Notes to Consolidated Financial Statements
(Unaudited)
Note 1 – Organization
Carbon Natural Gas Company and its subsidiaries
(referred to herein as “
we
”, “
us
”, or “
Carbon”
)
is an independent oil and gas company engaged in the exploration, development and production of oil and natural gas in the United
States. The Company’s business is comprised of the assets and properties of Nytis Exploration (USA) Inc. (“Nytis USA”)
and its subsidiary Nytis Exploration Company LLC (“Nytis LLC”) which conducts the Company’s operations in the
Appalachian and Illinois Basins, in addition to its subsidiaries, Carbon California Operating Company, LLC and Carbon California
Company, LLC which conducts the Company’s operations in California as well as our equity investment in Carbon Appalachian
Company, LLC (“Carbon Appalachia”).
Appalachian and Illinois Basin Operations
In the Appalachian and Illinois Basins,
Nytis LLC and Carbon Appalachia conducts our operations. The following illustrates this relationship as of March 31, 2018.
Ventura Basin Operations
In California, Carbon California Operating
Company, LLC (“
CCOC
”) conducts Carbon California Company, LLC’s (“
Carbon California
”)
operations. On February 1, 2018, an entity managed by Yorktown Partners, LLC (“Yorktown”) exercised a warrant it held
to purchase shares of our common stock at an exercise price of $7.20 per share (the “
California Warrant
”),
resulting in the issuance of 1,527,778 shares of our common stock. In exchange, we received Yorktown’s Class A Units of
Carbon California representing approximately 46.96% of the then outstanding Class A Units of Carbon California (a profits interest
of approximately 38.59%). After giving effect to the exercise on February 1, 2018, we own 56.4% of the voting and profits interests
of Carbon California and Prudential Capital Energy Partners, L.P. (“Prudential”) owns 43.6%. Yorktown owns 68.6% of
the outstanding shares of our common stock as of May 14, 2018, assuming the conversion of the preferred stock (described herein)
to 625,000 shares of our common stock. As of February 1, 2018, we consolidate Carbon California for financial reporting purposes.
Note 2 – Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”)
for interim financial information. Accordingly, they do not include all the information and footnotes required by GAAP for complete
financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements include
all adjustments (consisting of normal and recurring accruals) considered necessary to present fairly our financial position as
of March 31, 2018, and our results of operations and cash flows for the three months ended March 31, 2018 and 2017. Operating
results for the three months ended March 31, 2018, are not necessarily indicative of the results that may be expected for the
full year because of the impact of fluctuations in prices received for oil and natural gas, natural production declines, the uncertainty
of exploration and development drilling results and other factors. The unaudited condensed consolidated financial statements and
related notes included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated financial statements
and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2017. Except as disclosed
herein, there have been no material changes to the information disclosed in the notes to the consolidated financial statements
included in our 2017 Annual Report on Form 10-K.
Principles of Consolidation
The unaudited condensed consolidated financial
statements include the accounts of Carbon, CCOC, Carbon California and Nytis USA and its consolidated subsidiary, Nytis LLC. Carbon
owns 100% of Nytis USA and CCOC. Nytis USA owns approximately 99% of Nytis LLC. Carbon owns 56.4% of Carbon California.
Nytis LLC also holds an interest in 64 oil
and gas partnerships. For partnerships where we have a controlling interest, the partnerships are consolidated. We are currently
consolidating, on a pro-rata basis, 47 partnerships. In these instances, we reflect the non-controlling ownership interest in
partnerships and subsidiaries as non-controlling interests on our unaudited consolidated statements of operations and reflect
the non-controlling ownership interests in the net assets of the partnerships as non-controlling interests within stockholders’
equity on our unaudited consolidated balance sheet. All significant intercompany accounts and transactions have been eliminated.
In accordance with established practice in
the oil and gas industry our unaudited condensed consolidated financial statements also include our pro-rata share of assets, liabilities,
income, lease operating costs and general and administrative expenses of the oil and gas partnerships in which we have a non-controlling
interest.
Non-majority owned investments that do not
meet the criteria for pro-rata consolidation are accounted for using the equity method when we have the ability to significantly
influence the operating decisions of the investee. When we do not have the ability to significantly influence the operating decisions
of an investee, the cost method is used. All transactions, if any, with investees have been eliminated in the accompanying unaudited
condensed consolidated financial statements.
Effective February 1, 2018, Yorktown exercised
the California Warrant, which resulted in us acquiring Yorktown’s ownership interest in Carbon California in exchange for
shares of our common stock. Following the closing of the Seneca Acquisition on May 1, 2018 (see note 16), our ownership decreased
to 53.92% of the voting and profits interests of Carbon California, and Prudential owns the remainder.
Insurance Receivable
Insurance receivable is comprised of an insurance
receivable for the loss of property as a result of wildfires that impacted Carbon California in December 2017. The Company filed
claims with its insurance provider and is in receipt of partial funds associated with the claims as of March 31, 2018. Therefore,
the Company has determined the receivable is collectible and is included in insurance receivable on the unaudited consolidated
balance sheets.
Investments in Affiliates
Investments in non-consolidated affiliates
are accounted for under either the cost or equity method of accounting, as appropriate. The cost method of accounting is generally
used for investments in affiliates in which we have has less than 20% of the voting interests of a corporate affiliate or less
than a 3% to 5% interest of a partnership or limited liability company and do not have significant influence. Investments in non-consolidated
affiliates, accounted for using the cost method of accounting, are recorded at cost and impairment assessments for each investment
are made annually to determine if a decline in the fair value of the investment, other than temporary, has occurred. A permanent
impairment is recognized if a decline in the fair value occurs.
If we hold between 20% and 50% of the voting
interest in non-consolidated corporate affiliates or generally greater than a 3% to 5% interest of a partnership or limited liability
company and can exert significant influence or control (e.g., through our influence with a seat on the board of directors or management
of operations), the equity method of accounting is generally used to account for the investment. Equity method investments will
increase or decrease by our share of the affiliate’s profits or losses and such profits or losses are recognized in our unaudited
consolidated statements of operations. For our equity method investment in Carbon Appalachia, we use the hypothetical liquidation
at book value method to recognize our share of the affiliate’s profits or losses. We review equity method investments for
impairment whenever events or changes in circumstances indicate that an other than temporary decline in value has occurred.
Related Party Transactions
Management Reimbursements
In our role as manager of Carbon California
and Carbon Appalachia, we receive management reimbursements. We received approximately $753,000 and $50,000 for the three months
ended March 31, 2018, and for the one month ended January 31, 2018, from Carbon Appalachia and Carbon California, respectively.
These reimbursements are included in general and administrative – related party reimbursement on our unaudited consolidated
statements of operations. Effective February 1, 2018, the management reimbursements received from Carbon California are eliminated
at consolidation. This elimination includes $100,000 for the period February 1, 2018, through March 31, 2018.
In addition to the management reimbursements,
approximately $299,000 and $14,000 in general and administrative expenses were reimbursed for the three months ended March 31,
2018, and for the one month ended January 31, 2018, by Carbon Appalachia and Carbon California, respectively. The elimination of
Carbon California in consolidation includes approximately $28,000 for the period February 1, 2018, through March 31, 2018.
Operating Reimbursements
In our role as operator of Carbon California
and Carbon Appalachia, we receive reimbursements of operating expenses. These expenses are recorded directly to receivable –
related party on our unaudited consolidated balance sheets and are therefore not included in our operating expenses on our unaudited
consolidated statements of operations.
Use of Estimates
The preparation of financial statements
in conformity with GAAP requires management to makes estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. There have been no changes in our critical accounting estimates from those that were disclosed
in the 2017 Annual Report on Form 10-K. Actual results could differ from these estimates.
Earnings (Loss) Per Common
Share
Basic earnings per common share is computed
by dividing the net income (loss) attributable to common stockholders for the period by the weighted average number of common shares
outstanding during the period. The shares of restricted common stock granted to our officers, directors and employees are included
in the computation of basic net income per share only after the shares become fully vested. Diluted earnings per common share includes
both the vested and unvested shares of restricted stock and the potential dilution that could occur upon exercise of warrants to
acquire common stock computed using the treasury stock method, which assumes that the increase in the number of shares is reduced
by the number of shares which could have been repurchased by us with the proceeds from the exercise of warrants (which were assumed
to have been made at the average market price of the common shares during the reporting period).
The following table sets forth the calculation
of basic and diluted income per share:
|
|
Three months ended
March 31,
|
|
(in thousands except per share amounts)
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
3,569
|
|
|
$
|
3,292
|
|
Less: warrant derivative gain
|
|
|
(225
|
)
|
|
|
(830
|
)
|
Diluted net income
|
|
|
3,344
|
|
|
|
2,462
|
|
|
|
|
|
|
|
|
|
|
Basic weighted-average common shares outstanding during the period
|
|
|
6,996
|
|
|
|
5,487
|
|
|
|
|
|
|
|
|
|
|
Add dilutive effects of warrants and non-vested shares of restricted stock
|
|
|
230
|
|
|
|
738
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted-average common shares outstanding during the period
|
|
|
7,226
|
|
|
|
6,225
|
|
|
|
|
|
|
|
|
|
|
Basic net income per common share
|
|
$
|
0.51
|
|
|
$
|
0.60
|
|
Diluted net income per common share
|
|
$
|
0.46
|
|
|
$
|
0.40
|
|
Recently Adopted Accounting Pronouncement
In May 2014, the Financial Accounting Standards
Board ("FASB") issued Accounting Standard Update ("ASU") 2014-09,
Revenue from Contracts with Customers
(Topic 606) (“ASU 2014-09”), which establishes a comprehensive new revenue recognition standard designed to depict
the transfer of goods or services to a customer in an amount that reflects the consideration the entity expects to receive in exchange
for those goods or services. In March 2016, the FASB released certain implementation guidance through ASU 2016-08 (collectively
with ASU 2014-09, the "Revenue ASUs") to clarify principal versus agent considerations. The Revenue ASUs allow for the
use of either the full or modified retrospective transition method, and the standard will be effective for annual reporting periods
beginning after December 15, 2017 including interim periods within that period, with early adoption permitted for annual reporting
periods beginning after December 15, 2016. We adopted the guidance using the modified retrospective method with the effective date
of January 1, 2018. We did not record a cumulative-effect adjustment to the opening balance of retained earnings as no adjustment
was necessary. The adoption of the Revenue ASUs did not impact net income or cash flows. See note 10 for the new disclosures required
by the Revenue ASUs.
