If you were under an SEC inquiry and had bears attacking your accounting daily, wouldn't you try to be as transparent as possible in your earnings release to prove conclusively you were a legitimate business? I certainly would, and I would be worried about a company that becomes less transparent as scrutiny grows. That is why Linn Energy's (LINE) earnings release was so deeply troubling.
In the second quarter release in August (available here), the company included a financial statement that reconciled reported income with EBITDA, adjusted EBITDA, and distributable cash flow. In Linn's third quarter release (available here), the company does not show how net income reconciles with "net cash provided by operations" and "Excess (shortfall) of net cash provided by operating activities after distributions to unitholders and discretionary adjustments considered by the Board of Directors (these terms have replaced adjusted EBITDA and DCF). "
Why has Linn rolled back its transparency? Further, management typically hosts a conference call alongside a quarterly report. Instead, the press release read, "Management plans on hosting a conference call at a later date to discuss the Company's third quarter 2013 operational and financial results. The Company will issue a press release announcing the date and time of the third quarter call once a date has been established." Why would management decide not to address the public and answer questions when there are still major concerns?
Moreover, outlook for its merger with Berry Petroleum (BRY) looks as bleak as ever with Linn planning to file another Form S-4, their sixth, and with Berry more easily able to walk away after October 31. Perhaps, management could use a conference call to better explain the status of this deal; instead we get nothing but silence, deafening silence.
When it comes to analyzing the quarter, it isn't easy because so much is left missing from the press release. When a company only releases select data, there is always the concern that the company is simply releasing the best data points. There was not a single GAAP financial statement, no income statement, balance sheet, or statement of cash flows. Without this comprehensive information, it is impossible for anyone to responsibly state the quarter was good (or bad). I would put forth that a company facing accounting scrutiny should eagerly release GAAP statements not avoid doing so.
Yes, production looked robust at 823 MMcfe/d, but production alone is not beneficial for investors if it isn't profitable, and with total (expansionary and maintenance) cap-ex of $343 million, that is far from certain. The company suggests $116 million of that sum is maintenance, and that has been the crux of the accounting issue. Many have speculated the company is understating maintenance cap-ex and over-stating expansionary cap-ex, which allows the firm to distribute beyond its means. In this quarter, the company only netted $2 million in cash after distributions and adjustments, so there is little room for error. I have no evidence nor reason to believe Linn's accounting was anything but appropriate, but I believe if the company wants to move beyond these allegations, it should take the opportunity to release comprehensive data to eliminate the debt.
If anything, Linn Energy has increased the cloud of suspicion with this quarterly report. It has released less information than unusual, will not hold a conference call until some unspecified date, doesn't include any GAAP statements, or an explanation of cap-ex spending. Linn released production data, net income (without explaining how it achieved that net income), cash flow (without a net income reconciliation), and nothing else. As a consequence, it is virtually impossible to know whether this quarter was good and if its distribution is sustainable from the press release.
Instead, investors are forced to go to its 10-q filed with the SEC, available here. Linn and other MLPs have a disproportionately large retail ownership. I think it is safe to say many "mom and pop" investors don't look through a complex, 145 page document like a 10-q. Virtually all companies as such release financial statements and other important items in the earnings release, so all investors can easily check up on their investment. Linn is making this process more complicated, which makes one wonder if it wants its shareholder base to be uninformed.
Delving through the 10-q, it is hard to feel overly optimistic about Linn. So far this year, the company has generated only $130 million in free cash flow with $682 million in annual dividend payments. Yes, it is fair to add back expansion cap-ex to free cash to paint a better picture, but it is hard to feel certain that the distribution is safe. Linn's spending feels out of control. $343 million in capex against $494 million in revenue is unparalleled. With that level of spending, Linn should be generating significantly more revenue, making me question the success of their efforts. Capex, interest, and SG&A fully consume revenue. As such, leverage continues to grow as Linn is forced to borrow to pay distributions and expand its asset base. At this point, the company's massive expansion plans don't seem to be paying dividends.
After news of the SEC inquiry was announced in July, I bought units of LINE for $22. I sold them last week for a little over $28, and after this opaque earnings release, I am glad I did. By releasing less information than normal, management certainly invites suspicion, even if none is merited. I am not interested in owning units in a company where my concerns are intensifying. Where there is smoke, there is usually fire. This sparse release is certainly smoke. Only time will tell if there really is fire or just a PR-incompetent management team. Given these overhangs and uncertainty, Linn is simply not worth owning.