Quarterly Report (10-q)

Date : 05/10/2019 @ 9:07PM
Source : Edgar (US Regulatory)
Stock : Legacy Reserves Inc. (MM) (LGCY)
Quote : 0.0395  0.0 (0.00%) @ 1:00AM

Quarterly Report (10-q)

LEGACY RESERVES INC.Accelerated 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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2019 
 
or
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                        to                        
 
Commission File Number 1-38668
Legacy Reserves Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
82-4919553 
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
303 W. Wall, Suite 1800
Midland, Texas
79701 
(Address of principal executive offices)
(Zip code)
  (432) 689-5200
(Registrant’s 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 preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
x  Yes   o   No
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
 
x Yes   o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer x
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). o  Yes   x  No
 
Securities Registered pursuant to Section 12(b) of the Act:

Title of each class Trading Symbol(s) Name of each exchange on which registered
Common stock, par value $.01 LGCY NASDAQ Stock Market LLC

114,810,671 shares of common stock, par value $0.01, were outstanding as of  May 8, 2019 .




TABLE OF CONTENTS

Page
Glossary of Terms
Part I - Financial Information
Item 1.
Financial Statements.
Condensed Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018 (Unaudited).
Condensed Consolidated Statements of Operations for the three months ended March 31, 2019 and 2018 (Unaudited).
Condensed Consolidated Statement of Stockholders' Deficit / Partners' Deficit for the three months ended March 31, 2019 and 2018 (Unaudited). 
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and 2018 (Unaudited).
Notes to Condensed Consolidated Financial Statements (Unaudited).
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
Item 4.
Controls and Procedures.
Part II - Other Information
Item 1.
Legal Proceedings.
Item 1A.
Risk Factors.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
Item 6.
Exhibits.
Signatures

 
Page 2


GLOSSARY OF TERMS
 
Bbl.   One stock tank barrel or 42 U.S. gallons liquid volume.
 
Bcf.   Billion cubic feet.
 
Boe.   One barrel of oil equivalent, determined using a ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
 
Boe/d.   Barrels of oil equivalent per day.
 
Btu.   British thermal unit, which is the heat required to raise the temperature of a one-pound mass of water from 58.5 to 59.5 degrees Fahrenheit.
 
Developed acreage.   The number of acres that are allocated or assignable to productive wells or wells capable of production.
 
Development project.   A drilling or other project which may target proven reserves, but which generally has a lower risk than that associated with exploration projects.

Development well.   A well drilled within the proved area of an oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive.
 
Dry hole or well.   A well found to be incapable of producing hydrocarbons in sufficient quantities such that proceeds from the sale of such production would exceed production expenses and taxes.
 
Field.   An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition.
 
Gross acres or gross wells.   The total acres or wells, as the case may be, in which a working interest is owned.

Hydrocarbons.   Oil, NGL and natural gas are all collectively considered hydrocarbons.
 
Liquids.   Oil and NGLs.

MBbls.   One thousand barrels of crude oil or other liquid hydrocarbons.
 
MBoe.   One thousand barrels of crude oil equivalent, using a ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
 
Mcf.   One thousand cubic feet.

MGal.   One thousand gallons of natural gas liquids or other liquid hydrocarbons.
 
MMBbls. One million barrels of crude oil or other liquid hydrocarbons.
 
MMBoe. One million barrels of crude oil equivalent, using a ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
 
MMBtu. One million British thermal units.
 
MMcf.   One million cubic feet.

Net acres or net wells.   The sum of the fractional working interests owned in gross acres or gross wells, as the case may be.
 
NGL or natural gas liquids.   The combination of ethane, propane, butane and natural gasolines that when removed from natural gas become liquid under various levels of higher pressure and lower temperature.
 
Page 3


NYMEX.   New York Mercantile Exchange.

Oil.   Crude oil and condensate.

PV-10. PV-10 is a compilation of the standardized measure on a pre-tax basis.
 
Productive well.   A well that is found to be capable of producing hydrocarbons in sufficient quantities such that proceeds from the sale of such production exceed production expenses and taxes.
 
Proved developed reserves or PDPs.  Reserves that can be expected to be recovered through: (i) existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well.
 
Proved developed non-producing reserves or PDNPs.   Proved oil and natural gas reserves that are developed behind pipe, shut-in or that can be recovered through improved recovery only after the necessary equipment has been installed, or when the costs to do so are relatively minor. Shut-in reserves are expected to be recovered from (1) completion intervals which are open at the time of the estimate but which have not started producing, (2) wells that were shut-in for market conditions or pipeline connections, or (3) wells not capable of production for mechanical reasons. Behind-pipe reserves are expected to be recovered from zones in existing wells that will require additional completion work or future recompletion prior to the start of production.
 
Proved reserves.   Proved oil and gas reserves are those quantities of oil and gas, which by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible—from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations—prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation.
 
Proved undeveloped drilling location.   A site on which a development well can be drilled consistent with spacing rules for purposes of recovering proved undeveloped reserves.
 
Proved undeveloped reserves or PUDs.   Proved undeveloped oil and gas reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion.

(i) Proved reserves on undrilled acreage shall be limited to those directly offsetting development spacing areas that are reasonably certain of production when drilled, unless evidence using reliable technology exists that establishes reasonable certainty of economic producibility at greater distances.

(ii) Proved undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances, justify a longer time.

(iii) Under no circumstances shall estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual projects in the same reservoir or an analogous reservoir or by other evidence using reliable technology establishing reasonable certainty.

Recompletion.   The completion for production of an existing wellbore in another formation from that which the well has been previously completed.
 
Reserve acquisition cost.   The total consideration paid for an oil and natural gas property or set of properties, which includes the cash purchase price and any value ascribed to units issued to a seller adjusted for any post-closing items.
 
R/P ratio (reserve life).   The reserves as of the end of a period divided by the production volumes for the same period.
 
Reserve replacement.   The replacement of oil and natural gas produced with reserve additions from acquisitions, reserve additions and reserve revisions.
 
Page 4


Reserve replacement cost.   An amount per Boe equal to the sum of costs incurred relating to oil and natural gas property acquisition, exploitation, development and exploration activities (as reflected in our year-end financial statements for the relevant year) divided by the sum of all additions and revisions to estimated proved reserves, including reserve purchases. The calculation of reserve additions for each year is based upon the reserve report of our independent engineers. Management uses reserve replacement cost to compare our company to others in terms of our historical ability to increase our reserve base in an economic manner. However, past performance does not necessarily reflect future reserve replacement cost performance. For example, increases in oil and natural gas prices in recent years have increased the economic life of reserves, adding additional reserves with no required capital expenditures. On the other hand, increases in oil and natural gas prices have increased the cost of reserve purchases and reserves added through development projects. The reserve replacement cost may not be indicative of the economic value added of the reserves due to differing lease operating expenses per barrel and differing timing of production.

Reservoir.   A porous and permeable underground formation containing a natural accumulation of producible oil and/or natural gas that is confined by impermeable rock or water barriers and is individual and separate from other reserves.

Standardized measure.   The present value of estimated future net revenues to be generated from the production of proved reserves, determined in accordance with assumptions required by the Financial Accounting Standards Board and the Securities and Exchange Commission (using the average annual prices based on the unweighted arithmetic average of the first-day-of-the-month price for each month) without giving effect to non-property related expenses such as general and administrative expenses, debt service and future income tax expenses or to depreciation, depletion and amortization and discounted using an annual discount rate of 10%. Standardized measure does not give effect to derivative transactions. Standardized measure presented for periods prior to September 20, 2018 does not take into account provision for federal or state income tax because we were a limited partnership that allocated our taxable income to our unitholders and therefore will not be directly comparable to standardized measure presented for future periods.
 
Undeveloped acreage.   Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and natural gas regardless of whether such acreage contains proved reserves.
 
Working interest.   The operating interest that gives the owner the right to drill, produce and conduct operating activities on the property and a share of production.
 
Workover.   Operations on a producing well to restore or increase production.
Page 5


Part I – FINANCIAL INFORMATION

Item 1.  Financial Statements.

LEGACY RESERVES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
March 31, 2019 December 31, 2018
(In thousands)
Current assets:
Cash
$ 1,491  $ 1,098 
Accounts receivable, net:
Oil and natural gas  63,542  56,615 
Joint interest owners
16,142  15,370 
Other  283  — 
Fair value of derivatives (Notes 5 and 6)  9,708  66,662 
Prepaid expenses and other current assets (Note 1)  13,335  11,347 
Total current assets  104,501  151,092 
Oil and natural gas properties at cost:
Proved properties using the successful efforts method of accounting   3,507,534  3,471,456 
Unproved properties  19,680  19,863 
Accumulated depletion, depreciation, amortization and impairment  (2,221,624) (2,177,006)
Total oil and natural gas properties, net  1,305,590  1,314,313 
Other property and equipment, net of accumulated depreciation and amortization of $2,432 and $2,464, respectively (Note 11)  6,743  2,456 
Fair value of derivatives (Notes 5 and 6)  —  3,135 
Other assets  3,304  3,935 
Total assets $ 1,420,138  $ 1,474,931 

See accompanying notes to condensed consolidated financial statements.
 
 
Page 6


LEGACY RESERVES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' DEFICIT 
March 31, 2019 December 31, 2018
(In thousands)
Current liabilities: 
Current debt, net (Notes 1 and 2)  $ 883,092  $ 856,646 
Accounts payable  28,658  11,227 
Accrued oil and natural gas liabilities (Note 1)  76,284  98,886 
Fair value of derivatives (Notes 5 and 6)  2,207  — 
Asset retirement obligation (Note 8)  3,938  3,938 
Other (Note 11)  18,455  13,953 
Total current liabilities  1,012,634  984,650 
Long-term debt (Notes 1 and 2)  416,328  432,923 
Asset retirement obligation (Note 7)  250,867  248,796 
Fair value of derivatives (Notes 5 and 6)  —  550 
Other long-term liabilities (Note 11)  3,190  643 
Total liabilities  1,683,019  1,667,562 
Commitments and contingencies (Note 4 and 11) 
Stockholders' equity (deficit): 
Common stock, $0.01 par value; 945,000,000 shares authorized, 114,810,671 and 109,442,278 shares outstanding at March 31, 2019 and December 31, 2018, respectively 1,148  1,094 
Additional paid-in capital  32,571  24,752 
Accumulated deficit  (296,600) (218,477)
Total stockholders' deficit  (262,881) (192,631)
Total liabilities and stockholders' deficit  $ 1,420,138  $ 1,474,931 

See accompanying notes to condensed consolidated financial statements.
Page 7


LEGACY RESERVES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
March 31, 
2019 2018
(In thousands, except per share data) 
Revenues:
Oil sales  $ 77,761  $ 93,411 
Natural gas liquids (NGL) sales  4,515  7,396 
Natural gas sales  36,221  36,672 
Total revenues  118,497  137,479 
Expenses:
Oil and natural gas production  47,477  47,967 
Production and other taxes  6,149  7,326 
General and administrative  16,530  24,090 
Depletion, depreciation, amortization and accretion  42,549  36,547 
Impairment of long-lived assets  7,398  — 
(Gains) losses on disposal of assets  1,034  (20,395)
Total expenses  121,137  95,535 
Operating (loss) income  (2,640) 41,944 
Other income (expense):
Interest income  12 
Interest expense (Notes 2, 5 and 6)  (37,119) (27,368)
Gain on extinguishment of debt (Note 2)  13,105  51,693 
Equity in income of equity method investees  —  17 
Net (losses) on commodity derivatives (Notes 5 and 6)  (51,460) (1,704)
Other  (270) 275 
Income (Loss) before income taxes  (78,378) 64,869 
Income tax expense —  (487)
Net (Loss) Income  $ (78,378) $ 64,382 
(Loss) Income per share / unit - basic and diluted (Note 8)  $ (0.70) $ 0.62 
Weighted average number of shares / units used in computing net loss per share / unit 
Basic  111,225  103,994 
Diluted  111,225  104,301 
See accompanying notes to condensed consolidated financial statements.

Page 8


LEGACY RESERVES INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT / PARTNERS' DEFICIT
FOR THE THREE MONTHS ENDED MARCH 31, 2019 and 2018
(UNAUDITED)
March 31, 2019
Stockholders' Deficit 
Shares  Par Value  APIC  Acc. Deficit  Total Deficit 
Balance, December 31, 2018  109,442  $ 1,094  $ 24,752  $ (218,477) $ (192,631)
Stock-based compensation  —  —  4,156  —  4,156 
Debt exchange  5,368  54  3,663  —  3,717 
ASC 842 Adoption   —  —  —  255  255 
Net loss  —  —  —  (78,378) (78,378)
Balance, March 31, 2019  114,810  $ 1,148  $ 32,571  $ (296,600) $ (262,881)
 
March 31, 2018
Partners' Deficit 
Series A Preferred Equity  Series B Preferred Equity  Incentive Distribution Equity  Partner's Deficit
Units  Amount  Units  Amount  Units  Amount  LP Units  Limited Partner Amount  General Partner Amount  Total Partner's Deficit
(In thousands) 
Balance, December 31, 2017  2,300  $ 55,192  7,200  $ 174,261  100  $ 30,814  72,595  $ (531,794) $ (160) $ (271,687)
Unit-based compensation  —  —  —  —  —  —  —  263  —  263 
Vesting of restricted and phantom units  —  —  —  —  —  —  264  —  —  — 
Units issued in exchange for Standstill Agreement  —  —  —  —  —  —  3,800  5,928  —  5,928 
Net Income  —  —  —  —  —  —  —  64,367  15  64,382 
Balance, March 31, 2018  2,300  $ 55,192  7,200  $ 174,261  100  $ 30,814  76,659  $ (461,236) $ (145) $ (201,114)


See accompanying notes to condensed consolidated financial statements.


