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Concho Resources, Inc. (NYSE:CXO)

Q4 2008 Earnings Call Transcript

February 25, 2009 10:00 am ET

Executives

Jack F. Harper - Vice President - Business Development and Capital Markets

Timothy A. Leach - Chairman & Chief Executive Officer

Steven L. Beal - President & Chief Operating Officer

Analysts

Michael Scialla – Thomas Weisel

Noel Parks – Ladenburg

Curtis Trimble – Natixis Bleichroeder

Irene Haas – Canaccord Adams

Mark Lear – Sidoti & Company

Derrick Whitfield – Canaccord Adams

[Asha Heman] – JPMorgan

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2008 Concho Resources, Incorporated earnings conference call. My name is [Jasmine] and I’ll be your operator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) And I would now like to turn the presentation over to your host for today’s call, Jack Harper, Vice President of Capital Markets and Business Development. You may proceed sir.

Jack Harper

Good morning, I’ll read the forward-looking statement and then turn the call over to Tim. The following conference call contains forward-looking statements within the meaning of Section 27(a) of the Securities Act of 1933 and Section 21(e) of the Securities Exchange Act of 1934. All statements other than statements of historical fact included in this conference call that address activities, events or developments that the company expects, believes or anticipates will or may occur in the future are forward-looking statements.

These statements are based on certain assumptions made by the company and are subject to a number of assumptions, risks and uncertainties many of which are beyond the control of the company, which may cause actual results to differ materially from those implied or expressed by the forward-looking statements. Additional information concerning the factors that could cause actual results to materially differ from those in the forward-looking statements is contained in the company’s annual report on Form 10-K and quarterly report on Form 10-Q under the heading Cautionary Statement regarding forward-looking statements as filed with the Securities and Exchange Commission.

Any forward-looking statements speak only as of the date on which such statement is made and the company undertakes no obligation to correct or update any forward-looking statement except as required by applicable law.

I’ll now turn the call over to Concho’s Chairman and CEO, Tim Leach.

Timothy Leach

Thanks Jack. Thank you for diving into our call. Let me first say that on behalf of the management of Concho, I want to thank you for your interest in supporting our company. I think that a contributing factor to our success is the degree to which our shareholders and the investment community understand this company and its strategy. I’ve got the Concho management team here with me today at Midland, so after a few brief comments from me and Steve we will turn it back over and look forward to your questions.

We've accomplished many things in 2008. The performance goals that management is still accountable for that we believe drive the value of our stock were all exceeded. During 2008 net asset value, production reserves and EBITDAX grew at rates that exceeded our business plan, while drill bit, F&D was held about $10 of Boe.

Production increased 41% over 2007. Proved reserves increased 51% and EBITDAX per share increased 50%. Operationally, we completed almost 500 wells with a 99% success rate. In addition to the integration of the Permian and Wolfberry assets in 2008, we had great success further developing and exploring our New Mexico Permian assets.

As we mentioned on the call a few weeks ago, we’ve had good results on our New Mexico Yeso assets with larger fracs in 10-acre spaced wells. Additionally, the results we reported in the Lower Abo horizontal well play produced some of the most productive wells in our company's history. Our plan is to continue to develop these assets probably pursue new opportunities to grow the company.

The other accomplishments achieved during 2008 include adding two strong members to our management team. Both Darin Holderness and Matt Hyde had fit-in seamlessly with the rest of the team and are making major contributions.

Also during the last year, we've increased our coverage universe to 13 analysts and have made major progress in our shareholder base [inflow].

I’m very pleased with the company’s position today, and the opportunities that we have before us. Despite volatile industry and financial market conditions, we will continue to execute the same strategy that has been successful for the last 20 years. In 2009, we’ll manage our capital expenditures around our cash flow and concentrate on our activity in our core assets of operation.

Now let me turn the call over to Steve before we go to Q&A.

