1.     Summary of Significant Accounting Policies 

 

The accompanying unaudited interim financial statements and notes of Devon Energy Corporation (“Devon”, “we”, “us” or “our”) have been prepared pursuant to the rules and regulations of the SEC. 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 (“U.S.”) have been omitted. The accompanying unaudited interim financial statements and notes should be read in conjunction with the financial statements and notes included in Devon’s 2014 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 and six-month periods ended June 30, 2015 and 2014 and Devon’s financial position as of June 30, 2015.

 

Recently Issued Accounting Standards not yet Adopted

 

The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606).  This ASU provides guidance concerning the recognition and measurement of revenue from contracts with customers. Its objective is to increase the usefulness of information in the financial statements regarding the nature, timing and uncertainty of revenues. This ASU is effective for annual and interim periods beginning in 2018 and is required to be adopted using either the retrospective or cumulative effect transition method, with early adoption permitted in 2017. Devon has not yet selected a transition method and is evaluating the impact this ASU will have on its consolidated financial statements and related disclosures.

 

The FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis.  This ASU provides additional guidance to reporting entities in evaluating whether certain legal entities, such as limited partnerships, limited liability corporations and securitization structures, should be consolidated. The ASU is considered to be an improvement on current accounting requirements as it reduces the number of existing consolidation models. The ASU is effective for annual and interim periods beginning in 2016 and is required to be adopted using a retrospective or modified retrospective approach, with early adoption permitted. Devon is evaluating the impact this ASU will have on its consolidated financial statements and related disclosures.

 

The FASB issued ASU 2015-03, Interest – Imputation of Interest (Topic 835): Simplifying the Presentation of Debt Issuance Costs. This ASU requires debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the carrying amount of that debt liability rather than as an asset. This ASU is effective for annual and interim periods beginning in 2016 and is required to be applied retrospectively, with early adoption permitted. Devon does not expect the adoption to have a material impact on its consolidated financial statements. 

 

2.    Acquisitions and Divestitures

 

Acquisition of GeoSouthern and Formation of EnLink 

 

    On February 28, 2014, Devon completed its acquisition of interests in certain affiliates of GeoSouthern Energy Corporation (“GeoSouthern”). 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 EnLink Midstream, LLC (the “General Partner”) and EnLink Midstream Partners, LP (“EnLink”), which are both controlled by Devon and are publicly traded entities. 

 

The following unaudited pro forma financial information was prepared assuming both the GeoSouthern acquisition and the formation of EnLink and the General Partner occurred on January 1, 2014. The pro forma information has been included for comparative purposes only and 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 date indicated. In addition, it does not project Devon’s results of operations for any future period.

 

 

 

EnLink Acquisitions

 

    The following table summarizes EnLink’s acquisition activity for the first six months of 2015:  

 

 

 

 

EnLink Dropdowns

 

    In February 2015, EnLink acquired a 25% equity interest in EnLink Midstream Holdings, LP (“EMH”) from the General Partner in exchange for units valued at approximately $925 million. In May 2015, EnLink acquired the remaining 25% equity interest in EMH from the General Partner in exchange for units valued at approximately $900 million.

 

In April 2015, EnLink acquired the Victoria Express Pipeline and related truck terminal and storage assets (“VEX”) from Devon for approximately $180 million in cash and equity, subject to certain adjustments. EnLink also assumed approximately $35 million in certain future construction costs to expand the system to full capacity.

 

Asset Divestitures

 

    In the second quarter of 2014, Devon sold Canadian conventional assets for $2.8 billion ($3.125 billion Canadian dollars) and recognized a gain totaling $1.1 billion ($0.6 billion after-tax).  This gain is included as a separate item in the accompanying consolidated comprehensive statements of earnings. Included in the gain calculation were asset retirement obligations of approximately $700 million assumed by the purchaser as well as the derecognition of approximately $700 million of goodwill allocated to the sold assets. In conjunction with the divestiture, Devon repatriated approximately $2.8 billion of proceeds to the U.S. in the second quarter of 2014, which were utilized to repay commercial paper and term loan balances. Between collecting the divestiture proceeds and repatriating funds to the U.S., Devon recognized an $84 million foreign currency exchange loss and a $29 million foreign currency derivative loss. These losses are included in other nonoperating items in the accompanying consolidated comprehensive statements of earnings.

 

 

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 to hedge future prices received. Additionally, Devon and EnLink periodically enter into derivative financial instruments with respect to a portion of their oil, gas and NGL marketing activities. These commodity derivative financial instruments 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 June 30, 2015 and December 31, 2014, Devon held $189 million and $524 million, respectively, of cash collateral which represented the estimated fair value of certain derivative positions in excess of Devon’s credit guidelines. The collateral is reported in other current liabilities in the accompanying consolidated balance sheets.

 

Commodity Derivatives

 

As of June 30, 2015, 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 (“WTI”) futures price. The second table presents Devon’s oil derivatives that settle against the Western Canadian Select, West Texas Sour and Midland Sweet indices.

 

 

 

 

As of June 30, 2015, 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 Panhandle Eastern Pipe Line, El Paso Natural Gas, Houston Ship Channel and Transco Zone 4 indices.

 

 

 

 

 

 

    As of June 30, 2015, the following were open derivative positions associated with gas processing and fractionation at EnLink. EnLink’s NGL positions settle by purity product against the average of the prompt month OPIS Mont Belvieu, Texas index. EnLink’s natural gas derivatives settle against the Henry Hub Gas Daily index.

 

 

Interest Rate Derivatives

 

    As of June 30, 2015, Devon had the following open interest rate derivative positions:

 

 

 

Foreign Currency Derivatives

 

As of June 30, 2015, Devon had the following open foreign currency derivative position:

 

 

 

Financial Statement Presentation

 

The following table presents the net gains and losses recognized in the accompanying consolidated comprehensive statements of earnings associated with derivative financial instruments.

