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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2019

OR

 
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:  001-35245

http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=13185768&doc=10
SRC Energy Inc.
(Exact name of registrant as specified in its charter)

Colorado
20-2835920
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

1675 Broadway, Suite 2600
Denver, Colorado 80202
(Address of principal executive offices) (Zip Code)


Registrant's telephone number, including area code: (720) 616-4300

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 $.001 par value
 
SRCI
 
NYSE American

Indicate by check mark whether the registrant (1) has filed all reports 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 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: 243,563,280 outstanding shares of common stock as of November 4, 2019.




SRC ENERGY INC.

Index

 
 
 
Page
Part I - FINANCIAL INFORMATION
 
 
 
 
 
 
Item 1.
Financial Statements (unaudited)
 
 
 
 
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018
 
 
 
 
 
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2019 and 2018
 
 
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018
 
 
 
 
 
 
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2019 and 2018
 
 
 
 
 
 
Notes to Condensed Consolidated Financial Statements
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
 
 
Item 4.
Controls and Procedures
 
 
 
 
 
Part II - OTHER INFORMATION
 
 
 
 
 
 
Item 1.
Legal Proceedings
 
 
 
 
 
Item 1A.
Risk Factors
 
 
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
 
 
Item 3.
Defaults of Senior Securities
 
 
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
 
 
Item 5.
Other Information
 
 
 
 
 
Item 6.
Exhibits
 
 
 
 
 
SIGNATURES
 





SRC ENERGY INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited; in thousands, except share data)


ASSETS
September 30, 2019
 
December 31, 2018
Current assets:
 
 
 
Cash and cash equivalents
$
69,496

 
$
49,609

Accounts receivable:
 
 
 
Oil, natural gas, and NGL sales
60,611

 
100,973

Trade
19,698

 
39,415

Commodity derivative assets
15,166

 
34,906

Other current assets
14,616

 
7,537

Total current assets
179,587

 
232,440

 
 
 
 
Property and equipment:
 
 
 
Oil and gas properties, full cost method:
 
 
 
Proved properties, net of accumulated depletion
1,804,476

 
1,545,445

Wells in progress
200,326

 
227,262

Unproved properties and land, not subject to depletion
666,439

 
740,453

Oil and gas properties, net
2,671,241

 
2,513,160

Other property and equipment, net
4,395

 
5,540

Total property and equipment, net
2,675,636

 
2,518,700

Commodity derivative assets
3,287

 

Other assets
9,062

 
3,574

Total assets
$
2,867,572

 
$
2,754,714

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued expenses
$
104,840

 
$
150,010

Revenue payable
94,130

 
97,030

Production taxes payable
92,752

 
95,099

Asset retirement obligations
4,832

 
11,694

Total current liabilities
296,554

 
353,833

 
 
 
 
Revolving credit facility
165,000

 
195,000

Notes payable, net of issuance costs
540,293

 
539,360

Asset retirement obligations
43,802

 
40,052

Deferred taxes
87,279

 
37,967

Other liabilities
3,467

 
2,210

Total liabilities
1,136,395

 
1,168,422

 
 
 
 
Commitments and contingencies (See Note 15)


 


 
 
 
 
Shareholders' equity:
 
 
 
Preferred stock - $0.01 par value, 10,000,000 shares authorized: no shares issued and outstanding

 

Common stock - $0.001 par value, 400,000,000 shares authorized: 243,511,005 and 242,608,284 shares issued and outstanding as of September 30, 2019 and December 31, 2018, respectively
244

 
243

Additional paid-in capital
1,502,977

 
1,492,107

Retained earnings
227,956

 
93,942

Total shareholders' equity
1,731,177

 
1,586,292

 
 
 
 
Total liabilities and shareholders' equity
$
2,867,572

 
$
2,754,714


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

2

SRC ENERGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in thousands, except share and per share data)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Oil, natural gas, and NGL revenues
$
134,094

 
$
160,978

 
$
486,151

 
$
455,298

 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
Lease operating expenses
13,377

 
10,360

 
43,967

 
29,868

Transportation and gathering
4,021

 
1,994

 
12,739

 
5,729

Production taxes
10,843

 
12,824

 
31,114

 
41,325

Depreciation, depletion, and accretion
57,401

 
45,188

 
176,346

 
124,146

General and administrative
16,671

 
10,685

 
35,383

 
29,691

Total expenses
102,313

 
81,051

 
299,549

 
230,759

 
 
 
 
 
 
 
 
Operating income
31,781

 
79,927

 
186,602

 
224,539

 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
Commodity derivative gain (loss)
10,924

 
(8,529
)
 
(3,704
)
 
(28,604
)
Interest expense, net of amounts capitalized

 

 

 

Interest income
76

 
23

 
237

 
37

Other income
55

 
125

 
191

 
152

Total other income (expense)
11,055

 
(8,381
)
 
(3,276
)
 
(28,415
)
 
 
 
 
 
 
 
 
Income before income taxes
42,836

 
71,546

 
183,326

 
196,124

 
 
 
 
 
 
 
 
Income tax expense
13,041

 
8,918

 
49,312

 
18,076

Net income
$
29,795

 
$
62,628

 
$
134,014

 
$
178,048

 
 
 
 
 
 
 
 
Net income per common share:
 
 
 
 
 
 
 
Basic
$
0.12

 
$
0.26

 
$
0.55

 
$
0.74

Diluted
$
0.12

 
$
0.26

 
$
0.55

 
$
0.73

 
 
 
 
 
 
 
 
Weighted-average shares outstanding:
 
 
 
 
 
 
 
Basic
243,479,734

 
242,536,781

 
243,392,487

 
242,184,348

Diluted
244,547,642

 
243,560,046

 
244,134,202

 
243,207,058


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

3

SRC ENERGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in thousands)

 
Nine Months Ended September 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
134,014

 
$
178,048

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depletion, depreciation, and accretion
176,346

 
124,146

Settlement of asset retirement obligations
(5,689
)
 
(5,234
)
Provision for deferred taxes
49,312

 
18,076

Stock-based compensation expense
9,914

 
9,347

Mark-to-market of commodity derivative contracts:
 
 
 
Total loss on commodity derivatives contracts
3,704

 
28,604

Cash settlements on commodity derivative contracts
13,105

 
(13,263
)
Cash premiums paid for commodity derivative contracts
(1,474
)
 

Changes in operating assets and liabilities
50,073

 
3,830

Net cash provided by operating activities
429,305

 
343,554

 
 
 
 
Cash flows from investing activities:
 
 
 
Acquisition of oil and gas properties and leaseholds, net of post-closing adjustments
(4,120
)
 
(129,069
)
Capital expenditures for drilling and completion activities
(351,407
)
 
(331,702
)
Other capital expenditures
(33,969
)
 
(26,439
)
Acquisition of land and other property and equipment
(329
)
 
(2,914
)
Proceeds from sales of oil and gas properties and other
12,109

 
1,233

Net cash used in investing activities
(377,716
)
 
(488,891
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Proceeds from the employee exercise of stock options

 
4,302

Payment of employee payroll taxes in connection with shares withheld
(1,167
)
 
(1,106
)
Proceeds from the revolving credit facility

 
115,000

Principal repayments on the revolving credit facility
(30,000
)
 

Fees on debt and equity issuances and revolving credit facility amendments
(379
)
 
(2,173
)
Lease payments
(156
)
 
(222
)
Net cash provided by (used in) financing activities
(31,702
)
 
115,801

 
 
 
 
Net increase (decrease) in cash and cash equivalents
19,887

 
(29,536
)
 
 
 
 
Cash and cash equivalents at beginning of period
49,609

 
48,772

 
 
 
 
Cash and cash equivalents at end of period
$
69,496

 
$
19,236

Supplemental Cash Flow Information (See Note 16)

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

4

SRC ENERGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited; in thousands, except share data)

 
Number of Common
Shares
 
Par Value
Common Stock
 
Additional
Paid-In Capital
 
Retained
Earnings (Deficit)
 
Total Shareholders'
Equity
Balance, December 31, 2017
241,365,522

 
$
241

 
$
1,474,273

 
$
(166,080
)
 
$
1,308,434

Shares issued under stock bonus and equity incentive plans
268,676

 
1

 
(1
)
 

 

Shares issued for exercise of stock options
268,303

 

 
1,064

 

 
1,064

Stock-based compensation

 

 
3,395

 

 
3,395

Payment of tax withholdings using withheld shares

 

 
(705
)
 

 
(705
)
Other activity

 

 
(73
)
 

 
(73
)
Net income

 

 

 
65,796

 
65,796

Balance, March 31, 2018
241,902,501

 
242

 
1,477,953

 
(100,284
)
 
1,377,911

Shares issued under stock bonus and equity incentive plans
69,420

 

 

 

 

Shares issued for exercise of stock options
524,159

 

 
3,127

 

 
3,127

Stock-based compensation

 

 
3,768

 

 
3,768

Payment of tax withholdings using withheld shares

 

 
(305
)
 

 
(305
)
Net income

 

 

 
49,624

 
49,624

Balance, June 30, 2018
242,496,080

 
242

 
1,484,543

 
(50,660
)
 
1,434,125

Shares issued under stock bonus and equity incentive plans
58,519

 

 

 

 

Shares issued for exercise of stock options
17,600

 
1

 
111

 

 
112

Stock-based compensation

 

 
4,030

 

 
4,030

Payment of tax withholdings using withheld shares

 

 
(96
)
 

 
(96
)
Net income

 

 

 
62,628

 
62,628

Balance, September 30, 2018
242,572,199

 
$
243


$
1,488,588


$
11,968


$
1,500,799


5

SRC ENERGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited; in thousands, except share data)

 
Number of Common
Shares
 
Par Value
Common Stock
 
Additional
Paid-In Capital
 
Retained
Earnings
 
Total Shareholders'
Equity
Balance, December 31, 2018
242,608,284

 
$
243

 
$
1,492,107

 
$
93,942

 
$
1,586,292

Shares issued under stock bonus and equity incentive plans
709,042

 

 

 

 

Stock-based compensation

 

 
4,413

 

 
4,413

Payment of tax withholdings using withheld shares

 

 
(876
)
 

 
(876
)
Net income

 

 

 
49,751

 
49,751

Balance, March 31, 2019
243,317,326

 
243

 
1,495,644

 
143,693

 
1,639,580

Shares issued under stock bonus and equity incentive plans
110,880

 

 

 

 

Stock-based compensation

 

 
3,819

 

 
3,819

Payment of tax withholdings using withheld shares

 

 
(250
)
 

 
(250
)
Net income

 

 

 
54,468

 
54,468

Balance, June 30, 2019
243,428,206

 
243

 
1,499,213

 
198,161

 
1,697,617

Shares issued under stock bonus and equity incentive plans
82,799

 
1

 
(1
)
 

 

Stock-based compensation

 

 
3,806

 

 
3,806

Payment of tax withholdings using withheld shares

 

 
(41
)
 

 
(41
)
Net income

 

 

 
29,795

 
29,795

Balance, September 30, 2019
243,511,005

 
$
244

 
$
1,502,977

 
$
227,956

 
$
1,731,177




6

Table of Contents

SRC ENERGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.
Organization and Summary of Significant Accounting Policies

Organization:  SRC Energy Inc. (the "Company") is an independent oil and natural gas company engaged in the acquisition, development, and production of oil, natural gas, and natural gas liquids ("NGLs") in the Denver-Julesburg Basin ("D-J Basin") of Colorado. The Company’s common stock is listed and traded on the NYSE American under the symbol "SRCI."

Basis of Presentation:  The Company operates in one business segment, and all of its operations are located in the United States of America.

At the directive of the Securities and Exchange Commission ("SEC") to use "plain English" in public filings, the Company will use such terms as "we," "our," "us," or the "Company" in place of SRC Energy Inc. When such terms are used in this manner throughout this document, they are in reference only to the corporation, SRC Energy Inc., and are not used in reference to the Board of Directors, corporate officers, management, or any individual employee or group of employees.

The condensed consolidated financial statements include the accounts of the Company, including its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.  The Company prepares its condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

Merger: On August 25, 2019, the Company entered into an Agreement and Plan of Merger ("PDC Merger Agreement") with PDC Energy, Inc., a Delaware corporation ("PDC"), which provides that, among other things, and subject to the terms and conditions of the PDC Merger Agreement, SRC will be merged with and into PDC, with PDC continuing as the surviving corporation (the “PDC Merger”). Pursuant to the PDC Merger Agreement, at the effective time of the PDC Merger, the Company's shareholders will receive 0.158 of a share of PDC common stock for each outstanding share of the Company's common stock, plus cash in lieu of any fractional PDC shares that otherwise would have been issued (the "Merger Consideration"). The PDC Merger Agreement also addresses the treatment of SRC equity awards in the PDC Merger. PDC’s common stock is listed and traded on the NASDAQ Global Select Market under the symbol PDCE. The transaction was unanimously approved by the Boards of Directors of both companies. Completion of the PDC Merger is expected to occur early in the first quarter of 2020, subject to the approval of the Company's shareholders and PDC's stockholders and other customary closing conditions. For three and nine months ended September 30, 2019, the Company has incurred $8.0 million of merger transaction costs recognized in general and administrative expense of the condensed consolidated statements of operations.

Interim Financial Information:  The unaudited condensed consolidated interim financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the SEC as promulgated in Rule 10-01 of Regulation S-X.  The condensed consolidated balance sheet as of December 31, 2018 was derived from the Company's annual consolidated financial statements included within its Annual Report on Form 10-K for the year ended December 31, 2018 as filed with the SEC on February 20, 2019.  Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted pursuant to such SEC rules and regulations.  The Company believes that the disclosures included are adequate to make the information presented not misleading and recommends that these condensed financial statements be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2018.