Steven Beal

Thank you, Tim. Good morning everyone. I want to briefly touch on some financial and operational matters before we get to your questions. We’re very pleased with results of our drilling program in 2008 as evidenced by the organic growth and production we experienced last year. If you exclude production from the properties that we acquired in the Henry acquisition, full year 2008 production grew 24% over 2007, and fourth quarter ’08 production grew 28% when compared to the same quarter of 2007.

As Tim mentioned, we experienced the same level of success in our Texas drilling, which is almost exclusively in the Wolfberry as we did in Southeast New Mexico and we exhibit 2008 producing approximately 25,500 barrels of oil equivalent a day.

As those of you who know us well or where we believe the growth in and of itself is not to go over profitable growth is our objective. And to that end, our drill bit, finding and development cost in 2008 was $10.19 per Boe and our net margin before hedge effect for Boe as defined is revenues less lease operating expenses and production related taxes, exceeded $38 a barrel equivalent in the fourth quarter.

And to remind you that fourth quarter of 2008 was the first quarter that reflects full three months of results from our Henry acquisition that closed on July 31. So the majority of our remaining comments will be directed towards that quarter.

Production expense in the fourth quarter of $10.94 a barrel equivalent included $6.54 of field level operating expenses and $4.40 of production related taxes, all that’s inline with our previously issued 2009 guidance.

DD&A for the quarter, which was calculated utilizing year-end reserves as determined with the commodity price of $41 a barrel and $5.71 in Mcf was $20.77 of Boe.

In addition to the increase in DD&A that resulted from lower commodity prices and their associated effect on reserves, the depletion rate on the Henry properties as a result of purchase accounting adjustment is higher then the rate on our legacy assets.

I would like to remind you again about the cash G&A charge associated with the employees. We were fortunate not to add from the Henry acquisition. As you may recall our purchase agreement with Henry included a provision whereby our initial purchase price was reduced in exchange for our commitment to pay certain bonuses to the folks we added over the course of the next two years.

From an accounting perspective, we’re required to recognize that obligation over the period of service rather than recording it as an assumed liability at the date of the acquisition. And although this doesn’t change the cash impact of the payment on the company during the period, it does result in the obligation being reflected on the income statement as a part of G&A until we fully satisfy the obligation in 2010. The aggregate amount that was charged to expense in the fourth quarter was approximately $2 million with $4.3 million haven’t been charged to expense after the period August to December ’08.

I also wanted to briefly touch on three non-cash items that impacted the fourth quarter. First, we recognized a pretax impairment charge of $15.6 million associated with certain non-corporate properties principally in Texas and North Dakota. Secondly, we incurred an $18.2 million pretax exploration and abandonment charge and it was primarily associated with some exploratory lease hole on which we currently have no future drilling plans. These again were principally in Texas and to a lesser degree in New Mexico and Arkansas.

And finally we also recognize the $183.4 million pretax mark-to-market gain on our open derivative position in the fourth quarter. As you seen, we’ve included an appendix to the press release that’s the summary of our open derivative contracts as of February 24 of this year.

At December 31, our net debt was approximately $612 million, which resulted in net debt and total capitalization of 32%. We currently have about $330 million of availability under our senior revolving credit facility that has $960 million borrowing base and we’re on track that have our semiannual borrowing base redetermination completed in April.

As Tim alluded to, we’re currently operating under our financial plan for 2009, that’s predicated on a $40 of barrel NYMEX oil price and a $5 per Mcf NYMEX gas price. Under that plan our drilling activity will be concentrated on the Southeast New Mexico Shelf and in Wolfberry. We’re continuing to monitor commodity prices as well as drilling in completion cost in these core areas and we have seen some additional cost reduction since the year in 2008.

Based on our conversations with our JV partner in the Bakken and North Dakota, now it appears that our 2009 capital commitment there will be reduced by approximately $20 million to $25 million from our initial estimates. Despite this reduced level of partners reduced level of capital spending company wide, which we would currently estimate to be approximately $300 million. We expect to produce about 9.7 million barrels of oil equivalent this year, which will be an increase of about 37% over 2008.

