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Executives

Tim Leach - chairman and CEO

Steve Beal - President and COO

Analysts

Joe Allman - JPMorgan

Jeff Robertson - Lehman Brothers

Eric Hagen - Merrill Lynch

John Mansfield - SAC Capital

Salil Sharma - Highbridge

Concho Resources Inc. (CXO) Q1 2008 Earnings Call May 14, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2008 Concho Resources Incorporated Earnings Call. At this time all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of today's conference. (Operator Instructions). As a reminder, this conference call is being recorded for replay purposes.

Before we begin, the company has asked me to read the following. This conference call may contain 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. All statements, other than statements of historical facts that address activities, events, or developments that the company's expects, believes or anticipates will or may occur in the future are forward-looking statements. Without limiting the generality of the forgoing, forward-looking statements contained in this conference call specifically include the expectations of plans, strategies, objectives and anticipated financial and operating results of the company, including as to the company's drilling program, production, hedging activities, capital expenditure levels and other guidance included in the press release.

These statements are based on certain assumptions made by the company based on management's experience and perception of historical trends, current conditions, anticipated future developments and other factors believed to be appropriate. Such statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond the company's control, which may cause actual results to differ materially from those implied or expressed by the forward-looking statements.

These include risks relating to the financial performance and results, prices and demand for oil and natural gas, availability of drilling equipment and personnel, availability of sufficient capital to execute our business plan, our ability to replace reserves and efficiently develop and exploit our current reserves, and other important factors that could cause actual results to differ materially from those projected as described in the company's reports filed with the Securities and Exchange Commission.

Any forward-looking statements speak only as of the date of which the certain statements is made and the company undertakes no obligation to correct or update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

Now I will turn the call over to Tim Leach, chairman and CEO. Please proceed.

Tim Leach

Thank you. Good morning. This is Tim Leach. First, let me say thank you for dialing in and that I am pleased with Concho's performance in the first quarter. We're on track to achieve our 2008 plan. The growth continues to be strong, while our drilling costs and operating expenses remain in the ranges that we forecasted.

While operationally we are on plan, the profitability of our company continues to exceed our forecast. I believe that this is due both to the fundamental economics of the projects that we are drilling and the increased commodity price.

As a result of this increasing cash flow, the Concho board recently approved a substantial increase to our 2008 capital budget. A large portion of this increase is going to be invested in our core asset in Southeast New Mexico, allowing us to add a sixth drilling rig in that field to our drilling program. Consequently, we are also increasing our 2008 production guidance. So other than being on plan, the first quarter was relatively uneventful. But we anticipate that the remainder of the year will be quite busy.

So with that brief overview, let me turn it over to Steve to discuss the details of the first quarter with you. Thanks.

Steve Beal

Thanks, Tim. Good morning, everyone. Our production of 8.4 Bcf equivalent in the first quarter, which was a 17% increase over the first quarter of last year, was in line with our expectation for the quarter, despite the fact that we wound up drilling five fewer net wells on the Shelf asset in the quarter than we planned.

This was a result of some drilling delays we experienced on a couple of wells, where we were experimenting with our pipe program and the fact that the timing of receipted drilling permits from the state was such that we drilled more 50% owned wells and fewer 100% owned wells than we planned in the first quarter.

From a revenue perspective, the first quarter realized oil and gas prices were very strong, in part due to continued strength in the NGL market. As you saw in our press release, we expect that our 2008 gas price received before hedge effect will average about 10% to 15% above the average NYMEX Henry Hub price. This as I am sure you are aware, is a direct result of the significant NGL content in our gas stream, particularly on our core Southeast New Mexico Shelf asset.

Our top line oil and gas revenues for the quarter were reduced by approximately $7.5 million as a result of our derivative contracts that are designated as cash flow hedges. Additionally, approximately $4 million of the $17.2 million loss on derivatives not designated as hedges that you see on our income statement is the cash settlement payments for the quarter on those contracts not designated as hedges, with the remaining $13.2 million representing the non-cash market-to-market on the open positions as of March 31.

LOE per Mcfe, including ad valorem taxes, averaged $0.93 in the first quarter, which was actually 3% lower than our expectation. G&A for the quarter included $1.3 million of non-cash stock-based compensation and our cash run rate for G&A for the balance of 2008 is estimated to be approximately $6 million a quarter.