Page 9


LEGACY RESERVES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended March 31, 
2019 2018
(In thousands)
Cash flows from operating activities: 
Net loss  $ (78,378) $ 64,382 
Adjustments to reconcile net (loss) income to net cash provided by operating activities: 
Depletion, depreciation, amortization and accretion  42,549  36,547 
Amortization of debt discount and issuance costs  8,526  7,509 
Gain on extinguishment of debt  (13,105) (51,693)
Impairment of long-lived assets  7,398  — 
(Gain) loss on derivatives  52,168  837 
Equity in (income) loss of equity method investees  —  (17)
Stock/unit-based compensation  4,156  12,324 
(Gains) losses on disposal of assets  1,034  (20,395)
Changes in assets and liabilities: 
Increase in accounts receivable, oil and natural gas  (6,927) (3,499)
(Increase) decrease in accounts receivable, joint interest owners  (772) 6,346 
Increase in accounts receivable, other  (283) — 
(Increase) decrease in other assets  (712) 843 
Increase (decrease) in accounts payable  17,431  (9,730)
(Decrease) increase in accrued oil and natural gas liabilities
(4,230) 3,787 
Increase in other liabilities  6,572  6,776 
Total adjustments  113,805  (10,365)
Net cash provided by operating activities  35,427  54,017 
Cash flows from investing activities: 
Investment in oil and natural gas properties  (57,761) (73,870)
Proceeds associated with sale of assets  160  27,100 
Investment in other equipment  (4,424) (57)
Net cash settlements (paid) received on commodity derivatives  9,579  (2,795)
Net cash used in investing activities
(52,446) (49,622)
Cash flows from financing activities: 
Proceeds from long-term debt  71,000  265,626 
Payments of long-term debt  (50,000) (248,384)
Payments of debt issuance costs  (2,855) (22,875)
Net cash provided by (used in) financing activities  18,145  (5,633)
Net increase in cash and cash equivalents  1,126  (1,238)
Cash, beginning of period (1)  4,361  4,438 
Cash, end of period (1)  $ 5,487  $ 3,200 
Non-cash investing and financing activities: 
Asset retirement obligations associated with properties sold  $ (243) $ (15,708)
Debt exchange  $ 3,716  $ — 
Change in accrued capital expenditures  $ (18,372) $ (12,503)
Units issued in exchange for Standstill Agreement  $ —  $ 5,928 
See accompanying notes to condensed consolidated financial statements.

(1)  Inclusive of $4.0 million and $3.3 million of restricted cash as of March 31, 2019 and 2018. See "—Footnote 1—Summary of Significant Accounting Policies" for further discussion.
Page 10


LEGACY RESERVES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(1)  Summary of Significant Accounting Policies

(a) Organization, Basis of Presentation and Description of Business

Unless the context requires otherwise or unless otherwise noted, all references to “Legacy Reserves,” “Legacy Inc.,” “Legacy,” the “Company,” “we,” “us,” “our” or like terms are to Legacy Reserves Inc. and its subsidiaries for the periods after September 19, 2018, the date the Corporate Reorganization was consummated (as defined below). For the periods prior to September 20, 2018, unless the context requires otherwise or unless otherwise noted, all references to “Legacy Reserves,” “Legacy LP,” “Legacy,” the “Company,” “we,” “us,” “our” or like terms are to Legacy Reserves LP and its subsidiaries.

Legacy is an independent energy company engaged in the development, production and acquisition of oil and natural gas properties in the United States. Its current operations are focused on the horizontal development of unconventional plays in the Permian Basin and the cost-efficient management of shallow-decline oil and natural gas wells in the Permian Basin, East Texas, Rocky Mountain and Mid-Continent regions. 

The accompanying financial statements have been prepared on the accrual basis of accounting whereby revenues are recognized when earned, and expenses are recognized when incurred.  These condensed consolidated financial statements as of March 31, 2019 and for the three months ended March 31, 2019 and 2018 are unaudited. In the opinion of management, such financial statements include the adjustments and accruals, all of which are of a normal recurring nature, that are necessary for a fair presentation of the results for the interim periods. These interim results are not necessarily indicative of results for a full year. 

Certain information and footnote disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted in this Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Legacy's Annual Report on Form 10-K for the year ended December 31, 2018.

(b) Going Concern

Legacy has significant obligations and commitments coming due in the near term. The Credit Agreement (as defined in Note 2) matures on May 31, 2019 and as of March 31, 2019, Legacy had borrowings of $562 million and availability under the Credit Agreement of $13.0 million. In addition, Legacy received a temporary waiver under the Term Loan Credit Agreement (as defined in Note 2) of its requirement to deliver fiscal year 2018 audited financial statements without a "going concern" or like qualification or exception through May 31, 2019. Due to the short-term nature of this waiver and the anticipation that we will be in violation of this covenant upon expiry of the waiver, Legacy has determined that the total borrowings outstanding under the Term Loan Credit Agreement of $339.8 million are due in the near term and have thus recorded these as a current liability. Without additional sources of capital or a significant restructuring of its balance sheet, the maturity of the Credit Agreement raises substantial doubt about Legacy's ability to continue as a going concern, which means that Legacy may be unable to continue operations for the foreseeable future or realize assets and discharge liabilities in the ordinary course of operation.The consolidated financial statements do not include any adjustments that might result from the outcome of the going concern uncertainty.

In order to improve its liquidity position and address its near-term debt maturities, Legacy is currently evaluating financial, transactional and other strategic alternatives. There can be no assurance that sufficient liquidity can be raised or that debt maturities can be extended from any one or more of these transactions or that these transactions can be consummated within the period needed to meet our obligations. Should Legacy be unable to extend the debt maturities or consummate a transaction, Legacy will not have sufficient liquidity to repay its Credit Agreement at maturity and may need to seek relief under the U.S. Bankruptcy code. 

(c) Recent Developments

On March 21, 2019, we entered into the Twelfth Amendment (the “Twelfth Amendment”) to our Credit Agreement. The
Twelfth Amendment provides for, among other things, (i) an extension of the maturity of the Credit Agreement to May 31, 2019, (ii) an increase in the applicable interest rate by 2.25%, (iii) the payment of a fee equal to 0.35% of the amount of the
Page 11


current borrowing base under the Credit Agreement, payable on the effective date of the Twelfth Amendment, (iv) the mandatory termination of certain derivative contracts three days prior to the maturity of the Credit Agreement, (vi) the reduction in the borrowing base from $575 million to $570 million, effective May 22, 2019, (vii) the reduction in the maximum consolidated cash balance we can maintain to $15 million, effective April 1, 2019 and (viii) the payment of a fee equal to 0.15% of the amount of the current borrowing base under the Credit Agreement, payable on the earliest to occur of (x) May 31, 2019 or (y) an acceleration of the outstanding indebtedness under the Credit Agreement. Additionally, the Twelfth Amendment waives certain deviations from the requirements of the Credit Agreement, including the delivery of fiscal year 2018 audited financial statements with a “going concern” or like qualification or exception and non-compliance with the current ratio covenant for the fourth quarter of 2018.

On March 21, 2019, we entered into the Seventh Amendment (the “Seventh Amendment”) to our Term Loan Credit Agreement. The Seventh Amendment waives, through May 31, 2019, the requirement of the Term Loan Credit Agreement that the delivery of fiscal year 2018 audited financial statements not include a “going concern” or like qualification or exception. The Seventh Amendment also provides for, among other things, (i) an increase in the applicable interest rate by2.25%, (ii) a fee equal to 0.35% of the aggregate amount of term loans currently outstanding under the Term Loan Credit Agreement, to be paid in kind by increasing the aggregate amount of term loans outstanding as of the effective date of the Seventh Amendment and (iii) a fee equal to 0.15% of the aggregate amount of term loans currently outstanding under the Term Loan Credit Agreement, to be paid in kind by increasing the aggregate amount of term loans outstanding on the earliest to occur of (x) May 31, 2019 or (y) an acceleration of the outstanding indebtedness under the Term Loan Credit Agreement.

On September 20, 2018, we completed the previously announced transactions contemplated by the Amended and Restated Agreement and Plan of Merger (the “Merger Agreement”), dated July 9, 2018, by and among Legacy Inc., Legacy LP, Legacy Reserves GP, LLC (the “General Partner”) and Legacy Reserves Merger Sub LLC, a wholly owned subsidiary of Legacy Inc. (“Merger Sub”), and the GP Purchase Agreement, dated March 23, 2018, by and among Legacy Inc., the General Partner, Legacy LP, Lion GP Interests, LLC, Moriah Properties Limited, and Brothers Production Properties, Ltd., Brothers Production Company, Inc., Brothers Operating Company, Inc., J&W McGraw Properties, Ltd., DAB Resources, Ltd. and H2K Holdings, Ltd. (such transactions referred to herein collectively as the “Corporate Reorganization”). Upon the consummation of the Corporate Reorganization:

Legacy Inc., which prior to the Corporate Reorganization, was a wholly owned subsidiary of the General Partner, acquired all of the is sued and outstanding limited liability company interests in the General Partner and became the sole member of the General Partner with the General Partner becoming a subsidiary of Legacy Inc.; and

Legacy LP merged with Merger Sub, with Legacy LP continuing as the surviving entity and as a subsidiary of Legacy Inc. (the “Merger”), the limited partner interests of Legacy LP, other than the incentive distribution units in Legacy LP, were exchanged for shares of Legacy Inc.’s common stock, par value $0.01 (“common stock”) and the general partner interest remained outstanding.

The Corporate Reorganization was accounted for under ASC 805 as a combination of entities under common control. As
such, the assets and liabilities of the Partnership were recognized at their carrying values in Legacy Inc.

(d) Accrued Oil and Natural Gas Liabilities

Below are the components of accrued oil and natural gas liabilities as of March 31, 2019 and December 31, 2018:
March 31, 2019 December 31, 2018
(In thousands)
Revenue payable to joint interest owners
$ 18,972  $ 24,690 
Accrued lease operating expense
23,050  22,750 
Accrued Capital Expenditures 22,855  41,227 
Accrued ad valorem tax
6,623  5,255 
Other
4,784  4,964 
$ 76,284  $ 98,886 


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(e) Restricted Cash

Restricted cash on our Consolidated Balance Sheet as of March 31, 2019 and December 31, 2018 is $4.0 million and $3.3 million  respectively, and is included in the "Prepaid expenses and other current assets" line. The restricted cash amounts represent various deposits to secure the performance of contracts, surety bonds and other obligations incurred in the ordinary course of business. Legacy adopted Accounting Standards Update ("ASU") No. 2016-18, "Restricted Cash" as of January 1, 2018.

(f) Recent Accounting Pronouncements

None

(g) Income Taxes

Legacy’s provision for income taxes for the three months ended March 31, 2019 and 2018 is based on the estimated annual effective tax rate plus discrete items. The effective income tax rates were —% and 0.1% for the three months ended March 31, 2019 and 2018, respectively.

Effective September 20, 2018, pursuant to the Merger Agreement, Legacy Inc. became subject to federal and state income taxes. Prior to consummation of the Corporate Reorganization, Legacy LP was treated as a partnership for federal and state income tax purposes, in which the taxable income or loss was passed through to its unitholders. With the exception of the state of Texas and certain subsidiaries, Legacy LP did not directly pay federal and state income taxes and recognition was not given to federal and state income taxes for its operations.

On December 22, 2017, Public Law No. 115-97, commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law. The provisions of the Tax Act that impact Legacy include, but are not limited to, (1) reducing the U.S. federal corporate income tax rate from 35% to 21%, (2) full expensing of certain qualified property acquired after September 27, 2017, (3) limitations on the maximum deduction for net operating loss (NOL) as well as indefinite life carryforwards for tax years beginning after December 31, 2017 and (4) limitations on the maximum deduction for net business interest expense in tax years beginning after December 31, 2017. Legacy has previously recorded all amounts for the income effects of the Tax Act as of December 31, 2017.

All of Legacy's income is sourced within the United States. 

(h) Leases

The new standard was effective for us in the first quarter of 2019, and we adopted the new standard using a modified retrospective approach, with the date of initial application on January 1, 2019. Consequently, upon transition, we recognized an ROU asset and a lease liability, with the cumulative-effect of adoption in retained earnings as of January 1, 2019. We further utilized the package of practical expedients at transition to not reassess the following:

Whether any expired or existing contracts were or contained leases;

The lease classification for any expired or existing leases; and

Initial direct costs for any existing leases.

In addition, we elected the practical expedient to not assess whether existing or expired land easements that were not previously accounted for as leases under superseded guidance are or contain a lease under the new leases guidance.

We determine if an arrangement is a lease at inception of the arrangement. To the extent that we determine an arrangement represents a lease, we classify that lease as an operating lease or a finance lease. We capitalize operating and finance leases on our consolidated balance sheets through a right-of-use (“ROU”) asset and a corresponding lease liability. ROU assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease.

Operating leases are included in other property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. Operating lease ROU assets and liabilities are recognized at the commencement date of an arrangement based on the present value of lease payments over the lease term. The operating lease ROU asset also includes any lease payments made to the lessor prior to lease commencement, less any lease incentives, and initial direct costs incurred. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term.

Page 13


Finance leases are included in other property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. Finance lease ROU assets (that is, amounts capitalized in other property and equipment) and liabilities are recognized at the commencement date of an arrangement based on the present value of lease payments over the lease term. The finance lease ROU asset also includes any lease payments made to the lessor prior to lease commencement, less any lease incentives, and initial direct costs incurred. We generally amortize that ROU asset on a straight-line basis, while interest on the lease liability is calculated using the effective interest method. Lease expense recognized under our finance leases is, therefore, comprised of amortization on the finance lease ROU asset and interest on the finance lease liability.

Nature of Leases

In support of our operations, we lease certain corporate office space, field offices, compressors, drilling rigs, other production equipment, fleet vehicles and storage space under cancelable and non-cancelable contracts. A more detailed description of our material lease types is included below.

Corporate and Field Offices

We enter into long-term contracts to lease corporate and field office space in support of company operations. These contracts are generally structured with an initial non-cancelable term of two to ten years. To the extent that our corporate and field office contracts include renewal options, we evaluate whether we are reasonably certain to exercise those options on a contract by contract basis based on expected future office space needs, market rental rates, drilling plans and other factors. We have further determined that our current corporate and field office leases represent operating leases.

Compressors

We rent compressors from third parties in order to facilitate the downstream movement of our production to market. Our compressor arrangements are typically structured with a non-cancelable primary term of one to twenty four months and often continue thereafter on a month-to-month basis subject to termination by either party with thirty days’ notice. We have concluded that our compressor rental agreements represent operating leases with a lease term that equals the primary non-cancelable contract term. Upon completion of the primary term, both parties have substantive rights to terminate the lease without incurring a significant penalty. As a result, enforceable rights and obligations do not exist under the rental agreement subsequent to the primary term.

To the extent that our compressor rental arrangements have a primary term of twelve months or less, we have elected to apply the practical expedient for short-term leases. For those short-term compressor contracts, we do not apply the lease recognition requirements, and we recognize lease payments related to these arrangements in profit or loss on a straight-line basis over the lease term. Refer to “Practical Expedients & Accounting Policy Elections” below for additional detail.

Drilling Rigs

We enter into daywork contracts for drilling rigs with third party service contractors to support the development and exploitation of undeveloped reserves and acreage. Our drilling rig arrangements are typically structured with a term that is in effect until drilling operations are completed on a contractually specified well or well pad. Upon mutual agreement with the contractor, we typically have the option to extend the contract term for additional wells or well pads by providing thirty days’ notice prior to the end of the original contract term. We have concluded that our drilling rig arrangements represent short-term operating leases with a lease term that equals the period of time required to complete drilling operations on the contractually specified well or well pad (that is, generally one to a few months from commencement of drilling). We do not include the option to extend the drilling rig contract in the lease term due to the continuously evolving nature of our drilling schedules, which requires significant flexibility in the structure of the term of these arrangements, and the potential volatility in commodity prices in an annual period.

We have further elected to apply the practical expedient for short-term leases to our drilling rig leases. Accordingly, we do not apply the lease recognition requirements to our drilling rig contracts, and we recognize lease payments related to these arrangements in capital expenditures on a straight-line basis over the lease term. Refer to “Practical Expedients & Accounting Policy Elections” below for additional detail.

Other Production Equipment

We rent other production equipment, primarily electric submersible pumps, from third party vendors to be used in our production operations. These arrangements are typically structured with a non-cancelable term of 1 to 3 months and often continue thereafter on a month-to-month basis subject to termination by either party with thirty days’ notice. We have concluded that we are not reasonably certain of executing the month-to-month renewal options beyond a twelve month period based on the
Page 14


historical term for which we have used other production equipment, and, therefore, our other equipment agreements represent operating leases with a lease term up to twelve months.

We have further elected to apply the practical expedient for short-term leases to our other production equipment contracts. Accordingly, we do not apply the lease recognition requirements to these contracts, and we recognize lease payments related to these arrangements in profit or loss on a straight-line basis over the lease term. Refer to “Practical Expedients & Accounting Policy Elections” below for additional detail.

Fleet Vehicles

We execute fleet vehicle leases with a third party vendor in support of our day-to-day drilling and production operations. Our vehicle leases are typically structured with a term of 18 to 48 months. We have concluded that the majority of our vehicle leases represent operating leases.

Significant Judgments

Discount Rate

Our leases typically do not provide an implicit rate, and thus, we are required to use our incremental borrowing rate in determining the present value of lease payments based on the information available at commencement date. Our incremental borrowing rate reflects the rate of interest that we would pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. In order to determine our incremental borrowing rate, we utilized our current credit rating as well as best available market data, which includes public bond information for publicly traded upstream energy companies with similar credit ratings, to estimate our unsecured borrowing rate and applied adjustments to that rate to account for the effect of collateral. 

Legacy has determined the discount rate as of January 1, 2019 using end of day December 31, 2018 market data. This discount rate was used in the transition to ASC 842 as well as all new leases executed within 2019. Legacy intends to update the discount rate annually thereafter on January 1 to be used for all new leases within the year (for example, the discount rate will be updated as of January 1, 2020 to be applied to all new leases in 2020). In the event a material lease is executed within a fiscal year or there have been material changes in the market that would impact Legacy’s discount rate, Legacy will evaluate whether an intra-year update of the discount rate is required.

Variable Lease Cost

Practical Expedients & Accounting Policy Elections

Certain of our lease agreements include lease and non-lease components. For all current asset classes with multiple component types, we have utilized the practical expedient that exempts us from separating lease components from non-lease components. Accordingly, we account for the lease and non-lease components in an arrangement as a single lease component.

In addition, for all of our asset classes, we have made an accounting policy election not to apply the lease recognition requirements to our short-term leases (that is, a lease that, at commencement, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that we are reasonably certain to exercise). Accordingly, we recognize lease payments related to our short-term leases in profit or loss on a straight-line basis over the lease term. To the extent that there are variable lease payments, we recognize those payments in profit or loss in the period in which the obligation for those payments is incurred. Refer to “Nature of Leases” above for further information regarding those asset classes that include material short-term leases. 

Page 15


(2) Debt

Debt consists of the following as of March 31, 2019 and December 31, 2018:
March 31, 
December 31,
2019  2018 
(In thousands)
Current debt 
Credit Facility due 2019
$ 562,000  $ 541,000 
Second Lien Term Loans due 2020  339,812  338,626 
Unamortized debt issuance costs (15,612) (17,332)
Unamortized discount on Second Lien Term Loans  (3,108) (5,648)
Total current debt, net  $ 883,092  856,646 
Long-term debt 
8% Senior Notes due 2020  208,885  208,885 
6.625% Senior Notes due 2021  129,529  131,279 
8% Convertible Senior Notes due 2023  107,527  128,103 
$ 445,941  $ 468,267 
Unamortized discount on Senior Notes  (26,059) (31,517)
Unamortized debt issuance costs  (3,554) (3,827)
Total long-term debt, net  $ 416,328  $ 432,923 
Total debt, net  $ 1,299,420  $ 1,289,569 

  Credit Facility

On April 1, 2014, Legacy LP entered into a 5 year $1.5 billion secured revolving credit facility with Wells Fargo Bank, National Association, as administrative agent, Compass Bank, as syndication agent, UBS Securities LLC and U.S. Bank National Association, as co-documentation agents and the lenders party thereto (as amended, the “Credit Agreement”). On March 21, 2019, Legacy entered into the Twelfth Amendment to the Credit Agreement which, among other things, extended the maturity of the Credit Agreement from April 1, 2019 to May 31, 2019. Legacy's obligations under the Credit Agreement are secured by mortgages on over 95% of the total value of its oil and natural gas properties as well as a pledge of all of its ownership interests in its operating subsidiaries and Legacy's ownership interests in the General Partner. Concurrently with the Corporate Reorganization, the General Partner and Legacy Inc. provided guarantees of Legacy LP's obligations under the Credit Agreement. The amount available for borrowing at any one time is limited to the borrowing base and contains a $2 million sub-limit for letters of credit. The borrowing base was reaffirmed at $575 million as part of the Twelfth Amendment. Under the terms of the Credit Agreement, the borrowing base reduces to $570 million on May 22, 2019. The borrowing base is subject to semi-annual redeterminations on or about April 1 and October 1 of each year, but no redeterminations are scheduled between now and maturity on May 31, 2019. Additionally, either Legacy or the lenders may, once during each calendar year, elect to redetermine the borrowing base between scheduled redeterminations. Legacy also has the right, once during each calendar year, to request the redetermination of the borrowing base upon the proposed acquisition of certain oil and natural gas properties where the purchase price is greater than 10% of the borrowing base then in effect. Any increase in the borrowing base requires the consent of all the lenders and any decrease in or maintenance of the borrowing base must be approved by the lenders holding at least 66-2/3% of the outstanding aggregate principal amounts of the loans or participation interests in letters of credit issued under the Credit Agreement. If the requisite lenders do not agree on an increase or decrease, then the borrowing base will be the highest borrowing base acceptable to the lenders holding 66-2/3% of the outstanding aggregate principal amounts of the loans or participation interests in letters of credit issued under the Credit Agreement so long as it does not increase the borrowing base then in effect.

Prior to the Corporate Reorganization, the Credit Agreement contained a covenant that prohibited Legacy from paying distributions to its limited partners, including holders of its preferred units, if (i) Total Debt to EBITDA for the four fiscal quarters ending on the last day of the fiscal quarter immediately preceding the date of determination for which financial statements were available was greater than 4.00 to 1.00 or (ii) Legacy had unused lender commitments of less than or equal to 15% of the total lender commitments then in effect. Following the consummation of the Corporate Reorganization, the Credit Agreement contains a covenant that prohibits Legacy from paying dividends to its stockholders, if (i) Total Debt to EBITDA for
Page 16


the four fiscal quarters ending on the last day of the fiscal quarter immediately preceding the date of determination for which financial statements are available is greater than 3.00 to 1.00 or (ii) Legacy has unused lender commitments of less than or equal to 20% of the total lender commitments then in effect.

The Credit Agreement also contains covenants that, among other things, require us to maintain specified ratios or conditions as follows:

as of any day, first lien debt to EBITDA for the four fiscal quarters ending on the last day of the fiscal quarter immediately preceding the date of determination for which financial statements are available to not be greater than 2.50 to 1.00;

as of the last day of any fiscal quarter, secured debt to EBITDA as of the last day of any fiscal quarter for the four fiscal quarters then ending of not more than  4.5 to 1.0; 

as of the last day of any fiscal quarter, total EBITDA over the last four quarters to total interest expense over the last four quarters to be greater than  2.0 to 1.0;

consolidated current assets, as of the last day of the most recent quarter and including the unused amount of the total commitments, to consolidated current liabilities as of the last day of the most recent quarter of not less than  1.0 to 1.0, excluding non-cash assets and liabilities under FASB Accounting Standards Codification 815, which includes the current portion of oil, natural gas and interest rate derivatives; and

as of the last day of any fiscal quarter, the ratio of (a) the sum of (i) the net present value using NYMEX forward pricing, discounted at  10 percent per annum, of Legacy’s proved developed producing oil and gas properties as reflected in the most recent reserve report delivered either July 1 or December 31 of each year, as the case may be (giving pro forma effect to material acquisitions or dispositions since the date of such reports) (“PDP PV-10”), (ii) the net mark to market value of Legacy’s commodity derivative agreements and (iii) Legacy’s cash and cash equivalents, in each case as of such date to (b) Secured Debt as of such day to be equal to or less than 1.00 to 1.00. 

On September 14, 2018 and September 20, 2018, Legacy entered into the Tenth Amendment and Eleventh Amendment, respectively, to the Credit Agreement (the “Credit Agreement Amendments”). The Credit Agreement Amendments amend certain provisions set forth in the Credit Agreement to, among other items:

permit the issuance of the 2023 Convertible Notes;

provide that the 2023 Convertible Notes constitute debt that is permitted refinancing debt;

allow for the payment of a cash conversion incentive in connection with the early cashless conversion of the 2023 Convertible Notes into common stock; and

permit the redemption of certain senior notes or permitted refinancing debt of such senior notes with any combination of the following: (i) proceeds of certain permitted refinancing debt; (ii) net cash proceeds of any sale of equity interests (other than disqualified capital stock) of Legacy Inc.; and/or (iii) in exchange for equity interests (other than disqualified capital stock) of Legacy Inc.

All capitalized terms not defined in the foregoing description have the meaning assigned to them in the Credit Agreement.

As of March 31, 2019, Legacy’s ratio of consolidated current assets to consolidated current liabilities was less than 0.7 to 1.0, in violation of a covenant contained in the Credit Agreement. On May 9, 2019, Legacy received a waiver with respect to compliance with such covenant for the fiscal quarter ended March 31, 2019. Except with respect to compliance with the financial covenant that has been waived, as of March 31, 2019, Legacy was in compliance with all covenants of the Credit Agreement. If Legacy is unable to extend its debt maturities or consummate a transaction, Legacy anticipates breaching certain covenants under its Credit Agreement, which would constitute a default under its Credit Agreement. Defaults, if not remedied, would require a waiver from Legacy’s lenders in order for it to avoid an event of default and subsequent acceleration of all amounts outstanding under its Credit Agreement and potential foreclosure on its oil and natural gas properties. Furthermore, the failure to repay outstanding indebtedness when due under its Credit Agreement and certain other payment defaults or acceleration under its Credit Agreement could cause a cross-default or cross-acceleration of all of Legacy’s indebtedness.

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As of March 31, 2019, Legacy had approximately $562 million drawn under the Credit Agreement at a weighted-average interest rate of 7.79%, leaving approximately $13.0 million of availability under the Credit Agreement. For the three-month period ended March 31, 2019, Legacy paid in cash $7.9 million of interest expense on the Credit Agreement.

Second Lien Term Loan Credit Agreement

On October 25, 2016, Legacy entered into a Second Lien Term Loan Credit Agreement (as amended, the "Term Loan Credit Agreement") among Legacy, as borrower, Cortland Capital Market Services LLC ("Cortland"), as administrative agent and second lien collateral agent, and the lenders party thereto, providing for term loans up to an aggregate principal amount of $300.0 million (the “Second Lien Term Loans”). On March 21, 2019, Legacy entered into the Seventh Amendment to the Term Loan Credit Agreement (as defined below). The Second Lien Term Loans under the Term Loan Credit Agreement are issued with an upfront fee of 2% and bear interest at a rate of 12.00% per annum payable quarterly in cash. Effective March 21, 2019, the Seventh Amendment to the Term Loan Credit Agreement provides an increase of 2.25% to the interest rate paid on all term loans. GSO Capital Partners L.P. (“GSO”) and certain funds and accounts managed, advised or sub-advised, by GSO are the initial lenders thereunder. The Term Loan Credit Agreement matures on August 31, 2021; provided that, if on July 1, 2020, Legacy has greater than or equal to a face amount of $15.0 million of Senior Notes that were outstanding on the date the Term Loan Credit Agreement was entered into or any other senior notes with a maturity date that is earlier than August 31, 2021, the Term Loan Credit Agreement will mature on August 1, 2020. The Second Lien Term Loans are secured on a second lien priority basis by the same collateral that secures Legacy's Credit Agreement and are unconditionally guaranteed on a joint and several basis by the same wholly owned subsidiaries of Legacy that are guarantors under the Credit Agreement. In addition, upon consummation of the Corporate Reorganization, the General Partner and Legacy Inc. became guarantors. As of March 31, 2019, Legacy had approximately $339.8 million drawn under the Term Loan Credit Agreement. On December 31, 2017, Legacy entered into the Third Amendment to the Term Loan Credit Agreement among Legacy, as borrower, Cortland, as administrative agent and second lien collateral agent, and the lenders party thereto, including GSO and certain funds and accounts managed, advised or sub-advised by GSO, which, among other things, increased the maximum amount available for borrowing under the Second Lien Term Loans to $400.0 million, extended the availability of undrawn principal ($60.2 million of availability as of March 31, 2019) to October 25, 2019 and relaxed the asset coverage ratio to 0.85 to 1.00 until the fiscal quarter ended December 31, 2018.

Prior to the Corporate Reorganization, the Term Loan Credit Agreement contained a covenant that prohibited Legacy from paying distributions to its limited partners, including holders of its preferred units, if (i) Total Debt to EBITDA for the four fiscal quarters ending on the last day of the fiscal quarter immediately preceding the date of determination for which financial statements were available was greater than 4.00 to 1.00 or (ii) Legacy had unused lender commitments of less than or equal to 15% of the total lender commitments then in effect. Following consummation of the Corporate Reorganization, the Term Loan Credit Agreement contains a covenant that prohibits Legacy from paying dividends to the stockholders, if (i) Total Debt to EBITDA for the four fiscal quarters ending on the last day of the fiscal quarter immediately preceding the date of determination for which financial statements are available is greater than 3.00 to 1.00 or (ii) Legacy has unused lender commitments of less than or equal to 20% of the total lender commitments then in effect.

The Term Loan Credit Agreement also contains covenants that, among other things, requires Legacy to:
not permit, as of the last day of any fiscal quarter, the ratio of the sum of (i) the net present value using NYMEX forward pricing of Legacy’s PDP PV-10, (ii) the net mark to market value of Legacy’s commodity derivative agreements and (iii) Legacy’s cash and cash equivalents to Secured Debt to be less than 0.85 to 1.00 until the fiscal quarter ended December 31, 2018 and 1.00 to 1.00 thereafter; and

not permit, as of the last day of any fiscal quarter , Legacy’s ratio of Secured Debt as of such day to EBITDA for the four fiscal quarters then ending to be greater than 4.50 to 1.00.

On September 14, 2018 and September 20, 2018, Legacy entered into the Fifth Amendment and Sixth Amendment, respectively, to the Term Loan Credit Agreement (the “Term Loan Amendments”). The Term Loan Amendments amend certain provisions set forth in the Term Loan Credit Agreement to, among other items:

permit the issuance of the 2023 Convertible Notes;

provide that the 2023 Convertible Notes constitute debt that is permitted refinancing debt;

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allow for the payment of a cash conversion incentive in connection with the early cashless conversion of the 2023 Convertible Notes into common stock; and

permit the redemption of certain senior notes or permitted refinancing debt of such senior notes with any combination of the following: (i) proceeds of certain permitted refinancing debt; (ii) net cash proceeds of any sale of equity interests (other than disqualified capital stock) of Legacy Inc.; and/or (iii) in exchange for equity interests (other than disqualified capital stock) of Legacy Inc.

On March 21, 2019, we entered into the Seventh Amendment (the “Seventh Amendment”) to our Term Loan Credit Agreement. The Seventh Amendment waives, through May 31, 2019, the requirement of the Term Loan Credit Agreement that the delivery of fiscal year 2018 audited financial statements not include a “going concern” or like qualification or exception. The Seventh Amendment also provides for, among other things, (i) an increase in the applicable interest rate by 2.25%, (ii) a fee equal to 0.35% of the aggregate amount of term loans currently outstanding under the Term Loan Credit Agreement, to be paid in kind by increasing the aggregate amount of term loans outstanding as of the effective date of the Seventh Amendment and (iii) a fee equal to 0.15% of the aggregate amount of term loans currently outstanding under the Term Loan Credit Agreement, to be paid in kind by increasing the aggregate amount of term loans outstanding on the earliest to occur of (x) May 31, 2019 or (y) an acceleration of the outstanding indebtedness under the Term Loan Credit Agreement. Further, while we received a waiver of the covenant under our Term Loan Credit Agreement that requires us to deliver audited financial statements without a “going concern” or like qualification or exception, such waiver expires on May 31, 2019 and such default cannot be remedied. We will be in breach of that covenant if we do not receive another waiver on May 31, 2019. There can be no assurances that we will be able to obtain an additional waiver.

All capitalized terms used but not defined in the foregoing description have the meaning assigned to them in the Term Loan Credit Agreement.

As of March 31, 2019, Legacy was in compliance with all financial and other covenants of the Term Loan Credit Agreement.

8% Senior Notes Due 2020 ("2020 Senior Notes") 

On December 4, 2012, Legacy and its 100% owned subsidiary Legacy Reserves Finance Corporation (together, the "Issuers") completed a private placement offering to eligible purchasers of an aggregate principal amount of $300 million of its 2020 Senior Notes, which were subsequently registered through a public exchange offer that closed on January 8, 2014. The 2020 Senior Notes were issued at 97.848% of par.

Legacy has the option to redeem the 2020 Senior Notes, in whole or in part, at any time at the specified redemption prices set forth below together with any accrued and unpaid interest, if any, to the date of redemption.

Legacy may be required to offer to repurchase the 2020 Senior Notes at a purchase price of 101% of the principal amount, plus accrued and unpaid interest, if any, to the redemption date, in the event of a change of control as defined by the indenture. Legacy and Legacy Reserves Finance Corporation's obligations under the 2020 Senior Notes are guaranteed by its 100% owned subsidiaries Legacy Reserves Operating GP LLC, Legacy Reserves Operating LP, Legacy Reserves Services LLC., Legacy Reserves Energy Services LLC, Legacy Reserves Marketing LLC., Dew Gathering LLC and Pinnacle Gas Treating LLC, which constitute all of Legacy's wholly-owned subsidiaries other than Legacy Reserves Finance Corporation. In the future, the guarantees may be released or terminated under the following circumstances: (i) in connection with any sale or other disposition of all or substantially all of the properties of the guarantor; (ii) in connection with any sale or other disposition of sufficient capital stock of the guarantor so that it no longer qualifies as Legacy's Restricted Subsidiary (as defined in the indenture); (iii) if designated to be an unrestricted subsidiary; (iv) upon legal defeasance, covenant defeasance or satisfaction and discharge of the indenture; (v) upon the liquidation or dissolution of the guarantor provided no default or event of default has occurred or is occurring; (vi) at such time the guarantor does not have outstanding guarantees of its, or any other guarantor's, other debt; or (vii) upon merging into, or transferring all of its properties to Legacy or another guarantor and ceasing to exist. Refer to "Note 13 - Guarantors -" for further details on Legacy's guarantors.

The indenture governing the 2020 Senior Notes (as supplemented, the "2020 Notes Indenture") limits Legacy's ability and the ability of certain of its subsidiaries to (i) sell assets; (ii) pay distributions or dividends on, repurchase or redeem equity interests or purchase or redeem Legacy's subordinated debt, provided that such subsidiaries may pay dividends to the holders of their equity interests (including Legacy) and Legacy may pay distributions to the holders of its equity interests subject to the absence of certain defaults, the satisfaction of a fixed charge coverage ratio test and certain other conditions; (iii) make certain investments; (iv) incur or guarantee additional indebtedness or issue preferred securities; (v) create or incur certain liens; (vi)
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enter into agreements that restrict distributions or other payments from certain of its subsidiaries to Legacy; (vii) consolidate, merge or transfer all or substantially all of Legacy's assets; (viii) engage in certain transactions with affiliates; (ix) create unrestricted subsidiaries; and (x) engage in certain business activities. These covenants are subject to a number of important exceptions and qualifications. If at any time when the 2020 Senior Notes are rated investment grade by each of Moody's Investors Service, Inc. and Standard & Poor's Ratings Services and no Default (as defined in the indenture) has occurred and is continuing, many of such covenants will terminate and Legacy and its subsidiaries will cease to be subject to such covenants. The 2020 Notes Indenture also includes customary events of default. Legacy is in compliance with all financial and other covenants of the 2020 Senior Notes. However, if the lenders under Legacy's Credit Agreement or Term Loan Credit Agreement were to accelerate the indebtedness under Legacy’s Credit Agreement or Term Loan Credit Agreement as a result of a default, such acceleration could cause a cross-default of all of the 2020 Senior Notes and permit the holders of such notes to accelerate the maturities of such indebtedness.

In connection with the exchange of approximately $21.0 million aggregate principal amount of 2020 Senior Notes for the same aggregate principal of the 2023 Convertible Notes and the issuance of 105,020 shares of Common Stock in September 2018, Legacy recognized a $1.4 million gain on extinguishment of debt, which consisted of the difference between (1) the face amount of the exchanged 2020 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the fair value of the new 2023 Convertible Notes.

During the year ended December 31, 2018, Legacy exchanged 1,000,000 shares of Common Stock for $3.1 million of face amount of its outstanding 2020 Senior Notes. Legacy treated the exchange as an extinguishment of debt. Accordingly, Legacy recognized a gain for the difference between (1) the face amount of the 2020 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the fair value of the units issued in the exchange based on the closing price on the date of exchange.

During the year ended December 31, 2016, Legacy repurchased a face amount of $52.0 million of its 2020 Senior Notes on the open market. Legacy treated these repurchases as an extinguishment of debt. Accordingly, Legacy recognized a gain for the difference between (1) the face amount of the 2020 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the repurchase price.

On June 1, 2016, Legacy exchanged 2,719,124 units representing limited partner interests in the Partnership for $15.0 million of face amount of its outstanding 2020 Senior Notes. Legacy treated this exchange as an extinguishment of debt. Accordingly, Legacy recognized a gain for the difference between (1) the face amount of the 2020 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the fair value of the units issued in the exchange based on the closing price on June 1, 2016.

The indenture also includes customary events of default. As of the March 31, 2019 period end, Legacy was in compliance with all covenants of the 2020 Senior Notes.

Interest is payable on June 1 and December 1 of each year.

As of March 31, 2019, there was $208.9 million of 2020 Senior Notes outstanding.

6.625% Senior Notes Due 2021 ("2021 Senior Notes") 

On May 28, 2013, the Issuers completed a private placement offering to eligible purchasers of an aggregate principal amount of $250 million of its 2021 Senior Notes, which were subsequently registered through a public exchange offer that closed on March 18, 2014. The 2021 Senior Notes were issued at 98.405% of par.

On May 13, 2014, the Issuers completed a private placement offering to eligible purchasers of an aggregate principal amount of an additional $300 million of the 2021 Senior Notes, which were subsequently registered through a public exchange offer that closed on February 10, 2015. These 2021 Senior Notes were issued at 99.0% of par.

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The terms of the 2021 Senior Notes, including the Guarantors, are substantially identical to the terms of the 2020 Senior Notes with the exception of the interest rate and redemption provisions noted below. Legacy will have the option to redeem the 2021 Senior Notes, in whole or in part, at the specified redemption prices set forth below together with any accrued and unpaid interest, if any, to the date of redemption.

Legacy may be required to offer to repurchase the 2021 Senior Notes at a purchase price of 101% of the principal amount, plus accrued and unpaid interest, if any, to the redemption date, in the event of a change of control as defined by the indenture, as supplemented. Legacy is in compliance with all financial and other covenants of the 2021 Senior Notes. However, if the lenders under Legacy's Current Credit Agreement were to accelerate the indebtedness under Legacy's Current Credit Agreement as a result of a default, such acceleration could cause a cross-default of all of the 2021 Senior Notes and permit the holders of such notes to accelerate the maturities of such indebtedness.

As of March 31, 2019, Legacy was in compliance with all covenants of the 2021 Senior Notes.

During the three months ended March 31, 2019, $1.75 million of 2021 Senior Notes were exchanged for 593,367 shares of common stock. Legacy treated the exchange as an extinguishment of debt. Accordingly, Legacy recognized a gain for the difference between (1) the face amount of the 2021 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the fair value of the shares issued in the exchange based on the closing price on the date of exchange.  As of March 31, 2019, there were $129.5 million of 2021 Senior Notes outstanding. 

During the year ended December 31, 2018, Legacy exchanged 2,000,000 shares of Common Stock for $5 million of face amount of its outstanding 2020 Senior Notes. Legacy treated the exchange as an extinguishment of debt. Accordingly, Legacy recognized a gain for the difference between (1) the face amount of the 2021 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the fair value of the units issued in the exchange based on the closing price on the date of exchange.

On September 20, 2018, in connection with the exchange of approximately $109.0 million aggregate principal amount of 2021 Senior Notes for the same aggregate principal of the 2023 Convertible Notes, Legacy recognized a $10.7 million gain on extinguishment of debt, which consisted of the difference between (1) the face amount of the exchanged 2021 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the fair value of the new 2023 Convertible Notes.

On April 2, 2018, following receipt of the requisite consents of the holders of the 2021 Senior Notes, Legacy entered into the Second Supplemental Indenture (the “2021 Notes Supplemental Indenture”) to the initial indenture governing the 2021 Notes (the "2021 Notes Indenture").

On December 31, 2017, Legacy entered into a definitive agreement with certain funds managed by Fir Tree Partners pursuant to which Legacy acquired $187.0 million of the 6.625% Notes for a price of approximately $132 million inclusive of accrued but unpaid interest with a settlement date of January 5, 2018. Legacy treated these repurchases for accounting purposes as an extinguishment of debt. Additionally, Legacy recognized a gain for the difference between (1) the face amount of the 2021 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the repurchase price.

During the year ended December 31, 2016, Legacy repurchased a face amount of $117.3 million of its 2021 Senior Notes on the open market. Legacy treated these repurchases as an extinguishment of debt. Accordingly, Legacy recognized a gain for the difference between (1) the face amount of the 2021 Senior Notes repurchased net of the unamortized portion of both the original issuer's discount and issuance costs and (2) the repurchase price.
 
Interest is payable on June 1 and December 1 of each year.

8% Convertible Senior Notes Due 2023 ("2023 Convertible Notes")

On September 20, 2018, the Issuers, completed private exchanges with certain holders of senior notes, pursuant to which the Issuers exchanged (i) $21.004 million aggregate principal amount of 2020 Senior Notes for $21.004 million aggregate principal amount of 2023 Convertible Notes and 105,020 shares of common stock and (ii) $109.000 million aggregate principal amount of 2021 Senior Notes for $109.000 million aggregate principal amount of 2023 Convertible Notes. The 2023 Convertible Notes were issued pursuant to an Indenture, dated as of September 20, 2018 (the “2023 Convertible Note Indenture”).

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Upon issuance, Legacy separately accounted for the liability and equity components in accordance with Accounting Standards Codification 470-20. The initial fair value of the 2023 Convertible Notes in its entirety (inclusive of the equity component related to the conversion option) was estimated using observable inputs such as trades that occurred on the day of the transaction. The liability component was recorded at the estimated fair value of a similar debt instrument without the conversion feature. The difference between the aggregate principal amount of the 2023 Convertible Notes and the fair value of the liability component was recorded as a debt discount and is being amortized to interest expense over the term of the notes using the effective interest method. The fair value of the liability component of the 2023 Convertible Notes was estimated at $101 million, resulting in a debt discount of $29 million. The equity component, representing the value of the conversion option, was computed by deducting the fair value of the liability component from the initial fair value of the 2023 Convertible Notes. The equity component was recorded in additional paid-in capital within stockholders’ equity and will not be remeasured as long as it continues to meet the conditions for equity classification.

The 2023 Convertible Notes mature on September 20, 2023, unless earlier repurchased or redeemed by the Issuers or converted. The 2023 Convertible Notes are subject to redemption for cash, in whole or in part, at the Issuers’ option at a redemption price equal to 100% of the 2023 Convertible Notes to be redeemed, plus any accrued and unpaid interest. In addition, the Issuers are required to make an offer to holders of the 2023 Convertible Notes upon a change of control at a price equal to 101%, plus any accrued and unpaid interest, and an offer to holders of the 2023 Convertible Notes upon consummation by the Issuers or any restricted subsidiaries of certain asset sales at a price equal to 100%, plus any accrued and unpaid interest.

The 2023 Convertible Notes are convertible into shares of common stock at an initial conversion rate of 166.6667 shares per $1,000 principal amount of 2023 Convertible Notes, which is equal to an initial conversion price of $6.00 per share of common stock (the "Conversion Price").

The 2023 Convertible Notes are convertible, at the option of the holders, into shares of common stock at any time from the date of issuance up until the close of business on the earlier of (i) the business day prior to the date of a mandatory conversion notice, (ii) with respect to a 2023 Convertible Note called for redemption, the business day immediately preceding the redemption date or (iii) the business day immediately preceding the maturity date. In addition, if a holder exercises its right to convert on or prior to September 19, 2019, such holder will receive an early conversion payment, in cash, per $1,000 principal amount as follows:

Early Conversion Date  Early Conversion Payment 
December 1, 2018 through May 31, 2019  $64.22 
June 1, 2019 through September 19, 2019  $24.22 

Subject to compliance with certain conditions, the Issuers have the right to mandatorily convert all of the 2023 Convertible Notes if the volume weighted average price of the common stock equals or exceeds the conversion price for at least 20 trading days (whether or not consecutive) during any period of 30 consecutive trading days commencing on or after the initial issuance date.

The 2023 Convertible Notes are guaranteed by Legacy Inc., the General Partner, Legacy Reserves Operating GP LLC, Legacy Reserves Operating LP, Legacy Reserves Services LLC, Legacy Reserves Energy Services LLC, Legacy Reserves Marketing LLC, Dew Gathering LLC and Pinnacle Gas Treating LLC.

The terms of the 2023 Convertible Notes, including the Guarantors, are substantially identical to the terms of the 2020 Senior Notes and 2021 Senior Notes with the exception of the interest rate, conversion and redemption provisions noted above. Additionally, if the lenders under Legacy's Credit Agreement or Term Loan Credit Agreement were to accelerate the indebtedness under Legacy's Credit Agreement or Term Loan Credit Agreement as a result of a default, such acceleration could cause a cross-default of all of the 2023 Senior Notes and permit the holders of such notes to accelerate the maturities of such indebtedness.

During the three months ended March 31, 2019, $6.5 million of 2023 Convertible Notes were exchanged for 2,429,026 shares of common stock and $14.1 million of 2023 Convertible Notes were converted for 2,346,000 shares of common stock. Legacy recognized $1.6 million and $10.7 million of gain on extinguishment of debt on these transactions respectively.

As of March 31, 2019, there was $107.5 million of 2023 Convertible Notes were outstanding.

Interest is payable on June 1 and December 1 of each year.

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(3) Revenue from Contracts with Customers

Oil, NGL and natural gas sales revenues are generally recognized at the point in time that control of the product is transferred to the customer and collectability is reasonably assured. This generally occurs when oil or natural gas has been delivered to a pipeline or truck. A more detailed summary of the sale of each product type is included below.

Oil Sales

Legacy's oil sales contracts are generally structured such that Legacy sells its oil production to the purchaser at a contractually specified delivery point at or near the wellhead. The crude oil production is priced on the delivery date based upon prevailing index prices less certain deductions related to oil quality and physical location. Legacy recognizes revenue when control transfers to the purchaser upon delivery at the net price received from purchaser.

NGL and Natural Gas Sales

Under Legacy's gas processing contracts, Legacy delivers wet gas to a midstream processing entity at the wellhead or the inlet of the midstream processing entity’s system. The midstream processing entity processes the natural gas and remits proceeds to Legacy for the resulting sales of NGLs and residue gas. In these scenarios, Legacy evaluates whether it is the principal or the agent in the transaction. In virtually all of Legacy's gas processing contracts, Legacy has concluded that it is the agent, and the midstream processing entity is Legacy's customer. Accordingly, Legacy recognizes revenue upon delivery based on the net amount of the proceeds received from the midstream processing entity. Proceeds are generally tied to the prevailing index prices for residue gas and NGLs less deductions for gathering, processing, transportation and other expenses.

Under Legacy's dry gas sales that do not require processing, Legacy sells its natural gas production to third party purchasers at a contractually specified delivery point at or near the wellhead. Pricing provisions are tied to a market index, with certain deductions based on, among other factors, whether a well delivers to a gathering or transmission line, quality of natural gas, and prevailing supply and demand conditions, so that the price of the natural gas fluctuates to remain competitive with other available natural gas supplies. Legacy recognizes revenue upon delivery of the natural gas to third party purchasers based on the relevant index price net of deductions.

Imbalances

Natural gas imbalances occur when Legacy sells more or less than its entitled ownership percentage of total natural gas production. Any amount received in excess of its share is treated as a liability. If Legacy receives less than its entitled share, the underproduction is recorded as a receivable. Legacy did not have any significant natural gas imbalance positions as of December 31, 2017 and 2016.

Disaggregation of Revenue

Legacy has identified three material revenue streams in its business: oil sales, NGL sales, and natural gas sales. Revenue attributable to each of Legacy's identified revenue streams is disaggregated in the table below.
Three Months Ended
March 31, 
2019
(In thousands)
Revenues:
Oil sales  $ 77,761 
Natural gas liquids (NGL) sales  4,515 
Natural gas sales  36,221 
Total revenues  $ 118,497 

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Significant Judgments

Principal versus agent

Legacy engages in various types of transactions in which midstream entities process its gas and subsequently market resulting NGLs and residue gas to third-party customers on Legacy's behalf, such as Legacy's percentage-of-proceeds and gas purchase contracts. These types of transactions require judgment to determine whether Legacy is the principal or the agent in the contract and, as a result, whether revenues are recorded gross or net.

Transaction price allocated to remaining performance obligations

A significant number of Legacy's product sales are short-term in nature with a contract term of one year or less. For those contracts, Legacy has utilized the practical expedient in ASC 606 that exempts it from disclosure of the transaction price allocated to remaining performance obligations if the performance obligation is part of a contract that has an original expected duration of one year or less.

For Legacy's product sales that have a contract term greater than one year, Legacy has utilized the practical expedient in ASC 606 that states that it is not required to disclose the transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely to a wholly unsatisfied performance obligation. Under these sales contracts, each unit of product represents a separate performance obligation; therefore future volumes are wholly unsatisfied and disclosure of the transaction price allocated to remaining performance obligations is not required.

Contract balances

Under Legacy's product sales contracts, it is entitled to payment from purchasers once its performance obligations have been satisfied upon delivery of the product, at which point payment is unconditional, and record invoiced amounts as “Accounts receivable - oil and natural gas” in its consolidated balance sheet.

To the extent actual volumes and prices of oil and natural gas are unavailable for a given reporting period because of timing or information not received from third parties, the expected sales volumes and prices for those properties are estimated and also recorded as “Accounts receivable - oil and natural gas” in the accompanying consolidated balance sheets. In this scenario, payment is also unconditional, as Legacy has satisfied its performance obligations through delivery of the relevant product. As a result, Legacy has concluded that its product sales do not give rise to contract assets or liabilities under ASC 606.

Prior-period performance obligations

Legacy records revenue in the month production is delivered to the purchaser. However, settlement statements for certain oil, natural gas and NGL sales may not be received for 30 to 60 days after the date production is delivered, and as a result, Legacy is required to estimate the amount of production that was delivered to the midstream purchaser and the price that will be received for the sale of the product. Additionally, to the extent actual volumes and prices of oil are unavailable for a given reporting period because of timing or information not received from third party purchasers, the expected sales volumes and prices for those barrels of oil are also estimated.

Legacy records the differences between its estimates and the actual amounts received for product sales in the month that payment is received from the purchaser. Legacy has existing internal controls in place for its estimation process, and any identified differences between its revenue estimates and actual revenue received historically have not been significant. For the three months ended March 31, 2019, revenue recognized in the reporting period related to performance obligations satisfied in prior reporting periods was not material.

(4)  Commitments and Contingencies

From time to time, Legacy is a party to various legal proceedings arising in the ordinary course of business. While the outcome of lawsuits cannot be predicted with certainty, Legacy is not currently a party to any proceeding that it believes could have a potential material adverse effect on its financial condition, results of operations or cash flows.

Legacy is subject to numerous laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. To the extent laws are enacted or other governmental action is taken that
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restricts drilling or imposes environmental protection requirements that result in increased costs to the oil and natural gas industry in general, the business and prospects of Legacy could be adversely affected.

Legacy has employment agreements with its executive officers. The employment agreements with its executive officers specify that if the executive officer is terminated by Legacy for other than cause or following a change in control or by the executive officer for good reason, the executive officer shall receive severance pay ranging from 12 to 36 months’ salary plus bonus and COBRA benefits, respectively.

(5)  Fair Value Measurements

Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are classified and disclosed in one of the following categories:

Level 1:
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Legacy considers active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
 
Level 2:
Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that Legacy values using observable market data. Substantially all of these inputs are observable in the marketplace throughout the term of the derivative instrument, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category include non-exchange traded derivatives such as over-the-counter commodity price swaps and collars and interest rate swaps as well as long-term incentive plan liabilities calculated using the Black-Scholes model to estimate the fair value as of the measurement date.
 
Level 3:
Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e. supported by little or no market activity). Legacy’s valuation models are primarily industry standard models that consider various inputs including: (a) quoted forward prices for commodities, (b) time value, and (c) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Level 3 instruments currently are limited to Midland-Cushing crude oil differential swaps. Although Legacy utilizes third party broker quotes to assess the reasonableness of its prices and valuation techniques, Legacy does not have sufficient corroborating evidence to support classifying these assets and liabilities as Level 2.

Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. Legacy’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.
Page 25


Fair Value on a Recurring Basis 

The following tables sets forth by level within the fair value hierarchy Legacy's Financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2019 and December 31, 2018:

March 31, 2019
Fair Value Measurements Using
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Total Fair Value
Gross Amounts Offset in the Consolidated Balance Sheets
Net Amounts Presented in the Consolidated Balance Sheets
(In thousands) 
Assets: 
Current 
Commodity derivatives  $ —  $ 19,250  $ —  $ 19,250  $ (10,877) $ 8,373 
Interest rate derivatives  —  1,335  —  1,335  —  1,335 
Noncurrent 
Commodity derivatives  —  —  —  —  —  — 
Interest rate derivatives  —  —  —  —  —  — 
Liabilities: 
Current 
Commodity derivatives  —  (13,084) —  (13,084) 10,877  (2,207)
LTIP liability(a)  —  —  —  —  —  — 
Noncurrent 
Commodity derivatives  —  —  —  —  —  — 
Net fair value instruments  $ —  $ 7,501  $ —  $ 7,501  $ —  $ 7,501 



Page 26


December 31, 2018
Fair Value Measurements Using
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Total Fair Value
Gross Amounts Offset in the Consolidated Balance Sheets
Net Amounts Presented in the Consolidated Balance Sheets
(In thousands) 
Assets:
Current 
Commodity derivatives  $ —  $ 69,288  $ —  $ 69,288  $ (4,670) $ 64,618 
Interest rate derivatives
—  2,044  —  2,044  —  2,044 
Noncurrent 
Commodity derivatives
—  3,473  —  3,473  (338) 3,135 
Interest rate derivatives
—  —  —  —  —  — 
Liabilities:
Current 
Commodity derivatives
—  (4,670) —  (4,670) 4,670  — 
Noncurrent 
Commodity derivatives
—  (888) —  (888) 338  (550)
Net fair value instruments  $ —  $ 69,247  $ —  $ 69,247  $ —  $ 69,247 

Legacy estimates the fair values of the commodity derivatives based on published forward commodity price curves for the underlying commodities as of the date of the estimate for those commodities for which published forward pricing is readily available. For those commodity derivatives for which forward commodity price curves are not readily available, Legacy estimates, with the assistance of third-party pricing experts, the forward curves as of the date of the estimate. Legacy validates the data provided by third parties by understanding the pricing models used, obtaining market values from other pricing sources, analyzing pricing data in certain situations and confirming, where applicable, that those securities trade in active markets. Legacy estimates the option value of puts and calls combined into hedges, including three-way collars and enhanced swaps, using an option pricing model which takes into account market volatility, market prices, contract parameters and discount rates based on published London interbank offered rates ("LIBOR") and interest rate swaps. Due to the lack of an active market for periods beyond one-month from the balance sheet date for its oil price differential swaps, Legacy has reviewed historical differential prices and known economic influences to estimate a reasonable forward curve of future pricing scenarios based upon these factors. In order to estimate the fair value of our interest rate swaps, Legacy uses a yield curve based on money market rates and interest rate swaps, extrapolates a forecast of future interest rates, estimates each future cash flow, derives discount factors to value the fixed and floating rate cash flows of each swap, and then discounts to present value all known (fixed) and forecasted (floating) swap cash flows. Curve building and discounting techniques used to establish the theoretical market value of interest bearing securities are based on readily available money market rates and interest swap market data. The determination of the fair values above incorporates various factors including the impact of our non-performance risk and the credit standing of the counterparties involved in Legacy’s derivative contracts. The risk of nonperformance by Legacy’s counterparties is mitigated by the fact that most of our current counterparties (or their affiliates) are also current or former bank lenders under the Legacy’s revolving credit facility. In addition, Legacy routinely monitors the creditworthiness of its counterparties. As the factors described above are based on significant assumptions made by management, these assumptions are the most sensitive to change.

Page 27


The following table sets forth a reconciliation of changes in the fair value of financial assets and liabilities classified as Level 3 in the fair value hierarchy:
Significant Unobservable Inputs
(Level 3)
Three Months Ended
March 31, 
2019 2018
(In thousands)
Beginning balance
$ —  $ (5,088)
Total gains  —  14,060 
Settlements, net  —  937 
Ending balance
$ —  $ 9,909 
Gains (losses) included in earnings relating to derivatives still held as of
March 31, 2019 and 2018
$ —  $ 13,939 

During periods of market disruption, including periods of volatile oil and natural gas prices, rapid credit contraction or
illiquidity, it may be difficult to value certain of Legacy's derivative instruments if trading becomes less frequent and/or
market data becomes less observable. There may be certain asset classes that were previously in active markets with observable data that become illiquid due to changes in the financial environment. In such cases, more derivative instruments may fall to Level 3 and thus require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation as well as valuation methods which are more sophisticated or require greater estimation thereby resulting in valuations with less certainty. Further, rapidly changing commodity and unprecedented credit and equity market conditions could materially impact the valuation of derivative instruments as reported within Legacy's consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on Legacy's results of operations or financial condition.

Page 28


Fair Value on a Non-Recurring Basis

Nonfinancial assets and liabilities measured at fair value on a non-recurring basis include certain nonfinancial assets and liabilities as may be acquired in a business combination and thereby measured at fair value; measurements of oil and natural gas property impairments; and the initial recognition of asset retirement obligations ("ARO") for which fair value is used. These ARO estimates are derived from historical costs as well as management’s expectation of future cost environments. As there is no corroborating market activity to support the assumptions used, Legacy has designated these liabilities as Level 3. A reconciliation of the beginning and ending balances of Legacy’s asset retirement obligation is presented in Note 8.

Nonrecurring fair value measurements of proved oil and natural gas properties during the three months ended March 31, 2019 consist of adjustments of the carrying value oil and natural gas properties to their fair value of $4.7 million. Legacy incurred impairment charges of $7.4 million as oil and natural gas properties with a net cost basis of $12.1 million were written down to their fair value of $4.7 million. Legacy periodically reviews oil and natural gas properties for impairment when facts and circumstances indicate that their carrying value may not be recoverable. In order to determine whether the carrying value of an asset is recoverable, Legacy compares net capitalized costs of proved oil and natural gas properties to estimated undiscounted future net cash flows using management’s expectations of future oil and natural gas prices. These future price scenarios reflect Legacy’s estimation of future price volatility. If the net capitalized cost exceeds the undiscounted future net cash flows, Legacy writes the net cost basis down to the discounted future net cash flows, which is management's estimate of fair value. Significant inputs used to determine the fair value include estimates of: (i) reserves; (ii) future operating and development costs; (iii) future commodity prices; and (iv) a market-based weighted average cost of capital rate. The underlying commodity prices embedded in the Company's estimated cash flows are the product of a process that begins with NYMEX forward curve pricing, adjusted for estimated location and quality differentials, as well as other factors that Legacy's management believes will impact realizable prices. The inputs used by management for the fair value measurements utilized in this review include significant unobservable inputs, and therefore, the fair value measurements employed are classified as Level 3 for these types of assets.

The carrying amount of the revolving debt of $562 million as of March 31, 2019 approximates fair value because Legacy's current borrowing rate does not materially differ from market rates for similar bank borrowings. Legacy has classified the revolving debt as a Level 2 item within the fair value hierarchy. The carrying amount of the second lien term loan debt under Legacy’s Second Lien Term Loan Credit Agreement approximates fair value because Legacy’s current borrowing rate does not materially differ from market rates for similar borrowings. Legacy has classified the Second Lien Term Loans as a Level 2 item within the fair value hierarchy. As of March 31, 2019, the fair values of the 2020 Senior Notes, the 2021 Senior Notes and the 2023 Convertible Notes were $60.6 million, $37.6 million and $35.5 million, respectively. As these valuations are based on unadjusted quoted prices in an active market, the fair values are classified as Level 1 items within the fair value hierarchy.

Page 29


(6) Derivative Financial Instruments

Commodity derivative transactions

Due to the volatility of oil and natural gas prices, Legacy periodically enters into price-risk management transactions (e.g., swaps, enhanced swaps or collars) for a portion of its oil and natural gas production to achieve a more predictable cash flow, as well as to reduce exposure from price fluctuations. While the use of these arrangements limits Legacy’s ability to benefit from increases in the prices of oil and natural gas, it also reduces Legacy’s potential exposure to adverse price movements. Legacy’s arrangements, to the extent it enters into any, apply to only a portion of its production, provide only partial price protection against declines in oil and natural gas prices and limit Legacy’s potential gains from future increases in prices. None of these instruments are used for trading or speculative purposes.
 
These derivative instruments are intended to mitigate a portion of Legacy’s price-risk and may be considered hedges for
economic purposes, but Legacy has chosen not to designate them as cash flow hedges for accounting purposes. Therefore, all
derivative instruments are recorded on the balance sheet at fair value with changes in fair value being recorded in current period
earnings.
 
By using derivative instruments to mitigate exposures to changes in commodity prices, Legacy 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 Legacy, which creates credit risk. Legacy minimizes the credit or repayment risk in derivative instruments by entering into transactions with high-quality counterparties.
 
The following table sets forth a reconciliation of the changes in fair value of Legacy's commodity derivatives for the three months ended March 31, 2019 and 2018:
Three Months Ended March 31, 
2019  2018 
(In thousands)
Beginning fair value of commodity derivatives
$ 67,205  $ 6,318 
Total gain (loss) - oil derivatives
(49,572) (742)
Total gain (loss) - natural gas derivatives
(1,888) (962)
Crude oil derivative cash settlements paid (received)
(7,045) 4,894 
Natural gas derivative cash settlements paid (received) (2,534) (2,099)
Ending fair value of commodity derivatives
$ 6,166  $ 7,409 
 


Page 30


As of March 31, 2019, Legacy had the following NYMEX West Texas Intermediate crude oil swaps paying floating prices and receiving fixed prices for a portion of its future oil production as indicated below:
Average
Price
Time Period
Volumes (Bbls)
Price per Bbl
Range per Bbl
April-December 2019  2,475,000  $61.33  $57.15 
-
$67.65 

As of March 31, 2019, Legacy had the following Midland-to-Cushing crude oil differential swaps paying a floating differential and receiving a fixed differential for a portion of its future oil production as indicated below:
Average
Price
Time Period
Volumes (Bbls)
Price per Bbl
Range per Bbl
April-December 2019  1,743,000  $(3.61) $(1.15)
-
$(5.60)

As of March 31, 2019, Legacy had the following Midland-to-Cushing crude oil differential enhanced swaps paying a floating differential and receiving a fixed differential for a portion of its future oil production as indicated below:
Average Short  Average Swap 
Time Period  Volumes (Bbls)  Call Price per Bbl  Price per Bbl 
April-December 2019  1,100,000  $70.00  $(2.91)

As of March 31, 2019, Legacy had the following NYMEX Henry Hub natural gas swaps paying floating natural gas prices and receiving fixed prices for a portion of its future natural gas production as indicated below:

Average
Price
Time Period
Volumes (MMBtu)
Price per MMBtu
Range per MMBtu
April-December 2019  26,225,000  $3.30  $3.05 
-
$3.39 

Interest rate derivative transactions

Due to the volatility of interest rates, Legacy periodically enters into interest rate risk management transactions in the form of interest rate swaps for a portion of its outstanding debt balance. These transactions allow Legacy to reduce exposure to interest rate fluctuations. While the use of these arrangements limits Legacy’s ability to benefit from decreases in interest rates, it also reduces Legacy’s potential exposure to increases in interest rates. Legacy’s arrangements, to the extent it enters into any, apply to only a portion of its outstanding debt balance, provide only partial protection against interest rate increases and limit Legacy’s potential savings from future interest rate declines. It is never management’s intention to hold or issue derivative instruments for speculative trading purposes. Conditions sometimes arise where actual borrowings are less than notional amounts hedged, which has, and could result in overhedged amounts.

Legacy does not designate these derivatives as cash flow hedges, even though they reduce its exposure to changes in interest rates. Therefore, the mark-to-market of these instruments is recorded in current earnings as a component of interest expense. The total impact on interest expense from the mark-to-market and settlements was as follows:

Three Months Ended March 31, 
2019  2018 
(In thousands)
Beginning fair value of interest rate swaps
$ 2,044  $ 2,117 
Total gain on interest rate swaps
(80) 943 
Cash settlements received (629) (77)
Ending fair value of interest rate swaps
$ 1,335  $ 2,983 
 
Page 31


The table below summarizes the interest rate swap position as of March 31, 2019:
Weighted Average
Estimated Fair Value at
Notional Amount
Fixed Rate
Effective Date
Maturity Date
March 31, 2019
(Dollars in thousands)
$ 235,000  1.363  % 9/1/2015 9/1/2019 $ 1,335 

(7) Asset Retirement Obligation
 
An asset retirement obligation (“ARO”) associated with the retirement of a tangible long-lived asset is recognized as a liability in the period in which it is incurred and becomes determinable. When liabilities for dismantlement and abandonment costs, excluding salvage values, are initially recorded, the carrying amount of the related oil and natural gas properties is increased. The fair value of the additions to the ARO asset and liability is estimated using valuation techniques that convert future cash flows to a single discounted amount. Significant inputs to the valuation include estimates of: (i) plug and abandon costs per well based on existing regulatory requirements; (ii) remaining life per well; (iii) future inflation factors; and (iv) a credit-adjusted risk-free interest rate. These inputs require significant judgments and estimates by Legacy's management at the time of the valuation and are the most sensitive and subject to change. Accretion of the liability is recognized each period using the interest method of allocation, and the capitalized cost is depleted using the units of production method. Should either the estimated life or the estimated abandonment costs of a property change materially upon Legacy’s periodic review, a new calculation is performed using the same methodology of taking the abandonment cost and inflating it forward to its abandonment date and then discounting it back to the present using Legacy’s credit-adjusted-risk-free rate. The carrying value of the ARO is adjusted to the newly calculated value, with a corresponding offsetting adjustment to the asset retirement cost. When obligations are relieved by sale of the property or plugging and abandoning the well, the related liability and asset costs are removed from Legacy's balance sheet. Any difference in the cost to plug and the related liability is recorded as a gain or loss on Legacy's statement of operations in the disposal of assets line item.
 
The following table reflects the changes in the ARO during the three months ended March 31, 2019 and year ended December 31, 2018:
March 31, 2019 December 31, 2018
(In thousands)
Asset retirement obligation - beginning of period $ 252,734  $ 274,686 
Liabilities incurred with properties acquired —  226 
Liabilities incurred with properties drilled —  65 
Liabilities settled during the period (893) (2,258)
Liabilities associated with properties sold (243) (27,673)
Current period accretion 3,207  12,568 
Current period revisions to previous estimates —  (4,880)
Asset retirement obligation - end of period  $ 254,805  $ 252,734 
 

Page 32


(8) Stockholders' Deficit / Partners' Deficit

Preferred Units

On September 20, 2018, in connection with the Corporate Reorganization, all of Legacy LP's 8% Series A Fixed-to-Floating Cumulative Redeemable Perpetual Preferred Units and 8.000% Series B Fixed-to-Floating Rate Cumulative Redeemable Perpetual Preferred Units outstanding were converted into shares of common stock.

Incentive Distribution Units

On September 20, 2018, all of Legacy LP's Incentive Distribution Units outstanding were canceled in connection with the Corporate Reorganization.

Loss per share / unit

The following table sets forth the computation of basic and diluted income per share / unit:
Three Months Ended
March 31, 
2019  2018 
(In thousands)
Net Income (loss)  $ (78,378) $ 64,382 
Net income attributable to unitholders  (78,378) 64,382 
Weighted average number of shares / units outstanding - basic  111,225  103,994 
Effect of dilutive securities: 
Restricted shares
—  307 
Weighted average number of shares / units outstanding - diluted  111,225  104,301 
Basic and Diluted (loss) income per share / units  $ (0.70) $ 0.62 

For the three months ended March 31, 2019, 7,773,732 restricted stock units were excluded from the calculation of diluted loss per share due to their anti-dilutive effect. For the three and three months ended March 31, 2018, 191,430 restricted units and 1,160,424 phantom units were excluded from the calculation of diluted loss per share due to their anti-dilutive effect.

As of March 31, 2019, 17,921,170 shares related to 2023 Convertible Notes were excluded from the calculation of diluted earnings per share due to their anti-dilutive effect.

(9) Stock-Based Compensation
 
Legacy LP Long-Term Incentive Plan
 
On March 15, 2006, a Long-Term Incentive Plan (as amended, “Legacy LP LTIP”) for Legacy was created and Legacy adopted the Legacy LP LTIP for its employees, consultants and directors, its affiliates and its general partner. The awards under the long-term incentive plan may include unit grants, restricted units, phantom units, unit options and unit appreciation rights (“UARs”). The Legacy LP LTIP permits the grant of awards that may be made or settled in units up to an aggregate of 5,000,000 units.

As of March 31, 2018, grants of awards net of forfeitures and, in the case of phantom units, historical exercises covering 3,399,767 units had been made, comprised of 266,014 unit option awards, 988,873 restricted unit awards, 1,424,114 phantom unit awards and 720,766 unit awards.

Pursuant to the terms of the Corporate Reorganization, the Legacy LP LTIP was terminated.
 
Page 33


Unit Appreciation Rights

Legacy LP previously issued UARs under the Legacy LP LTIP to employees. A unit appreciation right is a notional unit that entitles the holder, upon vesting, to receive cash valued at the difference between the closing price of units on the exercise date and the exercise price, as determined on the date of grant. Because these awards were settled in cash, Legacy accounted for the UARs by utilizing the liability method.

For the three-months ended March 31, 2018, Legacy recorded $0.8 million of compensation expense due to the change in liability from December 31, 2017 and 2016, respectively, based on its use of the Black-Scholes model to estimate the March 31, 2018 fair value of these UARs.

Legacy LP did not issue UARs to employees during the year ended December 31, 2018 or the three-month period ended March 31, 2019. All outstanding UARs vested on September 20, 2018 in connection with the Corporate Reorganization and were subsequently exercised or forfeited.

Phantom Units

Legacy LP previously issued phantom units under the Legacy LP LTIP to executive officers. A phantom unit is a notional unit that entitles the holder, upon vesting, to receive either one Partnership unit for each phantom unit or the cash equivalent of a Partnership unit, as stipulated by the form of the grant. Legacy accounted for the phantom units settled in Partnership units by utilizing the equity method. Legacy accounted for the phantom units settled in cash by utilizing the liability method. On September 20, 2018, in connection with the Corporate Reorganization, 391,674 Phantom units that settle in cash and 1,032,440 phantom units that settle in units vested.

Compensation expense related to the phantom units was $11.8 million for the three months ended March 31, 2018. All phantom units vested on September 20, 2018 in connection with the Corporate Reorganization.

Restricted Units

Legacy LP previously issued restricted units to certain employees and members of management. All restricted units vested on September 20, 2018 in connection with the Corporate Reorganization.

Compensation expense related to restricted units was $0.2 million for the three months ended March 31, 2018.

Board Units

On May 15, 2018, Legacy granted and issued 12,019 units to four non-employee directors who serve on the Board of Directors of Legacy and 6,010 units to two non-employee directors of Legacy LP who, after the corporate reorganization, do not serve on the Board of Directors of Legacy Inc. The value of each unit was $8.69 at the time of issuance.

Legacy Reserves Inc. 2018 Omnibus Incentive Plan

On September 19, 2018, the Legacy Inc. 2018 Omnibus Incentive Plan (the "Legacy Inc. LTIP") was approved by the former unitholders of Legacy LP in connection with the Corporate Reorganization for it and its affiliates' employees, consultants and directors. The Legacy Inc. LTIP provides for up to 10,500,000 shares (the "Share Reserve") to be used for awards, and that the Share Reserve will increase proportionately by 10% of all shares of common stock issued by Legacy Inc. after the effective date of the Legacy Inc. LTIP and before the first anniversary of the effective date. The awards under the Legacy Inc. LTIP may include stock grants, restricted stock, restricted stock units ("RSUs") and stock options. As of March 31, 2019, grants of awards net of forfeitures covering 7,806,302 shares had been made, compromised of 7,773,732 restricted stock units and 32,570 stock awards.

Page 34


Restricted Stock Units

During the three months ended March 31, 2019, Legacy issued an aggregate 516,594 RSUs to executive and non-executive employees. The RSUs vest over a three -year period. Non-cash compensation expense related to the RSUs was $4.2 million for the three months ended March 31, 2019. RSUs are accounted for under the equity method.

The following table summarizes the status of RSU activity since January 1, 2019: 

Number of Restricted Stock Units Grant Date Fair Value
Outstanding at January 1, 2019 7,302,809  $ 4.88 
Granted 516,594  $ 1.32 
Cancelled/Forfeited (45,671) $ 4.23 
Outstanding at March 31, 2019 7,773,732  $ 4.65 

As of March 31, 2019, there was a total of $27.8 million of unrecognized compensation expense related to the unvested portion of these RSUs. At March 31, 2019, this cost was expected to be recognized over a weighted-average period of 2.98 years. Pursuant to the provisions of ASC 718, Legacy’s issued shares, as reflected in the accompanying consolidated balance sheet at March 31, 2019, do not include 7,773,732 shares related to unvested RSUs.

Board Shares

On September 25, 2018, Legacy granted and issued 5,030 shares to four non-employee directors who serve on the Board of Directors of Legacy in accordance with Legacy's director compensation policy. The value of each share was $4.97 at the time of issuance. 


(10) Income Taxes

Effective September 20, 2018, pursuant to the Merger Agreement, Legacy Inc. became subject to federal and state income taxes. Prior to consummation of the Corporate Reorganization, Legacy LP was treated as a partnership for federal and state income tax purposes, in which the taxable income or loss was passed through to its unitholders. Legacy LP was subject to Texas margin tax. In addition, certain of Legacy LP’s subsidiaries were c-corporations subject to federal and state income taxes. Therefore, with the exception of the state of Texas and certain subsidiaries, Legacy LP did not directly pay federal and state income taxes and recognition was not given to federal and state income taxes for its operations.

On December 22, 2017, Public Law No. 115-97, commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law. The provisions of the Tax Act that impact us include, but are not limited to, (1) reducing the U.S. federal corporate income tax rate from 35% to 21%, (2) temporary bonus depreciation that will allow for full expensing of certain qualified property acquired after September 27, 2017, (3) limitations on the maximum deduction for net operating loss (NOL) carryforwards generated in tax years beginning after December 31, 2017, to 80 percent of a taxpayer’s taxable income and (4) limitations on the maximum deduction for net business interest expense in tax years beginning after December 31, 2017, to 30% of the taxpayer’s adjusted taxable income. We have previously reported preliminary amounts for the income effects of the Tax Act for Legacy as of December 31, 2017.

For the period ended March 31, 2019 and 2018 we recorded income/(loss) before income taxes of $(78,378) and $64,869. respectively. All of Legacy's income is sourced within the United States. The effective combined U.S. federal and state income tax rates were 0% and 0.75% for the three months ended March 31, 2019 and 2018, respectively. During the three months ended March 31, 2019, the Legacy Inc. has recorded a full valuation allowance against its deferred tax position. A valuation allowance has been recorded as management does not believe that it is more-likely-than-not that its deferred tax assets will be realized.




Page 35


(11) Leases

As previously described in Note 1 – Summary of Significant Accounting Policies, we lease certain office space, office equipment, production field offices, compressors, drilling rigs, vehicles and other production equipment under cancellable and non-cancelable leases to support our operations.

The components of our total lease cost were as follows:

Three Months Ended
March 31, 
2019 
(In thousands)
Operating lease cost $836 
Finance lease cost: 
Amortization of right-of-use assets 
Interest on lease liabilities 
Total finance lease costs 
Short-term lease cost $3,675 
Total   $4,519 
 

Supplemental cash flow information related to our leases is included in the table below:

Three Months Ended
March 31, 
2019 
(In thousands)
Cash paid for amounts included in lease liabilities:
Operating cash flows from operating leases  $ 4,511 
Operating cash flows from finance leases 
Right-of-use assets obtained in exchange for lease obligations: 
Operating leases  $ 836 
Finance leases



Page 36


Supplemental balance sheet information related to our leases is included in the table below:

Three Months Ended
March 31, 
2019 
(In thousands)
Operating Leases
Operating lease right-of-use assets  $ 3,963 
Other current liabilities  (1,742)
Other long-term liabilities  (2,477)
Total operating lease liabilities  $ (4,219)
Finance Leases 
Other property and equipment  96 
Accumulated depreciation and amortization  (6)
Other property and equipment, net  $ 90 
Other current liabilities   (22)
Other long-term liabilities (70)
Total finance lease liabilities $ (92)


Our weighted average remaining lease term and weighted average discount rate by lease classification were as follows:

Three Months Ended
March 31, 
2019 
Weighted Average Remaining Lease Term (Years)
Operating leases  1.88
Finance leases  2.57
Weighted Average Discount Rate 
Operating leases  24.31  %
Finance leases  24.31  %


Our lease liabilities with enforceable contract terms that are greater than one year mature as follows:

Operating Leases Finance Leases
(in thousands)
Remainder of 2019 $ 3,100  $ 50 
2020 1,612  47 
2021 376  27 
2022  205  — 
2023  110  — 
Thereafter  —  — 
Total lease payments  $ 5,403  $ 124 
Less imputed interest  (1,184) (32)
Total   $ 4,219  $ 92 


Page 37


(12)  Guarantors

Legacy LP's 2020 Senior Notes were issued in a private offering on December 4, 2012 and were subsequently registered through a public exchange offer that closed on January 8, 2014. Legacy LP's 2021 Senior Notes were issued in two separate private offerings on May 28, 2013 and May 8, 2014. $250 million aggregate principal amount of our 2021 Senior Notes were subsequently registered through a public exchange offer that closed on March 18, 2014. The remaining $300 million of aggregate principal amount of Legacy's 2021 Senior Notes were subsequently registered through a public exchange offer that closed on February 10, 2015. Legacy LP's 2023 Convertible Notes were issued in exchange for portions of the 2020 Senior Notes and 2021 Senior Notes on September 20, 2018. The 2020 Senior Notes, the 2021 Senior Notes and the 2023 Convertible Notes are guaranteed by Legacy LP's 100% owned subsidiaries Legacy Reserves Operating GP LLC, Legacy Reserves Operating LP, Legacy Reserves Services LLC, Legacy Reserves Energy Services LLC, Legacy Reserves Marketing LLC, Dew Gathering LLC and Pinnacle Gas Treating LLC, which constitute all of Legacy's wholly-owned subsidiaries other than Legacy Reserves Finance Corporation, and certain other future subsidiaries (the “Guarantors”, together with any future 100% owned subsidiaries that guarantee the Partnership's 2020 Senior Notes, 2021 Senior Notes and the 2023 Convertible Notes, the “Subsidiaries”) as well as Legacy Inc. and the General Partner, as parent guarantors (the "Parent Guarantors"). The Subsidiaries are 100% owned, directly or indirectly, by the Partnership and the guarantees by the Subsidiaries are full and unconditional, except for customary release provisions described in “—Footnote 2—Debt.” Legacy LP is 100% owned, directly or indirectly, by the Parent Guarantors and the guarantees by the Parent Guarantors are full and unconditional, except for customary release provisions described in “—Footnote 2—Debt.” Legacy LP has no assets or operations independent of the Subsidiaries, and there are no significant restrictions upon the ability of the Subsidiaries to distribute funds to the Partnership. The guarantees constitute joint and several obligations of the Guarantors and Parent Guarantors.

(13)  Subsequent Events

On May 9, 2019, the lenders for the Credit Agreement agreed to waive Legacy's compliance with the ratio of consolidated current assets to consolidated current liabilities covenant contained in the Credit Agreement for the fiscal quarter ended March 31, 2019.
Page 38


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

Cautionary Statement Regarding Forward-Looking Information

This document contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control, which may include statements about:

our ability to pursue , obtain and consummate financial, transactional and other strategic alternatives to address our liquidity, near-term debt maturities and capital structure;

the adequacy and availability of capital resources, credit and liquidity, including, but not limited to, debt refinancing or extensions, exchanges or repurchases of debt, issuances of debt or equity securities, access to additional borrowing
capacity and our ability to generate sufficient cash flow from operations to fund our capital expenditures and meeting
working capital needs;

our ability to comply with, renegotiate or receive waivers of debt covenants under our Credit Agreement (as defined
below) and our Term Loan Credit Agreement (as defined below);

our business strategy;

the amount of oil and natural gas we produce;

the price at which we are able to sell our oil and natural gas production;

our ability to identify, acquire, exploit and appropriately finance additional oil and natural gas properties at  economically attractive prices;

our ability to replace reserves and increase reserve value;

our drilling locations and our ability to continue our development activities at economically attractive costs;

the level of our lease operating expenses, general and administrative costs and finding and development costs;

the level of our capital expenditures;

our ability to divest non-core assets at economically attractive prices;

our future operating results; and

our plans, objectives, expectations and intentions.

All of these types of statements, other than statements of historical fact included in this document, are forward-looking
statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “could,” “should,” “expect,” “plan,” “project,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “pursue,” “target,” “continue,” the negative of such terms or other comparable terminology.

The forward-looking statements contained in this document are largely based on our expectations, which reflect estimates and assumptions made by our management. These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors. Although we believe such estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control. In addition, management’s assumptions about future events may prove to be inaccurate. All readers are cautioned that the forward-looking statements contained in this document are not guarantees of future performance, and our expectations may not be realized or the forward-looking events and circumstances may not occur. Actual results may differ materially from those anticipated or implied in the forward-looking statements due to factors described in Part 1. Item 1A. Risk Factors in our annual report on Form 10-K for the fiscal year ended December 31, 2018. The forward-looking statements in this document speak only as of the date of this document; we disclaim any obligation to update these statements unless required by securities law, and we caution you not to rely on them unduly.

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Overview

Because of our historical growth through acquisitions and development of properties as well as large fluctuations in commodity prices, historical results of operations and period-to-period comparisons of these results and certain financial data may not be meaningful or indicative of future results.

Going Concern

We have significant obligations and commitments coming due in the near term. On March 21, 2019, we entered into an amendment to the Credit Agreement (as defined below) pursuant to which the lenders agreed to extend the maturity date from April 1, 2019 to May 31, 2019 and as of March 31, 2019, we had availability under the Credit Agreement of $13.0 million. Without additional sources of capital or a significant restructuring of our balance sheet, the maturity of our Credit Agreement raises substantial doubt about our ability to continue as a going concern, which means that we may be unable to continue operations for the foreseeable future or realize assets and discharge liabilities in the ordinary course of operation.

In order to improve our liquidity position and address near-term debt maturities, we are currently evaluating financial, transactional and other strategic alternatives. There can be no assurance that sufficient liquidity can be raised or that debt maturities can be extended from any one or more of these transactions or that these transactions can be consummated within the period needed to meet our obligations. Should Legacy be unable to extend the debt maturities or consummate a transaction, we will not have sufficient liquidity to repay its Credit Agreement at maturity and may need to seek relief under the U.S. Bankruptcy code. Please see “Risk Factors—Risks Related to Our Business—We have engaged financial and legal advisors to assist us in, among other things, evaluating financial, transactional and other strategic alternatives to address our liquidity and capital structure that may be time consuming, disruptive and costly to our business, and —We may need to seek relief under the U.S. Bankruptcy Code, even if we are successful in effecting a financial, transactional or other strategic alternative. Any bankruptcy proceeding may result in holders of our equity securities and our other stakeholders receiving little or no consideration,” in Part 1, Item 1A, Risk Factors of Legacy’s annual report on Form 10-K for the fiscal year ended December 31, 2018.

Recent Developments

On March 21, 2019, we entered into the Twelfth Amendment (the “Twelfth Amendment”) to our Credit Agreement. The
Twelfth Amendment provides for, among other things, (i) an extension of the maturity of the Credit Agreement to May 31, 2019, (ii) an increase in the applicable interest rate by 2.25%, (iii) the payment of a fee equal to 0.35% of the amount of the current borrowing base under the Credit Agreement, payable on the effective date of the Twelfth Amendment, (iv) the mandatory termination of our derivative contracts three days prior to the maturity of the Credit Agreement, (vi) the reduction in the borrowing base from $575 million to $570 million, effective May 22, 2019, (vii) the reduction in the maximum consolidated cash balance we can maintain to $15 million, effective April 1, 2019 and (viii) the payment of a fee equal to 0.15% of the amount of the current borrowing base under the Credit Agreement, payable on the earliest to occur of (x) May 31, 2019 or (y) an acceleration of the outstanding indebtedness under the Credit Agreement. Additionally, the Twelfth Amendment waives certain deviations from the requirements of the Credit Agreement, including the delivery of fiscal year 2018 audited financial statements with a “going concern” or like qualification or exception and non-compliance with the current ratio covenant for the fourth quarter of 2018.

On March 21, 2019, we entered into the Seventh Amendment (the “Seventh Amendment”) to our Term Loan Credit Agreement. The Seventh Amendment waives, through May 31, 2019, the requirement of the Term Loan Credit Agreement that the delivery of fiscal year 2018 audited financial statements not include a “going concern” or like qualification or exception. The Seventh Amendment also provides for, among other things, (i) an increase in the applicable interest rate by 2.25%, (ii) a fee equal to 0.35% of the aggregate amount of term loans currently outstanding under the Term Loan Credit Agreement, to be paid in kind by increasing the aggregate amount of term loans outstanding as of the effective date of the Seventh Amendment and (iii) a fee equal to 0.15% of the aggregate amount of term loans currently outstanding under the Term Loan Credit Agreement, to be paid in kind by increasing the aggregate amount of term loans outstanding on the earliest to occur of (x) May 31, 2019 or (y) an acceleration of the outstanding indebtedness under the Term Loan Credit Agreement.

We anticipate breaching certain covenants under Legacy LP's $1.5 billion secured revolving credit facility with Wells Fargo Bank, National Association, as administrative agent and the lenders party thereto as amended most recently by the Twelfth Amendment thereto (as amended, the “Credit Agreement”) and Legacy LP's second lien term loan credit agreement (as amended, our “Term Loan Credit Agreement”), which would constitute a default under our Credit Agreement or our Term Loan Credit Agreement. On May 9, 2019, we received a waiver from the lenders under our Credit Agreement for non-compliance
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with the current ratio covenant for the quarter ended March 31, 2019. Further, while we received a waiver of the covenant under our Term Loan Credit Agreement that requires us to deliver audited financial statements without a “going concern” or like qualification or exception, such waiver expires on May 31, 2019 and such default cannot be remedied. Defaults, if not remedied, would require a waiver from our lenders in order for us to avoid an event of default and subsequent acceleration of all amounts outstanding under our Credit Agreement or our Term Loan Credit Agreement or foreclosure on our oil and natural gas properties. Furthermore, the failure to repay outstanding indebtedness when due under our Credit Agreement and certain other payment defaults or acceleration under our Credit Agreement or our Term Loan Credit Agreement could cause a cross-default or cross-acceleration of all of our indebtedness.  

As set forth under “Investing Activities” below, we have entered into oil and natural gas derivatives designed to mitigate the effects of price fluctuations covering a portion of our expected production, which allows us to mitigate, but not eliminate, oil and natural gas price risk. Such derivative instruments are not designated as cash flow hedges and, therefore, the mark-to-market adjustment reflecting the change in fair value associated with these instruments is recorded in current earnings.

