10-Q 1 q22018diamondback10-q.htm DIAMONDBACK 10-Q Document



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

 
 
FORM 10-Q

 
ý
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED June 30, 2018
OR
o
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-35700
 
 
Diamondback Energy, Inc.
(Exact Name of Registrant As Specified in Its Charter)
 
 

Delaware
 
45-4502447
(State or Other Jurisdiction of
Incorporation or Organization)
 
(IRS Employer
Identification Number)
 
 
500 West Texas, Suite 1200
Midland, Texas
 
79701
(Address of Principal Executive Offices)
 
(Zip Code)
(432) 221-7400
(Registrant Telephone Number, Including Area Code)
 
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 past 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  ý    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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. (Check One):
Large Accelerated Filer
 
ý
 
Accelerated Filer
 
o
 
 
 
 
Non-Accelerated Filer
 
o
 
Smaller Reporting Company
 
o
 
 
 
 
 
 
 
 
 
 
 
Emerging Growth Company
 
o

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.    o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
As of August 3, 2018, 98,621,440 shares of the registrant’s common stock were outstanding.





DIAMONDBACK ENERGY, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2018
TABLE OF CONTENTS
 








GLOSSARY OF OIL AND NATURAL GAS TERMS
The following is a glossary of certain oil and gas terms that are used in this Quarterly Report on Form 10-Q (this “report”):
Basin
A large depression on the earth’s surface in which sediments accumulate.
Bbl
Stock tank barrel, or 42 U.S. gallons liquid volume, used in this report in reference to crude oil or other liquid hydrocarbons.
BOE
Barrels of oil equivalent, with six thousand cubic feet of natural gas being equivalent to one barrel of oil.
BOE/d
BOE per day.
British Thermal Unit or Btu
The quantity of heat required to raise the temperature of one pound of water by one degree Fahrenheit.
Completion
The process of treating a drilled well followed by the installation of permanent equipment for the production of natural gas or oil, or in the case of a dry hole, the reporting of abandonment to the appropriate agency.
Crude oil
Liquid hydrocarbons retrieved from geological structures underground to be refined into fuel sources.
Finding and development costs
Capital costs incurred in the acquisition, exploitation and exploration of proved oil and natural gas reserves divided by proved reserve additions and revisions to proved reserves.
Gross acres or gross wells
The total acres or wells, as the case may be, in which a working interest is owned.
Horizontal drilling
A drilling technique used in certain formations where a well is drilled vertically to a certain depth and then drilled at a right angle with a specified interval.
Horizontal wells
Wells drilled directionally horizontal to allow for development of structures not reachable through traditional vertical drilling mechanisms.
Mb/d
Thousand barrels per day.
Mcf
Thousand cubic feet of natural gas.
Mineral interests
The interests in ownership of the resource and mineral rights, giving an owner the right to profit from the extracted resources.
MMBtu
Million British Thermal Units.
Net acres or net wells
The sum of the fractional working interest owned in gross acres.
Oil and natural gas properties
Tracts of land consisting of properties to be developed for oil and natural gas resource extraction.
Plugging and abandonment
Refers to the sealing off of fluids in the strata penetrated by a well so that the fluids from one stratum will not escape into another or to the surface. Regulations of all states require plugging of abandoned wells.
Prospect
A specific geographic area which, based on supporting geological, geophysical or other data and also preliminary economic analysis using reasonably anticipated prices and costs, is deemed to have potential for the discovery of commercial hydrocarbons.
Proved reserves
The estimated quantities of oil, natural gas and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be commercially recoverable in future years from known reservoirs under existing economic and operating conditions.
Reserves
The estimated remaining quantities of oil and natural gas and related substances anticipated to be economically producible, as of a given date, by application of development projects to known accumulations. In addition, there must exist, or there must be a reasonable expectation that there will exist, the legal right to produce or a revenue interest in the production, installed means of delivering oil and natural gas or related substances to the market and all permits and financing required to implement the project. Reserves are not assigned to adjacent reservoirs isolated by major, potentially sealing, faults until those reservoirs are penetrated and evaluated as economically producible. Reserves should not be assigned to areas that are clearly separated from a known accumulation by a non-productive reservoir (i.e., absence of reservoir, structurally low reservoir or negative test results). Such areas may contain prospective resources (i.e., potentially recoverable resources from undiscovered accumulations).
Reservoir
A porous and permeable underground formation containing a natural accumulation of producible natural gas and/or oil that is confined by impermeable rock or water barriers and is separate from other reservoirs.
Royalty interest
An interest that gives an owner the right to receive a portion of the resources or revenues without having to carry any costs of development.
Spacing
The distance between wells producing from the same reservoir. Spacing is often expressed in terms of acres (e.g., 40-acre spacing) and is often established by regulatory agencies.

ii



Working interest
An operating interest that gives the owner the right to drill, produce and conduct operating activities on the property and receive a share of production and requires the owner to pay a share of the costs of drilling and production operations.

iii



GLOSSARY OF CERTAIN OTHER TERMS
The following is a glossary of certain other terms that are used in this report.
Company
Diamondback Energy, Inc., a Delaware corporation.
Equity Plan
The Company’s Equity Incentive Plan.
Exchange Act
The Securities Exchange Act of 1934, as amended.
GAAP
Accounting principles generally accepted in the United States.
General Partner
Viper Energy Partners GP LLC, a Delaware limited liability company and the General Partner of the Partnership.
NYMEX
New York Mercantile Exchange.
Partnership
Viper Energy Partners LP, a Delaware limited partnership.
Partnership Agreement
The first amended and restated agreement of limited partnership, dated June 23, 2014, entered into by the General Partner and Diamondback in connection with the closing of the Viper Offering.
Operating Company
Viper Energy Partners LLC, a Delaware limited liability company and a subsidiary of the Partnership.
SEC
United States Securities and Exchange Commission.
Securities Act
The Securities Act of 1933, as amended.
2024 Senior Notes
The Company’s 4.750% senior unsecured notes due 2024 in the aggregate principal amount of $500 million.
2025 Senior Notes
The Company’s 5.375% senior unsecured notes due 2025 in the aggregate principal amount of $500 million.
Senior Notes
The 2024 Senior Notes and the 2025 Senior Notes.
Viper LTIP
Viper Energy Partners LP Long Term Incentive Plan.
Viper Offering
The Partnerships’ initial public offering.
Wells Fargo
Wells Fargo Bank, National Association.


iv



CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Various statements contained in this report that express a belief, expectation, or intention, or that are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Exchange Act. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans and objectives of management are forward-looking statements. When used in this report, the words “could,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “may,” “continue,” “predict,” “potential,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. In particular, the factors discussed in this report and detailed under Part II, Item 1A. Risk Factors in this report and our Annual Report on Form 10–K for the year ended December 31, 2017 could affect our actual results and cause our actual results to differ materially from expectations, estimates or assumptions expressed, forecasted or implied in such forward-looking statements.

Forward-looking statements may include statements about our:

business strategy;

exploration and development drilling prospects, inventories, projects and programs;

oil and natural gas reserves;

acquisitions, including our pending acquisition of certain leasehold acres and other assets from Ajax Recourses, LLC discussed elsewhere in this report;

identified drilling locations;

ability to obtain permits and governmental approvals;

technology;

financial strategy;

realized oil and natural gas prices;

production;

lease operating expenses, general and administrative costs and finding and development costs;

future operating results; and

plans, objectives, expectations and intentions.

All forward-looking statements speak only as of the date of this report or, if earlier, as of the date they were made. We do not intend to, and disclaim any obligation to, update or revise any forward-looking statements unless required by securities laws. You should not place undue reliance on these forward-looking statements. These forward-looking statements are subject to a number of risks, uncertainties and assumptions. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this report are reasonable, we can give no assurance that these plans, intentions or expectations will be achieved or occur, and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.


v

Diamondback Energy, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)



 
June 30,
December 31,
 
2018
2017
 
(In thousands, except par values and share data)
Assets
 
 
Current assets:
 
 
Cash and cash equivalents
$
113,927

$
112,446

Accounts receivable:
 
 
Joint interest and other
91,036

73,038

Oil and natural gas sales
167,854

158,575

Inventories
13,264

9,108

Derivative instruments

531

Prepaid expenses and other
7,266

4,903

Total current assets
393,347

358,601

Property and equipment:
 
 
Oil and natural gas properties, full cost method of accounting ($4,286,320 and $4,105,865 excluded from amortization at June 30, 2018 and December 31, 2017, respectively)
10,315,425

9,232,694

Midstream assets
343,387

191,519

Other property, equipment and land
85,472

80,776

Accumulated depletion, depreciation, amortization and impairment
(2,401,240
)
(2,161,372
)
Net property and equipment
8,343,044

7,343,617

Funds held in escrow

6,304

Deferred tax asset
72,049


Investment in real estate, net
108,564


Other assets
37,391

62,463

Total assets
$
8,954,395

$
7,770,985

Liabilities and Stockholders’ Equity
 
 
Current liabilities:
 
 
Accounts payable-trade
$
73,974

$
94,590

Accrued capital expenditures
369,957

221,256

Other accrued liabilities
94,266

92,512

Revenues and royalties payable
77,550

68,703

Derivative instruments
111,330

100,367

Total current liabilities
727,077

577,428

Long-term debt
1,967,074

1,477,347

Derivative instruments
8,514

6,303

Asset retirement obligations
21,780

20,122

Deferred income taxes
217,476

108,048

Other long term liabilities
7


Total liabilities
2,941,928

2,189,248

Commitments and contingencies (Note 16)
 
 
Stockholders’ equity:
 
 
Common stock, $0.01 par value, 200,000,000 shares authorized, 98,619,628 issued and outstanding at June 30, 2018; 98,167,289 issued and outstanding at December 31, 2017
986

982

Additional paid-in capital
5,307,358

5,291,011

Retained earnings (accumulated deficit)
323,105

(37,133
)
Total Diamondback Energy, Inc. stockholders’ equity
5,631,449

5,254,860

Non-controlling interest
381,018

326,877

Total equity
6,012,467

5,581,737

Total liabilities and equity
$
8,954,395

$
7,770,985

See accompanying notes to consolidated financial statements.

