UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended September 30, 2017

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o 

 

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 October 30, 2017: 148,696,032 shares

 

 

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

 

  

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Various statements and information contained in or incorporated by reference into this 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 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 “Part I, Item 1A, Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2016, as well as those factors summarized below:

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

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

·         drilling, completion and operating risks;

·         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;

·         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, completion 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;

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

·         the impact of potential changes in our credit ratings;

·         cybersecurity risks, such as those involving unauthorized access, malicious software, data privacy breaches by employees or others with authorized access, cyber or phishing-attacks, ransomware and other security issues;

·         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 the 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. The consolidated financial statements also include the accounts of a variable interest entity (“VIE”) where the Company is the primary beneficiary of the arrangements. See Note 4 for additional information regarding the circumstances surrounding the VIE. All material intercompany balances and transactions have been eliminated.

 

Reclassifications. Certain prior period amounts have been reclassified to conform to the 2017 presentation. These reclassifications had no impact on net income (loss), total stockholders’ equity or total 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 stock-based compensation, fair value of business combinations, fair value of nonmonetary exchanges, fair value of derivative financial instruments 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, 2016 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 notes to the 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, 2016.

 

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. 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. At December 31, 2016, the majority of the Company’s cash was invested in stable value government money market funds.

 

Equity method investments. At December 31, 2016, the Company owned a 50 percent membership interest in a midstream joint venture, Alpha Crude Connector, LLC (“ACC”), that operated a crude oil gathering and transportation system in the Northern Delaware Basin. In February 2017, the Company closed on the divestiture of its ownership interest in ACC. See Note 4 for additional information regarding the disposition of ACC.

 

The Company accounted 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 $129 million at December 31, 2016, and was included in other assets in the Company’s consolidated balance sheet. Gains and losses incurred from the Company’s equity investment in ACC were recorded in other income (expense) in its consolidated statements of operations.

 

The Company owns a 23.75 percent membership interest in Oryx Southern Delaware Holdings, LLC (“Oryx”), an entity that operates a crude oil gathering and transportation system in the Southern Delaware Basin. The Company accounts for its investment in Oryx under the equity method of accounting for investments in unconsolidated affiliates. The Company’s net investment in Oryx was approximately $47 million and $42 million at September 30, 2017 and December 31, 2016, respectively, and is included in other assets in the Company’s consolidated balance sheets. Gains and losses incurred from the Company’s equity investment in Oryx are recorded in other income (expense) in its consolidated statements of operations.

 

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 during the drilling and production phases and records such reimbursements as reductions of general and administrative expense. The Company earned reimbursements of approximately $4 million for each of the three months ended September 30, 2017 and 2016 and approximately $12 million for each of the nine months ended September 30, 2017 and 2016.

 

Recently adopted accounting pronouncements. The Company adopted Accounting Standards Update (“ASU”) No. 2016-09, “Compensation–Stock Compensations (Topic 718): Improvements to Employee Share-based Payment Accounting,” on January 1, 2017. The adoption did not have an impact on prior period consolidated financial statements. The Company elected to account for forfeitures of share-based payments as they occur. At December 31, 2016, the Company had not recorded compensation expense of approximately $8 million based on forecasted forfeitures nor the associated deferred tax benefit of approximately $3 million. The Company recognized all excess tax benefits not previously recorded, which totaled approximately $5 million at December 31, 2016. Upon adoption, the Company recorded a cumulative-effect adjustment, which decreased retained earnings by less than $1 million, increased additional paid-in capital by approximately $8 million, and decreased net deferred income taxes by approximately $8 million. The Company elected to prospectively classify excess tax benefits and deficiencies as operating activities on the consolidated statements of cash flows and will prospectively record those excess tax benefits and deficiencies as discrete items in the income tax provision in the consolidated statements of operations. Under the new standard, for the nine months ended September 30, 2017, the Company recorded excess tax benefits of approximately $6 million as offsets to the Company’s income tax provision. Also under the new standard, for the three and nine months ended September 30, 2017, the Company recorded forfeitures of share-based payments of approximately $1 million and $7 million, respectively.

