Note 3 – Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated condensed financial statements include the accounts of all wholly-owned and majority-owned subsidiaries. All intercompany profits, transactions and balances have been eliminated. Third-party interests in our majority-owned subsidiaries are presented as noncontrolling interests.

Investment in Affiliate

Through December 31, 2014, we included the results of Petrodelta in our financial statements under the equity method of accounting. Effective December 31, 2014, we determined that we no longer had significant influence within our investment in Petrodelta and in accordance with Accounting Standards Codification “ASC 323 – Investments – Equity Method” and as such, we account for our investment in Petrodelta under the cost method (“ASC 325 – Investments – Other”). Under the cost method we will not recognize any equity in earnings from our investment in Petrodelta in our results of operations, but will recognize any cash dividends in the period they are received. We also performed an impairment analysis of the carrying value of our investment at December 31, 2014. Based on this assessment we recorded a one-time pre-tax impairment charge of $355.7 million against the carrying value of our investment in the fourth quarter of 2014. We continue to monitor the carrying value of our investment and may record additional impairments if we believe that any future decrease in the estimated fair value of the investment is other than temporary.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Oil and Gas Properties

The major components of property and equipment are as follows:



	As of September 30,		As of December 31,
	2015		2014
	(in thousands)
Unproved property costs - Dussafu PSC	$	51,029	$	50,324
Oilfield inventories		3,426		3,966
Other administrative property		2,777		2,670
Total property and equipment		57,232		56,960
Accumulated depreciation		(2,466)		(2,453)
Total property and equipment, net	$	54,766	$	54,507

Other Administrative Property

Furniture, fixtures and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives, which range from three to five years. Leasehold improvements are recorded at cost and amortized using the straight-line method over the life of the applicable lease. For the three and nine months ended September 30, 2015, depreciation expense was $0.0 million and $0.1 million, respectively. For the three and nine months ended September 30, 2014, depreciation expense was $0.0 million and $0.2 million, respectively.

Other Assets

Other assets at September 30, 2015 and December 31, 2014 include deposits, prepaid expenses expected to be realized in the next 12 to 24 months and deferred financing costs. Deferred financing costs relate to specific financings and are amortized over the life of the financings to which the costs relate using the interest rate method. Other assets at September 30, 2015 and December 31, 2014 also consisted of a blocked payment related to our drilling operations in Gabon in accordance with the United States (“U.S.”) sanctions against Libya as set forth in Executive Order 13566 of February 25, 2011, and administered by the United States Treasury Department’s Office of Foreign Assets Control (“OFAC”). During the nine months ended September 30, 2015, we amortized $0.3 million in deferred financing costs. During the nine months ended September 30, 2015, we recorded a $0.6 million allowance for doubtful accounts to general and administrative costs associated with the blocked payment. See Note 12 – Commitments and Contingencies.



	As of September 30,		As of December 31,
	2015		2014
	(in thousands)
Deposits and long-term prepaid expenses	$	143	$	101
Deferred financing costs		—		283
Gabon – blocked payment		550		1,100
	$	693	$	1,484

Capitalized Interest

We capitalize interest costs for qualifying oil and gas properties. The capitalization period begins when expenditures are incurred on qualified properties, activities begin which are necessary to prepare the property for production and interest costs have been incurred. The capitalization period continues as long as these events occur. The average additions for the period are used in the interest capitalization calculation. During the three and nine months ended September 30, 2015, we did not capitalize interest costs due to insufficient on-going activity related to our oil and gas activities. During the three and nine months ended September 30, 2014, we capitalized interest costs for qualifying oil and gas property additions related to our Dussafu project in Gabon of $0.0 million and $0.2 million, respectively.

Fair Value Measurements

We measure and disclose our fair values in accordance with the provisions of ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”). ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price) and establishes a three-level hierarchy, which encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of the hierarchy are defined as follows:

Level 1 – Inputs to the valuation techniques that are quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs to the valuation techniques that are other than quoted prices but are observable for the assets or liabilities, either directly or indirectly.

