Devon Energy Corporation — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Unless otherwise noted, dollar amounts are U.S. dollars in millions. The filing is unaudited.
Business context and reporting period
Devon was repositioning as a North America onshore exploration and production company, funding onshore development, share repurchases and debt reduction with proceeds from offshore divestitures. It completed its Gulf of Mexico exit and sold assets in Azerbaijan and China; the Brazil sale remained pending.
Financial performance and liquidity
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenue | $2,353 | $1,848 | $7,805 | $5,570 |
| Continuing-operations earnings (loss) | $429 | $382 | $1,855 | ($3,310) |
| Discontinued-operations earnings | $1,661 | $117 | $2,133 | $164 |
| Net earnings (loss) | $2,090 | $499 | $3,988 | ($3,146) |
| Diluted net earnings (loss) per share | $4.79 | $1.12 | $8.99 | ($7.09) |
- Reported profit benefited materially from offshore sale gains: the Azerbaijan divestiture generated a $1.5 billion after-tax gain in Q3; the nine-month total also included a $235 million after-tax gain on the China-Panyu sale. Continuing-operations earnings were $429 million in Q3 and $1.855 billion year to date.
- Oil, gas and NGL sales were $1.683 billion in Q3 and $5.535 billion year to date. Derivatives added gains of $209 million and $874 million, respectively. The combined realized commodity price, excluding hedges, rose 17% in Q3 and 33% year to date.
- Production declined 3% in Q3 and 4% year to date, largely reflecting divestitures; North America onshore production excluding divestiture effects rose 4% in Q3 and declined 1% year to date. Marketing and midstream operating profit was $125 million in Q3, up 20%, and $383 million year to date, up 1%.
- Lease operating expense was $415 million in Q3 and $1.271 billion year to date; expense per Boe rose 3% to $7.35 and 4% to $7.44, respectively. Q3 restructuring costs were $63 million, mainly a $70 million office-lease charge partly offset by severance estimate reductions, plus $11 million of asset impairments.
- Cash from operating activities was $4.236 billion for the first nine months ($3.912 billion continuing operations), compared with $3.292 billion total in 2009. Cash capital expenditures were $4.793 billion, including the $500 million Pike oil-sands investment. Investing activities provided net cash of $1.643 billion, principally reflecting divestitures.
- Cash and equivalents were $3.608 billion on the balance sheet; including cash classified with assets held for sale, the cash-flow statement reported $3.998 billion. Available revolving credit was $2.613 billion. Current assets were $5.950 billion and current liabilities $4.450 billion.
- Debt was $5.629 billion at September 30, comprising $1.808 billion short-term and $3.821 billion long-term, versus $7.279 billion at December 31, 2009. Devon had no commercial paper outstanding, and its credit-agreement debt-to-capitalization ratio was 15.3%, within the 65% covenant limit.
Material changes versus the prior comparable period
- Revenue growth reflected higher realized commodity prices and stronger derivative gains, despite lower total production. Q3 oil, gas and NGL sales increased $202 million year over year; higher prices more than offset volume-related declines.
- Net earnings improved substantially, but the comparison is distorted by divestiture gains in 2010 and the $6.408 billion pre-tax U.S. oil-and-gas property write-down recorded in 2009.
- Divestitures generated $5.610 billion of after-tax proceeds in the first nine months. Devon repaid $1.4 billion of commercial paper and redeemed $350 million of 7.25% notes early, while investing in onshore assets and repurchasing shares.
- Capital expenditures increased from $3.807 billion to $4.793 billion. Total debt declined, while cash rose substantially due to operating cash flow and asset-sale proceeds.
Outlook, commentary, risks and contingencies
- Management expected the $3.2 billion Brazil asset sale to close around year-end 2010, subject to Brazilian government approval, and expected a gain at closing. It estimated total offshore divestiture proceeds of approximately $10 billion pre-tax and $8 billion after-tax once all sales were completed. Angola exploration-asset divestiture remained ongoing.
- Management intended to redeploy proceeds into North America onshore exploration and development, reduce debt and continue its share-repurchase program, authorized up to $3.5 billion through December 31, 2011. Through September, 14.7 million shares had been repurchased for $936 million, or $63.61 per share.
- Operational plans included expected Jackfish 2 steam injection in Q2 2011 and first production by year-end 2011; Jackfish 3 facilities construction could begin by end-2011, with start-up targeted for 2015. The Cana processing plant was expected to begin operations by end-2010. These are management expectations, not guarantees.
- Commodity prices remain a key cash-flow risk. At September 30, approximately 61% of estimated 2010 gas production and 70% of estimated oil production were subject to hedges or fixed-price contracts. Management estimated that a 10% increase in relevant forward curves would reduce gas-derivative fair value by about $163 million and oil-derivative fair value by about $95 million.
- Other risks include production and reserve uncertainty, drilling and operating costs, regulatory and environmental changes, currency movements, and completion or approval of divestitures. A temporary uncontrolled steam release at Jackfish in July led to cleanup and repair costs. Management said routine legal matters and environmental exposure were not expected to be material; royalty-related False Claims Act litigation remained a potential contingency.
- Management reported effective disclosure controls as of September 30, 2010, and no material change in internal control over financial reporting during the quarter. No formal earnings or production guidance was provided in the supplied filing text.
Important facts for investors to verify
- Separate recurring continuing-operations performance from the large, nonrecurring divestiture gains included in reported net income.
- Confirm the timing, approvals, proceeds, tax effects and expected gain for the Brazil sale, and the status and value of the remaining Angola divestiture.
- Assess commodity-price exposure, hedge volumes and terms, derivative valuation sensitivity, and the effect of hedges on realized prices and cash flow.
- Track onshore production growth and capital returns against increased capital spending, including execution and costs at Jackfish and other liquids-focused projects.
- Reconcile cash balances including assets held for sale, debt maturities and liquidity; review the pace and remaining authorization of share repurchases.
- Review restructuring estimates, lease obligations, asset-retirement obligations, and the outcome of royalty, environmental and other legal contingencies.