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 considered necessary to present fairly our financial position as of September 30, 2018, and our results of operations and cash flows for the three and nine months ended September 30, 2018 and 2017. Operating results for the three and nine months ended September 30, 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, seasonality, 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, Carbon California, CCOC, 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 53.9% of Carbon California and Prudential owns 46.1% voting and profits interest in Carbon California.

Nytis LLC also holds an interest in 64 oil and gas partnerships. For the 47 partnerships where we have a controlling interest, the partnerships are consolidated. 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, non-controlling ownership interests in the net assets of the partnerships as non-controlling interests within stockholders’ equity on our unaudited consolidated balance sheets. 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 interest 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. On May 1, 2018, Carbon California closed the Seneca Acquisition. Following the exercise of the California Warrant by Yorktown and the Seneca Acquisition, we own 53.9%, of the voting and profits interests, and Prudential owns 46.1%.

Insurance Receivable

Insurance receivable is comprised of insurance claims 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 a portion of partial funds associated with the claims as of September 30, 2018. Therefore, the Company has determined the receivable is collectible and is included in insurance receivable on the unaudited consolidated balance sheets. As of September 30, 2018, the Company has an insurance receivable of $871,000 and collected $2.7 million from the previously submitted claims.

Long-term Assets

Long-term assets are comprised of (i) debt issuance costs, (ii) bonds, and (iii) deferred registration fees associated with a registration statement for a possible equity offering of the Company’s Common Stock. We have recorded debt issuance costs and amortize the balance over the life of the loan. As of September 30, 2018, we have within non-current assets approximately $1.7 million of deferred financing costs associated with our credit facility and with Carbon California’s Senior Revolving Notes (note 7). As of September 30, 2018, we have incurred approximately $1.9 million for outside professional services in conjunction with the preparation of the completion of a registration statement associated with the possible offering. We will continue to accumulate deferred financing costs until the completion of the registration statement and a successful equity offering is commenced which at that time will be recognized as a financing charge and applied against the equity component of the transaction. If the raise is unsuccessful, the amount will be expensed in the current period.

Accounting for Oil and Gas Operations

The Company uses the full cost method of accounting for oil and gas properties. Accordingly, all costs incidental to the acquisition, exploration and development of oil and gas properties, including costs of undeveloped leasehold, dry holes and leasehold equipment, are capitalized. Overhead costs incurred that are directly identified with acquisition, exploration and development activities undertaken by the Company for its own account, and which are not related to production, general corporate overhead or similar activities, are also capitalized.

Unproved properties are excluded from amortized capitalized costs until it is determined if proved reserves can be assigned to such properties. The Company assesses its unproved properties for impairment at least annually. Significant unproved properties are assessed individually.

Capitalized costs are depleted by an equivalent unit-of-production method, converting oil to gas at the ratio of one barrel of oil to six thousand cubic feet of natural gas. Depletion is calculated using capitalized costs, including estimated asset retirement costs, plus the estimated future expenditures (based on current costs) to be incurred in developing proved reserves, net of estimated salvage values.

No gain or loss is recognized upon disposal of oil and gas properties unless such disposal significantly alters the relationship between capitalized costs and proved reserves. All costs related to production activities, including work-over costs incurred solely to maintain or increase levels of production from an existing completion interval, are charged to expense as incurred.

The Company performs a ceiling test quarterly. The full cost ceiling test is a limitation on capitalized costs prescribed by SEC Regulation S-X Rule 4-10. The ceiling test is not a fair value based measurement, rather it is a standardized mathematical calculation. The ceiling test provides that capitalized costs less related accumulated depletion and deferred income taxes may not exceed the sum of (1) the present value of future net revenue from estimated production of proved oil and gas reserves using the un-weighted arithmetic average of the first-day-of-the month price for the previous twelve month period, excluding the future cash outflows associated with settling asset retirement obligations that have been accrued on the balance sheet, at a discount factor of 10%; plus (2) the cost of properties not being amortized, if any; plus (3) the lower of cost or estimated fair value of unproved properties included in the costs being amortized, if any; less (4) income tax effects related to differences in the book and tax basis of oil and gas properties. Should the net capitalized costs exceed the sum of the components noted above, a ceiling test write-down would be recognized to the extent of the excess capitalized costs. Such impairments are permanent and cannot be recovered in future periods even if the sum of the components noted above exceeds the capitalized costs in future periods.

