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CXO > SEC Filings for CXO > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for CONCHO RESOURCES INC


7-Nov-2013

Quarterly Report


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

The following discussion is intended to assist you in understanding our business and results of operations together with our present financial condition. This section should be read in conjunction with our historical consolidated financial statements and notes. As a result of the acquisitions and divesture discussed below, many comparisons between periods may be difficult or impossible.

In December 2012, we closed the sale of certain of our non-core assets for cash consideration of approximately $503.1 million, which resulted in a pre-tax gain of approximately $0.9 million (included in discontinued operations). For the nine months ended September 30, 2012, these assets produced an average of 5,044 Boe per day.

In July 2012, we acquired certain producing and non-producing assets from Three Rivers Operating Company (the "Three Rivers Acquisition") for cash consideration of approximately $1.0 billion. The Three Rivers Acquisition was primarily funded with borrowings under our credit facility. The results of operations prior to July 2012 do not include results from the Three Rivers Acquisition.

In February 2012, we acquired certain producing and non-producing assets from Petroleum Development Corporation (the "PDC Acquisition") for cash consideration of approximately $189.2 million. The PDC Acquisition was primarily funded with borrowings under our credit facility. The results of operations prior to March 2012 do not include results from the PDC Acquisition.

Certain statements in our discussion below are forward-looking statements. These forward-looking statements involve risks and uncertainties. We caution that a number of factors could cause actual results to differ materially from those implied or expressed by the forward-looking statements. Please see "Cautionary Statement Regarding Forward-Looking Statements."

Overview

We are an independent oil and natural gas company engaged in the acquisition, development and exploration of producing oil and natural gas properties. Our core operations are primarily focused in the Permian Basin of Southeast New Mexico and West Texas. We refer to our three core operating areas as the
(i) New Mexico Shelf, where we primarily target the Yeso formation,
(ii) Delaware Basin, where we primarily target the Bone Spring formation (which includes the Avalon Shale and the Bone Spring sands) and the Wolfcamp shale, and
(iii) Texas Permian, where we primarily target the Wolfberry, a term applied to the combined Wolfcamp and Spraberry horizons. Oil comprised 61.2 percent of our
447.2 MMBoe of estimated proved reserves at December 31, 2012 and 62.2 percent of our 24.7 MMBoe of production for the nine months ended September 30, 2013. We seek to operate the wells in which we own an interest, and we operated wells that accounted for 91.3 percent of our proved developed producing PV-10 and 81.6 percent of our approximately 5,800 gross wells at December 31, 2012. By controlling operations, we are able to more effectively manage the cost and timing of exploration and development of our properties, including the drilling and stimulation methods used.

Financial and Operating Performance

Our financial and operating performance for the nine months ended September 30, 2013, as compared to the nine months ended September 30, 2012, included the following highlights:

Net income was $145.2 million ($1.38 per diluted share) for the first nine months of 2013, as compared to net income of $356.4 million ($3.43 per diluted share) during the nine months ended September 30, 2012. The decrease in net income was primarily due to:

$157.3 million loss on derivatives not designated as hedges for the nine months ended September 30, 2013, as compared to a $109.5 million gain on derivatives not designated as hedges during the nine months ended September 30, 2012, primarily related to commodity future price curves at the respective measurement periods;

$149.1 million increase in depreciation, depletion and amortization ("DD&A") expense from continuing operations, primarily due to increased continuing operations production from (i) costs incurred associated with new wells that were successfully drilled and completed in the fourth quarter of 2012 and the first nine months of 2013 and (ii) our acquisitions in 2012;


$76.7 million increase in oil and natural gas production costs from continuing operations due in part to increased production related to our wells successfully drilled and completed in 2012 and 2013 and our acquisitions in 2012;

$65.4 million non-cash impairment charge in 2013 due primarily to downward adjustments to our economically recoverable proved reserves due to (i) reduced well performance and (ii) decreases in estimated realized natural gas prices, primarily on non-core natural gas properties in our New Mexico Shelf area;