 

New accounting pronouncements issued but not yet adopted. In May 2014, the Financial Accounting Standards Board (the “FASB”) issued 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 No. 2014-09 by one year. That new standard is now effective for annual reporting periods beginning after December 15, 2017. The Company expects to use the modified retrospective method to adopt the standard, meaning the cumulative effect of initially applying the standard will be recognized with an adjustment to retained earnings on January 1, 2018. The Company has substantially completed its internal evaluation of the adoption of this standard, which included a review of all revenue-related contracts with customers and the application of the new revenue recognition model against those contracts. The Company is also updating its revenue recognition policy to conform to the new standard. The Company also expects to expand its revenue recognition related disclosure. Including those changes previously discussed, the Company does not expect this new guidance will have a material impact 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 financing and operating leases. Lease expense recognition on the consolidated statements of operations will be effectively unchanged. This guidance is effective for reporting periods beginning after December 15, 2018, and early adoption is permitted. The Company does not plan to early adopt the standard. The Company enters into lease agreements to support its operations. These agreements are for leases on assets such as office space, vehicles, field services, well equipment and drilling rigs. The Company is currently in the process of reviewing all contracts that could be applicable to this new guidance. The Company believes this new guidance will have a moderate impact to its consolidated balance sheets due to the recognition of right-of-use assets and lease liabilities that are not currently recognized under currently applicable guidance.

 

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments–Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which replaces the current “incurred loss” methodology for recognizing credit losses with an “expected loss” methodology. This new methodology requires that a financial asset measured at amortized cost be presented at the net amount expected to be collected. This standard is intended to provide more timely decision-useful information about the expected credit losses on financial instruments. This guidance is effective for fiscal years beginning after December 15, 2019, and early adoption is allowed as early as fiscal years beginning after December 15, 2018. The Company does not believe this new guidance will have a material impact on its consolidated financial statements.

 

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business,” with the objective of adding guidance to assist in evaluating whether transactions should be accounted for as asset acquisitions or as business combinations. The guidance provides a screen to determine when an integrated set of assets and activities is not a business. The screen requires that when substantially all of the fair value of the acquired assets is concentrated in a single asset or a group of similar assets, the set is not a business. If the screen is not met, to be considered a business, the set must include an input and a substantive process that together significantly contribute to the ability to create output. This new guidance is effective for annual periods beginning after December 15, 2017, and early adoption is allowed. The Company is evaluating the impact 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 gas 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 15 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 nine months ended September 30, 2017:

 

 

The following table provides an aging at September 30, 2017 and December 31, 2016 of capitalized exploratory well costs based on the date drilling was completed:

 

Note 4. Acquisitions and divestitures

 

Midland Basin acquisition. In July 2017, the Company completed an acquisition in the Midland Basin. As consideration for the acquisition, the Company paid approximately $595 million in cash. The acquisition is subject to customary post-closing adjustments.

 

Concurrent with the acquisition, the Company entered into a transaction structured as a reverse like-kind exchange (“Reverse 1031 Exchange”) in accordance with Section 1031 of the Internal Revenue Code of 1986, as amended (the “Code”). In connection with the Reverse 1031 Exchange, the Company assigned the ownership of the oil and natural gas properties acquired to a VIE formed by an exchange accommodation titleholder. The Company operates the properties pursuant to a management agreement with the VIE. At September 30, 2017, the Company was determined to be the primary beneficiary of the VIE, as the Company had the ability to control the activities that most significantly impact the VIE’s economic performance. The assets currently held by the VIE attributable to the acquisition will be conveyed to the Company or one of its subsidiaries, and the VIE structure will terminate, upon the earlier of (i) the completion of the Reverse 1031 Exchange or (ii) the expiration of the time allowed by the treasury regulations and published Internal Revenue Service guidance to complete the Reverse 1031 Exchange, which is 180 days from commencement. At September 30, 2017, the VIE’s total assets and liabilities included in the Company’s consolidated balance sheet were approximately $607 million and $605 million, respectively.

 

Northern Delaware Basin acquisition. In April 2017, the Company closed on the remainder of its acquisition in the Northern Delaware Basin. As consideration for the entire acquisition, the Company paid approximately $160 million in cash, of which $43 million was held in escrow at December 31, 2016, and issued to the seller approximately 2.2 million shares of its common stock with an approximate value of $291 million.

 

ACC divestiture. In February 2017, the Company closed on the divestiture of its ownership interest in ACC. The Company and its joint venture partner entered into separate agreements to sell 100 percent of their respective ownership interests in ACC. After adjustments for debt and working capital, the Company received cash proceeds from the sale of approximately $801 million. After direct transaction costs, the Company recorded a pre-tax gain on disposition of assets of approximately $655 million. The Company’s net investment in ACC at the time of closing was approximately $129 million.

Note 5.  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. The restricted stock-based compensation awards generally vest over a period ranging from one to eight years.

 

A summary of the Company’s Stock Incentive Plan activity for the nine months ended September 30, 2017 is presented below:

 

 

The following table reflects the future stock-based compensation expense to be recorded for all the stock-based compensation awards that were outstanding at September 30, 2017: