NOTE 3. FRESH START ACCOUNTING

In connection with emergence from the Chapter 11 proceedings on the Effective Date, the Company applied the provisions of fresh start accounting, pursuant to Accounting Standards Codification (“ASC”) 852 Reorganizations (“ASC 852”), to its consolidated financial statements, which resulted in the Company becoming a new entity for financial reporting purposes. Harvest qualified for fresh start accounting as (i) the holders of existing voting common units of the Predecessor received less than 50% of the voting shares of the emerged entity and (ii) the reorganization value of assets immediately prior to confirmation was less than the post-petition liabilities and allowed claims. ASC 852 requires that fresh start accounting be applied when the Bankruptcy Court enters the Confirmation Order confirming the Plan, or as of a later date when all material conditions precedent to the effectiveness of the Plan are resolved, which was June 4, 2018. The Company elected to apply fresh start accounting effective May 31, 2018, to coincide with the timing of its normal accounting period close. The Company evaluated the events between May 31, 2018 and June 4, 2018 and concluded that the use of an accounting convenience date of May 31, 2018 did not have a material impact on the results of operations or financial position.

Upon adoption of fresh start accounting, the reorganization value derived from the enterprise value was allocated to the Company’s assets and liabilities based on their fair values (except for deferred income taxes) in accordance with ASC 805 Business Combinations (“ASC 805”). The amount of deferred income taxes recorded was determined in accordance with ASC 740 Income Taxes (“ASC 740”). The Effective Date fair values of the Company’s assets and liabilities differed materially from their recorded values as reflected on the historical balance sheet of the Predecessor. The effects of the Plan and the application of fresh start accounting were reflected in the consolidated financial statements as of May 31, 2018 and the related adjustments thereto were recorded on the consolidated statement of operations for the five months ended May 31, 2018.

As a result of the adoption of fresh start accounting and the effects of the implementation of the Plan, the Company’s consolidated financial statements subsequent to May 31, 2018 are not comparable to its consolidated financial statements prior to May 31, 2018. References to “Successor” relate to the financial position and results of operations of the reorganized Company as of and subsequent to May 31, 2018. References to “Predecessor” relate to the financial position of the Company prior to, and results of operations through and including, May 31, 2018.

The Company’s consolidated financial statements and related notes are presented with a black line division, which delineates the lack of comparability between amounts presented after May 31, 2018 and amounts presented on or prior to May 31, 2018. The Company’s financial results for future periods following the application of fresh start accounting will be different from historical trends and the differences may be material.

Reorganization Value

In the disclosure statement associated with the Plan, which was confirmed by the Bankruptcy Court, the Successor’s enterprise value was estimated to be within a range of $450 million to $550 million, with a midpoint estimate of approximately $500 million. Enterprise value represents the estimated fair value of a company’s interest-bearing debt, its stockholders’ equity and working capital. Based on the estimates and assumptions utilized in the fresh start accounting process, the Company estimated the Successor’s enterprise value to be approximately $524.6 million before the consideration of cash and cash equivalents on hand at the Effective Date. Reorganization value represents the fair value of the Successor’s total assets prior to the consideration of liabilities and is intended to approximate the amount a willing buyer would pay for the assets immediately after a restructuring. The reorganization value, which was derived from the Successor’s enterprise value, was allocated to the Company’s individual assets based on their estimated fair values.

The following table is a reconciliation of the enterprise value to the estimated fair value of the Successor’s common stock at the Effective Date (in thousands):


Enterprise Value	$	524,596
Plus: Cash and cash equivalents		21,082
Less: Fair value of debt		(297,000)
Fair value of Successor equity	$	248,678

The following table is a reconciliation of the enterprise value to the reorganization value of the Successor assets at the Effective Date (in thousands):


Enterprise Value	$	524,596
Plus: Cash and cash equivalents		21,082
Plus: Other working capital liabilities		36,787
Plus: Other long-term liabilities		121,041
Reorganization value of Successor assets	$	703,506

The Company’s assets consist primarily of producing oil and natural gas properties. The fair values of proved and unproved oil and natural gas properties were estimated using valuation techniques consistent with the income approach, converting future cash flows to a single discounted amount. The factors to determine fair value include, but are not limited to, estimates of: (i) economic reserves, (ii) future operating and development costs, (iii) future commodity prices and (iv) a market-based weighted average cost of capital. These inputs require significant judgments and estimates by the Company’s management at the time of the valuation and are the most sensitive and subject to change. The underlying commodity prices embedded in the Company’s estimated cash flows are the product of a process that incorporates forward commodity pricing, analyst pricing estimates and adjustments for estimated location and quality differentials, as well as other factors as necessary that the Company’s management believes will impact realizable prices. The fair value of support equipment and facilities were estimated using a cost approach, 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.

