UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
For the quarterly period ended March 31, 2013
or
Commission File Number 001-32318
DEVON ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
(State of other jurisdiction of
incorporation or organization)
(I.R.S. Employer
identification No.)
333 West Sheridan Avenue,
Oklahoma City, Oklahoma
Registrant’s telephone number, including area code: (405) 235-3611
Former name, address and former fiscal year, if changed from last report: Not applicable
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
On April 24, 2013, 406 million shares of common stock were outstanding.
FORM 10-Q
TABLE OF CONTENTS
Item 1. Consolidated Financial Statements
Consolidated Comprehensive Statements of Earnings
Consolidated Statements of Cash Flows
Consolidated Balance Sheets
Consolidated Statements of Stockholders’ Equity
Notes to Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Signatures
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements regarding our expectations and plans, as well as future events or conditions. Such forward-looking statements are based on our examination of historical operating trends, the information used to prepare our December 31, 2012 reserve reports and other data in our possession or available from third parties. Such statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond our control. Consequently, actual future results could differ materially from our expectations due to a number of factors, such as changes in the supply of and demand for oil, natural gas and NGLs and related products and services; exploration or drilling programs; political or regulatory events; general economic and financial market conditions; and other factors discussed in this report.
All subsequent written and oral forward-looking statements attributable to Devon, or persons acting on its behalf, are expressly qualified in their entirety by the cautionary statements above. We assume no duty to update or revise our forward-looking statements based on new information, future events or otherwise.
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DEVON ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED COMPREHENSIVE STATEMENTS OF EARNINGS
Revenues:
Oil, gas and NGL sales
Oil, gas and NGL derivatives
Marketing and midstream revenues
Total revenues
Expenses and other, net:
Lease operating expenses
Marketing and midstream operating costs and expenses
Depreciation, depletion and amortization
General and administrative expenses
Taxes other than income taxes
Interest expense
Restructuring costs
Asset impairments
Other, net
Total expenses and other, net
Earnings (loss) from continuing operations before income taxes
Current income tax expense
Deferred income tax expense (benefit)
Earnings (loss) from continuing operations
Loss from discontinued operations, net of tax
Net earnings (loss)
Basic net earnings (loss) per share:
Basic earnings (loss) from continuing operations per share
Basic loss from discontinued operations per share
Basic net earnings (loss) per share
Diluted net earnings (loss) per share:
Diluted earnings (loss) from continuing operations per share
Diluted loss from discontinued operations per share
Diluted net earnings (loss) per share
Comprehensive earnings (loss):
Other comprehensive earnings (loss), net of tax:
Foreign currency translation
Pension and postretirement plans
Other comprehensive earnings (loss), net of tax
Comprehensive earnings (loss)
See accompanying notes to consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile earnings from continuing operations to net cash from operating activities:
Unrealized change in fair value of financial instruments
Other noncash charges
Net increase in working capital
Increase in long-term other assets
Increase (decrease) in long-term other liabilities
Cash from operating activities – continuing operations
Cash from operating activities – discontinued operations
Net cash from operating activities
Cash flows from investing activities:
Capital expenditures
Proceeds from property and equipment divestitures
Purchases of short-term investments
Redemptions of short-term investments
Other
Cash from investing activities – continuing operations
Cash from investing activities – discontinued operations
Net cash from investing activities
Cash flows from financing activities:
Net short-term borrowings
Credit facility borrowings
Proceeds from stock option exercises
Dividends paid on common stock
Excess tax benefits related to share-based compensation
Net cash from financing activities
Effect of exchange rate changes on cash
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
4
CONSOLIDATED BALANCE SHEETS
ASSETS
Current assets:
Cash and cash equivalents
Short-term investments
Accounts receivable
Other current assets
Total current assets
Property and equipment, at cost:
Oil and gas, based on full cost accounting:
Subject to amortization
Not subject to amortization
Total oil and gas
Total property and equipment, at cost
Less accumulated depreciation, depletion and amortization
Property and equipment, net
Goodwill
Other long-term assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Revenues and royalties payable
Short-term debt
Other current liabilities
Total current liabilities
Long-term debt
Asset retirement obligations
Other long-term liabilities
Deferred income taxes
Stockholders’ equity:
Common stock, $0.10 par value. Authorized 1.0 billion shares; issued 406 million shares in 2013 and 2012, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive earnings
Total stockholders’ equity
Commitments and contingencies (Note 16)
Total liabilities and stockholders’ equity
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Three Months Ended March 31, 2013
Balance as of December 31, 2012
Net loss
Other comprehensive loss, net of tax
Common stock repurchased
Common stock retired
Common stock dividends
Share-based compensation
Share-based compensation tax benefits
Balance as of March 31, 2013
Three Months Ended March 31, 2012
Balance as of December 31, 2011
Net earnings
Other comprehensive earnings, net of tax
Stock option exercises
Balance as of March 31, 2012
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Summary of Significant Accounting Policies
The accompanying unaudited financial statements and notes of Devon Energy Corporation (“Devon”) have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission. Pursuant to such rules and regulations, certain disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The accompanying financial statements and notes should be read in conjunction with the accompanying financial statements and notes included in Devon’s 2012 Annual Report on Form 10-K.