As Tim mentioned, our board did approve $68 million increase in our 2008 capital budget, which now stands at $318 million. Based on actual commodity prices so far this year and our outlook for the remainder of the year, we expect that this budget will be substantially funded with internally generated cash flow.

Just as a reminder, our current operating philosophy is to fund our drilling program with internally generated cash flow and utilized our unfunded credit capacity for acquisition related activities.

$37 million of the budget increase will be directed to our core Southeast New Mexico Shelf asset and will be utilized to fund the addition of a sixth rig to our drilling program, as Tim mentioned, which we expect to stand up in July, and to expand our Paddock re-stimulation and Blinebry deepening programs.

In total, we now expect to spend approximately $242 million, or 76% of our total budget, on this core asset, where we will drill 132 wells, deepen 39 existing Paddock wells to the Blinebry and re-stimulate 63 existing Paddock producers.

We are also increasing the amount of capital we are going to devote to two of our emerging resource plays, the Bakken Shale in North Dakota and the Horizontal Wolfcamp oil play in Southeast New Mexico. Combined, we now expect to spend $30 million this year in these two areas, compared to the $7 million that was contemplated in our original budget.

As you know, our activity in the Bakken is concentrated in both Mountrail and McKenzie Counties and we participate as a non-operator in both of those areas. We are increasing the amount of capital devoted to the Bakken in North Dakota due to the early success we have seen on the drilling projects we participated in thus far.

In the horizontal Wolfcamp oil play, as you know, we participate primarily as an operator across this acreage, which is located just north of our Southeast New Mexico Shelf core asset.

We purchased approximately 500 square miles of 3D seismic data covering the Southeast New Mexico Shelf, which includes both our core Yeso play and the horizontal Wolfcamp oil play. And based on evaluation of some of that data, as well as increased well control across the Wolfcamp, we've restarted our drilling program.

As Tim mentioned, in conjunction with the capital budget increase in our results so far this year, we are increasing our 2008 production guidance from 35 Bcf to 37 Bcf equivalent to 37 Bcf to 39 Bcf equivalent, which is an increase at the midpoint of 5.5%.

The routine annual maintenance shutdown of our primary gas processing plant on the Shelf did occur in April, as we expected. That this plant turnaround will have the effect of reducing second quarter production by approximately half a Bcf equivalent and we have provided for this production interruption in the annual guidance that I just mentioned to you.

From a liquidity perspective, our net debt at March 31 was approximately $283 million, resulting in net debt to total capitalization of about 26%. We currently have $235 million of availability on our senior credit facility and are just completing our semiannual borrowing base re-determination, which will result in additional capacity under that facility.

Kind of in summary, we are pleased with our start to this year from an operational perspective. And we believed our capital structure positions us to take advantage of additional opportunities should they arise.

I think it's also important to note that while the expansion of our capital budget will obviously have some positive effect on this year's production, the more significant impact will come in 2009 as we realize the effect of the increased rig count for a full year.

So with that, we will now open the floor and are happy to take any questions that you might have.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question will be from the line of Joe Allman of JPMorgan. Please proceed.

Joe Allman - JPMorgan

Hey, good morning, everybody.

Steve Beal

Hi, Joe.

Tim Leach

Hi, Joe.

Joe Allman - JPMorgan

Hi guys. Hey I missed the very beginning of your call, so I apologize if you covered this. But could you talk about any increases in the drilling inventory that you've had since your last update there?

Steve Beal

Joe, as you know, as we talked about before, particularly with regard to, I'm going to speak specifically with regard to the Shelf first. There's a very little open acreage in our core area on the Shelf. So the inventory increases there will come either from acquisition or from term assignment or farm out from some of the current owners.

We're working on both those things every day. We have had what we believe to be pretty good success on that, but we're just not ready yet to talk about the aggregate amount of inventory expansion.

Now, I will also tell you, just to remind everybody, in this capital budget that we talked about earlier, that doesn't include in any expected acquisition activity. So we don't have any production from expected acquisitions baked in to our production forecast. But we're working everyday on both acquiring properties there and getting drilling opportunities farmed out or turned out to us. We just don't have anything yet today we're ready to talk about.

