Note 1—Basis of Presentation and Summary of Significant Accounting Policies

Description of Business

Centennial Resource Development, Inc. (the “Company”) was originally incorporated in Delaware on November 4, 2015 as a special purpose acquisition company under the name Silver Run Acquisition Corporation for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination involving the Company and one or more businesses.

On February 29, 2016, the Company consummated its initial public offering of Units each consisting of one share of Class A Common Stock and one-third of one Public Warrant. On October 11, 2016, the Company consummated the acquisition of approximately 89% of the outstanding membership interests in Centennial Resource Production, LLC, a Delaware limited liability company (“CRP” and such acquisition, the “Business Combination”). In connection with the closing of the Business Combination, the Company changed its name from "Silver Run Acquisition Corporation" to "Centennial Resource Development, Inc." and continued the listing of its Class A Common Stock and Public Warrants on NASDAQ under the symbols "CDEV" and "CDEVW," respectively. Refer to Note 2—Business Combination for further discussion of the Business Combination.

CRP was formed in August 2012 by an affiliate of NGP Energy Capital Management, a family of energy-focused private equity investment funds, in connection with the acquisition of all of the oil and natural gas properties and certain other assets of Celero, which was formed in 2006 to focus on the development and acquisition of oil and natural gas properties in Texas and New Mexico, primarily in the Permian Basin in West Texas. Until the closing of the Business Combination, CRP operated as a privately-held independent oil and natural gas company.

The Company’s Class A Common Stock and Public Warrants trade on The NASDAQ Capital Market (“NASDAQ”) under the ticker symbols “CDEV” and “CDEVW,” respectively. The Units automatically separated into their component securities prior to or upon closing of the Business Combination and, as a result, no longer trade as a separate security. The consolidated financial statements include the accounts of the Company and CRP and its wholly-owned subsidiaries.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair presentation, have been included. Certain prior period amounts have been reclassified to conform to the current presentation on the accompanying consolidated and combined financial statements. In connection with the preparation of the consolidated financial statements, the Company evaluated subsequent events after the balance sheet date of December 31, 2016, through the filing date of this report.

As a result of the Business Combination, the Company is the acquirer for accounting purposes, and CRP is the acquiree and accounting Predecessor. The Company’s financial statement presentation distinguishes a “Predecessor” for CRP for periods prior to the Business Combination. The Company is the “Successor” for periods after the Business Combination, which includes consolidation of CRP subsequent to the Business Combination on October 11, 2016. The Merger was accounted for as a business combination using the acquisition method of accounting, and the Successor financial statements reflect a new basis of accounting that is based on the fair value of the net assets acquired. Refer to Note 2—Business Combination for further discussion of the Business Combination. As a result of the application of the acquisition method of accounting as of the Business Combination, the financial statements for the Predecessor period and for the Successor period are presented on a different basis of accounting and are therefore, not comparable.

Principles of Consolidation

The consolidated financial statements included herein have been prepared in accordance with GAAP and the rules and regulations of Securities and Exchange Commission (“SEC”). The consolidated financial statements include the accounts of the Company and its majority owned subsidiary CRP, and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the Company’s consolidated and combined financial statements requires the Company’s management to make various assumptions, judgments and estimates to determine the reported amounts of assets, liabilities, revenues and expenses, and in the disclosures of commitments and contingencies. Changes in these assumptions, judgments, and estimates will occur as a result of the passage of time and the occurrence of future events and, accordingly, actual results could differ from amounts previously established.

The more significant areas requiring the use of assumptions, judgments and estimates include: (1) oil and natural gas reserves; (2) cash flow estimates used in impairment tests of long-lived assets; (3) depreciation, depletion and amortization; (4) asset retirement obligations; (5) determining fair value and allocating purchase price in connection with business combinations; (6) valuation of derivative instruments; and (7) accrued revenue and related receivables.

Cash and Cash Equivalents

The Company considers all highly liquid instruments with an original maturity of three months or less at the time of issuance to be cash equivalents. The Company's cash management process provides for the daily funding of checks as they are presented to the bank.

Accounts Receivable

Accounts receivable consists mainly of receivables from oil and natural gas purchasers and from joint interest owners on properties the Company operates. For receivables from joint interest owners, the Company typically has the ability to withhold future revenue disbursements to recover non-payment of joint interest billings. Generally, oil and natural gas receivables are collected within two months and the Company has had minimal bad debts.

Although diversified among many companies, collectibility is dependent upon the financial wherewithal of each individual company and is influenced by the general economic conditions of the industry. Receivables are not collateralized. The Company establishes an allowance for doubtful accounts equal to the estimable portions of accounts receivable for which failure to collect is probable. The Company had no allowance for doubtful accounts at December 31, 2016 (Successor). The allowance for doubtful accounts at December 31, 2015 (Predecessor) was $0.1 million.

