3. Fresh Start Accounting

Upon emergence on the Effective Date, the Company adopted fresh start accounting as required by generally accepted accounting principles in the United States (“US GAAP”). The Company qualified for fresh start accounting because (i) the holders of existing voting shares of the pre-emergence debtor-in-possession received less than 50% of the voting shares of the post-emergence successor entity and (ii) the reorganization value of the Company’s assets immediately prior to confirmation was less than the post-petition liabilities and allowed claims. The Company applied fresh start accounting as of October 21, 2016, the Effective Date.

Adopting fresh start accounting results in a new reporting entity for financial reporting purposes with no beginning retained earnings or deficit. The cancellation of all existing shares outstanding on the Effective Date and issuance of new shares in the reorganized Company caused a related change of control under US GAAP. As a result of the application of fresh start accounting, as well as the effects of the implementation of the Plan, the Company’s consolidated financial statements on or after October 21, 2016, are not comparable with the consolidated financial statements prior to that date. References to “Successor Period” relate to the financial position and results of operations for the period October 21, 2016 through December 31, 2016 and references to “Predecessor Period” refer to the financial position and results of operations of the Company from January 1, 2016 through October 20, 2016.

Reorganization Value

Reorganization value represents the fair value of the Company’s total assets prior to the consideration of liabilities and is intended to approximate the amount a willing buyer would pay for the Company’s assets immediately after restructuring. The reorganization value was allocated to the Company’s individual assets based on their estimated fair values.

The Company’s reorganization value was derived from its enterprise value. Enterprise value represents the estimated fair value of an entity’s long-term debt and equity. The enterprise value of the Company on the Effective Date, as approved by the Bankruptcy Court in support of the Plan, was estimated to be within a range of $500.0 million to $700.0 million, with a mid-point value of $600.0 million. Based upon the various estimates and assumptions necessary for fresh start accounting, as further discussed below, the estimated enterprise value was determined to be $600.0 million before consideration of cash and cash equivalents and outstanding debt at the Effective Date. As a result, the reorganization value was determined to be $751.3 million at the Effective Date, as reconciled below.

Valuation of Oil and Gas Properties

The Company’s principal assets are its oil and gas properties, which the Company accounts for under the full cost accounting method as described in “—Note 4. Summary of Significant Accounting Policies”. With the assistance of valuation experts, the Company determined the fair value of its oil and gas properties based on the discounted net cash flows expected to be generated from these assets. The computations were based on market conditions and reserves in place as of the Effective Date.

The foundation for the computation of the fair value of the Company was a reserves report prepared by its independent reserve auditors. The engineering assumptions contained within this reserves report were consistent with both (i) previous engineering assumptions made by the Company when preparing reserve reports in prior years and (ii) assumptions promulgated by the Securities and Exchange Commission (“SEC”). These assumptions include type curves and analogous reservoir characteristics determined utilizing electrical logs, radioactivity logs, core analyses, geologic maps and available downhole and production data, seismic data and well test data, among others.

Upon completion of the Company’s reserves report, it utilized outside third-party experts to assist management in the preparation of a valuation report utilizing assumptions consistent with a market participant. This valuation report utilized the income approach in determining the fair value of the Company’s oil and gas reserves, excluding possible reserves, for which the market approach was utilized. The income approach involves the projection of cash flows a market participant would expect an asset or business to generate over its remaining useful life. Cash flows are projected on an annual basis for a discrete period of time and then converted to their present value using a rate of return that captures the relevant risk of achieving the projected cash flows. Finally, the present value of the residual value, or terminal value, is added to these discrete cash flows to arrive at the estimate of total value. The market approach measures value through the use of prices, market multiples and other relevant information involving identical or comparable assets or business interests. The significant assumptions utilized within the valuation report included the following:

Pricing—The Company utilized pricing based on the six year New York Mercantile Exchange strip as of the Effective Date. NGL prices were based upon a historical percentage correlation of the price of West Texas Intermediate to the price of a Y-grade barrel. Prices beyond six years were escalated at 2.0% to account for inflation. Price differentials that have been calculated utilizing historical results were applied to account for quality and transportation differentials.

Weighted-Average Cost of Capital (“WACC”)—The WACC reflects the required return of capital providers, both debt and equity. Eight guideline companies were selected that had operations in the Mid-Continent area and were organized as C-corporations. A cost of equity was calculated using a capital asset pricing model, in which the cost of equity equals a risk-free rate plus a risk premium that is reflective of the asset or business interest. The risk free rate utilized was 2.2% based upon the normalized 20-year U.S. Treasury Bond rate as of the Effective Date. The risk premium was calculated utilizing three primary inputs. First, a beta was determined based upon the respective two-year weekly betas for each guideline company, adjusted for debt of their capital structures and then re-levered using the selected Company capital structure. Next, a market risk premium of 6.0% was utilized based upon industry data. Finally, a size premium of 3.6% was applied based upon the size of the interest in the assets of the Company utilizing industry data. A cost of debt was then calculated to be approximately 7.0% based upon the weighted average energy yield of the guideline companies at the Effective Date and then adjusted for a 35.0% tax effective to arrive at an estimated after-tax cost of debt of 4.6%. Based upon these inputs, the capital asset pricing model arrived at a WACC of 11.0%, which was utilized by the Company in its determination of fair value.

Operating and Other Costs—Operating costs from the reserves report prepared by the Company were escalated by 2.0% to account for inflation. Ad valorem and production taxes were estimated as a percentage of revenue and applied to the forward price adjusted revenues. Corporate general and administrative costs were estimated based a blend of historical general and administrative expenses and forecasts of such expenses for the next five years. Corporate general and administrative expenses were escalated at 2.0% after five years to account for inflation.

Capital Expenditures—Capital expenditures were based upon the average historical capital expended by the Company in the development of its wells and were escalated by 2.0% to account for inflation.

Possible Reserves—The Company utilized the guideline transaction method to determine the value of possible reserve acreage. In determining the value of possible reserve acreage, the Company utilized data from widely utilized industry sources as well as data from other relevant transactions in the area. These industry sources publish oil and gas lease data compiled from private transactions, federal oil and gas lease sales as well as state oil and gas lease sales. The Company then utilized this data to arrive at a range of acreage values for each county.

Based upon the analysis completed by the Company with the assistance of outside third-party valuation experts, it concluded the fair value of its proved reserves was $539.0 million and the value of its probable and possible reserves, characterized as unproved properties, was $66.2 million as of the Effective Date.

The following table presents the estimated fair value of the Company’s stock as of the Effective Date (in thousands, except per share value):

	As of October 21, 2016
Enterprise value	$	600,000
Plus: Cash and cash equivalents	76,540
Less: Fair value of debt	(128,059		)
Less: Fair value of warrants	(37,329		)

Fair value of stock on the Effective Date	$	511,152


Total shares issuable under the Plan	25,000
Restricted shares granted under 2016 LTIP at October 21, 2016	686

Total shares	25,686

Per share value (1)	$	19.90

(1)

The per share value shown above was calculated based upon the financial information determined using US GAAP at the Effective Date. The fair value per share agreed upon by the parties to the Chapter 11 Cases at the Effective Date was determined to be $19.66 per common share.

On the Effective Date, the Company entered into (i) a warrant agreement with holders of Allowed Third Lien Notes Claims (the “Third Lien Notes Warrant Agreement”) with respect to third lien warrants (the “Third Lien Notes Warrants”) and (ii) a warrant agreement with holders of Allowed Unsecured Notes Claims and Allowed General Unsecured Claims (the “Unsecured Creditor Warrant Agreement”, and together with the Third Lien Notes Warrant Agreement, the “Warrant Agreements”) with respect to warrants (the “Unsecured Creditor Warrants”, and together with the Third Lien Notes Warrants, the “Warrants”).

At the Effective Date, the Company issued 4,411,765 Third Lien Notes Warrants allowing for the purchase of up to an aggregate of 4,411,765 shares of common stock at an initial exercise price of $24.00 per share, and 2,213,789 Unsecured Creditor Warrants allowing for the purchase of up to an aggregate of 2,213,789 shares of common stock at an initial exercise price of $46.00 per share. The Warrants expire on April 21, 2020.

