The $744 million of net earnings Devon reported in the third quarter of 2005 is after a net reduction for items that securities analysts typically exclude from their published estimates. Collectively, these items reduced Devon's reported net earnings in the third quarter of 2005 by $108 million, or 24 cents per diluted share. The most significant of these items, changes in the fair value of derivative financial instruments, reduced third quarter 2005 net earnings by $134 million pre-tax ($86 million after tax). Third quarter 2005 net earnings were also reduced by $51 million pre-tax ($34 million after tax) for additional interest costs associated with the early redemption of debt. These items and other excluded items are described more fully in the following pages of this release.
For the nine months ended September 30, 2005, Devon reported net earnings of $2.0 billion or $4.22 per common share ($4.15 per diluted common share). Net earnings for the nine months ended September 30, 2004, were $1.5 billion, or $3.13 per share ($3.04 per diluted common share).
"We had record earnings in the third quarter despite the disruptions caused by the Gulf hurricanes," said J. Larry Nichols, chairman and chief executive officer. "Devon's strong financial results are allowing us to expand our search for new oil and gas reserves in the United States, Canada and abroad. Through the first nine months of 2005 we have invested a record $2.6 billion, enabling us to drill 1,837 wells. This was 20 percent more wells than we drilled in the first nine months of 2004."
Operating Highlights Include 2,000th Barnett Shale Well
Devon drilled 644 productive wells in the third quarter of 2005 with an overall success rate of 98 percent. Operating highlights included:
Sales of oil, gas and natural gas liquids climbed to $2.3 billion in the third quarter of 2005. This was a 24 percent increase over third quarter 2004 sales of $1.9 billion. Higher realized oil, gas and natural gas liquids prices more than offset the production impact of property divestitures completed in 2005.
Combined oil, gas and natural gas liquids production in the third quarter of 2005 was 598 thousand barrels of oil equivalent (Boe) per day. This compares to third quarter 2004 production of 679 thousand Boe per day. The decrease in 2005 is primarily attributable to property divestitures and, to a lesser extent, the recent hurricanes.
Devon's third quarter 2005 average realized natural gas price increased 38 percent to $7.13 per thousand cubic feet, compared with $5.17 per thousand cubic feet in the third quarter of 2004. The company's third quarter 2005 average realized oil price increased 49 percent to $43.45 per barrel compared with $29.19 per barrel in the third quarter of 2004. Devon's average realized price for natural gas liquids for the third quarter of 2005 was $32.23 per barrel, a 32 percent increase over the $24.36 per barrel realized in the comparable quarter of 2004.
Marketing and midstream operating margin increased 24 percent to $111 million compared with $89 million in the third quarter of 2004. Marketing and midstream revenues decreased one percent to $405 million while related expenses decreased eight percent to $294 million in the third quarter of 2005.
Higher Activity Levels Reflected in Higher Unit Costs
Lease operating expenses decreased one percent to $319 million in the third quarter of 2005 compared with the same quarter in 2004. On a unit of production basis, lease operating expenses increased 12 percent to $5.80 per Boe compared with the third quarter of 2004. The increase in per-unit expenses reflects higher transportation costs, higher ad valorem taxes and the foreign exchange effect of the weaker U.S. dollar on Devon's Canadian operations. Power, fuel and repairs and maintenance costs also increased.
Production taxes increased 67 percent to $81 million in the third quarter of 2005, compared with the third quarter of 2004. Higher oil and gas sales contributed to the increase in production taxes. In addition, third quarter 2004 production taxes were reduced by an $18 million adjustment related principally to previous accounting periods.
Depreciation, depletion and amortization (DD&A) of oil and gas properties decreased seven percent to $493 million from $532 million in the third quarter of 2004. This decrease follows the decrease in production resulting from oil and gas property divestitures in the first half of 2005. The DD&A rate was $8.96 per Boe in the third quarter of 2005.
General and administrative expenses increased to $70 million, a 20 percent increase over third quarter 2004. Higher costs relate to increased activity, a larger personnel base and increases in compensation and benefits.
Third quarter 2005 interest expense increased 50 percent to $164 million compared with the third quarter of 2004. The increase was attributable to a $51 million charge in the 2005 quarter resulting from early redemption of long-term debt.
Income tax expense was $395 million, or 35 percent of pre-tax earnings in the third quarter of 2005. Of total income tax expense, $203 million was current and $192 million was deferred. As a result of finalizing Devon's 2004 tax return in the third quarter of 2005, the company accelerated the utilization of certain deferred tax benefits. This resulted in a $76 million reclassification of deferred tax benefits to reduce current tax expense in the third quarter of 2005.
$1.2 Billion of Cash Applied to Debt Reduction and Share Repurchases
Devon retired $668 million of long-term debt with cash on hand in the third quarter of 2005. This included the early retirement of its 6.75 percent notes due in 2011 with a face value of $400 million. The company also repurchased 10.4 million shares of its common stock during the quarter for $567 million completing the 50 million share repurchase program announced in September 2004. A second 50 million share repurchase program is now under way.
Cash flow before balance sheet changes was $1.6 billion in the third quarter of 2005. This was a 26 percent increase over the same quarter in 2004. Following the debt retirements, stock repurchases and other uses of cash in the quarter, cash and short term investments were $1.9 billion as of September 30, 2005. At September 30, 2005, Devon's net debt to adjusted capitalization was 23 percent. Reconciliations of cash flow before balance sheet changes, net debt and adjusted capitalization, all of which are non-GAAP measures, are provided in this release.
Items Excluded from Published Earnings Estimates
Devon's reported net earnings include items of income and expense that are typically excluded by securities analysts in their published estimates for the company's financial results. These items and their effects upon third quarter 2005 reported earnings were as follows:
The following table summarizes the effects of these items on earnings and income taxes. Included in the table are the tax effects of an income tax accrual adjustment and oil and gas property divestitures that did not affect net earnings.
Summary of Items Typically Excluded by Securities Analysts (in millions) Cash Flow Before Balance Pretax After-tax Sheet Earnings Income Tax Effect Earnings Changes Effect Current Deferred Total Effect Effect Change in fair value of financial instruments $(134) (4) (44) (48) (86) (8) Foreign exchange effect 15 --- 3 3 12 --- Additional interest costs on debt retirement (51) (17) --- (17) (34) (34) Income tax accrual adjustment --- (76) 76 --- --- 76 Effects of oil and gas property divestitures --- 42 (42) --- --- (42) Totals $(170) (55) (7) (62) (108) (8)
In aggregate, these items decreased third quarter 2005 net earnings by $108 million, or 25 cents per common share (24 cents per diluted share). These items and their associated tax effects decreased cash flow before balance sheet changes by $8 million.
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