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XCO > SEC Filings for XCO > Form 10-Q on 7-Aug-2013All Recent SEC Filings

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Form 10-Q for EXCO RESOURCES INC


7-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to "EXCO," "EXCO Resources," "Company," "we," "us," and "our" are to EXCO Resources, Inc. and its consolidated subsidiaries. Forward-looking statements
This Quarterly Report on Form 10-Q contains forward-looking statements, as defined in Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These forward-looking statements relate to, among other things, the following:

our future financial and operating performance and results;

our business strategy;

market prices for oil, natural gas and natural gas liquids;

our future use of derivative financial instruments; and

our plans and forecasts.

We have based these forward-looking statements on our current assumptions, expectations and projections about future events.
We use the words "may," "expect," "anticipate," "estimate," "believe," "continue," "intend," "plan," "budget" and other similar words to identify forward-looking statements. The statements that contain these words should be read carefully because they discuss future expectations, contain projections of results of operations or our financial condition and/or state other "forward-looking" information. We do not undertake any obligation to update or revise any forward-looking statements, except as required by applicable securities laws. These statements also involve risks and uncertainties that could cause our actual results or financial condition to materially differ from our expectations in this Quarterly Report on Form 10-Q, including, but not limited to:

fluctuations in the prices of oil, natural gas and natural gas liquids;

the availability of foreign oil, natural gas and natural gas liquids;

future capital requirements and availability of financing;

our ability to meet our current and future debt service obligations;

disruption of credit and capital markets and the ability of financial institutions to honor their commitments;

estimates of reserves and economic assumptions;

geological concentration of our reserves;

risks associated with drilling and operating wells;

exploratory risks, primarily related to our activities in shale formations including our recent acquisition in the Eagle Ford shale;

risks associated with the operation of natural gas pipelines and gathering systems;

discovery, acquisition, development and replacement of oil and natural gas reserves;

cash flow and liquidity;

timing and amount of future production of oil and natural gas;

availability of drilling and production equipment;

marketing of oil and natural gas;

political and economic conditions and events in oil-producing and natural gas-producing countries;

title to our properties;

litigation;

competition;

general economic conditions, including costs associated with drilling and operation of our properties;

environmental or other governmental regulations, including legislation to reduce emissions of greenhouse gases, legislation of derivative financial instruments, regulation of hydraulic fracture stimulation and elimination of income tax incentives available to our industry;

receipt and collectability of amounts owed to us by purchasers of our production and counterparties to our derivative financial instruments;

decisions whether or not to enter into derivative financial instruments;

potential acts of terrorism;

our ability to manage joint ventures with third parties including the resolution of any material disagreements and our partners' ability to satisfy obligations under these arrangements;

actions of third party co-owners of interests in properties in which we also own an interest;

fluctuations in interest rates; and


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our ability to effectively integrate companies and properties that we acquire.

We believe that it is important to communicate our expectations of future performance to our investors. However, events may occur in the future that we are unable to accurately predict, or over which we have no control. We caution users of the financial statements not to place undue reliance on any forward-looking statements. When considering our forward-looking statements, keep in mind the cautionary statements in this Quarterly Report on Form 10-Q, and the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the Securities and Exchange Commission, or the SEC, on February 21, 2013.
Our revenues, operating results and financial condition substantially depend on prevailing prices for oil and natural gas and the availability of capital. Declines in oil or natural gas prices may have a material adverse effect on our financial condition, liquidity, results of operations, the amount of oil or natural gas that we can produce economically and the ability to fund our operations. Historically, oil and natural gas prices and markets have been volatile, with prices fluctuating widely, and they are likely to continue to be volatile.
Overview
We are an independent oil and natural gas company engaged in the acquisition, exploration, exploitation, development and production of onshore U.S. oil and natural gas properties. Our principal operations are conducted in certain key U.S. oil and natural gas areas including Texas, Louisiana, and the Appalachia region. In addition to our oil and natural gas producing operations, we own 50% interests in two midstream joint ventures located in East Texas/North Louisiana and Appalachia.
Our primary strategy includes evaluating acquisitions that meet our strategic and financial objectives, and exploiting our shale resource plays. We plan to carry out this strategy by leveraging our management and technical team's experience, exploiting our multi-year inventory of development drilling locations in our shale plays, actively seeking acquisition opportunities both inside and outside our existing operating areas, managing our liquidity and maintaining financial flexibility. These approaches enhance our ability to execute our business plan over the entire commodity price cycle, protect our returns on investments and manage our capital structure.
Our current acquisition strategy focuses on producing properties with upside development opportunities. These acquisitions are dependent on oil and natural gas prices, availability of producing properties and attractive acreage, acceptable rates of return and availability of borrowing capacity or capital from other sources. While we expect to continue to evaluate acreage acquisition opportunities in our shale areas, we believe the current market provides greater opportunities from producing property acquisitions rather than undeveloped acreage acquisitions.
Like all oil and natural gas exploration and production companies, we face the challenge of natural production declines. Oil and natural gas production from a given well naturally decreases over time. We attempt to offset the impact of this natural decline by drilling to identify and develop additional reserves and adding reserves through acquisitions.