Joe Allman - JPMorgan

Okay, that's helpful. And then your first quarter production was up a little bit from the fourth quarter and it appears that, given your full-year product guidance, that you're going to see the acceleration in the second, third and fourth quarters. Can you kind of give us some more color on kind of what's going on there?

Steve Beal

Yeah, I think you're exactly right. And I think you got a couple of things at work. One is that the kind of wells we're drilling, you don't see a sequential quarterly build. You see the compounding effect. To give you kind of a sense of where we are our October '07 production was about 85.6 million cubic feet a day.

We exited March; our March rate for 2008 was 95.2 million a day. So we saw 11% increase, if you look from the beginning of those six months to the end of those six months. And you're right; our expectation is for the remaining three quarters of the year that you will see an accelerated rate of growth.

Joe Allman - JPMorgan

Okay. Can you describe, like, why is it kind of clumpy like that? Or is it clumpier?

Steve Beal

Well, I think clumpy is probably a good word to use for it. And it's just you don't necessarily have a smooth timing of bringing wells on. You get like we saw in the first quarter, we wound up drilling a few more 50% owned wells than we'd planned just because of how the permits came to us. So you're not every well we drill in the play has the exact same working in net revenue interest, you can have actual drilling activity within a given quarter that differs a little bit from the planned activity.

Joe Allman - JPMorgan

Okay.

Steve Beal

In fairness, the fourth quarter was a good quarter for us. I mean we were really pleased with where we ended fourth quarter production. The 8.4 B's in the first quarter is actually one-tenth of a B above what our plan had for the first quarter of '08.

Joe Allman - JPMorgan

Got you. I'm just trying to understand that better. And then on the horizontal Wolfcamp oil play, you guys are going to recommence that and can you talk about what your conclusion is and what the problem was with that second well? And I think previously you said the next well is probably going to be pretty close to the first well. Can you confirm that and talk about your plans going forward?

Steve Beal

Yes. I think the ultimate conclusion is as we hopefully, as we tried to communicate before, and that is the play was more complex than we thought. As I mentioned, the seismic data that we've acquired includes seismic over the Wolfcamp. We've taken that data and on the basis of the interpretation of some of that data and some of the markers we're looking for, we think we have a better understanding of the dynamics around the play.

But also, importantly, there's been a significant amount of additional drilling activity there, so you have a lot more well control than we were dealing with six to nine months ago. And that the first of the restarted wells, if you will, is an offset to the Reindeer well, which was the first well we drilled in the play that came on a year ago February.

Joe Allman - JPMorgan

And all another activity, have you had some participation in that, so that you actually have the data in the logs?

Steve Beal

We've had, yes. Not in all of it, Joe, but in some of it, yes.

Joe Allman - JPMorgan

Got you. Okay, very good stuff, thanks guys.

Operator

Your next question will be from the line of Jeff Robertson of Lehman Brothers. Please proceed.

Jeff Robertson - Lehman Brothers

Good morning. Steve, can you talk a little bit about how the 3D impacts your Yeso program, if it does?

Steve Beal

Well, the short answer is, we do think it does, Jeff, and that's one of the reasons why we purchased it. I think from two perspectives. It will enable us to gain a greater understanding of why and how you see on the margin better results in some areas, better -than or rather than others. It will also enable us to try to better refine potential areas that we'd want to add to our position, because, as you know, there's a significant amount of opportunity in that play that we don't own.

And in addition to that, as you guys all know, one of the things we like about Southeast New Mexico is the fact that you've got such a thick producing interval where you've got opportunities above and below the Yeso, and it will help us as we look at those opportunities as well.

Now, that data is still being processed and it will likely be call at July before all of that data is processed. So there will be a bit of an evolution of our knowledge relative to that seismic data over the rest of this year.

Jeff Robertson - Lehman Brothers

So, Steve, that's all new vintage data, correct?

Steve Beal

No, it's not all new vintage. But it's taking some new vintage data; it's taking some older data and reprocessing it.

Jeff Robertson - Lehman Brothers

Okay. And secondly, on the increased capital program, about how much of those dollars in the total program are going to be spent on projects that are currently carried in the proved reserves?

