XML 40 R22.htm IDEA: XBRL DOCUMENT

Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2015

The consolidated financial statements include the accounts and balances of the Company and its wholly owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America. All intercompany accounts and transactions are eliminated in consolidation.

As of December 31, 2015, the Company’s wholly-owned subsidiaries included:

Earthstone Operating, LLC (formerly Oak Valley Operating, LLC), a Texas limited liability company formed on May 26, 2011. Earthstone Operating serves as the operator on all Company-operated properties in Fayette and Gonzales Counties, Texas and Oklahoma;

EF Non-Op, LLC, a Texas limited liability company formed on December 1, 2010. EF Non-Op holds interests in oil and natural gas properties located in La Salle County, Texas;

Sabine River Energy, LLC, a Texas limited liability company formed on May 18, 2011. Sabine holds interests in oil and natural gas properties located in Texas and Oklahoma;

Basic Petroleum Services, Inc. (“BPS”), a Texas corporation formed March 30, 1977. BPS is a service company which provides services to one of the fields that the Company operates in South Texas; and

1058286 B.C. Ltd (“Merger Sub”), a British Columbia corporation formed December 14, 2015. Merger Sub was incorporated for the purposes of effecting the previously announced arrangement agreement dated December 16, 2015 among the Company, Merger Sub and Lynden Energy Corp. and has not conducted any activities other than those incidental to its formation and the matters contemplated by the arrangement agreement.

Use of Estimates

The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the respective reporting periods.

Estimated quantities of crude oil, natural gas and natural gas liquids reserves are the most significant of our estimates. All the reserves data included in these Consolidated Financial Statements are estimates. Reservoir engineering is a subjective process of estimating underground accumulations of crude oil, natural gas and natural gas liquids. There are numerous uncertainties inherent in estimating quantities of proved crude oil, natural gas and natural gas liquids reserves. The accuracy of any reserves estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, reserves estimates may be different from the quantities of crude oil, natural gas and natural gas liquids that are ultimately recovered.

Other items subject to estimates and assumptions include the carrying amounts of property, plant and equipment, goodwill and asset retirement obligations, valuation allowances for deferred income tax assets, and valuation of derivative instruments, among others. Management evaluates estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic and commodity price environment. The volatility of commodity prices results in increased uncertainty inherent in such estimates and assumptions. Further declines in commodity prices could result in an additional reduction in our fair value estimates and cause us to perform analyses to determine if our oil and natural gas properties need to be further impaired. As future commodity prices cannot be determined accurately, actual results could differ significantly from our estimates. See Supplemental Information on Oil and Gas Exploration and Production Activities (Unaudited).

Cash and Cash Equivalents

Cash and cash equivalents consists of all demand deposits and funds invested in highly liquid investments with an original maturity date of three months or less.

Accounts Receivable

Accounts receivable include amounts due from crude oil, natural gas, and natural gas liquids purchasers, other operators for which the Company holds an interest, and from non-operating working interest owners. Accrued crude oil, natural gas, and natural gas liquids sales from purchasers and operators consist of accrued revenues due under normal trade terms, generally requiring payment within 60 days of production.

An allowance for doubtful accounts is established based on reviews of individual customer accounts, recent loss experience, current economic conditions, and other pertinent factors. Accounts deemed uncollectible are charged to the allowance.

Provisions for bad debts and recoveries on accounts previously charged off are added to the allowance. The Company routinely assesses the recoverability of all material trade receivables and other receivables to determine their collectability. At December 31, 2015 and 2014, the Company deemed all their significant account receivables collectible.

Advances

The Company, in its execution of its drilling program, has other working interest partners. The Company, through its joint operating agreements, requires its working interest partners to pay a drilling advance for their share of the estimated drilling and completion costs. Until such advances are applied to actual drilling and completion invoices, the Company carries the advance as a current liability on the consolidated balance sheets. The Company expects such advances to be applied against the partners’ joint interest billings for its share of drilling operations.

Derivative Instruments

The Company utilizes derivative instruments in order to manage exposure to commodity price risk associated with future oil and natural gas production. The Company recognizes all derivatives as either assets or liabilities, measured at fair value, and recognizes changes in the fair value of derivatives in current earnings. The Company has elected to not designate any of its positions for hedge accounting. Accordingly, these derivative contracts are marked-to-market and any changes in the estimated values of derivative contracts held at the balance sheet date are recognized in Net gain (loss) on derivative contracts in the Consolidated Statements of Operations as unrealized gains or losses on derivative contracts. Realized gains or losses on derivative contracts are also recognized in Net gain (loss) on derivative contracts in the Consolidated Statements of Operations.

Oil and Gas Properties

Proved Properties

The Company follows the successful efforts method of accounting for its oil and gas properties. Under this method, costs to acquire oil and gas properties, drill and equip exploratory wells that find proved reserves, and drill and equip development wells are capitalized. Exploration costs, including unsuccessful exploratory wells and geological and geophysical costs, are charged to operations as incurred. Upon sale or retirement of oil and gas properties, the costs and related accumulated depreciation, depletion, and amortization are eliminated from the accounts and the resulting gain or loss is recognized.

Costs incurred to maintain wells and related equipment, lease and well operating costs, and other exploration costs are charged to expense as incurred. If additions to proved oil and gas properties will be paid within twelve months of year-end, then such additions are accrued at year-end and are included in Additions to oil and gas property and equipment financial statement line item on the Consolidated Statements of Cash Flows. Gains and losses arising from the sale of properties are included in operating income (loss) on the Consolidated Statements of Operations.

The Company’s lease acquisition costs and development costs of proved oil and gas properties are amortized using the units-of-production method, at the field level, based on total proved reserves and proved developed reserves, respectively. Depletion expense for oil and gas producing property and related equipment was $30.7 million, $18.1 million, and $16.9 million, for the years ended December 31, 2015, 2014, and 2013, respectively.

The Company reviews its proved oil and gas properties for impairment when events and circumstances indicate a decline in the recoverability of the carrying values of such properties, such as a negative revision of reserves estimates or sustained decrease in commodity prices. We estimate future cash flows expected in connection with the properties and compare such future cash flows to the carrying amount of the properties to determine if the carrying amount is recoverable. If, upon review, the sum of the undiscounted pretax cash flows is less than the carrying amount, then the carrying amount is written down to its estimated fair value.

The Company recognized impairment charges on its proved oil and gas properties in 2015, 2014, and 2013. See Note 5 Asset Impairments.

Unproved Properties

Unproved properties consist of costs incurred to acquire undeveloped leases as well as the cost to acquire unproved reserves. Undeveloped lease costs and unproved reserve acquisition costs are capitalized. If additions to unproved oil and gas properties will be paid within twelve months of year-end, then such additions are accrued for at year-end and are included in the Additions to oil and gas property and equipment financial statement line item on the Consolidated Statements of Cash Flows. Unproved oil and gas leases are generally for a primary term of three to five years. In most cases, the term of the unproved leases can be extended by paying delay rentals, meeting contractual drilling obligations, or by the presence of producing wells on the leases. Unproved costs related to successful exploratory drilling are reclassified to proved properties and depleted on a units-of-production basis.

The Company reviews its unproved properties periodically for impairment. In determining whether an unproved property is impaired, the Company considers numerous factors including, but not limited to, current exploration plans, favorable or unfavorable exploration activity on the property being evaluated and/or adjacent properties, our geologists' evaluation of the property, and the remaining months in the lease term for the property.

The Company recognized impairment charges on its unproved oil and gas properties in 2015, 2014, and 2013. See Note 5 Asset Impairments.

