Note 3 - Acquisitions and Divestitures

Acquisition of Majority Control of Carbon California

Carbon California was formed in 2016 by us and entities managed by Yorktown and Prudential to acquire oil and gas producing assets in the Ventura Basin of California.

In connection with the entry into the limited liability company agreement of Carbon California, we received Class B Units and issued to Yorktown the California Warrant exercisable for shares of our common stock. The exercise price for the California Warrant was payable exclusively with Class A Units of Carbon California held by Yorktown and the number of shares of our common stock for which the California Warrant was exercisable was determined, as of the time of exercise, by dividing (a) the aggregate unreturned capital of Yorktown’s Class A Units of Carbon California by (b) the exercise price. The California Warrant had a term of seven years and included certain standard registration rights with respect to the shares of our common stock issuable upon exercise of the California Warrant.

The issuance of the Class B Units and the California Warrant were in contemplation of each other (note 6), and under non-monetary related party guidance, we accounted for the California Warrant, at issuance, based on the fair value of the California Warrant as of the date of grant (February 15, 2017) and recorded a long-term warrant liability with an associated offset to Additional Paid in Capital (“APIC”). Future changes to the fair value of the California Warrant were recognized in earnings. We accounted for the fair value of the Class B Units at their estimated fair value at the date of grant, which became our investment in Carbon California with an offsetting entry to Additional Paid In Capital (“APIC”). Additionally, we accounted for our 17.81% profits interest in Carbon California as an equity method investment until January 31, 2018.

On February 1, 2018, Yorktown exercised the California Warrant resulting in the issuance of 1,527,778 shares of our common stock in exchange for Yorktown’s Class A Units of Carbon California representing approximately 46.96% of the outstanding Class A Units of Carbon California (a profits interest of approximately 38.59%). After giving effect to the exercise on February 1, 2018, we owned 56.4% of the voting and profits interests of Carbon California. 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% voting and profits interest in Carbon California.

The exercise of the California Warrant and the acquisition of the additional ownership interest is accounted for as a step acquisition in which we obtained control in accordance with ASC 805, Business Combinations (“ASC 805”) (referred to herein as the “Carbon California Acquisition”). We recognized 100% of the identifiable assets acquired, liabilities assumed and the non-controlling interest at their respective fair value as of the date of the acquisition. We exchanged 1,527,778 common shares at a fair value of approximately $8.3 million ($5.45 per share), for 11,000 Class A Units of Carbon California, representing a 38.59% profits ownership interest in Carbon California. We followed the fair value method to allocate the consideration transferred to the identifiable net assets acquired and non-controlling interest (“NCI”) on a preliminary basis as follows:

	Amount (in thousands)
Fair value of Carbon common shares transferred as consideration	$	8,326
Fair value of NCI		16,466
Fair value of previously held interest		7,244
Fair value of business acquired	$	32,036

Assets acquired and liabilities assumed are as follows:

	Amount (in thousands)
Cash	$	275
Accounts receivable:
Joint interest billings and other		690
Receivable - related party		1,610
Prepaid expense, deposits, and other current assets		1,723
Oil and gas properties:
Proved		56,477
Unproved		1,495
Other property and equipment, net		877
Other long-term assets		475
Accounts payable and accrued liabilities		(6,054	)
Commodity derivative liability - short-term		(916	)
Commodity derivative liability - long-term		(1,729	)
Asset retirement obligations - short-term		(384	)
Asset retirement obligations - long-term		(2,537	)
Subordinated Notes, related party, net		(8,874	)
Senior Revolving Notes, related party		(11,000	)
Notes payable		(92	)
Total net assets acquired	$	32,036

The preliminary fair value of the assets acquired and liabilities assumed were determined using various valuation techniques, including an income approach.

On the date of the acquisition, we derecognized our equity investment in Carbon California and recognized a gain of approximately $5.4 million based on the fair value of our previously held interest compared to its carrying value.

For assets and liabilities accounted for as business combinations, including the Carbon California acquisition, to determine the fair value of the assets acquired, the Company primarily used the income approach and made market assumptions as to projections of estimated quantities of oil and natural gas reserves, future production rates, future commodity prices including price differentials as of the date of closing, future operating and development costs, a market participant weighted average cost of capital, and the condition of vehicles and equipment. The determination of the fair value of the accounts payable and accrued liabilities assumed required significant judgement, including estimates relating to production assets.

