Note 4 - Acquisitions and Divestitures

Acquisitions

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 non-current 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 53.92% of the voting and profits interests, and Prudential owns 46.08% 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”) as follows:

	Amount (in thousands)
Fair value of Carbon common shares transferred as consideration	$	8,327
Fair value of NCI		16,466
Fair value of previously held interest		7,243
Fair value of contribution associated with acquisition of Yorktown’s interest in CCC		8,637
Fair value of business acquired	$	40,673

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		65,114
Unproved		1,495
Other property, plant, and equipment, net		877
Other non-current assets		475
Accounts payable and accrued liabilities		(6,054	)
Commodity derivative liability - current		(916	)
Commodity derivative liability - non-current		(1,729	)
Asset retirement obligations - current		(384	)
Asset retirement obligations - non-current		(2,537	)
Subordinated Notes, related party, net		(8,874	)
Senior Revolving Notes, related party		(11,000	)
Notes payable		(92	)
Total net assets acquired	$	40,673

During the 4^th Quarter of 2018, the Company finalized the determination of fair value and purchase price allocation related to the Carbon California Acquisition. Based on the final valuation received, the allocation of fair value exceeded the consideration by $8.6 million, which has been reflected in equity as a capital contribution from Yorktown who held a significant membership interest in CCC and is the Company’s largest shareholder (see Note 17).

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

On May 1, 2018, Carbon California acquired approximately 309 oil wells and approximately 6,800 gross acres (6,600 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 from Seneca Resources Corporation (“Seneca Acquisition”). 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. We raised our $5.0 million through the issuance of 50,000 shares of Preferred Stock to Yorktown. 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, plant and equipment acquired, and accounts payable and liabilities assumed, required significant judgement, including estimates relating to the production assets and the other transaction costs. We recorded $5.1 million 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 proved oil and gas properties, net on the balance sheet. Below is the summary of the identifiable assets acquired (in thousands):

	Amount (in thousands)
Identifiable assets acquired:
Proved oil and gas properties	$	38,021
Unproved oil and gas properties		100
Other property, plant and equipment		588
Other assets		167
Total identified assets	$	38,876

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

Below are unaudited consolidated results of operations for the twelve months ended December 31, 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 December 31, 2018, includes the Carbon California Acquisition results of operations for the period February 1, 2018 through December 31, 2018, inclusive of the Seneca Acquisition results of operations for the period May 1, 2018 through December 31, 2018.

	Unaudited Pro Forma Consolidated Results For Year Ended December 31,
(in thousands, except per share amounts)	2018			2017
Revenue	$	33,256		$	35,122
Net (loss) income before non-controlling interests		5,232			13,969
Net (loss) income attributable to non-controlling interests		(2,334	)		92
Net (loss) income attributable to controlling interests	$	7,566		$	13,877
Net income per share (basic)	$	1.00		$	2.49
Net income per share (diluted)	$	0.96		$	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 working interest in the acquired wells from 60% to 100%. The Liberty Acquisition was funded through borrowings under our previous credit facility. The Liberty Acquisition is accounted for as a non-significant asset acquisition.

Majority Control of Carbon Appalachia

On December 16, 2016, Carbon Appalachia was formed by us, entities managed by Yorktown and entities managed by Old Ironsides to acquire producing assets in the Appalachian Basin in Kentucky, Tennessee, Virginia and West Virginia. Carbon Appalachia began substantial operations on April 3, 2017 and is engaged primarily in acquiring, developing, exploiting, producing, processing, marketing, and transporting oil and natural gas in the Appalachia Basin.

On April 3, 2017, Carbon, Yorktown and Old Ironsides entered in to a limited liability company agreement (the “Carbon Appalachia LLC Agreement”), with an initial equity commitment of $100.0 million, of which $37.0 million has been contributed as of December 31, 2018. Carbon Appalachia (i) issued Class A Units to us, Yorktown and Old Ironsides for an aggregate cash consideration of $12.0 million, (ii) issued Class B Units to us, and (iii) issued Class C Units to us. Additionally, Carbon Appalachia Enterprises, LLC, formerly known as Carbon Tennessee Company, LLC (“Carbon Appalachia Enterprises”), a subsidiary of the Company, entered into a 4-year $100.0 million senior secured asset-based revolving credit facility with LegacyTexas Bank (the “Revolver”) with an initial borrowing base of $10.0 million.

In connection with Carbon entering into the Carbon Appalachia LLC Agreement, and Carbon Appalachia engaging in the transactions described above, Carbon received 1,000 Class B Units and issued to Yorktown a warrant to purchase approximately 408,000 shares of our common stock at an exercise price dictated by the warrant agreement (the “Appalachia Warrant”). The Appalachia Warrant is payable exclusively with Class A Units of Carbon Appalachia held by Yorktown. On November 1, 2017, Yorktown exercised the Appalachia Warrant, resulting in us acquiring 2,940 Class A Units from Yorktown.

