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

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

Commission file number: 1-33615

Concho Resources Inc.

(Exact name of registrant as specified in its charter)

Delaware		76-0818600
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification No.)
550 West Texas Avenue, Suite 100
Midland, Texas		79701
(Address of principal executive offices)		(Zip code)

(432) 683-7443

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o 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.

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

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 2, 2009: 85,784,691 shares.

 

 

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION		iii
Item 1. Consolidated Financial Statements (Unaudited)		iii
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			42
Item 3. Quantitative and Qualitative Disclosures About Market Risk			63
Item 4. Controls and Procedures			65
PART II — OTHER INFORMATION			66
Item 1. Legal Proceedings			66
Item 1A. Risk Factors			66
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			66
Item 6. Exhibits			67
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 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (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 in our Annual Report on Form 10-K for the year ended December 31, 2008 and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2009 and June 30, 2009, 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 and financial strategy;

•

the estimated quantities of oil and natural gas reserves;

•

our use of industry technology;

•

our realized oil and natural gas prices;

•

the timing and amount of the future production of our oil and natural gas;

•

the amount, nature and timing of our capital expenditures;

•

the drilling of our wells;

•

our competition and government regulations;

•

the marketing of our oil and natural gas;

•

our exploitation activities 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;

•

our plans, objectives, expectations and intentions contained in this report that are not historical; and

•

our ability to integrate acquisitions.

     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 any 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.

PART I — FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements (Unaudited)

Consolidated Balance Sheets at September 30, 2009 and December 31, 2008			1
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008			2
Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2009			3
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008			4
Condensed Notes to Consolidated Financial Statements			5

Concho Resources Inc.

Consolidated Balance Sheets
Unaudited

		September 30,				December 31,
(in thousands, except share and per share data)		2009				2008
Assets
Current assets:
Cash and cash equivalents		$	15,695			$	17,752
Accounts receivable, net of allowance for doubtful accounts:
Oil and natural gas			67,021				48,793
Joint operations and other			72,402				92,833
Related parties			138				314
Derivative instruments			9,405				113,149
Deferred income taxes			5,800				—
Prepaid costs and other			8,462				5,942
Total current assets			178,923				278,783
Property and equipment, at cost:
Oil and natural gas properties, successful efforts method			2,980,268				2,693,574
Accumulated depletion			(468,247	)			(306,990	)
Total oil and natural gas properties, net			2,512,021				2,386,584
Other property and equipment, net			16,151				14,820
Total property and equipment, net			2,528,172				2,401,404
Deferred loan costs, net			21,982				15,701
Inventory			24,351				19,956
Intangible asset, net — operating rights			36,909				37,768
Noncurrent derivative instruments			30,727				61,157
Other assets			462				434
Total assets		$	2,821,526			$	2,815,203
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable:
Trade		$	12,010			$	7,462
Related parties			793				312
Other current liabilities:
Bank overdrafts			2,810				9,434
Revenue payable			40,532				22,286
Accrued and prepaid drilling costs			120,726				154,196
Derivative instruments			23,158				1,866
Deferred income taxes			—				37,205
Other current liabilities			42,204				38,057
Total current liabilities			242,233				270,818
Long-term debt			645,747				630,000
Noncurrent derivative instruments			16,559				—
Deferred income taxes			591,029				573,763
Asset retirement obligations and other long-term liabilities			13,258				15,468
Commitments and contingencies (Note K)
Stockholders’ equity:
Common stock, $0.001 par value; 300,000,000 authorized; 85,605,502 and 84,828,824 shares issued at September 30, 2009 and December 31, 2008, respectively			86				85
Additional paid-in capital			1,023,543				1,009,025
Retained earnings			289,488				316,169
Treasury stock, at cost; 12,380 and 3,142 shares at September 30, 2009 and December 31, 2008, respectively			(417	)			(125	)
Total stockholders’ equity			1,312,700				1,325,154
Total liabilities and stockholders’ equity		$	2,821,526			$	2,815,203

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

Concho Resources Inc.

Consolidated Statements of Operations
Unaudited

		Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands, except per share amounts)		2009				2008				2009				2008
Operating revenues:
Oil sales		$	121,301			$	130,600			$	287,786			$	301,826
Natural gas sales			32,193				39,857				79,042				112,725
Total operating revenues			153,494				170,457				366,828				414,551
Operating costs and expenses:
Oil and natural gas production			25,439				27,041				76,022				65,915
Exploration and abandonments			2,776				16,824				10,195				20,288
Depreciation, depletion and amortization			54,835				32,528				157,985				75,822
Accretion of discount on asset retirement obligations			220				270				799				571
Impairments of long-lived assets			1,131				2,758				9,686				2,827
General and administrative (including non-cash stock-based compensation of $2,548 and $1,925 for the three months ended September 30, 2009 and 2008, respectively, and $6,661 and $4,954 for the nine months ended September 30, 2009 and 2008, respectively)			12,715				10,778				38,633				27,044
Bad debt expense			—				1,106				—				2,905
Ineffective portion of cash flow hedges			—				(416	)			—				(1,336	)
(Gain) loss on derivatives not designated as hedges			7,783				(163,312	)			94,435				(43,678	)
Total operating costs and expenses			104,899				(72,423	)			387,755				150,358
Income (loss) from operations			48,595				242,880				(20,927	)			264,193
Other income (expense):
Interest expense			(6,809	)			(10,255	)			(17,379	)			(19,755	)
Other, net			(200	)			334				(348	)			1,665
Total other expense			(7,009	)			(9,921	)			(17,727	)			(18,090	)
Income (loss) before income taxes			41,586				232,959				(38,654	)			246,103
Income tax (expense) benefit			(21,824	)			(91,031	)			11,973				(96,230	)
Net income (loss)		$	19,762			$	141,928			$	(26,681	)		$	149,873
Basic earnings per share:
Net income (loss) per share		$	0.23			$	1.75			$	(0.31	)		$	1.93
Weighted average shares used in basic earnings per share			85,061				81,288				84,798				77,489
Diluted earnings per share:
Net income (loss) per share		$	0.23			$	1.72			$	(0.31	)		$	1.90
Weighted average shares used in diluted earnings per share			86,088				82,724				84,798				78,945

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

Concho Resources Inc.

Consolidated Statement of Stockholders’ Equity
Unaudited

										Additional																Total
		Common Stock								Paid-in				Retained				Treasury Stock								Stockholders’
(in thousands)		Shares				Amount				Capital				Earnings				Shares				Amount				Equity
BALANCE AT DECEMBER 31, 2008			84,829			$	85			$	1,009,025			$	316,169				3			$	(125	)		$	1,325,154
Net loss			—				—				—				(26,681	)			—				—				(26,681	)
Stock options exercised			513				1				4,500				—				—				—				4,501
Stock-based compensation for restricted stock			269				—				3,433				—				—				—				3,433
Cancellation of restricted stock			(5	)			—				—				—				—				—				—
Stock-based compensation for stock options			—				—				3,228				—				—				—				3,228
Excess tax benefits related to stock-based compensation			—				—				3,357				—				—				—				3,357
Purchase of treasury stock			—				—				—				—				9				(292	)			(292	)
BALANCE AT SEPTEMBER 30, 2009			85,606			$	86			$	1,023,543			$	289,488				12			$	(417	)		$	1,312,700

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

Concho Resources Inc.