Seneca Acquisition

In October 2017, Carbon California signed a Purchase and Sale Agreement with Seneca Resources (“Seneca”) to acquire approximately 309 oil wells and approximately 5,700 gross acres (5,500 net) of oil and gas leases, and fee interests in and to certain lands, situated in the Ventura Basin, together with associated pipelines, facilities, equipment and other property rights. The transaction closed on May 1, 2018 for a purchase price of $43.0 million, subject to customary and standard purchase price adjustments. We contributed approximately $5.0 million to Carbon California to fund our portion of the purchase price, through the $5.0 Preferred Stock issuance. Prudential also contributed $5.0 million to fund its share of the equity portion of the purchase price. Carbon California funded the remaining purchase price from cash, increased borrowings under the Senior Revolving Notes and $3.0 million in proceeds from the issuance of Senior Subordinated Notes.

Utilizing the assistance of third-party valuation specialists, we considered various factors in our estimate of fair value of the acquired assets including (i) reserves, (ii) production rates, (iii) future operating and development costs, (iv) future commodity prices, including price differentials, (v) future cash flows, and (vi) working conditions and expected lives of vehicles and equipment.

We determined that substantially all of the fair value of the assets acquired related to proved oil and gas properties and, as such the Seneca Acquisition does not meet the definition of a business. Therefore, we have accounted for the transaction as an asset acquisition and allocated the purchase price based on the relative fair value of the assets acquired.

The fair value of the production assets were determined using the income approach using Level 3 inputs according to the ASC 820, Fair Value, hierarchy. The fair value of the other assets was determined using the market approach using Level 3 inputs. The determination of the fair value of the oil and gas and other property and equipment acquired and accounts payable and accrued liability assumed, required significant judgement, including estimates relating to the production assets and the other transaction costs. We recorded $639,000 in Asset Retirement Obligation (“ARO”), and $330,000 in assumed liabilities in connection with the Seneca Acquisition. We incurred transaction costs related to the Seneca Acquisition in the amount of $318,000. As this acquisition was determined to be an asset acquisition, transaction costs were capitalized to oil and gas properties- proved, net on the balance sheet. Below is the summary of the assets acquired (in thousands):

Identifiable assets acquired:
Proved oil and gas properties	$	37,386
Unproved oil and gas properties		100
Other property and equipment		545
Intangible assets		300
Total identified assets	$	38,331

Consolidation of Carbon California and Seneca Acquisition Unaudited Pro Forma Results of Operations

Below are unaudited consolidated results of operations for the three and nine months ended September 30, 2018 and 2017, as though the Carbon California Acquisition and the Seneca Acquisition had been completed as of January 1, 2017. The Carbon California Acquisition closed February 1, 2018, and the Seneca Acquisition closed May 1, 2018, and accordingly, our unaudited consolidated statements of operations for the year ended September 30, 2018, includes the Carbon California Acquisition results of operations for the period February 1, 2018 through September 30, 2018, inclusive of the Seneca Acquisition results of operations for the period May 1, 2018 through September 30, 2018.

	Unaudited Pro Forma Consolidated Results For Three Months Ended September 30,						Unaudited Pro Forma Consolidated Results For Nine Months Ended September 30,
(in thousands, except per share amounts)	2018			2017			2018			2017
Revenue	$	12,742		$	11,227		$	33,256		$	35,122
Net (loss) income before non-controlling interests		(455	)		(1,518	)		5,232			13,969
Net (loss) income attributable to non-controlling interests		270			16			(2,334	)		92
Net (loss) income attributable to controlling interests	$	(725	)	$	(1,534	)	$	7,566		$	13,877
Net income per share (basic)	$	(0.09	)	$	(0.27	)	$	1.00		$	2.49
Net income per share (diluted)	$	(0.10	)	$	(0.27	)	$	.96		$	2.14

Liberty Acquisition

On July 11, 2018, we completed an acquisition of 54 operated oil and gas wells covering approximately 55,000 gross acres (22,000 net) and the associated mineral interests in the Appalachian Basin for a purchase price of $3.0 million, subject to customary and standard purchase price adjustments (the “Liberty Acquisition”). The Liberty Acquisition increased our ownership in the acquired wells from 60% to 100%. The Liberty Acquisition was funded through borrowings under our Credit Facility. The Liberty Acquisition is accounted for as a non-significant asset acquisition.