Steve Beal

You're going to see about that same relationship, Jeff, as was the case with the original budget and that was about 60% of the budget was devoted to projects not in the proven category.

Jeff Robertson - Lehman Brothers

Thank you.

Steve Beal

I will say with regard to the Bakken and the horizontal Wolfcamp, none of that is in the proven category.

Jeff Robertson - Lehman Brothers

Thanks.

Operator

Your next question will be from the line of Eric Hagen of Merrill Lynch. Please proceed.

Eric Hagen - Merrill Lynch

Hey, good morning.

Steve Beal

Good morning Eric.

Eric Hagen - Merrill Lynch

Do you have an exit rate for the first quarter?

Steve Beal

March's was 95.2 million equivalent a day.

Eric Hagen - Merrill Lynch

Great. And then in terms of the re-stimulations, can you give any color on those? Are they working, as well as, better than your expectations, too early to tell?

Steve Beal

On balance I'd say they're kind of right in line with our expectation. Now, again, in fairness, we think we've got something north of 300 candidates there and we're early days in having more than a month or two worth of data on many of those. But so far what we've seen is pretty much in line with what we hoped we would see and frankly is the reason why we've expanded that program this year.

Eric Hagen - Merrill Lynch

Have you given a cost or reserves added? You quantified that at all?

Steve Beal

On the re-stims?

Eric Hagen - Merrill Lynch

On the re-stims, yes.

Steve Beal

That was in the press release at the end of last year, Eric. It's a kind of $200,000 for 20,000 barrels equivalent type.

Eric Hagen - Merrill Lynch

Okay, great. Thanks, Jack. Finally, the last one was on acquisitions, following up on some previous questions. Are you looking at all outside of your core area in the Permian or are you pretty much focused in expanding there?

Steve Beal

Well, I think, answering your question in a bit of a different way. We're looking primarily in the Permian, including looking within our core area on the Shelf. But we look at a lot of things in other parts of the Permian.

I think if you guys have heard us speak before, one of the things that Tim has tried to make a point of emphasizing is that there are a significant number of plays going on in the Permian Basin. What we've got going on in the Southeast New Mexico Shelf being, but one of those. And we have looked and are looking at some of those others to see, if we think any of those fit with what we're trying to do.

Eric Hagen - Merrill Lynch

Okay, great. Thanks.

Operator

Your next question will be from the line of John Mansfield of SAC Capital. Please proceed.

John Mansfield - SAC Capital

Yes, good morning. I just wanted to ask, can you just give us a little update on the status of the water flood pilot on the Shelf, please?

Steve Beal

Hey, John, good morning. We're continuing to inject water. We've been injecting water now for almost nine months. We haven't seen any response yet. We haven't seen anything happening with the offset wells that would be unusual. So from our perspective, it is continuing to go as we hoped it would go and that is taking some time for the reservoir to fill up before you started to see response.

Tim Leach

And water's going in zone.

Steve Beal

Yes and water's going in zone.

John Mansfield - SAC Capital

Got it, okay, thank you.

Operator

Your next question is a follow-up from the line of Joe Allman of JPMorgan. Please proceed.

Joe Allman - JPMorgan

Hi, again, guys. In terms of in recent quarters you were able to improve efficiencies in your core Blinebry, Paddock play, so could you talk about that? What's your opportunity to improve efficiencies further? Have you done that and what's your opportunity to do that? And then can you just give some comments on drilling and completion costs, what you're seeing in your various areas?

Steve Beal

Joe, I think with regard to efficiencies, and Joe Wright is here with us as well so I'm going to ask him to chime in if I get off the mark here, but I think we've seen the step change in efficiencies. As you know, when we began drilling on this asset it was taking about 18 to 19 days down, depending on exactly where you are, from down 10 to 12 days. So I think that step change in efficiency has taken place.

Now, incrementally on the margin, we're continuing to try things to help us improve those efficiencies. But I think it'd be misleading to suggest that, we think you can see an additional step change in efficiency beyond what we've already realized.

On the cost side, on the Shelf, on the core asset, today our ASCs are averaging about 4% to 6% above where they were at the end of 2007 and that's largely been driven by increased in pipe prices, we've seen a little bit of pressure on drilling rights and obviously anything that has fuel associated with it prices have gone up. But today we've seen about 4% to 6% and that's kind of our expectation of where they'll shake out for the year.

Which we of course don't like to see, but by the same token, as you know, with the kind of rates of return that these drilling projects generate for us, 4% to 6% move in capital costs doesn't materially affect the economics.

Joe Allman - JPMorgan

Okay, very helpful. And then any additional comments, can you give us any color on any of your other emerging plays? Have those advanced? I know the Bakken has advanced and you're drilling some more wells there, but how about any of the other emerging plays?

Steve Beal

I think right now there hasn't been anything certainly that's advanced to the degree that we've seen advancement in the Bakken and the Wolfcamp oil play. We've got limited amounts of activity going on in each of those others, but there really hasn't been a material change in the status of those.

Joe Allman - JPMorgan

Are you looking at some additional emerging plays, adding those to the inventory?

Steve Beal

Yes and no. I think as I mentioned earlier, we look at lots of opportunities across the Permian. In fairness, I don't know, whether the market would characterize those as emerging plays or not. But we are looking at opportunities in other horizons across the Permian.

Joe Allman - JPMorgan

Okay, great. Thanks for your help.

Operator

(Operator Instructions)

Your next question will be from the line of Salil Sharma of Highbridge. Please proceed.

Salil Sharma - Highbridge

Hi. Good morning.

Steve Beal

Good morning.

Tim Leach

Morning.

Salil Sharma - Highbridge

A couple of quick ones from me. When I go through your presentation, the drilling program, you show the rate of returns at 60, 70 and 80, but given where commodities are right now, what sort of rate of returns are you seeing in your core play? Because I'm sure it's well above 100 and I'm wondering is it closer to 200 at this point?

Tim Leach

I guess my view on it is once it gets over 100, the rate of return metric kind of starts to lose its meaning. But it's well over 1200.

Salil Sharma - Highbridge

Got you. And the second would be given the large concentration of ownership. Do you have any thoughts on how you're thinking about improving the liquidity on the stock?

Steve Beal

Well, I think, as you guys know, the concentrated owners, if you will, that own unregistered shares have reg rights. Those reg rights are operative every six months. I think that depending on, if you went owner by owner, the time horizon in which those folks are looking for liquidity varies.

I think over time it's fair to assume that we will be bringing some shares to the market to register, which will obviously have the effect of increasing the public flow. Right now about 52% of our shares are held by the public, with the remainder being held privately, including the shares owned by officers and directors.

Salil Sharma - Highbridge

Thank you very much.

Operator

Your next question is a follow-up from John Mansfield of SAC Capital. Please proceed.

Steve Beal

Hey, John.

John Mansfield - SAC Capital

Hey. Sorry. Just wanted to ask one follow-up on the drilling times on the Shelf.

Steve Beal

Yes?

John Mansfield - SAC Capital

Before it had been about 15 days per well, correct?

Steve Beal

By before do you mean initially or?

John Mansfield - SAC Capital

Well, yes, since last year, it looked like it was about two wells per rig per month on the Shelf.

Steve Beal

Right. But that takes in to account move time.

John Mansfield - SAC Capital

Yes. And now are we looking more at 10 days, so you're really drilling per rig drilling 2.5 wells per rig per month on the Shelf?

Steve Beal

Well, I think John, that would be in a perfect world, if everything went exactly right and you were drilling kind of on the west. So if you were drilling, because, as you know, the Yeso gets deeper as you move from west to east. So, if you were on the western side, things went well, you could get a well down in ten days.

But just to remind everyone that the drilling program that we have for this year is spread across the entirety of the position. So, you're drilling 5,500 foot wells and 7,000 or 7,500 foot wells. So still, on average, we use as our sort of model, if you will, two wells per month per rig.

John Mansfield - SAC Capital

Got it. Okay. Thank you.

Operator

And there are no more questions at this time. I'll turn the call back over to Tim Leach for closing remarks.

Tim Leach

Okay. Thank you for dialing in. Again, we think it was a quarter that puts us on track to achieve the '08 goals we have, and we look forward to talking to you again next quarter. If any other questions come up that you want to talk offline, give Jack a call. Thank you very much.

Operator

Thank you for your participation in today's conference. This concludes our presentation and you may now disconnect. Have a great day.

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