3.  Derivative Financial Instruments

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 Devon's exposure to interest rate volatility. Devon has elected not to designate any of its derivative instruments for hedge accounting treatment.

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

4.     Other Current Assets

  The components of other current assets include the following:

5.Property and Equipment

Offshore Divestitures

        In November 2009, Devon announced plans to reposition itself strategically as a North America onshore exploration and production company. As part of this strategic repositioning, Devon is bringing forward the value of its offshore assets by divesting them. 

Closed Transactions

The following table presents Devon's offshore divestiture transactions that closed in the first nine months of 2010. Gross proceeds represent contract prices based upon a January 1, 2010 effective date for the Gulf of Mexico and Azerbaijan divestitures, a May 1, 2010 effective date for the China-Panyu divestiture, and a September 1, 2010 effective date for the China-Exploration divestiture. After-tax proceeds represent gross proceeds adjusted for customary purchase price adjustments, selling costs and income taxes. The purchase price adjustments consist primarily of net cash flow subsequent to the effective date of the divestitures. Proved reserves in the following table are based upon estimated proved reserves as of the divestiture dates.

        Proceeds from these divestitures are being used to retire debt and repurchase Devon common shares. Additionally, Devon is using divestiture proceeds to fund North America Onshore exploration and development opportunities, including a joint-venture investment in the Pike oil sands discussed below.

Under full cost accounting rules, sales or other dispositions of oil and gas properties are generally accounted for as adjustments to capitalized costs, with no recognition of gain or loss. However, if not recognizing a gain or loss on the disposition would otherwise significantly alter the relationship between a cost center's capitalized costs and proved reserves, then a gain or loss must be recognized.

The Gulf of Mexico divestitures presented above did not significantly alter such relationship for Devon's United States cost center. Therefore, Devon did not recognize a gain in connection with the Gulf of Mexico divestitures. The Azerbaijan divestiture included all of Devon's properties in its Azerbaijan cost center. As a result, Devon recognized a $1.5 billion ($1.5 billion after-tax) gain during the third quarter of 2010 in connection with the Azerbaijan divestiture. Panyu was Devon's only producing property in its China cost center. As a result, Devon recognized a $308 million ($235 million after-tax) gain in connection with the Panyu divestiture in the second quarter of 2010. No gain was recognized upon the divestiture of Devon's exploratory assets in China in the third quarter of 2010. These gains are included in "earnings from discontinued operations" in the accompanying 2010 consolidated statements of operations.

Pending Transaction

Devon has entered into an agreement to sell its assets in Brazil for $3.2 billion. This  transaction continues to progress through the approval process of the Brazilian government and is on track to close around the end of 2010. Devon expects to record a gain upon the close of the transaction.

Deepwater Drilling Rigs

As part of its offshore operations, Devon was leasing three deepwater drilling rigs. The Seadrill West Sirius and Ocean Endeavor deepwater drilling rigs were used in Devon's Gulf of Mexico operations. The Transocean Deepwater Discovery is being used in Devon's operations in Brazil.

In conjunction with the deepwater Gulf of Mexico divestiture that closed in the second quarter of 2010, the buyer assumed Devon's lease and remaining commitments for the Seadrill West Sirius rig. Subsequent to closing all its Gulf of Mexico divestitures, Devon agreed to pay $31 million to the owner of the Ocean Endeavor rig to terminate the lease. The $31 million lease termination cost is included in oil and gas property and equipment in the accompanying September 30, 2010, consolidated balance sheet. The buyer of Devon's assets in Brazil will assume Devon's lease and remaining commitments for the Transocean Deepwater Discovery rig when the divestiture transaction closes.

Oil Sands Joint Venture

In conjunction with certain offshore divestitures in the second quarter of 2010, Devon formed a heavy oil joint venture to operate and develop the Pike oil sands leases in Alberta, Canada. As a result, Devon acquired a 50 percent interest in the Pike oil sands leases for $500 million. Devon will also fund $155 million of Canadian dollar capital costs on behalf of its joint-venture partner in the form of a non-interest bearing promissory note. The majority of the capital costs are expected to be paid during 2011 and 2012. See Note 7 for more information regarding the promissory note.

8.     Asset Retirement Obligations  

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

During the first nine months of 2010 and 2009, Devon recognized revisions to its asset retirement obligations totaling $194 million and $22 million, respectively. The primary factors causing the 2010 and 2009 increases were an overall increase in abandonment cost estimates and a decrease in the discount rate used to present value the obligations.

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

9.     Retirement Plans

The following table presents the components of net periodic benefit cost for Devon's pension and other post retirement benefit plans.

10.  Stockholders' Equity

Stock Repurchases

During the first nine months of 2010, Devon repurchased 14.7 million common shares under its $3.5 billion stock repurchase program for $936 million, or $63.61 per share. This program expires December 31, 2011.

Dividends

Devon paid common stock dividends of $211 million and $213 million (quarterly rates of $0.16 per share) in the first nine months of 2010 and 2009, respectively.

12.  Fair Value Measurements    

The following tables provide carrying value and fair value measurement information for Devon's financial assets and liabilities.

