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 financial statements and notes included in Devon's 2013 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 for a fair statement of Devon's results of operations and cash flows for the three-month periods ended March 31, 2014 and 2013 and Devon's financial position as of March 31, 2014.

 

Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of Devon and entities in which it holds a controlling interest. All intercompany transactions have been eliminated. Undivided interests in oil and natural gas exploration and production joint ventures are consolidated on a proportionate basis. Investments in non-controlled entities, over which Devon has the ability to exercise significant influence over operating and financial policies, are accounted for using the equity method. In applying the equity method of accounting, the investments are initially recognized at cost, and subsequently adjusted for Devon’s proportionate share of earnings, losses, and distributions. Investments accounted for using the equity method and cost method are reported as a component of other long-term assets.

 

As discussed more fully in Note 2, on March 7, 2014, Devon completed a business combination whereby Devon controls both EnLink Midstream Partners, LP (the “Partnership”) and its general partner entity, EnLink Midstream, LLC (“EnLink”). Devon controls both the Partnership’s and EnLink’s operations; therefore, the Partnership and EnLink’s accounts are included in Devon’s accompanying consolidated financial statements subsequent to the completion of the transaction. The portions of the Partnership and EnLink’s net earnings and stockholders’ equity not attributable to Devon’s controlling interest are shown separately as noncontrolling interests in the accompanying consolidated comprehensive statements of earnings and consolidated balance sheets.

 

Intangible Assets

 

EnLink’s long-term assets include intangible assets,  consisting of customer relationships. These assets are amortized on a straight-line basis over the expected periods of benefits, which range from fifteen to twenty years.

 

2.    Acquisitions and Divestitures

 

Formation of EnLink Midstream, LLC and EnLink Midstream Partners, LP

On March 7, 2014, Devon, Crosstex Energy, Inc. and Crosstex Energy, LP (together with Crosstex Energy, Inc., “Crosstex”) completed a business combination to combine substantially all of Devon’s U.S. midstream assets with Crosstex’s assets to form a new midstream business. The new business consists of the Partnership and EnLink, a master limited partnership and a general partner entity, respectively, which are both publicly traded entities. 

 

In exchange for a controlling interest in both EnLink and the Partnership, Devon contributed its equity interest in a newly formed Devon subsidiary EnLink Midstream Holdings, LP (“EnLink Holdings”) and $100 million in cash. EnLink Holdings owns Devon’s midstream assets in the Barnett Shale in north Texas and the Cana and Arkoma Woodford Shales in Oklahoma, as well as Devon’s economic interest in Gulf Coast Fractionators in Mt. Belvieu, Texas. The Partnership and EnLink each own 50 percent of EnLink Holdings.

 

The ownership of EnLink is approximately:

 

 

The ownership of the Partnership is approximately:

 

 

 

 

This business combination was accounted for using the acquisition method of accounting. Under the acquisition method of accounting, EnLink Holdings was the accounting acquirer because its parent company, Devon, obtained control of EnLink and the Partnership as a result of the business combination. Consequently, EnLink Holdings’ assets and liabilities retained their carrying values. Additionally, the Crosstex assets acquired and liabilities assumed by the Partnership and EnLink in the business combination, as well as EnLink’s noncontrolling interest in the Partnership, were recorded at their fair values which were measured as of the acquisition date, March 7, 2014. The excess of the purchase price over the estimated fair values of Crosstex’s net assets acquired was recorded as goodwill. The purchase price allocation has been prepared on a preliminary basis pending receipt of a final valuation report and is subject to material change. 

 

The following table summarizes the preliminary estimate of the purchase price and its allocation to the assets acquired and liabilities assumed (in millions, except unit price).

 

 

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(1) The final purchase price is based on the fair value of Crosstex Energy Inc.’s common shares as of the closing date, March 7, 2014.

(2) The Partnership converted the preferred units to common units in February 2014.

(3) The final purchase price is based on the fair value of the Partnership’s common shares as of the closing date, March 7, 2014.

 

The preliminary allocation of the purchase price is as follows (in millions):

 

 

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(1)  Goodwill was the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Goodwill is not amortized and is not deductible for tax purposes.

 

GeoSouthern Energy Acquisition

 

On November 20, 2013, Devon entered into a Purchase and Sale Agreement with GeoSouthern Energy Corporation (“GeoSouthern”) and a wholly owned subsidiary of GeoSouthern to acquire GeoSouthern’s interests in certain affiliates (the “Acquired Companies”) that own certain oil and gas properties, leasehold mineral interest and related assets located in the Eagle Ford Shale. On February 28, 2014, the GeoSouthern acquisition closed and GeoSouthern transferred the Acquired Companies to Devon in exchange for the aggregate purchase price of approximately $6.0 billion. Devon funded the acquisition price with cash on hand and debt financing. In connection with the GeoSouthern acquisition, Devon acquired approximately 82,000 net acres located in DeWitt and Lavaca counties in south Texas. The transaction was accounted for using the acquisition method, which requires, among other things, that assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. The purchase price allocation has been prepared on a preliminary basis and is subject to material change. The following table summarizes the preliminary allocation of the purchase price to the assets acquired and liabilities assumed in the transaction (in millions).

 

 

 

EnLink and GeoSouthern Operating Results

 

The following table presents EnLink’s and GeoSouthern’s operating revenues and net earnings included in Devon’s consolidated statements of earnings subsequent to the transactions described above.