Recently Issued Accounting Pronouncements
In February 2016, the FASB issued ASU No.
2016-02,
Leases
(“ASU 2016-02”). The objective of this ASU is to increase transparency and comparability among
organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements.
ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 and
should be applied using a modified retrospective approach. Early adoption is permitted. The Company is currently evaluating the
impact on its financial statements of adopting ASU 2016-02.
In March 2018, the FASB issued ASU No. 2018-05,
Amendments
to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118
(“ASU 2018-05”). The objective
of this ASU is to codify the guidance provided by Staff Accounting Bulletin No. 118 regarding the accounting for the income tax
effects of the Tax Cuts and Jobs Act (the “TCJA”) passed by Congress in December 2017 if such accounting is not complete
by the time a company issues its financial statements that include the reporting period in which the TCJA was enacted. ASU
2018-05 was effective upon addition to the FASB Codification in March 2018.
Note 3 – Acquisitions and Divestitures
Acquisition of Majority Control of Carbon California
Carbon California was formed in 2016 by us
and entities managed by Yorktown and Prudential to acquire producing assets in the Ventura Basin of California.
In connection with the entry into the limited
liability company agreement of Carbon California, we received Class B Units and issued to Yorktown a warrant (“the California
Warrant”). The exercise price for the California Warrant was payable exclusively with Class A Units of Carbon California
held by Yorktown and the number of shares of our common stock for which the California Warrant was exercisable was determined,
as of the time of exercise, by dividing (a) the aggregate unreturned capital of Yorktown’s Class A Units of Carbon California
by (b) the exercise price. The California Warrant had a term of seven years and included certain standard registration rights with
respect to the shares of our common stock issuable upon exercise of the California Warrant.
The issuance of the Class B Units and the
California Warrant were in contemplation of each other, and under non-monetary related party guidance, we accounted for the California
Warrant, at issuance, based on the fair value of the California Warrant as of the date of grant (February 15, 2017) and recorded
a long-term warrant liability with an associated offset to Additional Paid in Capital (“APIC”). Future changes to
the fair value of the California Warrant are recognized in earnings. We accounted for the fair value of the Class B Units at their
estimated fair value at the date of grant, which became our investment in Carbon California with an offsetting entry to APIC.
Additionally, we accounted for our 17.81% profits interest in Carbon California as an equity method investment until January 31,
2018.
On February 1, 2018, Yorktown exercised the
California Warrant resulting in the issuance of 1,527,778 shares of our common stock in exchange for Yorktown’s Class A Units
of Carbon California representing approximately 46.96% of the outstanding Class A Units of Carbon California (a profits interest
of approximately 38.59%). After giving effect to the exercise on February 1, 2018, we owned 56.4% of the voting and profits interests
of Carbon California.
The exercise of the California Warrant and
the acquisition of the additional ownership interest is accounted for as a step acquisition in which we obtained control in accordance
with ASC 805,
Business Combinations
(“ASC 805”) (referred to herein as the “Carbon California Acquisition”).
We recognized 100% of the identifiable assets acquired, liabilities assumed and the non-controlling interest at their respective
fair value as of the date of the acquisition. We exchanged 1,527,778 common shares at a fair value of approximately $8.3 million
($5.45 per share), for 11,000 Class A Units of Carbon California, representing a 38.59% ownership interest in Carbon California.
We followed the fair value method to allocate the consideration transferred to the identifiable net assets acquired and non-controlling
interest (“NCI”) on a preliminary basis as follows:
|
|
Amount
(in thousands)
|
|
Fair value of Carbon common shares transferred as consideration
|
|
$
|
8,326
|
|
Fair value of NCI
|
|
|
16,466
|
|
Fair value of previously held interest
|
|
|
7,244
|
|
Fair value of business acquired
|
|
$
|
32,036
|
|
|
|
|
|
|
Assets acquired and liabilities assumed
|
|
|
|
|
|
|
|
Amount
(in thousands)
|
|
Cash
|
|
$
|
275
|
|
Accounts receivable:
|
|
|
|
|
Joint interest billings and other
|
|
|
690
|
|
Receivable - related party
|
|
|
1,610
|
|
Prepaid expense, deposits, and other current assets
|
|
|
1,723
|
|
Oil and gas properties:
|
|
|
|
|
Proved
|
|
|
56,477
|
|
Unproved
|
|
|
1,495
|
|
Other property and equipment, net
|
|
|
877
|
|
Other long-term assets
|
|
|
475
|
|
Accounts payable and accrued liabilities
|
|
|
(6,054
|
)
|
Commodity derivative liability – short-term
|
|
|
(916
|
)
|
Commodity derivative liability – long-term
|
|
|
(1,729
|
)
|
Asset retirement obligations – short-term
|
|
|
(384
|
)
|
Asset retirement obligations – long-term
|
|
|
(2,537
|
)
|
Notes, related party, net
|
|
|
(8,874
|
)
|
Revolver, related party
|
|
|
(11,000
|
)
|
Notes payable
|
|
|
(92
|
)
|
Total net assets acquired
|
|
$
|
32,036
|
|
The preliminary fair value of the assets acquired
and liabilities assumed were determined using various valuation techniques, including an income approach. The fair value measurements
were primarily based on significant inputs that are not directly observable in the market and are considered Level 3 under the
fair value measurements and disclosure framework.
On the date of the acquisition, we derecognized
our equity investment in Carbon California and recognized a gain of approximately $5.4 million based on the fair value of our
previously held interest compared to its carrying value.
For assets and liabilities accounted for as
business combinations, including the Carbon California Acquisition, to determine the fair value of the assets acquired, the Company
primarily used the income approach and made market assumptions as to projections of estimated quantities of oil and natural gas
reserves, future production rates, future commodity prices including price differentials as of the date of closing, future operating
and development costs, a market participant weighted average cost of capital, and the condition of vehicles and equipment. The
determination of the fair value of the accounts payable and accrued liabilities assumed required significant judgement, including
estimates relating to production assets.
Consolidation of Carbon California Unaudited
Pro Forma Results of Operations
Below are unaudited consolidated results of
operations for the quarters ended March 31, 2018 and 2017 as though the Carbon California Acquisition had been completed as of
January 1, 2017. The Carbon California Acquisition closed February 1, 2018, and accordingly, the Company’s unaudited consolidated
statements of operations for the quarter ended March 31, 2018, includes the results of operations for the period February 1, 2018,
through March 31, 2018.
|
|
Unaudited Pro Forma Consolidated Results
|
|
|
|
For Three Months Ended
March 31,
|
|
(in thousands, except per share amounts)
|
|
2018
|
|
|
2017
|
|
Revenue
|
|
$
|
6,672
|
|
|
$
|
8,232
|
|
Net income before non-controlling interests
|
|
|
3,543
|
|
|
|
444
|
|
Net income attributable to non-controlling interests
|
|
|
1,115
|
|
|
|
44
|
|
Net income attributable to controlling interests
|
|
$
|
2,428
|
|
|
$
|
400
|
|
Net income per share (basic)
|
|
$
|
0.35
|
|
|
$
|
0.07
|
|
Net income (loss) per share (diluted)
|
|
$
|
0.30
|
|
|
$
|
(0.07
|
)
|
Note 4 – Property and Equipment
Net property and equipment as of March 31, 2018 and December
31, 2017, consists of the following:
(in thousands)
|
|
March 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Oil and gas properties:
|
|
|
|
|
|
|
Proved oil and gas properties
|
|
$
|
173,242
|
|
|
$
|
114,893
|
|
Unproved properties not subject to depletion
|
|
|
3,505
|
|
|
|
1,947
|
|
Accumulated depreciation, depletion, amortization and impairment
|
|
|
(83,286
|
)
|
|
|
(80,715
|
)
|
Net oil and gas properties
|
|
|
93,461
|
|
|
|
36,125
|
|
|
|
|
|
|
|
|
|
|
Furniture and fixtures, computer hardware and software, and other equipment
|
|
|
2,955
|
|
|
|
1,758
|
|
Accumulated depreciation and amortization
|
|
|
(1,324
|
)
|
|
|
(1,021
|
)
|
Net other property and equipment
|
|
|
1,631
|
|
|
|
737
|
|
|
|
|
|
|
|
|
|
|
Total net property and equipment
|
|
$
|
95,092
|
|
|
$
|
36,862
|
|
We had approximately $3.5 million and $1.9
million, at March 31, 2018 and December 31, 2017, respectively, of unproved oil and gas properties not subject to depletion. At
March 31, 2018 and December 31, 2017, our unproved properties consist principally of leasehold acquisition costs in the following
areas:
(in thousands)
|
|
March 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Ventura Basin
|
|
$
|
1,495
|
|
|
$
|
-
|
|
Illinois Basin:
|
|
|
|
|
|
|
|
|
Indiana
|
|
|
430
|
|
|
|
432
|
|
Illinois
|
|
|
151
|
|
|
|
136
|
|
Appalachian Basin:
|
|
|
|
|
|
|
|
|
Kentucky
|
|
|
918
|
|
|
|
915
|
|
Ohio
|
|
|
65
|
|
|
|
66
|
|
West Virginia
|
|
|
446
|
|
|
|
398
|
|
|
|
|
|
|
|
|
|
|
Total unproved properties not subject to depletion
|
|
$
|
3,505
|
|
|
$
|
1,947
|
|
During the three months ended March 31, 2018
and 2017, there were no expiring leasehold costs that were reclassified into proved property. The excluded properties are assessed
for impairment at least annually. Subject to industry conditions, evaluations of most of these properties and the inclusion of
their costs in amortized capital costs is expected to be completed within five years.