Devon's Level 3 fair value measurements included in the table above relate to a non-interest bearing promissory note and certain long-term investments. Included below is a summary of the changes in Devon's Level 3 fair value measurements during the first nine months of 2010 and 2009.  

13. Restructuring Costs 

Employee Severance

In the fourth quarter of 2009, Devon recognized $153 million of estimated employee severance costs associated with the planned divestiture of its offshore assets that was announced in November 2009. This amount was based on estimates of the number of employees that will ultimately be impacted by the divestitures and included amounts related to cash severance costs and accelerated vesting of share-based grants. Of the $153 million total, $105 million related to Devon's U.S. Offshore operations and the remainder related to its International discontinued operations.

As discussed in Note 5, Devon had divested all its U.S. Offshore assets by the end of the second quarter of 2010 and a significant part of its International assets by the end of the third quarter of 2010. As a result of these divestitures and associated employee terminations, Devon decreased its estimate of employee severance costs in the second and third quarters of 2010 by $14 million and $21 million, respectively. As a result, Devon now estimates it will incur approximately $118 million of employee severance costs. The lower estimate results primarily from more offshore employees than previously estimated receiving comparable positions with the purchaser of the properties or in Devon's U.S. Onshore operations. Of the $118 million total, $78 million relates to Devon's U.S. Offshore operations and the remainder relates to its International discontinued operations. Of the $35 million reduction recognized during 2010, $27 million relates to Devon's U.S. Offshore operations and the remainder relates to its International discontinued operations.

Lease Obligations

As a result of the divestitures discussed above, Devon ceased using certain office space that was subject to non-cancellable operating lease arrangements. Consequently, in the third quarter of 2010, Devon recognized $70 million of restructuring costs that represent the present value of its future obligations under the leases, net of anticipated sublease income. Devon's estimate of lease obligations was based upon certain key estimates that could change over the term of the leases. These estimates include the estimated sublease income that Devon may receive over the term of the leases, as well as the amount of variable operating costs that Devon will be required to pay under the leases.

Asset Impairments

In the third quarter of 2010, Devon recognized $11 million of asset impairment charges for leasehold improvements and furniture associated with the office space it ceased using.

Financial Statement Presentation

Recognition and adjustments to cash severance, accelerated vesting of share-based grants, lease obligations and asset impairments are included in restructuring costs in the accompanying 2010 consolidated statements of operations. Amounts related to cash severance and lease obligations are accrued for in other current liabilities and other long-term liabilities in the accompanying consolidated balance sheets, while amounts related to accelerated share-based awards are recorded as a reduction to Devon's additional paid-in capital in the accompanying consolidated balance sheets. Asset impairments are presented as a reduction to Devon's net property and equipment in the accompanying consolidated 2010 balance sheet.

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

The schedule below summarizes the components of restructuring costs in the accompanying consolidated statements of operations.

16.  Discontinued Operations

Revenues related to Devon's discontinued operations totaled $139 million and $573 million in the third quarter and first nine months of 2010, respectively, and $250 million and $646 million in the third quarter and first nine months of 2009, respectively.

The following table presents the main classes of assets and liabilities associated with Devon's discontinued operations.

Reductions of Carrying Value of Oil and Gas Properties

In the first quarter of 2009, Devon reduced the carrying values of its Brazilian and other International oil and gas properties, which are now held for sale, $109 million due to full cost ceiling limitations. The Brazilian reduction of $103 million, which had no related tax benefit, resulted largely from an exploratory well drilled at the BM-BAR-3 block in the offshore Barreirinhas Basin. After drilling this well in the first quarter of 2009, Devon concluded that the well did not have adequate reserves for commercial viability. As a result, the seismic, leasehold and drilling costs associated with this well contributed to the reduction recognized in the first quarter of 2009.

Divestitures

See Note 5 for more information on the Azerbaijan and China divestitures.

17.          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 (loss) per share for the three-month and nine-month periods ended September 30, 2010 and 2009. Because a net loss from continuing operations was generated during the nine-month period ended September 30, 2009, the dilutive shares produce an antidilutive net loss per share result. Therefore, the diluted loss per share amount from continuing operations in the nine months ended September 30, 2009 reported in the accompanying 2009 consolidated statement of operations is the same as the basic loss per share amount.

Certain options to purchase shares of Devon's common stock are excluded from the dilution calculations because the options are antidilutive. During the three-month and nine-month periods ended September 30, 2010, 8.6 million shares and 7.9 million shares, respectively, were excluded from the diluted earnings per share calculations. During the three-month and nine-month periods ended September 30, 2009, 7.1 million shares and 8.9 million shares, respectively, were excluded from the diluted earnings per share calculations.

18.   Segment Information

Devon manages its operations through distinct operating segments, or divisions, which are defined primarily by geographic areas. For financial reporting purposes, Devon aggregates its United States divisions into one reporting segment due to the similar nature of the business. However, Devon's Canadian and International divisions are reported as separate reporting segments primarily due to significant differences in the respective regulatory environments.

Following is certain financial information regarding Devon's reporting segments. The revenues reported are all from external customers.

19.  Supplemental Information to Statements of Cash Flows

Information related to Devon's cash flows is presented below.