Devon Energy - 10-Q quarterly report FY2011 Q2

 

(Mark One)

     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 o

     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 o

     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 o   No þ

     On July 22, 2011, 416.5 million shares of common stock were outstanding.

     This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included or incorporated by reference in this report, including, without limitation, statements regarding our future financial position, business strategy, budgets, projected revenues, projected costs and plans and objectives of management for future operations, are forward-looking statements. Such forward-looking statements are based on our examination of historical operating trends, the information used to prepare the December 31, 2010 reserve reports and other data in our possession or available from third parties. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “project,” “estimate,” “anticipate,” “believe,” or “continue” or similar terminology. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from our expectations include, but are not limited to, our assumptions about:

     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. We assume no duty to update or revise our forward-looking statements based on changes in internal estimates or expectations or otherwise.

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

     The accompanying unaudited consolidated 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 consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes included in Devon’s 2010 Annual Report on Form 10-K.

     The unaudited interim consolidated financial statements furnished in this report reflect all adjustments that are, in the opinion of management, necessary to a fair statement of Devon’s financial position as of June 30, 2011 and Devon’s results of operations and cash flows for the three-month and six-month periods ended June 30, 2011 and 2010.

     In May 2011, the FASB issued Accounting Standards Update 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This update does not require additional fair value measurements and is not intended to establish valuation standards or affect valuation practices outside of financial reporting. However, beginning in Devon’s 2011 Annual Report on Form 10-K, this update will require certain additional disclosures related to Devon’s fair value measurements. Devon does not expect the adoption of this update will materially impact its financial statement disclosures.

     In June 2011, the FASB issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income. Beginning in Devon’s 2011 Annual Report on Form 10-K, this update will give Devon the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Devon has not determined which presentation option it will choose but does not expect its selection to materially impact the presentation of its financial statements.

     Devon periodically invests excess cash in U.S. Treasury and other marketable securities that are presented as short-term investments in the accompanying June 30, 2011 consolidated balance sheet. During the first half of 2011, Devon invested a portion of the International offshore divestiture proceeds it had received into United States Treasury securities, causing short-term investments to increase. The carrying value of these investments approximates their fair value. As of June 30, 2011, the average remaining maturity of these investments was 67 days, with a weighted average yield of 0.06 percent.

     The components of accounts receivable include the following:

     Devon periodically enters into commodity and interest rate derivative financial instruments. These instruments are used to manage the inherent uncertainty of future revenues due to oil, gas and NGL price volatility and to manage exposure to interest rate volatility. Devon does not 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.

     Devon’s derivative financial instruments include financial price swaps, basis swaps, costless price collars and call options. Under the terms of the price swaps, Devon receives a fixed price for its production and pays a variable market price to the contract counterparty. For the basis swaps, Devon receives a fixed differential between two regional gas index prices and pays a variable differential on the same two index prices to the contract counterparty. The price collars set a floor and ceiling price for the hedged production. If the applicable monthly price indices are outside of the ranges set by the floor and ceiling prices in the various collars, Devon will cash-settle the difference with the counterparty to the collars. Under the terms of the call options, Devon sold to counterparties the right to purchase production at a predetermined price.

     Devon periodically enters into interest rate swaps to manage its exposure to interest rate volatility. Devon’s interest rate swaps include contracts in which Devon receives a fixed rate and pays a variable rate on a total notional amount. Devon also had forward starting swaps and U.S. Treasury locks. In conjunction with Devon’s debt issuance discussed in Note 7, Devon received $35 million from the net settlement of its forward starting swaps and U.S. Treasury locks in July 2011.

     By using derivative financial instruments to manage exposures to changes in commodity prices and interest rates, Devon exposes itself to credit risk and market 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 minimal 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 generally require cash collateral to be posted if either its or the counterparty’s credit rating falls below investment grade. The mark-to-market exposure threshold, above which collateral must be posted, decreases as the debt rating falls further below investment grade. Such thresholds generally range from zero to $55 million for the majority of Devon’s contracts. As of June 30, 2011, the credit ratings of all Devon’s counterparties were investment grade.

