UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended March 31, 2016

or

For the transition period from                                           to                                          

 

Commission file number: 1-33615

Concho Resources Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No o  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No o 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ☑  

 

Number of shares of the registrant’s common stock outstanding at May 2, 2016: 131,550,680 shares

 

 

  

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Various statements and information contained in or incorporated by reference into this Quarterly Report on Form 10-Q (this “Quarterly Report”) that express a belief, expectation, or intention, or that are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). These forward-looking statements include statements, projections and estimates concerning our future financial position, operations, performance, business strategy, oil and natural gas reserves, drilling program, capital expenditures, liquidity and capital resources, the timing and success of specific projects, outcomes and effects of litigation, claims and disputes, derivative activities and potential financing. Forward-looking statements are generally accompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,” “anticipate,” “potential,” “could,” “may,” “foresee,” “plan,” “goal” or other words that convey the uncertainty of future events or outcomes. Forward-looking statements are not guarantees of performance. We have based these forward-looking statements on our current expectations and assumptions about future events and their potential effect on us. These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate under the circumstances. Actual results may differ materially from those implied or expressed by any forward-looking statements. These forward-looking statements speak only as of the date of this Quarterly Report, or if earlier, as of the date they were made. We disclaim any obligation to update or revise these statements unless required by law, and we caution you not to rely on them unduly. While our management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties relating to, among other matters, the risks discussed in “Part II, Item 1A, Risk Factors” in this Quarterly Report and in our Annual Report on Form 10-K for the year ended December 31, 2015, as well as those factors summarized below:

·         declines in the prices we receive for our oil and natural gas, or sustained depressed prices we receive, for our oil and natural gas;

·         uncertainties about the estimated quantities of oil and natural gas reserves;

·         drilling and operating risks;

·         the adequacy of our capital resources and liquidity including, but not limited to, access to additional borrowing capacity under our credit facility;

·         the effects of government regulation, permitting and other legal requirements, including new legislation or regulation of hydraulic fracturing and the export of oil and natural gas;

·         the impact of potential changes in our credit ratings;

·         environmental hazards, such as uncontrollable flows of oil, natural gas, brine, well fluids, toxic gas or other pollution into the environment, including groundwater contamination;

·         difficult and adverse conditions in the domestic and global capital and credit markets;

·         risks related to the concentration of our operations in the Permian Basin of Southeast New Mexico and West Texas;

·         disruptions to, capacity constraints in or other limitations on the pipeline systems that deliver our oil, natural gas liquids and natural gas and other processing and transportation considerations;

·         the costs and availability of equipment, resources, services and qualified personnel required to perform our drilling and operating activities;

·         potential financial losses or earnings reductions from our commodity price risk-management program;

·         risks and liabilities associated with acquired properties or businesses;

·         uncertainties about our ability to successfully execute our business and financial plans and strategies;

·         uncertainties about our ability to replace reserves and economically develop our current reserves;

·         general economic and business conditions, either internationally or domestically;

·         competition in the oil and natural gas industry; and

·         uncertainty concerning our assumed or possible future results of operations.

Reserve engineering is a process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact way. The accuracy of any reserve estimate depends on the quality of available data, the interpretation of such data and price and cost assumptions made by our reserve engineers. In addition, the results of drilling, testing and production activities may justify revisions of estimates that were made previously. If significant, such revisions would change the schedule of any further production and development drilling. Accordingly, reserve estimates may differ from the quantities of oil and natural gas that are ultimately recovered.  

PART I – FINANCIAL INFORMATION

 

Item 1.  Consolidated Financial Statements (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

  

Note 1. Organization and nature of operations

 

Concho Resources Inc. (the “Company”) is a Delaware corporation formed on February 22, 2006. The Company’s principal business is the acquisition, development, exploration and production of oil and natural gas properties primarily located in the Permian Basin of Southeast New Mexico and West Texas.  

 

Note 2. Summary of significant accounting policies

 

Principles of consolidation. The consolidated financial statements of the Company include the accounts of the Company and its 100 percent owned subsidiaries. The Company consolidates the financial statements of these entities. All material intercompany balances and transactions have been eliminated.

 

Reclassifications. Certain prior period amounts have been reclassified to conform to the 2016 presentation. These reclassifications had no impact on net income (loss), total stockholders’ equity or cash flows.

 

Use of estimates in the preparation of financial statements. Preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. Depletion of oil and natural gas properties is determined using estimates of proved oil and natural gas reserves. There are numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. Similarly, evaluations for impairment of proved and unproved oil and natural gas properties are subject to numerous uncertainties including, among others, estimates of future recoverable reserves, commodity price outlooks and prevailing market rates of other sources of income and costs. Other significant estimates include, but are not limited to, asset retirement obligations, fair value of derivative financial instruments, fair value of business combinations, fair value of nonmonetary exchanges, fair value of stock-based compensation and income taxes.