Recent Developments

Haynesville and Eagle Ford Acquisitions
On July 2, 2013, we entered into definitive agreements to acquire producing and undeveloped oil and natural gas assets in the Haynesville and Eagle Ford shale formations for an aggregate purchase price of approximately $1.0 billion, subject to customary preliminary purchase price adjustments, from subsidiaries of Chesapeake Energy Corporation, or Chesapeake. Upon execution of these agreements, we deposited $31.6 million and $68.1 million into escrow accounts for the acquisition of the Haynesville and Eagle Ford assets, respectively. The escrow accounts will remain in place after closing and will primarily be used to settle title and environmental defect adjustments.
We amended and restated the EXCO Resources Credit Agreement to facilitate these acquisitions, which increased the borrowing base to $1.6 billion, including a $1.3 billion revolving commitment and a $300.0 million term loan. The credit agreement provides that net proceeds from certain asset sales in excess of the borrowing base value (if any) will be used to reduce the outstanding borrowings by July 31, 2014. At any time after nine months from the closing date, the lenders have the right to demand that we engage investment bankers to publicly sell or privately place debt securities in an amount that is sufficient (i) to pay off $400.0 million less the amount of net asset sale proceeds received by EXCO and applied to reduce the outstanding borrowings, and (ii) reduce the amounts outstanding under the EXCO Resources Credit Agreement so that there is at least $100.0 million in available borrowing capacity. The term loan portion of the facility is expected to be replaced with a new term loan containing terms and conditions customary for a transaction of this nature. See further discussion of the EXCO Resources Credit Agreement within "Note 9. Long-term debt" in the Notes to our Condensed Consolidated Financial Statements.


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We closed the acquisition of the Haynesville assets on July 12, 2013 for a purchase price of $288.2 million, after customary preliminary purchase price adjustments. The acquisition was funded with borrowings from the EXCO Resources Credit Agreement. The acquisition included certain producing wells and non-producing oil, natural gas and mineral leases located in our core Haynesville shale operating area in Caddo Parish and DeSoto Parish, Louisiana. These properties included Chesapeake's non-operated interests in 170 wells operated by EXCO on approximately 5,600 net acres, and operated interests in 11 producing wells on approximately 4,000 net acres. The acquisition added approximately 55 identified drilling locations in the Haynesville shale formation to our drilling inventory. These assets are subject to BG Group's preferential right to acquire a 50% interest, which was formally offered to BG Group on July 13, 2013. Their election must be made within 60 days of our offer. We closed the acquisition of the Eagle Ford assets on July 31, 2013 for a purchase price of $685.3 million, after customary preliminary purchase price adjustments. The acquisition included certain producing wells and non-producing oil, natural gas and mineral leases in the Eagle Ford shale in the counties of Zavala, Dimmit, La Salle and Frio in South Texas. These properties include operated interests in 120 wells on approximately 55,000 net acres. The acquisition added approximately 300 identified drilling locations to our drilling inventory. In addition, we entered into a farm-out agreement with Chesapeake covering an additional 147,000 net acres adjacent to the acquired properties. Pursuant to the terms of the farm-out agreement, Chesapeake retains an overriding royalty interest in wells drilled on acreage covered by the farm-out agreement, with an option to convert the overriding royalty interest to a working interest at payout of the well.
In connection with closing the acquisition of the Eagle Ford assets, we entered into a participation agreement with Kohlberg Kravis Roberts & Co. L.P., or KKR, and sold an undivided 50% interest in the undeveloped acreage we acquired for approximately $130.9 million, after preliminary closing adjustments, or the KKR Participation Agreement. Proceeds from the sale of properties under the KKR Participation Agreement were used to reduce outstanding borrowings under the EXCO Resources Credit Agreement. After giving effect to the acquisition and the KKR payment, the EXCO Resources Credit Agreement borrowing base and outstanding borrowings were reduced by $130.9 million. This resulted in a borrowing base of $1.5 billion under the EXCO Resources Credit Agreement, with $1.3 billion of outstanding indebtedness including $269.1 million remaining under the asset sale requirement as of July 31, 2013.
The KKR Participation Agreement provides that EXCO and KKR will jointly fund future costs to develop the Eagle Ford assets. With respect to each well drilled, EXCO will assign half of its undivided 50% interest in such well to KKR such that KKR will fund and own 75% of each well drilled and EXCO will fund and own 25% of each well drilled. When each quarterly tranche of wells drilled has been on production for one year, EXCO is required to offer to purchase KKR's 75% working interest at fair market value as defined in the KKR Participation Agreement, subject to specific well criteria and return hurdles. With respect to the first year (first four quarters) of the development program, we are required to make our first offer during the fourth quarter of 2014 for wells that have been on line for approximately one year. The parties have agreed on approximately 300 identified locations to be drilled over a five year period.