Consolidated Statements of Cash Flows
Unaudited

		Nine Months Ended September 30,
(in thousands)		2009				2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	(26,681	)		$	149,873
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation, depletion and amortization			157,985				75,822
Impairments of long-lived assets			9,686				2,827
Accretion of discount on asset retirement obligations			799				571
Exploration expense, including dry holes			6,950				17,860
Non-cash compensation expense			6,661				4,954
Bad debt expense			—				2,905
Deferred income taxes			(21,840	)			86,908
(Gain) loss on sale of assets			147				(777	)
Ineffective portion of cash flow hedges			—				(1,336	)
(Gain) loss on derivatives not designated as hedges			94,435				(43,678	)
Dedesignated cash flow hedges reclassified from accumulated other comprehensive income			—				260
Other non-cash items			2,656				2,749
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable			(10,367	)			26,209
Prepaid costs and other			(2,519	)			(1,035	)
Inventory			(3,979	)			(14,985	)
Accounts payable			5,029				(12,472	)
Revenue payable			17,581				6,982
Other current liabilities			(4,465	)			15,763
Net cash provided by operating activities			232,078				319,400
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures on oil and natural gas properties			(316,756	)			(213,666	)
Acquisition of oil and gas properties, businesses and other assets			—				(586,925	)
Additions to other property and equipment			(3,716	)			(6,711	)
Proceeds from the sale of oil and natural gas properties and other assets			1,004				1,034
Settlements received (paid) on derivatives not designated as hedges			77,590				(29,170	)
Net cash used in investing activities			(241,878	)			(835,438	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt			672,650				767,800
Payments of long-term debt			(656,916	)			(460,700	)
Exercise of stock options			4,501				3,861
Excess tax benefit from stock-based compensation			3,357				2,884
Net proceeds from issuance of common stock			—				242,426
Proceeds from repayment of employee notes			—				333
Payments for loan costs			(8,933	)			(15,541	)
Purchase of treasury stock			(292	)			(125	)
Bank overdrafts			(6,624	)			(954	)
Net cash provided by financing activities			7,743				539,984
Net increase (decrease) in cash and cash equivalents			(2,057	)			23,946
Cash and cash equivalents at beginning of period			17,752				30,424
Cash and cash equivalents at end of period		$	15,695			$	54,370
SUPPLEMENTAL CASH FLOWS:
Cash paid for interest and fees, net of $33 and $1,090 capitalized interest		$	13,291			$	16,164
Cash paid for income taxes		$	5,598			$	5,964
NON-CASH INVESTING ACTIVITIES:
Deferred tax effect of acquired oil and gas properties		$	(835	)		$	200,786

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

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. All material intercompany balances and transactions have been eliminated.

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

     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, 2008 is derived from audited consolidated financial statements. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments necessary to present fairly the Company’s financial position at September 30, 2009, its results of operations for the three and nine months ended September 30, 2009 and 2008, and its cash flows for the nine months ended September 30, 2009 and 2008. All such adjustments are of a normal recurring nature. In preparing the accompanying consolidated financial statements, management has made certain estimates and assumptions that affect reported amounts in the consolidated financial statements and disclosures of contingencies. Actual results may differ from those estimates. The results for interim periods are not necessarily indicative of annual results.

     Certain disclosures have been condensed or omitted from these consolidated financial statements. Accordingly, these consolidated 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, 2008.

     Deferred loan costs. Deferred loan costs are stated at cost, net of amortization, which is computed using the effective interest and straight-line methods. The Company had deferred loan costs of $22.0 million and $15.7 million, net of accumulated amortization of $7.5 million and $4.9 million, at September 30, 2009 and December 31, 2008, respectively.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     Future amortization expense of deferred loan costs at September 30, 2009 is as follows:

										Total
		Credit				8.625%				Deferred
(in thousands)		Facility				Notes				Loan Costs
Remaining 2009		$	853			$	189			$	1,042
2010			3,411				802				4,213
2011			3,411				881				4,292
2012			3,411				968				4,379
2013 & thereafter			1,990				6,066				8,056
Total		$	13,076			$	8,906			$	21,982

     Intangible assets. The Company has capitalized certain operating rights acquired in an acquisition in 2008, see Note D. The gross operating rights of approximately $38.7 million, which have no residual value, are amortized over the estimated economic life of approximately 25 years. Impairment will be assessed if indicators of potential impairment exist or when there is a material change in the remaining useful economic life. Amortization expense for the three and nine months ended September 30, 2009 was approximately $0.4 million and $1.2 million, respectively, and $0.3 million for the three and nine months ended September 30, 2008. The following table reflects the estimated aggregate amortization expense at September 30, 2009 for each of the periods presented below:

(in thousands)
Remaining 2009		$	387
2010			1,549
2011			1,549
2012			1,549
2013			1,549
Thereafter			30,326
Total		$	36,909

     Oil and natural 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 from or payable to the other owners unless the imbalance has reached a level at which 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.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     The following table reflects the Company’s natural gas imbalance positions at September 30, 2009 and December 31, 2008 as well as amounts reflected in oil and natural gas production expense for the three and nine months ended September 30, 2009 and 2008:

		September 30, 2009								December 31, 2008
						Overtake								Overtake
						(Undertake)								(Undertake)
(dollars in thousands)		Amount				Volume (Mcf)				Amount				Volume (Mcf)
Natural gas imbalance receivable (included in other assets)		$	434				(96,549	)		$	406				(90,321	)
Natural gas imbalance liability (included in asset retirement obligations and other long-term liabilities)		$	(451	)			79,973			$	(472	)			85,698

