sm-20200930

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2020

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

For the transition period from ___________ to ___________

Commission File Number 001-31539

SM ENERGY COMPANY

(Exact name of registrant as specified in its charter)

Delaware

41-0518430

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

1775 Sherman Street, Suite 1200, Denver, Colorado

80203

(Address of principal executive offices)

(Zip Code)

(303) 861-8140

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common stock, $0.01 par value	SM	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☑

Accelerated filer

☐

Non-accelerated filer

☐

Smaller reporting company

☐

Emerging growth company

☐

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of October 21, 2020, the registrant had 114,572,800 shares of common stock outstanding.

TABLE OF CONTENTS


Item		Page
	Cautionary Information about Forward-Looking Statements	3

	Part I	4

Item 1.	Financial Statements (unaudited)	4

	Condensed Consolidated Balance Sheets September 30, 2020, and December 31, 2019	4

	Condensed Consolidated Statements of Operations Three and Nine Months Ended September 30, 2020, and 2019	5

	Condensed Consolidated Statements of Comprehensive Income (Loss) Three and Nine Months Ended September 30, 2020, and 2019	6

	Condensed Consolidated Statements of Stockholders’ Equity Continuous Quarterly Presentation Ended September 30, 2020, and 2019	7

	Condensed Consolidated Statements of Cash Flows Nine Months Ended September 30, 2020, and 2019	9

	Notes to Condensed Consolidated Financial Statements	10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

Item 3.	Quantitative and Qualitative Disclosures About Market Risk (included within the content of Item 2)	45

Item 4.	Controls and Procedures	45

	Part II	46

Item 1.	Legal Proceedings	46

Item 1A.	Risk Factors	46

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 5.	Other Information	49

Item 6.	Exhibits	51

Cautionary Information about Forward-Looking Statements

This Report on Form 10-Q (“Form 10-Q” or “this report”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements included in this report, other than statements of historical facts, that address activities, conditions, events, or developments with respect to our financial condition, results of operations, business prospects or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “budget,” “could,” “estimate,” “expect,” “forecast,” “intend,” “pending,” “plan,” “potential,” “project,” “target,” “will,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements appear throughout this report, and include statements about such matters as:

•the impacts of macroeconomic events and the global COVID-19 pandemic (“Pandemic”) on us, our industry, our financial condition, results of operations, future operations, business prospects, capital and financial resources, ability to service our debt, ability to access the capital markets, and our plans to address the foregoing;

•the amount and nature of future capital expenditures and the availability of liquidity and capital resources to fund capital expenditures;

•our expected total production volumes for the fiscal year 2020;

•any changes to the borrowing base or aggregate lender commitments under our Sixth Amended and Restated Credit Agreement, as amended (“Credit Agreement”);

•our outlook on future crude oil, natural gas, and natural gas liquids (also respectively referred to as “oil,” “gas,” and “NGLs” throughout this report) prices, well costs, service costs, lease operating costs, and general and administrative costs;

•our drilling of wells and other exploration and development activities, our ability to obtain permits and governmental approvals, and plans by us, our joint development partners, and/or other third-party operators;

•possible or expected acquisitions and divestitures, including the possible divestiture or farm-down of, or joint development of, certain properties;

•oil, gas, and NGL reserve estimates and estimates of both future net revenues and the present value of future net revenues associated with those reserve estimates;

•future oil, gas, and NGL production estimates, identified drilling locations, as well as drilling prospects, inventories, projects and programs;

•cash flows, liquidity, interest and related debt service expenses, changes in our effective tax rate, and our ability to repay debt in the future;

•business strategies and other plans and objectives for future operations, including plans for expansion and growth of operations or to defer capital investment, plans with respect to future dividend payments, and our outlook on our future financial condition or results of operations; and

•other similar matters, such as those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2 of this report.

Our forward-looking statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments, and other factors that we believe are appropriate under the circumstances. These statements are subject to known and unknown risks and uncertainties, which may cause our actual results and performance to be materially different from any future results or performance expressed or implied by the forward-looking statements. Factors that may cause our financial condition, results of operations, business prospects or economic performance to differ from expectations include the factors discussed in the Risk Factors section in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019 (“2019 Form 10-K”), in Part II, Item 1A of our Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2020 and June 30 , 2020, our 2020 Proxy Statement, and the Risk Factors section in Part II, Item 1A of this report.