Level 3 – Inputs to the valuation techniques that are unobservable for the assets or liabilities.

Financial instruments, which potentially subject us to concentrations of credit risk, are primarily cash and cash equivalents, accounts receivable, stock appreciation rights, restricted stock units, debt, embedded derivatives and warrant derivative liabilities. We maintain cash and cash equivalents in bank deposit accounts with commercial banks with high credit ratings, which, at times may exceed the federally insured limits. We have not experienced any losses from such investments. Concentrations of credit risk with respect to accounts receivable are limited due to the nature of our receivables. In the normal course of business, collateral is not required for financial instruments with credit risk. The estimated fair value of cash and cash equivalents and accounts receivable approximates their carrying value due to their short-term nature (Level 1). The following tables set forth by level within the fair value hierarchy our financial liabilities that were accounted for at fair value as of September 30, 2015 and December 31, 2014.



	As of September 30, 2015
	Level 1		Level 2		Level 3		Total
	(in thousands)
Recurring
Assets:
Embedded derivative asset	$	—	$	—	$	3,481	$	3,481
	$	—	$	—	$	3,481	$	3,481

Liabilities:
Stock appreciation rights liability	$	—	$	414	$	312	$	726
Restricted stock units liability		—		393		137		530
Warrant derivative liability		—		—		27,613		27,613
	$	—	$	807	$	28,062	$	28,869



	As of December 31, 2014
	Level 1		Level 2		Level 3		Total
	(in thousands)
Recurring
Liabilities:
Stock appreciation rights liability	$	—	$	356	$	—	$	356
Restricted stock units liability		—		652		—		652
	$	—	$	1,008	$	—	$	1,008

As of September 30, 2015, the fair value of our liability awards included $0.7 million for our stock appreciation rights (“SARs”) and $0.6 million for the restricted stock units (“RSUs”) which were recorded in accrued expenses and other long-term liabilities, respectively. As of December 31, 2014, the fair value of our liability awards included $0.4 million for our SARs and $0.4 million for our RSUs which were recorded in accrued expenses. Our remaining $0.2 million for the RSUs liability was recorded in other long-term liabilities.

Derivative Financial Instruments

As required by ASC 820, a financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value liabilities and their placement within the fair value hierarchy levels. See Note 11 – Warrant Derivative Liabilities for a description and discussion of our warrant derivative liability as well as a description of the valuation models and inputs used to calculate the fair value. See Note 10 – Debt and Financing for a description and discussion of our embedded derivatives related to our 9.0% Note and 15.0% Note as well as a description of the valuation models and inputs used to calculate the fair value. All of our embedded derivatives and warrants are classified as Level 3 within the fair value hierarchy.

During the three and nine months ended September 30, 2015, there was a change in the fair value of the CT Warrant liability of $10.0 million and $12.4 million, respectively, as reflected in our consolidated condensed statement of operations and comprehensive income (loss) as change in fair value of warrant liabilities. As of September 30, 2015, the fair value of the 15.0% Note was $10.4 million. During the three and nine months ended September 30, 2015, there was a change in the fair value of embedded derivative liability of $1.9 million and $2.3 million, respectively, and a change in the fair value of the embedded derivative assets of $0.8 million and $1.0 million, respectively, recorded as change in fair value of derivative assets and liabilities as reflected in our consolidated condensed statement of operations and comprehensive income (loss).

Changes in Level 3 Instruments Measured at Fair Value on a Recurring Basis

The following table provides a reconciliation of financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3).




