DEVON ENERGY CORP quarterly report, Q2 FY2018

Business context and reporting period

Devon Energy Corporation’s unaudited Form 10-Q covers the three and six months ended June 30, 2018. The company’s continuing operations are oil and gas exploration and production in the U.S. and Canada. Devon classified its EnLink Midstream and General Partner interests as discontinued operations after agreeing to sell them; the sale closed July 18, 2018, after quarter-end.

Key financial metrics

Amounts are in millions of U.S. dollars except per-share and production figures.

• Q2 production averaged 541,000 Boe/d, including 520,000 Boe/d from retained assets. Retained production was up 5% year over year; total production was up 1%.
• Q2 realized price was $31.81/Boe before hedges and $29.13/Boe after hedges. Commodity derivative settlements were a $131 million cash loss in the quarter.
• At June 30, cash and cash equivalents were $1.46 billion; total debt was $6.07 billion, comprising $277 million short-term and $5.79 billion long-term. Devon had no borrowings under its $3.0 billion revolving credit facility and reported $2.9 billion of availability after letters of credit. Its debt-to-capitalization covenant ratio was 26.1%, below the 65% limit.
• No operating margin figure is clearly provided in the filing text. ASC 606 adoption increased reported Q2 revenue and production expenses by $65 million, and first-half amounts by $127 million, with no effect on pre-tax earnings.

Material changes versus comparable periods

• Q2 total revenue rose 4% year over year, while first-half revenue fell 3%. For the first half, higher oil and NGL prices were more than offset in upstream results by derivative valuation and settlement effects and higher production expenses.
• Devon reported a Q2 continuing-operations loss versus earnings a year earlier. Management attributed the year-over-year decline in net earnings primarily to weaker upstream operations, including a $623 million adverse year-over-year swing in commodity derivative valuation changes and cash settlements, and higher production expenses. Higher field prices partly offset those effects.
• Q2 operating cash flow from continuing operations was down 54% year over year; first-half continuing operating cash flow declined 24%. First-half capital expenditures increased to $1.35 billion from $884 million.
• Q2 results included $154 million of asset impairments and $94 million of workforce-restructuring costs. First-half financing costs included a $312 million loss on early debt retirement; Devon said the debt tender reduced estimated annualized cash interest expense by about $64 million.
• Devon generated $197 million of discontinued-operations net earnings in the first half, of which $63 million was attributable to Devon. These results are excluded from continuing operations.

Outlook, management commentary, risks and unusual items

• Management’s “2020 Vision” emphasizes cash-flow growth, investment focused on the Delaware Basin and STACK, portfolio simplification, debt reduction and shareholder returns. Management cited 30% first-half production growth in the STACK and Delaware Basin compared with the first half of 2017.
• Expected 2018 capital expenditures were $2.3–$2.6 billion, including $2.2–$2.4 billion for exploration and production. No specific full-year production or earnings guidance is stated in the provided filing text.
• Devon’s sale of EnLink and the General Partner generated approximately $3.1 billion of announced proceeds and closed in July. Devon expected to record a gain of approximately $2.5 billion in Q3 and said the proceeds would support expansion of its share repurchase authorization to $4.0 billion. The company expected to complete the program by the first half of 2019; through July 27 it had repurchased 23.2 million shares for $942 million.
• Devon completed a $553 million Barnett Shale sale (approximately $481 million after customary purchase-price adjustments); it also reported about $4.2 billion of total divestiture proceeds toward a $5 billion target and was marketing approximately $1 billion of additional non-core assets.
• The quarterly dividend rose 33%, from $0.06 to $0.08 per share, beginning in Q2. Devon repurchased 13.7 million shares for $521 million through June 30.
• Approximately 50% of expected oil and gas production for the rest of 2018 was hedged, according to management. Commodity prices, derivative valuations, regional price differentials and midstream capacity constraints remain important exposures; a 10% change in relevant commodity forward curves was estimated to change net derivative positions by approximately $522 million.
• Other disclosed risks include reserve-estimation uncertainty, operational and regulatory risks, counterparty credit exposure, indebtedness, cybersecurity, third-party operators and environmental matters. Devon reported royalty litigation and audits but did not expect material exposure; it said other legal proceedings and environmental exposure were not expected to be material. The filing reported no material change to previously disclosed risk factors.
• Management said the EnLink sale gain was expected to reduce the U.S. deferred-tax-asset valuation allowance significantly; the effect remained subject to further evaluation. Devon maintained a 100% valuation allowance on U.S. deferred tax assets at June 30.

Important facts for investors to verify

1. Confirm the completed EnLink and General Partner sale proceeds, Q3 gain, tax and valuation-allowance effects, and the continuing commercial terms of gathering and processing contracts.
2. Assess cash generation after capital spending, and distinguish continuing operations from discontinued EnLink results and related cash flows.
3. Review the scale and timing of share repurchases and dividends against operating cash flow, liquidity and debt obligations.
4. Evaluate commodity hedge volumes, prices, basis exposure and fair-value sensitivity, alongside realized prices and production-cost trends.
5. Track execution of the $2.3–$2.6 billion 2018 capital plan, targeted divestitures and stated cost savings, including the effect of workforce reductions and impairments.
6. Consider that core earnings are a non-GAAP measure: Q2 core earnings attributable to Devon were $177 million, versus a GAAP net loss attributable to Devon of $425 million.