We capitalized overhead applicable to acquisition,
development and exploration activities of approximately $71,000 and $75,000 for the three months ended March 31, 2018 and 2017,
respectively.
Depletion expense related to oil and gas properties
for the three months ended March 31, 2018 and 2017, was approximately $1.3 million and $533,000, or $0.76 and $0.41 per Mcfe,
respectively. Depreciation expense related to furniture and fixtures, computer hardware and software, and other equipment for
the three months ended March 31, 2018 and 2017, was approximately $149,000 and $40,000, respectively.
Note 5 – Asset Retirement Obligation
Our asset retirement obligations (“ARO”)
relate to future costs associated with the plugging and abandonment of oil and gas wells, removal of equipment and facilities from
leased acreage and returning such land to its original condition. The fair value of a liability for an ARO is recorded in the period
in which it is incurred or acquired, and the cost of such liability is recorded as an increase in the carrying amount of the related
long-lived asset by the same amount. The liability is accreted each period and the capitalized cost is depleted on a units-of-production
basis as part of the full cost pool. Revisions to estimated AROs result in adjustments to the related capitalized asset and corresponding
liability.
The estimated ARO liability is based on
estimated economic lives, estimates as to the cost to abandon the wells in the future, and federal and state regulatory
requirements. The liability is discounted using a credit-adjusted risk-free rate estimated at the time the liability is
incurred or acquired or increased as a result of a reassessment of expected cash flows and assumptions inherent in the
estimation of the liability. Upward revisions to the liability could occur due to changes in estimated abandonment costs or
well economic lives, or if federal or state regulators enact new requirements regarding the abandonment of wells. AROs are
valued utilizing Level 3 fair value measurement inputs (see note 12).
The following table is a reconciliation of
the ARO:
|
|
Three Months Ended
March 31,
|
|
(in thousands)
|
|
2018
|
|
|
2017
|
|
Balance at beginning of period
|
|
$
|
7,737
|
|
|
$
|
5,120
|
|
Accretion expense
|
|
|
141
|
|
|
|
78
|
|
Additions from Carbon California Company, LLC
|
|
|
2,921
|
|
|
|
-
|
|
Additions during period
|
|
|
-
|
|
|
|
3
|
|
|
|
|
10,799
|
|
|
|
5,201
|
|
Less: ARO recognized as a current liability
|
|
|
(767
|
)
|
|
|
(124
|
)
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
10,032
|
|
|
$
|
5,077
|
|
Note 6 – Investments in
Affiliates
Carbon California
Carbon California was formed in 2016 by us
and entities managed by Yorktown and Prudential to acquire producing assets in the Ventura Basin in California. On February 15,
2017, we, Yorktown and Prudential entered into a limited liability company agreement (the “Carbon California LLC Agreement”)
of Carbon California, a Delaware limited liability company.
Prior to February 1, 2018, we held 17.81% of
the voting and profits interests, Yorktown held 38.59% of the voting and profits interests and Prudential held 43.59% of the voting
and profits interests in Carbon California. On February 1, 2018, Yorktown exercised the California Warrant, pursuant to which Yorktown
obtained additional shares of common stock in us in exchange for the transfer and assignment by Yorktown of all its rights in Carbon
California. Following the exercise of the California Warrant by Yorktown, we owned 56.4% of the voting and profits interests, and
Prudential held the remainder of the interests, in Carbon California. We consolidate Carbon California for financial reporting
purposes.
On February 15, 2017, Carbon California (i)
issued and sold Class A Units to Yorktown and Prudential for an aggregate cash consideration of $22.0 million, (ii) entered into
a Note Purchase Agreement (the “Note Purchase Agreement”) with Prudential Legacy Insurance Company of New Jersey and
Prudential Insurance Company of America for the issuance and sale of up to $25.0 million of Senior Secured Revolving Notes (the
“Senior Revolving Notes”) due February 15, 2022 and (iii) entered into a Securities Purchase Agreement (the “Securities
Purchase Agreement”) with Prudential for the issuance and sale of $10.0 million of Senior Subordinated Notes (the “Subordinated
Notes”) due February 15, 2024. We are not a guarantor of the Senior Revolving Notes or the Subordinate Notes which are held
by Carbon California.
The closing of the Note Purchase Agreement
and the Securities Purchase Agreement on February 15, 2017, resulted in the sale and issuance by Carbon California of (i) Senior
Revolving Notes in the principal amount of $10.0 million and (ii) Subordinated Notes in the original principal amount of $10.0
million. The maximum principal amount available under the Senior Revolving Notes is based upon the borrowing base attributable
to Carbon California’s proved oil and gas reserves which is to be determined at least semi-annually. As of March 31, 2018,
the borrowing base was $15.0 million, of which $13.0 million was outstanding. On May 1, 2018, the borrowing base increased to
$41.0 million (see note 16).
Net proceeds from the offering transaction
were used by Carbon California to complete the acquisitions of oil and gas assets in the Ventura Basin of California, which acquisitions
also closed on February 15, 2017. The remainder of the net proceeds were used to fund field development projects, to fund a future
complementary acquisition and for general working capital purposes of Carbon California.
For the period February 15, 2017 (inception)
through January 31, 2018, based on our 17.8% interest in Carbon California, our ability to appoint a member to the board of directors
and our role of manager of Carbon California, we accounted for our investment in Carbon California under the equity method of
accounting as we believed we exerted significant influence. We used the Hypothetical Liquidation at Book Value (“HLBV”)
to determine our share of profits or losses in Carbon California and adjusted the carrying value of our investment accordingly.
The HLBV is a balance-sheet approach that calculates the amount each member of Carbon California would have received if Carbon
California were liquidated at book value at the end of each measurement period. The change in the allocated amount to each member
during the period represents the income or loss allocated to that member. In the event of liquidation of Carbon California, to
the extent that Carbon California has net income, available proceeds are first distributed to members holding Class A and Class
B units and any remaining proceeds are then distributed to members holding Class A units. For the period February 15, 2017 (inception)
through January 31, 2018, Carbon California incurred a net loss of which our share (as a holder of Class B Units for that period)
was zero.
In connection with our entry into the Carbon
California LLC Agreement, we received the aforementioned Class B Units and issued to Yorktown the California Warrant. The exercise
price for the California Warrant was payable exclusively with Class A Units of Carbon California held by Yorktown and the number
of shares of our common stock for which the California Warrant was exercisable was determined, as of the time of exercise, by dividing
(a) the aggregate unreturned capital of Yorktown’s Class A Units of Carbon California by (b) the exercise price. The California
Warrant had a term of seven years and included certain standard registration rights with respect to the shares of our common stock
issuable upon exercise of the California Warrant. On February 1, 2018, Yorktown exercised the California Warrant. As a result of
the warrant exercise, Carbon holds 11,000 Class A Units of Carbon California and all of the Class B units, resulting in an aggregate
Sharing Percentage of 56.4%. Effective February 1, 2018, the Company consolidates Carbon California in its unaudited condensed
consolidated financial statements.
Carbon Appalachia
Carbon Appalachia was formed in 2016 by us,
Yorktown and entities managed by Old Ironsides Energy LLC (“Old Ironsides”) to acquire producing assets in the Appalachian
Basin in Kentucky, Tennessee, Virginia and West Virginia.
Outlined below is a summary of i) our contributions,
ii) our resulting percentage of Class A unit ownership and iii) our overall resulting Sharing Percentage of Carbon Appalachia
after giving effect to the Class C Unit ownership. Holders of units within each class of units participate in profit or losses
and distributions according to their proportionate share of each class of units (“Sharing Percentage”). Each contribution
and its use are described in detail following the table.
Timing
|
|
Capital
Contribution
|
|
Resulting Class A
Units (%)
|
|
|
Resulting
Sharing %
|
|
April 2017
|
|
$0.24 million
|
|
|
2.00
|
%
|
|
|
2.98
|
%
|
August 2017
|
|
$3.71 million
|
|
|
15.20
|
%
|
|
|
16.04
|
%
|
September 2017
|
|
$2.92 million
|
|
|
18.55
|
%
|
|
|
19.37
|
%
|
November 2017
|
|
Warrant exercise
|
|
|
26.50
|
%
|
|
|
27.24
|
%
|
On April 3, 2017, we, Yorktown and Old Ironsides,
entered in to a limited liability company agreement (the “Carbon Appalachia LLC Agreement”), with an initial equity
commitment of $100.0 million, of which $37.0 million has been contributed as of March 31, 2018.
Pursuant to the Carbon Appalachia LLC Agreement,
we acquired a 2.0% interest in Carbon Appalachia for $240,000 of Class A Units associated with our initial equity commitment of
$2.0 million. We also have the ability to earn up to an additional 14.7% of Carbon Appalachia distributions (represented by Class
B Units) after certain return thresholds to the holders of Class A Units are met. The Class B Units were acquired for no cash consideration.
In addition, we acquired a 1.0% interest represented
by Class C Units which were obtained in connection with the contribution to Carbon Appalachia of a portion of our working interest
in undeveloped properties in Tennessee. If Carbon Appalachia agrees to drill horizontal Chattanooga Shale wells on these properties,
it will pay 100% of the cost of drilling and completion of the first 20 wells to earn a 75% working interest in such properties.
We, through our subsidiary, Nytis LLC, will retain a 25% working interest in the properties. There was no activity associated with
these properties in 2017 nor in the first quarter of 2018.