For the three and nine months ended September 30, 2018, the Company did not recognize a ceiling test impairment as the Company’s full cost pool did not exceed the ceiling limitations. For the three months ended September 30, 2017, the Company did not recognize a ceiling test impairment as the Company’s full cost pool did not exceed the ceiling limitations.

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 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 received reimbursements for the provision of management from Carbon Appalachia of approximately $744,000 and $2.3 million for the three and nine months ended September 30, 2018, and $50,000 for the one month ended January 31, 2018, from Carbon California. These reimbursements are included in general and administrative - related party reimbursement on our unaudited consolidated statements of operations. Effective February 1, 2018, the management reimbursement received from Carbon California is eliminated at consolidation. This elimination was $650,000 for the period February 1, 2018 through September 30, 2018.

In addition to the management reimbursements, approximately $376,000 and $1.1 million in general and administrative expenses were reimbursed for the three and nine months ended September 30, 2018, from Carbon Appalachia, and $14,000 for the one month ended January 31, 2018, from Carbon California. General and administrative expenses reimbursed by Carbon California and eliminated upon consolidation were approximately $42,000 for the period February 1, 2018, through September 30, 2018.

Operating Reimbursements

In our role as operator of 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.

Carbon California Credit Facilities

The credit facilities of Carbon California, including the Senior Revolving Notes, Carbon California Notes and Carbon California 2018 Subordinated Notes (all defined below), are held by Prudential Legacy Insurance Company of New Jersey and Prudential Insurance Company of America or its affiliates (“Prudential”). See note 7.

Preferred Stock

In April 2018, we issued 50,000 shares of Preferred Stock to Yorktown in conjunction with our Seneca Acquisition. See note 9.

Old Ironsides Membership Interest Purchase Agreement

On May 4, 2018, we entered into a Membership Interest Purchase Agreement with Old Ironsides to 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 in Carbon Appalachia and Carbon Appalachia will become a wholly-owned subsidiary of ours. See note 6.

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 consolidated 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 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. We issued 50,000 shares of Series B Convertible Preferred Stock, par value $0.01 per share (the “Preferred Stock”), and the difference between the carrying amount of the Preferred Stock in equity and the fair value of the Preferred Stock) is treated as a dividend for purposes of calculating earnings per common share. The Preferred Stock deemed dividend could potentially dilute basic earnings per common share in the future.

In periods when we report a net loss, all shares of restricted stock are excluded from the calculation of diluted weighted average shares outstanding because of its anti-dilutive effect on loss per share. As a result, all restricted stock is excluded from the calculation of diluted earnings per common share for the three months ended September 30, 2018. Potentially dilutive securities (restricted stock awards) included in the calculation of diluted earnings per share totaled 315,040 for the three months ended September 30, 2018. Potentially dilutive securities that are anti-dilutive totaled 315,040 for the three months ended September 30, 2018 and 901,109 for the three months ended September 30, 2017. The dilutive units did not have a material impact on our earnings per common share calculations for any of the periods presented.

The following table sets forth the calculation of basic and diluted income per share:

	Three months ended September 30,						Nine months ended September 30,
(in thousands except per share amounts)	2018			2017			2018			2017

Net income (loss) attributable to controlling interest	$	(725	)	$	(462	)	$	2,264		$	4,834
Less: warrant derivative gain		-			-			(225	)		(2,494	)
Less: deemed dividend for convertible preferred shares		(77	)		-			(147	)		-
Less: beneficial conversion feature		-			-			(1,125	)		-
Diluted net (loss) income	$	(802	)	$	(462	)	$	767		$	2,340

Basic weighted-average common shares outstanding during the period		7,701			5,628			7,466			5,579

Add dilutive effects of warrants and non-vested shares of restricted stock		-			-			315			907

Diluted weighted-average common shares outstanding during the period		7,701			5,628			7,781			6,486

Basic net (loss) income per common share	$	(0.09	)	$	(0.08	)	$	0.30		$	0.87
Diluted net (loss) income per common share	$	(0.10	)	$	(0.08	)	$	0.10		$	0.36

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 is 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 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), which establishes a comprehensive new lease standard designed to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. An entity that elects to apply the practical expedients will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP standards. ASU 2016-02 is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is in the process of evaluating the effect of adopting ASU 2016-02 on the financial statements, accounting policies, and internal controls. The adoption is expected to result in an increase in the assets and liabilities recorded on its consolidated balance sheet and additional disclosures. The Company does not expect a material impact on its consolidated statement of operations.

There were various updates recently issued by the FASB, most of which represented technical corrections to the accounting literature or application to specific industries and are not expected to a have a material impact on our reported financial position, results of operations, or cash flows.