The accompanying unaudited interim financial statements furnished in this report reflect all adjustments that are, in the opinion of management, necessary to a fair statement of Devon’s results of operations and cash flows for the three-month periods ended March 31, 2013 and 2012 and Devon’s financial position as of March 31, 2013.
2. Derivative Financial Instruments
Objectives and Strategies
Devon periodically enters into derivative financial instruments with respect to a portion of its oil, gas and NGL production. These instruments are used to manage the inherent uncertainty of future revenues due to commodity price volatility and typically include financial price swaps, basis swaps, costless price collars and call options.
Devon periodically enters into interest rate swaps to manage its exposure to interest rate volatility. Devon periodically enters into foreign exchange forward contracts to manage its exposure to fluctuations in exchange rates.
Devon does not intend to hold or issue derivative financial instruments for speculative trading purposes and has elected not to designate any of its derivative instruments for hedge accounting treatment.
Counterparty Credit Risk
By using derivative financial instruments, Devon is exposed to credit risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. To mitigate this risk, the hedging instruments are placed with a number of counterparties whom Devon believes are acceptable credit risks. It is Devon’s policy to enter into derivative contracts only with investment grade rated counterparties deemed by management to be competent and competitive market makers. Additionally, Devon’s derivative contracts contain provisions that provide for collateral payments, depending on levels of exposure and the credit rating of the counterparty. As of March 31, 2013, Devon did not hold any collateral from its counterparties.
Commodity Derivatives
As of March 31, 2013, Devon had the following open oil derivative positions. Devon’s oil derivatives settle against the average of the prompt month NYMEX West Texas Intermediate futures price.
Period
Q2-Q4 2013
Q1-Q4 2014
Q1-Q4 2015
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
As of March 31, 2013, Devon had the following open natural gas derivative positions. The first table presents Devon’s natural gas swaps and collars that settle against the Inside FERC first of the month Henry Hub index. The second table presents Devon’s natural gas swaps and collars that settle against the AECO index.
As of March 31, 2013, Devon had the following open NGL derivative positions. Devon’s NGL swaps settle against the average of the prompt month OPIS Mont Belvieu, Texas hub.
Interest Rate Derivatives
As of March 31, 2013, Devon had the following open interest rate derivative positions:
Notional
$750
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Foreign Currency Derivatives
As of March 31, 2013, Devon had the following open foreign currency derivative positions:
Forward Contract
Currency
Canadian Dollar
Financial Statement Presentation
The following table presents the cash settlements and unrealized gains and losses on fair value changes included in the accompanying comprehensive statements of earnings associated with derivative financial instruments. Cash settlements and unrealized gains and losses on fair value changes associated with Devon’s commodity derivatives are presented in the “Oil, gas and NGL derivatives” caption in the accompanying comprehensive statements of earnings. Cash settlements and unrealized gains and losses on fair value changes associated with Devon’s interest rate and foreign currency derivatives are presented in the “Other, net” caption in the accompanying comprehensive statements of earnings.
Cash settlements:
Commodity derivatives
Interest rate derivatives
Foreign currency derivatives
Total cash settlements
Unrealized gains (losses):
Total unrealized losses
Net gain (loss) recognized on comprehensive statements of earnings
The following table presents the derivative fair values included in the accompanying balance sheets.
Asset derivatives:
Total asset derivatives
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Liability derivatives:
Total liability derivatives
3. Restructuring Costs
Office Consolidation
In October 2012, Devon announced plans to consolidate its U.S. personnel into a single operations group centrally located at the company’s headquarters in Oklahoma City. As of March 31, 2013, Devon had substantially completed this initiative and incurred $118 million of restructuring costs associated with the office consolidation.
Divestiture of Offshore Assets
In the fourth quarter of 2009, Devon announced plans to divest its offshore assets. As of March 31, 2013, Devon had divested all of its U.S. Offshore and International assets and incurred $196 million of restructuring costs associated with the divestitures.
The schedule below summarizes restructuring costs presented in the accompanying comprehensive statements of earnings related to the office consolidation. There were no costs related to the offshore divestitures in the three months ended March 31, 2013 and 2012, respectively.
Lease obligations and other
In the three months ended March 31, 2013, Devon incurred $23 million of restructuring costs related to office space that is subject to non-cancellable operating lease agreements that Devon ceased using as a part of the office consolidation. Devon also recognized $9 million of asset impairment charges for leasehold improvements and furniture associated with the office consolidation.
