UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Concho Resources Inc.

(Exact name of registrant as specified in its charter)

Delaware		76-0818600
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

550 West Texas Avenue, Suite 100
Midland, Texas		79701
(Address of principal executive offices)		(Zip code)

(432) 683-7443
(Registrant’s telephone number, including area code)

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 þ     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. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer   þ (Do not check if a smaller reporting company)		Smaller reporting company 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 þ

Number of shares of the registrant’s common stock outstanding at November 12, 2008: 84,706,291 shares.

 

 

TABLE OF CONTENTS

		Page
PART I — FINANCIAL INFORMATION
Item 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)			iii
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			29
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			47
Item 4. CONTROLS AND PROCEDURES			48
PART II — OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS			49
Item 1A. RISK FACTORS			49
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			62
Item 6. EXHIBITS			63
SIGNATURES			64
EX-31.1
EX-31.2
EX-32.1
EX-32.2

Cautionary statement regarding forward-looking statements

     This report may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) that are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact included in this report, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans and objectives of management are forward-looking statements. When used in this report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. In particular, the factors discussed below and elsewhere in this report could affect our actual results and cause our actual results to differ materially from expectations, estimates, or assumptions expressed in, forecasted in, or implied in such forward-looking statements.

     Forward-looking statements may include statements about:

	•		our business strategy;
	•		the estimated quantities of crude oil and natural gas reserves;
	•		technology;
	•		our financial strategy;
	•		our crude oil and natural gas realized prices;
	•		the timing and amount of our future production of crude oil and natural gas;
	•		the amount, nature and timing of our capital expenditures;
	•		our drilling of wells;
	•		our competition and government regulations;
	•		the marketing of our crude oil and natural gas;
	•		our exploitation or property acquisitions;
	•		the costs of exploiting and developing our properties and conducting other operations;
	•		general economic and business conditions;
	•		our cash flow and anticipated liquidity;
	•		uncertainty regarding our future operating results; and
	•		our plans, objectives, expectations and intentions contained in this report that are not historical.

     You should not place undue reliance on these forward-looking statements. All forward-looking statements speak only as of the date of this report. We do not undertake any obligation to release publicly any revisions to the forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events except as required by law.

     Although we believe that our plans, objectives, expectations and intentions reflected in or suggested by the forward-looking statements we make in this report are reasonable, we can give no assurance that they will be achieved. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.

Item 1. Consolidated Financial Statements (Unaudited)

Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007			1
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2008 and 2007			2
Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2008			3
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007			4
Condensed Notes to Consolidated Financial Statements			5

Concho Resources Inc.

		September 30,				December 31,
(in thousands, except share and per share data)		2008				2007
Assets
Current assets:
Cash and cash equivalents		$	54,370			$	30,424
Accounts receivable, net of allowance for doubtful accounts:
Oil and gas			54,851				36,735
Joint operations and other			67,507				21,183
Related parties			548				—
Derivative instruments			11,965				1,866
Deferred income taxes			6,983				13,502
Prepaid costs and other			5,398				4,273
Total current assets			201,622				107,983
Property and equipment, at cost:
Oil and gas properties, successful efforts method			2,580,508				1,555,018
Accumulated depletion and depreciation			(244,175	)			(167,109	)
Total oil and gas properties, net			2,336,333				1,387,909
Other property and equipment, net			13,593				7,085
Total property and equipment, net			2,349,926				1,394,994
Deferred loan costs, net			16,558				3,426
Inventory			22,790				1,459
Intangible asset, net — operating rights			48,524				—
Noncurrent derivative instruments			23,981				—
Other assets			373				367
Total assets		$	2,663,774			$	1,508,229
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable:
Trade		$	19,419			$	14,222
Related parties			1,062				2,119
Other current liabilities:
Bank overdrafts			4,697				5,651
Revenue payable			22,194				14,494
Accrued and prepaid drilling costs			145,861				39,276
Derivative instruments			29,870				36,414
Income taxes payable			3,584				29
Current portion of long-term debt			—				2,000
Other current liabilities			27,859				14,437
Total current liabilities			254,546				128,642
Long-term debt			635,000				325,404
Noncurrent derivative instruments			24,857				10,517
Deferred income taxes			543,239				259,070
Asset retirement obligations and other long-term liabilities			17,387				9,198
Commitments and contingencies (Note L)
Stockholders’ equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized; and none issued and outstanding at September 30, 2008 and December 31, 2007			—				—
Common stock, $0.001 par value; 300,000,000 authorized; 84,620,765 and 75,832,310 shares issued at September 30, 2008 and December 31, 2007, respectively			85				76
Additional paid-in capital			1,006,496				752,380
Notes receivable from employees			—				(330	)
Retained earnings			187,340				37,467
Accumulated other comprehensive loss			(5,051	)			(14,195	)
Treasury stock, at cost; 3,142 and zero shares of treasury stock at September 30, 2008 and December 31, 2007, respectively			(125	)			—
Total stockholders’ equity			1,188,745				775,398
Total liabilities and stockholders’ equity		$	2,663,774			$	1,508,229

The accompanying notes are an integral part of these consolidated financial statements.

Concho Resources Inc.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(in thousands, except per share amounts)		2008				2007				2008				2007
Operating revenues:
Oil sales		$	130,600			$	45,685			$	301,826			$	128,152
Natural gas sales			39,857				23,413				112,725				67,395
Total operating revenues			170,457				69,098				414,551				195,547
Operating costs and expenses:
Oil and gas production			27,041				13,773				65,915				37,925
Exploration and abandonments			16,824				11,805				20,288				18,110
Depreciation, depletion and amortization			32,528				18,003				75,822				55,036
Accretion of discount on asset retirement obligations			270				106				571				334
Impairments of long-lived assets			2,758				1,379				2,827				4,577
General and administrative (including non-cash stock-based compensation of $1,925 and $702 for the three months ended September 30, 2008 and 2007, respectively, and $4,954 and $2,656 for the nine months ended September 30, 2008 and 2007, respectively)			10,778				4,646				27,044				16,567
Bad debt expense			1,106				—				2,905				—
Contract drilling fees — stacked rigs			—				—				—				4,269
Ineffective portion of cash flow hedges			(416	)			(22	)			(1,336	)			1,134
Gain on derivatives not designated as hedges			(163,312	)			(3,088	)			(43,678	)			(3,088	)
Total operating costs and expenses			(72,423	)			46,602				150,358				134,864
Income from operations			242,880				22,496				264,193				60,683
Other income (expense):
Interest expense			(10,255	)			(9,054	)			(19,755	)			(29,803	)
Other, net			334				484				1,665				957
Total other expense			(9,921	)			(8,570	)			(18,090	)			(28,846	)
Income before income taxes			232,959				13,926				246,103				31,837
Income tax expense			(91,031	)			(5,972	)			(96,230	)			(13,335	)
Net income			141,928				7,954				149,873				18,502
Preferred stock dividends			—				—				—				(45	)
Net income applicable to common shareholders		$	141,928			$	7,954			$	149,873			$	18,457
Basic earnings per share:
Net income per share		$	1.75			$	0.12			$	1.93			$	0.30
Weighted average shares used in basic earnings per share			81,288				69,067				77,489				60,648
Diluted earnings per share:
Net income per share		$	1.72			$	0.11			$	1.90			$	0.29
Weighted average shares used in diluted earnings per share			82,724				69,913				78,945				62,858

The accompanying notes are an integral part of these consolidated financial statements.

Concho Resources Inc.

																						Accumulated
										Additional				Notes								other												Total
		Common stock								paid-in				receivable from				Retained				comprehensive				Treasury stock								stockholders’
(in thousands)		Shares				Amount				capital				employees				earnings				loss				Shares				Amount				equity
BALANCE AT DECEMBER 31, 2007			75,832			$	76			$	752,380			$	(330	)		$	37,467			$	(14,195	)			—			$	—			$	775,398
Comprehensive income
Net income			—				—				—				—				149,873				—				—				—				149,873
Deferred hedge losses, net of taxes of $7,013			—				—				—				—				—				(10,909	)			—				—				(10,909	)
Net settlement losses included in earnings, net of taxes of $12,891			—				—				—				—				—				20,053				—				—				20,053
Total comprehensive income																																			159,017
Issuance of common stock			8,304				8				242,418				—				—				—				—				—				242,426
Stock options exercised			430				1				3,860				—				—				—				—				—				3,861
Restricted stock issued as stock-based compensation			98				—				1,578				—				—				—				—				—				1,578
Cancellation of restricted stock			(43	)			—				—				—				—				—				—				—				—
Stock-based compensation for stock options			—				—				3,376				—				—				—				—				—				3,376
Excess tax benefits related to stock-based compensation			—				—				2,884				—				—				—				—				—				2,884
Proceeds from notes receivable — employees			—				—				—				333				—				—				—				—				333
Accrued interest — employee notes			—				—				—				(3	)			—				—				—				—				(3	)
Purchase of treasury stock			—				—				—				—				—				—				3				(125	)			(125	)
BALANCE AT SEPTEMBER 30, 2008			84,621			$	85			$	1,006,496			$	—			$	187,340			$	(5,051	)			3			$	(125	)		$	1,188,745

The accompanying notes are an integral part of these consolidated financial statements.

Concho Resources Inc.

		Nine Months Ended
		September 30,
(in thousands)		2008				2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	149,873			$	18,502
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, depletion and amortization			75,822				55,036
Impairments of long-lived assets			2,827				4,577
Accretion of discount on asset retirement obligations			571				334
Exploration expense, including dry holes			17,860				17,117
Non-cash compensation expense			4,954				2,656
Bad debt expense			2,905				—
Deferred income taxes			86,908				11,460
Gain on sale of assets			(777	)			—
Ineffective portion of cash flow hedges			(1,336	)			1,134
Gain on derivatives not designated as hedges			(43,678	)			(3,088	)
Dedesignated cash flow hedges reclassified from accumulated other comprehensive income (loss)			260				(722	)
Other non-cash items			2,749				3,523
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable			26,209				11,355
Prepaid costs and other			(1,035	)			230
Inventory			(14,985	)			(95	)
Accounts payable			(12,472	)			(9,230	)
Revenue payable			6,982				(5,325	)
Other current liabilities			16,992				(4,757	)
Income taxes payable			(1,229	)			225
Net cash provided by operating activities			319,400				102,932
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures on oil and gas properties			(213,666	)			(113,936	)
Acquisition of oil and gas properties, businesses and other assets			(586,925	)			(256	)
Additions to other property and equipment			(6,711	)			(2,218	)
Proceeds from the sale of oil and gas properties			1,034				96
Settlements received (paid) on derivatives not designated as hedges			(29,170	)			1,286
Net cash used in investing activities			(835,438	)			(115,028	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt			767,800				283,600
Payments of long-term debt			(460,700	)			(433,700	)
Exercise of stock options			3,861				—
Excess tax benefit from stock-based compensation			2,884				—
Net proceeds from issuance of common stock			242,426				173,002
Payments of preferred stock dividends			—				(132	)
Proceeds from repayment of employee notes			333				10,644
Payments for loan origination costs			(15,541	)			(2,572	)
Purchase of treasury stock			(125	)			—
Bank overdrafts			(954	)			—
Net cash provided by financing activities			539,984				30,842
Net increase in cash and cash equivalents			23,946				18,746
Cash and cash equivalents at beginning of period			30,424				1,122
Cash and cash equivalents at end of period		$	54,370			$	19,868
SUPPLEMENTAL CASH FLOWS:
Cash paid for interest and fees, net of $1,090 and $2,160 capitalized interest		$	16,164			$	32,322
Cash paid for income taxes		$	5,964			$	2,050

The accompanying notes are an integral part of these consolidated financial statements.

Concho Resources Inc.

Note A. Organization and nature of operations

     Concho Resources Inc. (“Resources”) is a Delaware corporation formed by Concho Equity Holdings Corp. (“CEHC”) on February 22, 2006, for purposes of effecting the combination of CEHC, Chase Oil Corporation, Caza Energy LLC (“Caza”) and certain other parties thereto (collectively with Chase Oil Corporation and Caza, the “Chase Group”). Pursuant to the Combination Agreement dated February 24, 2006, Resources acquired working interests in oil and natural gas properties in Southeast New Mexico from the Chase Group (the “Chase Group Properties”) and issued shares of Resources common stock to certain stockholders of CEHC in exchange for their capital stock of CEHC. CEHC is a Delaware corporation formed on April 21, 2004 by certain members of Resources’ management team and private equity investors. CEHC commenced substantial oil and gas operations in December 2004 upon its acquisition of certain oil and gas properties located in Southeast New Mexico and West Texas. The combination transaction described above (the “Combination”) was accounted for as an acquisition by CEHC of the Chase Group Properties and a simultaneous reorganization of Resources such that CEHC is now a wholly-owned subsidiary of Resources. Prior to the Combination, Resources had no assets, operations or net equity. Upon the closing of the Combination, the executive officers of CEHC became the executive officers of Resources. Resources and its wholly-owned subsidiaries are collectively referred to herein as the “Company.”

     In the Combination, CEHC’s shareholders received 23,767,691 shares of common stock of the Company in exchange for their preferred and common shares of CEHC, excluding eighteen holders owning an aggregate of 254,621 shares of CEHC 6% Series A Preferred Stock and 127,313 shares of CEHC common stock, as discussed in Note H. In addition, the Chase Group transferred the Chase Group Properties to the Company in exchange for cash in the aggregate amount of approximately $409 million and 34,794,638 shares of the Company’s common stock. In connection with the Company’s initial public offering and secondary public offering (both described below), the Chase Group sold a total of 18,638,014 shares of the Company’s common stock. At September 30, 2008 and December 31, 2007, the Chase Group owned approximately 10 percent and 21 percent, respectively, of the total outstanding common stock of the Company.

     The Company’s principal business is the acquisition, development, exploitation and exploration of oil and gas properties in the Permian Basin region of Southeast New Mexico and West Texas.

     Initial public offering. On August 7, 2007, the Company completed an initial public offering (the “IPO”) of its common stock. The Company sold 13,332,851 shares of its common stock in the IPO and certain shareholders, including its executive officers and certain members of the Chase Group, sold 7,554,256 shares of the Company’s common stock at $11.50 per share. After deducting underwriting discounts of approximately $9.6 million and offering expenses of approximately $4.5 million, the Company received net proceeds of approximately $139.2 million. In conjunction with the IPO, the underwriters were granted an option to purchase 3,133,066 additional shares of the Company’s common stock. The underwriters fully exercised this option and purchased the additional shares on August 9, 2007. After deducting underwriting discounts of approximately $2.2 million, the Company received net proceeds of approximately $33.8 million. The aggregate net proceeds of approximately $173.0 million received by the Company at closing on August 7, 2007 and August 9, 2007 were utilized to reduce bank debt.

     Secondary public offering. On December 19, 2007, the Company completed a secondary public offering of 11,845,000 shares of the Company’s common stock, which was sold by certain of the Company’s stockholders, including certain members of the Chase group. The Chase Group sold 10,194,732 shares of the Company’s common stock in the aggregate and certain other stockholders of the Company sold 1,650,268 shares of the Company’s common stock in the aggregate, including one of the Company’s executive officers who sold 45,000 shares of the Company’s common stock. Chase Oil Corporation granted the underwriters an option to purchase up to 1,776,615 additional shares of the Company’s common stock to cover over-allotments, which was fully exercised on December 19, 2007. The Company did not receive any proceeds from the sale of the Company’s common stock in this secondary offering.

Note B. Summary of significant accounting policies

     Principles of consolidation. The consolidated financial statements of the Company include the accounts of the Company and its wholly- owned subsidiaries, including CEHC. All material intercompany balances and transactions have been eliminated.

     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, 2007 is derived from audited financial statements. In the opinion of management, the accompanying financial statements reflect all adjustments

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

necessary to present fairly the Company’s financial position at September 30, 2008, its results of operations for the three and nine months ended September 30, 2008 and 2007 and its cash flows for the nine months ended September 30, 2008 and 2007. All such adjustments are of a normal recurring nature. In preparing the accompanying financial statements, management has made certain estimates and assumptions that affect reported amounts in the financial statements and disclosures of contingencies. Actual results may differ from those estimates. Certain amounts presented in prior period financial statements have been reclassified for consistency with current period presentation. The results for interim periods are not necessarily indicative of annual results.

     Certain disclosures have been condensed or omitted from these financial statements. Accordingly, these financial statements should be read with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

     Intangible assets. The Company has capitalized certain operating rights acquired in an acquisition, see Note D. The operating rights, which have no residual value, are amortized over the estimated economic life of approximately 25 years. Impairment will be assessed when there is a material change in the remaining useful economic life.

     Oil and gas sales and imbalances. Oil and natural gas revenues are recorded at the time of delivery of such products to pipelines for the account of the purchaser or at the time of physical transfer of such products to the purchaser. The Company follows the sales method of accounting for oil and natural gas sales, recognizing revenues based on the Company’s share of actual proceeds from the oil and natural gas sold to purchasers. Oil and natural gas imbalances are generated on properties for which two or more owners have the right to take production “in-kind” and, in doing so, take more or less than their respective entitled percentage. Imbalances are tracked by well, but the Company does not record any receivable to or payable from the other owners unless the imbalance has reached a level whereby it exceeds the remaining reserves in the respective well. If reserves are insufficient to offset the imbalance and the Company is in an overtake position, a liability is recorded for the amount of shortfall in reserves valued at a contract price or the market price in effect at the time the imbalance is generated. If the Company is in an undertake position, a receivable is recorded for an amount that is reasonably expected to be received, not to exceed the current market value of such imbalance.

     At September 30, 2008, the Company had a natural gas imbalance liability, included in asset retirement obligations and other long-term liabilities in the accompanying consolidated balance sheet of approximately $445,000 related to the Company’s overtake position of 81,093 Mcf on certain wells and a natural gas imbalance receivable, included in other assets in the accompanying consolidated balance sheet of approximately $373,000 related to the Company’s undertake position of 82,990 Mcf on certain wells.

     At December 31, 2007, the Company had a natural gas imbalance liability, included in asset retirement obligations and other long-term liabilities in the accompanying consolidated balance sheet, of approximately $621,000 related to the Company’s overtake position of 96,215 Mcf on certain wells and a natural gas imbalance receivable, included in other assets in the accompanying consolidated balance sheet, of approximately $367,000 related to the Company’s undertake position of 81,569 Mcf on certain wells.

     Treasury stock. Treasury stock purchases are recorded at cost. Upon reissuance, the cost of treasury shares held is reduced by the average purchase price per share of the aggregate treasury shares held.

     General and administrative expense. The Company receives fees for its operation of jointly owned oil and gas properties and records such reimbursements as reductions of general and administrative expense. Such fees totaled approximately $2,125,000 and $222,000 for the three months ended September 30, 2008 and 2007, respectively, and $2,629,000 and $852,000 for the nine months ended September 30, 2008 and 2007, respectively.

Note C. Exploratory well costs

     Costs of drilling exploratory wells are capitalized, pending management’s determination of whether the wells have found proved reserves. If proved reserves are found, the costs remain capitalized. If proved reserves are not found, the capitalized costs of drilling the well are charged to expense. Management makes this determination as soon as possible after completion of drilling considering the guidance provided in Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 19, “Financial Accounting and Reporting by Oil and Gas Producing Companies” and FASB Staff Position (“FSP”) No. 19-1, “Accounting for Suspended Well Costs.”

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     The following table provides an aging, at September 30, 2008 and December 31, 2007, of capitalized exploratory well costs based on the date drilling was completed:

		September 30,				December 31,
(in thousands)		2008				2007
Wells in progress		$	3,446			$	4,199
Capitalized exploratory well costs that have been capitalized for a period of one year or less			13,061				16,857
Capitalized exploratory well costs that have been capitalized for a period greater than one year			—				—
Total capitalized exploratory well costs		$	16,507			$	21,056

     At September 30, 2008, the capitalized exploratory well costs of approximately $16.5 million had been deferred for a period of one year or less and were related primarily to the Company’s New Mexico shelf properties and emerging resource plays.

Note D. Acquisitions

     On July 31, 2008, the Company closed the acquisition of (a) Henry Petroleum LP and certain entities affiliated with Henry Petroleum LP (the “Henry Entities”) and (b) additional non-operated interests in certain Henry Entities’ oil and gas properties from persons affiliated with the Henry Entities (collectively the “7/31/08 Acquisition”). In late August and early September 2008, the Company acquired additional non-operated interests in certain Henry Entities oil and gas properties from persons affiliated with the Henry Entities (which in combination with the 7/31/2008 Acquisition is referred to as the “Acquisition” or “Henry Properties”). The Company paid $586.9 million in cash for the Acquisition.

     The cash paid for the Acquisition was funded with (a) borrowings under the Company’s senior credit facility, see Note K, and (b) proceeds from a private placement of approximately 8.3 million shares of the Company’s common stock, see Note H.

     The Acquisition is being accounted for using the purchase method of accounting for business combinations. Under the purchase method of accounting, the Company recorded the Henry Properties’ assets and liabilities at fair value. The purchase price of the acquired Henry Properties’ net assets will be based on the total value of the cash consideration. The initial purchase price allocation is preliminary and subject to adjustment. Any future adjustments to the allocation of the total purchase price are not anticipated to be material to the Company’s consolidated financial statements.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     The following tables represent the preliminary allocation of the total purchase price of the Henry Properties to the acquired assets and liabilities of the Henry Properties and the consideration paid for the Henry Properties. The allocation represents the fair values assigned to each of the assets acquired and liabilities assumed:

(in thousands)
Fair value of Henry Properties’ net assets:
Current assets, excluding cash acquired of $18,960		$	95,085
Proved oil and gas properties			590,850
Unproved oil and gas properties			220,350
Other long-term assets			7,820
Intangible assets — operating rights			48,849
Total assets acquired			962,954
Current liabilities			(129,369	)
Asset retirement obligations and other long-term liabilities			(6,837	)
Noncurrent derivative liabilities			(39,037	)
Deferred tax liability			(200,786	)
Total liabilities assumed			(376,029	)
Total purchase price		$	586,925
Consideration paid for Henry Properties’ net assets:
Cash consideration paid, excluding cash acquired of $18,960		$	581,275
Acquisition costs			5,650
Total purchase price		$	586,925

     Estimated acquisition costs include legal and accounting fees, advisory fees and other acquisition-related costs.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     The following unaudited pro forma combined condensed financial data for the nine months ended September 30, 2008 and 2007 was derived from the historical financial statements of the Company and Henry Properties giving effect to the acquisition as if it had occurred on January 1, 2007. The unaudited pro forma combined condensed financial data has been included for comparative purposes only and is not necessarily indicative of the results that might have occurred had the Acquisition taken place as of the dates indicated and is not intended to be a projection of future results.

		Nine Months Ended
		September 30,
(in thousands, except per share data)		2008				2007
Operating revenues		$	509,976			$	290,972
Net income (loss) applicable to common shareholders		$	134,959			$	(6,124	)
Earnings (loss) per common share:
Basic		$	1.57			$	(0.09	)
Diluted		$	1.55			$	(0.09	)

Note E. Fair value measurements

     The Company adopted SFAS No. 157, “Fair Value Measurements,” (“SFAS No. 157”) effective January 1, 2008 for financial assets and liabilities measured on a recurring basis. SFAS No. 157 applies to all financial assets and financial liabilities that are being measured and reported on a fair value basis. In February 2008, the FASB issued FSP No. 157-2, which delayed the effective date of SFAS No. 157 by one year for nonfinancial assets and liabilities. As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements. The statement requires fair value measurements be classified and disclosed in one of the following categories:

		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, investments and interest rate swaps. The Company’s valuation models are primarily industry-standard models that consider various inputs including: (a) quoted forward prices for commodities, (b) time value and (c) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. The Company utilizes our counterparties’ valuations to assess the reasonableness of our prices and valuation techniques.
		Level 3:		Measured based on 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). Level 3 instruments primarily include derivative instruments, such as basis swaps, commodity price collars and floors, as well as investments. The Company’s valuation models are primarily industry-standard models that consider various inputs including: (a) quoted forward prices for commodities, (b) time value, (c) volatility factors and (d) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Although the Company utilizes our counterparties’ valuations to assess the reasonableness of our prices and valuation techniques, the Company does not have sufficient corroborating market evidence to support classifying these assets and liabilities as Level 2.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     As required by SFAS No. 157, financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels. The following table summarizes the valuation of the Company’s financial instruments by SFAS No. 157 pricing levels at September 30, 2008:

		Fair value measurements using
		Quoted				Significant								Total
		prices				other				Significant				carrying value
		in active				observable				unobservable				at
		markets				inputs				inputs				September 30,
(in thousands)		(Level 1)				(Level 2)				(Level 3)				2008
Commodity derivative swap contracts		$	—			$	(34,200	)		$	—			$	(34,200	)
Commodity derivative collar contracts			—				—				15,419				15,419
Total financial assets (liabilities)		$	—			$	(34,200	)		$	15,419			$	(18,781	)

     The following table sets forth a reconciliation of changes in the fair value of financial assets and liabilities classified as Level 3 in the fair value hierarchy:

(in thousands)
Balance as of January 1, 2008		$	1,866
Gains (losses), realized or unrealized			12,185
Purchases, issuances, and settlements			1,368
Balance as of September 30, 2008		$	15,419
Total gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets (liabilities) still held at the reporting date		$	13,553

Note F. New accounting pronouncements

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115,” which became effective in 2008. SFAS No. 159 permits entities to measure eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other generally accepted accounting principles. The fair value measurement election is irrevocable and subsequent changes in fair value must be recorded in earnings. The Company adopted this statement January 1, 2008, and the Company did not elect the fair value option for any of its eligible financial instruments or other items. As such, the adoption had no impact on the Company’s consolidated financial statements.

     In April 2007, the FASB issued FASB Staff Position FIN 39-1, “Amendment of FASB Interpretation No. 39” (“FIN No. 39-1”). FIN No. 39-1 clarifies that a reporting entity that is party to a master netting arrangement can offset fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments that have been offset under the same master netting arrangement. FIN No. 39-1 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company adopted FIN No. 39-1 effective January 1, 2008, and it has had no material impact on the Company’s consolidated financial statements.

     In June 2007, the FASB ratified a consensus opinion reached by the Emerging Issues Task Force (“EITF”) on EITF Issue 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF Issue 06-11 requires an employer to recognize tax benefits realized from dividend or dividend equivalents paid to employees for certain share-based payment awards as an

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

increase to additional paid-in capital and include such amounts in the pool of excess tax benefits available to absorb future tax deficiencies on share-based payment awards. If an entity’s estimate of forfeitures increases (or actual forfeitures exceed the entity’s estimates), or if an award is no longer expected to vest, entities should reclassify the dividends or dividend equivalents paid on that award from retained earnings to compensation cost. However, the tax benefits from dividends that are reclassified from additional paid-in capital to the income statement are limited to the entity’s pool of excess tax benefits available to absorb tax deficiencies on the date of reclassification. The adoption of EITF Issue 06-11 has not had a significant effect on the Company’s financial statements since it historically has accounted for the income tax benefits of dividends paid for share-based payment awards in the manner described in the consensus.

     In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”), which replaces FASB Statement No. 141. SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) also establishes disclosure requirements that will enable users to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is effective for acquisitions that occur in an entity’s fiscal year that begins after December 15, 2008, which will be the Company’s fiscal year 2009. The impact, if any, will depend on the nature and size of business combinations the Company consummates after the effective date.

     In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an Amendment of ARB No. 51.” SFAS No. 160 requires that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS No. 160 also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. This statement is effective as of the beginning of an entity’s first fiscal year beginning after December 15, 2008, which will be the Company’s fiscal year 2009. Based upon the Company’s September 30, 2008 consolidated balance sheet, the statement would have no impact.

     In December 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 110, “Share-Based Payment” (“SAB No. 110”). SAB No. 110 amends SAB No. 107, "Share-Based Payment,” and allows for the continued use, under certain circumstances, of the simplified method in developing an estimate of the expected term on stock options accounted for under SFAS No. 123R, “Share-Based Payment (revised 2004).” SAB No. 110 is effective for stock options granted after December 31, 2007. The Company continued to use the simplified method in developing an estimate of the expected term on stock options granted in the first three quarters of 2008. The Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its shares of common stock have been publicly traded.

     In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”), which amends and expands the disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), to provide an enhanced understanding of an entity’s use of derivative instruments, how they are accounted for under SFAS No. 133 and their effect on the entity’s financial position, financial performance and cash flows. The provisions of SFAS No. 161 are effective as of January 1, 2009. The Company is currently evaluating the impact on its consolidated financial statements of adopting SFAS No. 161.

     In June 2008, the FASB issued Staff Position No. EITF 03-6-1 “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” (“FSP EITF 03-6-1”) which provides that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and, therefore, need to be included in the earnings allocation in computing earnings per share under the two class method. FSP EITF 03-6-1 is effective for us on January 1, 2009 and all prior-period EPS data (including any amounts related to interim periods, summaries of earnings and selected financial data) will be adjusted retroactively to conform to its provisions. Early application of FSP EITF 03-6-1 is not permitted. Although restricted stock awards meet this definition, the Company does not expect the application of FSP EITF 03-6-1 to have a significant impact on its reported earnings per share.

     In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the united

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

States of America. This statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company does not expect the adoption of SFAS No. 162 to have an impact on its financial statements.

     In October 2008, the FASB issued FASB Staff Position (“FSP”) No. SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active.” FSP No. SFAS 157-3 clarifies the application of SFAS No. 157 as it relates to the valuation of financial assets in a market that is not active for those financial assets. This FSP is effective immediately and includes those periods for which financial statements have not been issued. The Company currently does not have any financial assets that are valued using inactive markets, and as a result, the Company is not impacted by the issuance of FSP No. SFAS 157-3.

Note G. Asset retirement obligations

     The Company’s asset retirement obligations represent the estimated present value of the estimated cash flows the Company will incur to plug, abandon and remediate its producing properties at the end of their production lives, in accordance with applicable state laws. The Company does not provide for a market risk premium associated with asset retirement obligations because a reliable estimate cannot be determined. The Company has no assets that are legally restricted for purposes of settling asset retirement obligations.

     The following table summarizes the Company’s asset retirement obligation transactions recorded in accordance with the provisions of SFAS No. 143 during the nine months ended September 30, 2008 and 2007:

		Nine Months Ended
		September 30,
(in thousands)		2008				2007
Asset retirement obligations, beginning of period		$	9,418			$	8,700
Liabilities incurred from new wells			660				309
Liabilities assumed in acquisitions			7,062				—
Accretion expense			571				334
Liabilities settled upon plugging and abandoning wells			—				(34	)
Revision of estimates			350				(2,032	)
Asset retirement obligations, end of period		$	18,061			$	7,277

Note H. Stockholders’ equity

     Common stock private placement. On June 5, 2008, the Company entered into a common stock purchase agreement with certain unaffiliated third-party investors to sell certain shares of the Company’s common stock in a private placement (the “Private Placement”) contemporaneous with the closing of the Acquisition. On July 31, 2008, the Company issued 8,302,894 shares of its common stock at $30.11 per share. The Private Placement resulted in net proceeds of approximately $242.4 million to the Company, after payment of approximately $7.6 million for the fee paid to the placement agent.

     In connection with the Private Placement, the Company entered into a registration rights agreement with the investors. On October 24, 2008, pursuant to the registration rights agreement, the Company filed a registration statement to register the shares of common stock issued in the Private Placement.

     Treasury stock. On June 12, 2008, the restrictions on certain restricted stock awards issued to five of the Company’s executive officers lapsed. Immediately upon the lapse of restrictions, these executive officers became liable for certain federal income taxes on the value of such shares. In accordance with the Company’s 2006 Stock Incentive Plan and the applicable restricted stock award agreements, four of such officers elected to deliver shares of the Company’s common stock to the Company to satisfy such tax liability, and the Company acquired 3,142 shares to be held as treasury stock in the approximate amount of $125,000.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     Equity commitments. Pursuant to a stock purchase agreement (the “Stock Purchase Agreement”) entered into on August 13, 2004, CEHC obtained private equity commitments totaling $202.5 million, comprised of equity commitments from fourteen private investors (the “Private Investors”) of approximately $188.9 million and equity commitments from the five original officers (the “Officers”) of the Company in the aggregate amount of approximately $13.6 million. The original commitments were subject to call by a vote of the board of directors over a four year period beginning August 13, 2004 (the “Take-Down Period”), with the first date on which capital was called being August 13, 2004. Subsequent calls were made on November 11, 2004, June 22, 2005, December 7, 2005 and February 10, 2006. The percentage of total commitments called per capital call date was approximately 15.0 percent, 23.3 percent, 10.0 percent, 15.0 percent and 22.0 percent, respectively. In conjunction with the exchange of CEHC common stock for Resources common stock as of the date of the Combination, the remaining 14.7 percent of these private equity commitments was terminated.

     In addition to this arrangement between CEHC, the Private Investors and the Officers, certain employees and other officers of the Company entered into separate subscription agreements with the Company. The officers’ and employees’ equity purchases were paid for in a combination of cash and the issuance of notes payable to the Company with recourse only to any equity security of the Company held by the respective officer or employee (the “Purchase Notes”). Based on guidance contained in SFAS No. 123R, the agreements to sell stock to the Company’s officers and certain employees subject to the Purchase Notes are accounted for as the issuance of options (“Bundled Capital Options” for the Officers and “Capital Options” for certain employees) on the dates that the various subscription agreements were signed and the purchase commitments were made.

     Capital calls. From inception of CEHC through February 23, 2006, the Private Investors purchased 16,113,170 Preferred Units for $161.1 million in cash; the Company’s officers purchased 2,240,083 CEHC common shares and 938,303 Preferred Units for $3.6 million in cash and Purchase Notes totaling $8.0 million, and certain employees purchased 425,221 Preferred Units for $1.0 million in cash and Purchase Notes totaling $3.8 million.

     6% Series A preferred stock. Preferred stock dividends were generally paid on the anniversary of date of issuance of preferred stock as a part of the Preferred Units. There were no dividend payments made during the three and nine months ended September 30, 2008, because there was no outstanding preferred stock. Preferred stock dividends of approximately $132,000 were paid during the nine months ended September 30, 2007. As discussed in Note A and below, the majority of the CEHC preferred stock was converted into Resources common stock in the Combination.

     Dividend payments continued to be made through April 16, 2007 to the eighteen employee shareholders that did not convert their shares of CEHC preferred stock to Resources common stock in the Combination. On April 16, 2007, these CEHC preferred shares were exchanged for 190,972 shares of the Company’s common stock. These shares are reported as if converted on the date of the Combination.

     Purchase notes. On April 23, 2007, the Company’s officers repaid their Purchase Notes in full, including principal of $9,426,000 and accrued interest of $1,037,000 in the aggregate. The agreements to sell stock to the executive officers of the Company subject to Purchase Notes were accounted for as the issuance of options. As such, the repayment of the executive officer Purchase Notes represents the full exercise of the options on the Bundled Capital Options (as defined in Note O) the officers held as well as the Capital Options (as defined in Note O) of one certain employee who was formerly an executive officer.

     At September 30, 2008, all Purchase Notes from all employees had been paid in full. As such, the repayment of the Purchase Notes represents the full exercise of the options on the Capital Options held by certain employees.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     The following table summarizes the Capital Options activity for the nine months ended September 30, 2008:

		Number of				Weighted
		capital				average
		options				exercise price
Nine months ended September 30, 2008
Outstanding at beginning of period			38,385			$	8.34
$10 Capital Options exercised			(38,385	)		$	8.34
Outstanding at end of period			—			$	—
Vested outstanding at end of period			—			$	—

     Conversion of CEHC 6% Series A Preferred Stock and CEHC common stock. On February 27, 2006, concurrent with the closing of the Combination described in Note A, the majority of the shares outstanding of CEHC preferred stock and outstanding shares of CEHC common stock were converted to shares of the Company’s common stock, as described below.

     Eighteen employee shareholders owning an aggregate of 254,621 shares of CEHC preferred stock and 127,313 shares of CEHC common stock did not convert their shares to the Company’s common stock at the date of the Combination. On April 16, 2007, these remaining shares of CEHC were exchanged for 318,285 shares of the Company’s common stock. These shares are reported as if converted on the date of the Combination. In addition, CEHC made a final dividend payment to these eighteen employee shareholders on their CEHC preferred stock in the aggregate amount of approximately $99,000 on April 16, 2007.

     Also in conjunction with the Combination described in Note A and the conversion of CEHC preferred stock into the Company’s common stock at the ratio of 0.75:1, the CEHC Bundled Capital Options were converted into the Company’s Bundled Capital Options and CEHC Capital Options were converted into the Company’s Capital Options. The Company’s Capital Options are considered to be exercisable for 1.25 shares of the Company’s common stock.

Note I. Stock incentive plan

     The Company’s 2006 Stock Incentive Plan (together with applicable option agreements and restricted stock agreements, the “Plan”) provides for granting stock options and restricted stock awards to employees and individuals associated with the Company.

     Restricted stock awards. All restricted shares are treated as issued and outstanding in the accompanying consolidated balance sheets. If a grantee terminates employment or other services prior the lapse date, the awarded shares are forfeited and cancelled and are no longer considered issued and outstanding, subject to the discretion of the compensation committee. A summary of the Company’s restricted stock awards during the nine months ended September 30, 2008 is presented below:

		Number of				Grant date
		restricted				fair value
		shares				per share
Restricted stock:
Outstanding at December 31, 2007			371,549
Shares granted			98,001			$	34.78
Shares cancelled / forfeited			(42,791	)
Lapse of restrictions			(42,001	)
Outstanding at September 30, 2008			384,758

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     A summary of the impact on the consolidated statements of operations for the Company’s restricted stock awards during the three and nine months ended September 30, 2008 and 2007 is presented below:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(in thousands)		2008				2007				2008				2007
Stock-based compensation expense related to restricted stock		$	716			$	226			$	1,578			$	1,007
Income tax benefit related to restricted stock		$	276			$	95			$	617			$	422
Deductions in current taxable income related to restricted stock		$	68			$	140			$	1,088			$	565

     Stock option awards. In calculating compensation expense for options granted during the nine months ended September 30, 2008, the Company estimated the fair value of each grant using the Black-Scholes option-pricing model. Weighted average assumptions utilized in the model are shown below:

Risk-free interest rate			3.19	%
Expected term (years)			6.21
Expected volatility			38.25	%
Expected dividend yield			—

     As permitted by SAB No. 110, the Company used the simplified method to calculate the expected term for stock options granted during the three and nine months ended September 30, 2008, since it does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its shares of common stock have been publicly traded. Expected volatilities are based on a combination of historical and implied volatilities of comparable companies.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     A summary of the Company’s stock option awards under the Plan for the nine months ended September 30, 2008 is presented below:

						Weighted
						average
		Number of				exercise
		options				price
Stock options:
Outstanding at December 31, 2007			3,011,722			$	9.71
Options granted			594,055			$	23.57
Options forfeited			(275,593	)		$	14.96
Options exercised			(430,351	)		$	8.98
Outstanding at September 30, 2008			2,899,833			$	12.16
Vested at September 30, 2008			1,749,398			$	9.10
Exercisable at September 30, 2008			668,957			$	10.55

     The following table summarizes information about the Company’s vested stock options outstanding and exercisable at September 30, 2008:

										Weighted
										average				Weighted				Intrinsic
						Number				remaining				average				value at
						vested and				contractual				exercise				September 30,
						exercisable				life				price				2008
																		(in thousands)
Vested options:
Exercise price		$	8.00				1,397,198			2.53 years				$	8.00			$	27,399
Exercise price		$	12.00				160,950			4.68 years				$	12.00				2,512
Exercise price		$	14.68				191,250			8.03 years				$	14.68				2,472
							1,749,398							$	9.10			$	32,383
Exercisable options:
Exercise price		$	8.00				370,778			3.83 years				$	8.00			$	7,271
Exercise price		$	12.00				106,929			5.90 years				$	12.00				1,669
Exercise price		$	14.68				191,250			8.03 years				$	14.68				2,472
							668,957							$	10.55			$	11,412

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     The following table summarizes information about stock-based compensation for stock options for the three and nine months ended September 30, 2008 and 2007:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(in thousands)		2008				2007				2008				2007
Grant date fair value for awards during the period:
Time vesting options (a)		$	206			$	87			$	389			$	87
Officer stock options (c)			585				1,156				5,675				1,156
Total		$	791			$	1,243			$	6,064			$	1,243
Stock-based compensation expense from stock options:
Time vesting options (a)		$	48			$	6			$	113			$	6
Performance vesting options:
Officers (b)			138				141				402				420
Certain employee (b)			11				10				31				30
Officer stock options (c)			1,012				319				2,830				1,193
Total		$	1,209			$	476			$	3,376			$	1,649
Income taxes and other information:
Income tax benefit related to stock options		$	461			$	200			$	1,319			$	691
Deductions in current taxable income related to stock options exercised		$	2,880			$	—			$	8,218			$	—
Number of stock options exercised			167				—				430				—

     Future stock-based compensation expense. Future stock-based compensation expense at September 30, 2008 is summarized in the table below:

		Restricted				Stock
(in thousands)		stock				options				Total
Remaining 2008		$	768			$	1,236			$	2,004
2009			2,228				2,936				5,164
2010			1,272				1,328				2,600
2011			391				486				877
2012			—				51				51
Total		$	4,659			$	6,037			$	10,696

Note J. Derivative financial instruments

     The Company, from time to time, uses derivative financial instruments as cash flow hedges of its commodity price risks. Commodity hedges are used to (a) reduce the effect of the volatility of price changes on the natural gas and crude oil the Company produces and sells, (b) support the Company’s annual capital budget and expenditure plans and (c) support the economics associated with acquisitions.

     Currently, the Company does not designate its derivative instruments to qualify for hedge accounting. Accordingly, the Company reflects the changes in the fair value of its derivative instruments in the statements of operations.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     A key requirement for designation of derivative instruments to qualify for hedge accounting is that at both the inception of the hedge and on an ongoing basis, the hedging relationship is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the hedge. Generally, the hedging relationship can be considered to be highly effective if there is a high degree of historical correlation between the hedging instrument and the forecasted transaction. For all quarters ended prior to July 1, 2007, prices received for the Company’s natural gas were highly correlated with the Inside FERC — El Paso Natural Gas index (the “Index”) — the Index referenced in all of the Company’s natural gas derivative instruments. However, during the quarter ended September 30, 2007, this historical relationship did not meet the criteria as being highly correlated. Natural gas produced from the Company’s New Mexico shelf assets has a substantial component of natural gas liquids. Prices received for natural gas liquids are not highly correlated to the price of natural gas, but are more closely correlated to the price of oil. During the third quarter of 2007, the price of oil and natural gas liquids, and therefore, the prices the Company received for its natural gas (including natural gas liquids) rose substantially and at a significantly higher rate than the corresponding change in the Index. This resulted in a decrease in correlation between the prices received and the Index below the level required for cash flow hedge accounting. According to SFAS No. 133, an entity shall discontinue hedge accounting prospectively for an existing hedge if the hedge is no longer highly effective. Hedge accounting must be discontinued regardless of whether the Company believes the hedge will be prospectively highly effective. The hedge must be discontinued during the period the hedges became ineffective. As a result, any changes in fair value must be recorded in earnings. Because the natural gas and natural gas liquids prices fluctuate at different rates over time, the loss of effectiveness does not relate to any single date.

     During the three months ended June 30, 2007, the Company determined that all of its natural gas commodity contracts no longer qualified as hedges under the requirements of SFAS No. 133 for the reason stated in the above paragraph. These contracts are referred to as “dedesignated hedges.”

     Therefore, June 30, 2007, was considered the last date the Company’s natural gas hedges were highly effective, and the Company discontinued hedge accounting during the three months ended September 30, 2007 and all periods thereafter. Mark-to-market adjustments related to these dedesignated hedges are recorded each period to earnings. Effective portions of dedesignated hedges, previously recorded in accumulated other comprehensive income (“AOCI”) as of June 30, 2007, remain in AOCI and are being reclassified into earnings under natural gas revenues, during the periods which the hedged forecasted transaction affects earnings.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     Commodity derivative contracts not designated as hedges. During the nine months ended September 30, 2008, the Company entered into additional commodity derivative contracts to hedge a portion of its estimated future production. The following table summarizes information about these additional commodity derivative contracts at September 30, 2008:

		Aggregate												Remaining
		remaining				Daily				Index				contract
		volume				volume				price				period
Crude oil (volumes in Bbls):
Price collar			768,000				2,104			$	120.00-$134.60	(a)			1/1/09 – 12/31/09
Price swap			128,800				1,400				$  99.25	(a)			10/1/08 – 12/31/08
Price swap			147,000				1,598				$124.35	(a)			10/1/08 – 12/31/08
Price swap			292,000				800				$  98.35	(a)			1/1/09 – 12/31/09
Price swap			348,000				953				$125.10	(a)			1/1/09 – 12/31/09
Price swap			240,000				658				$128.80	(a)			1/1/10 – 12/31/10
Price swap			336,000				921				$128.66	(a)			1/1/11 – 12/31/11
Price swap			504,000				1,377				$127.80	(a)			1/1/12 – 12/31/12
Natural gas (volumes in MMBtus):
Price swap			1,825,000				5,000				$    8.44	(b)			1/1/09 – 12/31/09

     Commodity derivative contracts assumed in the Acquisition. As part of the Acquisition, the Company assumed the following commodity derivative contracts at September 30, 2008:

		Aggregate												Remaining
		remaining				Daily				Index				contract
		volume				volume				price				period
Crude oil (volumes in Bbls):
Price swap			125,873				1,368			$	74.85	(a)			10/1/08 - 12/31/08
Price swap			443,491				1,215			$	73.59	(a)			1/1/09 - 12/31/09
Price swap			401,746				1,101			$	72.03	(a)			1/1/10 - 12/31/10
Price swap			221,746				608			$	68.92	(a)			1/1/11 - 12/31/11

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
Unaudited

     Fair value and activity of commodity derivative contracts. The following table sets forth the Company’s outstanding commodity derivative contracts at September 30, 2008:

						Aggregate												Remaining
		Fair value				remaining				Daily				Index				contract
		asset (liability)				volume				volume				price				period
		(in thousands)
Cash flow hedges:
Crude oil (volumes in Bbls):
Price swap		$	(7,844	)			239,200				2,600				$ 67.50	(a)			10/1/08 – 12/31/08
Cash flow hedges dedesignated:
Natural gas (volumes in MMBtus):
Price collar			1,065				1,242,000				13,500				$6.50 – $9.35	(b)			10/1/08 – 12/31/08
Derivatives not designated as hedges:
Crude oil (volumes in Bbls):
Price collar			14,354				768,000				2,104			$	120.00 – $134.60	(a)			1/1/09 – 12/31/09
Price swap			(3,753	)			585,673				6,366				$  92.93	(a) (c)			10/1/08 – 12/31/08
Price swap			(27,465	)			1,813,491				4,968				$  87.16	(a) (c)			1/1/09 – 12/31/09
Price swap			(6,654	)			641,746				1,758				$  93.26	(a) (c)			1/1/10 – 12/31/10
Price swap			(102	)			557,746				1,528				$104.91	(a) (c)			1/1/11 – 12/31/11
Price swap			9,217				504,000				1,377				$127.80	(a)			1/1/12 – 12/31/12
Natural gas (volumes in MMBtus):
Price swap			2,401				1,825,000				5,000				$    8.44	(b)			1/1/09 – 12/31/09
Net liability		$	(18,781	)