     As of June 30, 2011, 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.

     As of June 30, 2011, Devon had the following open natural gas derivative positions. Devon’s natural gas derivative swaps, collars and call options settle against the Inside Ferc first of the month Henry Hub index.

     As of June 30, 2011, Devon had the following open NGL derivative positions:

     As of June 30, 2011, Devon had the following open interest rate derivative positions:

     The following table presents the derivative fair values included in the accompanying consolidated balance sheets.

     The following table presents the cash settlements and unrealized gains and losses on fair value changes included in the accompanying consolidated statements of operations associated with these 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 consolidated statements of operations. Cash settlements and unrealized gains and losses on fair value changes associated with Devon’s interest rate derivatives are presented in the “Interest-rate and other financial instruments” caption in the accompanying consolidated statements of operations.

     The components of other current assets include the following:

     During the first six months of 2011, Devon’s Canadian goodwill increased $96 million entirely due to foreign currency translation.

     Devon has a $2.7 billion syndicated, unsecured revolving line of credit (the “Senior Credit Facility”). As of June 30, 2011, Devon had 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 to be less than 65 percent. The credit agreement contains definitions of total funded debt and total capitalization that include adjustments to the respective amounts reported in the consolidated financial statements. Also, total capitalization is adjusted to add back noncash financial writedowns such as full cost ceiling impairments or goodwill impairments. As of June 30, 2011, Devon was in compliance with this covenant. Devon’s debt-to-capitalization ratio at June 30, 2011, as calculated pursuant to the terms of the agreement, was 19.3 percent.

     In March 2011, Devon’s Board of Directors authorized an increase in its commercial paper program from $2.2 billion to $5.0 billion. Commercial paper debt generally has a maturity of between 1 and 90 days, although it can have a maturity of up to 365 days, and bears interest at rates agreed to at the time of the borrowing. The interest rate is based on a standard index such as the Federal Funds Rate, LIBOR, or the money market rate as found on the commercial paper market.

     Although Devon ended the second quarter of 2011 with approximately $6.7 billion of cash and short-term investments, the vast majority of this amount consists of proceeds from its International divestitures. Based on Devon’s evaluation of future cash needs across its operations in the United States and Canada, these proceeds remain outside of the United States.

     Consequently, during the first six months of 2011, Devon borrowed $2.3 billion of commercial paper in the United States primarily to fund capital expenditures, common stock repurchases and dividends in excess of cash flow generated by its United States operating activities. As of June 30, 2011, Devon’s average borrowing rate on its $2.3 billion of commercial paper borrowings was 0.27 percent.

     In July 2011, Devon received net proceeds totaling $2,224 million from the issuance of $500 million of 2.40% senior notes due July 15, 2016, $500 million of 4.00% senior notes due July 15, 2021 and $1,250 million of 5.60% senior notes due July 15, 2041. The net proceeds from issuance of this long-term debt is being used to repay substantially all of Devon’s outstanding commercial paper as of June 30, 2011 as it matures. Therefore, $2,224 million of Devon’s outstanding commercial paper is classified as long-term debt in the accompanying June 30, 2011 consolidated balance sheet.

     The schedule below summarizes changes in Devon’s asset retirement obligations.

     During the first six months of 2010, Devon recognized a revision to its asset retirement obligations totaling $194 million. The increase was primarily due to an overall increase in abandonment cost estimates and a decrease in the discount rate used to calculate the present value of the obligations.

     During the first six months of 2010, Devon reduced its asset retirement obligations by $256 million for those obligations that were assumed by purchasers of Devon’s Gulf of Mexico oil and gas properties in 2010.

     The following table presents the components of net periodic benefit cost for Devon’s pension and other postretirement benefit plans.