		Three Months Ended September 30,								Nine Months Ended September 30,
(dollars in thousands)		2009				2008				2009				2008
Value of net overtake (undertake) arising during the period (increasing (reducing) oil and natural gas production expense)		$	(9	)		$	(45	)		$	(49	)		$	(182	)
Net overtake (undertake) position arising during the period (Mcf)			(1,882	)			(8,440	)			(11,951	)			(16,543	)

     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 the operation of jointly owned oil and natural gas properties and records such reimbursements as reductions of general and administrative expense. Such fees totaled approximately $3.2 million and $2.1 million for the three months ended September 30, 2009 and 2008, respectively, and $8.6 million and $2.6 million for the nine months ended September 30, 2009 and 2008, respectively.

     Reclassifications. Certain prior period amounts have been reclassified to conform to the 2009 presentation. These reclassifications had no impact on net income (loss), total stockholders’ equity or cash flows.

     Recent accounting pronouncements:

     In June 2009, the Financial Accounting Standards Board (“FASB”) issued ASC 105-10 (formerly Statement of Financial Accounting Standards No. 168), Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. The FASB Accounting Standards Codification (the “Codification”) has become the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with Generally Accepted Accounting Principles (“GAAP”). All existing accounting standard documents are superseded by the Codification and any accounting literature not included in the Codification will not be authoritative. However, rules and interpretive releases of the United States Securities and Exchange Commission (the “SEC”) issued under the authority of federal securities laws will continue to be the source of authoritative generally accepted accounting principles for SEC registrants. Effective September 30, 2009, there will be no more references made to the superseded FASB standards in the Company’s consolidated financial statements. The Codification does not change or alter existing GAAP and, therefore, will not have an impact on the Company’s financial position, results of operations or cash flows.

     ASU 2009-05. In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05, Fair Value Measurements and Disclosures (Topic 820)—Measuring Liabilities at Fair Value (“ASU 2009-05”). The FASB issued this update because some entities have expressed concern that there may be a lack of observable market information to measure the fair value of a liability. ASU 2009-05 is effective for the first reporting period beginning after August 28, 2009, with earlier application permitted. The guidance provides clarification on measuring liabilities at fair value when a quoted price in an active market is not available. In such circumstances, ASU 2009-05 specifies that a valuation technique should be applied that uses either the quote of the liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique consistent with existing fair value measurement guidance. Examples of the alternative valuation methods include using a present value technique or a market

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

approach, which is based on the amount at the measurement date that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability. The guidance also states that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustments to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The Company adopted ASU 2009-05 effective September 30, 2009, and the adoption did not have a significant impact on the Company’s consolidated financial statements.

     ASU 2009-11. In September 2009, the FASB issued ASU 2009-11, Extractive Activities — Oil and Gas: Amendment to Section 932-10-S99, which makes a technical correction in ASC 932-10-S99-5 related to an SEC Observer comment, regarding the accounting and disclosures for gas balancing arrangements. The ASU amends FASB ASC 932-10-S99-5 because the SEC staff has not taken a position on whether the entitlements method or sales method is preferable for gas-balancing arrangements as defined in FASB ASC 932-815-55-1 and FASB ASC 932-815-55-2 that do not meet the definition of a derivative.

     With the entitlements method, sales revenue is recognized to the extent of each well partner’s proportionate share of gas sold regardless of which partner sold the gas. Under the sales method, sales revenue is recognized for all gas sold by a partner even if the partner’s ownership is less than 100% of the gas sold.

     ASU 2009-11 included an instruction in FASB ASC 932-10-S99-5 that public companies must account for all significant gas imbalances consistently using one accounting method. Both the method and any significant amount of imbalances in units and value should be disclosed in regulatory filings. The Company currently accounts for all gas balances under the sales method and makes all required disclosures.