EXCO/HGI Partnership
On February 14, 2013, we formed a partnership, or the EXCO/HGI Partnership, with Harbinger Group Inc., or HGI. Pursuant to the agreements governing the transaction, we contributed our conventional non-shale assets in East Texas and North Louisiana and our shallow Canyon Sand and other assets in the Permian Basin of West Texas to the EXCO/HGI Partnership in exchange for net proceeds of $574.8 million, after final purchase price adjustments, and a 25.5% economic interest in the EXCO/HGI Partnership. HGI's economic interest in the EXCO/HGI Partnership is 74.5%. The primary strategy of the EXCO/HGI Partnership is to acquire conventional producing oil and natural gas properties to enhance asset value and cash flow. Proceeds from the formation of the EXCO/HGI Partnership were used to reduce our outstanding indebtedness under the EXCO Resources Credit Agreement.
Immediately following the closing, the EXCO/HGI Partnership entered into an agreement to purchase the remaining shallow Cotton Valley assets within our joint venture with an affiliate of BG Group, for $130.9 million after customary preliminary purchase price adjustments. The assets acquired as a result of this transaction represented an incremental working interest in properties owned by the EXCO/HGI Partnership. The transaction closed on March 5, 2013 and was funded with borrowings from the EXCO/HGI Partnership's credit agreement, or the EXCO/HGI Partnership Credit Agreement.

Acreage transaction
On March 13, 2013, we closed a sale and joint development agreement with a private party for the sale of an undivided 50% of our interest in certain undeveloped acreage. We received $37.9 million in cash, after final closing adjustments. In addition to the cash consideration received at closing, the purchaser agreed to fund our share of drilling and completion costs within the joint venture area up to $18.9 million, with any remaining unfunded amount paid to us by June 30, 2016.


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Critical accounting policies
We consider accounting policies related to our estimates of proved reserves, accounting for derivatives, business combinations, share-based payments, oil and natural gas properties, goodwill, revenue recognition, asset retirement obligations and income taxes as critical accounting policies. The policies include significant estimates made by management using information available at the time the estimates are made. However, these estimates could change materially if different information or assumptions were used. These policies are summarized in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 21, 2013.