1

Diamondback Energy, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)



 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
2017
 
2018
2017
 
(In thousands, except per share amounts)
Revenues:
 
 
 
 
 
Oil sales
$
460,437

$
237,884

 
$
879,705

$
444,958

Natural gas sales
11,365

12,693

 
25,743

22,615

Natural gas liquid sales
43,135

16,857

 
76,248

32,359

Lease bonus
928

583

 
928

2,185

Midstream services
7,983

1,417

 
19,378

2,547

Other operating income
2,425


 
4,466


Total revenues
526,273

269,434

 
1,006,468

504,664

Costs and expenses:
 
 
 
 
 
Lease operating expenses
42,647

28,989

 
79,992

55,615

Production and ad valorem taxes
32,202

15,879

 
59,506

31,604

Gathering and transportation
6,813

3,015

 
11,098

5,634

Midstream services
17,601

1,828

 
28,790

2,682

Depreciation, depletion and amortization
129,867

75,173

 
245,083

134,102

General and administrative expenses (including non-cash equity-based compensation, net of capitalized amounts, of $5,650 and $6,168 for the three months ended June 30, 2018 and 2017, respectively, and $13,101 and $13,231 for the six months ended June 30, 2018 and 2017, respectively)
14,529

11,892

 
30,854

25,636

Asset retirement obligation accretion
365

350

 
720

673

Other operating expense
946


 
1,476


Total costs and expenses
244,970

137,126

 
457,519

255,946

Income from operations
281,303

132,308

 
548,949

248,718

Other income (expense):
 
 
 
 
 
Interest expense, net
(17,096
)
(8,245
)
 
(30,797
)
(20,470
)
Other income, net
84,472

8,324

 
87,208

9,469

Gain (loss) on derivative instruments, net
(58,587
)
33,320

 
(90,932
)
71,021

Gain on revaluation of investment
4,465


 
5,364


Total other income (expense), net
13,254

33,399

 
(29,157
)
60,020

Income before income taxes
294,557

165,707

 
519,792

308,738

Provision for (benefit from) income taxes
(6,607
)
1,579

 
40,474

3,536

Net income
301,164

164,128

 
479,318

305,202

Net income attributable to non-controlling interest
82,018

5,723

 
97,360

10,524

Net income attributable to Diamondback Energy, Inc.
$
219,146

$
158,405

 
$
381,958

$
294,678

Earnings per common share:


 


Basic
$
2.22

$
1.61

 
$
3.87

$
3.08

Diluted
$
2.22

$
1.61

 
$
3.87

$
3.07

Weighted average common shares outstanding:
 
 
 
 
 
Basic
98,614

98,142

 
98,584

95,665

Diluted
98,797

98,354

 
98,820

95,925

Dividends declared per share
$
0.125

$

 
$
0.250

$


See accompanying notes to consolidated financial statements.

2

Diamondback Energy, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
(Unaudited)


 
Common Stock
Additional Paid-in Capital
Retained Earnings (Accumulated Deficit)
Non-Controlling Interest
Total
 
Shares
Amount
 
(In thousands)
Balance December 31, 2016
90,144
$
901

$
4,215,955

$
(519,394
)
$
320,830

$
4,018,292

Net proceeds from issuance of common units - Viper Energy Partners LP




147,492

147,492

Unit-based compensation




1,537

1,537

Common units issued for acquisition




3,050

3,050

Stock-based compensation


15,939



15,939

Distribution to non-controlling interest




(14,123
)
(14,123
)
Common shares issued in public offering, net of offering costs


14



14

Common shares issued for acquisition
7,686
77

809,096



809,173

Exercise of stock options and vesting of restricted stock units
299
3

355



358

Net income



294,678

10,524

305,202

Balance June 30, 2017
98,129
$
981

$
5,041,359

$
(224,716
)
$
469,310

$
5,286,934

 
 
 
 
 
 
 
Balance December 31, 2017
98,167
$
982

$
5,291,011

$
(37,133
)
$
326,877

$
5,581,737

Impact of adoption of ASU 2016-01, net of tax
 


(9,393
)
(6,671
)
(16,064
)
Unit-based compensation




1,740

1,740

Stock-based compensation


16,351



16,351

Distribution to non-controlling interest




(38,288
)
(38,288
)
Dividend paid



(12,327
)

(12,327
)
Exercise of stock options and vesting of restricted stock units
452
4

(4
)



Net income



381,958

97,360

479,318

Balance June 30, 2018
98,620
$
986

$
5,307,358

$
323,105

$
381,018

$
6,012,467



















See accompanying notes to consolidated financial statements.

3

Diamondback Energy, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)

 
Six Months Ended June 30,
 
2018
2017
 
 
 
 
(In thousands)
Cash flows from operating activities:
 
 
Net income
$
479,318

$
305,202

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Provision for deferred income taxes
39,966

2,334

Asset retirement obligation accretion
720

673

Depreciation, depletion and amortization
245,083

134,102

Amortization of debt issuance costs
1,434

1,811

Change in fair value of derivative instruments
13,705

(68,010
)
Income from equity investment

(156
)
Gain on revaluation of investment
(5,358
)

Equity-based compensation expense
13,101

13,231

Loss (gain) on sale of assets, net
3,123

(67
)
Changes in operating assets and liabilities:
 
 
Accounts receivable
(1,067
)
(36,137
)
Accounts receivable-related party

289

Restricted cash

500

Inventories
(17,983
)
(3,059
)
Prepaid expenses and other
(2,926
)
(4,966
)
Accounts payable and accrued liabilities
(1,299
)
26,782

Accounts payable and accrued liabilities-related party

(2
)
Accrued interest
(11,953
)
(7,756
)
Income tax payable
(358
)
1,017

Revenues and royalties payable
8,847

28,643

Net cash provided by operating activities
764,353

394,431

Cash flows from investing activities:
 
 
Additions to oil and natural gas properties
(650,058
)
(291,767
)
Additions to midstream assets
(94,503
)
(4,444
)
Purchase of other property, equipment and land
(3,978
)
(13,825
)
Acquisition of leasehold interests
(101,216
)
(1,860,980
)
Acquisition of mineral interests
(253,102
)
(122,679
)
Acquisition of midstream assets

(50,279
)
Proceeds from sale of assets
3,879

1,295

Investment in real estate
(110,480
)

Funds held in escrow
10,989

121,391

Equity investments
(125
)
(188
)
Net cash used in investing activities
(1,198,594
)
(2,221,476
)
Cash flows from financing activities:
 
 
Proceeds from borrowings under credit facility
569,000

266,000

Repayment under credit facility
(388,000
)
(221,000
)
Proceeds from senior notes
312,000


Debt issuance costs
(4,375
)
(1,605
)
Public offering costs
(2,288
)
(296
)
Proceeds from public offerings

147,725

Proceeds from exercise of stock options

358

Dividends to stockholders
(12,327
)

Distributions to non-controlling interest
(38,288
)
(14,123
)

4

Diamondback Energy, Inc. and Subsidiaries
Consolidated Statements of Cash Flows - Continued
(Unaudited)

 
Six Months Ended June 30,
 
2018
2017
 
 
 
Net cash provided by financing activities
435,722

177,059

Net increase (decrease) in cash and cash equivalents
1,481

(1,649,986
)
Cash and cash equivalents at beginning of period
112,446

1,666,574

Cash and cash equivalents at end of period
$
113,927

$
16,588

 
 
 
Supplemental disclosure of cash flow information:
 
 
Interest paid, net of capitalized interest
$
44,199

$
26,500

Supplemental disclosure of non-cash transactions:
 
 
Change in accrued capital expenditures
$
148,701

$
93,415

Capitalized stock-based compensation
$
4,990

$
4,244

Common stock issued for oil and natural gas properties
$

$
809,173

Asset retirement obligations acquired
$
39

$
2,180


See accompanying notes to consolidated financial statements.

5

Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)



1.    DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

Organization and Description of the Business

Diamondback Energy, Inc. (“Diamondback” or the “Company”), together with its subsidiaries, is an independent oil and gas company currently focused on the acquisition, development, exploration and exploitation of unconventional, onshore oil and natural gas reserves in the Permian Basin in West Texas. Diamondback was incorporated in Delaware on December 30, 2011.

The wholly-owned subsidiaries of Diamondback, as of June 30, 2018, include Diamondback E&P LLC, a Delaware limited liability company, Diamondback O&G LLC, a Delaware limited liability company, Viper Energy Partners GP LLC, a Delaware limited liability company, Rattler Midstream LLC (formerly known as White Fang Energy LLC), a Delaware limited liability company, and Tall City Towers LLC, a Delaware limited liability company. The consolidated subsidiaries include these wholly-owned subsidiaries as well as Viper Energy Partners LP, a Delaware limited partnership (the “Partnership”), and the Partnership’s wholly-owned subsidiary Viper Energy Partners LLC, a Delaware limited liability company (the “Operating Company”).

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries after all significant intercompany balances and transactions have been eliminated upon consolidation.

The Partnership is consolidated in the financial statements of the Company. As of June 30, 2018, the Company owned approximately 64% of the Partnership’s total units outstanding. The Company’s wholly-owned subsidiary, Viper Energy Partners GP LLC, is the General Partner of the Partnership.

These financial statements have been prepared by the Company without audit, pursuant to the rules and regulations of the SEC. They reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for interim periods, on a basis consistent with the annual audited financial statements. All such adjustments are of a normal recurring nature. Certain information, accounting policies and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted pursuant to such rules and regulations, although the Company believes the disclosures are adequate to make the information presented not misleading. This Quarterly Report on Form 10–Q should be read in conjunction with the Company’s most recent Annual Report on Form 10–K for the fiscal year ended December 31, 2017, which contains a summary of the Company’s significant accounting policies and other disclosures.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

Certain amounts included in or affecting the Company’s consolidated financial statements and related disclosures must be estimated by management, requiring certain assumptions to be made with respect to values or conditions that cannot be known with certainty at the time the consolidated financial statements are prepared. These estimates and assumptions affect the amounts the Company reports for assets and liabilities and the Company’s disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Actual results could differ from those estimates.

The Company evaluates these estimates on an ongoing basis, using historical experience, consultation with experts and other methods the Company considers reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from the Company’s estimates. Any effects on the Company’s business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known. Significant items subject to such estimates and assumptions include estimates of proved oil and natural gas reserves and related present value estimates of future net cash flows therefrom, the carrying value of oil and natural gas properties, asset retirement obligations, the fair value determination of acquired assets and liabilities assumed, equity-based compensation, fair value estimates of commodity derivatives and estimates of income taxes.

6


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)



Investments

The Partnership has an equity interest in a limited partnership that is so minor that the Partnership has no influence over the limited partnership’s operating and financial policies. This interest was acquired during the year ended December 31, 2014 and is accounted for under the cost method. Effective January 1, 2018, the Partnership adopted Accounting Standards Update 2016-01 which requires the Partnership to measure this investment at fair value which resulted in a downward adjustment of $18.7 million to record the impact of this adoption. For the three months and six months ended June 30, 2018, the Partnership recorded a gain of $4.5 million and $5.4 million, respectively, which then increased the Partnership’s investment balance to $20.4 million, which is included in other assets in the accompanying consolidated balance sheets.

New Accounting Pronouncements

Recently Adopted Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers”. This standard included a five-step revenue recognition model to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. Among other things, the standard also eliminated industry-specific revenue guidance, required enhanced disclosures about revenue, provided guidance for transactions that were not previously addressed comprehensively and improved guidance for multiple-element arrangements. The Company adopted this Accounting Standards Update effective January 1, 2018 using the modified retrospective approach. The Company utilized a bottom-up approach to analyze the impact of the new standard by reviewing its current accounting policies and practices to identify potential differences that would result from applying the requirements of the new standard to its revenue contracts and the impact of adopting this standards update on its total revenues, operating income and its consolidated balance sheet. The adoption of this standard did not result in a cumulative-effect adjustment.