     Recent developments in reserves reporting. In December 2008, the SEC released Final Rule, Modernization of Oil and Gas Reporting (the “Reserve Ruling”). The Reserve Ruling revises oil and natural gas reporting disclosures. The Reserve Ruling permits the use of new technologies to determine proved reserves estimates if those technologies have been demonstrated empirically to lead to reliable conclusions about reserve volume estimates. The Reserve Ruling will also allow, but not require, companies to disclose their probable and possible reserves to investors in documents filed with the SEC. In addition, the new disclosure requirements require companies to: (i) report the independence and qualifications of its reserves preparer or auditor; (ii) file reports when a third party is relied upon to prepare reserves estimates or conduct a reserves audit; and (iii) report oil and natural gas reserves using an average price based upon the prior 12-month period rather than a year-end price. The Reserve Ruling becomes effective for fiscal years ending on or after December 31, 2009. The Company is currently assessing the impact that adoption of the provisions of the Reserve Ruling will have on its financial position, results of operations and disclosures.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

Note C. Exploratory well costs

     The Company capitalizes exploratory well costs until a determination is made that the well has either found proved reserves or that it is impaired. The capitalized exploratory well costs are presented in unproved properties in the consolidated balance sheets. If the exploratory well is determined to be impaired, the well costs are charged to expense.

     The following table reflects the Company’s capitalized exploratory well activity during the three and nine months ended September 30, 2009:

		Three Months Ended				Nine Months Ended
(in thousands)		September 30, 2009				September 30, 2009
Beginning capitalized exploratory well costs		$	7,304			$	25,553
Additions to exploratory well costs pending the determination of proved reserves			35,822				129,664
Reclassifications due to determination of proved reserves			(30,474	)			(142,114	)
Exploratory well costs charged to expense			—				(451	)
Ending capitalized exploratory well costs		$	12,652			$	12,652

     The following table provides an aging, at September 30, 2009 and December 31, 2008, of capitalized exploratory well costs based on the date drilling was completed:

		September 30,				December 31,
(in thousands)		2009				2008
Wells in drilling progress		$	2,958			$	7,765
Capitalized exploratory well costs that have been capitalized for a period of one year or less			9,694				17,788
Capitalized exploratory well costs that have been capitalized for a period greater than one year			—				—
Total capitalized exploratory well costs		$	12,652			$	25,553

     At September 30, 2009, the Company had eleven gross exploratory wells waiting on completion, seven of which were in the Company’s New Mexico Permian area, three of which were in the Company’s Texas Permian area and one was in the Company’s emerging play in North Dakota. At September 30, 2009, the Company had five gross exploratory wells drilling in the following areas: one in the New Mexico Permian area, one in the Texas Permian area, one in the emerging play in North Dakota and two in the Lower Abo oil play in New Mexico.

Note D. Acquisitions

     Henry Entities acquisition. On July 31, 2008, the Company closed the acquisition of Henry Petroleum LP and certain entities affiliated with Henry Petroleum LP (the “Henry Entities”) and additional non-operated interests in oil and natural gas properties from persons affiliated with the Henry Entities. In August 2008 and September 2008, the Company acquired additional non-operated interests in oil and natural gas properties from persons affiliated with the Henry Entities. The assets acquired in the Henry Entities acquisition, including the additional non-operated interests, are referred to as the “Henry Properties.” The Company paid $583.7 million in cash for the Henry Properties acquisition.

     The cash paid for the Henry Properties acquisition was funded with (i) borrowings under the Company’s credit facility and (ii) proceeds from a private placement of approximately 8.3 million shares of the Company’s common stock.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     The Henry Properties acquisition was 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 is based on the total value of the cash consideration.

     The following tables represent the 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, net of cash acquired of $19,049 (a)		$	86,005
Proved oil and natural gas properties			593,634
Unproved oil and natural gas properties			233,527
Other long-term assets			7,392
Intangible assets — operating rights			38,717
Total assets acquired			959,275
Current liabilities			(114,394	)
Asset retirement obligations and other long-term liabilities			(7,529	)
Noncurrent derivative liabilities			(39,037	)
Deferred tax liability			(214,640	)
Total liabilities assumed			(375,600	)
Net purchase price		$	583,675
Consideration paid for Henry Properties’ net assets:
Cash consideration paid, net of cash acquired of $19,049		$	578,025
Acquisition costs (b)			5,650
Total purchase price		$	583,675

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     The following unaudited pro forma combined condensed financial data for the three and nine months ended September 30, 2008 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, 2008. 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 Henry Properties acquisition taken place as of the date indicated and is not intended to be a projection of future results.