Credit Risk and Other Concentrations

The Company normally sell production to a relatively small number of customers, as is customary in its business. For the year ended December 31, 2016, sales to Plains Marketing, LP (“Plains”), Shell Trading (US) Company, and Permian Transport and Trading accounted for 48%, 22%, and 11%, respectively, of the total revenue. For the years ended December 31, 2015 and December 31, 2014, the Company only had one major customer, Plains, which accounted for 64% and 78%, respectively, of total revenue. The loss of any of the Company’s major purchasers could materially and adversely affect its revenues in the short-term. However, based on the current demand for oil and natural gas and the availability of other purchasers, the Company believes that the loss of any major purchaser would not have a material adverse effect on its financial condition and results of operations because crude oil and natural gas are fungible products with well-established markets and numerous purchasers.

By using derivative instruments to economically hedge exposures 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. As of December 31, 2016, and through the filing date of this report, all of the Company’s derivative counterparties were members of the Company’s credit facility lender group. The credit facility is secured by the Company’s proved oil and natural gas properties and therefore, the Company is not required to post any collateral. The Company does not receive collateral from its counterparties. The maximum amount of loss due to credit risk that the Company would incur if its counterparties failed completely to perform according to the terms of the contracts, based on the gross fair value of financial instruments, was approximately $0.7 million at December 31, 2016 (Successor). The Company minimizes the credit risk in derivative instruments by: (i) limiting its exposure to any single counterparty; and (ii) monitoring the creditworthiness of the Company’s counterparties on an ongoing basis. In accordance with the Company’s standard practice, its commodity derivatives are subject to counterparty netting under agreements governing such derivatives and therefore the risk of loss due to counterparty nonperformance is somewhat mitigated.

The Company places its temporary cash investments with high-quality financial institutions and does not limit the amount of credit exposure to any one financial institution. For the years ended December 31, 2016 (Successor) and December 31, 2015 (Predecessor), the Company has not incurred losses related to these investments.

Oil and Natural Gas Properties

The Company follows the successful efforts method of accounting for its oil and natural gas properties. Under the successful efforts method, the costs incurred to acquire, drill, and complete productive wells and development wells are capitalized. Oil and gas lease acquisition costs are also capitalized. Exploration costs, including personnel and other internal costs, geological and geophysical expenses, delay rentals for gas and oil leases, and costs associated with unsuccessful lease acquisitions are charged to expense as incurred. Costs of drilling exploratory wells are initially capitalized but are charged to expense if the well is determined to be unsuccessful. As of December 31, 2016 (Successor) and December 31, 2015 (Predecessor), no costs were capitalized in connection with exploratory wells in progress. Net carrying values of retired, sold or abandoned properties that constitute less than a complete unit of depreciable property are charged or credited, net of proceeds, to accumulated depreciation, depletion and amortization unless doing so significantly affects the unit-of-production amortization rate, in which case a gain or loss is recognized in income. Gains or losses from the disposal of complete units of depreciable property are recognized to income.

Unproved properties consist of costs to acquire undeveloped leases as well as costs to acquire unproved reserves. The Company evaluates significant unproved properties for impairment based on remaining lease term, drilling results, reservoir performance, seismic interpretation or future plans to develop acreage. Unproved properties and the related costs are transferred to proved properties when reserves are discovered on or otherwise attributed to the property. There was no abandonment and impairment expense for the period from October 11, 2016, through December 31, 2016 (Successor). For the period from January 1, 2016, through October 10, 2016 (Predecessor), the Company recorded abandonment and impairment expense of $2.5 million for leases which have expired, or are expected to expire. For the year ended December 31, 2015 (Predecessor), the Company recorded abandonment and impairment expense of $7.6 million for leases which have expired, or are expected to expire. For the year ended December 31, 2014 (Predecessor), the Company recorded impairment expense of $20.0 million, of which $13.8 million was attributable to an impairment of unproved properties and $6.2 million was attributable to leases which had expired, or were expected to expire.

The Company reviews it proved oil and natural gas properties for impairment when events and circumstances indicate a possible decline in the recoverability of the carrying amount of such property. The Company estimates the expected future cash flows of its oil and natural gas properties and compares these undiscounted cash flows to the carrying amount of the oil and natural gas properties to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, the Company will write down the carrying amount of the oil and natural gas properties to fair value. The factors used to determine fair value include, but are not limited to, estimates of reserves, future commodity prices, future production estimates, estimated future capital expenditures and discount rates commensurate with the risk associated with realizing the projected cash flows. There were no impairments of proved oil and natural gas properties for the periods October 11, 2016, through December 31, 2016 (Successor) and January 1, 2016, through October 10, 2016 (Predecessor) and for the years ended December 31, 2015 (Predecessor) and December 31, 2014 (Predecessor).