In January 2016, the Financial Accounting Standards Board issued Accounting Standards Update 2016-01, “Financial Instruments–Overall”. This update applies to any entity that holds financial assets or owes financial liabilities. This update requires equity investments (except for those accounted for under the equity method or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. The Partnership adopted this standard effective January 1, 2018 by means of a negative cumulative-effect adjustment totaling $18.7 million.

In August 2016, the Financial Accounting Standards Board issued Accounting Standards Update 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments”. This update apples to all entities that are required to present a statement of cash flows. This update provides guidance on eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies; including bank-owned life insurance policies; distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The Company adopted this update effective January 1, 2018 using the retrospective transition method. Adoption of this standard did not have an effect on the presentation on the Statement of Cash Flows.

In November 2016, the Financial Accounting Standards Board issued Accounting Standards Update 2016-18, “Statement of Cash Flows - Restricted Cash”. This update affects entities that have restricted cash or restricted cash equivalents. The Company adopted this update effective January 1, 2018. The adoption of this update did not have an effect on the presentation on the Statement of Cash Flows.

In January 2017, the Financial Accounting Standards Board issued Accounting Standards Update 2017-01, “Business Combinations - Clarifying the Definition of a Business”. This update apples to all entities that must determine whether they acquired or sold a business. This update provides a screen to determine when a set is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. The Company adopted

7


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


this update prospectively effective January 1, 2018. The adoption of this update did not have an impact on its financial position, results of operations or liquidity.

Accounting Pronouncements Not Yet Adopted

In February 2016, the Financial Accounting Standards Board issued Accounting Standards Update 2016-02, “Leases”. This update applies to any entity that enters into a lease, with some specified scope exemptions. Under this update, a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. While there were no major changes to the lessor accounting, changes were made to align key aspects with the revenue recognition guidance. This update will be effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. Entities will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Company believes the primary impact of adopting this standard will be the recognition of assets and liabilities on the balance sheet for current operating leases. The Company is still evaluating the impact of this standard.

In January 2018, the Financial Accounting Standards Board issued Accounting Standards Update 2018-01, “Leases - Land Easement Practical Expedient for Transition to Topic 842”. This update applies to any entity that holds land easements. The update allows entities to adopt a practical expedient to not evaluate existing or expired land easements under Topic 842 that were not previously accounted for as leases under the current leases guidance. An entity that elects this practical expedient should evaluate new or modified land easements under Topic 842 beginning at the date that the entity adopts Topic 842. The Company believes the adoption of this update will not have an impact on its financial position, results of operations or liquidity.

In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update 2016-13, “Financial Instruments - Credit Losses”. This update affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. This update will be effective for financial statements issued for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. This update will be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company does not believe the adoption of this standard will have a material impact on the Company’s consolidated financial statements since the Company does not have a history of credit losses.

In June 2018, the Financial Accounting Standards Board issued Accounting Standards Update 2018-07, “Stock Compensation - Improvements to Nonemployee Share-Based Payment Accounting”. This update applies the existing employee guidance to nonemployee share-based transactions, with the exception of specific guidance related to the attribution of compensation cost. This update will be effective for financial statements issued for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The Company is currently evaluating the impact of the adoption of this update, but does not believe it will have a material impact.

3.    REVENUE FROM CONTRACTS WITH CUSTOMERS

Revenue from Contracts with Customers

Sales of oil, natural gas and natural gas liquids are recognized at the point control of the product is transferred to the customer. Virtually all of the pricing provisions in the Company’s contracts are tied to a market index, with certain adjustments based on, among other factors, whether a well delivers to a gathering or transmission line, the quality of the oil or natural gas and the prevailing supply and demand conditions. As a result, the price of the oil, natural gas and natural gas liquids fluctuates to remain competitive with other available oil, natural gas and natural gas liquids supplies.

Oil sales

The Company’s oil sales contracts are generally structured where it delivers oil to the purchaser at a contractually agreed-upon delivery point at which the purchaser takes custody, title and risk of loss of the product. Under this arrangement, the Company or a third party transports the product to the delivery point and receives a specified

8


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


index price from the purchaser with no deduction. In this scenario, the Company recognizes revenue when control transfers to the purchaser at the delivery point based on the price received from the purchaser. Oil revenues are recorded net of any third-party transportation fees and other applicable differentials in the Company’s consolidated statements of operations.

Natural gas and natural gas liquids sales

Under the Company’s natural gas processing contracts, it delivers natural gas to a midstream processing entity at the wellhead, battery facilities or the inlet of the midstream processing entity’s system. The midstream processing entity gathers and processes the natural gas and remits proceeds to the Company for the resulting sales of natural gas liquids and residue gas. In these scenarios, the Company evaluates whether it is the principal or the agent in the transaction. For those contracts where the Company has concluded it is the principal and the ultimate third party is its customer, the Company recognizes revenue on a gross basis, with transportation, gathering, processing, treating and compression fees presented as an expense in its consolidated statements of operations.

In certain natural gas processing agreements, the Company may elect to take its residue gas and/or natural gas liquids in-kind at the tailgate of the midstream entity’s processing plant and subsequently market the product. Through the marketing process, the Company delivers product to the ultimate third-party purchaser at a contractually agreed-upon delivery point and receives a specified index price from the purchaser. In this scenario, the Company recognizes revenue when control transfers to the purchaser at the delivery point based on the index price received from the purchaser. The gathering, processing, treating and compression fees attributable to the gas processing contract, as well as any transportation fees incurred to deliver the product to the purchaser, are presented as transportation, gathering, processing, treating and compression expense in its consolidated statements of operations.

Midstream Revenue

Substantially all revenues from gathering, compression, water handling, disposal and treatment operations are derived from intersegment transactions for services Rattler Midstream LLC (“Rattler”) provides to exploration and production operations. The portion of such fees shown in the Company’s consolidated financial statements represent amounts charged to interest owners in the Company’s operated wells, as well as fees charged to other third parties for water handling and treatment services provided by Rattler or usage of Rattler’s gathering and compression systems. For gathering and compression revenue, Rattler satisfies its performance obligations and recognizes revenue when low pressure volumes are delivered to a specified delivery point. Revenue is recognized based on the per MMbtu gathering fee or a per barrel gathering fee charged by Rattler in accordance with the gathering and compression agreement. For water handling and treatment revenue, Rattler satisfies its performance obligations and recognizes revenue when the fresh water volumes have been delivered to the fracwater meter for a specified well pad and the wastewater volumes have been metered downstream of the Company’s facilities. For services contracted through third party providers, Rattler’s performance obligation is satisfied when the service performed by the third party provider has been completed. Revenue is recognized based on the per barrel fresh water delivery or a wastewater gathering and disposal fee charged by Rattler in accordance with the water services agreement.

Transaction price allocated to remaining performance obligations

The Company’s product sales contracts do not originate until production occurs and, therefore, are not considered to exist beyond each days’ production. Therefore, there are no remaining performance obligation under any of our product sales contracts.

Contract balances

Under the Company’s product sales contracts, it has the right to invoice its customers once the performance obligations have been satisfied, at which point payment is unconditional. Accordingly, the Company’s product sales contracts do not give rise to contract assets or liabilities under Accounting Standards Codification 606.

Prior-period performance obligations

The Company records revenue in the month production is delivered to the purchaser. However, settlement statements for certain natural gas and natural gas liquids sales may not be received for 30 to 90 days after the date

9


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


production is delivered, and as a result, the Company is required to estimate the amount of production delivered to the purchaser and the price that will be received for the sale of the product. The Company records the differences between its estimates and the actual amounts received for product sales in the month that payment is received from the purchaser. The Company has existing internal controls for its revenue estimation process and related accruals, and any identified differences between its revenue estimates and actual revenue received historically have not been significant. For the three months ended June 30, 2018, revenue recognized in the reporting period related to performance obligations satisfied in prior reporting periods was not material. The Company believes that the pricing provisions of its oil, natural gas and natural gas liquids contracts are customary in the industry. To the extent actual volumes and prices of oil and natural gas sales are unavailable for a given reporting period because of timing or information not received from third parties, the revenue related to expected sales volumes and prices for those properties are estimated and recorded.

4.    ACQUISITIONS

On January 31, 2018, Tall City Towers LLC, a subsidiary of the Company, completed its acquisition of the Fasken Center office buildings in Midland, TX where the Company’s corporate offices are located for a net purchase price of $109.7 million.

On February 28, 2017, the Company completed its acquisition of certain oil and natural gas properties, midstream assets and other related assets in the Delaware Basin for an aggregate purchase price consisting of $1.74 billion in cash and 7.69 million shares of the Company’s common stock, of which approximately 1.15 million shares were placed in an indemnity escrow. This transaction included the acquisition of (i) approximately 100,306 gross (80,339 net) acres primarily in Pecos and Reeves counties for approximately $2.5 billion and (ii) midstream assets for approximately $47.6 million. The Company used the net proceeds from its December 2016 equity offering, net proceeds from its December 2016 debt offering, cash on hand and other financing sources to fund the cash portion of the purchase price for this acquisition.

The following represents the fair value of the assets and liabilities assumed on the acquisition date. The aggregate consideration transferred was $2.5 billion, resulting in no goodwill or bargain purchase gain.
 
(in thousands)
Proved oil and natural gas properties
$
386,308

Unevaluated oil and natural gas properties
2,122,597

Midstream assets
47,432

Prepaid capital costs
3,460

Oil inventory
839

Equipment
163

Revenues and royalties payable
(9,650
)
Asset retirement obligations
(1,550
)
Total fair value of net assets
$
2,549,599


The Company included in its consolidated statements of operations revenues of $48.0 million and direct operating expenses of $6.9 million for the period from February 28, 2017 to June 30, 2017 due to the acquisition.


10


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


Pro Forma Financial Information

The following unaudited summary pro forma consolidated statement of operations data of Diamondback for the three months and six months ended June 30, 2017 have been prepared to give effect to the February 28, 2017 acquisition as if it had occurred on January 1, 2016. The pro forma data are not necessarily indicative of financial results that would have been attained had the acquisitions occurred on January 1, 2016. The pro forma data also necessarily exclude various operation expenses related to the properties and the financial statements should not be viewed as indicative of operations in future periods.
 
Three Months Ended June 30, 2017
 
Six Months Ended June 30, 2017
 
(in thousands, except per share amounts)
Revenues
$
269,434

 
$
527,593

Income from operations
132,308

 
263,060

Net income
164,128

 
310,414

Basic earnings per common share
1.61

 
3.24

Diluted earnings per common share
1.61

 
3.24


5.    VIPER ENERGY PARTNERS LP

The Partnership is a publicly traded Delaware limited partnership, the common units of which are listed on the Nasdaq Global Market under the symbol “VNOM”. The Partnership was formed by Diamondback on February 27, 2014, to, among other things, own, acquire and exploit oil and natural gas properties in North America. The Partnership is currently focused on oil and natural gas properties in the Permian Basin and the Eagle Ford Shale. Viper Energy Partners GP LLC, a fully-consolidated subsidiary of Diamondback, serves as the general partner of the Partnership. As of June 30, 2018, the Company owned approximately 64% of the Partnership’s total units outstanding.

Recapitalization, Tax Status Election and Related Transactions by Viper

In March 2018, the Partnership announced that the Board of Directors of the General Partner had unanimously approved a change of the Partnership’s federal income tax status from that of a pass-through partnership to that of a taxable entity via a “check the box” election. In connection with making this election, on May 9, 2018 the Partnership (i) amended and restated its First Amended and Restated Partnership Agreement, (ii) amended and restated the First Amended and Restated Limited Liability Company Agreement of the Operating Company, (iii) amended and restated its existing registration rights agreement with the Company and (iv) entered into an exchange agreement with the Company, the General Partner and the Operating Company. Simultaneously with the effectiveness of these agreements, the Company delivered and assigned to the Partnership the 73,150,000 common units the Company owned in exchange for (i) 73,150,000 of the Partnership’s newly-issued Class B units and (ii) 73,150,000 newly-issued units of the Operating Company pursuant to the terms of a Recapitalization Agreement dated March 28, 2018, as amended as of May 9, 2018 (the “Recapitalization Agreement”). Immediately following that exchange, the Partnership continued to be the managing member of the Operating Company, with sole control of its operations, and owned approximately 36% of the outstanding units issued by the Operating Company, and the Company owned the remaining approximately 64% of the outstanding units issued by the Operating Company. The Operating Company units and the Partnership’s Class B units owned by the Company are exchangeable from time to time for the Partnership’s common units (that is, one Operating Company unit and one Partnership Class B unit, together, will be exchangeable for one Partnership common unit).

On May 10, 2018, the change in the Partnership’s income tax status became effective. On that date, pursuant to the terms of the Recapitalization Agreement, (i) the General Partner made a cash capital contribution of $1.0 million to the Partnership in respect of its general partner interest and (ii) the Company made a cash capital contribution of $1.0 million to the Partnership in respect of the Class B units. The Company, as the holder of the Class B units, and the General Partner, as the holder of the general partner interest, are entitled to receive an 8% annual distribution on the outstanding amount of these capital contributions, payable quarterly, as a return on this invested capital. On May 10, 2018, the Company also exchanged 731,500 Class B units and 731,500 units in the Operating Company for 731,500 common units of the Partnership and a cash amount of $10,000 representing a proportionate return of the $1.0 million invested capital in respect of the Class B units. The General Partner continues to serve as the Partnership’s general partner and the Company continues to control the Partnership. After the effectiveness of the tax status election and the

11


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


completion of related transactions, the Partnership’s minerals business continues to be conducted through the Operating Company, which continues to be taxed as a partnership for federal and state income tax purposes. This structure is anticipated to provide significant benefits to the Partnership’s business, including operational effectiveness, acquisition and disposition transactional planning flexibility and income tax efficiency. For additional information regarding the tax status election and related transactions, please refer to the Partnership’s Definitive Information Statement on Schedule 14C filed with the SEC on April 17, 2018 and the Partnership’s Current Report on Form 8-K filed with the SEC on May 15, 2018.

Partnership Agreement

The second amended and restated agreement of limited partnership, dated as of May 9, 2018, as amended as of May 10, 2018 (the “Partnership Agreement”), requires the Partnership to reimburse the General Partner for all direct and indirect expenses incurred or paid on the Partnership’s behalf and all other expenses allocable to the Partnership or otherwise incurred by the General Partner in connection with operating the Partnership’s business. The Partnership Agreement does not set a limit on the amount of expenses for which the General Partner and its affiliates may be reimbursed. These expenses include salary, bonus, incentive compensation and other amounts paid to persons who perform services for the Partnership or on its behalf and expenses allocated to the General Partner by its affiliates. The General Partner is entitled to determine the expenses that are allocable to the Partnership. For the three months ended June 30, 2018 and 2017, the General Partner allocated $0.6 million to the Partnership. For the six months ended June 30, 2018 and 2017, the General Partner allocated $1.2 million to the Partnership.

Tax Sharing

In connection with the closing of the Viper Offering, the Partnership entered into a tax sharing agreement with Diamondback, dated June 23, 2014, pursuant to which the Partnership agreed to reimburse Diamondback for its share of state and local income and other taxes for which the Partnership’s results are included in a combined or consolidated tax return filed by Diamondback with respect to taxable periods including or beginning on June 23, 2014. The amount of any such reimbursement is limited to the tax the Partnership would have paid had it not been included in a combined group with Diamondback. Diamondback may use its tax attributes to cause its combined or consolidated group, of which the Partnership may be a member for this purpose, to owe less or no tax. In such a situation, the Partnership agreed to reimburse Diamondback for the tax the Partnership would have owed had the tax attributes not been available or used for the Partnership’s benefit, even though Diamondback had no cash tax expense for that period. For the three months and six months ended June 30, 2018, the Partnership accrued state income tax expense of $0.2 million for its share of Texas margin tax for which the Partnership’s results are included in a combined tax return filed by Diamondback.

Other Agreements

See Note 12—Related Party Transactions for information regarding the advisory services agreement the Partnership and the General Partner entered into with Wexford Capital LP (“Wexford”).

The Partnership has entered into a secured revolving credit facility with Wells Fargo, as administrative agent sole book runner and lead arranger. See Note 9—Debt for a description of this credit facility.


12


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


6.    PROPERTY AND EQUIPMENT

Property and equipment includes the following:
 
June 30,
December 31,
 
2018
2017
 
 
 
 
(in thousands)
Oil and natural gas properties:
 
 
Subject to depletion
$
6,029,105

$
5,126,829

Not subject to depletion
4,286,320

4,105,865

Gross oil and natural gas properties
10,315,425

9,232,694

Accumulated depletion
(1,237,781
)
(1,009,893
)
Accumulated impairment
(1,143,498
)
(1,143,498
)
Oil and natural gas properties, net
7,934,146

7,079,303

Midstream assets
343,387

191,519

Other property, equipment and land
85,472

80,776

Accumulated depreciation
(19,961
)
(7,981
)
Property and equipment, net of accumulated depreciation, depletion, amortization and impairment
$
8,343,044

$
7,343,617

 
 
 
Balance of costs not subject to depletion:
 
 
Incurred in 2018
$
374,515

 
Incurred in 2017
2,720,793

 
Incurred in 2016
717,065

 
Incurred in 2015
239,745

 
Incurred in 2014
234,202

 
Total not subject to depletion
$
4,286,320

 

The Company uses the full cost method of accounting for its oil and natural gas properties. Under this method, all acquisition, exploration and development costs, including certain internal costs, are capitalized and amortized on a composite unit of production method based on proved oil, natural gas liquids and natural gas reserves. Internal costs capitalized to the full cost pool represent management’s estimate of costs incurred directly related to exploration and development activities such as geological and other administrative costs associated with overseeing the exploration and development activities. Costs, including related employee costs, associated with production and operation of the properties are charged to expense as incurred. All other internal costs not directly associated with exploration and development activities are charged to expense as they are incurred. Capitalized internal costs were approximately $6.7 million and $5.1 million for the three months ended June 30, 2018 and 2017, respectively, and $13.7 million and $10.2 million for the six months ended June 30, 2018 and 2017, respectively. Costs associated with unevaluated properties are excluded from the full cost pool until the Company has made a determination as to the existence of proved reserves. The inclusion of the Company’s unevaluated costs into the amortization base is expected to be completed within three to five years. Acquisition costs not currently being amortized are primarily related to unproved acreage that the Company plans to prove up through drilling. The Company has no plans to let any acreage expire. Sales of oil and natural gas properties, whether or not being amortized currently, are accounted for as adjustments of capitalized costs, with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil, natural gas liquids and natural gas.

Under this method of accounting, the Company is required to perform a ceiling test each quarter. The test determines a limit, or ceiling, on the book value of the proved oil and natural gas properties. Net capitalized costs are limited to the lower of unamortized cost net of deferred income taxes, or the cost center ceiling. The cost center ceiling is defined as the sum of (a) estimated future net revenues, discounted at 10% per annum, from proved reserves, based on the trailing 12-month unweighted average of the first-day-of-the-month price, adjusted for any contract provisions or financial derivatives, if any, that hedge the Company’s oil and natural gas revenue, and excluding the estimated

13


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


abandonment costs for properties with asset retirement obligations recorded on the balance sheet, (b) the cost of properties not being amortized, if any, and (c) the lower of cost or market value of unproved properties included in the cost being amortized, including related deferred taxes for differences between the book and tax basis of the oil and natural gas properties. If the net book value, including related deferred taxes, exceeds the ceiling, an impairment or non-cash writedown is required.

At June 30, 2018, there was $90.0 million in exploration costs and development costs and $35.5 million in capitalized interest that was not subject to depletion. At December 31, 2017, there were $26.0 million in exploration costs and development costs and $22.1 million in capitalized interest that was not subject to depletion.

7.    ASSET RETIREMENT OBLIGATIONS

The following table describes the changes to the Company’s asset retirement obligation liability for the following periods:
 
Six Months Ended June 30,
 
2018
2017
 
 
 
 
(in thousands)
Asset retirement obligations, beginning of period
$
21,285

$
17,422

Additional liabilities incurred
1,535

990

Liabilities acquired
39

2,180

Liabilities settled
(1,420
)
(149
)
Accretion expense
720

673

Revisions in estimated liabilities
15

(2
)
Asset retirement obligations, end of period
22,174

21,114

Less current portion
394

1,575

Asset retirement obligations - long-term
$
21,780

$
19,539


The Company’s asset retirement obligations primarily relate to the future plugging and abandonment of wells and related facilities. The Company estimates the future plugging and abandonment costs of wells, the ultimate productive life of the properties, a risk-adjusted discount rate and an inflation factor in order to determine the current present value of this obligation. To the extent future revisions to these assumptions impact the present value of the existing asset retirement obligation liability, a corresponding adjustment is made to the oil and natural gas property balance. The current portion of the asset retirement obligation liability is included in other accrued liabilities in the Company’s consolidated balance sheets.

8.    EQUITY METHOD INVESTMENTS

In October 2014, the Company obtained a 25% interest in HMW Fluid Management LLC (“HMW LLC”), which was formed to develop, own and operate an integrated water management system to gather, store, process, treat, distribute and dispose of water to exploration and production companies operating in Midland, Martin and Andrews Counties, Texas. On June 30, 2018, HMW LLC’s operating agreement was amended effective January 1, 2018. As a result of the amendment, the Company will no longer recognize an equity investment in HMW LLC but will instead consolidate its interests in the net assets of HMW LLC. In exchange for the Company’s 25% investment, the Company received a 50% undivided ownership interest in two of the four salt water disposal wells and associated assets previously owned by HMW LLC. The Company’s basis in the assets is equivalent to its basis in the equity investment in HMW LLC. During the six months ended June 30, 2017, the Company invested $0.2 million in this entity and recorded $0.2 million, which is the Company’s share of HMW LLC’s net income, bringing its total investment to $6.7 million at June 30, 2017.