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Our results of operations
A summary of key financial data for the three and six months ended June 30, 2013 and 2012 related to our results of operations is presented below:

                         Three Months Ended June 30,                        Six Months Ended June 30,
(dollars in                                               Quarter to
thousands, except per                                      quarter                                            Period to
unit prices)                 2013             2012          change            2013              2012        period change
Production:
Oil (Mbbls)                        50            182            (132 )            152              374              (222 )
Natural gas liquids
(Mbbls)                            43            131             (88 )            125              253              (128 )
Natural gas (Mmcf)             37,695         48,162         (10,467 )         77,288           95,154           (17,866 )
Total production
(Mmcfe) (1)                    38,253         50,040         (11,787 )         78,950           98,916           (19,966 )
Average daily
production (Mmcfe)                420            550            (130 )            436              543              (107 )
Revenues before derivative financial instrument activities:
Oil                     $       4,524     $   15,721     $   (11,197 )   $     12,858       $   34,371     $     (21,513 )
Natural gas liquids             1,461          5,259          (3,798 )          4,554           11,713            (7,159 )
Natural gas                   144,347         96,998          47,349          271,143          206,742            64,401
Total revenues          $     150,332     $  117,978     $    32,354     $    288,555       $  252,826     $      35,729
Oil and natural gas derivative financial instruments:
Cash settlements on
derivative financial
instruments             $         794     $   61,815     $   (61,021 )   $     17,511       $  111,960     $     (94,449 )
Non-cash change in
fair value of
derivative financial
instruments                    54,452        (77,073 )       131,525           (5,779 )        (73,353 )          67,574
Total derivative
financial instrument
activities              $      55,246     $  (15,258 )   $    70,504     $     11,732       $   38,607     $     (26,875 )
Average sales price (before cash settlements of derivative financial instruments):
Oil (per Bbl)           $       90.48     $    86.38     $      4.10     $      84.59       $    91.90     $       (7.31 )
Natural gas liquids
(per Bbl)                       33.98          40.15           (6.17 )          36.43            46.30             (9.87 )
Natural gas (per Mcf)            3.83           2.01            1.82             3.51             2.17              1.34
Natural gas
equivalent (per Mcfe)            3.93           2.36            1.57             3.65             2.56              1.09
Costs and expenses:
Oil and natural gas
operating costs         $      11,902     $   18,863     $    (6,961 )   $     25,519       $   41,659     $     (16,140 )
Production and ad
valorem taxes                   3,981          6,789          (2,808 )          9,229           13,982            (4,753 )
Gathering and
transportation                 23,408         25,913          (2,505 )         47,884           52,336            (4,452 )
Depletion                      45,366         83,515         (38,149 )         84,357          169,031           (84,674 )
Depreciation and
amortization                    2,022          3,822          (1,800 )          4,339            7,888            (3,549 )
General and
administrative (2)             26,574         18,637           7,937           44,558           40,142             4,416
Interest expense               15,105         20,369          (5,264 )         35,297           37,133            (1,836 )
Costs and expenses
(per Mcfe):
Oil and natural gas
operating costs         $        0.31     $     0.38     $     (0.07 )   $       0.32       $     0.42     $       (0.10 )
Production and ad
valorem taxes                    0.10           0.14           (0.04 )           0.12             0.14             (0.02 )
Gathering and
transportation                   0.61           0.52            0.09             0.61             0.53              0.08
Depletion                        1.19           1.67           (0.48 )           1.07             1.71             (0.64 )
Depreciation and
amortization                     0.05           0.08           (0.03 )           0.05             0.08             (0.03 )
General and
administrative                   0.69           0.37            0.32             0.56             0.41              0.15
Net income (loss)       $      85,598     $ (496,433 )   $   582,031     $    243,718       $ (778,082 )   $   1,021,800

(1) Mmcfe is calculated by converting one barrel of oil or natural gas liquids into six Mcf of natural gas.

(2) Share-based compensation expense included in general and administrative expenses was $4.6 million and $2.6 million for the three months ended June 30, 2013 and 2012, respectively, and $6.3 million and $5.5 million for the six months ended June 30, 2013 and 2012, respectively.


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Following is a discussion of our financial condition and results of operations for the three and six months ended June 30, 2013 and 2012. The comparability of our results of operations was impacted by:

the formation of the EXCO/HGI Partnership in the first quarter of 2013;

fluctuations in oil, natural gas and natural gas liquids prices, which impact our oil and natural gas reserves, revenues, cash flows and net income or loss;

ceiling test write-downs in 2013 and 2012;

asset impairments and other non-recurring costs;

mark-to-market gains and losses from our derivative financial instruments;

changes in proved reserves and production volumes and their impact on depletion;

the impact of declining natural gas production volumes from our significantly reduced horizontal drilling activities in shale formations; and

significant changes in the amount of our long-term debt.