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The schedule below summarizes Devon’s restructuring liabilities.
Lease obligations—Offshore
Employee severance—Offshore
Balance as March 31, 2012
Lease obligations and other—Office consolidation
Employee severance—Office consolidation
4. Other, net
The components of other, net in the accompanying comprehensive statements of earnings include the following:
Accretion of asset retirement obligations
Foreign exchange loss (gain)
Interest income
5. Earnings (Loss) Per Share
The following table reconciles earnings (loss) from continuing operations and common shares outstanding used in the calculations of basic and diluted earnings per share.
Three Months Ended March 31, 2013:
Loss from continuing operations
Attributable to participating securities
Basic and diluted loss per share
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Three Months Ended March 31, 2012:
Earnings from continuing operations
Basic earnings per share
Dilutive effect of potential common shares issuable
Diluted earnings per share
Certain options to purchase shares of Devon’s common stock are excluded from the dilution calculation because the options are antidilutive. These excluded options totaled 7.7 million shares and 6.4 million shares during the three-month periods ended March 31, 2013 and 2012, respectively.
6. Other Comprehensive Earnings
Components of other comprehensive earnings consist of the following:
Foreign currency translation:
Beginning accumulated foreign currency translation
Change in cumulative translation adjustment
Income tax benefit (expense)
Ending accumulated foreign currency translation
Pension and postretirement benefit plans:
Beginning accumulated pension and postretirement benefits
Recognition of net actuarial loss and prior service cost in earnings (1)
Income tax expense
Ending accumulated pension and postretirement benefits
Accumulated other comprehensive earnings, net of tax
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7. Supplemental Information to Statements of Cash Flows
Net change in working capital:
Change in accounts receivable
Change in other current assets
Change in accounts payable
Change in revenues and royalties payable
Change in income taxes payable
Change in other current liabilities
Interest paid (net of capitalized interest)
Income taxes paid (received)
8. Short-Term Investments
The components of short-term investments include the following:
Canadian treasury, agency and provincial securities
U.S. treasuries
9. Accounts Receivable
The components of accounts receivable include the following:
Joint interest billings
Gross accounts receivable
Allowance for doubtful accounts
Net accounts receivable
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10. Property and Equipment
Asset Impairments
In the first quarter of 2013, Devon recognized asset impairments related to its oil and gas property and equipment as presented below.
U.S. oil and gas assets
Canada oil and gas assets
Total asset impairments
Under the full-cost method of accounting, capitalized costs of oil and gas properties, net of accumulated DD&A and deferred income taxes, may not exceed the full cost “ceiling” at the end of each quarter. The ceiling is calculated separately for each country and is based on the present value of estimated future net cash flows from proved oil and gas reserves, discounted at 10 percent per annum, net of related tax effects. Estimated future net cash flows are calculated using end-of-period costs and an unweighted arithmetic average of commodity prices in effect on the first day of each of the previous 12 months.
The oil and gas impairments resulted primarily from declines in the U.S. and Canada full cost ceilings since December 31, 2012. The lower ceiling values resulted primarily from decreases in the 12-month average trailing prices for oil, bitumen and NGLs, which have reduced proved reserve values.
If pricing conditions do not improve, Devon may incur a full cost ceiling impairment related to its oil and gas property and equipment in future quarters of 2013.
11. Goodwill
During the first three months of 2013, Devon’s Canadian goodwill decreased $62 million entirely due to foreign currency translation.
12. Debt
Commercial Paper
As of March 31, 2013, Devon had $3.7 billion of outstanding commercial paper at an average rate of 0.35 percent.
Credit Lines
Devon has a $3.0 billion syndicated, unsecured revolving line of credit (the “Senior Credit Facility”). As of March 31, 2013 there were no borrowings under the Senior Credit Facility. The Senior Credit Facility contains only one material financial covenant. This covenant requires Devon’s ratio of total funded debt to total capitalization, as defined in the credit agreement, to be no greater than 65 percent. As of March 31, 2013, Devon was in compliance with this covenant with a debt-to-capitalization ratio of 26.3 percent.
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13. Asset Retirement Obligations
The schedule below summarizes changes in Devon’s asset retirement obligations.
Asset retirement obligations as of beginning of period
Liabilities incurred
Liabilities settled
Revision of estimated obligation
Liabilities assumed by others
Accretion expense on discounted obligation
Foreign currency translation adjustment
Asset retirement obligations as of end of period
Less current portion
Asset retirement obligations, long-term
14. Retirement Plans
The following table presents the components of net periodic benefit cost for Devon’s pension and postretirement benefit plans.
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost (1)
Net actuarial loss (1)
Net periodic benefit cost (2)
15. Stockholders’ Equity
Dividends
Devon paid common stock dividends of $81 million and $80 million in the first three months of 2013 and 2012, respectively. The quarterly cash dividend was $0.20 per share for both periods. In March 2013, Devon announced an increase of its quarterly cash dividend to $0.22 per share that will begin in the second quarter of 2013.