We regularly conduct financial sensitivity analyses to assess the effect of changes in pricing and production. These analyses allow us to determine our ability to execute our capital investment programs, the value of our proved reserves, our projected borrowing base under our revolving credit facility and, more generally, our ability to meet future financial obligations.

We also face the challenge of natural production declines. As initial reservoir pressures are depleted, oil and natural gas production from a given well or formation decreases. We attempt to overcome this natural decline through a combination of acquiring additional reserves, drilling to find additional reserves, recompleting or adding pay in existing wellbores and improving artificial lift.

Trends Affecting Our Business and Operations
 
Irrespective of our balance sheet constraints, sustained periods of low prices for oil or natural gas have and could materially and adversely affect our financial position, our results of operations, the quantities of oil and natural gas reserves that we can economically produce and our access to capital.

Outlook. The oil and natural gas industry is in a challenging environment, especially over the past five years, as evidenced by volatility in the crude oil prices that ranged from over $100 per barrel in early 2014 to less than $30 per barrel in early 2016. While prices in 2017 and 2018 have recovered off the lows experienced in 2016 they have experienced a sharp decline at the end of 2018 from levels seen in 2017 and, despite a recovery in 2019, are still well below levels seen in 2014. Sustained development activity in the Permian Basin has created certain basin-wide operational challenges. Crude oil and associated natural gas production growth has strained existing takeaway capacity and caused widening basis differentials in the Permian Basin relative to benchmark crude oil and natural gas prices, which affect the prices we realize for our crude oil and natural gas production. The narrowing of these basis differentials is largely dependent on the construction of new takeaway capacity and other factors beyond our control. While we believe that a significant number of these projects will be completed in 2019, there is no guarantee that these projects will be completed on time or at all. In addition, the availability of services related to drilling, completion and other well site activity is becoming tighter. We do not have the ability to control the supply of these services and if we are unable to find adequate services for our operations at economic prices, there could be a material adverse impact on our financial condition. Also, production from our horizontal development within the Permian Basin has, from time to time, been temporarily shut-in or constrained due to proximate development operations. We cannot control or accurately forecast the timing, duration or other operational impositions associated with such well interference but the impacts could have a material adverse effect on our financial condition. We intend to continue to prudently manage our historical low-decline proved developed producing oil and gas properties to support the development of our high return prospects as we pursue additional cash flow and increase oil and natural gas reserves.

We anticipate breaching certain covenants under the Credit Agreement and the Term Loan Credit Agreement, which would constitute a default under our Credit Agreement or our Term Loan Credit Agreement. On May 9, 2019, we received a waiver from the lenders under our Credit Agreement for non-compliance with the current ratio covenant for the quarter ended March 31, 2019. Further, while we received a waiver of the covenant under our Term Loan Credit Agreement that requires us to deliver audited financial statements without a “going concern” or like qualification or exception, such waiver expires on May 31, 2019 and such default cannot be remedied. Defaults, if not remedied, would require a waiver from our lenders in order for us to avoid an event of default and subsequent acceleration of all amounts outstanding under our Credit Agreement or our Term Loan Credit Agreement or foreclosure on our oil and natural gas properties. Furthermore, the failure to repay outstanding indebtedness when due under our Credit Agreement and certain other payment defaults or acceleration under our Credit Agreement or our Term Loan Credit Agreement could cause a cross-default or cross-acceleration of all of our indebtedness.

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Considering the current environment for the oil and natural gas industry, our goals in 2019 are to:

reposition our balance sheet by evaluating and opportunistically pursuing strategic alternatives to materially reduce our outstanding indebtedness and restructure our near term maturity indebtedness.

minimize production declines and operating costs through efficient operations; and

efficiently develop our horizontal inventory in the Permian Basin to generate strong cash-on-cash investment returns.

In the event that cash flows from operations are greater than we currently anticipate, whether as a result of increased commodity prices, reduced interest expense or otherwise, or additional external financing sources become available to us, we intend to pay down debt, accelerate our development plan, and increase development capital expenditures.

Our future growth will depend on our ability to continue to add reserves in excess of production. We will maintain our focus on adding reserves through organic development projects and acquisitions. Our ability to add reserves through organic development projects and acquisitions is dependent upon many factors including our ability to raise capital, obtain regulatory approvals and contract drilling rigs and completions equipment and personnel.

Our revenues are highly sensitive to changes in oil and natural gas prices and to levels of production. As set forth under “Investing Activities,” we have entered into oil and natural gas derivatives designed to mitigate the effects of price fluctuations covering a portion of our expected production, which allows us to mitigate, but not eliminate, oil and natural gas price risk. By removing a portion of our price volatility on our future oil and natural gas production through 2019, we have mitigated, but not eliminated, the potential effects of changing oil and natural gas prices on our cash flows from operations for those periods. Commodity prices may decrease, which could alter our acquisition and development plans, and adversely affect our growth strategy and ability to access additional capital in the capital markets and through our revolving credit facility. We continuously conduct financial sensitivity analyses to assess the effect of changes in pricing and production. These analyses allow us to determine how changes in oil and natural gas prices will affect our ability to execute our development plans and to meet future financial obligations. Further, the financial analyses allow us to monitor any impact such changes in oil and natural gas prices may have on the value of our proved reserves and their impact on any redetermination to our borrowing base under our revolving credit facility.

Production and Operating Costs Reporting

We strive to increase our production levels to maximize our revenue and cash flow. Additionally, we continuously monitor our operations to ensure that we are incurring operating costs at the optimal level. Accordingly, we continuously monitor our production and operating costs per well to determine if any wells or properties should be shut-in or recompleted.
 
Such costs include, but are not limited to, the cost of electricity to lift produced fluids, chemicals to treat wells, field personnel to monitor the wells, well repair expenses to restore production, well workover expenses intended to increase production, and ad valorem taxes. We incur and separately report severance taxes paid to the states in which our properties are located. These taxes are reported as production taxes and are a percentage of oil and natural gas revenue. Ad valorem taxes are a percentage of property valuation. While gathering and transportation costs are generally borne by the purchasers of our oil and the price paid for our oil reflects these costs, much of our natural gas production is subject to such costs before the transfer of ownership to the purchaser, and we recognize these expenses as operating costs. We do not consider royalties paid to mineral owners an expense as we deduct hydrocarbon volumes owned by mineral owners from the reported hydrocarbon sales volumes.

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Operating Data
 
The following table sets forth selected unaudited financial and operating data of Legacy for the periods indicated.
Three Months Ended March 31, 
2019 2018
(In thousands, except per unit data) 
Revenues:
Oil sales  $ 77,761  $ 93,411 
Natural gas liquids (NGL) sales  4,515  7,396 
Natural gas sales  36,221  36,672 
Total revenue  $ 118,497  $ 137,479 
Expenses:
Oil and natural gas production, excluding ad valorem taxes  $ 44,964  $ 45,585 
Ad valorem taxes  2,513  2,382 
Total oil and natural gas production  $ 47,477  $ 47,967 
Production and other taxes  $ 6,149  $ 7,326 
General and administrative, excluding transaction costs and LTIP  $ 9,705  $ 9,502 
Transaction costs  2,669  1,782 
LTIP expense  4,156  12,806 
Total general and administrative  $ 16,530  $ 24,090 
Depletion, depreciation, amortization and accretion  $ 42,549  $ 36,547 
Commodity derivative cash settlements:
Oil derivative cash settlements (paid) received  $ 7,045  $ (4,894)
Natural gas derivative cash settlements received  $ 2,534  $ 2,099 
Production:
Oil (MBbls)  1,613  1,547 
Natural gas liquids (MGal)  10,020  9,244 
Natural gas (MMcf)  13,938  14,280 
Total (MBoe)  4,175  4,147 
Average daily production (Boe/d)  46,389  46,078 
Average sales price per unit (excluding derivative cash settlements):
Oil price (per Bbl)  $ 48.21  $ 60.38 
Natural gas liquids price (per Gal)  $ 0.45  $ 0.80 
Natural gas price (per Mcf)  $ 2.60  $ 2.57 
Combined (per Boe)  $ 28.38  $ 33.15 
Average sales price per unit (including derivative cash settlements):
Oil price (per Bbl)  $ 52.58  $ 57.22 
Natural gas liquids price (per Gal)  $ 0.45  $ 0.80 
Natural gas price (per Mcf)  $ 2.78  $ 2.72 
Combined (per Boe)  $ 30.68  $ 32.48 
Average WTI oil spot price (per Bbl)
$ 54.82  $ 62.91 
Average Henry Hub natural gas spot price (per MMbtu)
$ 2.92  $ 3.08 
Average unit costs per Boe:
Oil and natural gas production, excluding ad valorem taxes  $ 10.77  $ 10.99 
Ad valorem taxes  $ 0.60  $ 0.57 
Production and other taxes  $ 1.47  $ 1.77 
General and administrative excluding transaction costs and LTIP  $ 2.32  $ 2.29 
Total general and administrative  $ 3.96  $ 5.81 
Depletion, depreciation, amortization and accretion  $ 10.19  $ 8.81 
 

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Results of Operations
 
Three-Month Period Ended March 31, 2019 Compared to Three-Month Period Ended March 31, 2018 

Our revenues from the sale of oil were $77.8 million and $93.4 million for the three-month periods ended March 31, 2019 and 2018, respectively. Our revenues from the sale of NGLs were $4.5 million and $7.4 million for the three-month periods ended March 31, 2019 and 2018, respectively. Our revenues from the sale of natural gas were $36.2 million and $36.7 million for the three-month periods ended March 31, 2019 and 2018, respectively. The $15.7 million decrease in oil revenues reflects a decrease in the average realized price of $12.17 per Bbl (20.16)% comprised of a decrease in average realized price due to an decrease in the average West Texas Intermediate (“WTI”) crude oil price of $8.09 per Bbl as well as widening differentials. This decrease was partially offset by the increase in oil production of 66 MBbls (4.27%) due to our Permian horizontal drilling program. The $2.9 million decrease in NGL sales reflects a decrease in the realized NGL price of $0.35 per Gal (43.75%) partially offset by increased ethane recoveries in our Piceance Basin properties. The $0.5 million lower realized natural gas revenues is a reflection of decreased natural gas production of approximately 342 MMcf (2.39%) partially offset by an increase in realized price of $0.03 per Mcf (1.17%). This increase was primarily due to reduced regional differentials partially offset by lower NYMEX Henry Hub prices.
 
For the three-month period ended March 31, 2019, we recorded $51.5 million of net losses on oil and natural gas derivatives. Commodity derivative gains and losses represent the changes in fair value of our commodity derivatives during the period and are based on oil and natural gas futures prices. The net losses recognized during the three-month period ended March 31, 2019 are primarily due to increased projected oil prices and reduction in the projected Midland to Cushing differential during the period, which reduced the total value of our oil derivatives. For the three-month period ended March 31, 2018, we recorded $1.7 million of net losses on oil and natural gas derivatives. Settlements of such contracts resulted in net cash receipts(payments) of $9.6 million and $(2.8) million during the three months ended March 31, 2019 and 2018, respectively.

Our oil and natural gas production expenses, excluding ad valorem taxes, decreased to $45.0 million ($10.77 per Boe) for the three-month period ended March 31, 2019 from $45.6 million ($10.99 per Boe) for the three-month period ended March 31, 2018. This decrease can be attributed to general cost containment activities causing a decrease during the period for costs per Boe of $0.22. Our ad valorem tax expense increased to $2.5 million for the three-month period ended March 31, 2019 compared to $2.4 million or the three-month period ended March 31, 2018.

Our production and other taxes were $6.1 million and $7.3 million for the three-month periods ended March 31, 2019 and 2018, respectively. Production and other taxes decreased due to the decrease in our weighted average product price.

Our general and administrative expenses were $16.5 million and $24.1 million for the three-month periods ended March 31, 2019 and 2018, respectively. General and administrative expenses decreased due to reduction in LTIP expense of $8.7 million partially offset by increased legal and consulting expenses.

We incurred depletion, depreciation, amortization and accretion expense, or DD&A, of $42.5 million and $36.5 million for the three-month periods ended March 31, 2019 and 2018, respectively. DD&A increased $6.0 million due primarily to increased net cost basis related to our horizontal Permian activities along with increases in associated production.

In the three-month period ended March 31, 2019, we recognized impairment expense of $7.4 million on 6 separate producing fields primary related to increases in lease expenditures as well as declining commodity prices. In the three-month period ended March 31, 2018, we did not recognize impairment.

We recorded losses/(gains) on disposal of assets of $1.0 million and $(20.4) million for the three-month periods ended March 31, 2019 and 2018, respectively. The losses in 2019 were primarily related to the disposition of marginal oil and natural gas assets partially offset by costs associated with disposal.

We recorded interest expense of $37.1 million and $27.4 million for the three-month periods ended March 31, 2019 and 2018, respectively. Interest expense increased period over period due to increased interest rates and accelerated amortization related to our Term Loan Credit Agreement acceleration of indebtedness to May 31, 2019.

We recorded gain on extinguishment of debt of $13.1 million due to the exchange  of 2021 Senior Notes and exchange and conversion of 2023 Senior Notes as compared to $51.7 million in 2018.

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As of the three months ended March 31, 2019, the Legacy Inc. has a full valuation allowance against its deferred tax position and thus no income tax expense was recognized. A valuation allowance has been recorded as management does not believe it is more-likely-than-not that its deferred tax assets will be realized.

As a result of the items described above, Legacy recorded net income (losses) of $(78.4) million and $64.4 million for the three-month periods ended March 31, 2019 and 2018, respectively.

Non-GAAP Financial Measure

Our management uses Adjusted EBITDA as a tool to provide additional information and metrics relative to the performance of our business. Our management believes that Adjusted EBITDA is useful to investors because this measure is used by many companies in the industry as a measure of operating and financial performance and is commonly employed by financial analysts and others to evaluate the operating and financial performance of Legacy from period to period and to compare it with the performance of other peers within the industry. Adjusted EBITDA may not be comparable to a similarly titled measure of other publicly traded limited partnerships or limited liability companies because all companies may not calculate Adjusted EBITDA in the same manner.

The following presents a reconciliation of “Adjusted EBITDA,” which is a non-GAAP measure, to its nearest comparable GAAP measure. Adjusted EBITDA should not be considered as an alternative to GAAP measures, such as net income, operating income, cash flow from operating activities, or any other GAAP measure of financial performance. Adjusted EBITDA is defined as net income (loss) plus:

Interest expense;
Gain on extinguishment of debt;
Income tax expense;
Depletion, depreciation, amortization and accretion;
Impairment of long-lived assets;
(Gain) loss on disposal of assets;
Equity in (income) loss of equity method investees;
Share-based compensation expense related to LTIP awards accounted for under the equity or liability methods;
Minimum payments earned in excess of overriding royalty interest;
Net (gains) losses on commodity derivatives;
Net cash settlements (paid) received on commodity derivatives;
Transaction costs.