differentials and oilfield-service cost increases as key concerns. Lower prices could reduce cash flow, economic production and borrowing bases. Capital spending may be adjusted, and additional funding may not be available on acceptable terms.
- Firm Midland oil transportation agreements were intended to cover most existing, Ajax-related and anticipated production growth. The company also obtained an option for up to a 10% interest in the EPIC Crude Oil Pipeline project tied to a 100,000-bbl/day commitment.
- After the Ajax and ExL closings, Diamondback reported $748 million of revolver borrowings as of October 31; the company’s borrowing base was subsequently raised to $2.65 billion and its elected commitment to $2.0 billion. These subsequent changes should be distinguished from September 30 liquidity.
- The company reported compliance with financial covenants at September 30. Commodity-price, customer-concentration, counterparty, floating-rate, acquisition-integration and merger-completion risks remain relevant. Management said routine litigation was not expected to have a material adverse effect; no off-balance-sheet arrangements were reported.
Important facts for investors to verify
- Whether the Energen merger closed as expected, its final consideration and assumed debt, and the resulting pro forma leverage and share count.
- Final funding, cash outlay, acquired production and integration results for Ajax and ExL/EnergyQuest, including revolver use after closing.
- Oil-price differentials, transportation capacity and realized prices; Q3 oil differentials widened materially despite higher benchmark prices.
- Cash flows relative to drilling, infrastructure and acquisition spending, and whether the 2018 capital budget and year-end liquidity expectations were achieved.
- Commodity hedge settlements and fair-value exposure: the filing reported a $129.8 million net derivative liability at September 30.
- Effects of Viper’s tax-status change and the reported discrete tax items on comparable earnings and future tax expense.