 

Interim financial statements. The accompanying consolidated financial statements of the Company have not been audited by the Company’s independent registered public accounting firm, except that the consolidated balance sheet at December 31, 2015 is derived from audited consolidated financial statements. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments necessary to present fairly the Company’s consolidated financial statements. All such adjustments are of a normal, recurring nature. In preparing the accompanying consolidated financial statements, management has made certain estimates and assumptions that affect reported amounts in the consolidated financial statements and disclosures of contingencies. Actual results may differ from those estimates. The results for interim periods are not necessarily indicative of annual results.

 

Certain disclosures have been condensed in or omitted from these consolidated financial statements. Accordingly, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Cash equivalents. The Company considers all cash on hand, depository accounts held by banks, money market accounts and investments with an original maturity of three months or less to be cash equivalents. At March 31, 2016, the Company had approximately $145.8 million of restricted cash in an account held by a trustee in connection with a tax-free exchange transaction. During April 2016, the cash amount was transferred to the Company. The Company’s cash and cash equivalents are held in financial institutions in amounts that exceed the insurance limits of the Federal Deposit Insurance Corporation. However, management believes that the Company’s counterparty risks are minimal based on the reputation and history of the institutions selected.

 

Equity method investments. The Company owns a 50 percent membership interest in a midstream joint venture, Alpha Crude Connector, LLC (“ACC”), to construct a crude oil gathering and transportation system in the northern Delaware Basin. The Company has the option to purchase the membership interest of the other investor in ACC. This purchase option becomes exercisable three months after the completion date of the pipeline and remains exercisable for a period of twelve months. The Company expects the option to become exercisable during the third quarter of 2016. The Company accounts for its investment in ACC under the equity method of accounting for investments in unconsolidated affiliates. The Company’s net investment in ACC was approximately $122.9 million and $98.9 million at March 31, 2016 and December 31, 2015, respectively, and is included in other assets in the Company’s consolidated balance sheet. The equity loss for the three months ended March 31, 2016 and 2015 was approximately $1.0 million and $0.8 million, respectively, and is included in other expense in the Company’s consolidated statement of operations. During the three months ended March 31, 2015, the Company recorded $0.6 million of capitalized interest on its investment in ACC. ACC commenced partial operations in late 2015. The Company expects the system to be fully operational during 2016.

 

During 2015, the Company purchased a 25 percent membership interest in an entity, which is constructing a crude oil gathering and transportation system in the southern Delaware Basin. The system is expected to be completed and operational during 2016. The Company accounts for its investment under the equity method of accounting for investments in unconsolidated affiliates. The Company’s net investment was approximately $18.9 million and $20.8 million at March 31, 2016 and December 31, 2015, respectively, and is included in other assets in the Company’s consolidated balance sheet. The equity loss for the three months ended March 31, 2016 was approximately $1.9 million.  

 

Revenue recognition. Oil and natural gas revenues are recorded at the time of physical transfer of such products to the purchaser, which for the Company is primarily at the wellhead. The Company follows the sales method of accounting for oil and natural gas sales, recognizing revenues based on the Company’s actual proceeds from the oil and natural gas sold to purchasers.  

 

General and administrative expense. The Company receives fees for the operation of jointly-owned oil and natural gas properties and records such reimbursements as reductions of general and administrative expense. Such fees totaled approximately $6.5 million and $6.4 million for the three months ended March 31, 2016 and 2015, respectively.

 

Recent accounting pronouncements. In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” which outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This new revenue recognition model provides a five-step analysis in determining when and how revenue is recognized. The new model will require revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration a company expects to receive in exchange for those goods or services.

 

In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,” which deferred the effective date of ASU 2014-09 by one year. That new standard is now effective for annual reporting periods beginning after December 15, 2017. An entity can apply ASU 2014-09 using either a full retrospective method, meaning the standard is applied to all of the periods presented, or a modified retrospective method, meaning the cumulative effect of initially applying the standard is recognized in the most current period presented in the financial statements. The Company is evaluating the impact that this new guidance will have on its consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which supersedes current lease guidance. The new lease standard requires all leases with a term greater than one year to be recognized on the balance sheet while maintaining substantially similar classifications for finance and operating leases. Lease expense recognition on the income statement will be effectively unchanged. This guidance is effective for reporting periods beginning after December 15, 2018

and early adoption is permitted. The Company is evaluating the impact that this new guidance will have on its consolidated financial statements.

 

In March 2016, the FASB issued ASU No. 2016-09, “Compensation–Stock Compensations (Topic 718): Improvements to Employee Share-based Payment Accounting,” which changes the accounting and presentation for share-based payment arrangements in the following areas: (i) recognition in the statement of operations of excess tax benefits and deficiencies; (ii) cash flow presentation of excess tax benefits and deficiencies; (iii) minimum statutory withholding thresholds and the classification on the cash flow statement of the withheld amounts; and (iv) an accounting policy election to recognize forfeitures as they occur. This guidance is effective for reporting periods beginning after December 15, 2016 and early adoption is permitted. The Company is evaluating the impact that this new guidance will have on its consolidated financial statements.