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16. Commitments and Contingencies
Devon is party to various legal actions arising in the normal course of business. Matters that are probable of unfavorable outcome to Devon and which can be reasonably estimated are accrued. Such accruals are based on information known about the matters, Devon’s estimates of the outcomes of such matters and its experience in contesting, litigating and settling similar matters. None of the actions are believed by management to involve future amounts that would be material to Devon’s financial position or results of operations after consideration of recorded accruals. Actual amounts could differ materially from management’s estimates.
Royalty Matters
Numerous natural gas producers and related parties, including Devon, have been named in various lawsuits alleging royalty underpayments. The suits allege that the producers and related parties used below-market prices, made improper deductions, used improper measurement techniques and entered into gas purchase and processing arrangements with affiliates that resulted in underpayment of royalties in connection with natural gas and NGLs produced and sold. Devon’s largest exposure for such matters relates to royalties in New Mexico. Devon does not currently believe that it is subject to material exposure with respect to such royalty matters.
Environmental Matters
Devon is subject to certain laws and regulations relating to environmental remediation activities associated with past operations, such as the Comprehensive Environmental Response, Compensation, and Liability Act and similar state statutes. In response to liabilities associated with these activities, loss accruals primarily consist of estimated uninsured remediation costs. Devon’s monetary exposure for environmental matters is not expected to be material.
Chief Redemption Matters
In 2006, Devon acquired Chief Holdings LLC (“Chief”) from the owners of Chief, including Trevor Rees-Jones, the majority owner of Chief. In 2008, a former owner of Chief filed a petition against Rees-Jones, as the former majority owner of Chief, and Devon, as Chief’s successor pursuant to the 2006 acquisition. The petition claimed, among other things, violations of the Texas Securities Act, fraud and breaches of Rees-Jones’ fiduciary responsibility to the former owner in connection with Chief’s 2004 redemption of the owner’s minority ownership stake in Chief.
On June 20, 2011, a court issued a judgment against Rees-Jones for $196 million, of which $133 million of the judgment was also issued against Devon. Devon did not have a legal right of set off with respect to the judgment. Therefore, it had recorded a $133 million long-term liability relating to the judgment with an offsetting $133 million long-term receivable relating to its right to be indemnified by Rees-Jones and certain other parties pursuant to the indemnification agreement.
The plaintiffs and Rees-Jones have settled all claims related to the 2004 redemption. Under the terms of the settlement, Rees-Jones and Devon received full releases for all of the plaintiffs’ claims with Rees-Jones funding all settlement payments. Consequently, Devon reversed the previously recorded liability and asset in the first quarter of 2013.
Other Matters
Devon is involved in other various routine legal proceedings incidental to its business. However, to Devon’s knowledge, there were no other material pending legal proceedings to which Devon is a party or to which any of its property is subject.
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17. Fair Value Measurements
The following tables provide carrying value and fair value measurement information for certain of Devon’s financial assets and liabilities. The carrying values of cash, accounts receivable, other current receivables, accounts payable, other payables and accrued expenses included in the accompanying balance sheets approximated fair value at March 31, 2013 and December 31, 2012. Therefore, such financial assets and liabilities are not presented in the following tables.
March 31, 2013 assets (liabilities):
Cash equivalents
Long-term investments
Debt
December 31, 2012 assets (liabilities):
The following methods and assumptions were used to estimate the fair values in the tables above.
Level 1 Fair Value Measurements
Cash equivalents and short-term investments — Amounts consist primarily of U.S. and Canadian treasury securities and money market investments. The fair value approximates the carrying value.
Level 2 Fair Value Measurements
Cash equivalents and short-term investments — Amounts consist primarily of Canadian agency and provincial securities and commercial paper investments. The fair value approximates the carrying value.
Commodity, interest rate and foreign currency derivatives — The fair values of commodity, interest rate and foreign currency derivatives are estimated using internal discounted cash flow calculations based upon forward curves and data obtained from independent third parties for contracts with similar terms or data obtained from counterparties to the agreements.
Debt — Devon’s debt instruments do not actively trade in an established market. The fair values of its fixed-rate debt are estimated based on rates available for debt with similar terms and maturity. The fair values of Devon’s variable-rate commercial paper and credit facility borrowings are the carrying values.
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Level 3 Fair Value Measurements
Long-term investments — Devon’s long-term investments presented in the tables above consisted entirely of auction rate securities. Due to auction failures and the lack of an active market for Devon’s auction rate securities, quoted market prices for these securities were not available. Therefore, Devon used valuation techniques that rely on unobservable inputs to estimate the fair values of its long-term auction rate securities. These inputs were based on continued receipts of principal at par, the collection of all accrued interest to date, the probability of full repayment of the securities considering the U.S. government guarantees substantially all of the underlying student loans, and the AAA credit rating of the securities. As a result of using these inputs, Devon concluded the estimated fair values of its long-term auction rate securities approximated the par values as of March 31, 2013 and December 31, 2012.