We caution you that forward-looking statements are not guarantees of future performance and actual results or performance may be materially different from those expressed or implied in forward-looking statements. The forward-looking statements in this report speak only as of the filing of this report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by applicable securities laws.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands, except share data)


	September 30, 2020		December 31, 2019
ASSETS
Current assets:
Cash and cash equivalents	$	10	$	10
Accounts receivable	136,613		184,732
Derivative assets	128,046		55,184
Prepaid expenses and other	10,221		12,708
Total current assets	274,890		252,634
Property and equipment (successful efforts method):
Proved oil and gas properties	8,307,165		8,934,020
Accumulated depletion, depreciation, and amortization	(4,713,442)		(4,177,876)
Unproved oil and gas properties	907,864		1,005,887
Wells in progress	226,452		118,769

Other property and equipment, net of accumulated depreciation of $66,025 and $64,032, respectively	37,062		72,848
Total property and equipment, net	4,765,101		5,953,648
Noncurrent assets:
Derivative assets	31,509		20,624
Other noncurrent assets	50,785		65,326
Total noncurrent assets	82,294		85,950
Total assets	$	5,122,285	$	6,292,232
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	287,777	$	402,008

Derivative liabilities	76,969		50,846
Other current liabilities	12,532		19,189
Total current liabilities	377,278		472,043
Noncurrent liabilities:
Revolving credit facility	178,000		122,500
Senior Notes, net	2,175,038		2,610,298


Asset retirement obligations	87,014		84,134

Deferred income taxes	34,582		189,386
Derivative liabilities	33,068		3,444
Other noncurrent liabilities	52,197		61,433
Total noncurrent liabilities	2,559,899		3,071,195

Commitments and contingencies (note 6)

Stockholders’ equity:
Common stock, $0.01 par value - authorized: 200,000,000 shares; issued and outstanding: 114,572,800 and 112,987,952 shares, respectively	1,146		1,130
Additional paid-in capital	1,827,836		1,791,596
Retained earnings	365,872		967,587
Accumulated other comprehensive loss	(9,746)		(11,319)
Total stockholders’ equity	2,185,108		2,748,994
Total liabilities and stockholders’ equity	$	5,122,285	$	6,292,232

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

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share data)


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2020		2019		2020		2019
Operating revenues and other income:
Oil, gas, and NGL production revenue	$	282,012	$	389,419	$	806,035	$	1,136,749
Net gain on divestiture activity	—		—		91		323
Other operating revenues	(997)		898		255		1,347
Total operating revenues and other income	281,015		390,317		806,381		1,138,419
Operating expenses:
Oil, gas, and NGL production expense	95,257		129,042		295,254		373,397
Depletion, depreciation, amortization, and asset retirement obligation liability accretion	181,708		211,125		596,053		595,201
Exploration	8,547		11,626		29,683		33,851

Impairment	8,750		6,337		1,007,263		25,092
General and administrative	24,452		32,578		79,126		95,584
Net derivative (gain) loss	63,871		(100,889)		(314,269)		(3,463)
Other operating expense, net	1,562		1,021		10,174		422
Total operating expenses	384,147		290,840		1,703,284		1,120,084
Income (loss) from operations	(103,132)		99,477		(896,903)		18,335
Interest expense	(41,519)		(40,584)		(123,385)		(118,191)
Gain on extinguishment of debt	25,070		—		264,546		—
Other non-operating expense, net	(1,680)		(548)		(2,359)		(1,427)
Income (loss) before income taxes	(121,261)		58,345		(758,101)		(101,283)
Income tax (expense) benefit	22,969		(16,111)		158,662		16,337
Net income (loss)	$	(98,292)	$	42,234	$	(599,439)	$	(84,946)

Basic weighted-average common shares outstanding	114,371		112,804		113,462		112,441
Diluted weighted-average common shares outstanding	114,371		113,334		113,462		112,441
Basic net income (loss) per common share	$	(0.86)	$	0.37	$	(5.28)	$	(0.76)
Diluted net income (loss) per common share	$	(0.86)	$	0.37	$	(5.28)	$	(0.76)
Dividends per common share	$	0.01	$	0.05	$	0.02	$	0.10

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

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(in thousands)


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2020		2019		2020		2019
Net income (loss)	$	(98,292)	$	42,234	$	(599,439)	$	(84,946)
Other comprehensive income, net of tax:
Pension liability adjustment	1,195		190		1,573		572
Total other comprehensive income, net of tax	1,195		190		1,573		572
Total comprehensive income (loss)	$	(97,097)	$	42,424	$	(597,866)	$	(84,374)

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

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(in thousands, except share data and dividends per share)


				Additional Paid-in Capital				Accumulated Other Comprehensive Loss		Total Stockholders’ Equity
	Common Stock					Retained Earnings
	Shares	Amount
Balances, December 31, 2019	112,987,952	$	1,130	$	1,791,596	$	967,587	$	(11,319)	$	2,748,994
Net loss	—	—		—		(411,895)		—		(411,895)
Other comprehensive income	—	—		—		—		190		190
Cash dividends declared, $0.01 per share	—	—		—		(1,130)		—		(1,130)

Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings	730	—		(3)		—		—		(3)
Stock-based compensation expense	—	—		5,561		—		—		5,561


Balances, March 31, 2020	112,988,682	$	1,130	$	1,797,154	$	554,562	$	(11,129)	$	2,341,717
Net loss	—	—		—		(89,252)		—		(89,252)
Other comprehensive income	—	—		—		—		188		188

Issuance of common stock under Employee Stock Purchase Plan	297,013	3		944		—		—		947

Stock-based compensation expense	267,576	3		5,709		—		—		5,712
Issuance of warrants	—	—		21,520		—		—		21,520