$29.1 million increase in general and administrative expense due to (a) including an adjustment to our bonus accrual for services related to 2012 of approximately $5.9 million ($0.24 per Boe) recorded in 2013 and (b) an increase in the number of employees and related personnel expenses to handle our increased activities, both from (i) increased drilling and exploration activities and (ii) our acquisitions in 2012;

$33.1 million increase in interest expense due to a 24 percent increase in the weighted average debt balance outstanding between the periods, primarily related to our acquisitions in 2012 and the timing of our capital expenditures;

$28.6 million loss on extinguishment of debt in 2013 related to the tender offer and redemption of our 8.625% senior notes; and

$19.6 million pre-tax gain from discontinued operations in 2013 related to the post-closing adjustments to the divestiture of certain non-core assets in the fourth quarter of 2012 compared to $45.9 million of income from operations before income taxes related to the same assets in 2012;

partially offset by:

$345.5 million increase in oil and natural gas revenues from continuing operations as a result of a 23 percent increase in production, coupled with a 3 percent increase in commodity price realizations per Boe (excluding the effects of derivative activities).

Average daily sales volumes from continuing operations increased by 23 percent from 73,599 Boe per day during the first nine months of 2012 to 90,514 Boe per day during the first nine months of 2013. The increase was primarily comprised of our successful drilling efforts during 2012 and 2013, with the remaining increase due to approximately 7,200 Boe per day attributable to our acquisitions in 2012, offset in part by normal production declines and curtailed production in our New Mexico Shelf area, discussed later.

Net cash provided by operating activities increased by approximately $99.0 million to $944.6 million for the first nine months of 2013, as compared to $845.6 million in the first nine months of 2012, primarily due to increased oil and natural gas revenues, partially offset by (i) increases in oil and natural gas production costs, general and administrative expense and interest expense and (ii) a larger negative variance in working capital changes, which adjust for the timing of receipts and payments of actual cash.

Long-term debt increased by approximately $487.5 million during the first nine months of 2013, primarily as a result of the spending on drilling in excess of our operating cash flow.

At September 30, 2013, availability under our credit facility was approximately $2.3 billion.

Commodity Prices

Our results of operations are heavily influenced by commodity prices. Commodity prices may fluctuate widely in response to (i) relatively minor changes in the supply of and demand for oil, (ii) natural gas and NGLs market uncertainty and
(iii) a variety of additional factors that are beyond our control. Factors that may impact future commodity prices, including the price of oil, natural gas and NGLs include:

economic stimulus initiatives in the United States;

worldwide and continuing economic struggles in Eurozone nations' economies;


political and economic developments in the Middle East;

demand from Asian and European markets;

the extent to which members of the Organization of Petroleum Exporting Countries and other oil exporting nations are able to continue to manage oil supply through export quotas;

technological advances affecting energy consumption and energy supply;

the effect of energy conservation efforts;

the price and availability of alternative fuels;

domestic and foreign governmental regulations and taxation;

the proximity, capacity, cost and availability of pipelines and other transportation facilities;

the quality of the oil we produce;

the overall global demand for oil; and

overall North American natural gas supply and demand fundamentals, including:

the United States economy impact,

weather conditions, and

liquefied natural gas deliveries to the United States.

Although we cannot predict the occurrence of events that may affect future commodity prices or the degree to which these prices will be affected, the prices for any commodity that we produce will generally approximate current market prices in the geographic region of the production. From time to time, we expect that we may economically hedge a portion of our commodity price risk to mitigate the impact of price volatility on our business. See Note H of the Condensed Notes to Consolidated Financial Statements included in "Item 1. Consolidated Financial Statements (Unaudited)" for additional information regarding our commodity derivative positions at September 30, 2013.

