Devon Energy Corporation — Q2 2014 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 30, 2014, compared with the corresponding 2013 periods. Devon is an oil and gas producer and, following its March 2014 combination with Crosstex, consolidates EnLink Midstream. Results also include GeoSouthern’s Eagle Ford operations from February 28, 2014. All figures below are in U.S. dollars unless noted.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total operating revenue | $4.510 billion | $3.088 billion | $8.235 billion | $5.059 billion |
| Operating income (loss) | $1.774 billion | $1.100 billion | $2.464 billion | $(757) million |
| Net earnings (loss) attributable to Devon | $675 million | $683 million | $999 million | $(656) million |
| Diluted earnings (loss) per share | $1.64 | $1.68 | $2.44 | $(1.63) |
| Adjusted earnings attributable to Devon (non-GAAP) | $574 million | $491 million | $1.121 billion | $761 million |
| Net cash from operating activities | $2.049 billion | $1.396 billion | $3.459 billion | $2.398 billion |
| Production | 667 MBoe/d | 698 MBoe/d | 679 MBoe/d | 692 MBoe/d |
| Realized price per Boe, before hedge settlements | $44.12 | $35.00 | $42.61 | $32.13 |
- Q2 total operating margin was approximately 39%, compared with 36% a year earlier; the six-month margin was approximately 30%, versus a loss-making period in 2013. These figures include material effects from asset-sale gains and the changing business mix.
- Commodity derivatives generated losses of $399 million in Q2 and $719 million in the first half, compared with gains of $366 million and $46 million, respectively, in 2013. Hedge cash settlements reduced the realized price per Boe by $1.78 in Q2 and $1.70 for the first half.
- Cash and cash equivalents were $1.706 billion at June 30, down from $6.066 billion at year-end 2013. Total debt was $12.355 billion, versus $12.022 billion; this includes $475 million classified as short-term debt. Devon had no borrowings on its $3.0 billion revolving credit facility and reported a 23.4% debt-to-capitalization ratio against a 65% covenant limit.
- Cash capital expenditures were $3.341 billion, excluding acquisitions. Total capital expenditures including $6.224 billion of acquisitions were $9.565 billion. Operating cash flow exceeded cash capital expenditures by approximately $118 million, before acquisitions and other investing, financing and working-capital considerations.
- Devon paid $189 million in common dividends during the first half and raised the quarterly dividend to $0.24 per share in Q2.
Material changes versus the prior comparable period
- Revenue rose substantially, reflecting higher oil and gas realizations, Eagle Ford production from the GeoSouthern acquisition, and EnLink’s consolidated marketing and midstream activity. Reported revenue growth is not solely organic: marketing and midstream revenue was $2.230 billion in Q2 versus $500 million a year earlier, with substantial associated product-purchase costs.
- Devon said higher commodity prices, liquids growth and oil realizations drove adjusted earnings and operating cash flow higher. Core and emerging production grew, but total production declined 4% in Q2 and 2% for the first half, principally reflecting non-core divestitures and lower gas production.
- Six-month 2014 GAAP earnings included a $1.072 billion pretax gain on Canadian asset sales. The first half of 2013 included $1.953 billion of asset impairments; both items affect comparisons. Adjusted earnings exclude specified items and are non-GAAP measures.
- Increased average debt associated with the GeoSouthern acquisition and EnLink formation contributed to higher net financing costs. Devon repaid $3.2 billion of debt balances during Q2 using Canadian divestiture proceeds, cash and free cash flow, while total reported debt at quarter-end also included EnLink debt.
- Lease operating expense per Boe increased 9% in Q2 and 11% for the first half. Management attributed the increase to the mix shift toward higher-cost Canadian heavy oil and U.S. liquids operations, as well as cost pressures. Net G&A also increased, including transaction-related costs and higher employee compensation.
Outlook, commentary, risks and unusual items
- Management described the non-core divestiture program as nearing completion. A June 30 agreement to sell U.S. non-core assets to Linn Energy for $2.3 billion was expected to close in Q3 2014; the filing does not report a completed sale or provide formal production, earnings or cash-flow guidance.
- Canadian conventional assets were sold for $2.8 billion (C$3.125 billion); approximately $2.8 billion of proceeds was repatriated to the U.S. Devon recorded $247 million of additional tax expense tied to the repatriation, as well as foreign-exchange losses associated with moving the proceeds.
- Devon’s commodity hedges mitigate some price exposure but can materially affect reported results and realized prices. At June 30, sensitivity analysis indicated that a 10% change in forward curves could change net oil-derivative positions by approximately $727 million on the upside or $645 million on the downside, and gas positions by approximately $223 million or $192 million, respectively.
- Devon identified its Canadian reporting unit as a goodwill-monitoring concern: at the October 2013 test, estimated fair value exceeded carrying value by about 11%, with $2.1 billion of goodwill allocated to Canada at June 30, 2014. Lower commodity prices, weaker results or unfavorable reserve changes could trigger impairment.
- Contractual obligations totaled $34.196 billion, including $12.357 billion of debt, $7.895 billion of scheduled interest and significant purchase and operational agreements. Approximately $2.1 billion of operational commitments were between Devon and EnLink; the filing notes condensate supply disruptions could affect Canadian heavy-oil transport.
- Management reported no material change in risk factors or legal proceedings from the 2013 Form 10-K. It stated routine legal, royalty and environmental matters were not expected to have a material effect after recorded accruals, while noting actual outcomes could differ from estimates. Forward-looking statements are subject to commodity-market, operational, regulatory, economic and transaction risks.
Important facts for investors to verify
- Whether the Linn Energy sale closed on the expected terms and how its proceeds were applied to debt, liquidity and the portfolio.
- How much reported revenue and earnings growth reflects acquired or consolidated operations versus organic production and pricing; review EnLink’s noncontrolling interests and marketing-related costs.
- The sustainability of adjusted earnings and cash generation after accounting for derivative settlements, the Canadian divestiture gain, repatriation taxes and acquisition-related spending.
- Post-divestiture production trends, unit operating costs and the pace and returns of investment in the Eagle Ford, Permian and other core areas.
- Debt, available liquidity and covenant headroom, including EnLink’s separate facilities and commitments; confirm the reported debt and cash position after subsequent transactions.
- Canadian goodwill impairment sensitivity, open derivative exposure, and the status of material legal, royalty, environmental and contractual contingencies.