Balances, June 30, 2020	113,553,271	$	1,136	$	1,825,327	$	465,310	$	(10,941)	$	2,280,832
Net loss	—	—		—		(98,292)		—		(98,292)
Other comprehensive income	—	—		—		—		1,195		1,195
Cash dividends declared, $0.01 per share	—	—		—		(1,146)		—		(1,146)

Issuance of common stock upon vesting of RSUs and settlement of PSUs, net of shares used for tax withholdings	1,019,529	10		(1,567)		—		—		(1,557)
Stock-based compensation expense	—	—		4,164		—		—		4,164
Other	—	—		(88)		—		—		(88)


Balances, September 30, 2020	114,572,800	$	1,146	$	1,827,836	$	365,872	$	(9,746)	$	2,185,108

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

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED) (Continued)

(in thousands, except share data and dividends per share)


				Additional Paid-in Capital				Accumulated Other Comprehensive Loss		Total Stockholders’ Equity
	Common Stock					Retained Earnings
	Shares	Amount
Balances, December 31, 2018	112,241,966	$	1,122	$	1,765,738	$	1,165,842	$	(12,380)	$	2,920,322
Net loss	—	—		—		(177,568)		—		(177,568)
Other comprehensive income	—	—		—		—		263		263
Cash dividends declared, $0.05 per share	—	—		—		(5,612)		—		(5,612)

Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings	2,579	—		(18)		—		—		(18)
Stock-based compensation expense	—	—		5,838		—		—		5,838


Balances, March 31, 2019	112,244,545	$	1,122	$	1,771,558	$	982,662	$	(12,117)	$	2,743,225
Net income	—	—		—		50,388		—		50,388
Other comprehensive income	—	—		—		—		119		119

Issuance of common stock under Employee Stock Purchase Plan	184,079	2		1,957		—		—		1,959
Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings	290	—		(2)		—		—		(2)
Stock-based compensation expense	96,719	1		6,153		—		—		6,154

Other	—	—		(1)		1		—		—
Balances, June 30, 2019	112,525,633	$	1,125	$	1,779,665	$	1,033,051	$	(11,998)	$	2,801,843
Net income	—	—		—		42,234		—		42,234
Other comprehensive income	—	—		—		—		190		190
Cash dividends declared, $0.05 per share	—	—		—		(5,643)		—		(5,643)

Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings	331,530	4		(1,644)		—		—		(1,640)
Stock-based compensation expense	—	—		6,766		—		—		6,766


Balances, September 30, 2019	112,857,163	$	1,129	$	1,784,787	$	1,069,642	$	(11,808)	$	2,843,750

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

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)


	For the Nine Months Ended September 30,
	2020		2019
Cash flows from operating activities:
Net loss	$	(599,439)	$	(84,946)
Adjustments to reconcile net loss to net cash provided by operating activities:
Net gain on divestiture activity	(91)		(323)
Depletion, depreciation, amortization, and asset retirement obligation liability accretion	596,053		595,201
Impairment	1,007,263		25,092
Stock-based compensation expense	15,437		18,758
Net derivative gain	(314,269)		(3,463)
Derivative settlement gain	286,270		23,843
Amortization of debt discount and deferred financing costs	13,084		11,554
Gain on extinguishment of debt	(264,546)		—
Deferred income taxes	(159,064)		(13,620)
Other, net	(6,203)		(2,291)
Net change in working capital	(40,411)		11,781





Net cash provided by operating activities	534,084		581,586

Cash flows from investing activities:
Net proceeds from the sale of oil and gas properties (1)	92		12,520
Capital expenditures	(419,777)		(788,642)

Acquisition of proved and unproved oil and gas properties	(7,075)		(2,581)
Net cash used in investing activities	(426,760)		(778,703)

Cash flows from financing activities:
Proceeds from revolving credit facility	1,165,500		1,124,500
Repayment of revolving credit facility	(1,110,000)		(995,500)

Debt issuance costs related to 10.0% Senior Secured Notes due 2025	(12,886)		—
Cash paid to repurchase Senior Notes	(94,262)		—
Repayment of 1.50% Senior Convertible Notes due 2021	(53,508)		—
Net proceeds from sale of common stock	947		1,959
Dividends paid	(1,130)		(5,612)
Other, net	(1,985)		(2,684)
Net cash provided by (used in) financing activities	(107,324)		122,663

Net change in cash, cash equivalents, and restricted cash	—		(74,454)
Cash, cash equivalents, and restricted cash at beginning of period	10		77,965
Cash, cash equivalents, and restricted cash at end of period	$	10	$	3,511

Supplemental schedule of additional cash flow information and non-cash activities:
Operating activities:
Cash paid for interest, net of capitalized interest	$	(122,174)	$	(113,122)

Investing activities:
Increase (decrease) in capital expenditure accruals and other	$	(17,405)	$	34,878
Non-cash investing and financing activities (2)(3)

Reconciliation of cash, cash equivalents, and restricted cash:
Cash and cash equivalents	$	10	$	10
Restricted cash (1)	—		3,501
Cash, cash equivalents, and restricted cash at end of period	$	10	$	3,511

____________________________________________

(1) As of September 30, 2019, a portion of net proceeds from the sale of oil and gas properties was restricted for future property acquisitions.