In 2017, Carbon Appalachia Enterprises, LLC,
formerly known as Carbon Tennessee Company, LLC (“CAE”), a subsidiary of Carbon Appalachia, entered into a 4-year
$100.0 million (with $1.5 million sublimit for letters of credit) senior secured asset-based revolving credit facility with LegacyTexas
Bank with an initial borrowing base of $10.0 million (the “CAE Credit Facility”).
The CAE Credit Facility borrowing base was
adjusted for acquisitions completed in 2017. Most recently, on April 30, 2018, CAE Credit Facility was amended, which increased
the borrowing base to $70.0 million with redeterminations as of April 1 and October 1 each year. As of March 31, 2018, there was
approximately $38.0 million outstanding under the CAE Credit Facility.
The CAE Credit Facility is guaranteed by
each of CAE’s existing and future direct or indirect subsidiaries (subject to certain exceptions). CAE’s obligations
and those of CAE’s subsidiary guarantors under the CAE Credit Facility are secured by essentially all of CAE’s tangible
and intangible personal and real property (subject to certain exclusions).
Interest is payable quarterly and accrues
on borrowings under the CAE Credit Facility at a rate per annum equal to either (i) the base rate plus an applicable margin between
0.00% and 1.00% or (ii) the Adjusted LIBOR rate plus an applicable margin between 3.00% and 4.00% at our option. The actual margin
percentage is dependent on the CAE Credit Facility utilization percentage. CAE is obligated to pay certain fees and expenses in
connection with the CAE Credit Facility, including a commitment fee for any unused amounts of 0.50%.
The CAE Credit Facility contains affirmative
and negative covenants that, among other things, limit CAE’s ability to (i) incur additional debt; (ii) incur additional
liens; (iii) sell, transfer or dispose of assets; (iv) merge or consolidate, wind-up, dissolve or liquidate; (v) make dividends
and distributions on, or repurchases of, equity; (vi) make certain investments; (vii) enter into certain transactions with our
affiliates; (viii) enter into sales-leaseback transactions; (ix) make optional or voluntary payments of debt; (x) change the nature
of our business; (xi) change our fiscal year to make changes to the accounting treatment or reporting practices; (xii) amend constituent
documents; and (xiii) enter into certain hedging transactions.
The affirmative and negative covenants
are subject to various exceptions, including basket amounts and acceptable transaction levels. In addition, the CAE Credit Facility
requires CAE’s compliance, on a consolidated basis, with (i) a maximum Debt/EBITDA ratio of 3.5 to 1.0 and (ii) a minimum
current ratio of 1.0 to 1.0.
CAE may at any time repay the loans under
the CAE Credit Facility, in whole or in part, without penalty. CAE must pay down borrowings under the CAE Credit Facility or provide
mortgages of additional oil and natural gas properties to the extent that outstanding loans and letters of credit exceed the borrowing
base.
In connection with our entry into the Carbon
Appalachia LLC Agreement, and Carbon Appalachia engaging in certain transactions during 2017, we received the aforementioned Class
B Units and issued to Yorktown awarrant to purchase approximately 408,000 shares of our common stock at an exercise price of $7.20
per share (the “Appalachia Warrant”). The Appalachia Warrant was payable exclusively with Class A Units of Carbon
Appalachia held by Yorktown and the number of shares of our common stock for which the Appalachia Warrant was exercisable was
determined, as of the time of exercise, by dividing (a) the aggregate unreturned capital of Yorktown’s Class A Units of
Carbon Appalachia plus a required 10% internal rate of return by (b) the exercise price.
On November 1, 2017, Yorktown exercised the
Appalachia Warrant, resulting in the issuance of approximately 432,000 shares of our common stock in exchange for Class A Units
representing approximately 7.95% of then outstanding Class A Units of Carbon Appalachia. We accounted for the exercise through
extinguishment of the warrant liability associated with the Appalachia Warrant of approximately $1.9 million and the receipt of
Yorktown’s Class A Units as an increase to investment in affiliates in the amount of approximately $2.9 million. After giving
effect to the exercise, we own 26.5% of Carbon Appalachia’s outstanding Class A Units along with 100% of its Class C Units.
The issuance of the Class B Units and the Appalachia
Warrant were in contemplation of each other, and under non-monetary related party guidance, we accounted for the Appalachia Warrant,
at issuance, based on the fair value of the Appalachia Warrant as of the date of grant (April 3, 2017) and recorded a warrant liability
with an associated offset to APIC. Future changes to the fair value of the Appalachia Warrant are recognized in earnings. We accounted
for the fair value of the Class B Units at their estimated fair value at the date of grant, which became our investment in Carbon
Appalachia with an offsetting entry to APIC.
As of the grant date of the Appalachia Warrant,
we estimated that the fair market value of the Appalachia Warrant was approximately $1.3 million, and the fair value of the Class
B Units was approximately $924,000. The difference in the fair value of the Appalachia Warrant from the grant date though its exercise
on November 1, 2017, was approximately $619,000 and was recognized in warrant derivative gain in our consolidated statements of
operations for the year ended December 31, 2017.
Based on our 27.24% combined Class A and Class
C interest (and our ability as of March 31, 2018 to earn up to an additional 14.7%) in Carbon Appalachia, our ability to appoint
a member to the board of directors and our role of manager of Carbon Appalachia, we are accounting for our investment in Carbon
Appalachia under the equity method of accounting as we believe we exert significant influence. We use the HLBV to determine our
share of profits or losses in Carbon Appalachia and adjust the carrying value of our investment accordingly. Our investment in
Carbon Appalachia is represented by our Class A and C interests, which we acquired by contributing approximately $6.9 million
in cash and unevaluated property. In the event of liquidation of Carbon Appalachia, available proceeds are first distributed to
members holding Class C Units then to holders of Class A Units until their contributed capital is recovered with an internal rate
of return of 10%. Any additional distributions would then be shared between holders of Class A, Class B and Class C Units. For
the three months ended March 31, 2018, Carbon Appalachia earned net income, of which our share is approximately $413,000. The
ability of Carbon Appalachia to make distributions to its owners, including us, is dependent upon the terms of its credit facilities,
which currently prohibit distributions unless agreed to by the lender.
As of March 31, 2018, Carbon Appalachia is
in compliance with all CAE Credit Facility covenants.
The following table sets forth, selected historical
unaudited financial data for Carbon Appalachia.
(in thousands)
|
|
As of
March 31,
2018
|
|
Current assets
|
|
$
|
21,452
|
|
Total oil and gas properties, net
|
|
$
|
83,404
|
|
Current liabilities
|
|
$
|
17,086
|
|
Non-current liabilities
|
|
$
|
58,730
|
|
Total members’ equity
|
|
$
|
42,506
|
|
(in thousands)
|
|
Three months ended
March 31,
2018
|
|
Revenues
|
|
$
|
25,743
|
|
Operating expenses
|
|
|
23,534
|
|
Income from operations
|
|
|
2,208
|
|
Net income
|
|
|
1,526
|
|
Investments in Affiliates
During the three months ended March 31, 2018
and 2017, we recorded total equity method income of approximately $437,000 and $7,000, respectively. Additionally, on February
1, 2018, as a result of the Carbon California Acquisition, we derecognized our equity investment in Carbon California and recognized
a gain of approximately $5.4 million based on the fair value of our previously held interest compared to its carrying value.
Note 7 – Credit Facilities
Our Credit Facility
In 2016, we entered into a 4-year $100.0
million senior secured asset-based revolving credit facility with LegacyTexas Bank. LegacyTexas Bank is the initial lender and
acts as administrative agent.
The credit facility has a maximum availability
of $100.0 million (with a $500,000 sublimit for letters of credit), which availability is subject to the amount of the borrowing
base. The initial borrowing base established under the credit facility was $17.0 million. The borrowing base is subject to semi-annual
redeterminations in March and September. On March 30, 2018, the borrowing base was increased from $23.0 to $25.0 million, of which
approximately $23.2 million was outstanding as of March 31, 2018. Our effective interest rate as of March 31, 2018 was 7.59%.
The credit facility is guaranteed by each
of our existing and future subsidiaries (subject to certain exceptions). Our obligations and those of our subsidiary guarantors
under the credit facility are secured by essentially all of our tangible and intangible personal and real property (subject to
certain exclusions).
Interest is payable quarterly and accrues
on borrowings under the credit facility at a rate per annum equal to either (i) the base rate plus an applicable margin between
0.50% and 1.50% or (ii) the Adjusted LIBOR rate plus an applicable margin between 3.50% and 4.50% at our option. The actual margin
percentage is dependent on the credit facility utilization percentage. We are obligated to pay certain fees and expenses in connection
with the credit facility, including a commitment fee for any unused amounts of 0.50%.
The credit facility contains affirmative
and negative covenants that, among other things, limit our ability to (i) incur additional debt; (ii) incur additional liens; (iii)
sell, transfer or dispose of assets; (iv) merge or consolidate, wind-up, dissolve or liquidate; (v) make dividends and distributions
on, or repurchases of, equity; (vi) make certain investments; (vii) enter into certain transactions with our affiliates; (viii)
enter into sales-leaseback transactions; (ix) make optional or voluntary payments of debt; (x) change the nature of our business;
(xi) change our fiscal year to make changes to the accounting treatment or reporting practices; (xii) amend constituent documents;
and (xiii) enter into certain hedging transactions.
The affirmative and negative covenants
are subject to various exceptions, including basket amounts and acceptable transaction levels. In addition, the credit facility
requires our compliance, on a consolidated basis, with (i) a maximum Debt/EBITDA ratio of 3.5 to 1.0 and (ii) a minimum current
ratio of 1.0 to 1.0.
On March 27, 2018, the credit facility was
amended to revise the calculation of the Leverage Ratio from a Debt/EBITDA ratio to a Net Debt/Adjusted EBITDA ratio, reset the
testing period used in the determination of Adjusted EBITDA, eliminated the minimum current ratio and substituted alternative
liquidity requirements, including maximum allowed current liabilities in relation to current assets, a minimum cash balance requirement
of $750,000 and maximum aged trade payable requirements. As of March 31, 2018, we were in compliance with our financial covenants.