Other Property and Equipment

Other property and equipment such as office furniture and equipment, buildings, vehicles, and computer hardware and software is recorded at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets ranging from three to twenty years. Major renewals and improvements are capitalized while expenditures for maintenance and repairs are expensed as incurred. When other property and equipment is sold or retired, the capitalized costs and related accumulated depreciation are removed from the accounts.

Deferred Loan Costs

Deferred loan costs related to the Company’s revolving credit facility are included in the line item Other noncurrent assets in the consolidated balance sheets and are stated at cost, net of amortization. These costs are amortized to interest expense on a straight line basis over the borrowing term.

Derivative Financial Instruments

In order to manage its exposure to oil and natural gas price volatility, the Company enters into derivative transactions from time to time, including commodity swap agreements, basis swap agreements, collar agreements, and other similar agreements relating to the price risk associated with a portion of its production. To the extent legal right of offset exists with a counterparty, the Company reports derivative assets and liabilities on a net basis. The Company has exposure to credit risk to the extent the counterparty is unable to satisfy its settlement obligation. The Company actively monitors the creditworthiness of counterparties and assesses the impact, if any, on its derivative position.

The Company records derivative instruments on the consolidated balance sheets as either an asset or liability measured at fair value and records changes in the fair value of derivatives in current earnings as they occur. The Company’s derivatives have not been designated as hedges for accounting purposes. For additional discussion on derivatives, please refer to Note 9—Derivative Instruments.

Asset Retirement Obligations

The Company recognizes an estimated liability for future costs associated with the abandonment of its oil and natural gas properties. A liability for the fair value of an asset retirement obligation and corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is drilled or acquired. The increase in carrying value is included in proved oil and natural gas properties in the accompanying consolidated balance sheets. The Company depletes the amount added to proved oil and natural gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective oil and natural gas properties. For additional discussion, please refer to Note 11—Asset Retirement Obligations.

Revenue Recognition

The Company derives revenue primarily from the sale of produced oil, natural gas, and NGLs. Revenue is recognized when the Company’s production is delivered to the purchaser, but payment is generally received between 30 and 90 days after the date of production. No revenue is recognized unless it is determined that title to the product has transferred to the purchaser. At the end of each month, the Company estimates the amount of production delivered to the purchaser and the price the Company will receive. The Company follows the sales method of accounting for its oil and natural gas revenue, whereby revenue is recorded based on the Company’s share of volume sold, regardless of whether the Company has taken its proportional share of volume produced. A receivable or liability is recognized only to the extent that the Company has an imbalance on a specific property greater than the expected remaining proved reserves. The Company had no significant imbalances as of December 31, 2016 or 2015.

Income Taxes

Income taxes and uncertain tax positions are accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, Accounting for Income Taxes (“ASC 740”). Deferred income taxes are provided for the differences between the bases of assets and liabilities for financial reporting and income tax purposes. Tax positions meeting the more-likely-than-not recognition threshold are measured pursuant to the guidance set forth in ASC 740. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.

Equity Based Compensation (Successor)

The Company recognizes compensation related to all stock-based awards, including stock options, in the financial statements based on their estimated grant-date fair value. The Company grants various types of stock-based awards including stock options and restricted stock. The fair value of stock option awards is determined using the Black-Scholes option pricing model. Service-based restricted stock are valued using the market price of the Company’s common stock on the grant date. Compensation cost is recognized ratably over the applicable vesting period. See Note 8—Equity Based Compensation for additional information regarding the Company’s equity based compensation (successor).

Equity Based Compensation (Predecessor)

Pursuant to the LLC Agreement of CRP (prior to the Business Combination), certain incentive units were available to be issued to the Company’s management and employees, consisting of Tier I, Tier I A, Tier II, Tier III and Tier IV units. The incentive units were intended to be compensation for services rendered to CRP. Tier Incentive units are accounted for as liability awards under FASB ASC Topic 718, Compensation: Stock Compensation (“ASC 718”), with compensation expense based on period-end fair value. Refer to Note 8—Equity Based Compensation for additional information regarding the CRP’s equity based compensation (Predecessor).

Earnings (Loss) Per Share

The two-class method of computing earnings per share is required for entities that have participating securities. The two-class method is an earnings allocation formula that determines earnings per share for participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. Basic earnings (loss) per share is calculated by dividing earnings (loss) available to common shareholders by the weighted average shares-basic during each period.

The Company’s preferred series B shares have a non-forfeitable right to participate in distributions with common stockholders on a pro rata, as-converted basis and as such are considered participating securities. Shares of the Company’s unvested restricted stock are eligible to receive dividends; however, dividend rights will be forfeited if the award does not vest. Accordingly, these shares are not considered participating securities. Shares of the Company’s class C common stock and warrants do not share in the earnings or losses and are therefore not participating securities.