(2) Please refer to Note 3 - Divestitures, Assets Held for Sale, and Acquisitions for discussion of the carrying value of properties exchanged during the nine months ended September 30, 2020, and 2019, respectively.

(3) Please refer to Note 5 - Long-Term Debt for discussion of the debt transactions executed during the nine months ended September 30, 2020.

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

SM ENERGY COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 - Summary of Significant Accounting Policies

Description of Operations

SM Energy Company, together with its consolidated subsidiaries (“SM Energy” or the “Company”), is an independent energy company engaged in the acquisition, exploration, development, and production of oil, gas, and NGLs in the State of Texas.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, the instructions to Quarterly Report on Form 10-Q, and Regulation S-X. These financial statements do not include all information and notes required by GAAP for annual financial statements. However, except as disclosed herein, there has been no material change in the information disclosed in the notes to the consolidated financial statements included in the 2019 Form 10-K. In the opinion of management, all adjustments, consisting of normal recurring adjustments considered necessary for a fair presentation of interim financial information, have been included. Operating results for the periods presented are not necessarily indicative of expected results for the full year. In connection with the preparation of the Company’s unaudited condensed consolidated financial statements, the Company evaluated events subsequent to the balance sheet date of September 30, 2020, and through the filing of this report. Additionally, certain prior period amounts have been reclassified to conform to current period presentation in the accompanying unaudited condensed consolidated financial statements.

Significant Accounting Policies

The significant accounting policies followed by the Company are set forth in Note 1 - Summary of Significant Accounting Policies in the 2019 Form 10-K and are supplemented by the notes to the unaudited condensed consolidated financial statements included in this report. These unaudited condensed consolidated financial statements should be read in conjunction with the 2019 Form 10-K.

Recently Issued Accounting Standards

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 was issued to reduce the complexity of accounting for income taxes for those entities that fall within the scope of the accounting standard. The guidance is to be applied using a prospective method, excluding amendments related to franchise taxes, which should be applied on either a retrospective basis for all periods presented or a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, with early adoption permitted. The Company early adopted ASU 2019-12 on January 1, 2020, and there was no material impact on the Company’s unaudited condensed consolidated financial statements or disclosures upon adoption.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). ASU 2020-04 was issued to provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. Generally, the guidance is to be applied as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. ASU 2020-04 is effective for all entities as of March 12, 2020 through December 31, 2022. The Company is evaluating the options provided by ASU 2020-04. Please refer to Note 5 - Long-Term Debt for discussion of the use of the London Interbank Offered Rate (“LIBOR”) in connection with borrowings under the Credit Agreement.

In August 2020, the FASB issued ASU No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40) (“ASU 2020-06”). ASU 2020-06 was issued to reduce the complexity associated with accounting for certain financial instruments with characteristics of liabilities and equity. The guidance is to be applied using either a modified retrospective or a fully retrospective method. ASU 2020-06 is effective for fiscal years beginning after December 15, 2021, with early adoption permitted. The Company is evaluating the impact of ASU 2020-06 on its consolidated financial statements and related disclosures.

As disclosed in the 2019 Form 10-K, on January 1, 2020, the Company adopted ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. As expected, there was no material impact on the Company’s unaudited condensed consolidated financial statements or disclosures upon adoption of these ASUs.

There are no ASUs that would have a material effect on the Company’s unaudited condensed consolidated financial statements and related disclosures that have been issued but not yet adopted by the Company as of September 30, 2020, or through the filing of this report.

Note 2 - Revenue from Contracts with Customers

The Company recognizes its share of revenue from the sale of produced oil, gas, and NGLs from its Midland Basin and South Texas assets. Oil, gas, and NGL production revenue presented within the accompanying unaudited condensed consolidated statements of operations (“accompanying statements of operations”) is reflective of the revenue generated from contracts with customers.

The tables below present oil, gas, and NGL production revenue by product type for each of the Company’s operating regions for the three and nine months ended September 30, 2020, and 2019:


	Midland Basin						South Texas						Total
	Three Months Ended September 30,						Three Months Ended September 30,						Three Months Ended September 30,
	2020			2019			2020			2019			2020			2019
	(in thousands)
Oil production revenue	$	194,547		$	277,361		$	13,100		$	15,496		$	207,647		$	292,857
Gas production revenue	23,304			17,780			26,251			46,267			49,555			64,047
NGL production revenue	115			124			24,695			32,391			24,810			32,515
Total	$	217,966		$	295,265		$	64,046		$	94,154		$	282,012		$	389,419
Relative percentage	77		%	76		%	23		%	24		%	100		%	100		%

____________________________________________

Note: Amounts may not calculate due to rounding.