 

 

 

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

   

 

 

 

4.     Share-Based Compensation

 

The following table presents the effects of share-based compensation included in Devon’s accompanying consolidated comprehensive statements of earnings. Devon’s gross general and administrative expense for the first six months of 2015 and 2014 includes $18 million and $6 million, respectively, 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. For the six months ended June 30, 2014, approximately $15 million of associated expense for these accelerated awards is included in restructuring costs in the accompanying consolidated comprehensive statements of earnings.

 

 

 

Under its 2009 Long-Term Incentive Plan, as amended (the “2009 Plan”), and its 2015 Long-Term Incentive Plan (the “2015 Plan”), Devon granted share-based awards to certain employees and directors in the first six months of 2015. 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 June 30, 2015, Devon’s unrecognized compensation cost related to unvested awards and units was $267 million. Such cost is expected to be recognized over a weighted-average period of 2.8 years.

 

Performance-Based Restricted Stock Awards

 

The following table presents a summary of Devon’s unvested performance-based restricted stock awards.

 

 

As of June 30, 2015, Devon’s unrecognized compensation cost related to unvested awards was $8 million. Such cost is expected to be recognized over a weighted-average period of 3.2 years.

 

Performance Share Units

 

The following table presents a summary of the grant-date fair values of performance share units granted in 2015 and the related assumptions.

 

 

 

 

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

 

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As of June 30, 2015, Devon’s unrecognized compensation cost related to unvested units was $64 million. Such cost is expected to be recognized over a weighted-average period of 2.2 years.

 

2015 Long-Term Incentive Plan

 

In the second quarter of 2015, Devon’s stockholders approved the 2015 Plan. The 2015 Plan replaces the 2009 Plan. From the effective date of the 2015 Plan, no further awards may be made under the 2009 Plan, and awards previously granted will continue to be governed by the terms of the 2009 Plan. Subject to the terms of the 2015 Plan, awards may be made under the 2015 Plan for a total of 28 million shares of Devon common stock, plus the number of shares available for issuance under the 2009 Plan (including shares subject to outstanding awards under the 2009 Plan that are subsequently forfeited, cancelled or expire). The 2015 Plan authorizes the Compensation Committee, which consists of independent, non-management members of Devon’s Board of Directors, to grant nonqualified and incentive stock options, restricted stock awards or units, Canadian restricted stock units, performance awards or units and stock appreciation rights to eligible employees. The 2015 Plan also authorizes the grant of nonqualified stock options, restricted stock awards or units and stock appreciation rights to non-employee directors. To calculate the number of shares that may be granted in awards under the 2015 Plan, options and stock appreciation rights represent one share and other awards represent three shares.

 

EnLink Share-Based Awards 

 

    In March 2015, the General Partner and EnLink issued restricted incentive units as bonus payments to officers and certain employees for 2014. The combined grant fair value was $7 million, and the total cost was recognized in the first quarter of 2015 due to the awards vesting immediately.

 

    As of June 30, 2015, the General Partner and EnLink both had unrecognized compensation cost related to unvested restricted incentive units of  $24 million. Such cost is expected to be recognized for the General Partner and EnLink over a weighted-average period of 1.9 and 2.0 years, respectively. Additionally, the General Partner and EnLink both had unrecognized compensation cost related to unvested performance units of $4 million. Such cost is expected to be recognized over a weighted-average period of 2.5 years for both the General Partner and EnLink.

 

 

5.     Asset Impairments

 

In the first six months of 2015, Devon recognized asset impairments 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% 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 from a decline in the U.S. full cost ceiling. This lower ceiling value resulted from decreases in the 12-month average trailing prices for oil, gas and NGLs, which reduced proved reserves and proved reserves values.

 

 

 

6.     Income Taxes

 

The following table presents Devon’s total income tax expense (benefit) and a reconciliation of its effective income tax rate to the U.S. statutory income tax rate.

 

 

 

    Devon estimates its annual effective income tax rate in recording its quarterly provision for income taxes in the various jurisdictions in which it operates. Statutory tax rate changes and other significant or unusual items are recognized as discrete items in the quarter in which they occur.

 

    In the second quarter of 2015, Devon recognized $57 million of income tax benefits in conjunction with favorable tax settlements. In addition, changes in statutory tax rates in Texas and the province of Alberta, Canada resulted in a net increase to deferred tax expense of $44 million.

 

     Devon and its subsidiaries are subject to U.S. federal income tax as well as income or capital taxes in various state and foreign jurisdictions. Devon’s tax reserves are related to tax years that may be subject to examination by the relevant taxing authority. Devon is under audit in the U.S. and various foreign jurisdictions as part of its normal course of business.

 

In the second quarter of 2014, Devon recognized $247 million of additional income tax expense related to the $2.8 billion of repatriations to the U.S. Prior to the repatriation, Devon had recognized a $143 million deferred income tax liability associated with the planned repatriation. When the repatriation was made, Devon retained a larger property basis in Canada than was previously estimated, resulting in the incremental tax in the second quarter.

 

In the first quarter of 2014, Devon recorded a $48 million deferred tax liability in conjunction with the formation of the General Partner, which impacted the effective tax rate as reflected in the table above.

 

 

7.     Net 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 net earnings per share.

 

Certain options to purchase shares of Devon’s common stock are excluded from the dilution calculation because the options are antidilutive. During the three-month and six-month periods ended June 30, 2015, 3.3 million shares and 4.0 million shares, respectively, were excluded from the diluted net earnings per share calculations. During the three-month and six-month periods ended June 30, 2014, 2.6 million shares and 3.4 million shares, respectively, were excluded from the diluted net earnings per share calculations.