On August 15, 2017, the Carbon Appalachia LLC Agreement was amended and, as a result, we agreed to contribute an initial commitment of future capital contributions as well as Yorktown’s, and Yorktown will not participate in future capital contributions. Carbon Appalachia issued Class A Units to us and Old Ironsides for an aggregate cash consideration of $14.0 million. The borrowing base of the Revolver increased to $22.0 million and Carbon Appalachia Enterprises borrowed $8.0 million under the Revolver.

On September 29, 2017, Carbon Appalachia issued Class A Units to us and Old Ironsides for an aggregate cash consideration of $11.0 million.

Prior to the closing of the OIE Membership Acquisition, Old Ironsides held 27,195 Class A Units, which equated to a 72.76% aggregate share ownership of Carbon Appalachia and we held (i) 9,805 Class A Units, (ii) 1,000 Class B Units and (iii) 121 Class C Units, which equated to a 27.24% aggregate share ownership of Carbon Appalachia.

On December 31, 2018, we acquired all of Old Ironsides Class A Units of Carbon Appalachia for approximately $58.1 million, subject to certain closing adjustments. We paid $33.0 million in cash and delivered promissory notes in the aggregate original principal amount of approximately $25.1 million to Old Ironsides (the “Old Ironsides Notes”). The Old Ironsides Notes bear interest at 10% per annum and have a term of five years, the first three of which require interest-only payments at the end of each calendar quarter beginning with the quarter ending March 31, 2019. At the end of the three-year interest-only period, the then current outstanding principal balance and interest is to be paid in 24 equal monthly payments. The Old Ironsides Notes also provide for mandatory prepayments upon the occurrence of certain subsequent liquidity events and a one-time principal reduction payment in the aggregate amount of $2.0 million on or before February 1, 2019. The $2.0 million payment was made to Old Ironsides on February 1, 2019.

The Old Ironsides Acquisition is accounted for as a business combination in accordance with ASC 805, Business Combinations (“ASC 805”). We recognized 100% of the identifiable assets acquired and liabilities assumed at their respective fair value as of the date of the acquisition. The $58.1 million purchase price was paid for OIE’s outstanding interest, representing approximately 72.76% interest in Carbon Appalachia.

The Company, utilizing the assistance of third-party valuation specialists, considered various factors in its estimate of fair value of the acquired assets and liabilities including (i) reserves, (ii) production rates, (iii) future operating and development costs, (iv) future commodity prices, including price differentials, (v) future cash flows, (vi) a market participant-based weighted average cost of capital, and (vii) real estate market conditions.

We followed the fair value method to allocate the consideration transferred to the identifiable net assets acquired on a preliminary basis as follows:

	Amount (in thousands)
Cash consideration	$	33,000
Old Ironsides Notes		25,065
Fair value of previously held equity interest		14,158
Fair value of business acquired	$	72,223

Assets acquired and liabilities assumed are as follows:

	Amount (in thousands)
Cash	$	12,283
Accounts receivable:
Revenue		12,834
Trade receivable		1,941
Commodity derivative asset		198
Inventory		900
Prepaid expenses, deposits, and other current assets		456
Oil and gas properties:
Proved		107,499
Unproved		1,869
Other property, plant and equipment, net		15,626
Other non-current assets		514
Accounts payable and accrued liabilities		(19,114	)
Due to related parties		(458	)
Firm transportation contract obligations		(18,724	)
Asset retirement obligations		(5,626	)
Notes payable		(37,975	)
Total net assets acquired	$	72,223

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 Appalachia and recognized a gain of approximately $1.3 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 Appalachia 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 Company used the income approach and made market assumptions as to projections of utilization, future operating costs and a market participant weighted average costs of capital to determine the fair value of the firm transportation obligations as well as the plant facilities. The determination of the fair value of accounts payable and accrued liabilities assumed required significant judgement, including estimates relating to production assets.

Consolidation of Carbon Appalachia and OIE Membership Acquisition Unaudited Pro Forma Results of Operations

Below are unaudited consolidated results of operations for the twelve months ended December 31, 2018 and for the period of April 3, 2017 (inception) through December 31, 2017, as though the OIE Membership Acquisition had been completed as of April 3, 2017.

	For Year Ended December 31,		For the period of April 3, 2017 (inception) through December 31,
(in thousands, except per share amounts)	2018		2017
Revenue	$	136,592	$	54,058
Net (loss) income before non-controlling interests		11,320		7,208
Net (loss) income attributable to non-controlling interests		4,375		81
Net (loss) income attributable to controlling interests	$	5,596		7,127
Net income per share (basic)	$	0.74		1.26
Net income per share (diluted)	$	0.69		0.62