	Midland Basin						South Texas						Total
	Nine Months Ended September 30,						Nine Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019			2020			2019
	(in thousands)
Oil production revenue	$	585,041		$	791,055		$	33,815		$	45,007		$	618,856		$	836,062
Gas production revenue	46,559			49,821			78,569			144,563			125,128			194,384
NGL production revenue	218			102			61,833			106,201			62,051			106,303
Total	$	631,818		$	840,978		$	174,217		$	295,771		$	806,035		$	1,136,749
Relative percentage	78		%	74		%	22		%	26		%	100		%	100		%

____________________________________________

Note: Amounts may not calculate due to rounding.

The Company recognizes oil, gas, and NGL production revenue at the point in time when custody and title (“control”) of the product transfers to the purchaser, which differs depending on the applicable contractual terms. Transfer of control drives the presentation of transportation, gathering, processing, and other post-production expenses (“fees and other deductions”) within the accompanying statements of operations. Fees and other deductions incurred by the Company prior to control transfer are recorded within the oil, gas, and NGL production expense line item on the accompanying statements of operations. When control is transferred at or near the wellhead, sales are based on a wellhead market price that is impacted by fees and other deductions incurred by the purchaser subsequent to the transfer of control. Please refer to Note 2 - Revenue from Contracts with Customers in the 2019 Form 10-K for more information regarding the types of contracts under which oil, gas, and NGL production revenue is generated.

Significant judgments made in applying the guidance in Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers, relate to the point in time when control transfers to purchasers in gas processing arrangements with midstream processors. The Company does not believe that significant judgments are required with respect to the determination of the transaction price, including amounts that represent variable consideration, as volume and price carry a low level of estimation uncertainty given the precision of volumetric measurements and the use of index pricing with generally predictable differentials. Accordingly, the Company does not consider estimates of variable consideration to be constrained.

The Company’s performance obligations arise upon the production of hydrocarbons from wells in which the Company has an ownership interest. The performance obligations are considered satisfied upon control transferring to a purchaser at the wellhead, inlet, or tailgate of the midstream processor’s processing facility, or other contractually specified delivery point. The time period between

production and satisfaction of performance obligations is generally less than one day; thus, there are no material unsatisfied or partially unsatisfied performance obligations at the end of the reporting period.

Revenue is recorded in the month when performance obligations are satisfied. However, settlement statements from the purchasers of hydrocarbons and the related cash consideration are received 30 to 90 days after production has occurred. As a result, the Company must estimate the amount of production delivered to the customer and the consideration that will ultimately be received for sale of the product. Estimated revenue due to the Company is recorded within the accounts receivable line item on the accompanying unaudited condensed consolidated balance sheets (“accompanying balance sheets”) until payment is received. The accounts receivable balances from contracts with customers within the accompanying balance sheets as of September 30, 2020, and December 31, 2019, were $79.3 million and $146.3 million, respectively. To estimate accounts receivable from contracts with customers, the Company uses knowledge of its properties, historical performance, contractual arrangements, index pricing, quality and transportation differentials, and other factors as the basis for these estimates. Differences between estimates and actual amounts received for product sales are recorded in the month that payment is received from the purchaser.

Note 3 - Divestitures, Assets Held for Sale, and Acquisitions

Divestitures

No material divestitures occurred during the first nine months of 2020 and 2019, and there were no assets classified as held for sale as of September 30, 2020, or December 31, 2019.

Acquisitions

During the third quarter of 2020, the Company completed a non-monetary acreage trade of primarily undeveloped properties located in Upton County, Texas, resulting in the exchange of approximately 535 net acres, with $6.5 million of carrying value attributed to the properties transferred by the Company. This trade was recorded at carryover basis with no gain or loss recognized. Also during the third quarter of 2020, the Company acquired approximately 380 net acres of proved and unproved properties in Martin County, Texas, for $7.1 million.

During the first nine months of 2019, the Company completed several non-monetary acreage trades of primarily undeveloped properties located in Howard, Martin, and Midland Counties, Texas, resulting in the exchange of approximately 2,100 net acres, with $70.8 million of carrying value attributed to the properties transferred by the Company. These trades were recorded at carryover basis with no gain or loss recognized.

Note 4 - Income Taxes

The provision for income taxes for the three and nine months ended September 30, 2020, and 2019, consisted of the following:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2020			2019			2020			2019
	(in thousands)
Current portion of income tax (expense) benefit:
Federal	$	—		$	3,826		$	—		$	3,826
State	173			(320)			(402)			(1,109)
Deferred portion of income tax (expense) benefit	22,796			(19,617)			159,064			13,620
Income tax (expense) benefit	$	22,969		$	(16,111)		$	158,662		$	16,337
Effective tax rate	18.9		%	27.6		%	20.9		%	16.1		%

Recorded income tax expense or benefit differs from the amounts that would be provided by applying the statutory United States federal income tax rate to income or loss before income taxes. These differences primarily relate to the effect of state income taxes, excess tax benefits and deficiencies from stock-based compensation awards, tax limitations on the compensation of covered individuals, changes in valuation allowances, and the cumulative impact of other smaller permanent differences. The quarterly rate can also be affected by the proportional impacts of forecasted net income or loss for each period presented, as reflected in the table above.