Debt — Devon’s Level 3 debt consisted of a non-interest bearing promissory note. Due to the lack of an active market, quoted marked prices for this note, or similar notes, were not available. Therefore, Devon used valuation techniques that relied on unobservable inputs to estimate the fair value of its promissory note. The fair value of this debt was estimated using internal discounted cash flow calculations based upon estimated future payment schedules and a 3.125 percent interest rate.
Included below is a summary of the changes in Devon’s Level 3 fair value measurements during the first three months of 2013 and 2012.
Long-term investments balance at beginning of period
Redemptions of principal
Long-term investments balance at end of period
Debt balance at beginning of period
Foreign exchange translation adjustment
Debt balance at end of period
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18. Segment Information
Devon manages its operations through distinct operating segments, which are defined primarily by geographic areas. For financial reporting purposes, Devon aggregates its U.S. operating segments into one reporting segment due to the similar nature of the businesses. However, Devon’s Canadian operating segment is reported as a separate reporting segment primarily due to the significant differences between the U.S. and Canadian regulatory environments. Devon’s segments are all primarily engaged in oil and gas producing activities. Revenues are all from external customers.
Loss from continuing operations before income taxes
Income tax benefit
Earnings from continuing operations before income taxes
19
The following discussion and analysis addresses material changes in our results of operations and capital resources and uses for the three-month period ended March 31, 2013, compared to the three-month period ended March 31, 2012, and in our financial condition and liquidity since December 31, 2012. For information regarding our critical accounting policies and estimates, see our 2012 Annual Report on Form 10-K under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Overview of 2013 Results
Key components of our financial performance are summarized below, which exclude amounts from our discontinued operations.
Adjusted earnings (1)
Earnings (loss) per share
Adjusted earnings per share (1)
Production (MBoe/d)
Realized price per Boe
Operating margin per Boe (2)
Operating cash flow
Adjusted operating cash flow (1)
Capitalized costs
Shareholder distributions
Our net loss in the first three months of 2013 resulted from noncash asset impairments, which reduced our earnings by $1.9 billion ($1.3 billion after tax). Excluding the asset impairments and other items typically excluded by securities analysts, our adjusted earnings were $270 million, or $0.66 per diluted share. This compares to adjusted earnings of $427 million, or $1.05 per diluted share, in the first three months 2012. Earnings were lower in 2013 primarily because of lower oil and NGL prices.
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Results of Operations
Production, Prices and Revenues
Oil (MBbls/d)
U.S.
Canada
Total
Bitumen (MBbls/d)
Gas (MMcf/d)
NGLs (MBbls/d)
Combined (MBoe/d)
Oil (per Bbl)
Bitumen (per Bbl)
Gas (per Mcf)
NGLs (per Bbl)
Combined (per Boe)
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The volume and price changes in the tables above caused the following changes to our oil, gas and NGL sales between the three months ended March 31, 2013 and 2012.
2012 sales
Change due to volumes
Change due to prices
2013 sales
Upstream sales increased $92 million due to an 11 percent increase in our liquids production, partially offset by an 8 percent decline in our gas production in the first three months of 2013. As a result of continued development of our oil properties, primarily in the Permian Basin, oil sales increased $88 million. Bitumen sales increased $35 million due to development of our Jackfish thermal heavy oil projects in Canada. Additionally, our NGL sales increased $18 million primarily as a result of continued drilling in the liquids-rich gas portions of the Cana-Woodford and Barnett Shales and the Permian Basin. These increases were partially offset by decreases in our gas production, which resulted in a $49 million decline in sales.
Production information for our key properties is summarized below:
Upstream sales decreased $203 million during the first three months of 2013 due to a 4 percent decrease in our realized price without hedges. Our liquids sales were the most significantly impacted with a $314 million decrease in sales due to prices. The largest contributors to the lower liquids prices were a decrease in the average NYMEX West Texas Intermediate
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index price along with wider bitumen differentials and lower NGL prices at the Mont Belvieu, Texas hub. The lower realized prices in our liquids were partially offset by higher realized gas prices, which resulted in additional sales of $111 million. The change in our gas price was largely due to fluctuations of the North American regional index prices upon which our gas sales are based.
Oil, Gas and NGL Derivatives
A summary of our open commodity derivative positions is included in Note 2 to the financial statements included in “Item 1. Consolidated Financial Statements” of this report. The following tables provide financial information associated with our commodity derivatives. The first table presents the cash settlements and unrealized gains and losses that are recognized as components of our revenues. The subsequent tables present our oil, bitumen, gas and NGL prices with, and without, the effects of the cash settlements. The prices do not include the effects of unrealized gains and losses.