General
The availability of a ready market and prices for oil, natural gas and natural gas liquids are dependent upon a number of factors that are beyond our control. These factors include, among other things:
the level of domestic production and economic activity;

the domestic oversupply of natural gas;

the inability to export domestic oil, natural gas and natural gas liquids;

the level of domestic and industrial demand for natural gas for utilities and manufacturing operations;

the available capacity at natural gas storage facilities and quantities of inventories in storage;

the availability of imported oil and natural gas;

actions taken by foreign oil producing nations;

the cost and availability of natural gas pipelines with adequate capacity and other transportation facilities;

the cost and availability of other competitive fuels;

fluctuating and seasonal demand for oil, natural gas, natural gas liquids and refined products;

the extent of governmental regulation and taxation (under both present and future legislation) of the exploration, production, refining, transportation, pricing, use and allocation of oil, natural gas, refined products and substitute fuels; and

trends in fuel use and government regulations that encourage less fuel use and encourage or mandate alternative fuel use.

Accordingly, in light of the many uncertainties affecting the supply and demand for oil, natural gas, natural gas liquids and refined petroleum products, we cannot accurately predict the prices or marketability of oil, natural gas and natural gas liquids from any producing well in which we have or may acquire an interest.
Marketing arrangements
We produce oil, natural gas and natural gas liquids. We do not refine or process the oil, natural gas or natural gas liquids we produce. We sell the majority of the oil we produce under short-term contracts using market sensitive pricing. The majority of our contracts are based on NYMEX pricing, which is typically calculated as the average of the daily closing prices of oil to be delivered one month in the future. We also sell a portion of our oil at F.O.B. field prices posted by the principal purchaser of oil where our producing properties are located. Our sales contracts are of a type common within the industry, and we usually negotiate a separate contract for each property. Generally, we sell our oil to purchasers and refiners near the areas of our producing properties. We sell the majority of our natural gas under individually negotiated gas purchase contracts using market sensitive pricing. Our sales contracts vary in length from spot market sales of a single day to term agreements that may extend for a year or more. Our natural gas customers include utilities, natural gas marketing companies and a variety of commercial and industrial end users. The natural gas purchase contracts define the terms and conditions unique to each of these sales. The price received for natural gas sold on the spot market varies daily, reflecting changing market conditions. Some of our natural gas is sold under contracts which provide for sharing in a percentage of proceeds of natural gas liquids extracted by third party plants.
We may be unable to market all of the oil and natural gas we produce. If our oil and natural gas can be marketed, we may be unable to negotiate favorable pricing and contractual terms. Changes in oil or natural gas prices may significantly affect our revenues, cash flows, the value of our oil and natural gas properties and the estimates of recoverable oil and natural gas reserves. Further, significant declines in the prices of oil or natural gas may have a material adverse effect on our business and on our financial condition.


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We engage in oil and natural gas production activities in geographic regions where, from time to time, the supply of oil or natural gas available for delivery exceeds the demand. If this occurs, companies purchasing oil or natural gas in these areas may reduce the amount of oil or natural gas that they purchase from us. If we cannot locate other buyers for our production or for any of our oil or natural gas reserves, we may shut in our oil or natural gas wells for certain periods of time. If this occurs, we may incur additional payment obligations under our oil and natural gas leases and, under certain circumstances, the oil and natural gas leases might be terminated. Economic conditions, particularly low oil and natural gas prices, may negatively impact the liquidity and creditworthiness of our purchasers and may expose us to risk with respect to the ability to collect payments for the oil and natural gas we deliver.
Summary
For the three months ended June 30, 2013, we reported net income of $85.6 million compared to a net loss of $496.4 million for the three months ended June 30, 2012. The net income for the three months ended June 30, 2013 was primarily the result of income from operations and unrealized gains on derivative instruments. For the six months ended June 30, 2013, we reported net income of $243.7 million compared to a net loss of $778.1 million for the six months ended June 30, 2012. The net income for the six months ended June 30, 2013 was primarily the result of income from operations and the gain on the . . .

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