	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(in thousands)
Financial assets - embedded derivative asset
Beginning balance	$	2,627	$	—	$	—	$	—
Additions - fair value at issuance		—		—		2,504		—
Change in fair value		854		—		977		—
Ending balance	$	3,481	$	—	$	3,481	$	—




	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(in thousands)
Financial liabilities - embedded derivative liability
Beginning balance	$	13,015	$	—	$	—	$	—
Additions - fair value at issuance		—		—		13,449		—
Change in fair value		(1,873)		—		(2,307)		—
Conversion of debt		(11,142)		—		(11,142)		—
Ending balance	$	—	$	—	$	—	$	—




	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(in thousands)
Financial liabilities - warrant derivative liabilities:
Beginning balance	$	37,595	$	1,953	$	—	$	1,953
Additions - fair value at issuance		—		—		40,013		—
Change in fair value		(9,982)		—		(12,400)		—
Ending balance	$	27,613	$	1,953	$	27,613	$	1,953




	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(in thousands)
Financial liabilities - stock appreciation rights
Beginning balance	$	—	$	—	$	—	$	—
Additions - fair value at issuance		—		—		—		—
Change in fair value		312		—		312		—
Ending balance	$	312	$	—	$	312	$	—




	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(in thousands)
Financial liabilities - restricted stock units
Beginning balance	$	—	$	—	$	—	$	—
Additions - fair value at issuance		—		—		—		—
Change in fair value		137		—		137		—
Ending balance	$	137	$	—	$	137	$	—

During three and nine months ended September 30, 2015 and 2014 no transfers were made between Level 1, Level 2 and Level 3 liabilities or investments.

Share-Based Compensation

We use a fair value based method of accounting for stock-based compensation. We generally utilize the Black-Scholes option pricing model to measure the fair value of stock options and SARs. Restricted stock and RSUs are measured at their fair values. On September 9, 2015, Harvest’s stockholders approved an amendment to our 2010 Long-Term Incentive Plan to increase the number of shares of our common stock available for issuance and the number of shares that may be granted in the form of full value awards. The Company accounts for the SARs and RSUs that are granted as liability awards as these awards are cash settled.

On July 22, 2015, we issued stock based compensation awards to certain employees as follows: 847,000 stock options to purchase common shares at an exercise price of $1.13 per share, vesting ratably over three years from the date of grant; 5,062,000 SARs at an exercise price of $1.13 per share, vesting ratably over three years from the date of grant; and 1,571,000 restricted stock units vesting at three years from the date of grant. Subject to the above vesting requirements, the options, SARs and RSUs awarded will not become exercisable until the first day on which the volume weighted average price of the common stock over any 30-day period, commencing on or after the award date, equals or exceeds $2.50 per share, as reported by the NYSE. The dual vesting requirements necessitated that all of these awards be valued using a Monte Carlo simulation model. The SARs and RSUs are classified as liability awards at September 30, 2015.

The assumptions summarized in the following table were used to calculate the fair value of the stock appreciation rights granted on July 22, 2015 that were outstanding as of the balance sheet date presented on our consolidated condensed balance sheet:



	Fair Value
	Hierarchy	As of September 30,
	Level	2015
Significant assumptions (or ranges):
Stock price	Level 1 input	$	1.39
Exercise price	Level 1 input	$	1.13
Threshold price	Level 1 input	$	2.50
Term (years)			4.81
Volatility	Level 2 input		100.0	%
Risk-free rate	Level 1 input		1.33	%
Dividend yield	Level 2 input		0.0	%

On September 9, 2015, we issued 320,004 restricted stock units vesting one year from the date of grant to our directors. These awards are classified as liability awards. There awards were measured at their fair values using the intrinsic value model.

The assumptions summarized in the following table were used to calculate the fair value of the restricted stock units granted on July 22, 2015 that were outstanding as of the balance sheet date presented on our consolidated condensed balance sheet:



	Fair Value
	Hierarchy	As of September 30,
	Level	2015
Significant assumptions (or ranges):
Stock price	Level 1 input	$	1.39
Threshold price	Level 1 input	$	2.50
Term (years)			10.0
Volatility	Level 2 input		80.0	%
Risk-free rate	Level 1 input		2.06	%
Dividend yield	Level 2 input		0.0	%

During the three and nine months ended September 30, 2015, the Company recognized share based compensation of $0.7 million and $2.2 million, respectively.

