Devon Energy Corporation — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; balance-sheet comparisons are with December 31, 2009. Amounts are in U.S. dollars unless stated otherwise.
Business context
Devon reported as an oil and gas producer with U.S. and Canadian continuing operations and international assets classified as discontinued operations. The company was repositioning toward high-growth North American onshore exploration and production, using offshore asset sales to fund debt reduction, onshore investment and share repurchases.
Financial results and liquidity
| Metric | Q1 2010 | Q1 2009 or prior date |
|---|---|---|
| Total revenue | $3.220 billion | $1.900 billion |
| Net earnings (loss) | $1.192 billion; diluted EPS $2.66 | $(3.959) billion; diluted EPS $(8.92) |
| Continuing-operations earnings (loss) | $1.074 billion | $(3.882) billion |
| Net cash from operating activities | $1.495 billion, including $1.341 billion from continuing operations | $1.047 billion |
| Cash capital expenditures | $1.247 billion | $1.926 billion |
| Cash and cash equivalents | $724 million on balance sheet; $1.182 billion including cash held for sale | $646 million on balance sheet |
| Total debt | $6.085 billion | $7.279 billion at Dec. 31, 2009 |
| Total assets / stockholders’ equity | $30.677 billion / $16.955 billion | $29.686 billion / $15.570 billion |
- Revenue rose 69%. Oil, gas and NGL sales were $2.070 billion; reported revenue also included a $620 million net gain on commodity derivatives. $524 million of that gain was unrealized.
- Oil and gas production declined 5% to 56 million Boe, while realized prices excluding hedges increased 58% to $37.07 per Boe.
- Lease operating expense fell 6% to $414 million; oil and gas property DD&A fell 24% to $426 million. Marketing and midstream operating profit declined 9% to $133 million.
- Operating cash flow increased 43% year over year. Cash capital spending was below operating cash flow; property-sale proceeds also supported liquidity and debt repayment.
- Current assets were $3.748 billion and current liabilities $3.108 billion. At March 31, available credit capacity was $3.022 billion, including the short-term facility subsequently cancelled.
Material changes and unusual items
- The year-earlier quarter included a $6.408 billion pre-tax ($4.1 billion after-tax) U.S. oil and gas property write-down tied to the full-cost ceiling and lower gas prices. No comparable write-down was recorded in Q1 2010; this is a major reason for the earnings reversal.
- Q1 2010 derivative gains were substantially larger than in Q1 2009 ($620 million versus $154 million), principally due to unrealized gas-swap fair-value gains. Cash settlements were $96 million in 2010 versus $118 million in 2009.
- Devon sold interests in the Jack, St. Malo and Cascade deepwater projects for $1.3 billion before tax ($1.1 billion after tax) and used proceeds primarily to repay commercial paper. Commercial paper declined to $240 million from $1.432 billion at year-end.
- Asset retirement obligations increased to $1.727 billion from $1.513 billion at the start of the quarter, including a $205 million upward revision, primarily reflecting higher abandonment-cost estimates and a lower discount rate.
- Discontinued operations generated $118 million of earnings, compared with a $77 million loss in Q1 2009.
Outlook, management commentary and risks
- Management expected total offshore divestiture proceeds to exceed $10 billion before tax and estimated approximately $8 billion after tax. As of the filing, announced sales included the remaining deepwater Gulf of Mexico, Brazil and Azerbaijan assets to BP for $7.0 billion; shallow-water Gulf of Mexico assets for $1.05 billion; and the Panyu field offshore China for $515 million. Certain transactions remained subject to closing; management expected announced divestitures to close by year-end 2010.
- Devon expected to use sale proceeds to reduce debt, fund North American onshore opportunities and repurchase shares. In early May it authorized repurchases of up to $3.5 billion and agreed to acquire 50% of BP’s interest in the Kirby oil sands leases for $500 million, plus $150 million of capital funding.
- Management said it was increasing North American onshore drilling as oil prices and divestiture proceeds improved. Approximately 56% of estimated 2010 gas production and 69% of estimated oil production were covered by collars, swaps or fixed-price contracts as of March 31.
- In early May, Devon cancelled its $700 million short-term credit facility and reduced the commercial-paper program limit from $2.85 billion to approximately $2.2 billion. The senior facility had about $2.562 billion available at May 3. The company was compliant with its debt-to-capitalization covenant; its agreement-calculated ratio was 17.1% against a 65% maximum.
- Key risks include commodity prices and regional differentials, production and reserve uncertainty, drilling and service availability, regulatory and environmental matters, foreign exchange, and completion of asset sales. Derivative fair values are sensitive to forward commodity prices; management disclosed estimated fair-value decreases of $159 million for a 10% increase in gas forward curves and $75 million for a 10% increase in oil forward curves.
- Management reported no material changes to previously disclosed risk factors and no material pending legal proceedings known to it. It stated environmental exposure was not expected to be material, while noting actual legal outcomes could differ from estimates. Disclosure controls were judged effective as of March 31, 2010.
Most important facts for investors to verify
- How much of reported earnings and future cash flow depends on derivative gains, especially unrealized fair-value movements.
- Closing timing, final proceeds, taxes, and any recognized gains or losses for the announced offshore and international asset sales.
- Production trends and the expected contribution from increased North American onshore drilling after the 5% year-over-year production decline.
- Whether the $3.5 billion repurchase authorization and Kirby investment proceed as described, and their impact on cash, debt and capital spending.
- The assumptions behind the $205 million asset-retirement-obligation revision and the remaining divestiture-related employee severance estimate.
- Current liquidity and debt capacity after the post-quarter facility cancellation and commercial-paper limit reduction.