3. FRESH-START ACCOUNTING

Upon the Company’s emergence from chapter 11 bankruptcy, the Company qualified for and adopted fresh-start accounting in accordance with the provisions set forth in ASC 852 as (i) the Reorganization Value of the Company’s assets immediately prior to the date of confirmation was less than the post-petition liabilities and allowed claims, and (ii) the holders of the existing voting shares of the Predecessor entity received less than 50% of the voting shares of the emerging entity. Refer to Note 2, “Reorganization,” for the terms of the Plan. Fresh-start accounting requires the Company to present its assets, liabilities, and equity as if it were a new entity upon emergence from bankruptcy. The new entity is referred to as “Successor” or “Successor Company.” However, the Company will continue to present financial information for any periods before adoption of fresh-start accounting for the Predecessor Company. The Predecessor and Successor Companies may lack comparability, as required in ASC Topic 205, Presentation of Financial Statements (ASC 205). ASC 205 states financial statements are required to be presented comparably from year to year, with any exceptions to comparability clearly disclosed. Therefore, “black-line” financial statements are presented to distinguish between the Predecessor and Successor Companies.

Adopting fresh-start accounting results in a new financial reporting entity with no beginning retained earnings or deficit as of the fresh-start reporting date. Upon the application of fresh-start accounting, the Company allocated the Reorganization Value (the fair value of the Successor Company’s total assets) to its individual assets based on their estimated fair values. The Reorganization Value is intended to represent the approximate amount a willing buyer would value the Company’s assets immediately after the reorganization.

Reorganization Value is derived from an estimate of Enterprise Value, or the fair value of the Company’s long-term debt, stockholders’ equity and working capital. The estimated Enterprise Value at the Effective Date was below the midpoint of the Court approved range of $1.6 billion to $1.8 billion, primarily reflecting the decline in forward commodity prices during the period between the Company’s analysis performed in advance of the July 2016 chapter 11 bankruptcy filing and the Effective Date. The Enterprise Value was derived from an independent valuation using an asset based methodology of estimated proved reserves, undeveloped acreage, and other financial information, considerations and projections, applying a combination of the income, cost and market approaches as of the fresh-start reporting date of September 9, 2016.

The Company’s principal assets are its oil and natural gas properties. For purposes of estimating the fair value of the Company’s proved, probable and possible reserves, an income approach was used which estimated fair value based on the anticipated cash flows associated with the Company’s reserves, risked by reserve category and discounted using a weighted average cost of capital rate of 10.5% for proved reserves and 12.5% for probable and possible reserves. The proved reserve locations were limited to wells expected to be drilled in the Company’s five year development plan. Weighted average commodity prices utilized in the determination of the fair value of oil and natural gas properties were $72.30 per barrel of oil, $3.50 per MMBtu of natural gas and $12.00 per barrel of oil equivalent of natural gas liquids, after adjustment for transportation fees and regional price differentials. Base pricing was derived from an average of forward strip prices and analysts’ estimated prices.

In estimating the fair value of the Company’s unproved acreage that was not included in the valuation of probable and possible reserves, a market approach was used in which a review of recent transactions involving properties in the same geographical location indicated the fair value of the Company’s unproved acreage from a market participant perspective.

See further discussion below in the “Fresh-start accounting adjustments” for the specific assumptions used in the valuation of the Company’s various other assets.

Although the Company believes the assumptions and estimates used to develop Enterprise Value and Reorganization Value are reasonable and appropriate, different assumptions and estimates could materially impact the analysis and resulting conclusions. The assumptions used in estimating these values are inherently uncertain and require judgment.The following table reconciles the Company’s Enterprise Value to the estimated fair value of the Successor’s common stock as of September 9, 2016 (in thousands):


	September 9, 2016
Enterprise Value	$	1,618,888
Plus: Cash		13,943
Less: Fair value of debt		(1,016,160)
Less: Fair value of redeemable noncontrolling interest		(41,070)
Less: Fair value of other long-term liabilities		(4,478)
Less: Fair value of warrants		(16,691)
Fair Value of Successor common stock	$	554,432

The following table reconciles the Company’s Enterprise Value to its Reorganization Value as of September 9, 2016 (in thousands):


	September 9, 2016
Enterprise Value	$	1,618,888
Plus: Cash		13,943
Plus: Current liabilities		178,639
Plus: Noncurrent asset retirement obligation		32,156
Reorganization Value of Successor assets	$	1,843,626

Condensed Consolidated Balance Sheet

The following illustrates the effects on the Company’s consolidated balance sheet due to the reorganization and fresh-start accounting adjustments. The explanatory notes following the table below provide further details on the adjustments, including the Company’s assumptions and methods used to determine fair value for its assets and liabilities. Amounts included in the table below are rounded to thousands.


	As of September 9, 2016
	Predecessor		Reorganization			Fresh-Start			Successor
	Company		Adjustments			Adjustments			Company
Current assets:
Cash and cash equivalents	$	111,464	$	(97,521)	(1)	$	—		$	13,943
Accounts receivable		116,859		—			—			116,859
Receivables from derivative contracts		97,648		—			—			97,648
Restricted cash		17,164		—			—			17,164
Prepaids and other		8,961		—			(1,332)	(7)		7,629
Total current assets		352,096		(97,521)			(1,332)			253,243
Oil and natural gas properties (full cost method):
Evaluated		7,712,003		—			(6,497,874)	(8)		1,214,129
Unevaluated		1,193,259		—			(861,144)	(8)		332,115
Gross oil and natural gas properties		8,905,262		—			(7,359,018)			1,546,244
Less—accumulated depletion		(6,803,231)		—			6,803,231	(8)		—
Net oil and natural gas properties		2,102,031		—			(555,787)			1,546,244
Other operating property and equipment:
Other operating property and equipment		100,079		—			(62,008)	(9)		38,071
Less—accumulated depreciation		(24,154)		—			24,154	(9)		—
Net other operating property and equipment		75,925		—			(37,854)			38,071
Other noncurrent assets:
Receivables from derivative contracts		4,431		—			—			4,431
Funds in escrow and other		1,610		—			27	(10)		1,637
Total assets	$	2,536,093	$	(97,521)		$	(594,946)		$	1,843,626
Current liabilities:
Accounts payable and accrued liabilities	$	160,000	$	13,688	(2)	$	—		$	173,688
Liabilities from derivative contracts		102		—			—			102
Other		414		—			4,435	(11)(12)		4,849
Total current liabilities		160,516		13,688			4,435			178,639
Long-term debt, net		1,031,114		—			(14,954)	(13)		1,016,160
Liabilities subject to compromise		2,007,703		(2,007,703)	(3)		—			—
Other noncurrent liabilities:
Liabilities from derivative contracts		525		—			—			525
Asset retirement obligations		48,955		—			(16,799)	(12)		32,156
Other		528		—			3,425	(11)(14)		3,953
Commitments and contingencies
Mezzanine equity:
Redeemable noncontrolling interest		219,891		—			(178,821)	(14)		41,070
Stockholders' equity:
Preferred stock (Predecessor)		—		—	(4)		—			—
Common Stock (Predecessor)		12		(12)	(4)		—			—
Common Stock (Successor)		—		9	(5)		—			9
Additional paid-in capital (Predecessor)		3,287,906		(3,287,906)	(4)		—			—
Additional paid-in capital (Successor)		—		571,114	(5)		—			571,114
Retained earnings (accumulated deficit)		(4,221,057)		4,613,289	(6)		(392,232)	(15)		—
Total stockholders' equity		(933,139)		1,896,494			(392,232)			571,123
Total liabilities and stockholders' equity	$	2,536,093	$	(97,521)		$	(594,946)		$	1,843,626

Reorganization adjustments

1) The table below details cash payments as of September 9, 2016, pursuant to the terms of the Plan described in Note 2, “Reorganization,” (in thousands):


Payment to Third Lien Noteholders	$	33,826
Payment to Unsecured Noteholders		37,595
Payment to Convertible Noteholder		15,000
Payment to Preferred Holders		11,100
Total Uses	$	97,521

2) In connection with the chapter 11 bankruptcy, the Company modified and rejected certain office lease arrangements and paid approximately $3.4 million for these modifications and rejections subsequent to the emergence from chapter 11 bankruptcy. This amount also reflects $10.3 million paid to the Company’s restructuring advisors subsequent to the emergence from chapter 11 bankruptcy.

3) Liabilities subject to compromise were as follows (in thousands):


13.0% senior secured third lien notes due 2022	$	1,017,970
9.25% senior notes due 2022		37,194
8.875% senior notes due 2021		297,193
9.75% senior notes due 2020		315,535
8.0% convertible note due 2020		289,669
Accrued interest		46,715
Office lease modification and rejection fees		3,427
Liabilities subject to compromise		2,007,703
Fair value of equity and warrants issued to Third Lien Noteholders, Unsecured Noteholders and Convertible Noteholder		(548,947)
Cash payments to Third Lien Noteholders, Unsecured Noteholders and Convertible Noteholder		(86,421)
Office lease modification and rejection fees		(3,427)
Gain on settlement of Liabilities subject to compromise	$	1,368,908

4) Reflects the cancellation of Predecessor equity, as follows (in thousands):


Predecessor Company stock	$	3,287,918
Fair value of equity issued to Predecessor common stockholders		(22,176)
Cash payment to Preferred Holders		(11,100)
Cancellation of Predecessor Company equity	$	3,254,642

5) Reflects the issuance of Successor equity. In accordance with the Plan, the Successor Company issued 3.6 million shares of common stock to the Predecessor Company’s existing common stockholders, 68.8 million shares of common stock to the Third Lien Noteholders, 14.0 million shares of common stock to the Unsecured Noteholders, and 3.6 million shares of common stock to the Convertible Noteholder. This amount is subject to dilution by warrants issued to the Unsecured Noteholders and the Convertible Noteholder totaling 4.7 million shares with an exercise price of $14.04 per share and a term of four years. The fair value of the warrants was estimated at $3.52 per share using a Black-Scholes-Merton valuation model.

6) The table below reflects the cumulative effect of the reorganization adjustments discussed above (in thousands):


Gain on settlement of Liabilities subject to compromise	$	1,368,908
Accrued reorganization items		(10,261)
Cancellation of Predecessor Company equity		3,254,642
Net impact to retained earnings (accumulated deficit)	$	4,613,289

Fresh-start accounting adjustments

7) Reflects the reclassification of tubulars and well equipment to “Oil and natural gas properties.”

8) In estimating the fair value of its oil and natural gas properties, the Company used a combination of the income and market approaches. For purposes of estimating the fair value of the Company’s proved, probable and possible reserves, an income approach was used which estimated fair value based on the anticipated cash flows associated with the Company’s reserves, risked by reserve category and discounted using a weighted average cost of capital rate of 10.5% for proved reserves and 12.5% for probable and possible reserves. The proved reserve locations were limited to wells expected to be drilled in the Company’s five year development plan. Weighted average commodity prices utilized in the determination of the fair value of oil and natural gas properties were $72.30 per barrel of oil, $3.50 per MMBtu of natural gas and $12.00 per barrel of natural gas liquids, after adjustment for transportation fees and regional price differentials. Base pricing was derived from an average of forward strip prices and analysts’ estimated prices.

9) In estimating the fair value of its other operating property and equipment, the Company used a combination of the income, cost, and market approaches.

For purposes of estimating the fair value of its gas gathering assets, an income approach was used that estimated future cash flows associated with the assets over the remaining useful lives. The valuation included such inputs as estimated future production, gathering and compression revenues, and operating expenses that were discounted at a weighted average cost of capital rate of 9.5%.

For purposes of estimating the fair value of its other operating assets, the Company used a combination of the market and cost approaches. A market approach was relied upon to value land and computer equipment, and in this valuation approach, recent transactions of similar assets were utilized to determine the value from a market participant perspective. For the remaining other operating assets, a cost approach was used. The estimation of fair value under the cost approach was based on current replacement costs of the assets, less depreciation based on the estimated economic useful lives of the assets and age of the assets.

10) Reflects the adjustment of the Company’s equity method investment in SBE Partners, L.P. to fair value based on an income approach, which calculated the discounted cash flows of the Company’s share of the partnership’s interest in oil and gas estimated proved reserves. The anticipated cash flows of the reserve were risked by reserve category and discounted at 10.5%. Weighted average commodity prices utilized in the determination of the fair value of oil and natural gas properties were $72.30 per barrel of oil, $3.50 per MMBtu of natural gas and $12.00 per barrel of oil equivalent of natural gas liquids, after adjustment for transportation fees and regional price differentials. Base pricing was derived from an average of forward strip prices and analysts’ estimated prices.

11) Records an intangible liability of approximately $8.3 million, $4.5 million of which was recorded as current, to adjust the Company’s active rig contract to fair value at September 9, 2016. The intangible liability will be amortized over the remaining life of the contract.

12) Reflects the adjustment of asset retirement obligations to fair value using estimated plugging and abandonment costs as of September 9, 2016, adjusted for inflation and then discounted at the appropriate credit-adjusted risk free rate ranging from 5.5% to 6.6% depending on the life of the well. The fair value of asset retirement obligations was estimated at $32.5 million, approximately $0.3 million of which was recorded as current.

13) Reflects the adjustment of the 2020 Second Lien Notes and the 2022 Second Lien Notes to fair value. The fair value estimate was based on quoted market prices from trades of such debt on September 9, 2016.

14) Reflects the adjustment of the Company’s redeemable noncontrolling interest and related embedded derivative of HK TMS to fair value. The fair value of the redeemable noncontrolling interest was estimated at $41.1 million and the embedded derivative was estimated at zero. For purposes of estimating the fair values, an income approach was used that estimated fair value based on the anticipated cash flows associated with HK TMS proved reserves, risked by reserve category and discounted using a weighted average cost of capital rate of 12.5%. The value of the redeemable noncontrolling interest was further reduced by a probability factor of the potential assignment of the common shares of HK TMS to Apollo, which occurred subsequent to the fresh-start date. Refer to Note 5, “Acquisitions and Divestitures,” for further information regarding the HK TMS Divestiture on September 30, 2016.

15) Reflects the cumulative effect of the fresh-start accounting adjustments discussed above.

Reorganization Items

Reorganization items represent (i) expenses or income incurred subsequent to the Petition Date as a direct result of the Plan, (ii) gains or losses from liabilities settled, and (iii) fresh‑start accounting adjustments and are recorded in “Reorganization items” in the Company’s consolidated statements of operations. The following table summarizes the net reorganization items (in thousands):


	Successor		Predecessor
	Period from		Period from
	September 10, 2016		January 1, 2016
	through		through
	December 31, 2016		September 9, 2016
Gain on settlement of Liabilities subject to compromise	$	—	$	1,368,908
Fresh start adjustments		—		(392,232)
Reorganization professional fees and other		(2,049)		(30,287)
Write-off debt discounts/premiums and debt issuance costs		—		(32,667)
Gain (loss) on reorganization items	$	(2,049)	$	913,722