Now let me stop there. We’ll open the floor for questions, and we’ll be happy to answer anything that you might have.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from Mike Scialla of Thomas Weisel Partners. Please proceed.

Michael Scialla – Thomas Weisel Partners

Hi guys. It’s Mike Scialla with Thomas Weisel.

Timothy Leach

Hi, Mike

Michael Scialla – Thomas Weisel

I don’t want to hurt your negotiating thought here but I just wonder what kind of cost reduction you think you’d need to see in Lower Abo play if oil prices stay where they are in order to get excited about drilling some more wells there?

Timothy Leach

Mike, it's not so much of cost reduction we’re waiting on there. It was just one of the things that was – the knob that was easiest for us to turn off. Our leases have long-term over there. So, I would expect to stand rigs up back there even at the current cost level. However, I would say that from where we are today, we still expect to maybe over the next several quarters to get more cost reduction out of the capital side of the business.

Michael Scialla – Thomas Weisel

Okay and what's your net acreage position there now?

Timothy Leach

About 22,000 net acres.

Michael Scialla – Thomas Weisel

So you really haven't added anything there recently?

Timothy Leach

No, we’ve had recent acreage acquisition but not anything since two or three weeks ago, when we reported.

Michael Scialla – Thomas Weisel

Okay. And in the Yeso, last year you said you expanded that to the North. Can you indicate how much acreage that added or additional locations if you kind of exclude the down spacing?

Timothy Leach

Well, this will be exclusively because of our northward expansion. It did not add any acreage. Generally all of our acreage is held by production. But if you remember last year when we talked about the number of combo wells that we had in inventory it was some number on the order of about 600 and now we have about a 1000.

Michael Scialla – Thomas Weisel

And that's all due just to the …

Timothy Leach

No, that’s not due just to the northern expansion, but the northern expansion was a big contributor to that.

Michael Scialla – Thomas Weisel

Okay. And then what do you need to see in terms of being confident that 10 acres spacing is going to work on for the Blinebry and on all that acreage?

Timothy Leach

I think just another year’s drilling program. I mean we’re confident. It’s working in the areas where we’re applying it, and as we spread that drilling program out over our entire acreage position those number of recognized proved locations will continue to grow.

Michael Scialla – Thomas Weisel

Great. I just had one last one and I’ll get back in the queue. You mentioned that you expect the cash tax percent to go up from previous guidance. I was thinking with commodity prices coming down, it would go the other way that your cash taxes would be reversed as you’re less profitable. Am I thinking about that wrong?

Steven Beal

Hey Mike, this is Steve. We’ve got a couple of issues at play, one is that it even if this commodity price level, it looks like we will be paying a significant amount of AMT. The other is we don’t really have any carry forwards to take advantage of as we move into 2009 and then lastly as you may recall, the tax basis in the Henry properties that we acquired and inherited is very low. So as we look at the cash stream it comes of those assets, it’s really not very well protected from a tax perspective because we just don’t have that much basis that we inherited on them.

Michael Scialla – Thomas Weisel

It makes sense. Okay. Thank you very much.

Operator

Your next question comes from the line Noel Parks of Ladenburg. Please proceed.

Noel Parks – Ladenburg

Good morning.

Timothy Leach

Hi, Noel.

Noel Parks – Ladenburg

Hi, I just had a quick question back on the Lower Abo. When you did the reserve announcement in the last call, you talked a good bit about encouraging results in the last couple of wells that you’ve done. I just want to circle back. You did an additional Reindeer well, as I recall that was in offset and can you just talk about what you’ve seen on that one?

Timothy Leach

Well, what we talked about two or three weeks ago was that for competitive reason we were going to stop talking about individual well results. So, we will tell you that we continued our completions out there, and we are still encouraged and we are still acquiring acreage.

Noel Parks – Ladenburg

Okay, fair enough. And I know another thing that you had promised us some more info on as the year went on, but I just wondered if you had an update. Just some of your thoughts on the new completion methods for the Blinebry, I think you signaled that you were pleased so far, but I was just wondering if you were close to being able to give us a little more detail of kind of what’s working there and how likely you think you’ll be able to keep doing the same thing with some more results going forward?