14


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


9.    DEBT

Long-term debt consisted of the following as of the dates indicated:
 
June 30,
December 31,
 
2018
2017
 
 
 
 
(in thousands)
4.750 % Senior Notes due 2024
$
500,000

$
500,000

5.375 % Senior Notes due 2025
800,000

500,000

Unamortized debt issuance costs
(15,736
)
(13,153
)
Unamortized premium costs
11,310


Revolving credit facility
321,500

397,000

Partnership revolving credit facility
350,000

93,500

Total long-term debt
$
1,967,074

$
1,477,347


2024 Senior Notes

On October 28, 2016, the Company issued $500.0 million in aggregate principal amount of 4.750% Senior Notes due 2024 (the “2024 Senior Notes”). The 2024 Senior Notes bear interest at a rate of 4.750% per annum, payable semi-annually, in arrears on May 1 and November 1 of each year, commencing on May 1, 2017 and will mature on November 1, 2024. All of the Company’s existing and future restricted subsidiaries that guarantee its revolving credit facility or certain other debt guarantee the 2024 Senior Notes; provided, however, that the 2024 Senior Notes are not guaranteed by the Partnership, the General Partner, Viper Energy Partners LLC or Rattler Midstream LLC, and will not be guaranteed by any of the Company’s future unrestricted subsidiaries.

The 2024 Senior Notes were issued under, and are governed by, an indenture among the Company, the subsidiary guarantors party thereto and Wells Fargo, as the trustee, as supplemented (the “2024 Indenture”). The 2024 Indenture contains certain covenants that, subject to certain exceptions and qualifications, among other things, limit the Company’s ability and the ability of the restricted subsidiaries to incur or guarantee additional indebtedness, make certain investments, declare or pay dividends or make other distributions on capital stock, prepay subordinated indebtedness, sell assets including capital stock of restricted subsidiaries, agree to payment restrictions affecting the Company’s restricted subsidiaries, consolidate, merge, sell or otherwise dispose of all or substantially all of its assets, enter into transactions with affiliates, incur liens, engage in business other than the oil and natural gas business and designate certain of the Company’s subsidiaries as unrestricted subsidiaries.

The Company may on any one or more occasions redeem some or all of the 2024 Senior Notes at any time on or after November 1, 2019 at the redemption prices (expressed as percentages of principal amount) of 103.563% for the 12-month period beginning on November 1, 2019, 102.375% for the 12-month period beginning on November 1, 2020, 101.188% for the 12-month period beginning on November 1, 2021 and 100.000% beginning on November 1, 2022 and at any time thereafter with any accrued and unpaid interest to, but not including, the date of redemption. Prior to November 1, 2019, the Company may on any one or more occasions redeem all or a portion of the 2024 Senior Notes at a price equal to 100% of the principal amount of the 2024 Senior Notes plus a “make-whole” premium and accrued and unpaid interest to the redemption date. In addition, any time prior to November 1, 2019, the Company may on any one or more occasions redeem the 2024 Senior Notes in an aggregate principal amount not to exceed 35% of the aggregate principal amount of the 2024 Senior Notes issued prior to such date at a redemption price of 104.750%, plus accrued and unpaid interest to the redemption date, with an amount equal to the net cash proceeds from certain equity offerings.

2025 Senior Notes

On December 20, 2016, the Company issued $500.0 million in aggregate principal amount of 5.375% Senior Notes due 2025 (the “2025 Senior Notes”). The 2025 Senior Notes bear interest at a rate of 5.375% per annum, payable semi-annually, in arrears on May 31 and November 30 of each year, commencing on May 31, 2017 and will mature on May 31, 2025. All of the Company’s existing and future restricted subsidiaries that guarantee its revolving credit

15


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


facility or certain other debt guarantee the 2025 Senior Notes, provided, however, that the 2025 Senior Notes are not guaranteed by the Partnership, the General Partner, Viper Energy Partners LLC or Rattler Midstream LLC, and will not be guaranteed by any of the Company’s future unrestricted subsidiaries.
On January 29, 2018, the Company issued $300.0 million aggregate principal amount of new 5.375% Senior Notes due 2025 (the “New 2025 Notes”) as additional notes under, and subject to the terms of, the 2025 Indenture. The New 2025 Notes were issued in a transaction exempt from the registration requirements under the Securities Act. The Company received approximately $308.4 million in net proceeds, after deducting the initial purchaser’s discount and its estimated offering expenses, but disregarding accrued interest, from the issuance of the New 2025 Notes. The Company used the net proceeds from the issuance of the New 2025 Notes to repay a portion of the outstanding borrowings under its revolving credit facility.
The 2025 Indenture contains certain covenants that, subject to certain exceptions and qualifications, among other things, limit the Company’s ability and the ability of the restricted subsidiaries to incur or guarantee additional indebtedness, make certain investments, declare or pay dividends or make other distributions on capital stock, prepay subordinated indebtedness, sell assets including capital stock of restricted subsidiaries, agree to payment restrictions affecting the Company’s restricted subsidiaries, consolidate, merge, sell or otherwise dispose of all or substantially all of the Company’s assets, enter into transactions with affiliates, incur liens, engage in business other than the oil and natural gas business and designate certain of the Company’s subsidiaries as unrestricted subsidiaries.
The Company may on any one or more occasions redeem some or all of the 2025 Senior Notes (including the New 2025 Notes) at any time on or after May 31, 2020 at the redemption prices (expressed as percentages of principal amount) of 104.031% for the 12-month period beginning on May 31, 2020, 102.688% for the 12-month period beginning on May 31, 2021, 101.344% for the 12-month period beginning on May 31, 2022 and 100.000% beginning on May 31, 2023 and at any time thereafter with any accrued and unpaid interest to, but not including, the date of redemption. Prior to May 31, 2020, the Company may on any one or more occasions redeem all or a portion of the 2025 Senior Notes (including the New 2025 Notes) at a price equal to 100% of the principal amount of the 2025 Senior Notes (including the New 2025 Notes) plus a “make-whole” premium and accrued and unpaid interest to the redemption date. In addition, any time prior to May 31, 2020, the Company may on any one or more occasions redeem the 2025 Senior Notes (including the New 2025 Notes) in an aggregate principal amount not to exceed 35% of the aggregate principal amount of the 2025 Senior Notes (including the New 2025 Notes) issued prior to such date at a redemption price of 105.375%, plus accrued and unpaid interest to the redemption date, with an amount equal to the net cash proceeds from certain equity offerings.

The Company’s Credit Facility

The Company and Diamondback O&G LLC, as borrower, entered into the second amended and restated credit agreement, dated November 1, 2013, as amended on June 9, 2014, November 13, 2014, June 21, 2016, December 15, 2016 and November 28, 2017, with a syndicate of banks, including Wells Fargo, as administrative agent, and its affiliate Wells Fargo Securities, LLC, as sole book runner and lead arranger. The credit agreement provides for a revolving credit facility in the maximum credit amount of $5.0 billion, subject to a borrowing base based on the Company’s oil and natural gas reserves and other factors (the “borrowing base”). The borrowing base is scheduled to be redetermined, under certain circumstances, annually with an effective date of May 1st, and, under certain circumstances, semi-annually with effective dates of May 1st and November 1st. In addition, the Company and Wells Fargo may each request up to two interim redeterminations of the borrowing base during any 12-month period. As of June 30, 2018, the borrowing base was set at $2.0 billion, the Company had elected a commitment amount of $1.0 billion and the Company had $321.5 million of outstanding borrowings under the revolving credit facility and $678.5 million available for future borrowings under its revolving credit facility.
Diamondback O&G LLC is the borrower under the credit agreement. As of December 31, 2017, the credit agreement is guaranteed by the Company, Diamondback E&P LLC and Rattler Midstream LLC (formerly known as White Fang Energy LLC) and will also be guaranteed by any of the Company’s future subsidiaries that are classified as restricted subsidiaries under the credit agreement. The credit agreement is also secured by substantially all of the assets of the Company, Diamondback O&G LLC and the guarantors.
The outstanding borrowings under the credit agreement bear interest at a per annum rate elected by the Company that is equal to an alternate base rate (which is equal to the greatest of the prime rate, the Federal Funds effective rate

16


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


plus 0.5%, and 3-month LIBOR plus 1.0%) or LIBOR, in each case plus the applicable margin. The applicable margin ranges from 0.25% to 1.25% in the case of the alternate base rate and from 1.25% to 2.25% in the case of LIBOR, in each case depending on the amount of loans and letters of credit outstanding in relation to the commitment, which is defined as the least of the maximum credit amount, the borrowing base and the elected commitment amount. The Company is obligated to pay a quarterly commitment fee ranging from 0.375% to 0.500% per year on the unused portion of the commitment, which fee is also dependent on the amount of loans and letters of credit outstanding in relation to the commitment. Loan principal may be optionally repaid from time to time without premium or penalty (other than customary LIBOR breakage), and is required to be repaid (a) to the extent the loan amount exceeds the commitment or the borrowing base, whether due to a borrowing base redetermination or otherwise (in some cases subject to a cure period), (b) in an amount equal to the net cash proceeds from the sale of property when a borrowing base deficiency or event of default exists under the credit agreement and (c) at the maturity date of November 1, 2022.
The credit agreement contains various affirmative, negative and financial maintenance covenants. These covenants, among other things, limit additional indebtedness, additional liens, sales of assets, mergers and consolidations, dividends and distributions, transactions with affiliates and entering into certain swap agreements and require the maintenance of the financial ratios described below.
Financial Covenant
 
Required Ratio
Ratio of total net debt to EBITDAX, as defined in the credit agreement
Not greater than 4.0 to 1.0
Ratio of current assets to liabilities, as defined in the credit agreement
Not less than 1.0 to 1.0

The covenant prohibiting additional indebtedness, as amended in November 2017, allows for the issuance of unsecured debt in the form of senior or senior subordinated notes if no default would result from the incurrence of such debt after giving effect thereto and if, in connection with any such issuance, the borrowing base is reduced by 25% of the stated principal amount of each such issuance.
As of June 30, 2018 and December 31, 2017, the Company was in compliance with all financial covenants under its revolving credit facility, as then in effect. The lenders may accelerate all of the indebtedness under the Company’s revolving credit facility upon the occurrence and during the continuance of any event of default. The credit agreement contains customary events of default, including non-payment, breach of covenants, materially incorrect representations, cross-default, bankruptcy and change of control. There are no cure periods for events of default due to non-payment of principal and breaches of negative and financial covenants, but non-payment of interest and breaches of certain affirmative covenants are subject to customary cure periods.

The Partnership’s Credit Agreement

On July 8, 2014, the Partnership entered into a secured revolving credit agreement with Wells Fargo, as administrative agent, certain other lenders and the Operating Company, the Partnership’s consolidated subsidiary, as guarantor. On May 8, 2018, the Operating Company assumed all liabilities as borrower under the credit agreement and the Partnership became a guarantor of the credit agreement. On July 20, 2018, the Operating Company, the Partnership, Wells Fargo and the other lenders amended and restated the credit agreement to reflect the assumption by the Operating Company.