We may at any time repay the loans under
the credit facility, in whole or in part, without penalty. We must pay down borrowings under the credit facility or provide mortgages
of additional oil and natural gas properties to the extent that outstanding loan and letters of credit exceed the borrowing base.
As required under the terms of the credit
facility, we entered into derivative contracts with fixed pricing for a certain percentage of our production. We are a party to
an ISDA Master Agreement with BP Energy Company that established standard terms for the derivative contracts and an inter-creditor
agreement with LegacyTexas Bank and BP Energy Company whereby any credit exposure related to the derivative contracts entered into
by the Company and BP Energy Company is secured by the collateral and backed by the guarantees supporting the credit facility.
Carbon California – Credit
Facilities
Effective as of February 1, 2018, our ownership
in Carbon California increased to 56.4% due to the exercise of the California Warrant. As a result, we consolidate Carbon California
for financial reporting purposes.
The table below details the notes payable
outstanding for Carbon California as of March 31, 2018 (in thousands):
Revolver, related party, due February 15, 2022
|
|
$
|
13,000
|
|
Notes, related party, due February 15, 2024
|
|
$
|
10,000
|
|
Total gross notes payable
|
|
|
23,000
|
|
Less: Deferred notes costs
|
|
|
(154
|
)
|
Less: Notes discount
|
|
|
(924
|
)
|
Total net notes payable
|
|
$
|
21,922
|
|
Carbon California- Revolver, Related
Party
On February 15, 2017, Carbon California entered
into a revolver agreement with Prudential Legacy Insurance Company of New Jersey and Prudential Insurance Company of America for
the issuance and sale of up to $25.0 million due February 15, 2022 (the “Revolver”). Carbon California may elect to
incur interest at either (i) 5.0% plus the London interbank offered rate (“LIBOR”) or (ii) 4.00% plus Prime Rate (which
is defined as the interest rate published daily by JPMorgan Chase Bank, N.A.). As of March 31, 2018, the Revolver’s effective
borrowing rate was 8.29%. In addition, the Revolver includes a commitment fee for any unused amounts at 0.50% as well as an annual
administrative fee of $75,000, payable on February 15 each year.
The maximum principal amount available under
the Revolver is based upon the borrowing base attributable to Carbon California’s proved oil and gas reserves, which is to
be determined at least semi-annually. As of March 31, 2018, the Revolver has a borrowing base of $15.0 million, of which $13.0
million is outstanding. On May 1, 2018, the borrowing base increased to $41.0 million (see note 16).
The Revolver is secured by all the assets of
Carbon California. The Revolver requires Carbon California, as of January 1 and July of each year, to hedge its anticipate proved
developed products production at such time for year one, two and three at a rate of 75%, 65% and 50%, respectively. Carbon California
may make principal payments in minimum installments of $500,000. Distributions to equity members are generally restricted.
Carbon California incurred fees directly associated
with the issuance of the Revolver and amortizes these fees over the life of the Revolver. The current portion of these fees are
included in prepaid expense and deposits and the long-term portion is included in other long-term assets for a combined value
of $706,000. During the three months ended March 31, 2018 and 2017, Carbon California amortized fees of $29,000 and $14,000, respectively.
The Revolver agreement requires Carbon California
to maintain certain financial and non-financial covenants which include the following ratios: total leverage ratio, senior leverage
ratio, interest coverage ratio, current ratio, and other qualitative covenants as defined in the Revolver agreement. As of March
31, 2018, Carbon California was in breach of its covenants; however, Carbon California obtained a waiver for the March 31, 2018
measurement period.
Carbon California Notes
On February 15, 2017, Carbon California entered
into an agreement with Prudential Capital Energy Partners, L.P. for the issuance and sale of $10.0 million of unsecured notes
(the “Carbon California Notes”) due February 15, 2024, bearing interest of 12% per annum.
Prudential received an additional 1,425 Class
A units, representing 5% of total sharing percentage, for the issuance of the Carbon California Notes. Carbon California valued
this unit issuance based on the relative fair value by valuing the units at $1,000 per unit and aggregating the amount with the
outstanding Carbon California Notes of $10.0 million. The Company then allocated the non-cash value of the units of approximately
$1.25 million, which was recorded as a discount to the Carbon California Notes. As of March 31, 2018, Carbon California had an
outstanding discount of $923,000, which is presented net of the Carbon California Notes within Credit facility-related party on
the unaudited consolidated balance sheets.
The Carbon California Notes require Carbon
California, as of January 1 and July 1 of each year, to hedge its anticipated production at such time for year one, two and three
at a rate of 67.5%, 58.5% and 45%, respectively.
Prepayment of the Carbon California Notes is
currently not available. After February 15, 2019, prepayment is allowed at 100%, subject to a 3.0% fee of outstanding principal.
Prepayment is not subject to such fee after February 17, 2020. Distributions to equity members are generally restricted.
The Carbon California Notes agreement requires
Carbon California to maintain certain financial and non-financial covenants, which include the following ratios: total leverage
ratio, senior leverage ratio, interest coverage ratio, asset coverage ratio, current ratio, and other qualitative covenants as
defined in the Revolver agreement. As of March 31, 2018, Carbon California was in breach of financial covenants; however, Carbon
California obtained a waiver for March 31, 2018 measurement period.
On May 1, 2018, in connection with the Seneca acquisition, the
Revolver and Carbon California Notes Agreement were amended. See note 16.
Note 8 – Income Taxes
We recognize deferred income tax assets
and liabilities for the estimated future tax consequences attributable to temporary differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases. We have net operating loss carryforwards available
in certain jurisdictions to reduce future taxable income. Future tax benefits for net operating loss carryforwards are recognized
to the extent that realization of these benefits is considered more likely than not. To the extent that available evidence raises
doubt about the realization of a deferred income tax asset, a valuation allowance is established.
At March 31, 2018, we have established
a full valuation allowance against the balance of net deferred tax assets.
Note 9 – Stockholders’
Equity
Authorized and Issued Capital Stock
Effective March 15, 2017, and pursuant to a
reverse stock split approved by the stockholders and Board of Directors, each 20 shares of issued and outstanding common stock
became one share of common stock and no fractional shares were issued. References to the number of shares and price per share give
retroactive effect to the reverse stock split for all periods presented.
As of March 31, 2018, we had 10.0 million
shares of common stock authorized with a par value of $0.01 per share, of which approximately 7.6 million were issued and outstanding,
and 1.0 million shares of preferred stock authorized with a par value of $0.01 per share. On April 6, 2018, the Company entered
into a preferred stock purchase agreement with Yorktown for a private placement of 50,000 shares of the Company’s Series
B Convertible Preferred Stock for $5.0 million. During the three months ended March 31, 2018, the increase in our issued and
outstanding common stock is primarily due to a) Yorktown’s exercise of the California Warrant (see note 3), resulting in
the issuance of approximately 1.5 million shares of our common stock in exchange for Class A Units in Carbon California representing
approximately 46.96% of the then outstanding Class A Units, in addition to b) restricted stock that vested during the quarter.
Carbon Stock Incentive Plans
We have two stock plans, the Carbon 2011
Stock Incentive Plan and the Carbon 2015 Stock Incentive Plan (collectively the “Carbon Plans”). The Carbon Plans were
approved by our shareholders and in the aggregate provide for the issuance of approximately 1.1 million shares of common stock
to our officers, directors, employees or consultants eligible to receive the awards under the Carbon Plans.
The Carbon Plans provide for the granting
of incentive stock options, non-qualified stock options, restricted stock awards, performance awards and phantom stock awards,
or a combination of the foregoing, as to employees, officers, directors or consultants, provided that only employees may be granted
incentive stock options and directors may only be granted restricted stock awards and phantom stock awards.
Restricted Stock
As of March 31, 2018, approximately 548,000
shares of restricted stock have been granted under the terms of the Carbon Plans. Restricted stock awards for employees vest ratably
over a three-year service period or cliff vest at the end of a three-year service period. For non-employee directors, the awards
vest upon the earlier of a change in control of us or the date their membership on the Board of Directors is terminated other
than for cause. We recognize compensation expense for these restricted stock grants based on the grant date fair value of the
shares, amortized ratably over three years for employee awards (based on the required service period for vesting) and seven years
for non-employee director awards (based on a market survey of the average tenure of directors among U.S. public companies). For
restricted stock granted between 2014 and 2017, we recognized compensation expense based on the grant date fair value of the shares,
utilizing an enterprise value approach, using valuation metrics primarily based on multiples of cash flow from operations, production
and reserves. For restricted stock and performance units granted in 2013, we utilized the closing price of our stock on the date
of grant to recognize compensation expense. During the three months ended March 31, 2018, 38,637 restricted stock units vested.
Compensation costs recognized for these
restricted stock grants were approximately $158,000 and $188,000 for the three months ended March 31, 2018 and 2017, respectively.
As of March 31, 2018, there was approximately $957,000 of unrecognized compensation costs related to these restricted stock grants
which we expect to be recognized over the next six years.
Restricted Performance Units
As of March 31, 2018, approximately 461,000
shares of performance units have been granted under the terms of the Carbon Plans. Performance units represent a contractual right
to receive one share of our common stock subject to the terms and conditions of the agreements, including the achievement of certain
performance measures relative to a defined peer group or the growth of certain performance measures over a defined period of time
as well as, in some cases, continued service requirements.
We account for the performance units granted
during 2014 through 2017 at their fair value determined at the date of grant, which were $11.80, $8.00, $5.40 and $7.20 per share,
respectively. The final measurement of compensation cost will be based on the number of performance units that ultimately vest.