Gas derivatives
Oil derivatives
NGL derivatives
Unrealized gains (losses) on fair value changes:
Total unrealized losses on fair value changes
Realized price without hedges
Cash settlements of hedges (1)
Realized price, including cash settlements
Cash settlements of hedges
Cash settlements presented in the tables above represent realized gains or losses related to various commodity derivatives. In addition to cash settlements, we also recognize unrealized changes in the fair values of our commodity derivatives in each reporting period. The changes in fair value result from new positions and settlements that occur during each period, as well as the relationships between contract prices and the associated forward curves. Including the cash settlements discussed above, our commodity derivatives incurred a net loss of $320 million and generated a net gain $145 million during the first three months of 2013 and 2012, respectively.
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Marketing and Midstream Revenues and Operating Costs and Expenses
Revenues
Operating costs and expenses
Operating profit
During the first three months of 2013, marketing and midstream operating profit increased $13 million primarily due to higher gas prices and lower operating expenses.
Lease Operating Expenses (“LOE”)
LOE ($ in millions):
LOE per Boe:
LOE increased $0.34 per Boe during the first three months of 2013. The largest contributor to the higher unit cost is related to our liquids production growth, particularly at the Permian Basin in the U.S. Such projects generally require a higher cost to produce per unit than our gas projects. We also experienced upward pressures on costs in certain operating areas, which also contributed to the higher LOE per Boe.
Depreciation, Depletion and Amortization (“DD&A”)
DD&A ($ in millions):
Oil & gas properties
Other properties
DD&A per Boe:
DD&A increased during the first three months of 2013 largely due to higher DD&A rates, resulting from our oil and gas drilling and development activities and construction of our new headquarters in Oklahoma City.
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General and Administrative Expenses (“G&A”)
Gross G&A
Capitalized G&A
Reimbursed G&A
Net G&A
Net G&A per Boe
Net G&A and net G&A per Boe decreased during the first three months of 2013 largely due to lower employee compensation and benefits and higher capitalized G&A.
Taxes Other Than Income Taxes
Production
Ad valorem and other
Percentage of oil, gas and NGL revenue:
Taxes other than income taxes as a percentage of oil, gas and NGL revenue increased primarily due to lower Canadian revenues with no associated production taxes as well as ad valorem and other taxes that do not change in direct correlation with oil, gas and NGL revenues.
Interest Expense
Interest based on debt outstanding
Capitalized interest
Interest expense increased primarily due to additional debt borrowings and lower capitalized interest, partially offset by lower weighted average interest rates. Borrowings were primarily used to fund capital expenditures in excess of our operating cash flow.
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Restructuring Costs
In the three months ended March 31, 2013, we incurred $38 million of restructuring costs associated with the consolidation of our U.S. personnel into one location in Oklahoma City. This amount includes $23 million related to office space that is subject to non-cancellable operating lease agreements that we ceased using as a part of the office consolidation. We also recognized $9 million of asset impairment charges for leasehold improvements and furniture associated with the office consolidation.
Under the full-cost method of accounting, capitalized costs of oil and gas properties are subject to a quarterly full cost ceiling test, which is discussed in Note 10 to the financial statements under “Item 1. Consolidated Financial Statements” of this report.
If pricing conditions do not improve, we may incur full cost ceiling impairments related to our oil and gas property and equipment in future quarters of 2013.
Income Taxes
The following table presents our total income tax expense (benefit) and a reconciliation of our effective income tax rate to the U.S. statutory income tax rate.
Total income tax expense (benefit) (in millions)
U.S. statutory income tax rate
State income taxes
Taxation on Canadian operations
Effective income tax rate
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Capital Resources, Uses and Liquidity
Sources and Uses of Cash
The following table presents the major source and use categories of our cash and short-term investments.
Operating cash flow – continuing operations
Debt activity, net
Divestitures of property and equipment
Net change in cash and short-term investments
Cash and short-term investments at end of period
Operating Cash Flow – Continuing Operations
Net cash provided by operating activities (“operating cash flow”) was our primary source of capital in the first three months of 2013. Our operating cash flow was comparable to the first three months of 2012.
During the first three months of 2013, our operating cash flow funded approximately 50 percent of our cash payments for capital expenditures. Leveraging our liquidity, we used cash balances and short-term debt to fund the remainder of our cash-based capital expenditures.
Debt Activity, Net
During the first three months of 2013, we utilized net commercial paper borrowings of $508 million to fund capital expenditures in excess of our operating cash flow. During the first three months of 2012, we utilized net credit facility and commercial paper borrowings of $1.1 billion to fund capital expenditures in excess of our operating cash flow.
Divestitures of Property and Equipment
In the first quarter of 2012, we received $71 million from the divestiture of our Angola operations.