Timothy Leach

Well, as we have applied these larger fracs we’re given in last year right to jump in here if I get out left here this field. The third party engineers gave us credit for increasing reserves in the Blinebry due to that frac that in some locations was up to 40% reserve increase. Now that was the highest reserve with increase we got in areas. So, as we expand this activity out just like the 10 acres spacing we will continue to get more credit for as we go through this year and get more data points. But it’s a fairly significant amount of reserve for our well in the Blinebry.

Noel Parks – Ladenburg

Okay and you said that 40% was the best credit that you’ve got in. Just any sense of why it seems to be more effective in some locations and others?

Timothy Leach

That’s a very large homogeneous field but it is still somewhat statistical. So you get a band of results and I think that when we apply this to all the wells that we’re drilling out there this year we will see consistent results throughout the program.

Noel Parks – Ladenburg

Okay great. That’s it for me.

Timothy Leach

Thanks Noel.

Operator

Next question comes from the line of Curtis Trimble of Natixis. Please proceed.

Curtis Trimble – Natixis Bleichroeder

Sure thank you. Good morning everyone. Just got a couple of softballs here. Can you give me the exit rates or the average production rate for the fourth quarter out of the two core assets, the Yeso and the Wolfberry?

Timothy Leach

Curtis, I may have to circle back with you on that. I don’t have that right at my figure tips.

Curtis Trimble – Natixis Bleichroeder

Okay no problem. And then looking at the balance sheet, you’ve got a fairly large line item on the crude and prepaid drilling cost. Can you tell me what composes that $154 million number in change?

Timothy Leach

That’s just primarily accrued capital cost and we cash call lot of our partners specific to Wolfberry and that will be the matter of cash call associated with that.

Curtis Trimble – Natixis Bleichroeder

Okay very good. I appreciate the color.

Timothy Leach

Thank you, Curtis.

Operator

Your next question comes from the line of Irene Haas of Canaccord Adams. Please proceed.

Irene Haas – Canaccord Adams

I just kind to want to measure the temperature here, how are the folks in the Permian Basin doing in particular, there is also the sector with all the rig count decreases just a general feel for it? And also the private producers, I mean how are they getting a lot do you see 2009 as a good year for you guys to do some consolidation?

Timothy Leach

Well the mood here is pretty much like it is the rest of the country. Every month you see more rigs being put back in the yard, we talked to you yesterday about the service companies and large layoffs throughout the Permian basin. I mean that is something that will have to happen before labor costs start coming down, but its unpleasant thing to watch. And we are seeing more consolidation opportunities in this environment. So that’s one of the basis for my comments of how pleased I’m with how we are positioned and the opportunities we’re seeing. We still are staying pretty focused however on those opportunities that in our core in Permian Basin.

Irene Haas – Canaccord Adams

Great, thank you.

Operator

(Operator Instructions). Your next question comes from the line of Mark Lear of Sidoti & Company. Please proceed.

Mark Lear – Sidoti & Company

Good morning.

Steven Beal

Hi Mark.

Mark Lear – Sidoti & Company

Just on the 10-acre infill drilling, are you just targeting the Blinebry with those wells or is it both Paddock and the Blinebry?

Steven Beal

It’s both the Paddock and the Blinebry almost 100% of the wells we drill out there we have both zones completed in it.

Mark Lear – Sidoti & Company

Okay, I just initially thought that only the Paddock was. What’s the perspective on 10-acres? What’s kind of change there? I guess to increase your confidence in drilling both on 10s?

Steven Beal

The Blinebry is a very similar zone in the Paddock and we're just getting more data as we drill more wells and increase the density of that spacing. We’re getting more data to allow us to book reserves to those 10-acre locations. So, it's more kind of a factor of time and the amount of data you have. As we said a year ago, there is not really a lot of reason to think that Blinebry recovery on 10-acres would be any different than the Paddock. They’re very similar zones.

Mark Lear – Sidoti & Company

So you’re not risking a EURs on infill drilling and all that?

