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CXO > SEC Filings for CXO > Form 10-K on 21-Feb-2014All Recent SEC Filings

Show all filings for CONCHO RESOURCES INC

Form 10-K for CONCHO RESOURCES INC


21-Feb-2014

Annual Report


Item 7. 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 well as the selected historical consolidated financial data included elsewhere in this report. As a result of the acquisitions and divestures discussed below, many comparisons between periods will be difficult or impossible.

In December 2012, we closed on the sale 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 year ended December 31, 2012, these assets produced an average of 4,937 Boe per day.

In July 2012, we acquired 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 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.

In November 2011, we acquired three entities affiliated with OGX Holdings II, LLC (collectively the "OGX Acquisition") for cash consideration of approximately $252.0 million. The results of operations prior to December 2011 do not include results from the OGX Acquisition.

In March 2011, we closed our divestiture of our Bakken assets for cash consideration of approximately $195.9 million and recognized a pre-tax gain on this sale of approximately $135.9 million (included in discontinued operations). For the first quarter of 2011, these assets produced an average of 1,369 Boe per day.

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 these 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 both on a vertical and horizontal basis, (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, all primarily on a horizontal basis, and
(iii) Texas Permian, where we primarily target the Wolfberry, a term applied to the combined Wolfcamp and Spraberry horizons, primarily on a vertical basis and the Wolfcamp shale on a horizontal basis. Oil comprised 61.1 percent of our
502.9 MMBoe of estimated proved reserves at December 31, 2013 and 62.8 percent of our 33.6 MMBoe of production for 2013. We seek to operate the wells in which we own an interest, and we operated wells that accounted for 91.1 percent of our proved developed producing PV-10 and 80.3 percent of our approximately 6,530 gross wells at December 31, 2013. 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 2013 included the following highlights:

Net income was $251.0 million ($2.39 per diluted share), as compared to net income of $431.7 million ($4.15 per diluted share) in 2012. The decrease in earnings was primarily due to:

$123.7 million loss on derivatives not designated as hedges for the year ended December 31, 2013, as compared to a $127.4 million gain on derivatives not designated as hedges during the year ended December 31, 2012, primarily related to commodity future price curves at the respective measurement periods;

$197.5 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 year ended December 31, 2013 and (ii) our acquisitions in 2012;

$111.7 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 todownward 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;

$36.0 million increase in general and administrative expense due to (a) including an adjustment to our bonus accrual for services related to 2012 of approximately $5.2 million ($0.15 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;

$35.9 million increase in interest expense due to a 17.4 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 $38.0 million of income from operations before income taxes related to the same assets in 2012;

partially offset by:

$500.1 million increase in oil and natural gas revenues from continuing operations as a result of a 20 percent increase in production coupled with a 6 percent increase in commodity price realizations per Boe (excluding the effects of derivative activities).

Average daily sales volumes from continuing operations increased by 20 percent from 76,397 Boe per day during 2012 to 92,150 Boe per day during 2013. The increase was primarily attributable to 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 $124.5 million to $1,362.0 million for 2013, as compared to $1,237.5 million in 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 was increased by approximately $0.5 billion during 2013, primarily as a result of the spending on drilling in excess of our operating cash flow.

At December 31, 2013, availability under our credit facility was approximately $2.2 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 natural gas liquids 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 natural gas liquids 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;

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 Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" for additional information regarding our commodity derivative positions at December 31, 2013.


Oil and natural gas prices have been subject to significant fluctuations during the past several years. In general, average oil and natural gas prices have increased during 2013 compared to 2012. The following table sets forth the average NYMEX oil and natural gas prices for the years ended December 31, 2013, 2012 and 2011, as well as the high and low NYMEX price for the same periods:

                                       Years Ended December 31,
                                   2013          2012          2011

Average NYMEX prices:
      Oil (Bbl)                 $   98.05     $   94.19     $   95.07
      Natural gas (MMBtu)       $    3.73     $    2.83     $    4.03
High and Low NYMEX prices:
      Oil (Bbl):
             High               $  110.53     $  109.77     $  113.93
             Low                $   86.68     $   77.69     $   75.67
      Natural gas (MMBtu):
             High               $    4.46     $    3.90     $    4.85
             Low                $    3.11     $    1.91     $    2.99

Further, the NYMEX oil price and NYMEX natural gas price reached highs and lows of $102.43 and $91.66 per Bbl and $5.56 and $4.01 per MMBtu, respectively, during the period from January 1, 2014 to February 18, 2014. At February 18, 2014, the NYMEX oil price and NYMEX natural gas price were $102.43 per Bbl and $5.55 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
                                                                            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

During 2013, we spent approximately 69 percent of our capital budget on horizontal drilling. We plan on spending approximately 91 percent of our 2014 capital budget on horizontal drilling.

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 year ended December 31, 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 Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" for additional information regarding our debt balance at December 31, 2013.


Derivative Financial Instruments

Derivative financial instrument exposure. At December 31, 2013, the fair value of our financial derivatives was a net liability of $66.2 million. All of our counterparties to these financial derivatives are 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.

New commodity derivative contracts. After December 31, 2013, we entered into the following additional oil basis swaps and natural gas price swaps to hedge additional amounts of our estimated future production:

                                    First          Second          Third            Fourth
                                   Quarter        Quarter         Quarter          Quarter           Total

Oil Basis Swaps: (a)
      2014:
            Volume (Bbl)             -            637,000        2,024,000        1,748,000        4,409,000
            Price per Bbl       $    -         $     (1.88)   $       (1.50)   $       (1.45)   $       (1.54)
Natural Gas Swaps: (b)
      2014:
            Volume (MMBtu)         351,000        364,000         368,000          276,000         1,359,000
            Price per MMBtu     $       4.35   $       4.35   $         4.35   $         4.35   $         4.35

(a) The basis differential price is between Midland - WTI and Cushing - WTI.
(b) The index prices for the natural gas price swaps are based on the NYMEX - Henry Hub last trading day futures prices.