Oil and natural gas prices have been subject to significant fluctuations during the past several years. In general, average oil prices were relatively consistent in the nine months ended September 30, 2013 compared to the same period in 2012, while in the three months ended September 30, 2013 compared to the same period in 2012 there was a significant increase in average oil prices. Average natural gas prices in 2013 significantly improved relative to 2012. The following table sets forth the average New York Mercantile Exchange ("NYMEX") oil and natural gas prices for the three and nine months ended September 30, 2013 and 2012, as well as the high and low NYMEX prices for the same periods:

                                   Three Months Ended          Nine Months Ended
                                     September 30,               September 30,
                                   2013          2012         2013          2012

Average NYMEX prices:
      Oil (Bbl)                 $  105.94     $  92.29     $   98.21     $   96.21
      Natural gas (MMBtu)       $    3.55     $   2.89     $    3.69     $    2.59

High and Low NYMEX prices:
      Oil (Bbl):
             High               $  110.53     $  99.00     $  110.53     $  109.77
             Low                $   97.99     $  83.75     $   86.68     $   77.69
      Natural gas (MMBtu):
             High               $    3.81     $   3.32     $    4.41     $    3.32
             Low                $    3.23     $   2.61     $    3.11     $    1.91


Further, the NYMEX oil and natural gas prices reached highs and lows of $104.10 and $94.61 per Bbl and $3.79 and $3.45 per MMBtu, respectively, during the period from September 30, 2013 to November 4, 2013. At November 4, 2013, the NYMEX oil and natural gas prices were $94.62 per Bbl and $3.45 per MMBtu, respectively.

Recent Events

2014 capital budget. In November 2013, we announced our 2014 capital budget of approximately $2.3 billion. Our 2014 capital program is expected to continue focusing on drilling in the Delaware Basin and Midland Basin. The 2014 capital budget, based on our current expectations of commodity prices and cost, will exceed our cash flow. We expect our cash flow and borrowings under our credit facility will be sufficient to fund our budgeted capital expenditure needs during 2014. However, our capital budget is largely discretionary, and if we experience sustained oil and natural gas prices significantly below the current levels or substantial increases in our costs, we may reduce our capital spending program to manage the level of capital outspend.

                                                                 2014
                                                               Capital
(in millions)                                                   Budget

Drilling and completion costs:
     New Mexico Shelf                                        $    152
     Delaware Basin                                             1,406
     Texas Permian                                                459
Facilities and other capital in our core operating areas          188
Acquisition of leasehold acreage                                   75
Geological and geophysical data                                    20
     Total                                                   $  2,300

Revised 2013 capital budget. For 2013, we increased our capital budget by approximately $200 million to a total of approximately $1.8 billion, excluding the costs of acquisitions other than customary leasehold purchases of acreage. Based on current commodity prices and capital costs, we believe our 2013 expected capital expenditures, excluding the effects of acquisitions, will exceed our 2013 cash flow. We have funded, and expect to continue to fund, the shortfall, if any, with borrowings under our credit facility.

Three-year accelerated growth plan. We have adopted an accelerated drilling program for the next three years which we expect will double production by 2016. By accelerating activity across our assets, we believe that we can deliver average annual organic production growth over the next three years in excess of our historical annual average while increasing oil mix and reducing leverage ratios.

Tender offer and redemption of senior notes and senior notes issuance. On June 3, 2013, we received tenders and consents from the holders of approximately $225.6 million in aggregate principal amount, or approximately 75.2 percent, of our outstanding 8.625% senior notes due 2017 (the "8.625% Notes") in connection with a cash tender offer for any and all of the 8.625% Notes at a price of 106.922 percent of the unpaid principal amount.

On June 21, 2013, we redeemed the remaining outstanding 8.625% Notes not purchased in the tender offer at a redemption price of 106.516 percent of the unpaid principal amount plus accrued and unpaid interest through June 20, 2013.

We recorded a loss on extinguishment of debt related to the redemption of the 8.625% Notes of approximately $28.6 million for the nine months ended September 30, 2013.

On June 4, 2013, we completed the issuance of an additional $850 million in principal amount of our 5.5% senior notes due 2023 (the "Offering") at 103.75 percent of par (resulting in a 4.884% yield) for net proceeds of approximately $867.8 million. We used a portion of the net proceeds from the Offering to fund the tender offer and redemption of the 8.625% Notes and to pay down amounts outstanding on the credit facility. See Note I of the Condensed Notes to Consolidated Financial Statements included in "Item 1. Consolidated Financial Statements (Unaudited)" for additional information regarding our debt balance at September 30, 2013.


