Devon Energy Corporation — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; unaudited. Comparisons are with the corresponding 2010 periods. Dollar amounts are in millions unless stated otherwise.
Business context and reporting period
Devon is an oil and gas producer with U.S. and Canadian onshore operations. In May 2011, it completed the sale of its Brazil operations, substantially completing its planned offshore divestitures. Results therefore include significant discontinued-operation sale gains; continuing results principally reflect North American onshore operations.
Financial performance and liquidity
- Q2 revenue: $3,220, up 44% from $2,232. Oil, gas and NGL sales were $2,200; derivative revenue was $416, including unrealized gains; marketing and midstream revenue was $604.
- Q2 earnings: Continuing-operations earnings were $184, versus $352 a year earlier; diluted continuing EPS was $0.43 versus $0.79. Net earnings were $2,743, or $6.48 diluted EPS, versus $706, or $1.58, largely because discontinued operations contributed $2,559.
- Six-month results: Revenue was $5,367 versus $5,452; continuing-operations earnings were $573 versus $1,426; net earnings were $3,159 versus $1,898. Diluted EPS was $7.41 versus $4.24, with the 2011 result heavily influenced by divestiture gains.
- Cash flow and investment: Six-month operating cash flow was $2,810, including $2,830 from continuing operations, versus total operating cash flow of $2,892 in 2010. Capital expenditures were $3,720; net investing cash outflow was $3,799. Cash and cash equivalents increased by $61 to $3,351.
- Margins and operating costs: North America Onshore realized price before hedges rose 22% to $36.63/Boe in Q2 and 5% to $34.80/Boe for six months. North America Onshore lease operating cost increased 3% to $7.55/Boe in Q2 and $7.52/Boe for six months. Continuing-operations net margin was approximately 5.7% in Q2 and 10.7% for six months, compared with 15.8% and 26.2%; reported earnings were affected by unusual tax and divestiture items.
- Debt and liquidity: Debt totaled $7,930 at June 30 ($1,962 short-term and $5,968 long-term). Cash plus short-term investments was about $6.7 billion, but most divestiture proceeds were held outside the United States. The $2.7 billion revolving facility was undrawn at quarter-end; the company reported a 19.3% covenant debt-to-capitalization ratio against a maximum of 65%. Commercial paper averaged 0.27% interest. In July, Devon issued $2.25 billion of senior notes and said proceeds would repay commercial paper as it matured.
- Balance sheet: Total assets were $38,537, stockholders’ equity $21,428, and current liabilities $4,484. Short-term investments rose to $3,367 from $145 at year-end 2010.
Material changes versus the prior comparable period
- Q2 oil, gas and NGL sales increased $418, driven principally by higher realized prices; North America Onshore production also grew. Q2 oil, gas and NGL production volumes increased 6% in total onshore, while total company volumes rose 3%.
- For the first six months, oil and NGL prices strengthened, but lower gas prices reduced sales; total revenue declined slightly. Continuing earnings fell substantially, reflecting higher deferred taxes and other changes, despite higher oil prices and production.
- Brazil’s sale generated a $2,546 gain in discontinued operations. Devon reported $2,559 of Q2 discontinued-operations earnings and stated that aggregate offshore divestitures generated about $10 billion of proceeds, or approximately $8 billion after tax assuming certain foreign proceeds are repatriated.
- Devon recorded $744 of tax expense related to assumed repatriation of foreign earnings: $725 deferred and $19 current. Excluding this item, management reported a 33% effective tax rate for both Q2 and the first half.
- Total debt rose from $5,630 at December 31, 2010, while the company also accumulated short-term investments from divestiture proceeds and borrowed U.S. commercial paper to fund spending and shareholder returns.
Outlook, management commentary, and risks
- Management increased its 2011 capital expenditure outlook from $5.4–$6.0 billion to $6.7–$7.3 billion, citing expanded oil and liquids-focused activity, industry cost inflation, and a weaker U.S. dollar against the Canadian dollar.
- Management emphasized near-term liquids growth. Jackfish 2 began production; Devon expected its 100%-owned project to ramp to 35 MBbls/day before royalties over 18 months. The company also reported growth in the Permian, Cana-Woodford, Barnett and Granite Wash areas.
- Devon raised expected 2011 qualified pension contributions from $84 to $346, including $246 contributed in the first half and $100 in July. It changed the target allocation toward 70% fixed income, 20% equity and 10% other investments.
- As of July 22, Devon had repurchased 35.1 million shares for $2.6 billion under its $3.5 billion program, which expires December 31, 2011. The quarterly dividend increased from $0.16 to $0.17 per share in Q2.
- Commodity-price exposure remains material. Derivative fair values depend on forward price curves; Devon estimated that a 10% increase in gas forward curves would increase unrealized losses by about $224, while a 10% increase in oil curves would reduce unrealized gains by about $300. Derivatives also expose the company to counterparty and market risk.
- A court judgment in the Chief matter included $133 against Devon. Devon appealed and recorded a $133 liability and matching indemnification receivable, stating it expected no net exposure if it could recover under the indemnity. Other disclosed risks include commodity prices, production and drilling outcomes, regulation, environmental matters, foreign exchange and capital-market conditions. Management said routine legal matters and environmental exposure were not expected to be material after recorded accruals.
- Management stated disclosure controls were effective at June 30, 2011, and reported no material change in internal control over financial reporting during Q2.
Important facts for investors to verify
- Separate recurring continuing-operation performance from the Brazil and other offshore divestiture gains, and reconcile the $744 repatriation-related tax expense to reported earnings.
- Confirm the location, availability and tax implications of the $6.7 billion of cash and short-term investments, most of which was held outside the United States.
- Track the revised $6.7–$7.3 billion capital spending outlook, production growth and cost inflation against subsequent results and cash generation.
- Review the July note issuance and commercial-paper repayment, including the reported debt classification and resulting interest burden.
- Monitor the Chief judgment appeal and indemnification recovery, as well as commodity-derivative exposure and hedge effects on realized prices and cash flow.