The credit agreement, as amended and restated, provides for a revolving credit facility in the maximum credit amount of $2.0 billion and a borrowing base based on the Partnership’s oil and natural gas reserves and other factors (the “borrowing base”) of $475.0 million, subject to scheduled semi-annual and other borrowing base redeterminations. The borrowing base is scheduled to be re-determined semi-annually with effective dates of May 1st and November 1st. In addition, the Operating Company and Wells Fargo each may request up to three interim redeterminations of the borrowing base during any 12-month period. As of June 30, 2018, the borrowing base was set at $475.0 million, and there was $350.0 million of outstanding borrowings and $125.0 million available for future borrowings under the revolving credit facility.

The outstanding borrowings under the credit agreement bear interest at a per annum rate elected by the Operating Company that is equal to an alternate base rate (which is equal to the greatest of the prime rate, the Federal Funds effective rate plus 0.5% and 3-month LIBOR plus 1.0%) or LIBOR, in each case plus the applicable margin. The applicable margin ranges from 0.75% to 1.75% per annum in the case of the alternate base rate and from 1.75% to 2.75% per annum in the case of LIBOR, in each case depending on the amount of loans and letters of credit outstanding

17


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


in relation to the commitment, which is defined as the lesser of the maximum credit amount and the borrowing base. The Operating Company is obligated to pay a quarterly commitment fee ranging from 0.375% to 0.500% per year on the unused portion of the commitment, which fee is also dependent on the amount of loans and letters of credit outstanding in relation to the commitment. Loan principal may be optionally repaid from time to time without premium or penalty (other than customary LIBOR breakage), and is required to be repaid (i) to the extent the loan amount exceeds the commitment or the borrowing base, whether due to a borrowing base redetermination or otherwise (in some cases subject to a cure period), (ii) in an amount equal to the net cash proceeds from the sale of property when a borrowing base deficiency or event of default exists under the credit agreement and (iii) at the maturity date of November 1, 2022. The loan is secured by substantially all of the assets of the Partnership and the Operating Company.

The credit agreement contains various affirmative, negative and financial maintenance covenants. These covenants, among other things, limit additional indebtedness, purchases of margin stock, additional liens, sales of assets, mergers and consolidations, dividends and distributions, transactions with affiliates and entering into certain swap agreements, and require the maintenance of the financial ratios described below:
Financial Covenant
 
Required Ratio
Ratio of total net debt to EBITDAX, as defined in the credit agreement
Not greater than 4.0 to 1.0
Ratio of current assets to liabilities, as defined in the credit agreement
Not less than 1.0 to 1.0

The covenant prohibiting additional indebtedness allows for the issuance of unsecured debt of up to $400.0 million in the form of senior unsecured notes and, in connection with any such issuance, the reduction of the borrowing base by 25% of the stated principal amount of each such issuance. A borrowing base reduction in connection with such issuance may require a portion of the outstanding principal of the loan to be repaid.

The lenders may accelerate all of the indebtedness under the credit agreement upon the occurrence and during the continuance of any event of default. The credit agreement contains customary events of default, including non-payment, breach of covenants, materially incorrect representations, cross-default, bankruptcy and change of control. There are no cure periods for events of default due to non-payment of principal and breaches of negative and financial covenants, but non-payment of interest and breaches of certain affirmative covenants are subject to customary cure periods.

10.    CAPITAL STOCK AND EARNINGS PER SHARE

Diamondback completed no equity offerings during the six months ended June 30, 2018 and June 30, 2017.

Partnership Equity Offerings

In January 2017, the Partnership completed an underwritten public offering of 9,775,000 common units, which included 1,275,000 common units issued pursuant to an option to purchase additional common units granted to the underwriters. The Partnership received net proceeds from this offering of approximately $147.5 million, after deducting underwriting discounts and commissions and estimated offering expenses, of which the Partnership used $120.5 million to repay the outstanding borrowings under its revolving credit agreement and the balance was used for general partnership purposes, which included additional acquisitions.
Earnings Per Share

The Company’s basic earnings per share amounts have been computed based on the weighted-average number of shares of common stock outstanding for the period. Diluted earnings per share include the effect of potentially dilutive shares outstanding for the period. Additionally, for the diluted earnings per share computation, the per share earnings of the Partnership are included in the consolidated earnings per share computation based on the consolidated group’s holdings of the subsidiary.


18


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


A reconciliation of the components of basic and diluted earnings per common share is presented in the table below:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
2017
 
2018
2017
 
(in thousands, except per share amounts)
Net income attributable to common stock
$
219,146

$
158,405

 
$
381,958

$
294,678

Weighted average common shares outstanding
 
 
 
 
 
Basic weighted average common units outstanding
98,614

98,142

 
98,584

95,665

Effect of dilutive securities:
 
 
 
 
 
Potential common shares issuable
183

212

 
236

260

Diluted weighted average common shares outstanding
98,797

98,354

 
98,820

95,925

Basic net income attributable to common stock
$
2.22

$
1.61

 
$
3.87

$
3.08

Diluted net income attributable to common stock
$
2.22

$
1.61

 
$
3.87

$
3.07


For the three months ended June 30, 2018 and 2017, there were 31,826 shares and 64,411 shares, respectively, and during the both six months ended June 30, 2018 and 2017, there were no shares that were not included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive for the periods presented. These shares could dilute basic earnings per share in future periods.

11.    EQUITY-BASED COMPENSATION

The following table presents the effects of the equity compensation plans and related costs:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
2017
 
2018
2017
 
(in thousands)
General and administrative expenses
$
5,650

$
6,168

 
$
13,101

$
13,231

Equity-based compensation capitalized pursuant to full cost method of accounting for oil and natural gas properties
2,349

1,901

 
4,990

4,244


Restricted Stock Units

The following table presents the Company’s restricted stock units activity under the Equity Plan during the six months ended June 30, 2018:
 
Restricted Stock
Awards & Units
Weighted Average Grant-Date
Fair Value
Unvested at December 31, 2017
243,577

$
90.88

Granted
81,633

$
113.81

Vested
(115,711
)
$
86.75

Forfeited
(5,672
)
$
92.78

Unvested at June 30, 2018
203,827

$
102.86


The aggregate fair value of restricted stock units that vested during the six months ended June 30, 2018 and 2017 was $10.0 million and $11.4 million, respectively. As of June 30, 2018, the Company’s unrecognized compensation cost related to unvested restricted stock awards and units was $15.0 million. Such cost is expected to be recognized over a weighted-average period of 1.6 years.


19


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


Performance Based Restricted Stock Units

To provide long-term incentives for the executive officers to deliver competitive returns to the Company’s stockholders, the Company has granted performance-based restricted stock units to eligible employees. The ultimate number of shares awarded from these conditional restricted stock units is based upon measurement of total stockholder return of the Company’s common stock (“TSR”) as compared to a designated peer group during a two-year or three-year performance period.

In February 2018, eligible employees received performance restricted stock unit awards totaling 117,423 units from which a minimum of 0% and a maximum of 200% units could be awarded. The awards have a performance period of January 1, 2018 to December 31, 2020 and cliff vest at December 31, 2020.

The fair value of each performance restricted stock unit is estimated at the date of grant using a Monte Carlo simulation, which results in an expected percentage of units to be earned during the performance period.

The following table presents a summary of the grant-date fair values of performance restricted stock units granted and the related assumptions for the February 2018 awards.
 
2018
 
Three-Year Performance Period
Grant-date fair value
$
170.45

Risk-free rate
1.99
%
Company volatility
35.90
%

The following table presents the Company’s performance restricted stock units activity under the Equity Plan for the six months ended June 30, 2018:
 
Performance Restricted Stock Units
Weighted Average Grant-Date Fair Value
Unvested at December 31, 2017
202,326

$
139.83

Granted
285,737

$
130.96

Vested
(168,314
)
$
103.41

Unvested at June 30, 2018(1)
319,749

$
151.08

(1)
A maximum of 639,498 units could be awarded based upon the Company’s final TSR ranking.

As of June 30, 2018, the Company’s unrecognized compensation cost related to unvested performance based restricted stock awards and units was $27.6 million. Such cost is expected to be recognized over a weighted-average period of 1.5 years.

Phantom Units

Under the Viper LTIP, the Board of Directors of the General Partner is authorized to issue phantom units to eligible employees. The Partnership estimates the fair value of phantom units as the closing price of the Partnership’s common units on the grant date of the award, which is expensed over the applicable vesting period. Upon vesting the phantom units entitle the recipient one common unit of the Partnership for each phantom unit.


20


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


The following table presents the phantom unit activity under the Viper LTIP for the six months ended June 30, 2018.
 
Phantom Units
 
Weighted Average Grant-Date
Fair Value
Unvested at December 31, 2017
105,439

 
$
17.10

Granted
101,403

 
$
23.18

Vested
(46,379
)
 
$
21.41

Unvested at June 30, 2018
160,463

 
$
19.70


The aggregate fair value of phantom units that vested during the six months ended June 30, 2018 was $1.0 million. As of June 30, 2018, the unrecognized compensation cost related to unvested phantom units was $1.9 million. Such cost is expected to be recognized over a weighted-average period of 1.1 years.

12.    RELATED PARTY TRANSACTIONS

Advisory Services Agreement - The Partnership

In connection with the closing of the Viper Offering, the Partnership and the General Partner entered into an advisory services agreement (the “Viper Advisory Services Agreement”) with Wexford, dated as of June 23, 2014, under which Wexford provides the Partnership and the General Partner with general financial and strategic advisory services related to the business in return for an annual fee of $0.5 million, plus reasonable out-of-pocket expenses. The Viper Advisory Services Agreement had an initial term of two years commencing on June 23, 2014, and will continue for additional one-year periods unless terminated in writing by either party at least ten days prior to the expiration of the then current term. The Partnership did not pay any amounts during the three months and six months ended June 30, 2018 or June 30, 2017 under the Viper Advisory Services Agreement.

Lease Bonus - The Partnership
During the three months and six months ended June 30, 2018, the Company did not pay the Partnership any lease bonus payments. During the three months ended June 30, 2017, the Company paid the Partnership $0.1 million in lease bonus payments to extend the term of one lease, reflecting an average bonus of $10,000 per acre. During the six months ended June 30, 2017, the Company paid the Partnership $0.1 million in lease bonus payments to extend the term of two leases, reflecting an average bonus of $7,459 per acre.
13.    INCOME TAXES

The Company’s effective income tax rates were 7.8% and 1.1% for the six months ended June 30, 2018 and 2017, respectively. Total income tax expense for the six months ended June 30, 2018 differed from amounts computed by applying the United States federal statutory tax rate to pre-tax income primarily due to (i) the impact of deferred taxes recognized by the Partnership as a result of its change in tax status, (ii) current and deferred state income taxes, (iii) net income attributable to the non-controlling interest, and (iv) the impact of permanent differences between book and taxable income. The Company recorded a discrete income tax benefit of approximately $0.3 million related to equity-based compensation for the six months ended June 30, 2018 and a discrete benefit of $72.7 million related to deferred taxes on the Partnership’s investment in the Operating Company arising from the change in the Partnership’s tax status. Total income tax expense for the six months ended June 30, 2018 differed from amounts computed by applying the federal statutory rate to pre-tax income primarily due to state income taxes and the change in the valuation allowance which offset the Company’s federal net deferred tax position in that period.