See below under the caption “Fresh Start Adjustments” for additional information regarding assumptions used in the valuation of the Company’s various other significant assets and liabilities.

Condensed Consolidated Balance Sheet

The adjustments included in the following condensed consolidated balance sheet reflect the effect of the transactions contemplated by the Plan (reflected in the column “Reorganization Adjustments”) as well as fair value and other required accounting adjustments resulting from the adoption of fresh start accounting (reflected in the column “Fresh Start Adjustments”). The explanatory notes provide additional information with regard to the adjustments recorded, the methods used to determine the fair values and significant assumptions.


	As of May 31, 2018
			Reorganization			Fresh Start
	Predecessor		Adjustments (1)			Adjustments			Successor
ASSETS
Current assets:
Cash and cash equivalents	$	35,020	$	(13,938)	(2)	$	—		$	21,082
Restricted cash		—		7,650	(3)		—			7,650
Accounts receivable:
Oil, natural gas and natural gas liquids revenues		48,986		1,261	(4)		—			50,247
Related party		1,503		(1,503)	(4)		—			—
Other		800		—			—			800
Other current assets		4,580		(527)	(5)		(1,791)	(12)		2,262
Total current assets		90,889		(7,057)			(1,791)			82,041
Oil and natural gas properties, net		1,355,504		—			(739,486)	(13)		616,018
Other assets		4,507		1,941	(6)		(1,001)	(14)		5,447
Total assets	$	1,450,900	$	(5,116)		$	(742,278)		$	703,506

LIABILITIES AND EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	34,922	$	2,177	(7)	$	(312)	(15)	$	36,787
Current portion of long-term debt		297,000		(297,000)	(8)		—			—
Total current liabilities		331,922		(294,823)			(312)			36,787
Liabilities subject to compromise		356,066		(356,066)	(9)		—			—
Asset retirement obligations		161,661		—			(41,641)	(15)		120,020
Long–term debt, net		—		297,000	(8)		—			297,000
Other long–term liabilities		1,021		—			—			1,021
Total liabilities		850,670		(353,889)			(41,953)			454,828
Commitments and contingencies (Note 14)
Stockholders’ / owners’ equity:
Predecessor common unitholders		621,144		65,175	(10)		(686,319)	(16)		—
Predecessor general partner interest		(20,914)		34,920	(10)		(14,006)	(16)		—
Successor common stock		—		100	(11)		—			100
Successor additional paid-in capital		—		248,578	(11)		—			248,578
Total stockholders’ / owners’ equity		600,230		348,773			(700,325)			248,678
Total liabilities and equity	$	1,450,900	$	(5,116)		$	(742,278)		$	703,506

_____________

Reorganization Adjustments

(1)Reflects amounts recorded as of the Effective Date for the implementation of the Plan, including among other items, settlement of the Predecessor’s liabilities subject to compromise, cancellation of the Predecessor’s equity, issuance of the Successor New Common Shares and the Warrants, repayment of certain of Predecessor’s liabilities and settlement with holders of the Senior Notes.

(2)Reflects the changes in cash and cash equivalents, including the following:


Funding of the professional fees escrow account	$	(7,650)
Payment of debt issuance costs on the Successor Exit Credit Facility		(2,813)
Payment of professional fees		(1,591)
Payment of success fees		(1,573)
Payment of derivative settlement		(216)
Payment of accrued interest payable under the Predecessor credit facility		(135)
Transfer of funds from Predecessor’s general partner		40
Changes in cash and cash equivalents	$	(13,938)

(3)Reflects the transfer of restricted cash to fund the professional fees escrow account.

(4)Primarily reflects the reclassification of the related party net receivable from EnerVest to a third party receivable as EnerVest is no longer a related party as result of the Restructuring. Also, reflects the cancellation of related party claims of $0.2 million with the general partner of EVEP as a result of the Debtor’s emergence from Chapter 11 bankruptcy proceedings.

(5)Represents the expense of certain prepaid professional fees as a result of the Debtor’s emergence from Chapter 11 bankruptcy proceedings.