In our opinion, the unaudited condensed consolidated financial statements contained herein reflect all adjustments, consisting solely of normal recurring items, which are necessary for the fair presentation of the Company's financial position, results of operations, and cash flows on a basis consistent with that of its prior audited financial statements.  However, the results of operations for interim periods may not be indicative of results to be expected for the full fiscal year.


7

Table of Contents

Major Customers: The Company sells production to a small number of customers as is customary in the industry. Customers representing 10% or more of our oil, natural gas, and NGL revenues (“major customers”) for each of the periods presented are shown in the following table:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Major Customers
 
2019
 
2018
 
2019
 
2018
Company A
 
26%
 
14%
 
26%
 
11%
Company B
 
14%
 
21%
 
20%
 
19%
Company C
 
24%
 
23%
 
17%
 
13%
Company D
 
12%
 
14%
 
10%
 
28%
Company E
 
*
 
14%
 
*
 
16%
* less than 10%

Based on the current demand for oil and natural gas, the availability of other buyers, the multiple contracts for sales of our products, and the Company having the option to sell to other buyers if conditions warrant, the Company believes that the loss of our existing customers or individual contracts would not have a material adverse effect on us. Our oil and natural gas production is a commodity with a readily available market, and we sell our products under many distinct contracts. In addition, there are several oil and natural gas purchasers and processors within our area of operations to whom our production could be sold.
 
Accounts receivable consist primarily of receivables from oil, natural gas, and NGL sales and amounts due from other working interest owners who are liable for their proportionate share of well costs. The Company typically has the right to withhold future revenue disbursements to recover outstanding joint interest billings on outstanding receivables from joint interest owners.

Customers with balances greater than 10% of total receivable balances as of each of the periods presented are shown in the following table (these companies do not necessarily correspond to those presented above):
 
 
As of
 
As of
Major Customers
 
September 30, 2019
 
December 31, 2018
Company A
 
13%
 
15%
Company B
 
18%
 
12%
Company C
 
*
 
13%
Company D
 
11%
 
*
Company E
 
15%
 
12%

* less than 10%

The Company operates exclusively within the United States of America, and except for cash and cash equivalents, all of the Company’s assets are utilized in, and all of our revenues are derived from, the oil and gas industry.

Recently Adopted Accounting Pronouncements:

In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") No. 2016-02, Leases (Topic 842), followed by other related ASUs that provided targeted improvements and additional practical expedient options (collectively “ASC 842”). ASC 842 requires lessees to recognize right-of-use (“ROU”) assets and lease payment liabilities in the balance sheet for leases representing the Company’s right to use the underlying assets over the lease term. Each lease that is recognized in the balance sheet will be classified as either finance or operating, with such classification affecting the pattern and classification of expense recognition in the consolidated statements of operations and presentation within the statements of cash flows.

The Company adopted ASC 842 on January 1, 2019 using the modified retrospective method. The Company elected as part of its adoption to also use the optional transition methodology whereby previously reported periods continue to be reported in accordance with historical accounting guidance for leases that were in effect for those prior periods. Policy elections and practical expedients that the Company has implemented as part of adopting ASC 842 include (a) excluding from the balance sheet leases with terms that are less than or equal to one year, (b) for all existing asset classes that contain both lease and non-lease components, combining these components together and accounting for them as a single lease component, (c) the package of practical expedients, which among other things allows the Company to avoid reassessing contracts that commenced prior to

8

Table of Contents

adoption that were properly evaluated under legacy GAAP, and (d) excluding land easements, which were not accounted for under the previous leasing guidance, that existed or expired before adoption of ASC 842. ASC 842 does not apply to leases used in the exploration or use of minerals, oil, and natural gas.

The Company's adoption of ASC 842 resulted in an increase in other assets, accounts payable and accrued expenses, and other liabilities line items on the accompanying condensed consolidated balance sheets as a result of the additional ROU assets and related lease liabilities. Upon adoption on January 1, 2019, the Company recognized approximately $2.4 million in ROU assets and $4.3 million in liabilities for its operating leases. There was no cumulative effect to retained earnings upon the adoption of this guidance. See Note 14 for the new disclosures required by ASC 842.

Recently Issued Accounting Pronouncements: There were various updates recently issued by the FASB, most of which represented technical corrections to the accounting literature or application to specific industries and are not expected to a have a material impact on our reported financial position, results of operations, or cash flows.