Goodwill

We account for goodwill in accordance with Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (ASC) 350, Intangibles—Goodwill and Other (“ASC 350”). Goodwill represents the excess of the purchase price over the estimated fair value of the assets acquired net of the fair value of liabilities assumed in an acquisition. ASC 350 requires that intangible assets with indefinite lives, including goodwill, be evaluated on an annual basis for impairment or more frequently if an event occurs or circumstances change that could potentially result in impairment. The goodwill impairment test requires the allocation of goodwill and all other assets and liabilities to reporting units. The Company recorded goodwill related to the reverse acquisition with Earthstone and the 2014 Eagle Ford Acquisition. During 2015, the Company fully impaired the goodwill related to the 2014 Eagle Ford Acquisition. See Note 5 Asset Impairments.

Asset Retirement Obligations

Asset retirement obligations represent the present value of the estimated cash flows expected to be incurred to plug, abandon, remediate oil and gas wells, remove equipment and facilities from leased acreage, and return land to its original condition. The fair value of a liability for an asset retirement obligation is recorded in the period in which it is incurred (typically when a well is completed or acquired or when an asset is installed at the producing location), and the costs of such liability increases the carrying amount of the related long-lived asset by the same amount.

After the liability is initially recorded, the carrying amount of the related long-lived asset is increased over time through a charge to accretion expense each period and the capitalized cost is depleted on a units-of-production basis based on the proved developed reserves of the related assets. Changes in timing or to the original estimate of cash flows will result in changes to the carrying amount of the liability. See Note 10 Asset Retirement Obligations for further disclosure regarding the asset retirement obligation.

Business Combinations

The Company accounts for the acquisition of oil and gas properties, that are not commonly controlled, based on the requirements of FASB ASC Topic 805, Business Combinations, which requires an acquiring entity to recognize the assets acquired and liabilities assumed at fair value under the acquisition method of accounting, provided such assets and liabilities qualify for acquisition accounting under the standard. The Company accounts for property acquisitions of proved developed oil and gas property as business combinations.

Revenue Recognition

Oil, natural gas, and natural gas liquids revenues represent income from the production and delivery of oil, natural gas, and natural gas liquids, recorded net of royalties. Revenues are recognized when production is sold to a purchaser at a fixed or determinable price, delivery has occurred, title has been transferred, and collectability of the revenue is probable. The Company follows the sales method of accounting for gas imbalances. The Company had no significant gas imbalances as of December 31, 2015, 2014, or 2013.

Concentration of Credit Risk

Credit risk represents the actual or perceived financial loss that the Company would record if its purchasers, operators, or counterparties failed to perform pursuant to contractual terms.

The purchasers of the Company’s oil, natural gas, and natural gas liquids production consist primarily of independent marketers, major oil and natural gas companies and gas pipeline companies. Historically, the Company has not experienced any significant losses from uncollectible accounts. In 2015, 2014 and 2013, one purchaser accounted for 62%, 60% and 21%, respectively, of the Company’s oil, natural gas, and natural gas liquids revenues. No other purchaser accounted for 10% or more of the Company’s oil, natural gas, and natural gas liquids revenues during 2015, 2014, and 2013.

The Company holds working interests in oil and gas properties for which a third party serves as operator. The operator sells the oil, natural gas, and NGLs to the purchaser, collects the cash, and distributes the cash to the Company. The Company recognizes the cash received as revenue. In 2015, one operator distributed 12% and in 2014, a different operator distributed 20% of the Company’s oil, natural gas and natural gas liquids revenues. In 2013, two operators distributed 47% and 11% of the Company’s oil, natural gas, and natural gas liquids revenues. No other operator accounted for 10% or more of the Company’s oil, natural gas, and natural gas liquids revenues during 2015, 2014, and 2013.

If purchasers and operators fail to perform pursuant to contractual terms, then the Company’s overall business may be adversely impacted. The Company’s management believes this risk is mitigated by the size, and reputation, of its purchasers and operators.

Commodity derivative contracts held by the Company are with three counterparties. The counterparties have investment-grade ratings from Moody’s and Standard & Poor.

The Company regularly maintains its cash in bank deposit accounts. Balances held by the Company at its banks typically exceed Federal Deposit Insurance Corporation (“FDIC”) insurance coverage, and as a result, there is a concentration of credit risk related to the amounts of deposit in excess of FDIC insurance coverage. The Company’s management believes this risk is not significant based upon the size and reputation of the financial institutions.