The Tax Cuts and Jobs Act, a historic reform of the U.S. federal income tax statutes, was enacted on December 22, 2017. As of the completion of the Company’s financial statements for the year ended December 31, 2017, the Company had substantially completed its accounting for the effects of the enactment of the Tax Cuts and Jobs Act and, with respect to those items for which the Company’s accounting was not complete, the Company made reasonable estimates of the effects on its deferred tax balances. At June 30, 2018, the Company has not made an adjustment to the provisional estimates recorded for the year ended December 31, 2017. The Company has considered in its estimated

21


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


annual effective tax rate for 2018 the impact of the statutory changes enacted by the Tax Cuts and Jobs Act, including reasonable estimates of those provisions effective for the 2018 tax year.

As discussed further in Note 5, on March 29, 2018, the Partnership announced that the Board of Directors of its General Partner had unanimously approved a change of the Partnership’s federal income tax status from that of a pass-through partnership to that of a taxable entity, which change became effective on May 10, 2018. The transactions undertaken in connection with the change in the Partnership’s tax status were not taxable to the Company. Subsequent to the Partnership’s change in tax status, the Partnership’s provision for income taxes for the period ended June 30, 2018 is based on its estimated annual effective tax rate plus discrete items. As such, the Partnership’s provision for income taxes is included in the Company’s consolidated financial statements and to the extent applicable, in net income attributable to the non-controlling interest.

14.    DERIVATIVES

All derivative financial instruments are recorded at fair value. The Company has not designated its derivative instruments as hedges for accounting purposes and, as a result, marks its derivative instruments to fair value and recognizes the cash and non-cash changes in fair value in the combined consolidated statements of operations under the caption “Gain (loss) on derivative instruments, net.”

The Company has used fixed price swap contracts, fixed price basis swap contracts and three-way costless collars with corresponding put, short put and call options to reduce price volatility associated with certain of its oil and natural gas sales. With respect to the Company’s fixed price swap contracts and fixed price basis swap contracts, the counterparty is required to make a payment to the Company if the settlement price for any settlement period is less than the swap or basis price, and the Company is required to make a payment to the counterparty if the settlement price for any settlement period is greater than the swap or basis price. The Company has fixed price basis swaps for the spread between the WTI Midland price and the WTI Cushing price.

Under the Company’s costless collar contracts, a three-way collar is a combination of three options: a ceiling call, a floor put, and a short put. The counterparty is required to make a payment to the Company if the settlement price for any settlement period is less than the ceiling price to a maximum of the difference between the floor price and the short put price.  The Company is required to make a payment to the counterparty if the settlement price for any settlement period is greater than the ceiling price. If the settlement price is between the floor and the ceiling price, there is no payment required.

The Company’s derivative contracts are based upon reported settlement prices on commodity exchanges, with crude oil derivative settlements based on New York Mercantile Exchange West Texas Intermediate pricing (Cushing and Magellan East Houston) and Crude Oil Brent, and with natural gas derivative settlements based on the New York Mercantile Exchange Henry Hub pricing.

By using derivative instruments to hedge exposure to changes in commodity prices, the Company exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk. The Company’s counterparties are participants in the secured second amended and restated credit agreement, which is secured by substantially all of the assets of the guarantor subsidiaries; therefore, the Company is not required to post any collateral. The Company does not require collateral from its counterparties. The Company has entered into derivative instruments only with counterparties that are also lenders in our credit facility and have been deemed an acceptable credit risk.


22


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


As of June 30, 2018, the Company had the following outstanding derivative contracts. When aggregating multiple contracts, the weighted average contract price is disclosed.
 
2018
 
2019
 
Volume (Bbls/MMBtu)
 
Fixed Price Swap (per Bbl/MMBtu)
 
Volume (Bbls/MMBtu)
 
Fixed Price Swap (per Bbl/MMBtu)
Oil Swaps - WTI Cushing
4,876,000

 
$
51.27

 
1,638,000
 
$
52.78

Oil Swaps - WTI Magellan East Houston
460,000

 
$
69.64

 
450,000
 
$
68.17

Oil Swaps - BRENT
1,472,000

 
$
59.69

 
725,000
 
$
72.63

Oil Basis Swaps
2,760,000

 
$
(0.88
)
 
0
 
$

Natural Gas Swaps
3,680,000

 
$
3.04

 
0
 
$


 
October 2018 - December 2018
 
January 2019 - June 2019
Oil Three-Way Collars
WTI Magellan East Houston
 
WTI Cushing
 
Brent
 
WTI Magellan East Houston
Volume (Bbls)
276,000
 
1,810,000
 
2,000,000
 
270,000
Short put price (per Bbl)
$
55.00

 
$
45.00

 
$
55.00

 
$
55.00

Floor price (per Bbl)
$
65.00

 
$
55.00

 
$
65.00

 
$
65.00

Ceiling price (per Bbl)
$
78.78

 
$
70.23

 
$
82.47

 
$
76.83


Balance sheet offsetting of derivative assets and liabilities

The fair value of swaps is generally determined using established index prices and other sources which are based upon, among other things, futures prices and time to maturity. These fair values are recorded by netting asset and liability positions that are with the same counterparty and are subject to contractual terms which provide for net settlement.

The following tables present the gross amounts of recognized derivative assets and liabilities, the amounts offset under master netting arrangements with counterparties and the resulting net amounts presented in the Company’s consolidated balance sheets as of June 30, 2018 and December 31, 2017.
 
June 30, 2018
December 31, 2017
 
(in thousands)
Gross amounts of assets presented in the Consolidated Balance Sheet
$

$
531

Net amounts of assets presented in the Consolidated Balance Sheet

531

 
 
 
Gross amounts of liabilities presented in the Consolidated Balance Sheet
119,844

106,670

Net amounts of liabilities presented in the Consolidated Balance Sheet
$
119,844

$
106,670



23


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


The net amounts are classified as current or noncurrent based on their anticipated settlement dates. The net fair value of the Company’s derivative assets and liabilities and their locations on the consolidated balance sheet are as follows:
 
June 30, 2018
December 31, 2017
 
(in thousands)
Current assets: derivative instruments
$

$
531

Noncurrent assets: derivative instruments


Total assets
$

$
531

Current liabilities: derivative instruments
$
111,330

$
100,367

Noncurrent liabilities: derivative instruments
8,514

6,303

Total liabilities
$
119,844

$
106,670


None of the Company’s derivatives have been designated as hedges. As such, all changes in fair value are immediately recognized in earnings. The following table summarizes the gains and losses on derivative instruments included in the consolidated statements of operations:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
2017
 
2018
2017
 
(in thousands)
Change in fair value of open non-hedge derivative instruments
$
(13,667
)
$
28,635

 
$
(13,705
)
$
68,010

Gain (loss) on settlement of non-hedge derivative instruments
(44,920
)
4,685

 
(77,227
)
3,011

Gain (loss) on derivative instruments
$
(58,587
)
$
33,320

 
$
(90,932
)
$
71,021


15.    FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.

The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value. The Company’s assessment of the significance of a particular input to the fair value measurements requires judgment and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy. The Company uses appropriate valuation techniques based on available inputs to measure the fair values of its assets and liabilities.
 
Level 1 - Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets as of the reporting date.

Level 2 - Observable market-based inputs or unobservable inputs that are corroborated by market data. These are inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date.

Level 3 - Unobservable inputs that are not corroborated by market data and may be used with internally developed methodologies that result in management’s best estimate of fair value.

Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.


24


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


Assets and Liabilities Measured at Fair Value on a Recurring Basis

Certain assets and liabilities are reported at fair value on a recurring basis, including the Company’s derivative instruments and cost method investment. The fair values of the Company’s fixed price swaps, fixed price basis swaps and costless collars are measured internally using established commodity futures price strips for the underlying commodity provided by a reputable third party, the contracted notional volumes, and time to maturity. These valuations are Level 2 inputs.

The following table provides fair value measurement information for financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017.
 
June 30, 2018
December 31, 2017
 
(in thousands)
Fixed price swaps:
 
 
Quoted prices in active markets level 1
$
20,438

$

Significant other observable inputs level 2
(119,844
)
(106,139
)
Significant unobservable inputs level 3


Total
$
(99,406
)
$
(106,139
)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The following table provides the fair value of financial instruments that are not recorded at fair value in the consolidated balance sheets:
 
June 30, 2018
December 31, 2017
 
Carrying
 
Carrying
 
 
Amount
Fair Value
Amount
Fair Value
 
(in thousands)
Debt:
 
 
 
 
Revolving credit facility
$
321,500

$
321,500

$
397,000

$
397,000

4.750% Senior Notes due 2024
500,000

488,750

500,000

501,855

5.375% Senior Notes due 2025
800,000

800,000

500,000

515,000

Partnership revolving credit facility
350,000

350,000

93,500

93,500


The fair value of the revolving credit facility and the Partnership’s revolving credit facility approximates their carrying value based on borrowing rates available to the Company for bank loans with similar terms and maturities and is classified as Level 2 in the fair value hierarchy. The fair value of the Senior Notes was determined using the June 30, 2018 quoted market price, a Level 1 classification in the fair value hierarchy.

16.    COMMITMENTS AND CONTINGENCIES

The Company could be subject to various possible loss contingencies which arise primarily from interpretation of federal and state laws and regulations affecting the natural gas and crude oil industry. Such contingencies include differing interpretations as to the prices at which natural gas and crude oil sales may be made, the prices at which royalty owners may be paid for production from their leases, environmental issues and other matters. Management believes it has complied with the various laws and regulations, administrative rulings and interpretations.

17.    SUBSEQUENT EVENTS

Recent Acquisition

On July 22, 2018, the Company entered into a definitive purchase agreement to acquire all leasehold interests and related assets of Ajax Resources, LLC which includes approximately 25,493 net leasehold acres in the Northern Midland Basin for $900.0 million in cash and approximately 2.6 million shares of the Company’s common stock,

25


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


subject to certain adjustments. This transaction is expected to close at the end of October 2018, effective as of July 1, 2018. The cash portion of this transaction is expected to be funded through a combination of cash on hand, proceeds from the sale of assets to the Partnership (described below), borrowing under the Company's revolving credit facility and/or proceeds from one more capital markets transactions, which may include a debt offering.