Derivatives. After September 30, 2013, we entered into the following additional oil price swaps to hedge additional amounts of our estimated future production:

                                          First          Second         Third          Fourth
                                         Quarter        Quarter        Quarter        Quarter         Total

Oil Swaps: (a)
        2013:
                Volume (Bbl)                                                          150,000        150,000
                Price per Bbl                                                      $   102.55     $   102.55

        2014:
                Volume (Bbl)             153,000        152,000        129,000         91,000        525,000
                Price per Bbl         $    97.78     $    97.78     $    97.71     $    97.53     $    97.72

        2015:
                Volume (Bbl)              94,000        100,000         85,000         96,000        375,000
                Price per Bbl         $    89.84     $    89.84     $    89.83     $    89.84     $    89.84

(a) The index prices for the oil price swaps are based on the NYMEX - West Texas Intermediate ("WTI") monthly average futures price.

Derivative Financial Instruments

Derivative financial instruments exposure. At September 30, 2013, the fair value of our financial derivatives was a net liability of $94.5 million. All of our counterparties to these financial derivatives are parties or affiliates of parties to our credit facility and have their outstanding debt commitments and derivative exposures collateralized pursuant to our credit facility. Under the terms of our financial derivative instruments and their collateralization under our credit facility, we do not have exposure to potential "margin calls" on our financial derivative instruments. We currently have no reason to believe that our counterparties to these commodity derivative contracts are not financially viable. Our credit facility does not allow us to offset amounts we may owe a lender against amounts we may be owed related to our financial instruments with such party or its affiliates.


Results of Operations

The following table sets forth summary information concerning our production and operating data from continuing operations for the three and nine months ended September 30, 2013and 2012. The table below excludes production and operating data that we have classified as discontinued operations, which is more fully described in Note M of the Condensed Notes to Consolidated Financial Statements included in "Item 1. Consolidated Financial Statements (Unaudited)." The actual historical data in this table excludes results from (i) the Three Rivers Acquisition for periods prior to July 2012 and (ii) the PDC Acquisition for periods prior to March 2012. Because of normal production declines, increased or decreased drilling activities and the effects of acquisitions or divestitures, the historical information presented below should not be interpreted as being indicative of future results.

                                                        Three Months Ended                           Nine Months Ended
                                                           September 30,                               September 30,
                                                    2013                 2012                   2013                   2012

Production and operating data from continuing
operations:
   Net production volumes:
       Oil (MBbl)                                    5,417                  4,312                 15,376                 12,141
       Natural gas (MMcf)                           19,593                 17,740                 56,006                 48,151
       Total (MBoe)                                  8,683                  7,269                 24,710                 20,166

   Average daily production volumes:
       Oil (Bbl)                                    58,880                 46,870                 56,322                 44,310
       Natural gas (Mcf)                           212,967                192,826                205,150                175,734
       Total (Boe)                                  94,375                 79,008                 90,514                 73,599

    Average prices:
       Oil, without derivatives (Bbl)           $   102.10         $        88.23         $        91.89         $        90.56
       Oil, with derivatives (Bbl) (a)          $    92.89         $        91.91         $        89.12         $        89.87
       Natural gas, without derivatives (Mcf)   $     5.10         $         4.79         $         4.91         $         5.04
       Natural gas, with derivatives (Mcf)
       (a)                                      $     5.33         $         4.80         $         5.00         $         5.06
       Total, without derivatives (Boe)         $    75.20         $        64.02         $        68.31         $        66.56
       Total, with derivatives (Boe) (a)        $    69.98         $        66.24         $        66.78         $        66.19

   Operating costs and expenses per Boe:
       Lease operating expenses and workover
       costs                                    $     7.77         $         6.87         $         7.59         $         7.00
       Oil and natural gas taxes                $     6.08         $         5.22         $         5.70         $         5.48
       Depreciation, depletion and
       amortization                             $    23.11         $        20.38         $        22.57         $        20.26
       General and administrative               $     4.70         $         4.88         $         5.06         $         4.76

(a) Includes the effect of cash settlements received from (paid on) commodity derivatives not designated as hedges:

                                                        Three Months Ended                           Nine Months Ended
                                                           September 30,                               September 30,
       (in thousands)                               2013                 2012                   2013                   2012

Cash receipts from (payments on) derivatives not designated as hedges:
Oil derivatives $ (49,864) $ 15,859 $ (42,528) $ (8,374) Natural gas derivatives 4,589 280 4,844 889 Total cash receipts from
(payments on) derivatives $ (45,275) $ 16,139 $ (37,684) $ (7,485)

The presentation of average prices with derivatives is a non-GAAP measure as a result of including the cash receipts from (payments on) commodity derivatives that are presented in our statements of cash flows. This presentation of average prices with derivatives is a means by which to reflect the actual cash performance of our commodity derivatives for the respective periods and presents oil and natural gas prices with derivatives in a manner consistent with the presentation generally used by the investment community.


The following table sets forth summary information from our discontinued operations concerning our production and operating data for the three and nine months ended September 30, 2012. The discontinued operations presentation is the result of reclassifying the results of operations from our December 2012 non-core assets divestiture, which is more fully described in Note M of the Condensed Notes to Consolidated Financial Statements included in "Item 1. Consolidated Financial Statements (Unaudited)."

                                                       Three Months Ended     Nine Months Ended
                                                       September 30, 2012    September 30, 2012

Production and operating data from discontinued
operations:
     Net production volumes:
          Oil (MBbl)                                            307                      912
          Natural gas (MMcf)                                  1,382                    2,819
          Total (MBoe)                                          537                    1,382

     Average daily production volumes:
          Oil (MBbl)                                          3,337                    3,329
          Natural gas (MMcf)                                 15,022                   10,288
          Total (MBoe)                                        5,840                    5,044

      Average prices:
          Oil, without derivatives (Bbl)                  $   86.70             $      90.48
          Oil, with derivatives (Bbl)                     $   86.70             $      90.48
          Natural gas, without derivatives (Mcf)          $    4.04             $       4.73
          Natural gas, with derivatives (Mcf)             $    4.04             $       4.73
          Total, without derivatives (Boe)                $   59.97             $      69.36
          Total, with derivatives (Boe)                   $   59.97             $      69.36

     Operating costs and expenses per Boe:
          Lease operating expenses and workover
          costs                                           $   10.84             $      11.81
          Oil and natural gas taxes                       $    5.37             $       6.18
          Depreciation, depletion and amortization        $   17.65             $      19.01
          General and administrative (a)                  $   (1.15)            $      (1.28)

(a) Represents the fees received from third-parties for operating oil and natural gas properties that were sold. We reflect these fees as a reduction of general and administrative expense.


Three Months Ended September 30, 2013 Compared to Three Months Ended September 30, 2012

Oil and natural gas revenues. Revenue from oil and natural gas operations was $652.9 million for the three months ended September 30, 2013, an increase of $187.6 million (40 percent) from $465.3 million for the three months ended September 30, 2012. This increase was primarily due to an increase in realized oil and natural gas prices and increased production due to successful drilling efforts during 2012 and 2013. Specific factors affecting oil and natural gas revenues include the following:

total oil production was 5,417 MBbl for the three months ended September 30, 2013, an increase of 1,105 MBbl (26 percent) from 4,312 MBbl for the three months ended September 30, 2012;

average realized oil price (excluding the effects of derivative activities) was $102.10 per Bbl during the three months ended September 30, 2013, an increase of 16 percent from $88.23 per Bbl during the three months ended September 30, 2012. For the three months ended September 30, 2013 and 2012, we realized approximately 96.4 percent and 95.6 percent, respectively, of the average NYMEX oil prices for the respective periods. The basis differential between the location of Midland, Texas and Cushing, Oklahoma (NYMEX pricing location) for our oil has a direct effect on our realized oil price. For the three months ended September 30, 2013 and 2012, the basis differential between WTI-Midland and WTI-Cushing was a price reduction of $0.29 per barrel and $1.74 per barrel, respectively, which is the primary reason for the higher realized oil price as compared as a percentage to the NYMEX price in 2013. The current outlook for the basis differential between WTI-Midland and WTI-Cushing . . .

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