During the third quarter of 2020, the proportional effect of recording discrete excess tax deficiencies from share-based compensation awards and other permanent items decreased the Company’s effective tax rate for the three months ended September 30, 2020, compared with the same period in 2019.

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted on March 27, 2020. The primary feature of the CARES Act that the Company benefited from was the acceleration of its refundable Alternative Minimum Tax (“AMT”) credits. On April 1, 2020, the Company filed an election to accelerate its remaining refundable AMT credits of $7.6 million. The Company received the refund in July 2020.

For all years before 2016, the Company is generally no longer subject to United States federal or state income tax examinations by tax authorities.

Note 5 - Long-Term Debt

The following table summarizes the Company’s total outstanding balance on its revolving credit facility, Senior Secured Notes net of unamortized discount and deferred financing costs, and Senior Unsecured Notes, net of unamortized deferred financing costs, as of September 30, 2020, and December 31, 2019:


	As of September 30, 2020		As of December 31, 2019
	(in thousands)
Revolving credit facility	$	178,000	$	122,500
Senior Secured Notes (1)	457,391		—
Senior Unsecured Notes (1)	1,717,647		2,610,298
Total	$	2,353,038	$	2,732,798

____________________________________________

(1) Senior Secured Notes and Senior Unsecured Notes have been defined below.

During the nine months ended September 30, 2020, the Company executed multiple transactions to reduce outstanding debt. During the second quarter of 2020, the Company initiated an offer to exchange its outstanding senior unsecured notes, as presented in the Senior Unsecured Notes section below (“Senior Unsecured Notes”), other than the 1.50% Senior Convertible Notes due 2021 (“2021 Senior Convertible Notes,” and together with the Senior Unsecured Notes, “Old Notes”), and a private exchange of its outstanding 2021 Senior Convertible Notes and portions of its outstanding Senior Unsecured Notes (“Private Exchange”), in each case for newly issued 10.0% Senior Secured Second Lien Notes due January 15, 2025 (“2025 Senior Secured Notes”), referred to together as “Exchange Offers.” In connection with the Exchange Offers, the Company and its lenders amended the Credit Agreement to increase the amount of permitted second lien indebtedness to an aggregate amount of $1.0 billion, inclusive of the 2021 Senior Convertible Notes (“Permitted Second Lien Debt”). Additionally, the Company amended the indenture governing its 2021 Senior Convertible Notes, by entering into the Third Supplemental Indenture, dated as of April 29, 2020 (“Third Supplemental Indenture”), to the original Indenture, dated as of May 21, 2015, as supplemented and amended by the Second Supplemental Indenture, dated as of August 12, 2016, collectively referred to as the “2021 Notes Indenture.” The Third Supplemental Indenture provides that the Company will satisfy any conversion obligation solely in cash.

On June 17, 2020 (“Settlement Date”), the Company exchanged $611.9 million in aggregate principal amount of Senior Unsecured Notes and $107.0 million in aggregate principal amount of 2021 Senior Convertible Notes for $446.7 million in aggregate principal amount of 2025 Senior Secured Notes, as well as, in connection with the Private Exchange, (a) $53.5 million in cash to certain holders of the 2021 Senior Convertible Notes and (b) warrants to acquire up to an aggregate of approximately 5.9 million shares, or approximately five percent of its outstanding common stock, exercisable upon the occurrence of certain future triggering events, to certain holders who exchanged Old Notes in the Private Exchange. Please refer to Note 11 - Fair Value Measurements for more information regarding the warrants issued by the Company. Pursuant to the 2021 Notes Indenture, upon the issuance of Permitted Second Lien Debt, the remaining outstanding 2021 Senior Convertible Notes became secured and are subsequently referred to as the “2021 Senior Secured Convertible Notes,” and together with the 2025 Senior Secured Notes, the “Senior Secured Notes.”

The following table summarizes the principal amounts of the Old Notes tendered as of the Settlement Date:


Title of Old Notes Tendered	Principal Amount of Old Notes Tendered
	(in thousands)
1.50% Senior Convertible Notes due 2021	$	107,015
6.125% Senior Notes due 2022	141,701
5.0% Senior Notes due 2024	155,339
5.625% Senior Notes due 2025	150,882
6.75% Senior Notes due 2026	80,765
6.625% Senior Notes due 2027	83,209
Total	$	718,911

The Company retired $611.9 million and $107.0 million in aggregate principal amount of its Senior Unsecured Notes and 2021 Senior Convertible Notes, respectively, upon the closing of the Exchange Offers. Upon closing, the Company paid $8.9 million of accrued and unpaid interest and accelerated $5.6 million of previously unamortized deferred financing costs associated with the retired Senior Unsecured Notes and 2021 Senior Convertible Notes and accelerated $6.1 million of previously unamortized debt discount associated with the retired 2021 Senior Convertible Notes. The Exchange Offers resulted in a net gain on extinguishment of debt of $227.3 million. The Company cancelled all retired Senior Unsecured Notes and 2021 Senior Convertible Notes upon the closing of the Exchange Offers.

