Note 1 - Summary of Significant Accounting Policies

Description of Operations

SM Energy Company, together with its consolidated subsidiaries (“SM Energy” or the “Company”), is an independent energy company engaged in the acquisition, exploration, development, and production of crude oil and condensate, natural gas, and natural gas liquids (also respectively referred to as “oil,” “gas,” and “NGLs” throughout this report) in onshore North America.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of SM Energy and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, the instructions to Quarterly Report on Form 10-Q, and Regulation S-X. These financial statements do not include all information and notes required by GAAP for annual financial statements. However, except as disclosed herein, there has been no material change in the information disclosed in the notes to the consolidated financial statements included in SM Energy’s Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Form 10-K”). In the opinion of management, all adjustments, consisting of normal recurring adjustments considered necessary for a fair presentation of interim financial information, have been included. Operating results for the periods presented are not necessarily indicative of expected results for the full year. In connection with the preparation of the Company’s unaudited condensed consolidated financial statements, the Company evaluated events subsequent to the balance sheet date of September 30, 2018, and through the filing of this report. Certain prior period amounts have been reclassified to conform to the current presentation on the accompanying unaudited condensed consolidated financial statements.

Correction of an Immaterial Error

The accompanying unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2018, include a non-cash adjustment that relates to prior years. For the three and nine months ended September 30, 2018, the depletion, depreciation, amortization, and asset retirement obligation liability accretion expense line item on the accompanying unaudited condensed consolidated statements of operations (“accompanying statements of operations”) includes $11.8 million of additional expense that should have been recognized in prior years. This non-cash adjustment, net of tax, resulted in reported net income for the nine months ended September 30, 2018, to be understated by $9.0 million, and reported net loss for the three months ended September 30, 2018, to be overstated by $9.0 million. This non-cash adjustment is not deemed material with respect to any prior period reported, the third quarter of 2018, or the anticipated results for fiscal year 2018.

Significant Accounting Policies

The significant accounting policies followed by the Company are set forth in Note 1 - Summary of Significant Accounting Policies in the 2017 Form 10-K, and are supplemented by the notes to the unaudited condensed consolidated financial statements included in this report. These unaudited condensed consolidated financial statements should be read in conjunction with the 2017 Form 10-K.

Recently Issued Accounting Standards

Effective December 31, 2017, the Company early adopted, on a retrospective basis, Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”) and FASB ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows and ASU 2016-18 is intended to clarify guidance on the classification and presentation of restricted cash and restricted cash equivalents in the statement of cash flows. The Company did not have restricted cash reported within the accompanying balance sheets as of September 30, 2018, or December 31, 2017. Please refer to Note 1 - Summary of Significant Accounting Policies in the 2017 Form 10-K for more information.

The accompanying unaudited condensed consolidated statements of cash flows (“accompanying statements of cash flows”) line items that were adjusted as a result of the adoption of ASU 2016-15 and ASU 2016-18 for the nine months ended September 30, 2017, are summarized as follows:



	For the Nine Months Ended September 30, 2017
	As Reported			As Adjusted
	(in thousands)
Cash flows from operating activities:
Non-cash (gain) loss on extinguishment of debt, net	$	22		N/A
Loss on extinguishment of debt	N/A			$	35
Net cash provided by operating activities	$	370,597		$	370,610

Cash flows from investing activities:
Acquisition deposit held in escrow	$	3,000		N/A
Net cash provided by (used in) investing activities	$	69,007		$	66,007

Cash flows from financing activities:
Cash paid for extinguishment of debt ⁽¹⁾	N/A			$	(13	)
Net cash used in financing activities	$	(7,561	)	$	(7,574	)

Net change in cash and cash equivalents	$	432,043		N/A
Net change in cash, cash equivalents, and restricted cash	N/A			$	429,043
Cash and cash equivalents at beginning of period	$	9,372		N/A
Cash, cash equivalents, and restricted cash at beginning of period	N/A			$	12,372
Cash and cash equivalents at end of period	$	441,415		N/A
Cash, cash equivalents, and restricted cash at end of period	N/A			$	441,415

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⁽¹⁾	Included as a component within the cash paid to repurchase Senior Notes, including premium line item on the accompanying statements of cash flows.

Effective January 1, 2018, the Company adopted FASB ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) and all related ASUs (“ASU 2014-09”). Under the new guidance, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. The Company adopted ASU 2014-09 using the modified retrospective transition method, which was applied to all active contracts as of the effective date. The adoption of ASU 2014-09 did not result in a change to current or prior period results nor did it result in a material change to the Company’s business processes, systems, or controls. However, upon adopting ASU 2014-09, the Company expanded its disclosures to comply with the expanded disclosure requirements of ASU 2014-09. Please refer to Note 2 - Revenue from Contracts with Customers for additional discussion.

Effective January 1, 2018, the Company adopted FASB ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”). ASU 2017-07 requires presentation of service cost in the same line item(s) as other compensation costs arising from services rendered by employees during the period and presentation of the remaining components of net benefit cost in a separate line item, outside of operating items, which the Company adopted with retrospective application. In addition, only the service component of the net benefit cost is eligible for capitalization, which the Company adopted with prospective application. Please refer to Note 1 - Summary of Significant Accounting Policies in the 2017 Form 10-K for more information.