Income Taxes

Deferred income taxes reflect the net tax effects, calculated at currently enacted rates, of (a) future deductible/taxable amounts attributable to events that have been recognized on a cumulative basis in the financial statements or income tax returns, and (b) operating loss and tax credit carryforwards. A valuation allowance for deferred tax assets is recorded when it is more likely than not that the benefit from the deferred tax asset will not be realized.

We classify interest related to income tax liabilities and penalties as applicable, as interest expense.

Since December of 2013 we have provided deferred income taxes on a portion of the undistributed earnings of our foreign subsidiaries as we are unable to assert that those earnings would be permanently reinvested, nor otherwise could be repatriated in a tax free manner, as part of our ongoing business.

As the conversion feature of the 9.0% Note was reasonably expected to be exercised at the time of the note’s issuance due to the conversion price being in-the-money, the interest on the 9.0% Note paid upon the conversion is non-deductible to the Company under Internal Revenue Code (“IRC”) Section 163(l). The 15.0% Note was issued, for income tax purposes, with original issue discount (“OID”). OID generally is deductible for income tax purposes. However, if the debt instrument constitutes an “applicable high-yield discount obligation” (“AHYDO”) within the meaning of IRC Section 163(i)(1), then a portion of the OID likely would be non-deductible pursuant to IRC Section 163(e)(5). Our analysis of on the 15.0% Note is that the note may be an AHYDO; consequently, a portion of the OID likely may be non-deductible for income tax purposes.

Noncontrolling Interests

Changes in noncontrolling interests were as follows:




	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(in thousands)
Balance at beginning of period	$	78,701	$	260,150	$	79,152	$	243,167
Contributions by noncontrolling interest owners		380		236		543		953
Net income (loss) attributable to noncontrolling interests		(294)		(273)		(908)		15,993
Balance at end of period	$	78,787	$	260,113	$	78,787	$	260,113

New Accounting Pronouncements

In April 2014, FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers” which is included in ASC 606, a new topic under the same name. The guidance in this update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The guidance supersedes the previous revenue recognition requirements and most industry-specific guidance. Additionally, the update supersedes some cost guidance related to construction type and production-type contracts. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer are amended to be consistent with the guidance on recognition and measurement (including the constraint on revenue) in this update.

The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the entity satisfies a performance obligation.

The new guidance also provides for additional qualitative and quantitative disclosures related to: (1) contracts with customers, including revenue and impairments recognized, disaggregation of revenue, and information about contract balances and performance obligations (including the transaction price allocated to the remaining performance obligations); (2) significant judgments and changes in judgments which impact the determination of the timing of satisfaction of performance obligations (over time or at a point in time), the transaction price and amounts allocated to performance obligations; and (3) assets recognized from the costs to obtain or fulfill a contract.

In July 2015, the FASB issued a decision to delay the effective date by one year. The new guidance is effective for annual and interim periods beginning after December 15, 2017. Early application is not permitted. An entity should apply the amendments either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the update recognized at the date of initial application. We are currently evaluating the impact of this guidance.

In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs”. The amendments in this update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. In June 2015 the FASB issued ASU 2015-15 as an amendment to this guidance to address the absence of authoritative guidance for debt issuance costs related to line-of-credit arrangements. The SEC staff stated that they would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-15 adds these SEC comments to the “S” section of the Codification. The guidance is effective for interim periods and annual period beginning after December 15, 2015; however early adoption is permitted. We do not believe the adoption of this guidance will have a material impact on our financial position, results of operations or cash flows.

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”). ASU 2014-15 requires management to assess an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. The standard is effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016, with early adoption permitted. We are currently evaluating the provisions of ASU 2014-15 and assessing the impact, if any, it may have on our consolidated financial statements.