Devon Energy Corporation — Q3 2012 Form 10-Q
Business context and reporting period. Devon is an oil and gas producer with U.S. and Canadian operations, reported as continuing operations. This unaudited filing covers the three and nine months ended September 30, 2012; comparisons are with the same periods in 2011 unless noted. Amounts are in millions of dollars except per-share and operating data.
Financial and operating performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $1,865 | $3,502 | $6,921 | $8,869 |
| Continuing-operations earnings (loss) | $(719) | $1,040 | $172 | $1,613 |
| Net earnings (loss), including discontinued operations | $(719) | $1,038 | $151 | $4,197 |
| Diluted earnings (loss) per share | $(1.80) | $2.50 | $0.37 | $9.93 |
| Cash from operating activities | Not stated separately | Not stated separately | $3,813 total; $3,787 continuing | $4,214 total; $4,227 continuing |
- Revenue drivers: Q3 oil, gas and NGL sales were $1,738, down from $2,111. The decline reflected lower realized prices, partly offset by higher production. Total revenue also included a $295 loss on commodity derivatives, versus a $738 gain a year earlier. Nine-month derivative results were a $515 gain versus a $986 gain in 2011.
- Production and realized prices: Q3 combined production increased 3% to 678,000 Boe/d; oil production rose 14% to 143,000 barrels/d. The combined realized price excluding hedges fell 20% to $27.85/Boe. For the first nine months, production rose 5% to 684,000 Boe/d, while the realized price fell 19% to $28.14/Boe.
- Costs and operating result: Q3 lease operating expense was $513, or $8.22/Boe, up 8% and 5%, respectively. DD&A was $716, up 26%; net G&A was $150, up 9%. Marketing and midstream operating profit fell 21% to $109 in Q3 and 29% to $289 for nine months.
- Cash flow and investment: Nine-month operating cash flow from continuing operations declined about 10% to $3,787. Capital expenditures were $6,228, versus $5,515, and property/equipment divestiture proceeds were $1,397 in the cash flow statement. Cash and cash equivalents ended at $5,338, down from $5,555 at year-end 2011; short-term investments were $2,164, up from $1,503.
- Debt and liquidity: September 30 debt totaled about $11.2 billion, including $2.8 billion of commercial paper and $8.455 billion of long-term debt. Devon issued $2.5 billion of senior notes in May; the filing reports $2.465 billion net proceeds. It reported a 24.7% debt-to-capitalization ratio, within the 65% covenant limit. On October 24, Devon established a $3.0 billion revolving credit facility maturing in 2017; as of that date, it reported $2.9 billion available and $3.2 billion of commercial paper outstanding.
Material changes versus prior period
- Q3 continuing operations swung to a $719 loss from $1.040 billion of earnings, principally due to a $1.128 billion noncash impairment and adverse unrealized commodity-derivative fair-value changes. The impairment was $719 million net of tax.
- For the first nine months, net earnings fell to $151 from $4.197 billion. The comparison is affected by the $2.584 billion of discontinued-operations earnings in 2011, primarily from offshore divestitures; 2012 discontinued operations recorded a $21 million loss.
- Oil and gas sales were pressured by sharply lower gas and NGL prices: Q3 realized gas and NGL prices excluding hedges declined 37% each year over year. Higher oil and liquids production partly offset these declines.
- Long-term debt increased to $8.455 billion from $5.969 billion at December 31, 2011, while short-term debt declined to $2.780 billion from $3.811 billion. Asset retirement obligations rose to $2.076 billion from $1.563 billion, including a $411 million revision, primarily for higher abandonment-cost estimates.
Outlook, commentary, risks and unusual items
- Management said operating cash flow is expected to remain Devon’s primary liquidity source. The company expected cash, operating cash flow, credit facilities and access to debt/equity markets to fund planned needs; it noted that much of its cash and short-term investments consisted of offshore divestiture proceeds held by foreign subsidiaries and not then expected to be repatriated.
- Devon previously expected 2012 capital expenditures of $6.2–$6.8 billion and increased its total estimated 2012 capital expenditures by approximately $1.7 billion as it expanded exploration activity. The filing does not provide a clear revised total range. Nine-month operating cash flow funded approximately 80% of cash capital expenditures net of divestiture proceeds.
- Management warned that continued depressed natural gas and NGL prices could cause another U.S. full-cost ceiling impairment in Q4 2012. The Q3 U.S. oil and gas impairment followed lower trailing average commodity prices and reduced proved-reserve values. Separate $22 million impairment was recorded for certain Texas midstream facilities.
- In 2012, Sinopec paid about $900 million for a 33.3% interest in five U.S. exploration plays and committed about $1.6 billion toward Devon’s future costs. Sumitomo paid about $400 million for a 30% interest in two Permian plays and committed about $1.0 billion toward future costs. Devon recognized the proceeds as reductions to oil and gas property costs, not gains.
- Devon completed its offshore divestiture program with the March 2012 Angola sale for $71 million. Aggregate offshore proceeds were $10.1 billion, or approximately $8 billion after tax assuming repatriation of a substantial portion under then-current tax law.
- Devon announced an October 2012 plan to consolidate U.S. personnel in Oklahoma City, close its Houston office and transfer certain asset responsibilities; it expected the initiative to be substantially complete by the end of Q1 2013.
- Risks include commodity-price and derivative fair-value volatility, operating and capital-spending demands, and possible further impairment. Devon disclosed royalty-underpayment and environmental matters but did not expect material exposure. A $133 million judgment against Devon in the Chief redemption litigation was under appeal; Devon reported an offsetting indemnification receivable and said it did not expect net exposure, subject to the outcome and collectability.
- Forward-looking statements are subject to supply and demand, drilling, political/regulatory, economic and market risks. Management stated disclosure controls were effective and reported no material change in internal control during the quarter.
Important facts for investors to verify
- Whether subsequent gas and NGL prices resulted in an additional Q4 2012 full-cost ceiling impairment.
- The actual 2012 capital expenditure total and funding mix, given the announced $1.7 billion increase and cash-flow deficit.
- Commodity-derivative settlement and fair-value effects, hedge coverage, and their impact on realized prices and earnings.
- How much offshore cash remained outside the U.S., any tax consequences of repatriation, and subsequent commercial-paper and credit-facility usage.
- Progress, costs and expected benefits of the Houston-to-Oklahoma City consolidation, and developments in the Chief judgment appeal and indemnification.