The accompanying statements of operations line items that were adjusted as a result of the adoption of ASU 2017-07 for the three and nine months ended September 30, 2017, are summarized as follows:



	For the Three Months Ended September 30, 2017						For the Nine Months Ended September 30, 2017
	As Reported			As Adjusted			As Reported			As Adjusted
	(in thousands)
Operating expenses:
Exploration	$	14,243		$	14,119		$	39,293		$	38,919
General and administrative	$	27,880		$	27,564		$	85,564		$	84,618
Total operating expenses	$	380,971		$	380,531		$	856,475		$	855,155

Income (loss) from operations	$	(85,592	)	$	(85,152	)	$	(67,637	)	$	(66,317	)

Other non-operating income, net	$	1,301		$	861		$	2,901		$	1,581

Effective January 1, 2018, the Company early adopted FASB ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”) by applying the changes in the period of adoption. ASU 2018-02 permits entities to reclassify tax effects stranded in accumulated other comprehensive income (loss) to retained earnings as a result of the enactment into law on December 22, 2017, of H.R.1, formally the Tax Cuts and Jobs Act (the “2017 Tax Act”). As a result of adopting ASU 2018-02, the Company reclassified $3.0 million of tax effects stranded in accumulated other comprehensive loss to retained earnings as of January 1, 2018. The Company’s policy for releasing income tax effects within accumulated other comprehensive loss is an incremental, unit-of-account approach.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which requires recognition of right-of-use assets and lease payment liabilities on the balance sheet by lessees for virtually all leases currently classified as operating leases. The scope of ASU 2016-02 does not apply to leases used in the exploration or use of minerals, oil, natural gas, or other similar non-regenerative resources. The Company has established a cross-functional project team and is leveraging external consultants to evaluate the impacts of ASU 2016-02, which includes an analysis of non-cancelable leases, drilling rig contracts, certain midstream agreements, and other existing arrangements that may contain a lease component. The Company has substantially completed the process of reviewing and determining the contracts to which the new guidance applies. Further, the Company is also evaluating policies, internal controls, and processes that will be necessary to support the additional accounting and disclosure requirements. The Company will continue to monitor guidance issued by the FASB to clarify ASU 2016-02 and certain industry implementation issues. The Company is in the final stages of implementing a lease administration system that will support the on-going maintenance and accounting for leases after adoption. Policy elections allowed under ASU 2016-02 that the Company anticipates making as part of its adoption include (a) not recognizing lease assets or liabilities when lease terms are less than twelve months, and (b) for agreements that contain both lease and non-lease components, combining these components together and accounting for them as a single lease. Other policy elections allowed for under ASU 2016-02 are still being evaluated. The Company will adopt ASU 2016-02 on January 1, 2019, using the modified retrospective approach. Adoption of this guidance is expected to result in an increase in right-of-use assets and related liabilities on the Company’s consolidated balance sheets; however, the full impact to the Company’s financial statements and related disclosures is still being evaluated.

In January 2018, the FASB issued ASU No. 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842 (“ASU 2018-01”), which provides an optional transitional practical expedient that allows entities to exclude from evaluation land easements that existed or expired before adoption of ASU 2016-02. Companies that elect this practical expedient will need to evaluate new or modified land easements after adopting ASU 2016-02. If this practical expedient is not elected, companies will need to evaluate all existing or expired land easements as part of the overall adoption of ASU 2016-02. The Company expects to elect to use this practical expedient as outlined in ASU 2018-01 and will adopt ASU 2018-01 at the same time it adopts ASU 2016-02.

In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”). ASU 2018-11 provides an additional transition method for adopting ASU 2016-02, as well as provides lessors with a practical expedient when applying ASU 2016-02 to certain leases. The Company anticipates making a policy election in connection with adopting ASU 2018-11, which will eliminate the need for adjusting prior period comparable financial statements prepared under current lease accounting guidance. The Company will adopt ASU 2018-11 at the same time it adopts ASU 2016-02.

In August 2018, the FASB issued ASU No. 2018-14, Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans (“ASU 2018-14”). ASU 2018-14 provides updated disclosure requirements related to retirement benefits and defined pension plans with the purpose of improving the effectiveness of disclosures with regard to such topics. The guidance is to be applied using a retrospective method and is effective for fiscal years ending after December 15, 2020, with early adoption permitted. The Company expects to early adopt ASU 2018-14 on December 31, 2018. The Company is evaluating the impact of this guidance on its consolidated financial statements, but does not expect the impact to be material.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The Company expects to adopt ASU 2018-15 on January 1, 2020, with prospective application. The Company is evaluating the impact of ASU 2018-15 on its consolidated financial statements.

Other than as disclosed above or in the 2017 Form 10-K, there are no other ASUs applicable to the Company that would have a material effect on the Company’s consolidated financial statements and related disclosures that have been issued but not yet adopted by the Company as of September 30, 2018, and through the filing of this report.