The Company uses the "if-converted" method to determine the potential dilutive effect of exchanges of outstanding CRP Common Units and corresponding shares of its outstanding Class C common stock, and the treasury stock method to determine the potential dilutive effect of its outstanding restricted stock and stock options.

The following table reflects the allocation of net income to common stockholders and EPS computations for the periods indicated based on a weighted average number of common stock outstanding for the period:



	Successor
	October 11, 2016 through December 31, 2016
(in thousands, except per share data)	October 11, 2016 through December 31, 2016
Net income (loss)	$	(8,081	)
Less: Loss allocable to participating securities	(46		)
Net loss available for common shareholders	$	(8,035	)

Basic net loss per share	$	(0.05	)
Diluted net loss per share	$	(0.05	)

Basic weighted average share outstanding	165,684
Add: Dilutive effects of stock options and RSUs	—
Diluted weighted average shares outstanding	165,684

Options and restricted shares of 2.7 million and 0.3 million, respectively, were not included in the weighted average shares-dilutive calculation for the period from October 11, 2016, through December 31, 2016 because their effect would have been anti-dilutive.

Segment Reporting

The Company operates in only one industry segment which is the exploration and production of oil and natural gas. All of its operations are conducted in one geographic area of the United States. All revenues are derived from customers located in the United States.

Recently Issued Accounting Standards

In August 2016, the FASB issued ASU 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. This update will be effective for financial statements issued for fiscal years beginning after December 31, 2017, including interim periods within those fiscal years with early adoption permitted. This update should be applied using the retrospective transition method. Adoption of this standard will only affect the presentation of the Company’s cash flows and will not have a material impact on its consolidated financial statements.

In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing. This update clarifies two principles of ASC Topic 606, Revenue from Contracts with Customers: identifying performance obligations and the licensing implementation guidance. This standard has the same effective date as ASU 2016-08, Revenue from Contracts with Customers: Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net), the revenue recognition standard discussed below. The adoption of this standard is not expected to have a material impact on the Company’s financial position, results of operations and liquidity.

March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation. This update applies to all entities that issue equity-based payment awards to their employees. Under this update, there were several areas that were simplified including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This update will be effective for financial statements issued for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years with early adoption permitted. The Company elected to early adopt this guidance in October 2016 in conjunction with the issuance of its equity awards.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net). Under this update, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update will be effective for annual and interim reporting periods beginning after December 15, 2017, with early application not permitted. This update allows for either full retrospective adoption, meaning this update is applied to all periods presented in the financial statements, or modified retrospective adoption, meaning this update is applied only to the most current period presented. The Company is currently evaluating the impact, if any, that the adoption of this update will have on its financial position, results of operations and liquidity.

In February 2016, the FASB issued ASU 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 its balance sheet for current operating leases.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This update supersedes most of the existing revenue recognition requirements in GAAP and requires (i) an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services and (ii) requires expanded disclosures regarding the nature, amount, timing and certainty of revenue and cash flows from contracts with customers. The standard will be effective for annual and interim reporting periods beginning after December 15, 2017, with early application permitted for annual reporting period beginning after December 31, 2016. The standard allows for either full retrospective adoption, meaning the standard is applied to all periods presented in the financial statements, or modified retrospective adoption, meaning the standard is applied only to the most current period presented. The Company is currently evaluating the impact of this standard on its consolidated financial statements.

Subsequent Events

On March 1, 2017, the Company delivered a notice of redemption of the Public Warrants, announcing its intention to redeem any unexercised and outstanding Public Warrants on March 31, 2017 for $0.01 per Public Warrant. As permitted under the warrant agreement that provides the terms of the Public Warrants, the notice of redemption requires all holders exercising their Public Warrants prior to March 31, 2017 to do so on a “cashless basis” and surrender their Public Warrants for a number of shares of Class A Common Stock equal to the product of the quotient equal to (i) the difference between $11.50 and $18.44 (the average last sale price of the Class A Common Stock for the ten trading days ending on February 24, 2017) divided by (ii) $18.44, or approximately 0.376, multiplied by the number of Public Warrants held by such holder, rounded down to the nearest whole share. Assuming all warrants are exercised by holders, Centennial will issue approximately 6.27 million shares of Class A Common Stock to the Public Warrant holders, resulting in a share count of approximately 253 million shares outstanding, which includes Class A Common Stock shares, the shares of Series B Preferred Stock held by Riverstone (assuming conversion to Class A Common Stock on a 250-to-one basis), and the shares of Class C Common Stock held by the Centennial Contributors. The Private Placement Warrants are non-redeemable so long as they are held by our Sponsor or its permitted transferees. Refer to Note 7—Shareholders' and Owners' Equity for additional information regarding the Company’s warrants.