The Company utilized the Black-Scholes-Merton option pricing model to determine the fair value of the Warrants. Determining the fair value of the Warrants required judgment, including estimating the expected term and the associated volatility.

The assumptions used to estimate the fair value the Warrants are as follows:

	Third Lien Notes Warrants			Unsecured Creditor Warrants
Risk-free interest rate (1)	1.04		%	1.04		%
Dividend yield	—			—
Expected life (2)	3.50			3.50
Expected volatility (3)	55.0		%	55.0		%
Strike Price	$	24.00		$	46.00
Calculated fair value	$	6.74		$	3.42

(1) U.S. Treasury yields as of the grant date were utilized for the risk-free interest rate assumption, matching the treasury yield terms to the expected life of the option.

(2) The expected life assumption was based upon the years until expiration of the Warrants.

(3) The Company utilized six peer companies of comparable size and industry to estimate asset volatility utilizing a period that is commensurate with the expected Warrant life. The Company weighted historical volatility and implied volatility 50/50 for those peer companies where both were available, with asset volatility ranging in the peer companies from 30.1% to 54.2%. The derived asset volatility was selected based upon the midpoint of the average and the third quartile of the peer group, and then relevered the utilizing the Company’s asset and equity information as of the Effective Date.

The following table reconciles the enterprise value to the estimated reorganization value as of the Effective Date (in thousands):

	As of October 21, 2016
Enterprise value	$	600,000
Plus: cash and cash equivalents	76,540
Plus: other working capital liabilities	60,118
Plus: other long-term liabilities	14,600

Reorganization value	$	751,258

Consolidated Balance Sheet

The following consolidated balance sheet is as of October 21, 2016. This consolidated balance sheet includes adjustments that reflect the consummation of the transactions contemplated by the Plan (reflected in the column “Reorganization Adjustments”) as well as fair value adjustments as a result of the adoption of fresh start accounting (reflected in the column “Fresh Start Adjustments”) as of the Effective Date (in thousands):

	Predecessor			Reorganization Adjustments			Fresh Start Adjustments			Successor
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	274,530		$	(197,990	){a}	$	—		$	76,540
Accounts receivable:
Oil and gas sales	33,895			—			—			33,895
Joint interest billing	4,739			—			—			4,739
Other	26			—			—			26
Other current assets	8,425			(2,748		){b}	—			5,677

Total current assets	321,615			(200,738		)	—			120,877

PROPERTY AND EQUIPMENT:
Oil and gas properties, on the basis of full-cost accounting	3,795,943			—			(3,176,723		){h}	619,220
Other property and equipment	12,175			—			(5,965		){h}	6,210
Less accumulated depreciation, depletion, amortization and impairment	(3,449,241		)	—			3,449,241		{h}	—

Net property and equipment	358,877			—			266,553			625,430

OTHER NONCURRENT ASSETS	3,701			1,250		{c} {a}	—			4,951

TOTAL	$	684,193		$	(199,488	)	$	266,553		$	751,258


LIABILITIES AND STOCKHOLDERS’ EQUITY/(DEFICIT)
CURRENT LIABILITIES:
Accounts payable	$	10,294		$	—		$	—		$	10,294
Accrued liabilities	65,240			(15,416		){a}	—			49,824
Debt classified as current	249,384			(249,384		){a} {d}	—			—

Total current liabilities	324,918			(264,800		)	—			60,118

ASSET RETIREMENT OBLIGATIONS	20,368			—			(6,385		){h}	13,983
OTHER LONG-TERM LIABILITIES	617			128,059		{d}	—			128,676
LIABILITIES SUBJECT TO COMPROMISE	1,882,187			(1,882,187		){e} {a}	—			—

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS’ EQUITY/(DEFICIT):
Preferred stock	—			—			—			—
Warrants	—			37,329		{e}	—			37,329
Common stock - predecessor	104			(104		){f}	—			—
Common stock - successor	—			247		{f}	—			247
Treasury stock	(3,134		)	3,134		{f}	—			—
Additional paid-in-capital - predecessor	891,292			(891,292		){f}	—			—
Additional paid-in-capital - successor	—			510,905		{f}	—			510,905
Retained deficit	(2,432,159		)	2,159,221		{g}	272,938		{i}	—

