Devon Energy Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; comparison is with Q1 2010 unless noted. Devon is an oil and gas producer with U.S. and Canadian operations; offshore and international assets were being divested and are reported as discontinued operations where applicable. Dollar amounts are in U.S. dollars.
Financial performance and liquidity
- Revenue: Total revenue was $2.147 billion, down 33% from $3.220 billion. Oil, gas and NGL sales fell 10% to $1.860 billion; marketing and midstream revenue declined 14% to $455 million. The revenue comparison is heavily affected by derivatives: those instruments recorded a $168 million loss in Q1 2011 versus a $620 million gain in Q1 2010.
- Earnings: Net earnings were $416 million, or $0.97 per diluted share, versus $1.192 billion, or $2.66 per diluted share. Continuing-operations earnings were $389 million versus $1.074 billion. Management cited prior-year unrealized commodity-hedge gains, lower 2011 gas prices, and divested offshore operations as key factors in the decline.
- Production and realized prices: North America onshore oil and NGL production increased 11% to 19 million barrels; gas production rose 5% to 228 Bcf. Combined realized price excluding hedges decreased 11% to $32.86 per Boe, principally reflecting a 24% decline in realized gas prices.
- Costs and margins: Lease operating expense was $424 million, up 2%; per-unit operating cost increased 1% to $7.48 per Boe. Marketing and midstream operating profit fell 9% to $122 million. DD&A on oil and gas properties increased 4% to $442 million. No consolidated operating margin is stated in the filing.
- Cash flow and investment: Cash from continuing operations was $1.266 billion, down about 6%; total operating cash flow, including discontinued operations, was $1.260 billion versus $1.495 billion. Capital expenditure cash payments were $1.827 billion versus $1.247 billion. Operating cash flow funded about 70% of cash capital expenditures, with commercial paper used for much of the balance.
- Debt and liquidity: Balance-sheet short- and long-term debt totaled $6.803 billion at March 31, 2011, versus $5.630 billion at year-end 2010. Devon reported $1.311 billion of cash and $1.636 billion of short-term investments; management cited approximately $3.4 billion in cash and short-term investments including amounts associated with discontinued operations. Most divestiture proceeds were held outside the United States. The $2.65 billion revolving credit facility had no borrowings at quarter-end; the company reported a 17.7% covenant debt-to-capitalization ratio and compliance with its 65% maximum.
Material changes versus Q1 2010 and year-end 2010
- Commodity derivative results swung from a $620 million gain to a $168 million loss, including unrealized fair-value losses of $254 million in Q1 2011 versus gains of $524 million in Q1 2010. Cash settlements remained positive at $86 million and $96 million, respectively.
- Production growth in North America onshore was offset in reported totals by the prior-year contribution from divested U.S. offshore properties. Gas price weakness reduced sales despite higher onshore production.
- Commercial paper borrowings increased by $1.197 billion during the quarter, primarily to fund U.S. capital spending, share repurchases and dividends in excess of U.S. operating cash generation. The board increased the commercial-paper program limit from $2.2 billion to $5.0 billion.
- Devon spent $696 million repurchasing 8.1 million shares in Q1; through April 25, repurchases under the $3.5 billion program totaled $2.1 billion. The quarterly dividend was raised from $0.16 to $0.17 per share beginning in Q2.
- Expected 2011 qualified pension contributions increased from $84 million to $346 million, including $32 million contributed in Q1.
Outlook, commentary and risks
- Management said it would continue exploration and development, with emphasis on growing liquids production, and expected its liquidity sources to fund planned capital expenditures, repurchases, debt payments and other commitments. The filing provides no quantified earnings or production guidance.
- Management expected to increase U.S. commercial-paper borrowings because much of the offshore-divestiture cash was held outside the United States. As of April 25, Devon reported $1.3 billion of commercial paper outstanding and $2.7 billion of available revolving-credit capacity.
- Remaining offshore sales in Brazil and Angola were subject to government approval. Management identified commodity prices and regional differentials, production and reserves, capital availability, drilling, weather, currencies, regulation—including hydraulic-fracturing and environmental rules—and divestiture execution among factors that could affect results.
- Commodity hedges reduce some price exposure but can generate material fair-value volatility. A 10% increase in relevant forward curves would have increased unrealized commodity-derivative losses by approximately $163 million for gas and $302 million for oil, according to the filing.
- Routine legal and environmental matters were disclosed; management did not expect material exposure after recorded accruals. The filing reported no material changes to previously disclosed risk factors, no material change in internal controls, and effective disclosure controls as of quarter-end.
Most important facts for investors to verify
- How much of the earnings decline reflects noncash derivative mark-to-market movements versus underlying production economics and realized prices.
- U.S.-available liquidity and future commercial-paper needs, given that most divestiture proceeds were held outside the United States and capital spending exceeded operating cash flow.
- Progress, timing, proceeds and required approvals for the remaining Brazil and Angola asset sales.
- Execution and returns on the increased drilling and capital program, particularly the strategy to grow liquids production.
- The increased pension contribution estimate, the share-repurchase pace, and their combined effect on liquidity and debt.