Steven Beal

I mean we think we have an enough data that internally we’ve run a model that we think models the likely outcome.

Mark Lear – Sidoti & Company

And they look the same?

Steven Beal

So that implies applying some level of risk.

Mark Lear – Sidoti & Company

Okay.

Steven Beal

And we also risk when we put in our financial models and forecast we have a risk factor that we apply.

Mark Lear – Sidoti & Company

Gotcha. In all those recent Abo wells look really good, but were either of them successful in kind of extending that play further south to that core area?

Steven Beal

Sure one of those wells, the High Lonesome, was a pretty significant step out.

Mark Lear – Sidoti & Company

To the South?

Steven Beal

No, to the East.

Mark Lear – Sidoti & Company

Okay. And I guess just a quick question. Some other operators are complaining about widening differentials for crude out there. Are you guys experiencing that as well?

Steven Beal

Mark, the guidance we’ve put out for '09, we still feel confident with that on the oil side and the gas side, which is kind of in the 5% to 8% discount in NYMEX on crude.

Timothy Leach

I think maybe that widening differentials in the Bakken, resources on the slowdown, we are seeing in the Bakken, I don't think we experiencing as much of that in the Permian.

Steven Beal

On the several barrels in the Permian, there is a little bit widen differential but our mixes are a little about more on the sweet side when you mix Texas in.

Mark Lear – Sidoti & Company

Thanks guys.

Steven Beal

Thank you.

Operator

Your next question comes from the line of Derrick Whitfield of Canaccord Adams. Please proceed. Derrick, your line is open.

Derrick Whitfield – Canaccord Adams

Hey guys. My question was just answered there by the last couple of rounds. So thanks.

Timothy Leach

Okay, thank you.

Operator

Your next question comes from the line of Joe Allman of JPMorgan. Please proceed.

Asha Heman – JPMorgan

Hi this is [Asha Heman] for Joe Allman. I just want to clarify that some 1000 drilling location you mentioned on Blinebry and Paddock. Is that a combination well or is a total of combination in Paddock or Blinebry stand?

Timothy Leach

Those are all combination wells.

Asha Heman – JPMorgan

Then can you give us a breakdown of the Paddock or Blinebry standalone locations?

Timothy Leach

As we roll this forward, I mean Blinebry standalones are kind of going away because we have turned it into combination locations.

Steven Beal

And on the Paddock standalone, I’ll get you an exact number later, but it is going to be about 200 to 250 Paddock standalone wells very few Blinebry standalone, because it tends that they are either going to be combination wells or deepening to the Blinebry.

Asha Heman – JPMorgan

Gotcha. And the update on the shallower than Yeso or deeper than Yeso locations?

Steven Beal

It stayed about the same. There is about 2 or 300 shallower and about 100 deeper than Yeso locations at the end of the year.

Asha Heman – JPMorgan

Okay, thank you.

Timothy Leach

Thanks.

Operator

And there are no further questions at this time. I would now like to turn the call back to Tim Leach for closing remarks.

Steven Beal

Yes this is Steve Beal. I wanted to circle back and answer a question that Curtis Trimble asked earlier about the relative contribution of the significant place to production. If you look at the December exit rate that I mentioned earlier about 25,500 barrels a day. About 16,000 Boes a day of that was coming from the Mexico, which of course is the largest production contributor there is the Yeso and about 6500 to 7000 barrels a day was coming from Texas and which again the largest contributor area is the Wolfberry. So I think it’s a proxy for what’s coming from those plays, that’s how we guide you the remaining production contribution in December would be the beta production contribution that we are seeing predominately from the Bakken in North Dakota.

Timothy Leach

Okay. Well, again I appreciate another lots of business today and multi calls. I appreciate you listening to this one, and thank you. We look forward to reporting to you again in other quarter.

Operator

Thank you for attending today's conference. This concludes your presentation, you may now disconnect. Good day.

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Source: Concho Resources, Inc. Q4, 2008 Earnings Call Transcript
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