		Nine Months Ended
(in thousands, except per share data)		September 30, 2008
Operating revenues		$	509,976
Net income		$	134,959
Earnings per common share:
Basic		$	1.57
Diluted		$	1.55

Note E. 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 obligations (“ARO”) recorded during the three and nine months ended September 30, 2009 and 2008:

		Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands)		2009				2008				2009				2008
Asset retirement obligations, beginning of period		$	14,386			$	10,356			$	16,809			$	9,418
Liabilities incurred from new wells			132				351				402				660
Liabilities incurred in acquisitions			—				7,062				—				7,062
Accretion expense			220				270				799				571
Disposition of wells sold			(81	)			—				(223	)			—
Liabilities settled upon plugging and abandoning wells			(630	)			—				(983	)			—
Revision of estimates			107				22				(2,670	)			350
Asset retirement obligations, end of period		$	14,134			$	18,061			$	14,134			$	18,061

Note F. 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 Henry Properties 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.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     Treasury stock. The restrictions on certain restricted stock awards issued to certain of the Company’s executive officers lapsed during the nine months ended September 30, 2009 and 2008. 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, some of such officers elected to deliver shares of the Company’s common stock to the Company in exchange for cash used to satisfy such tax liability. In total, at September 30, 2009, the Company acquired 12,380 shares that are held as treasury stock in the approximate amount of $417,000.

Note G. Incentive plans

     Defined contribution plan. The Company sponsors a 401(k) defined contribution plan for the benefit of all employees and maintains certain other acquired plans. The Company matches 100 percent of employee contributions, not to exceed 6 percent of the employee’s salary. The Company’s contributions to the plans for the three months ended September 30, 2009 and 2008 were approximately $0.3 million and $0.2 million, respectively, and $0.8 million and $0.5 million for the nine months ended September 30, 2009 and 2008, respectively.

     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. The following table shows the number of awards available under the Company’s Plan at September 30, 2009:

		Number of
		Common Shares
Approved and authorized awards			5,850,000
Restricted stock grants, net of forfeitures			(776,611	)
Stock option grants, net of forfeitures			(3,463,985	)
Awards available for future grant			1,609,404

     Restricted stock awards. All restricted shares are treated as issued and outstanding in the accompanying consolidated balance sheets. If an employee terminates employment prior to the date restrictions lapse, restricted shares awarded to such employee as to which restrictions have not lapsed are forfeited and cancelled and are no longer considered issued and outstanding. A summary of the Company’s restricted stock awards activity for the nine months ended September 30, 2009 is presented below:

		Number of				Grant Date
		Restricted				Fair Value
		Shares				Per Share
Outstanding at December 31, 2008			407,351
Shares granted			268,398			$	25.53
Shares cancelled / forfeited			(4,596	)
Lapse of restrictions			(193,358	)
Outstanding at September 30, 2009			477,795

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     The following table summarizes information about stock-based compensation for the Company’s restricted stock awards for the three and nine months ended September 30, 2009 and 2008:

		Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands)		2009				2008				2009				2008
Grant date fair value for awards during the period:
Employee grants		$	382			$	—			$	5,002			$	1,989
Officer and director grants (a)			84				577				1,934				1,419
Total		$	466			$	577			$	6,936			$	3,408
Stock-based compensation expense from restricted stock:
Employee grants		$	793			$	514			$	2,185			$	1,212
Officer and director grants (a)			440				202				1,248				366
Total		$	1,233			$	716			$	3,433			$	1,578
Income taxes and other information:
Income tax benefit related to restricted stock		$	137			$	276			$	1,064			$	617
Deductions in current taxable income related to restricted stock		$	699			$	68			$	5,066			$	1,268

     Stock option awards. A summary of the Company’s stock option award activity under the Plan for the nine months ended September 30, 2009 is presented below:

						Weighted
						Average
		Number of				Exercise
		Options				Price
Outstanding at December 31, 2008			2,731,324			$	12.46
Options granted			120,301			$	20.75
Options exercised			(512,876	)		$	8.77
Outstanding at September 30, 2009			2,338,749			$	13.70
Vested at end of period			1,639,459			$	10.74
Vested and exercisable at end of period			814,467			$	13.34

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     The following table summarizes information about the Company’s vested and exercisable stock options outstanding at September 30, 2009:

										Weighted
										Average				Weighted
						Number of				Remaining				Average
						Stock				Contractual				Exercise				Intrinsic
						Options				Life				Price				Value
																		(in thousands)
Vested options:
September 30, 2009:
Exercise price		$	8.00				1,121,212			2.38 years				$	8.00			$	31,753
Exercise price		$	12.00				118,681			4.63 years				$	12.00				2,886
Exercise price		$	14.84				263,750			6.96 years				$	14.84				5,664
Exercise price		$	21.84				102,250			8.42 years				$	21.84				1,481
Exercise price		$	31.81				33,566			8.76 years				$	31.81				152
							1,639,459							$	10.74			$	41,936
Vested and exercisable options:
September 30, 2009:
Exercise price		$	8.00				332,181			3.89 years				$	8.00			$	9,407
Exercise price		$	12.00				82,720			5.88 years				$	12.00				2,012
Exercise price		$	14.84				263,750			6.96 years				$	14.84				5,664
Exercise price		$	21.84				102,250			8.42 years				$	21.84				1,481
Exercise price		$	31.81				33,566			8.76 years				$	31.81				152
							814,467							$	13.34			$	18,716

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     The following table summarizes information about stock-based compensation for stock options for the three and nine months ended September 30, 2009 and 2008:

		Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands)		2009				2008				2009				2008
Grant date fair value for awards during the period:
Employee grants		$	50			$	206			$	50			$	389
Officer and director grants (a)			2,907				585				4,361				5,675
Total		$	2,957			$	791			$	4,411			$	6,064
Stock-based compensation expense from stock options:
Employee grants		$	132			$	48			$	273			$	113
Performance vesting options- officers			22				149				93				433
Officer and director grants (a)			1,161				1,012				2,862				2,830
Total		$	1,315			$	1,209			$	3,228			$	3,376
Income taxes and other information:
Income tax benefit related to stock options		$	194			$	461			$	1,000			$	1,319
Deductions in current taxable income related to stock options exercised		$	1,729			$	2,880			$	8,886			$	8,218

     In calculating compensation expense for stock options granted during the nine months ended September 30, 2009, the Company estimated the fair value of each grant using the Black-Scholes option-pricing model. Assumptions utilized in the model are shown below:

Risk-free interest rate			2.47	%
Expected term (years)			6.25
Expected volatility			63.19	%
Expected dividend yield			—

     The Company used the simplified method that is accepted by the SEC staff to calculate the expected term for stock options granted during the three and nine months ended September 30, 2009, 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.

     Modification of stock-based awards. Steven L. Beal, the Company’s former President and Chief Operating Officer, retired from such positions on June 30, 2009. Mr. Beal began serving as a consultant on July 1, 2009; see Note M. As part of the consulting agreement, certain of Mr. Beal’s stock-based awards were modified to permit vesting and exercise under the original terms of the stock-based awards as if Mr. Beal was still an employee of the Company while he is performing consulting services for the Company. As a result of this modification, the Company (i) immediately recognized $0.4 million of stock-based compensation during the three and nine months ended September 30, 2009 and (ii) will recognize additional stock-based compensation of $1.3 million in future periods.

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

     Future stock-based compensation expense. Future stock-based compensation expense at September 30, 2009 is summarized in the table below:

		Restricted				Stock
(in thousands)		Stock				Options				Total
Remaining 2009		$	1,200			$	1,059			$	2,259
2010			3,612				2,279				5,891
2011			2,231				927				3,158
2012			682				199				881
2013			41				18				59
Total		$	7,766			$	4,482			$	12,248

Note H. Disclosures about fair value measurements

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

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

Level 2:		Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that the Company values using observable market data. Substantially all of these inputs are observable in the marketplace throughout the full term of the derivative instrument, can be derived from observable data, or supported by observable levels at which transactions are executed in the marketplace. Level 2 instruments primarily include non-exchange traded derivatives such as over-the-counter commodity price swaps, basis swaps, investments and interest rate swaps. The Company’s valuation models are primarily industry-standard models that consider various inputs including: (i) quoted forward prices for commodities, (ii) time value and (iii) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. The Company utilizes its counterparties’ valuations to assess the reasonableness of its 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 commodity price collars and floors, as well as investments. The Company’s valuation models are primarily industry-standard models that consider various inputs including: (i) quoted forward prices for commodities, (ii) time value, (iii) volatility factors and (iv) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Although the Company utilizes its 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
September 30, 2009
Unaudited

     The fair value input hierarchy level to which an asset or liability measurement in its entirety falls is determined based on the lowest level input that is significant to the measurement in its entirety. The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at September 30, 2009, for each of the fair value hierarchy levels:

		Fair value measurements at reporting date using
						Significant
		Quoted prices in				other				Significant
		active markets for				observable				unobservable				Fair value at
		identical assets				inputs				inputs				September 30,
(in thousands)		(Level 1)				(Level 2)				(Level 3)				2009
Assets:
Commodity derivative price swap contracts		$	—			$	62,723			$	—			$	62,723
Commodity derivative price collar contracts			—				—				10,078				10,078
Interest rate derivative swap contracts			—				1,292				—				1,292
			—				64,015				10,078				74,093
Liabilities:
Commodity derivative price swap contracts			—				(58,186	)			—				(58,186	)
Commodity derivative basis swap contracts			—				(7,483	)			—				(7,483	)
Interest rate derivative swap contracts			—				(4,020	)			—				(4,020	)
Commodity derivative price collar contracts			—				—				(3,989	)			(3,989	)
			—				(69,689	)			(3,989	)			(73,678	)
Total financial assets (liabilities)		$	—			$	(5,674	)		$	6,089			$	415

     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 at December 31, 2008		$	49,562
Realized and unrealized losses			(9,429	)
Purchases, issuances, and settlements			(34,044	)
Balance at September 30, 2009		$	6,089
Total losses for the period included in earnings attributable to the change in unrealized losses relating to assets still held at the reporting date		$	(43,473	)

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

Assets and Liabilities Measured at Fair Value on a Recurring Basis

     The following table presents the carrying amounts and fair values of the Company’s financial instruments at September 30, 2009 and December 31, 2008:

		September 30, 2009								December 31, 2008
		Carrying				Fair				Carrying				Fair
(in thousands)		value				value				value				value
Assets:
Derivative instruments		$	40,132			$	40,132			$	174,306			$	174,306
Liabilities:
Derivative instruments		$	39,717			$	39,717			$	1,866			$	1,866
Credit facility		$	350,000			$	324,342			$	630,000			$	553,645
8.625% senior notes due 2017		$	295,747			$	307,500			$	—			$	—

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

     Credit facility. The fair value of the Company’s credit facility is estimated by discounting the principal and interest payments at the Company’s credit adjusted discount rate. The fair value at September 30, 2009 was approximately $324.3 million based on outstanding borrowings of $350 million and approximately $553.6 million at December 31, 2008 based on outstanding borrowings of $630 million.

     Senior notes. The fair value of the Company’s senior notes are based on quoted market prices.

     Derivative instruments. The fair value of the Company’s derivative instruments are estimated by management considering various factors, including closing exchange and over-the-counter quotations and the time value of the underlying commitments. 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 (i) summarizes the valuation of each of the Company’s financial instruments by required pricing levels and (ii) summarizes the gross fair value by the appropriate balance sheet classification, even when the derivative instruments are subject to netting arrangements and qualify for net presentation in the Company’s consolidated balance sheets at September 30, 2009 and December 31, 2008:

Concho Resources Inc.
Condensed Notes to Consolidated Financial Statements
September 30, 2009
Unaudited

		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)				2009
Assets (1)
Current:(a)
Commodity derivative price swap contracts		$	—			$	19,580			$	—			$	19,580
Commodity derivative price collar contracts			—				—				10,078				10,078
			—				19,580				10,078				29,658
Noncurrent:(b)
Commodity derivative price swap contracts			—				43,143				—				43,143
Interest rate derivative swap contracts			—				1,292				—				1,292
			—				44,435				—				44,435
Liabilities (1)
Current:(a)
Commodity derivative price swap contracts			—				(32,432	)			—				(32,432	)
Commodity derivative basis swap contracts			—				(4,630	)			—				(4,630	)
Interest rate derivative swap contracts			—				(4,020	)			—				(4,020	)
Commodity derivative price collar contracts			—				—				(2,329	)			(2,329	)
			—				(41,082	)			(2,329	)			(43,411	)
Noncurrent:(b)
Commodity derivative price swap contracts			—				(25,754	)			—				(25,754	)
Commodity derivative basis swap contracts			—				(2,853	)			—				(2,853	)
Commodity derivative price collar contracts			—				—				(1,660	)			(1,660	)
			—				(28,607	)			(1,660	)			(30,267	)
Total financial assets (liabilities)		$	—			$	(5,674	)		$	6,089			$	415
(a)    Total current financial assets (liabilities), gross basis														$	(13,753	)
(b)    Total noncurrent financial assets (liabilities), gross basis															14,168
Total financial assets (liabilities)														$	415