At March 31, 2018, we estimated that none of the performance units granted in 2016 and 2017 would vest, and, accordingly, no compensation
cost has been recorded for these performance units. During 2016, we estimated that it was probable that the performance units
granted in 2014 and 2015 would vest and therefore compensation costs of approximately $135,000 and $132,000 related to these performance
units were recognized for the three months ended March 31, 2018 and 2017, respectively. As of March 31, 2018, compensation costs
related to the performance units granted in 2014 and 2015 have been fully recognized. As of March 31, 2018, if change in control
and other performance provisions pursuant to the terms and conditions of these award agreements are met in full, the estimated
unrecognized compensation cost related to the performance units granted in 2012, 2016 and 2017 would be approximately $1.9 million.
Note 10 – Revenue Recognition
Revenue from Contracts with Customers
We recognize revenue when it satisfies a performance
obligation by transferring control over a product to a customer. Revenue is measured based on the consideration we expect to receive
in exchange for those products. Revenues from contracts with customers are recorded on the unaudited consolidated statements of
operations based on the type of product being sold.
Performance Obligations and Significant
Judgments
We sell oil and natural gas products in the
United States through a single reportable segment. We primarily sell products within two regions of the United States: Appalachia
and Illinois Basins and the Ventura Basin. We enter into contracts that generally include one type of distinct product in variable
quantities and priced based on a specific index related to the type of product. Most of our contract pricing provisions are tied
to a market index, with certain adjustments based on, among other factors, whether a well delivers to a gathering or transmission
line, quality of the oil or natural gas, and prevailing supply and demand conditions.
The oil and natural gas is typically sold
in an unprocessed state to processors and other third parties for processing and sale to customers. We recognize revenue at a
point in time when control of the oil or natural gas passes to the customer. For oil sales, control is typically transferred to
the customer upon receipt at the wellhead or a contractually agreed upon delivery point. Under our natural gas contracts with
processors, control transfers upon delivery at the wellhead or the inlet of the processing entity’s system. For our other
natural gas contracts, control transfers upon delivery to the inlet or to a contractually agreed upon delivery point. In the cases
where we sell to a processor, we have determined that we are the principal in the arrangement and the processors are our customers.
We recognize the revenue in these contracts based on the net proceeds received from the processor.
Transfer of control drives the presentation
of transportation and gathering costs within the accompanying unaudited consolidated statements of operations. Transportation and
gathering costs incurred prior to control transfer are recorded within the transportation and gathering expense line item on the
accompanying unaudited consolidated statements of operations, while transportation and gathering costs incurred subsequent to control
transfer are recorded as a reduction to the related revenue.
A portion of our product sales are short-term
in nature. For those contracts, we use the practical expedient in ASC 606-10-50-14 exempting us 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 our product sales that have a contract
term greater than one year, we have utilized the practical expedient in ASC 606-10-50-14(a) which states we are not required to
disclose the transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely
to an unsatisfied performance obligation. Under these sales contracts, each unit of product represents a separate performance obligation;
therefore, future volumes are unsatisfied and disclosure of the transaction price allocated to remaining performance obligations
is not required. We have no unsatisfied performance obligations at the end of each reporting period.
We do not believe that significant judgments
are required with respect to the determination of the transaction price, including any variable consideration identified. There
is a low level of uncertainty due to the precision of measurement and use of index-based pricing with predictable differentials.
Additionally, any variable consideration identified is not constrained.
Disaggregation of Revenues
In the following table, revenue for the three
months ended March 31, 2018, is disaggregated by primary region within the United States and major product line. As noted above,
we operate as one reportable segment.
(in thousands)
|
|
|
|
|
|
|
|
|
|
Type
|
|
Appalachia and
Illinois Basin
|
|
|
Ventura Basin
|
|
|
Total
|
|
Natural gas sales
|
|
$
|
3,805
|
|
|
$
|
134
|
|
|
$
|
3,939
|
|
Natural gas liquids sales
|
|
|
-
|
|
|
|
163
|
|
|
|
163
|
|
Oil sales
|
|
|
247
|
|
|
|
2,736
|
|
|
|
2,983
|
|
Total revenue
|
|
$
|
4,052
|
|
|
$
|
3,033
|
|
|
$
|
7,085
|
|
Contract Balances
Under our product sales contracts, we invoice
customers once our performance obligations have been satisfied, at which point payment is unconditional. Accordingly, our product
sales contracts do not typically give rise to contract assets or liabilities under ASC 606.
Prior Period Performance Obligations
We record revenue in the month production is
delivered to the purchaser, but settlement statements may not be received until 30 to 90 days after the month of production. As
such, we estimate the production delivered and the related pricing. Any differences between our initial estimates and actuals are
recorded in the month payment is received from the customer. These differences have not historically been material. For the three
months ended March 31, 2018, revenue recognized in the reporting period related to prior period performance obligations is immaterial.
The estimated revenue is recorded within Accounts
receivable - Revenue on the unaudited consolidated balance sheets.
Note 11 – Accounts Payable
and Accrued Liabilities
Accounts payable and accrued liabilities consist
of the following:
|
|
March 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
5,374
|
|
|
$
|
3,274
|
|
Oil and gas revenue suspense
|
|
|
2,032
|
|
|
|
1,776
|
|
Gathering and transportation payables
|
|
|
807
|
|
|
|
497
|
|
Production taxes payable
|
|
|
654
|
|
|
|
214
|
|
Drilling advances received from joint venture partner
|
|
|
1,359
|
|
|
|
245
|
|
Accrued lease operating expenses
|
|
|
1,650
|
|
|
|
684
|
|
Accrued ad valorem taxes-current
|
|
|
1,099
|
|
|
|
1,054
|
|
Accrued general and administrative expenses
|
|
|
2,794
|
|
|
|
2,473
|
|
Accrued asset retirement obligation-current
|
|
|
767
|
|
|
|
380
|
|
Accrued interest
|
|
|
663
|
|
|
|
247
|
|
Other liabilities
|
|
|
1,367
|
|
|
|
374
|
|
|
|
|
|
|
|
|
|
|
Total accounts payable and accrued liabilities
|
|
$
|
18,566
|
|
|
$
|
11,218
|
|
Note 12 – Fair Value Measurements
Authoritative guidance defines fair value
as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction
between market participants at the measurement date. The guidance establishes a hierarchy for inputs used in measuring fair value
that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable
inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability
developed based on market data obtained from sources independent of us. Unobservable inputs are inputs that reflect our assumptions
of what market participants would use in pricing the asset or liability developed based on the best information available in the
circumstances. The hierarchy is broken down into three levels based on the reliability of the inputs as follows:
|
Level 1:
|
Quoted prices are available in active markets for identical assets or liabilities;
|
|
Level 2:
|
Quoted prices in active markets for similar assets or liabilities that are observable for the asset or liability; or
|
|
Level 3:
|
Unobservable pricing inputs that are generally less observable from objective sources, such as discounted cash flow models or valuations.
|
Financial assets and liabilities are classified
based on the lowest level of input that is significant to the fair value measurement. Our policy is to recognize transfers in and/or
out of fair value hierarchy as of the end of the reporting period for which the event or change in circumstances caused the transfer.
We have consistently applied the valuation techniques discussed below for all periods presented.
The following table presents our financial
assets and liabilities that were accounted for at fair value on a recurring basis by level within the fair value hierarchy:
(in thousands)
|
|
Fair Value Measurements Using
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
March 31, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivatives
|
|
$
|
-
|
|
|
$
|
2,679
|
|
|
$
|
-
|
|
|
$
|
2,679
|
|
December 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivatives
|
|
$
|
-
|
|
|
$
|
225
|
|
|
$
|
-
|
|
|
$
|
225
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant derivative liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,017
|
|
|
$
|
2,017
|
|
Commodity Derivative
As of March 31, 2018, our commodity derivative
financial instruments are comprised of natural gas and oil swaps. The fair values of these agreements are determined under an income
valuation technique. The valuation model requires a variety of inputs, including contractual terms, published forward prices, volatilities
for options and discount rates, as appropriate. Our estimates of fair value of derivatives include consideration of the counterparty’s
credit worthiness, our credit worthiness and the time value of money. The consideration of these factors results in an estimated
exit-price for each derivative asset or liability under a market place participant’s view. All the significant inputs are
observable, either directly or indirectly; therefore, our derivative instruments are included within the Level 2 fair value hierarchy.
The counterparty for all our outstanding commodity derivative financial instruments as of March 31, 2018, is BP Energy Company.
Warrant Derivative
A third-party valuation specialist was utilized
to determine the fair value our California Warrant. The warrant is designated as Level 3. We review the valuations, including the
related model inputs and assumptions, and analyze changes in fair value measurements between periods. We corroborate such inputs,
calculations and fair value changes using various methodologies, and review unobservable inputs for reasonableness utilizing relevant
information from other published sources.
We estimated the fair value of the California
Warrant on February 15, 2017, the grant date of the warrant, to be approximately $5.8 million, using a call option pricing model
with the following assumptions: a seven-year term, exercise price of $7.20, volatility rate of 41.8% and a risk-free rate of 2.3%.
As we will receive Class A units in Carbon California in the event the holder exercises the California Warrant, we also considered
the fair value of the Class A units in its valuation. We utilized the same measurement as of December 31, 2017 for January 31,
2018, using a Monte Carlo valuation model which utilized unobservable inputs including the percentage return on our shares at
various timelines, the percentage return on the privately-held Carbon California Class A units at various timelines, an exercise
price of $7.20, volatility rate of 45%, a risk-free rate of 2.1% and an estimated remaining term of 6.4 years. As of December
31, 2017, the fair value of the California Warrant was approximately $2.0 million. On February 1, 2018, Yorktown exercised a warrant
it held to purchase shares of our common stock at an exercise price of $7.20 per share (the “
California Warrant
”),
resulting in the issuance of 1,527,778 shares of our common stock. In exchange, we received Yorktown’s Class A Units of
Carbon California representing approximately 46.96% of the outstanding Class A Units of Carbon California and a profits interest
of approximately 38.59%.