Results of Operations

The following table sets forth summary information concerning our production and operating data from continuing operations for the years ended December 31, 2013, 2012 and 2011. The table below excludes production and operating data that we have classified as discontinued operations, which is more fully described in Note N of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data." The actual historical data in this table excludes results from (i) the Three Rivers Acquisition for periods prior to July 2012, (ii) the PDC Acquisition for periods prior to March 2012 and (iii) the OGX Acquisition for periods prior to December 2011. 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.

                                                                   Years Ended December 31,
                                                         2013            2012                 2011

Production and operating data from continuing
operations:
   Net production volumes:
       Oil (MBbl)                                        21,126          16,859                  13,446
       Natural gas (MMcf)                                75,054          66,613                  51,118
       Total (MBoe)                                      33,635          27,961                  21,966
   Average daily production volumes:
       Oil (Bbl)                                         57,879          46,063                  36,838
       Natural gas (Mcf)                                205,627         182,003                 140,049
       Total (Boe)                                       92,150          76,397                  60,180
   Average prices:
       Oil, without derivatives (Bbl)                $    91.76      $    87.96         $         91.34
       Oil, with derivatives (Bbl) (a)               $    89.79      $    89.29         $         83.61
       Natural gas, without derivatives (Mcf)        $     5.08      $     5.06         $          7.62
       Natural gas, with derivatives (Mcf) (a)       $     5.21      $     5.07         $          8.13
       Total, without derivatives (Boe)              $    68.97      $    65.08         $         73.65
       Total, with derivatives (Boe) (a)             $    68.01      $    65.93         $         70.09
   Operating costs and expenses per Boe:
       Lease operating expenses and workover costs   $     7.85      $     6.90         $          6.69
       Oil and natural gas taxes                     $     5.69      $     5.39         $          5.96
       Depreciation, depletion and amortization      $    22.97      $    20.56         $         18.21
       General and administrative                    $     5.04      $     4.79         $          4.48

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

Years Ended December 31, (in thousands) 2013 2012 2011

Cash receipts from (payments on) derivatives not designated as hedges:

          Oil derivatives                            $  (41,616)     $   22,411         $      (103,969)
          Natural gas derivatives                         9,275           1,125                  25,739
          Interest rate derivatives                          -               -                   (6,624)
             Total cash receipts from (payments
             on) derivatives                         $  (32,341)     $   23,536         $       (84,854)

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 years ended December 31, 2012 and 2011. The discontinued operations presentation is the result of reclassifying the results of operations from the divestitures of our
(i) Bakken assets in March 2011 and (ii) non-core assets in December 2012 which are more fully described in Note N of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data."

                                                                                     Years Ended December 31,
                                                                                         2012               2011

Production and operating data from discontinued operations:
       Net production volumes:
            Oil (MBbl)                                                                      1,144            1,246
            Natural Gas (Mcf)                                                               3,978            2,596
            Total (MBoe)                                                                    1,807            1,678

       Average daily production volumes:
            Oil (Bbl)                                                                       3,126            3,415
            Natural gas (Mcf)                                                              10,869            7,112
            Total (Boe)                                                                     4,937            4,600

       Average prices:
            Oil, without derivatives (Bbl)                                          $       88.60       $    89.80
            Natural gas, without derivatives (Mcf)                                  $        4.67       $     7.64
            Total, without derivatives (Boe)                                        $       66.37       $    78.50

       Operating costs and expenses per Boe:
            Lease operating expenses and workover costs                             $       12.95       $    12.01
            Oil and natural gas taxes                                               $        6.01       $     6.89
            Depreciation, depletion and amortization                                $       16.68       $    18.15
            General and administrative (a)                                          $       (1.38)      $    (1.35)

(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 expenses.


The following tables present selected production and operating data for the fields which represent greater than 15 percent of our total proved reserves at December 31, 2013, 2012 and 2011:

                                                                                  Year Ended December 31, 2013
                                                                                    West                Yeso
                                                                                  Wolfberry            Central

Production and operating data:
       Net production volumes:
              Oil (MBbl)                                                              3,509               2,157
              Natural gas (MMcf)                                                     11,238               8,122
              Total (MBoe)                                                            5,382               3,511
       Average prices:
              Oil, without derivatives (Bbl)                                  $       93.05      $        90.42
              Natural gas, without derivatives (Mcf)                          $        6.15      $         6.24
              Total, without derivatives (Boe)                                $       73.51      $        70.00
       Production costs per Boe:
              Lease operating expenses including workovers                    $        9.30      $        12.38
              Oil and natural gas taxes                                       $        5.68      $         6.25




                                                                                  Year Ended December 31, 2012
                                                                                    West                Yeso
                                                                                  Wolfberry            Central

Production and operating data:
       Net production volumes:
              Oil (MBbl)                                                              3,402               4,053
              Natural gas (MMcf)                                                     10,399              14,915
              Total (MBoe)                                                            5,135               6,539
       Average prices:
              Oil, without derivatives (Bbl)                                  $       88.22      $        88.52
              Natural gas, without derivatives (Mcf)                          $        6.14      $         6.28
              Total, without derivatives (Boe)                                $       70.87      $        69.19
       Production costs per Boe:
. . .
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