Change in estimate: Production taxes are comprised primarily of two elements: severance tax and ad valorem tax. During the three months ended March 31, 2019, the Company reduced its estimate for 2018 severance taxes. When preparing the 2018 severance tax return, the credit for ad valorem taxes was greater than originally estimated, resulting in a reduction of 2018 severance taxes. Based on this analysis, the Company's prior year accrual was reduced, resulting in an approximate $7.9 million reduction to our production taxes, which increased our operating income for the three months ended March 31, 2019 by a corresponding amount, or $0.03 per basic and diluted common share.

2.
Property and Equipment

The capitalized costs related to the Company’s oil and gas producing activities were as follows (in thousands):
 
As of
 
As of
Oil and gas properties, full cost method:
September 30, 2019
 
December 31, 2018
Costs of proved properties:
 
 
 
Producing and non-producing
$
2,817,646

 
$
2,385,958

Less, accumulated depletion and full cost ceiling impairments
(1,013,170
)
 
(840,513
)
Subtotal, proved properties, net
1,804,476

 
1,545,445

 
 
 
 
Costs of wells in progress
200,326

 
227,262

 
 
 
 
Costs of unproved properties and land, not subject to depletion:
 
 
 
Lease acquisition and other costs
657,044

 
731,058

Land
9,395

 
9,395

Subtotal, unproved properties and land
666,439

 
740,453

 
 
 
 
Costs of other property and equipment:
 
 
 
Other property and equipment
10,060

 
9,642

Less, accumulated depreciation
(5,665
)
 
(4,102
)
Subtotal, other property and equipment, net
4,395

 
5,540

 
 
 
 
Total property and equipment, net
$
2,675,636

 
$
2,518,700



For proved producing and non-producing properties, the Company performs a ceiling test each quarter to determine whether there has been an impairment to its capitalized costs. At September 30, 2019 and December 31, 2018, the calculated value of the ceiling limitation exceeded the carrying value of our oil and gas properties subject to the test, and no impairments were necessary.


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Table of Contents

Capitalized Overhead: A portion of the Company’s overhead expenditures are directly attributable to acquisition, exploration, and development activities.  Under the full cost method of accounting, these expenditures, in the amounts shown in the table below, were capitalized in the full cost pool (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Capitalized overhead
$
3,485

 
$
3,129

 
$
10,635

 
$
9,522



3.
Depletion, depreciation, and accretion ("DD&A")

DD&A consisted of the following (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Depletion of oil and gas properties
$
55,984

 
$
44,230

 
$
172,009

 
$
121,259

Depreciation and accretion
1,417

 
958

 
4,337

 
2,887

Total DD&A Expense
$
57,401

 
$
45,188

 
$
176,346

 
$
124,146



Capitalized costs of proved oil and gas properties are depleted quarterly using the units-of-production method based on a depletion rate, which is calculated by comparing production volumes for the quarter to estimated total reserves at the beginning of the quarter.

4.
Asset Retirement Obligations

The Company recognizes obligations for its oil and natural gas operations for anticipated costs to remove and dispose of surface equipment, remediate the well, and reclaim the drilling site to its original use.  The estimated present value of such obligations is determined using several assumptions and judgments about the ultimate settlement amounts, inflation factors, credit-adjusted discount rates, timing of settlement, and changes in regulations.  Changes in estimates are reflected in the obligations as they occur.  If the fair value of a recorded asset retirement obligation changes, a revision is recorded to both the asset retirement obligation and the capitalized asset retirement cost.  The following table summarizes the changes in asset retirement obligations associated with the Company's oil and gas properties (in thousands):
 
Nine Months Ended September 30, 2019
Asset retirement obligations, December 31, 2018
$
51,746

Obligations incurred with development activities
1,616

Accretion expense
2,645

Obligations discharged with asset retirements and divestitures
(7,373
)
Asset retirement obligation, September 30, 2019
$
48,634

Less, current portion
(4,832
)
Long-term portion
$
43,802



5.
Revolving Credit Facility

On April 2, 2018, the Company entered into a second amended and restated credit agreement (the “Restated Credit Agreement”) with certain banks and other lenders. The Restated Credit Agreement provides a revolving credit facility (sometimes referred to as the "Revolver") and a $25 million swingline facility with a maturity date of April 2, 2023. The Revolver is available for working capital for exploration and production operations, acquisitions of oil and gas properties, and general corporate purposes and to support letters of credit. At September 30, 2019, the terms of the Revolver provided for up to $1.5 billion in borrowings, an aggregate elected commitment of $550 million, and a borrowing base limitation of $700 million. As of September 30, 2019 and December 31, 2018, the outstanding principal balance was $165.0 million and $195.0 million, respectively. At September 30, 2019 and December 31, 2018, the Company had $11.6 million and nil letters of credit issued, respectively. The average annual interest rate for borrowings during the nine months ended September 30, 2019 was 4.3%.


10

Table of Contents

Certain of the Company’s assets, including substantially all of its producing wells and developed oil and gas leases, have been designated as collateral under the Restated Credit Agreement. The amount available to be borrowed is subject to scheduled redeterminations on a semi-annual basis. On September 18, 2019, the lenders consented to a postponement of the redetermination scheduled for November 2019 to the earlier of (i) the termination of the PDC Merger Agreement and (ii) January 1, 2020, which is expected to be extended. If certain events occur or if the bank syndicate or the Company so elects in certain circumstances, an unscheduled redetermination could be undertaken. Completion of the PDC Merger would give rise to an event of default under the terms of the Restated Credit Agreement. To avoid an event of default, PDC will need to obtain waivers or consents from the lenders under the Restated Credit Agreement, or the Revolver will need to be repaid in full and terminated in connection with the PDC Merger.

The Restated Credit Agreement contains covenants that, among other things, restrict the payment of dividends, limit our overall commodity derivative positions, and require the Company to maintain compliance with certain financial and liquidity ratio covenants. As of September 30, 2019, the most recent compliance date, the Company was in compliance with these loan covenants and expects to remain in compliance throughout the next 12-month period.

6.
Notes Payable

2025 Senior Notes

In November 2017, the Company issued $550 million aggregate principal amount of 6.25% Senior Notes due 2025 (the "2025 Senior Notes") in a private placement to qualified institutional buyers. The maturity for the payment of principal is December 1, 2025. Interest on the 2025 Senior Notes accrues at 6.25%. Interest is payable on June 1 and December 1 of each year. The 2025 Senior Notes were issued pursuant to an indenture dated as of November 29, 2017. The associated expenses and underwriting discounts and commissions are amortized using the effective interest method at an effective interest rate of 6.6%.

The Indenture contains covenants that restrict the Company’s ability and the ability of certain of its subsidiaries to, among other restrictions and limitations: (i) incur additional indebtedness; (ii) incur liens; (iii) pay dividends; (iv) consolidate, merge, or transfer all or substantially all of its or their assets; (v) engage in transactions with affiliates; or (vi) engage in certain restricted business activities.  These covenants are subject to a number of exceptions and qualifications. If the PDC Merger is completed, PDC may be required to make a change of control offer to repurchase the 2025 Senior Notes from the holders at 101% of the principal amount of the 2025 Senior Notes, together with any accrued and unpaid interest to the date of purchase. The indenture governing the 2025 Senior Notes provides that, in certain circumstances, the notes will be guaranteed by one or more subsidiaries of the Company, in which case such guarantee would be made on a full and unconditional and joint and several senior unsecured basis. As of September 30, 2019, none of the Company's subsidiaries met the criteria in the Indenture to be considered a guarantor of the 2025 Senior Notes.

As of September 30, 2019, the most recent compliance date, the Company was in compliance with the Indenture covenants and expects to remain in compliance throughout the next 12-month period.

7.
Commodity Derivative Instruments

The Company has entered into commodity derivative instruments as described below. Our commodity derivative instruments may include but are not limited to "collars," "swaps," and "put" positions. Our derivative strategy, including the volumes and commodities covered and the relevant strike prices, is based in part on our view of expected future market conditions and our analysis of well-level economic return potential. In addition, our use of derivative contracts is subject to stipulations set forth in the Revolver.

The Company may, from time to time, add incremental derivatives to cover additional production, restructure existing derivative contracts, or enter into new transactions to modify the terms of current contracts in order to realize the current value of the Company’s existing positions. The Company does not enter into derivative contracts for speculative purposes.

The Company’s commodity derivative instruments are measured at fair value and are included in the accompanying condensed consolidated balance sheets as commodity derivative assets or liabilities. Unrealized gains and losses are recorded based on the changes in the fair values of the derivative instruments. Both the unrealized and realized gains and losses are recorded in the condensed consolidated statements of operations. The Company’s cash flow is only impacted when the actual settlements under commodity derivative contracts result in it making or receiving a payment to or from the counterparty. Actual cash settlements can occur at either the scheduled maturity date of the contract or at an earlier date if the contract is liquidated prior to its scheduled maturity. These settlements under the commodity derivative contracts are reflected as operating activities in the Company’s condensed consolidated statements of cash flows.

11

Table of Contents


The Company’s commodity derivative contracts as of September 30, 2019 are summarized below:
Settlement Period
 
Derivative
Instrument
 
Volumes
(Bbls per day)
 
Weighted-Average
Floor Price / Fixed Price
 
Weighted-Average Ceiling Price
Crude Oil - NYMEX WTI
 
 
 
 
 
 
 
 
Oct 1, 2019 - Dec 31, 2019
 
Collar
 
16,000

 
$
55.00

 
$
70.65

Jan 1, 2020 - Dec 31, 2020
 
Swap
 
8,000

 
$
55.04

 
 
 
 
 
 
 
 
 
 
 
Settlement Period
 
Derivative
Instrument
 
Volumes
(MMBtu per day)
 
Weighted-Average
Floor Price
 
Weighted-Average Ceiling Price
Natural Gas - NYMEX Henry Hub
 
 
 
 
 
 
 
 
Oct 1, 2019 - Dec 31, 2019
 
Collar
 
30,000

 
$
3.00

 
$
3.50

 
 
 
 
 
 
 
 
 
Settlement Period
 
Derivative
Instrument
 
Volumes
(MMBtu per day)
 
Fixed Basis Difference
 
 
Natural Gas - CIG Rocky Mountain
 
 
 
 
 
 
 
 
Oct 1, 2019 - Dec 31, 2019
 
Swap
 
30,000

 
$
(0.75
)
 
 
 
 
 
 
 
 
 
 
 
Settlement Period
 
Derivative
Instrument
 
Volumes
(Bbls per day)
 
Weighted-Average Fixed Price
 
 
Propane - Mont Belvieu
 
 
 
 
 
 
 
 
Oct 1, 2019 - Dec 31, 2019
 
Swap
 
2,000

 
$
37.52

 
 


Offsetting of Derivative Assets and Liabilities

As of September 30, 2019 and December 31, 2018, all derivative instruments held by the Company were subject to enforceable master netting arrangements held by various financial institutions. In general, the terms of the Company’s agreements provide for offsetting of amounts payable or receivable between the Company and the counterparty, at the election of either party, for transactions that occur on the same date and in the same currency. The Company’s agreements also provide that, in the event of an early termination, each party has the right to offset amounts owed or owing under that and any other agreement with the same counterparty. The Company’s accounting policy is to offset these positions in its condensed consolidated balance sheets.

The following table provides a reconciliation between the net assets and liabilities reflected on the accompanying condensed consolidated balance sheets of the Company’s derivative contracts (in thousands):
 
 
 
 
As of September 30, 2019
Underlying
 
Balance Sheet
Location
 
Gross Amounts of Recognized Assets and Liabilities
 
Gross Amounts Offset in the
Balance Sheet
 
Net Amounts of Assets and Liabilities Presented in the
Balance Sheet
Commodity derivative contracts
 
Current assets
 
$
44,510

 
$
(29,344
)
 
$
15,166

Commodity derivative contracts
 
Noncurrent assets
 
12,382

 
(9,095
)
 
3,287

Commodity derivative contracts
 
Current liabilities
 
29,344

 
(29,344
)
 

Commodity derivative contracts
 
Noncurrent liabilities
 
$
9,095

 
$
(9,095
)
 
$


12

Table of Contents

 
 
 
 
As of December 31, 2018
Underlying
 
Balance Sheet
Location
 
Gross Amounts of Recognized Assets and Liabilities
 
Gross Amounts Offset in the
Balance Sheet
 
Net Amounts of Assets and Liabilities Presented in the
Balance Sheet
Commodity derivative contracts
 
Current assets
 
$
39,485

 
$
(4,579
)
 
$
34,906

Commodity derivative contracts
 
Noncurrent assets
 

 

 

Commodity derivative contracts
 
Current liabilities
 
4,579

 
(4,579
)
 

Commodity derivative contracts
 
Noncurrent liabilities
 
$

 
$

 
$



The amount of gain (loss) recognized in the condensed consolidated statements of operations related to derivative financial instruments was as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Realized gain (loss) on commodity derivatives
$
4,532

 
$
(8,273
)
 
$
12,749

 
$
(16,228
)
Unrealized gain (loss) on commodity derivatives
6,392

 
(256
)
 
(16,453
)
 
(12,376
)
Total gain (loss)
$
10,924

 
$
(8,529
)
 
$
(3,704
)
 
$
(28,604
)


Realized gains and losses represent the monthly settlement of derivative contracts at their scheduled maturity date, net of the premiums attributable to settled commodity contracts. The following table summarizes derivative realized gains and losses during the periods presented (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Monthly settlement
$
5,029

 
$
(8,273
)
 
$
14,223

 
$
(16,228
)
Premiums paid
(497
)
 

 
(1,474
)
 

Total realized gain (loss)
$
4,532

 
$
(8,273
)
 
$
12,749

 
$
(16,228
)


Credit-Related Contingent Features

As of September 30, 2019, all of the counterparties to the Company's derivative instruments were members of the Company’s credit facility syndicate. The Company’s obligations under the Revolver and its derivative contracts are secured by liens on substantially all of the Company’s producing oil and gas properties.

8.
Fair Value Measurements

ASC 820, Fair Value Measurements and Disclosure, establishes a hierarchy for inputs used in measuring fair value for financial assets and liabilities that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company.  Unobservable inputs are inputs that reflect the Company’s assumptions of what market participants would use in pricing the asset or liability based on the best information available in the circumstances.  The hierarchy is broken down into three levels based on the reliability of the inputs as follows:

Level 1: Quoted prices available in active markets for identical assets or liabilities;
Level 2: Quoted prices in active markets for similar assets and liabilities that are observable for the asset or liability; and
Level 3: Unobservable pricing inputs that are generally less observable from objective sources, such as discounted cash or valuation models.

The 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.

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The Company’s non-recurring fair value measurement includes asset retirement obligations. The Company determines the estimated fair value of its asset retirement obligations by calculating the present value of estimated cash flows related to plugging and reclamation liabilities using Level 3 inputs. The significant inputs used to calculate such liabilities include estimates of costs to be incurred, the Company’s credit-adjusted risk-free rate, inflation rates, and estimated dates of reclamation. The asset retirement liability is accreted to its present value each period, and the capitalized asset retirement cost is depleted as a component of the full cost pool using the units-of-production method. See Note 4 for additional information.

The following table presents the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis by level within the fair value hierarchy (in thousands):
 
Fair Value Measurements at September 30, 2019
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets and liabilities:
 
 
 
 
 
 
 
Commodity derivative asset
$

 
$
18,453

 
$

 
$
18,453

Commodity derivative liability
$

 
$

 
$

 
$

 
Fair Value Measurements at December 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets and liabilities:
 
 
 
 
 
 
 
Commodity derivative asset
$

 
$
34,906

 
$

 
$
34,906

Commodity derivative liability
$

 
$

 
$

 
$



Commodity Derivative Instruments

The Company determines its estimate of the fair value of commodity derivative instruments using a market approach based on several factors, including quoted market prices in active markets, quotes from third parties, the credit rating of each counterparty, and the Company’s own credit standing. In consideration of counterparty credit risk, the Company assessed the possibility of whether the counterparties to its derivative contracts would default by failing to make any contractually required payments. The Company considers the counterparties to be of substantial credit quality and believes that they have the financial resources and willingness to meet their potential repayment obligations associated with the derivative transactions. At September 30, 2019, derivative instruments utilized by the Company consist of swaps and collars. The oil and natural gas derivative markets are highly active. Although the Company’s derivative instruments are valued based on several factors including public indices, the instruments themselves are traded with third-party counterparties. As such, the Company has classified these instruments as Level 2.

Fair Value of Financial Instruments

The Company’s financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, commodity derivative instruments (discussed above), notes payable, and credit facility borrowings. The carrying values of cash and cash equivalents, accounts receivable, and accounts payable are representative of their fair values due to their short-term maturities. Due to the variable interest rate paid on the credit facility borrowings, the carrying value is representative of its fair value.

The fair value of the 2025 Senior Notes is estimated to be $548.6 million at September 30, 2019. The Company determined the fair value of the 2025 Senior Notes at September 30, 2019 by using observable market-based information for these debt instruments. The Company has classified this fair value estimate as Level 1.


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9.
Interest Expense

The components of interest expense are (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Revolving credit facility
$
1,768

 
$
376

 
$
6,073

 
$
461

2025 Senior Notes
8,593

 
8,593

 
25,781

 
25,781

Amortization of issuance costs and other
937

 
905

 
2,585

 
2,905

Less: interest capitalized
(11,298
)
 
(9,874
)
 
(34,439
)
 
(29,147
)
Interest expense, net of amounts capitalized
$

 
$

 
$

 
$



10.
Stock-Based Compensation

As of September 30, 2019, there were 10,500,000 common shares authorized for grant under the 2015 Equity Incentive Plan, of which 1,000,173 shares were available for future grant. The shares available for future grant exclude 1,973,768 shares which have been reserved for future vesting of performance-vested stock units in the event that these awards meet the criteria to vest at their maximum multiplier.

The amount of stock-based compensation was as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Stock options
$
447

 
$
1,072

 
$
2,269

 
$
3,470

Performance-vested stock units
1,272

 
1,187

 
3,601

 
3,216

Restricted stock units and stock bonus shares
2,087