Devon Energy Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Unaudited financial statements; dollar amounts are in millions unless noted. Devon’s continuing business was principally North American onshore oil, gas and NGL production, alongside marketing and midstream operations. The company completed its Brazil divestiture in May 2011, substantially completing planned offshore divestitures.
Financial performance and position
- Q3 revenue: $3,502, up 49% from $2,353. Oil, gas and NGL sales were $2,111 versus $1,683; derivative revenue was $738 versus $209, including $642 of unrealized derivative gains; marketing and midstream revenue was $653 versus $461.
- Q3 earnings: Continuing-operations earnings were $1,040 versus $429; net earnings were $1,038 versus $2,090. Diluted EPS was $2.50 versus $4.79. The prior-year quarter included a large divestiture gain in discontinued operations.
- First nine months: Revenue was $8,869 versus $7,805. Continuing-operations earnings were $1,613 versus $1,855; net earnings were $4,197 versus $3,988. Diluted EPS was $9.93 versus $8.99. 2011 included $2,584 of discontinued-operations earnings, primarily divestiture gains.
- Taxes and earnings quality: Nine-month income tax expense was $1,883, including $744 related to assumed repatriation of foreign earnings. Excluding that amount, management reported a 33% effective tax rate for the nine months.
- Operating results: North America Onshore production rose 8% in Q3 to 61 MMBoe and 7% for the nine months to 178 MMBoe. Q3 realized combined price excluding hedges increased 16% to $34.72/Boe; nine-month price rose 7% to $34.78/Boe. North America Onshore operating cost increased 6% in Q3 to $7.81/Boe and 4% for the nine months to $7.62/Boe.
- Cash flow and investment: Nine-month cash from operating activities was $4,214, compared with $4,236; continuing-operations operating cash flow was $4,227 versus $3,912. Capital expenditures were $5,515, so operating cash flow less capital expenditures was approximately negative $1,301 (derived). Cash and cash equivalents were $5,618, with short-term investments of $1,231, at September 30.
- Debt and liquidity: Debt totaled $9,257 ($3,288 short-term and $5,969 long-term), compared with $5,630 at year-end 2010. The $2.7 billion revolving credit facility had no borrowings at quarter-end, subject to $0.1 billion of letters of credit. The credit-agreement debt-to-capitalization ratio was 22%, below the 65% limit. Most cash and investments—about $6.1 billion per segment disclosure—were held by foreign subsidiaries and not repatriated; U.S. funding needs were supported partly by commercial paper.
- Capital returns: Devon repurchased 26.0 million shares for $2.0 billion in the first nine months; cumulative repurchases under the $3.5 billion program were $3.2 billion at quarter-end. Dividends paid were $209.
Material changes versus the comparable period
- Q3 continuing-operations earnings improved, but total net earnings fell because Q3 2010 included a $1.5 billion after-tax gain from the Azerbaijan divestiture. For the first nine months, reported net earnings rose modestly, while continuing-operations earnings declined, affected by the 2011 repatriation tax charge.
- Production growth and higher oil and NGL prices lifted sales; North America Onshore liquids production increased faster than gas production. Nine-month gas prices excluding hedges fell 7%, partly offsetting stronger oil and NGL prices.
- Derivative gains were substantially higher in Q3 2011 than Q3 2010, largely reflecting unrealized fair-value changes. Cash settlements from commodity derivatives were lower: $96 in Q3 and $241 for nine months, versus $232 and $580, respectively, in 2010.
- Capital spending increased from $4,793 to $5,515 for the nine months. Debt rose as Devon funded investment, repurchases and other U.S. cash needs while offshore-sale proceeds remained abroad.
Outlook, risks, contingencies and unusual items
- Capital spending outlook: Devon raised expected 2011 capital expenditures from $5.4–$6.0 billion to approximately $7.3 billion, citing expanded oil- and liquids-focused activity, industry cost inflation and the weaker U.S. dollar against the Canadian dollar.
- Operating priorities: Management emphasized continued exploration and development, with a focus on near-term liquids growth. It cited production progress in the Permian, Jackfish, Cana-Woodford, Barnett and Granite Wash areas.
- Buyback: As of October 21, 2011, Devon had repurchased 47.6 million shares for $3.4 billion, or $71.32 per share, under the program expiring December 31, 2011.
- Hedging and market exposure: Commodity derivatives, including collars, swaps and sold call options, affect realized prices and reported earnings. A 10% increase in relevant forward curves would reduce the oil-derivative net asset position by about $208 and the gas-derivative position by about $153; decreases would increase those positions by approximately $215 and $153, respectively. Debt included $3.2 billion of floating-rate commercial paper at an average 0.27% rate.
- Legal contingency: A court judgment included $133 against Devon in a dispute related to the 2006 Chief acquisition. Devon appealed and recorded a $133 liability and an offsetting indemnification receivable; management said it did not expect net exposure, subject to the appeal and indemnity recovery.
- Other contingencies: Devon stated that routine legal, royalty and environmental matters were not expected to have a material financial effect after recorded accruals. Actual outcomes could differ from estimates.
- Other unusual items: Devon increased expected 2011 qualified pension contributions from $84 to $446 and had fully funded them by September 30. Foreign-currency translation reduced comprehensive earnings by $615 in Q3. Management reported effective disclosure controls and no material change in internal controls during the quarter.
- Principal risks identified: Commodity prices and regional differentials, production and reserves, operating and drilling costs, capital availability, foreign exchange, regulation and environmental requirements, weather, and counterparty performance. Management cautioned that forward-looking statements are uncertain and undertook no duty to update them.
Most important facts for investors to verify
- How much of reported earnings and derivative revenue reflects unrealized mark-to-market gains, divestiture gains or the one-time repatriation tax charge, versus recurring operations.
- Whether production growth, realized prices and rising per-unit costs support the revised approximately $7.3 billion 2011 capital-spending outlook and its funding needs.
- The availability and practical use of foreign-held cash, and the resulting reliance on U.S. commercial paper and other borrowing.
- Debt maturities, interest-rate exposure, covenant compliance and liquidity after continued capital spending and share repurchases.
- The outcome of the Chief judgment appeal and the collectability and scope of the related indemnification receivable.
- Actual performance of hedges, including the effects of collars and sold options on participation in higher commodity prices.