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. 

 

 

 

 

 

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:

 

 

 

 Foreign Currency Derivatives

 

As of March 31, 2013, Devon had the following open foreign currency derivative positions:

 

 

 

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.

 

 

 

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

 

 

 

 

 

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.

 

Financial Statement Presentation

 

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.

 

 

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.

 

 

The schedule below summarizes Devon’s restructuring liabilities. 

 

 

 

4.Other, net 

 

The components of other, net in the accompanying comprehensive statements of earnings include the following: 

 

 

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.

 

 

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:

 

 

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(1)  These accumulated other comprehensive earnings components are included in the computation of net periodic benefit cost, which is a component of general and administrative expenses on the accompanying comprehensive statements of earnings (see retirement plans footnote for additional details). 

7.Supplemental Information to Statements of Cash Flows 

 

 

 

 

8.Short-Term Investments

 

The components of short-term investments include the following: 

 

 

9. Accounts Receivable

 

The components of accounts receivable include the following: 

 

 

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.

 

 

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.  

 

13.Asset Retirement Obligations

 

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

 

 

14.Retirement Plans

 

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

 

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(1)  These net periodic benefit costs were reclassified out of comprehensive earnings in the current period.

(2)  Net periodic benefit cost is a component of general and administrative expenses on the accompanying comprehensive statements of earnings.

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.

 

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. 

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.

 

 

 

 

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.

 

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.