Additionally, during the first and third quarters of 2020, the Company repurchased certain of its Senior Unsecured Notes in open market transactions. During the three months ended September 30, 2020, the Company repurchased a total of $62.5 million in aggregate principal amount of its 6.125% Senior Notes due 2022 (“2022 Senior Notes”) and $29.0 million in aggregate principal amount of its 5.0% Senior Notes due 2024 (“2024 Senior Notes”) in open market transactions for a total settlement amount, excluding accrued interest, of $65.9 million. In connection with the repurchases, the Company recorded a gain on extinguishment of debt of $25.1 million for the three months ended September 30, 2020. This amount included discounts realized upon repurchase of $25.5 million partially offset by approximately $480,000 of accelerated unamortized deferred financing costs. During the three months ended March 31, 2020, the Company repurchased a total of $40.7 million in aggregate principal amount of its 2022 Senior Notes in open market transactions for a total settlement amount, excluding accrued interest, of $28.3 million. In connection with the repurchase, the Company recorded a gain on extinguishment of debt of $12.2 million for the three months ended March 31, 2020. This amount included discounts realized upon repurchase of $12.4 million partially offset by approximately $235,000 of accelerated unamortized deferred financing costs. The Company canceled all repurchased 2022 Senior Notes and 2024 Senior Notes upon settlement.

Please refer to the Credit Agreement and Senior Secured Notes sections below for additional information.

Credit Agreement

The Company’s Credit Agreement provides for a senior secured revolving credit facility with a maximum loan amount of $2.5 billion. During the second quarter of 2020, as a result of lower commodity prices and a corresponding decrease in the value of the Company’s proved reserves, the borrowing base and aggregate lender commitments under the Credit Agreement were both reduced to $1.1 billion. Also during the second quarter of 2020, the Company entered into the Third Amendment and the Fourth Amendment to the Credit Agreement (collectively, the “Amendments”), which permitted the Company to incur new second lien debt of up to $827.5 million prior to the fall semi-annual borrowing base redetermination, provided that all principal amounts of such debt are used to redeem unsecured senior debt of the Company for less than or equal to 80% of par value. The Amendments also permitted the Company to grant a second-priority security interest to the holders of the Company’s outstanding 2021 Senior Convertible Notes to secure the Company’s obligations under the 2021 Senior Convertible Notes. Additionally, the Amendments reduced the amount of dividends that the Company may declare and pay on an annual basis from $50.0 million to $12.0 million. As of the filing of this report, the fall semi-annual borrowing base redetermination was in process. The next scheduled borrowing base redetermination date is April 1, 2021.

The Credit Agreement is scheduled to mature on September 28, 2023, except that, pursuant to the Amendments, newly issued Permitted Second Lien Debt used to redeem any portion of the remaining 2022 Senior Notes must have maturities on or after 180 days after September 28, 2023; otherwise, the maturity date of the Credit Agreement will be July 2, 2023. Without regard to which maturity date is in effect, the maturity date could occur earlier on August 16, 2022, if the Company has not completed certain repurchase, redemption, or refinancing activities associated with its 2022 Senior Notes, and does not have certain unused availability for borrowing under the Credit Agreement, as outlined in the Credit Agreement.

Interest and commitment fees associated with the revolving credit facility are accrued based on a borrowing base utilization grid set forth in the Credit Agreement. The Third Amendment to the Credit Agreement amended the borrowing base utilization grid as presented in the table below. At the Company’s election, borrowings under the Credit Agreement may be in the form of Eurodollar, Alternate Base Rate (“ABR”), or Swingline loans. Eurodollar loans accrue interest at LIBOR, plus the applicable margin from the utilization grid, and ABR and Swingline loans accrue interest at a market-based floating rate, plus the applicable margin from the utilization grid. Commitment fees are accrued on the unused portion of the aggregate lender commitment amount at rates from the utilization grid and are included in the interest expense line item on the accompanying statements of operations.


Borrowing Base Utilization Percentage	<25%		≥25% <50%		≥50% <75%		≥75% <90%		≥90%
Eurodollar Loans (1)	1.750	%	2.000	%	2.500	%	2.750	%	3.000	%
ABR Loans or Swingline Loans	0.750	%	1.000	%	1.500	%	1.750	%	2.000	%
Commitment Fee Rate	0.375	%	0.375	%	0.500	%	0.500	%	0.500	%

____________________________________________

(1) The Credit Agreement specifies that if LIBOR is no longer a widely used benchmark rate, or if it is no longer used for determining interest rates for loans in the United States, a replacement interest rate that fairly reflects the cost to the lenders of funding loans shall be established by the Administrative Agent, as defined in the Credit Agreement, in consultation with the Company. Please refer to Note 1 - Summary of Significant Accounting Policies for discussion of FASB ASU 2020-04, which provides guidance related to reference rate reform.