Capital Expenditures
The amounts in the table below reflect cash payments for capital expenditures, including cash paid for capital expenditures incurred in prior periods.
Development
Exploration
Subtotal
Capitalized G&A and interest
Midstream
Corporate and other
Total capital expenditures
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Our capital expenditures consist of amounts related to our oil and gas exploration and development operations, our midstream operations and other corporate activities. The vast majority of our capital expenditures are for the acquisition, drilling and development of oil and gas properties, which totaled $1.7 billion and $1.9 billion in the first three months of 2013 and 2012, respectively. The 12% decline in exploration and development capital spending in the first three months of 2013 was primarily due to utilization of the drilling carries in 2013 from our Sinopec and Sumitomo joint venture arrangements.
Capital expenditures for our midstream operations are primarily for the construction and expansion of natural gas processing plants, natural gas gathering systems and oil pipelines. Our midstream capital expenditures are largely impacted by oil and gas drilling activities. The higher 2013 midstream expenditures primarily relate to our Access Pipeline in Canada.
The following table summarizes our common stock dividends (amounts in millions) during the first three months of 2013 and 2012. In the first quarter of 2013, we announced a 10% increase for our quarterly dividend to $0.22 per share beginning in the second quarter of 2013.
Liquidity
Historically, our primary sources of capital and liquidity have been our operating cash flow, asset divestiture proceeds and cash on hand. Additionally, we maintain revolving lines of credit and a commercial paper program, which can be accessed as needed to supplement operating cash flow and cash balances. Other available sources of capital and liquidity include debt and equity securities that can be issued pursuant to our shelf registration statement filed with the SEC. We estimate the combination of these sources of capital will be adequate to fund future capital expenditures, debt repayments and other contractual commitments. The following sections discuss changes to our liquidity subsequent to filing our 2012 Annual Report on Form 10-K.
Operating Cash Flow
Our operating cash flow is sensitive to many variables, the most volatile of which are the prices of the oil, gas and NGLs we produce. We expect operating cash flow to continue to be our primary source of liquidity. To mitigate some of the risk inherent in prices, we have utilized various derivative financial instruments to set minimum and maximum prices on a portion of our 2013 production. The key terms to our open oil, gas and NGL derivative financial instruments as of March 31, 2013 are presented in Note 2 to the financial statements under “Item 1. Consolidated Financial Statements” of this report.
Credit Availability
As of March 31, 2013, we had $2.9 billion of available capacity under our syndicated, unsecured revolving line of credit (the “Senior Credit Facility”), net of letters of credit outstanding. We also have access to $5.0 billion of short-term credit under our commercial paper program. At March 31, 2013, we had $3.7 billion of commercial paper borrowings outstanding.
The Senior Credit Facility contains only one material financial covenant. This covenant requires us to maintain a ratio of total funded debt to total capitalization, as defined in the credit agreement, to be no greater than 65 percent. As of March 31, 2013, we were in compliance with this covenant with a debt-to-capitalization ratio of 26.3 percent.
At March 31, 2013, we held approximately $6.5 billion of cash and short-term investments. Included in this total was $6.1 billion of cash and short-term investments held by our foreign subsidiaries. Based on planned investments to develop and grow our Canadian business, forecasts for our U.S. and Canadian operations, favorable borrowing conditions in the U.S., and existing U.S. income tax laws pertaining to repatriations of foreign earnings, we previously disclosed that we had no current expectations to repatriate the $6.1 billion to the U.S. However, due to our recent activity levels and evolving tax attributes, we expect that our net operating losses for U.S. income tax purposes can be used in conjunction with our foreign tax credits to partially offset current income taxes otherwise due upon repatriating a portion of our foreign cash to the U.S. Therefore, we now expect to repatriate approximately $2 billion to the U.S. Additionally, as we progress through 2013 and gain additional clarity on our current and expected tax attributes, we believe we could repatriate another sizeable amount of cash to the U.S. in a tax-efficient manner in 2013 or 2014. We anticipate using any repatriated funds to repay outstanding commercial paper borrowings.
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Non-GAAP Measures
We make reference to “adjusted earnings,” “adjusted earnings per share” and “adjusted cash flow” in “Overview of 2013 Results” in this Item 2 that are not required by or presented in accordance with GAAP. These non-GAAP measures should not be considered as alternatives to GAAP measures. Adjusted earnings represents net earnings excluding certain non-cash or non-recurring items that are typically excluded by securities analysts in their published estimates of our financial results. Adjusted cash flow represents cash flow from operating activities excluding certain balance sheet changes and non-recurring items that are typically excluded by securities analysts in their published estimates of our financial results. We believe these non-GAAP measures facilitate comparisons of our performance to earnings and cash flow estimates published by securities analysts. We also believe these non-GAAP measures can facilitate comparisons of our performance between periods and to the performance of our peers. The amounts below exclude any amounts from our discontinued operations.