Total stockholders’ equity/(deficit)	(1,543,897		)	1,819,440			272,938			548,481

TOTAL	$	684,193		$	(199,488	)	$	266,553		$	751,258

Reorganization Adjustments

{a} Adjustments reflect the following net cash payments recorded as of the Effective Date from implementation of the Plan (in thousands):

Uses:
Cash pay down of RBL	$	81,324
Cash payment to holders of Second Lien Notes Claims	60,000
Cash payment to the RBL lenders in consideration of a temporary reduction in the amount available to be drawn under the Exit Facility	40,000
Payment to escrow for professional fees related to the Plan incurred through the Effective Date	15,416
Debt issuance costs associated with the Exit Facility	1,250

Total uses	$	197,990

{b} Adjustment reflects the write off of unamortized debt issuance costs associated with the RBL.

{c} Adjustment reflects the debt issuance costs associated with the Exit Facility.

{d} Adjustment represents the establishment of Exit Facility, which superceded the RBL.

{e} As part of the Plan, the Bankruptcy Court approved the settlement of certain allowable claims, reported as liabilities subject to compromise in the Company’s historical consolidated balance sheet. As a result, a gain of $1.3 billion was recognized on the settlement of liabilities subject to compromise. The gain was calculated as follows (in thousands):

	Predecessor
Liabilities subject to compromise	$	1,882,187
Cash paid to holders of Second Lien Notes Claims	(60,000		)
Warrants issued to holders of Third Lien Notes Claims	(29,753		)
Warrants issued to holders of Unsecured Notes Claims	(7,575		)
Write-off of unamortized debt costs associated with RBL	(2,748		)
Common stock issued	(511,152		)

Gain on settlement	$	1,270,959

{f} Adjustments represent (i) the cancellation of predecessor stock that was authorized and outstanding prior to the Effective Date and (ii) the issuance of 24,687,500 shares of new common stock upon emergence on the Effective Date.

{g} This adjustment reflects the cumulative impact of the following reorganization adjustments (in thousands):

	Predecessor
Gain on settlement of liabilities subject to compromise	$	1,270,959
Common stock - predecessor	104
Treasury stock	(3,134		)
Additional paid-in-capital - predecessor	891,292

Net impact to Predecessor accumulated deficit	$	2,159,221

Fresh Start Adjustments

{h} The adjustments primarily represent (i) the removal of $3.4 billion of accumulated depreciation, depletion, amortization and impairment due to fresh start accounting, (ii) the $269.7 million increase in oil and gas properties due to the application of fresh start accounting, (iii) the $6.4 million decrease in the asset retirement obligation due to the application of fresh start accounting and (iv) an increase in other property and equipment.

{i} This adjustment reflects the cumulative impact of the fresh start adjustments discussed herein.

Reorganization Items

Reorganization items represent the direct and incremental costs of being in bankruptcy, such as professional fees, pre-petition liability claim adjustments and losses related to terminated contracts that are probable and can be estimated. Unamortized deferred financing costs as well as unamortized gains on the May 2015 troubled debt restructuring associated with debt classified as liabilities subject to compromise were also reclassified to reorganization items in order to reflect the expected amounts of allowed claims. The following table summarizes the gain on reorganization items, net, in the consolidated statements of operations (in thousands):

	Predecessor
	For the Period January 1, 2016 through October 20, 2016
Professional fees incurred	$	(38,835	)
Adjustment to unamortized debt issuance costs associated with 2020 Senior Notes	(10,738		)
Adjustment to unamortized debt issuance costs associated with 2021 Senior Notes	(12,671		)
Adjustment to unamortized gain on troubled debt restructuring associated with Second Lien Notes	39,599
Adjustment to unamortized gain on troubled debt restructuring associated with Third Lien Notes	71,808
Gain on settlement of liabilities subject to compromise	1,270,959
Fresh start adjustments	272,938
Other reorganization items (1)	1,221

Gain on reorganization items, net	$	1,594,281

(1) Other reorganization items primarily included $0.2 million related to Houston office fixed assets, which were abandoned, as well as a $1.6 million decrease in the liability previously recorded for the abandonment of the Houston office lease.