The following table presents the outstanding balance, total amount of letters of credit outstanding, and available borrowing capacity under the Credit Agreement as of October 21, 2020, September 30, 2020, and December 31, 2019:


	As of October 21, 2020		As of September 30, 2020		As of December 31, 2019
	(in thousands)
Revolving credit facility (1)	$	129,000	$	178,000	$	122,500
Letters of credit (2)	42,000		42,000		—
Available borrowing capacity	929,000		880,000		1,077,500
Total aggregate lender commitment amount	$	1,100,000	$	1,100,000	$	1,200,000

____________________________________________

(1) Unamortized deferred financing costs attributable to the revolving credit facility are presented as a component of the other noncurrent assets line item on the accompanying balance sheets and totaled $4.7 million and $5.9 million as of September 30, 2020, and December 31, 2019, respectively. These costs are being amortized over the term of the revolving credit facility on a straight-line basis.

(2) Letters of credit outstanding reduce the amount available under the credit facility on a dollar-for-dollar basis.

Senior Notes

Senior Secured Notes. Senior Secured Notes, net of unamortized discount and deferred financing costs, included within the Senior Notes, net line item on the accompanying balance sheets as of September 30, 2020, consisted of the following:


	As of September 30, 2020
	Principal Amount		Unamortized Debt Discount		Unamortized Deferred Financing Costs		Principal Amount, Net
	(in thousands)
10.0% Senior Secured Notes due 2025	$	446,675	$	(39,706)	$	(12,091)	$	394,878
1.50% Senior Secured Convertible Notes due 2021 (1)	65,485		(2,710)		(262)		62,513
Total	$	512,160	$	(42,416)	$	(12,353)	$	457,391

____________________________________________

(1) As discussed above, as required by the 2021 Notes Indenture and as permitted by the Credit Agreement, as the Company issued Permitted Second Lien Debt upon the closing of the Exchange Offers, its remaining 2021 Senior Convertible Notes contemporaneously became secured.

2025 Senior Secured Notes. On June 17, 2020, the Company issued $446.7 million in aggregate principal amount of 2025 Senior Secured Notes due January 15, 2025. The Company incurred fees of $12.9 million, which are being amortized as deferred financing costs over the life of the 2025 Senior Secured Notes. Upon the issuance of the 2025 Senior Secured Notes, the Company recorded $405.0 million as the initial carrying amount, which approximated their fair value at issuance. The excess of the principal amount of the 2025 Senior Secured Notes over its fair value was recorded as a debt discount. The debt discount and deferred financing costs are being amortized to interest expense through the maturity date.

In connection with the issuance of the 2025 Senior Secured Notes, the Company entered into an indenture dated as of June 17, 2020, with UMB Bank, N.A., as trustee, governing the 2025 Senior Secured Notes (“2025 Notes Indenture”). The Company may redeem some or all of its 2025 Senior Secured Notes prior to their maturity at redemption prices based on a premium, plus accrued and unpaid interest as described in the 2025 Notes Indenture.

The 2025 Senior Secured Notes are senior obligations of the Company, secured on a second-priority basis, ranking junior to the Company’s obligations under the Credit Agreement and equal in priority with the 2021 Senior Secured Convertible Notes. The 2025 Senior Secured Notes rank senior in right of payment with all of the Company’s existing and any future unsecured senior or subordinated debt.

2021 Senior Secured Convertible Notes. Upon issuance of the 2025 Senior Secured Notes, which was Permitted Second Lien Debt, as required by the 2021 Notes Indenture, and as permitted by the Credit Agreement, the 2021 Senior Convertible Notes became secured senior obligations of the Company on a second-priority basis, ranking junior to the Company’s obligations under the Credit Agreement and equal in priority with the 2025 Senior Secured Notes. The 2021 Senior Secured Convertible Notes rank senior in right of payment to all of the Company’s existing and any future unsecured senior or subordinated debt. During the second quarter of 2020, pursuant to the Third Supplemental Indenture, the Company agreed to satisfy any conversion obligation solely in cash, resulting in reclassification of the fair value of the equity components out of additional paid-in capital. Please refer to Note 5 - Long-Term Debt in the 2019 Form 10-K for additional detail on the Company’s 2021 Senior Convertible Notes and associated capped call transactions.

The 2021 Senior Secured Convertible Notes were not convertible at the option of holders as of September 30, 2020, or through the filing of this report. Notwithstanding the inability to convert, the if-converted value of the 2021 Senior Secured Convertible Notes did not exceed the principal amount. The Company has the ability to settle its 2021 Senior Secured Convertible Notes obligation, due July 1, 2021, with borrowings under its revolving credit facility. The remaining debt discount and debt-related issuance costs are being amortized to the principal value of the 2021 Senior Secured Convertible Notes as interest expense through the maturity date. Interest expense recognized on the 2021 Senior Secured Convertible Notes related to the stated interest rate and amortization of the debt discount totaled $1.1 million and $2.8 million for the three months ended September 30, 2020, and 2019, respectively, and totaled $