     Devon previously disclosed in its financial statements for the year ended December 31, 2010, that it expected to contribute $84 million to its qualified pension plans in 2011. Devon now expects to contribute $346 million to its qualified pension plans in 2011, including $246 million that was contributed in the first six months of 2011 and $100 million that was contributed in July 2011. The increase in Devon’s 2011 contributions is due to increased discretionary funding.

     As a result of the discretionary contributions noted above, Devon amended its target allocation for its pension plan assets in the second quarter of 2011. Devon previously disclosed a target allocation of 47.5% for equity securities, 40% for fixed

income and 12.5% for other investment types. Devon now expects an allocation of 70% fixed income, 20% equity and 10% for other investment types for its pension assets.

     During the first six months of 2011, Devon repurchased 15.2 million common shares under its $3.5 billion stock repurchase program announced in 2010 for $1.3 billion, or $84.52 per share. As of June 30, 2011, Devon had repurchased 33.5 million common shares for $2.5 billion, or $74.16 per share, under this program, which expires December 31, 2011.

     Devon paid common stock dividends of $140 million and $142 million in the first six months of 2011 and 2010, respectively. The quarterly cash dividend was $0.16 per share in the first and second quarter of 2010 and the first quarter of 2011. In the second quarter of 2011, Devon increased the dividend rate to $0.17 per share.

     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 although actual amounts could differ materially from management’s estimate.

     Numerous natural gas producers and related parties, including Devon, have been named in various lawsuits alleging violation of the federal False Claims Act. The suits allege that the producers and related parties used below-market prices, improper deductions, improper measurement techniques and transactions with affiliates, which resulted in underpayment of royalties in connection with natural gas and NGLs produced and sold from federal and Indian owned or controlled lands. Devon does not currently believe that it is subject to material exposure with respect to such royalty 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 costs associated with remediation. Devon’s monetary exposure for environmental matters is not expected to be material.

     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. Both Rees-Jones and Devon are appealing the judgment. However, if the appeal is unsuccessful, Devon can and will seek full payment of the judgment and any related interest, costs and expenses from Rees-Jones pursuant to an existing indemnification agreement between Rees-Jones, certain other parties and Devon. Devon does not expect to have any net exposure as a result of the judgment. However, because Devon does not have a legal right of set

off with respect to the judgment, Devon has recorded in its June 30, 2011 consolidated balance sheet both a $133 million liability relating to the judgment with an offsetting $133 million receivable relating to its right to be indemnified by Rees-Jones and certain other parties pursuant to the indemnification agreement.

     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.

     At the end of 2010, Devon’s commitments included approximately $0.6 billion related to lease contracts for a deepwater drilling rig and a floating, production, storage and offloading facility being used in Brazil. Devon’s remaining commitments for these leases were assumed by the buyer of its assets upon closing the Brazil divestiture transaction discussed in Note 15.

     Certain of Devon’s assets and liabilities are reported at fair value in the accompanying consolidated balance sheets. Such assets and liabilities include amounts for both financial and non-financial instruments. The following tables provide carrying value and fair value measurement information for Devon’s financial assets and liabilities.

     The carrying values of cash and cash equivalents, accounts receivable, other current receivables, accounts payable and other current payables and accrued expenses included in the accompanying consolidated balance sheets approximated fair value at June 30, 2011 and December 31, 2010. These assets and liabilities are not presented in the following table.

     Devon’s Level 3 fair value measurements included in the table above relate to certain long-term investments and a non-interest bearing promissory note. Included below is a summary of the changes in Devon’s Level 3 fair value measurements during the first six months of 2011 and 2010.

     In the fourth quarter of 2009, Devon announced plans to divest its offshore assets. As of June 30, 2011, Devon had divested all of its U.S. Offshore assets and substantially all of its International assets.

     Through the end of the second quarter of 2011, Devon had incurred $204 million of restructuring costs associated with these divestitures. This amount is comprised of $120 million of employee severance costs, $81 million associated with abandoned office leases and $3 million of other miscellaneous costs.

     The schedule below summarizes activity and balances associated with Devon’s restructuring liabilities.