Note 3. Exploratory well costs

 

The Company capitalizes exploratory well costs until a determination is made that the well has either found proved reserves or that it is impaired. After an exploratory well has been completed and found oil and natural gas reserves, a determination may be pending as to whether the oil and natural reserves can be classified as proved. In those circumstances, the Company continues to capitalize the well or project costs pending the determination of proved status if (i) the well has found a sufficient quantity of reserves to justify its completion as a producing well and (ii) the Company is making sufficient progress assessing the reserves and the economic and operating viability of the project. The capitalized exploratory well costs are carried in unproved oil and natural gas properties. See Note 16 for the proved and unproved components of oil and natural gas properties. If the exploratory well is determined to be impaired, the well costs are charged to exploration and abandonments expense in the consolidated statements of operations.

  

The following table reflects the Company’s net capitalized exploratory well activity during the three months ended March 31, 2016:

 

 

The following table provides an aging at March 31, 2016 and December 31, 2015 of capitalized exploratory well costs based on the date drilling was completed:

 

 

Delaware Basin project. At March 31, 2016, the Company had approximately $1.4 million of suspended well costs greater than one year recorded for a well that was initially drilled to monitor nearby wells and is also being used to determine the productivity potential of additional zones. At March 31, 2016, the Company also had approximately $6.0 million of suspended well costs greater than one year recorded for a well spud in late 2014 that tested multiple zones. Currently, the Company is evaluating results in the area to determine the most suitable lateral zone in which to complete. Both wells completed drilling in 2014.

 

Projects operated by others. At March 31, 2016, the Company had approximately $5.0 million of suspended well costs greater than one year recorded for five wells that are operated by others and waiting on completion. Two of these wells, with

suspended well costs totaling approximately $3.5 million, completed drilling in 2012 and are expected to be completed in 2016. The remaining three wells completed drilling in 2014 and are waiting on completion.

 

Texas Permian project. At March 31, 2016, the Company had approximately $0.3 million of suspended well costs recorded for a well that was initially drilled to monitor nearby pad wells. These costs became greater than one year old during the three months ended March 31, 2016.

 

Note 4. Acquisitions and divestitures

 

Asset acquisition. In March 2016, the Company completed an acquisition of 80 percent of a third-party seller’s interest in certain oil and natural gas properties and related assets in the southern Delaware Basin. As consideration for the acquisition, the Company issued to the seller approximately 2.2 million shares of common stock with an approximate value of $230.8 million, $146.2 million in cash and $40.0 million to carry a portion of the seller’s future development costs in these properties.

 

Asset divestiture. In February 2016, the Company sold certain assets in the northern Delaware Basin for estimated proceeds of approximately $294.1 million, subject to customary post-closing adjustments, and recognized a pre-tax gain of approximately $111.1 million.

 

Note 5. Asset retirement obligations

 

The Company’s asset retirement obligations primarily relate to the future plugging and abandonment of wells and facilities. The following table summarizes the Company’s asset retirement obligation activity during the three months ended March 31, 2016:

 

Note 6.  Stock incentive plan

 

The Company’s 2015 Stock Incentive Plan provides for granting stock options, restricted stock awards and performance awards to directors, officers and employees of the Company.

 

A summary of the Company’s activity for the three months ended March 31, 2016 is presented below:

 

 

The Company used the following assumptions to estimate the fair value of performance unit awards granted during the three months ended March 31, 2016:

 

 

The following table reflects the future stock-based compensation expense to be recorded for all the stock-based compensation awards that were outstanding at March 31, 2016:

 

Note 7. Disclosures about fair value measurements

 

The Company uses a valuation framework based upon inputs that market participants use in pricing an asset or liability, which are classified into two categories: observable inputs and unobservable inputs. Observable inputs represent market data obtained from independent sources, whereas unobservable inputs reflect a company’s own market assumptions, which are used if observable inputs are not reasonably available without undue cost and effort. These two types of inputs are further prioritized into the following fair value input hierarchy:

 

Level 1:     Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. The Company considers active markets to be those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

Level 2:     Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that the Company values using observable market data. Substantially all of these inputs are observable in the marketplace throughout the full term of the derivative instrument, can be derived from observable data, or supported by observable levels at which transactions are executed in the marketplace. Level 2 instruments primarily include non-exchange traded derivatives such as over-the-counter commodity price swaps, basis swaps, collars and floors, investments and interest rate swaps. The Company’s valuation models are primarily industry-standard models that consider various inputs including: (i) quoted forward prices for commodities, (ii) time value, (iii) current market and contractual prices for the underlying instruments and (iv) volatility factors, as well as other relevant economic measures.

 

Level 3:     Prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e., supported by little or no market activity). The Company’s valuation models are primarily industry-standard models that consider various inputs including: (i) quoted forward prices for commodities, (ii) time value, (iii) volatility factors and (iv) current market and contractual prices for the underlying instruments, as well as other relevant economic measures.

Financial Assets and Liabilities Measured at Fair Value

 

The following table presents the carrying amounts and fair values of the Company’s financial instruments at March 31, 2016 and December 31, 2015:

 

 

Cash and cash equivalents, accounts receivable, other current assets, accounts payable, interest payable and other current liabilities. The carrying amounts approximate fair value due to the short maturity of these instruments.

 

Senior notes. The fair values of the Company’s senior notes are based on quoted market prices. The debt securities are not actively traded and, therefore, are classified as Level 2 in the fair value hierarchy.