 

 

Pro Forma Financial Information

 

The following unaudited pro forma financial information has been prepared assuming both the EnLink formation and the GeoSouthern acquisition occurred on January 1, 2013. The pro forma information is not intended to reflect the actual results of operations that would have occurred if the business combination and acquisition had been completed at the dates indicated. In addition, they do not project Devon’s results of operations for any future period.

 

 

 

Canadian Conventional Assets Divestiture

 

In November 2013, Devon announced plans to divest certain non-core properties located throughout Canada and the U.S. In the first quarter of 2014, Devon completed minor divestiture transactions for $142 million. On April 1, 2014, Devon sold the majority of its Canadian conventional assets to Canadian Natural Resources Limited for approximately $2.7 billion after taxes ($3.125 billion in Canadian dollars).

 

3.     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. Additionally, EnLink manages its exposure to fluctuations in commodity prices by hedging the impact of market fluctuations.

 

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, 2014, Devon did not hold any cash collateral from its counterparties.

 

Commodity Derivatives

 

As of March 31, 2014, Devon had the following open oil derivative positions. The first table presents Devon’s oil derivatives that settle against the average of the prompt month NYMEX West Texas Intermediate futures price. The second table presents Devon’s oil derivatives that settle against the Western Canadian Select index.

 

 

 

 

 

As of March 31, 2014, Devon had the following open natural gas derivative positions. The first table presents Devon’s natural gas derivatives that settle against the Inside FERC first of the month Henry Hub index. The second table presents Devon’s natural gas derivatives that settle against the AECO index.

 

 

 

 

 

 

 

 

Interest Rate Derivatives

 

 

 

 

Foreign Currency Derivatives

 

As of March 31, 2014, Devon had the following open foreign currency derivative positions:

 

 

Financial Statement Presentation

 

The following table presents the net gains and losses recognized in the accompanying comprehensive statements of earnings associated with derivative financial instruments. Net gains and losses associated with Devon’s commodity derivatives are presented in oil, gas and NGL derivatives in the accompanying comprehensive statements of earnings.  Net gains and losses associated with EnLink’s midstream commodity derivatives are presented in marketing and midstream revenues in the accompanying comprehensive statements of earnings. Net gains and losses associated with Devon’s interest rate and foreign currency derivatives are presented in other nonoperating items in the accompanying comprehensive statements of earnings.

 

 

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

 

 

 

4.     Share-Based Compensation 

 

The following table presents the effects of share-based compensation included in Devon’s accompanying comprehensive statements of earnings. Devon’s gross general and administrative expense for the first quarter of 2014 includes $1 million of unit-based compensation related to grants made under EnLink’s long-term incentive plans. The vesting for certain share-based awards was accelerated in the first quarter of 2014 in conjunction with the divestiture of Devon’s Canadian conventional assets. The associated expense for these accelerated awards is included in restructuring costs in the accompanying comprehensive statements of earnings. See Note 6 for further details. 

 

 

Under its 2009 Long-Term Incentive Plan, as amended, Devon granted share-based awards to certain employees in the first quarter of 2014. The following sections include information related to these awards.

 

Restricted Stock Awards and Units

 

The following table presents a summary of Devon's unvested restricted stock awards and units.

 

 

 

As of March 31, 2014, Devon's unrecognized compensation cost related to unvested restricted stock awards and units was $279 million. Such cost is expected to be recognized over a weighted-average period of 2.7 years.

 

Performance Based Restricted Stock Awards

 

The following table presents a summary of Devon's performance based restricted stock awards.

 

 

As of March 31, 2014, Devon's unrecognized compensation cost related to these awards was $12 million. Such cost is expected to be recognized over a weighted-average period of 1.9 years.

 

Performance Share Units  

 

The following table presents a summary of the grant-date fair values of performance share units granted in 2014 and the related assumptions.

 

 

The following table presents a summary of Devon’s performance share units.

 

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As of March 31, 2014, Devon's unrecognized compensation cost related to unvested units was $63 million. Such cost is expected to be recognized over a weighted-average period of 2.1 years

 

5.     Asset Impairments

 

In the first quarter of 2013, Devon recognized asset impairments related to its oil and gas property and equipment as presented below.

 

 

Oil and Gas 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. The lower ceiling values resulted primarily from decreases in the 12-month average trailing prices for oil, bitumen and NGLs, which reduced proved reserve values. 

  

6.     Restructuring Costs 

 

Canadian Divestitures

 

In the first quarter of 2014, Devon recognized $37 million of estimated employee related costs associated with its Canadian non-core asset divestitures. Approximately $14 million of the employee related costs resulted from accelerated vesting of share-based grants, which are non-cash charges.

 

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 December 31, 2013, Devon had completed this initiative and incurred $134 million of restructuring costs associated with the office consolidation.

 

Financial Statement Presentation

 

The schedule below summarizes restructuring costs presented in the accompanying comprehensive statements of earnings related to the Canadian divestitures and office consolidation.

 

 

The schedule below summarizes Devon’s restructuring liabilities. 

 

 

 

 

7.     Other Operating Items

 

The components of other operating items in the accompanying consolidated statements of earnings include the following:

 

 

 

8.     Earnings (Loss) Per Share Attributable to Devon

 

The following table reconciles net earnings (loss) attributable to Devon 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 6.3 million shares and 7.7 million shares during the three-month periods ended March 31, 2014 and 2013, respectively.

 

 

9.     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 Note 15 for additional details).

 

 

10.     Supplemental Information to Statements of Cash Flows

 

 

    On March 7, 2014, Devon completed a business combination to form EnLink. With the exception of a $100 million cash payment to noncontrolling interests, the business combination was a  non-monetary transaction. See  Note 2 for additional details.