The following table summarizes the changes
in fair value of our financial instruments classified as Level 3 in the fair value hierarchy:
(in thousands)
|
|
Total
|
|
Balance, December 31, 2017
|
|
$
|
2,017
|
|
Warrant derivative gain for the period January 1- January 31, 2018
|
|
|
(225
|
)
|
CCC Warrant Exercise - liability extinguishment
|
|
|
(1,792
|
)
|
Balance, March 31, 2018
|
|
$
|
-
|
|
Assets and Liabilities Measured and
Recorded at Fair Value on a Non-Recurring Basis
The fair value of each of the following
assets and liabilities measured and recorded at fair value on a non-recurring basis are based on unobservable pricing inputs and
therefore, are included within the Level 3 fair value hierarchy.
We use the income valuation technique to estimate
the fair value of asset retirement obligations using the amounts and timing of expected future dismantlement costs, credit-adjusted
risk-free rates and time value of money. During the three months ended March 31, 2018 and 2017, we recorded approximately $5.6
million and $3,000, in additions to asset retirement obligations, respectively. Additions during the three months ended March
31, 2018, primarily related to the Carbon California Acquisition. See note 3 for additional information.
The exercise of the California Warrant and
the acquisition of the additional ownership interest in Carbon California on February 1, 2018, is accounted for as a step acquisition
in which we obtained control in accordance with ASC 805, Business Combinations (“ASC 805”). We consolidate the results
of Carbon California into our unaudited condensed consolidated financial statements from the date of the Carbon California Acquisition
forward. The Carbon California Acquisition was accounted for as a business combination, and the identifiable assets acquired,
and liabilities assumed, were recorded at their estimated fair value at the date of acquisition. We have completed our preliminary
valuation to determine the fair value of the identifiable assets acquired and liabilities assumed. The fair value of the assets
acquired was determined using various valuation techniques, including an income approach. The fair value measurements were primarily
based on significant inputs that are not directly observable in the market and are considered Level 3 under the fair value measurements
and disclosure framework. See note 3 for additional information.
We assume, at times, certain firm transportation
contracts as part of our acquisitions of oil and natural gas properties. The fair value of the firm transportation obligations
was determined based upon the contractual obligations assumed by us and discounted based upon our effective borrowing rate. These
contractual obligations are being amortized monthly as we pay these firm transportation obligations in the future.
Asset Retirement Obligation
The fair value of our asset retirement obligation
liability is recorded in the period in which it is incurred or assumed by taking into account the cost of abandoning oil and gas
wells ranging from $20,000 to $30,000, which is based on industry expectations for similar work; the estimated timing of reclamation
ranging from one to 75 years based on estimates from reserve engineers; an inflation rate of 1.92%; and a credit adjusted risk-free
rate of 7.24%, which takes into account our credit risk and the time value of money. Given the unobservable nature of the inputs,
the initial measurement of the asset retirement obligation liability is deemed to use Level 3 inputs (see note 3). During the
three months ended March 31, 2018, we recorded additions to asset retirement obligations of approximately $3.1 million, primarily
due to the Carbon California Acquisition. Carbon California estimates the fair value of asset retirement obligations using the
amounts and timing of expected future dismantlement costs, credit-adjusted risk-free rates and time value of money. Carbon California’s
asset retirement obligation is calculated upon assumption by taking into account the cost of abandoning oil and gas wells based
on industry expectations for similar work, the economic lives of its properties between 1-49 years; an inflation rate of 2.03%;
and a credit adjusted risk-free rate of 8.09%,
Class B Units
We received Class B Units from Carbon California
and Carbon Appalachia as part of the entry into the Carbon California LLC and Carbon Appalachia LLC agreements. We estimated the
fair value of the Class B units, in each case, by utilizing the assistance of third-party valuation specialists. The fair values
were based upon enterprise values derived from inputs including estimated future production rates, future commodity prices including
price differentials as of the dates of closing, future operating and development costs and comparable market participants.
Note 13 – Physical Delivery Contracts and Gas Derivatives
We historically have used commodity-based
derivative contracts to manage exposures to commodity price on certain of our oil and natural gas production. We do not hold or
issue derivative financial instruments for speculative or trading purposes. We also have entered into fixed price delivery contracts
to effectively provide commodity price hedges. Because these contracts are not expected to be net cash settled, they are considered
to be normal sales contracts and not derivatives. Therefore, these contracts are not recorded at fair value in the unaudited condensed
consolidated financial statements.
Pursuant to the terms of our credit facility
and Carbon California Note and Revolver Agreements, we have entered into swap and collar derivative agreements to hedge certain
of our oil and natural gas production through 2021. As of March 31, 2018, these derivative agreements consisted of the following:
Our Physical Delivery Contracts and
Gas Derivatives
|
|
Natural Gas Swaps
|
|
|
Natural Gas Collars
|
|
|
Oil Swaps
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average Price
|
|
|
|
|
|
Average
|
|
Year
|
|
MMBtu
|
|
|
Price (a)
|
|
|
MMBtu
|
|
|
Range (a)
|
|
|
Bbl
|
|
|
Price (b)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
|
2,610,000
|
|
|
$
|
3.00
|
|
|
|
-
|
|
|
|
-
|
|
|
|
52,000
|
|
|
$
|
53.51
|
|
2019
|
|
|
2,596,000
|
|
|
$
|
2.86
|
|
|
|
-
|
|
|
|
-
|
|
|
|
48,000
|
|
|
$
|
53.76
|
|
|
(a)
|
NYMEX Henry Hub Natural Gas futures contract for the respective period.
|
|
(b)
|
NYMEX Light Sweet Crude West Texas Intermediate futures contract for the respective period.
|
Carbon California Physical Delivery
Contracts and Gas Derivatives
|
|
Natural Gas Swaps
|
|
|
Natural Gas Collars
|
|
|
Oil Swaps
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average Price
|
|
|
WTI
|
|
|
Average
|
|
|
Brent
|
|
|
Average
|
|
Year
|
|
MMBtu
|
|
|
Price (a)
|
|
|
MMBtu
|
|
|
Range (a)
|
|
|
Bbl
|
|
|
Price (b)
|
|
|
Bbl
|
|
|
Price (c)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
|
270,000
|
|
|
$
|
3.03
|
|
|
|
-
|
|
|
|
-
|
|
|
|
123,649
|
|
|
$
|
53.10
|
|
|
|
20,000
|
|
|
$
|
67.20
|
|
2019
|
|
|
-
|
|
|
$
|
-
|
|
|
|
360,000
|
|
|
|
$2.60 - $3.03
|
|
|
|
139,797
|
|
|
$
|
51.96
|
|
|
|
-
|
|
|
$
|
-
|
|
2020
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
73,147
|
|
|
$
|
50.12
|
|
|
|
24,000
|
|
|
$
|
59.70
|
|
|
(a)
|
NYMEX Henry Hub Natural Gas futures contract for the respective period.
|
|
(b)
|
NYMEX Light Sweet Crude West Texas Intermediate futures contract for the respective period.
|
|
(c)
|
Brent for the respective period.
|
For our swap instruments, we receive a
fixed price for the hedged commodity and pay a floating price to the counterparty. The fixed-price payment and the floating-price
payment are netted, resulting in a net amount due to or from the counterparty.
Costless collars are designed to establish
floor and ceiling prices on anticipated future oil and gas production. The ceiling establishes a maximum price that we will receive
for the volumes under contract, while the floor establishes a minimum price.
The following table summarizes the fair value
of the derivatives recorded in the unaudited consolidated balance sheets (see note 12). These derivative instruments are not designated
as cash flow hedging instruments for accounting purposes:
(in thousands)
|
|
|
|
|
|
March 31,
2018
|
|
|
December 31,
2017
|
|
Commodity derivative contracts:
|
|
|
|
|
|
|
|
|
Commodity derivative asset
|
|
$
|
-
|
|
|
$
|
215
|
|
Other long-term assets
|
|
$
|
-
|
|
|
$
|
10
|
|
|
|
|
|
|
|
|
|
|
Commodity derivative liabilities
|
|
$
|
1,769
|
|
|
$
|
-
|
|
Commodity derivative liabilities, non-current
|
|
$
|
910
|
|
|
$
|
-
|
|
The table below summarizes the commodity settlements
and unrealized gains and losses related to our derivative instruments. These commodity settlements and unrealized gains and losses
are recorded and included in commodity derivative gain or loss in the accompanying unaudited consolidated statements of operations.
(in thousands)
|
|
For the three months ended
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
Commodity derivative contracts:
|
|
|
|
|
|
|
Settlement loss
|
|
$
|
(377
|
)
|
|
$
|
(23
|
)
|
Unrealized (loss) gain
|
|
|
(249
|
)
|
|
|
2,167
|
|
|
|
|
|
|
|
|
|
|
Total settlement and unrealized (loss) gain, net
|
|
$
|
(626
|
)
|
|
$
|
2,144
|
|
Commodity derivative settlement gains and
losses are included in cash flows from operating activities in our unaudited consolidated statements of cash flows.
The counterparty in all our derivative instruments
is BP Energy Company. We and Carbon California have entered into an International Swaps and Derivatives Association (“ISDA”)
Master Agreements with BP Energy Company that establishes standard terms for the derivative contracts and an inter-creditor agreements
whereby any credit exposure related to the derivative contracts entered into by us and BP Energy Company is secured by the collateral
and backed by the guarantees supporting the credit facility.
We and Carbon California net our derivative
instrument fair value amounts executed with BP Energy Company pursuant to the ISDA master agreement, which provides for the net
settlement over the term of the contracts and in the event of default or termination of the contracts. The following table summarizes
the location and fair value amounts of all derivative instruments in the unaudited consolidated balance sheets, as well as the
gross recognized derivative assets, liabilities and amounts offset in the unaudited consolidated balance sheets as of March 31,
2018.
|
|
|
|
|
|
|
|
|
|
Net
|
|
|
|
|
|
Gross
|
|
|
|
|
|
Recognized
|
|
|
|
|
|
Recognized
|
|
|
Gross
|
|
|
Fair Value
|
|
|
|
|
|
Assets/
|
|
|
Amounts
|
|
|
Assets/
|
|
|
|
Balance Sheet Classification
|
|
Liabilities
|
|
|
Offset
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivative assets:
|
|
Commodity derivative
|
|
$
|
531
|
|
|
$
|
(531
|
)
|
|
$
|
-
|
|
|
|
Other long-term assets
|
|
|
338
|
|
|
|
(338
|
)
|
|
|
-
|
|
Total derivative assets
|
|
|
|
$
|
869
|
|
|
$
|
(869
|
)
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivative liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivative
|
|
$
|
(2,300
|
)
|
|
$
|
531
|
|
|
$
|
(1,769
|
)
|
|
|
Commodity derivative: non-current
|
|
|
(1,248
|
)
|
|
|
338
|
|
|
|
(910
|
)
|
Total derivative liabilities
|
|
|
|
$
|
(3,548
|
)
|
|
$
|
869
|
|
|
$
|
(2,679
|
)
|
The following table summarizes the location
and fair value amounts of all derivative instruments in the consolidated balance sheets, as well as the gross recognized derivative
assets, liabilities and amounts offset in the consolidated balance sheets as of December 31, 2017.
|
|
|
|
|
|
|
|
|
|
Net
|
|
|
|
|
|
Gross
|
|
|
|
|
|
Recognized
|
|
|
|
|
|
Recognized
|
|
|
Gross
|
|
|
Fair Value
|
|
|
|
|
|
Assets/
|
|
|
Amounts
|
|
|
Assets/
|
|
|
|
Balance Sheet Classification
|
|
Liabilities
|
|
|
Offset
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivative assets:
|
|
Commodity derivative
|
|
$
|
624
|
|
|
$
|
(409
|
)
|
|
$
|
215
|
|
|
|
Other long-term assets
|
|
|
250
|
|
|
|
(240
|
)
|
|
|
10
|
|
Total derivative assets
|
|
|
|
$
|
874
|
|
|
$
|
(649
|
)
|
|
$
|
225
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivative liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivative
|
|
$
|
(409
|
)
|
|
$
|
409
|
|
|
$
|
-
|
|
|
|
Commodity derivative: non-current
|
|
|
(240
|
)
|
|
|
240
|
|
|
|
-
|
|
Total derivative liabilities
|
|
|
|
$
|
(649
|
)
|
|
$
|
649
|
|
|
$
|
-
|
|
Due to the volatility of oil and natural
gas prices, the estimated fair values of our derivatives are subject to large fluctuations from period to period.
Note 14 – Commitments
We have entered into employment agreements
with certain of our executives and officers. The term of the agreements generally ranges from one to two years and provides for
renewal provisions in one-year increments thereafter. The agreements provide for, among other items, severance and continuation
of benefit payments upon termination of employment or certain change of control events.
We have entered into long-term firm transportation
contracts to ensure the transport for certain of our gas production to purchasers. Firm transportation volumes and the related
demand charges for the remaining term of these contracts at March 31, 2018 are summarized in the table below.
Period
|
|
Dekatherms per day
|
|
|
Demand
Charges
|
|
Apr 2018 - Apr 2018
|
|
|
5,530
|
|
|
$
|
0.20
- $0.65
|
|
May 2018 - Mar 2020
|
|
|
3,230
|
|
|
$
|
0.20
- $0.62
|
|
Apr 2020 – May 2020
|
|
|
2,150
|
|
|
$
|
0.20
|
|
Jun 2020 – May 2036
|
|
|
1,000
|
|
|
$
|
0.20
|
|
A liability of approximately $230,000 related
to firm transportation contracts assumed in the EXCO Acquisition in 2016, which represents the remaining commitment, is reflected
on our unaudited consolidated balance sheets as of March 31, 2018. The fair value of these firm transportation obligations was
determined based upon the contractual obligations assumed by us and discounted based upon our effective borrowing rate. These
contractual obligations are being amortized monthly as we pay these firm transportation obligations in the future.
Capital Commitment
In our participation as a Class A member
of Carbon Appalachia we made a capital commitment of $23.6 million, of which we have contributed $6.9 million as of March 31, 2018.
As of March 31, 2018, we had no capital commitments associated
with Carbon California.
During March 2018, management became aware
that one of our field employees had been misappropriating funds from our suspended revenue accounts, or suspense accounts, over
a period of several years. Promptly following the discovery of the misappropriation, we terminated the employee and engaged an
external forensic specialist to lead an investigation to determine the extent and impact on our financial statements. That investigation
revealed that the employee’s ability to misappropriate funds from the suspense accounts was eliminated in 2017 when we moved
our revenue accounting function to our Denver office and instituted our current set of revenue accounting practices and internal
controls. As a result, the employee no longer had access to the suspense accounts.
The discovery of the misappropriation was
made in March 2018 when the employee attempted to misappropriate funds from a different source. This attempt was identified under
our current internal controls.
The investigation is still ongoing, but based
on the results so far, we have recorded a provision at March 31, 2018, to reflect the estimated loss of suspended revenue. Depending
upon the results of the investigation, which we are seeking to conclude as soon as reasonably practicable, we may determine that
the estimate should be increased or decreased. Furthermore, we will no longer be using printed manual checks for payments. Revenue
and other checks will require approval from more than one individual and we are evaluating our segregation of duties, specifically
related to the cash disbursement process, and will adjust where possible to strengthen the system of internal control. We
have determined that this event constituted a significant deficiency, but not a material weakness.
Note 15 – Supplemental Cash Flow Disclosure
Supplemental cash flow disclosures are presented
below:
|
|
Three Months Ended
March 31,
|
|
(in thousands)
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
Interest
|
|
$
|
336
|
|
|
$
|
216
|
|
Non-cash transactions:
|
|
|
|
|
|
|
|
|
Increase in asset retirement obligations
|
|
$
|
-
|
|
|
$
|
3
|
|
Decrease in accounts payable and accrued liabilities included in oil and gas properties
|
|
$
|
(71)
|
|
|
$
|
(8
|
)
|
Non-cash acquisition of Carbon California interests (see note 3)
|
|
$
|
(18,906
|
)
|
|
$
|
-
|
|
Carbon California Acquisition on February 1, 2018(see note 3)
|
|
$
|
17,114
|
|
|
$
|
-
|
|
Exercise of warrant derivative(see note 3)
|
|
$
|
(1,792
|
)
|
|
$
|
-
|
|
Note 16 – Subsequent Events
Seneca Acquisition
On May 1, 2018, through our subsidiary Carbon
California, we completed the acquisition of oil and gas producing properties and related facilities located in the Ventura Basin
of California for approximately $43.0 million, subject to normal and customary post-closing adjustments (“Seneca Acquisition”).
The Seneca Acquisition was funded through the combination of funds used from the Carbon California Revolver and Carbon California
Notes, and the issuance of an additional 10,000 Class A units for $11.0 million and sale of an additional $3.0 million of Senior
Subordinated Notes. Following the closing of the Seneca Acquisition and the resultant issuance of Class A Units on May 1, 2018,
our ownership decreased to 53.92% of the voting and profits interests of Carbon California.
Carbon California Notes and Carbon California Revolver, related
party
On May 1, 2018, Carbon California (i) entered
into an amendment to the Carbon California Revolver to increase the borrowing base available to $41.0 million and permit the consummation
of the Seneca Acquisition; (ii) entered into a securities purchase agreement with Prudential Capital Energy Partners, L.P. for
(a) the issuance and sale of $3.0 million of Senior Subordinated Notes due February 15, 2024 and (b) the issuance of 585 Class
A Units of Carbon California as partial consideration for the Subordinated Notes; and (iii) issued (a) an additional 5,000 Class
A Units of Carbon California to Prudential Capital Energy Partners, L.P in exchange for a $5.0 million capital contribution and
(b) an additional 5,000 Class A Units of Carbon California to us in exchange for a $5.0 million capital contribution.
Preferred Stock
On April 6, 2018, we entered into a preferred
stock purchase agreement with Yorktown, for a private placement of 50,000 shares of the Company’s Series B Convertible Preferred
Stock for proceeds of $5.0 million. These proceeds were used to fund our contribution to Carbon California for the Seneca Acquisition.
Old Ironsides Membership Interest Purchase Agreement
On May 4, 2018, we entered into a Membership
Interest Purchase Agreement (the “MIPA”) with Old Ironsides. Old Ironsides owns 73.5%, and we own the remaining 26.5%,
of the issued and outstanding Class A Units of Carbon Appalachia. We also own all of the Class B and Class C units of Carbon Appalachia.
Pursuant to the MIPA, we will acquire all of Old Ironsides’ membership interests of Carbon Appalachia.
Following
the closing of the transaction, we will own 100% of the issued and outstanding ownership interests in Carbon Appalachia, and Carbon
Appalachia will become a wholly-owned subsidiary.
Subject to the terms and conditions of the
MIPA, the Company will pay Old Ironsides, approximately $57.0 million at closing, subject to adjustment in accordance with the
MIPA.
The MIPA contains termination rights for us
and Old Ironsides, including, among others, if the closing of the transaction has not occurred on or before September 1, 2018 (a
date that is 120 days after execution of the MIPA). The MIPA may also be terminated by mutual written consent of us and Old Ironsides.
Carbon Appalachia Borrowing Base Increase
On April 30, 2018, CAE Credit Facility was
amended, resulting in an increase in the borrowing base to $70.0 million. As of March 31, 2018, there was approximately $38.0
million outstanding under the CAE Credit Facility.