Income Taxes

The provision for income taxes is based on taxes payable or refundable for the current year and deferred taxes on differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements, which result from temporary differences between the amount of taxable income and pretax financial income. The deferred tax assets and liabilities are calculated for the 2015 consolidated financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. Tax positions are evaluated for recognition and measurement, with deferred tax balances recorded at their anticipated settlement amounts. A valuation allowance has been provided for the 2015 deferred tax assets that based on current information is not expected to be realized. As noted in the Basis of Presentation, the historical financials, prior to December 19, 2014, are those of Oak Valley. Oak Valley was not subject to taxation and therefore tax provisions were not recorded on the historical consolidated financial statements. As result of the Exchange Agreement, Oak Valley as result of its change in tax status is now taxable and is subject to taxation and included in the purchase accounting adjustments is a charge to earnings to record a tax provision.

The Company follows the provisions of FASB ASC Topic 740, Income Taxes (“ASC Topic 740”), relating to accounting for uncertainties in income taxes. ASC Topic 740 clarifies the accounting for uncertainties in income taxes by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the consolidated financial statements. ASC Topic 740 requires that the Company recognize in the consolidated financial statements the financial effects of a tax position, if that position is more likely than not of being sustained upon examination, including resolution of any appeals or litigation processes, based upon the technical merits of the position. ASC Topic 740 also provides guidance on measurement, classification, interest and penalties and disclosure. Tax positions taken related to the Company’s pass-through status and state income tax liability, including deductibility of expenses, have been reviewed and the Company’s management is of the opinion that material positions taken by the Company would more likely than not be sustained upon examination. Accordingly, the Company has not recorded an income tax liability for uncertain tax positions at December 31, 2015, 2014, or 2013. The 2012 through 2015 tax years generally remain subject to examination.

Recently Issued Accounting Pronouncements

Revenue Recognition – In May 2014, the FASB issued updated guidance for recognizing revenue from contracts with customers. The objective of this guidance is to establish principles for reporting information about the nature, timing, and uncertainty of revenue and cash flows arising from an entity’s contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and change in judgments, and assets recognized from the costs to obtain or fulfill a contract. In August 2015, the FASB issued guidance deferring the effective date of this standards update for one year, to be effective for interim and annual periods after December 15, 2017; early adoption is permitted as of the original effective date of December 31, 2016. The Company will adopt this standards update, as required, beginning with the first quarter of 2018. The Company is in the process of evaluating the impact, if any, of the adoption of this guidance on its Consolidated Financial Statements.

Debt Issuance Costs – In April 2015, the FASB issued updated guidance which changes the presentation of debt issuance costs in the financial statements. Under this updated guidance, debt issuance costs are presented on the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. In August 2015, the FASB subsequently issued a clarification as to the handling of debt issuance costs related to line-of-credit arrangements that allows the presentation of these costs as an asset. The standards update is effective for interim and annual periods beginning after December 15, 2015. The Company will adopt this standards update, as required, beginning with the first quarter of 2016 and it will be retrospectively applied to all prior periods. The Company does not expect the adoption of this new presentation guidance to have a material impact on its Consolidated Balance Sheets.

Measurement-Period Adjustments – In September 2015, the FASB issued updated guidance that eliminates the requirement to restate prior periods to reflect adjustments made to provisional amounts recognized in a business combination. The updated guidance requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The standards update is effective prospectively for interim and annual periods beginning after December 15, 2015 with early adoption permitted. The Company will adopt this standard update, as required, beginning with the first quarter of 2016, and does not expect it to have a material impact on its Consolidated Financial Statements.

Income Taxes – In November 2015, the FASB issued updated guidance changing the presentation of deferred taxes on the balance sheet. The updated guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. The standards update is effective for annual and interim periods beginning after December 15, 2016 with early adoption permitted. The Company elected to early-adopt this standards update as of December 31, 2015 with prospective application. See Note 13 Income Taxes.