Diamondback Energy, Inc. quarterly report, Q2 FY2016

Diamondback Energy, Inc. — Q2 2016 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2016. Diamondback is a Permian Basin-focused oil and natural gas producer. Results are unaudited and include Viper Energy Partners, in which Diamondback held approximately 88% at quarter-end.

Financial performance and position

Metric	Q2 2016	Six months 2016	Comparable 2015
Revenue	$112.5 million	$200.0 million	$119.1 million Q2; $220.5 million six months
Net loss attributable to Diamondback	$155.5 million	$188.4 million	$212.3 million Q2; $206.4 million six months
Diluted loss per share	$2.17	$2.64	$3.45 Q2; $3.44 six months
Operating cash flow	Not separately presented here	$121.8 million	$199.8 million six months

• Reported operating margin was approximately -120% for Q2 and -81% for the first half; these losses include non-cash property impairments of $168.4 million and $199.2 million, respectively. The filing does not provide an adjusted operating margin.
• Average production rose 22.9% to 36,841 BOE/d in Q2 and 24.0% to 37,575 BOE/d in the first half. However, realized combined prices fell to $33.55/BOE in Q2 from $43.65, and to $29.24/BOE in the first half from $40.20.
• Q2 cash operating expense was $9.77/BOE versus $12.16; first-half cash operating expense was $9.71/BOE versus $12.45. Lower lease operating costs and DD&A per BOE were partly associated with lower service costs and the impairments.
• Cash and cash equivalents were $218.8 million at June 30, versus $20.1 million at year-end 2015. Current assets were $298.0 million and current liabilities $141.7 million; the simple current ratio was about 2.1.
• Long-term debt was $494.5 million: $450.0 million of 7.625% senior notes due 2021 and $51.5 million borrowed by Viper. Diamondback had no borrowings on its own revolving facility and reported $500 million of elected availability; its borrowing base had been reduced to $700 million. The company reported covenant compliance.
• First-half investing cash outflow was $180.4 million, including $149.7 million of development capital spending, $17.5 million of leasehold acquisitions and $11.3 million of royalty-interest acquisitions. Financing provided $257.3 million, primarily reflecting $254.5 million net proceeds from a January share offering.

Material changes and management commentary

• Revenue declined 5.5% in Q2 and 9.3% in the first half year over year, despite higher production. Management attributed the declines mainly to lower commodity prices, partly offset by production growth from drilling and acquisitions. First-half operating cash flow fell about 39% year over year.
• Property impairments were lower than in 2015 but remained material: $199.2 million for the first half of 2016 versus $323.5 million in 2015. Management warned that continued low prices could cause another non-cash full-cost impairment in Q3.
• Management cited improved drilling efficiency, with leading-edge well costs below $6 million for a 10,000-foot lateral and below $5 million for a 7,500-foot lateral. It operated four horizontal rigs and two completion crews, and said it might add a fifth rig if prices strengthen.
• The 2016 drilling, completion and infrastructure budget was raised in July from $250–$375 million to $350–$425 million, including plans for 60–75 gross operated horizontal wells. Management believed cash flow, cash on hand and revolver availability would fund operations through year-end, subject to commodity prices, production and other factors.
• After quarter-end, Diamondback agreed to acquire Southern Delaware Basin assets for $560 million, subject to adjustments and closing conditions, with closing scheduled for September. It completed a July share offering for approximately $551.8 million net proceeds, intended in part to fund the acquisition. This issuance increases the share count.
• Viper completed an August unit offering, leaving Diamondback with approximately 84% limited partner interest. Viper’s post-quarter acquisitions and pending acquisition were partly funded with revolving-credit borrowings; its borrowing stood at $132.5 million on July 22 before a subsequent $78 million repayment using offering proceeds.

Risks, contingencies and unusual items

• Commodity-price volatility is the central operating and liquidity risk. Lower prices can reduce revenue, reserve economics and borrowing bases, and trigger additional full-cost impairments. The February 2016 WTI low was $26.19/bbl; WTI was $48.27/bbl at June 30.
• Oil swaps covered 552,000 barrels for July–December 2016 at a $43.52/bbl fixed price and 1.095 million barrels for 2017 at $45.86/bbl. Derivatives were not designated as accounting hedges; fair-value changes therefore flow through earnings. Net derivative liability was $10.7 million at quarter-end.
• Revenue and receivables are concentrated: Shell Trading represented 52% of first-half revenue, Enterprise Crude Oil 13%, and Koch Supply & Trading 11%. Two customers represented approximately 78% of joint-operation receivables at June 30.
• Management recorded a $63.7 million valuation allowance against federal net operating losses during the first half, bringing the total allowance to $124.8 million, reflecting uncertainty about realization.
• The filing describes routine industry-related disputes and litigation; management did not expect pending matters to have a material adverse effect. It reported no material change in risk factors from the 2015 Form 10-K and no off-balance-sheet arrangements.

Key facts investors should verify

• Whether commodity prices, realized pricing and production support the higher 2016 capital budget and management’s year-end liquidity expectations.
• The final purchase price, closing and financing of the $560 million Southern Delaware Basin acquisition, including expected development economics.
• Whether the impairment outlook or reserve valuations change in subsequent quarters, and the assumptions underlying the full-cost ceiling test.
• Available borrowing capacity after future borrowing-base redeterminations, covenant headroom and Viper’s debt following acquisitions and repayments.
• The effect of the July equity issuance and Viper unit offering on per-share results, ownership and future cash distributions.