Adjusted Earnings and Adjusted Earnings Per Share
Below are reconciliations of our adjusted earnings and earnings per share to their comparable GAAP measures.
Net earnings (loss) (GAAP)
Adjustments (net of taxes):
Interest rate and other financial instruments
Adjusted earnings (Non-GAAP)
Earnings (loss) per share (GAAP)
Adjusted earnings per share (Non-GAAP)
Adjusted Cash Flow
Below is a reconciliation of our adjusted operating cash flow to its comparable GAAP measure.
Operating cash flow (GAAP)
Changes in assets and liabilities
Adjusted operating cash flow (Non-GAAP)
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Commodity Price Risk
We have commodity derivatives that pertain to a portion of our production for the last nine months of 2013, as well as 2014 and 2015. The key terms to our open oil, gas and NGL derivative financial instruments as of March 31, 2013 are presented in Note 2 to the financial statements under “Item 1. Consolidated Financial Statements” of this report.
The fair values of our commodity derivatives are largely determined by estimates of the forward curves of the relevant price indices. At March 31, 2013, a 10 percent change in the forward curves associated with our commodity derivative instruments would have changed our net asset positions by the following amounts:
Gain (loss):
Interest Rate Risk
At March 31, 2013, we had total debt outstanding of $12.2 billion. Of this amount, $8.5 billion bears fixed interest rates averaging 5.4 percent. The remaining $3.7 billion of commercial paper borrowings bears interest rates that averaged 0.35 percent.
As of March 31, 2013, we had open interest rate swap positions that are presented in Note 2 to the financial statements under “Item 1. Consolidated Financial Statements” of this report. The fair values of our interest rate swaps are largely determined by estimates of the forward curves of the Federal Funds rate. A 10 percent change in these forward curves would not have materially impacted our balance sheet at March 31, 2013.
Foreign Currency Risk
Our net assets, net earnings and cash flows from our Canadian subsidiaries are based on the U.S. dollar equivalent of such amounts measured in the Canadian dollar functional currency. Assets and liabilities of the Canadian subsidiaries are translated to U.S. dollars using the applicable exchange rate as of the end of a reporting period. Revenues, expenses and cash flow are translated using an average exchange rate during the reporting period. A 10 percent unfavorable change in the Canadian-to-U.S. dollar exchange rate would not materially impact our March 31, 2013 balance sheet.
Our non-Canadian foreign subsidiaries have a U.S. dollar functional currency. However, one of these foreign subsidiaries holds Canadian-dollar cash and engages in short-term intercompany loans with Canadian subsidiaries that are sometimes based in Canadian dollars. Additionally, at March 31, 2013, we held foreign currency exchange forward contracts to hedge exposures to fluctuations in exchange rates on the Canadian-dollar cash and intercompany loans. The increase or decrease in the value of the forward contracts is offset by the increase or decrease to the U.S. dollar equivalent of the Canadian-dollar cash. The value of the intercompany loans increases or decreases from the remeasurement of the loans into the U.S. dollar functional currency. Based on the amount of the intercompany loans as of March 31, 2013, a 10 percent change in the foreign currency exchange rates would not have materially impacted our balance sheet.
Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure that material information relating to Devon, including its consolidated subsidiaries, is made known to the officers who certify Devon’s financial reports and to other members of senior management and the Board of Directors.
Based on their evaluation, our principal executive and principal financial officers have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) were effective as of March 31, 2013, to ensure that the information required to be disclosed by Devon in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.
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Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. Other Information
There have been no material changes to the information included in Item 3. “Legal Proceedings” in our 2012 Annual Report on Form 10-K.
There have been no material changes to the information included in Item 1A. “Risk Factors” in our 2012 Annual Report on Form 10-K.
The following table provides information regarding purchases of our common stock that were made by us during the first three months of 2013.
January 1 – January 31
February 1 – February 28
March 1 – March 31
Under the Devon Canada Corporation Savings Plan (the “Canadian Plan”), eligible Canadian employees may purchase shares of our common stock through an investment in the Canadian Plan, which is administered by an independent trustee, Sun Life Assurance Company of Canada. Eligible Canadian employees purchased approximately 3,600 shares of our common stock in the first quarter of 2013, at then-prevailing stock prices, that they held through their ownership in the Canadian Plan. We acquired the shares sold under the Canadian Plan through open-market purchases. These shares and any interest in the Canadian Plan were offered and sold in reliance on the exemptions for offers and sales of securities made outside of the U.S., including under Regulation S for offers and sales of securities to employees pursuant to an employee benefit plan established and administered in accordance with the law of a country other than the U.S.
Not applicable.
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(a) Exhibits required by Item 601 of Regulation S-K are as follows:
ExhibitNumber
Description
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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INDEX TO EXHIBITS
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