(6)Reflects the capitalization of the deferred financing costs of $2.8 million related to the Successor’s Exit Credit Facility, offset by the write-off of $0.8 million of deferred financing costs related to the Predecessor’s credit facility.

(7)Net increase in accounts payable and accrued liabilities reflects the following:


Recognition of payables for success fees	$	4,086
Recognition of payables for professional fees		32
Payment of professional fees		(1,590)
Payment of derivative settlement		(216)
Payment of accrued interest payable under the Predecessor credit facility		(135)
Net increase in accounts payable and accrued liabilities	$	2,177

(8)Reflects the reclassification of $297.0 million in borrowings under the Exit Credit Facility to long-term debt.

(9)Settlement of liabilities subject to compromise and the resulting net gain were determined as follows:


Senior Notes	$	343,348
Accrued interest payable		12,718
Total liabilities subject to compromise of Predecessor		356,066
Issuance of common stock to holders of the Senior Notes		(227,366)
Gain on settlement of liabilities subject to compromise	$	128,700

The amount of disallowed interest during the period from the Petition Date through the Effective Date of emergence not included in the accrued interest payable in the table above was $4.7 million.

(10)Reflects the cancellation of the Predecessor company common unitholders and general partner interest.


			General
	Common		Partner
	Unitholders		Interest
Net gain from reorganization adjustments	$	118,940	$	2,426
Contribution from general partner		—		40
Issuance of common stock to Predecessor common unitholders		(11,967)		—
Issuance of warrants to Predecessor common unitholders		(9,345)		—
Cancellation of Predecessor common unitholders / general partner interest		(32,453)		32,454
Predecessor equity reorganization adjustments	$	65,175	$	34,920

(11)Reflects the issuance of 10,000,016 shares of common stock at a par value of $0.01 per share in accordance with the Plan, and the issuance of 800,000 warrants in accordance with the Plan. The fair value of the Warrants was determined by using the Black-Scholes model and were reasonably estimated to be approximately $11.68 per share. See Note 15 for additional information on the issuance of the Successor’s Warrants.


Issuance of shares of Successor common stock at par value of $0.01 per share	$	100
Additional paid-in capital from issuance of Successor common stock		239,233
Additional paid-in capital from issuance of Successor warrants		9,345
Fair value of Successor equity	$	248,678

See Note 15 for additional information on the issuances of the Successor’s equity.

Fresh Start Adjustments

(12)Reflects the adjustment to write-down certain other current assets to fair value.

(13)Reflects a decrease of oil and natural gas properties, net. In determining the fair value of the oil and gas properties both the income and market approach were utilized and the accumulated depreciation, depletion and impairment was eliminated. The following table summarizes the components of oil and natural gas properties as of the Effective Date: based on the methodology discussed above and the elimination of accumulated depreciation, depletion and impairment. The fresh start adjustments to oil and natural gas properties, net are as follows:


	Successor		Predecessor
	Fair Value		Historical Book Value
Proved oil and natural gas properties	$	547,136	$	2,593,249
Unproved oil and natural gas properties		68,882		—
		616,018		2,593,249
Accumulated depreciation, depletion and amortization		—		(1,237,745)
Net capitalized costs	$	616,018	$	1,355,504

(14)Reflects the write-off of immaterial other assets not anticipated to have value to Harvest.

(15)Reflects a decrease of $42.0 million for asset retirement obligations. The fair value of asset retirement obligations was estimated using valuation techniques that convert future cash flows to a single discounted amount. Significant inputs to the valuation include estimates of: (i) plugging and abandonment costs per well based on existing regulatory requirements, (ii) remaining life per well, (iii) future inflation factors and (iv) a credit-adjusted risk free rate.

(16)Reflects the cumulative impact of the fresh start adjustments discussed above.

Reorganization Items, Net

The Company has incurred significant costs associated with the reorganization. These costs, which are expensed as incurred, are expected to significantly affect the Company’s results of operations. Reorganization items, net, represent costs, gains and losses directly associated with the Chapter 11 proceedings since the Petition Date.

The following table summarizes the components of reorganization items, net, included in the accompanying consolidated statements of operations:


	Successor		Predecessor
	Seven Months		Five Months
	Ended		Ended
	December 31, 2018		May 31, 2018
Gain on settlement of liabilities subject to compromise	$	—	$	128,700
Fresh start valuation adjustments		—		(700,325)
Professional fees		(2,323)		(13,345)
Other		—		(2,355)
Reorganization items, net	$	(2,323)	$	(587,325)