Pending Drop-down Transaction
On July 27, 2018, the Company entered into a definitive agreement with the Partnership to sell to the Partnership mineral interests underlying 34,349 gross (1,696 net royalty) acres primarily in the Pecos County in the Permian Basin, approximately 80% of which are operated by the Company for $175.0 million, subject to post-closing adjustments (the “Drop-down Transaction”). The Company anticipates that the closing of the Drop-down Transaction will occur in August 2018.
Second Quarter Dividend Declaration
On August 2, 2018, the Board of Directors of the Company declared a cash dividend for the second quarter of 2018 of $0.125 per share of common stock, payable on August 27, 2018 to its stockholders of record at the close of business on August 20, 2018.
Commodity Contracts

Subsequent to June 30, 2018, the Company entered into new fixed price basis swaps and three-way costless collars. The Company’s derivative contracts are based upon reported settlement prices on commodity exchanges, with crude oil derivative settlements based on New York Mercantile Exchange West Texas Intermediate pricing (Cushing and Magellan East Houston) and Crude Oil Brent.

The following tables present the derivative contracts entered into by the Company subsequent to June 30, 2018. When aggregating multiple contracts, the weighted average contract price is disclosed.
 
Volume (Bbls/MMBtu)
 
Fixed Price Swap (per Bbl/MMBtu)
January 2019 - March 2019
 
 
 
Oil Basis Swaps - WTI Cushing
180,000
 
$
(10.13
)

 
WTI - Magellan East Houston
Oil Three-Way Collars
October 2018 - December 2018
 
January 2019 - June 2019
Volume (Bbls)
184,000
 
362,000
Short put price (per Bbl)
$
55.00

 
$
55.00

Floor price (per Bbl)
$
65.00

 
$
65.00

Ceiling price (per Bbl)
$
77.40

 
$
76.33


The Partnership’s Amended and Restated Senior Secured Revolving Credit Agreement

On July 20, 2018, the Operating Company, as borrower, and the Partnership, as guarantor, entered into an Amended and Restated Senior Secured Revolving Credit Agreement among Wells Fargo Bank, National Association, as administrative agent, and the lenders party thereto, which amended and restated the Senior Secured Revolving Credit Agreement, dated as of July 8, 2014, as amended, to incorporate the terms of an assignment and assumption dated May 8, 2018 by and between the Partnership and the Operating Company, whereby the Partnership assigned its liabilities and rights as borrower under the Senior Secured Revolving Credit Agreement to the Operating Company, with the Operating Company becoming the borrower and assuming all liabilities of the borrower thereunder and the Partnership becoming a guarantor under the Senior Secured Revolving Credit Agreement. All other material terms of the Senior Secured Revolving Credit Agreement remained unchanged and are in effect as of the date of the Amended and Restated Senior Secured Revolving Credit Agreement.


26


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


The Partnership’s July 2018 Equity Offering

In July 2018, the Partnership completed an underwritten public offering of 10,080,000 common units, which included 1,080,000 common units issued pursuant to an option to purchase additional common units granted to the underwriters. The Partnership received net proceeds from this offering of approximately $305.3 million, after deducting underwriting discounts and commissions and estimated offering expenses. The Partnership used the net proceeds to purchase units of the Operating Company. The Operating Company in turn used the net proceeds to repay a portion of the $361.5 million then outstanding borrowings under the revolving credit facility.

Lease Bonus Payments

Subsequent to June 30, 2018, the Company paid the Partnership $2.0 million related to two new leases, reflecting an average bonus of $10,000 per acre.

18.    GUARANTOR FINANCIAL STATEMENTS

As of June 30, 2018, Diamondback E&P LLC and Diamondback O&G LLC (the “Guarantor Subsidiaries”) are guarantors under the indentures relating to the 2024 Senior Notes and the 2025 Senior Notes, as supplemented. In connection with the issuance of the 2024 Senior Notes and the 2025 Senior Notes (including the New 2025 Senior Notes), the Partnership, the General Partner, Viper Energy Partners LLC and Rattler Midstream LLC were designated as Non-Guarantor Subsidiaries. The following presents condensed consolidated financial information for the Company (which for purposes of this Note 18 is referred to as the “Parent”), the Guarantor Subsidiaries and the Non–Guarantor Subsidiaries on a consolidated basis. Elimination entries presented are necessary to combine the entities. The information is presented in accordance with the requirements of Rule 3-10 under the SEC’s Regulation S-X. The financial information may not necessarily be indicative of results of operations, cash flows or financial position had the Guarantor Subsidiaries operated as independent entities. The Company has not presented separate financial and narrative information for each of the Guarantor Subsidiaries because it believes such financial and narrative information would not provide any additional information that would be material in evaluating the sufficiency of the Guarantor Subsidiaries.


27


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


Condensed Consolidated Balance Sheet
June 30, 2018
(In thousands)
 
 
 
 
 
Non–
 
 
 
 
 
 
 
Guarantor
 
Guarantor
 
 
 
 
 
Parent
 
Subsidiaries
 
Subsidiaries
 
Eliminations
 
Consolidated
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
65,218

 
$
15,823

 
$
32,886

 
$

 
$
113,927

Accounts receivable

 
227,807

 
31,083

 

 
258,890

Accounts receivable - related party

 

 
8,137

 
(8,137
)
 

Intercompany receivable
2,862,029

 
787,088

 

 
(3,649,117
)
 

Inventories

 
13,264

 

 

 
13,264

Other current assets
441

 
6,530

 
295

 

 
7,266

Total current assets
2,927,688

 
1,050,512

 
72,401

 
(3,657,254
)
 
393,347

Property and equipment:
 
 
 
 
 
 
 
 
 
Oil and natural gas properties, at cost, full cost method of accounting

 
8,956,243

 
1,359,596

 
(414
)
 
10,315,425

Midstream assets

 
343,387

 

 

 
343,387

Other property, equipment and land

 
84,471

 
1,001

 

 
85,472

Accumulated depletion, depreciation, amortization and impairment

 
(2,183,228
)
 
(214,252
)
 
(3,760
)
 
(2,401,240
)
Net property and equipment

 
7,200,873

 
1,146,345

 
(4,174
)
 
8,343,044

Investment in subsidiaries
4,262,879

 
1,284

 
1,000

 
(4,265,163
)
 

Deferred income taxes

 

 
72,049

 

 
72,049

Investment in real estate

 
108,564

 

 

 
108,564

Other assets

 
11,831

 
25,560

 

 
37,391

Total assets
$
7,190,567

 
$
8,373,064

 
$
1,317,355

 
$
(7,926,591
)
 
$
8,954,395

Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable-trade
$
11

 
$
73,954

 
$
9

 
$

 
$
73,974

Intercompany payable
37,962

 
3,619,292

 

 
(3,657,254
)
 

Other current liabilities
8,095

 
641,960

 
3,048

 

 
653,103

Total current liabilities
46,068

 
4,335,206

 
3,057

 
(3,657,254
)
 
727,077

Long-term debt
1,295,574

 
321,500

 
350,000

 

 
1,967,074

Derivative instruments

 
8,514

 

 

 
8,514

Asset retirement obligations

 
21,780

 

 

 
21,780

Deferred income taxes
217,476

 

 

 

 
217,476

Other long term liabilities

 
7

 

 

 
7

Total liabilities
1,559,118

 
4,687,007

 
353,057

 
(3,657,254
)
 
2,941,928

Commitments and contingencies
 
 
 
 
 
 
 
 
 
Stockholders’ equity
5,631,449

 
3,686,057

 
389,797

 
(4,075,854
)
 
5,631,449

Non-controlling interest

 

 
574,501

 
(193,483
)
 
381,018

Total equity
5,631,449

 
3,686,057

 
964,298

 
(4,269,337
)
 
6,012,467

Total liabilities and equity
$
7,190,567

 
$
8,373,064

 
$
1,317,355

 
$
(7,926,591
)
 
$
8,954,395


28


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


Condensed Consolidated Balance Sheet
December 31, 2017
(In thousands)
 
 
 
 
 
Non–
 
 
 
 
 
 
 
Guarantor
 
Guarantor
 
 
 
 
 
Parent
 
Subsidiaries
 
Subsidiaries
 
Eliminations
 
Consolidated
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
54,074

 
$
34,175

 
$
24,197

 
$

 
$
112,446

Accounts receivable

 
205,859

 
25,754

 

 
231,613

Accounts receivable - related party

 

 
5,142

 
(5,142
)
 

Intercompany receivable
2,624,810

 
2,267,308

 

 
(4,892,118
)
 

Inventories

 
9,108

 

 

 
9,108

Other current assets
618

 
4,461

 
355

 

 
5,434

Total current assets
2,679,502

 
2,520,911

 
55,448

 
(4,897,260
)
 
358,601

Property and equipment:
 
 
 
 
 
 
 
 
 
Oil and natural gas properties, at cost, full cost method of accounting

 
8,129,211

 
1,103,897

 
(414
)
 
9,232,694

Midstream assets

 
191,519

 

 

 
191,519

Other property, equipment and land

 
80,776

 

 

 
80,776

Accumulated depletion, depreciation, amortization and impairment

 
(1,976,248
)
 
(189,466
)
 
4,342

 
(2,161,372
)
Net property and equipment

 
6,425,258

 
914,431

 
3,928

 
7,343,617

Funds held in escrow

 

 
6,304

 

 
6,304

Investment in subsidiaries
3,809,557

 

 

 
(3,809,557
)
 

Other assets

 
25,609

 
36,854

 

 
62,463

Total assets
$
6,489,059

 
$
8,971,778

 
$
1,013,037

 
$
(8,702,889
)
 
$
7,770,985

Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable-trade
$
1

 
$
91,629

 
$
2,960

 
$

 
$
94,590

Intercompany payable
132,067

 
4,765,193

 

 
(4,897,260
)
 

Other current liabilities
7,236

 
472,933

 
2,669

 

 
482,838

Total current liabilities
139,304

 
5,329,755

 
5,629

 
(4,897,260
)
 
577,428

Long-term debt
986,847

 
397,000

 
93,500

 

 
1,477,347

Derivative instruments

 
6,303

 

 

 
6,303

Asset retirement obligations

 
20,122

 

 

 
20,122

Deferred income taxes
108,048

 

 

 

 
108,048

Total liabilities
1,234,199

 
5,753,180

 
99,129

 
(4,897,260
)
 
2,189,248

Commitments and contingencies

 

 

 

 

Stockholders’ equity
5,254,860

 
3,218,598

 
913,908

 
(4,132,506
)
 
5,254,860

Non-controlling interest

 

 

 
326,877

 
326,877

Total equity
5,254,860

 
3,218,598

 
913,908

 
(3,805,629
)
 
5,581,737

Total liabilities and equity
$
6,489,059

 
$
8,971,778

 
$
1,013,037

 
$
(8,702,889
)
 
$
7,770,985




29


Diamondback Energy, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
(Unaudited)


Condensed Consolidated Statement of Operations
Three Months Ended June 30, 2018
(In thousands)
 
 
 
 
 
Non–
 
 
 
 
 
 
 
Guarantor
 
Guarantor
 
 
 
 
 
Parent
 
Subsidiaries
 
Subsidiaries
 
Eliminations
 
Consolidated
Revenues: