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Fresh Start Accounting

9 Months Ended

Sep. 30, 2020

Note 2. Fresh Start Accounting

Fresh Start Accounting

Upon emergence from bankruptcy, we met the criteria and were required to adopt fresh start accounting in accordance with FASC Topic 852, Reorganizations, which on the Emergence Date resulted in a new entity, the Successor, for financial reporting purposes, with no beginning retained earnings or deficit as of the fresh start reporting date. The criteria requiring fresh start accounting are: (1) the holders of the then-existing common shares of the Predecessor received less than 50 percent of the new common shares of the Successor outstanding upon emergence from bankruptcy and (2) the reorganization value of the Company’s assets immediately prior to confirmation of the Plan was less than the total of all post-petition liabilities and allowed claims.

Fresh start accounting requires that new fair values be established for the Company’s assets, liabilities and equity as of the date of emergence from bankruptcy, September 18, 2020, and therefore certain values and operational results of the condensed consolidated financial statements subsequent to September 18, 2020 are not comparable to those in the Company’s condensed consolidated financial statements prior to, and including September 18, 2020. The Emergence Date fair values of the Successor’s assets and liabilities differ materially from their recorded values as reflected on the historical balance sheet of the Predecessor.

Reorganization Value

The reorganization value derived from the range of enterprise values associated with the Plan was allocated to the Company’s identifiable tangible and intangible assets and liabilities based on their fair values. Under FASC Topic 852, reorganization value generally approximates the fair value of the entity before considering liabilities and is intended to approximate the amount a willing buyer would pay for the assets immediately after the effects of the restructuring. The value of the reconstituted entity (i.e., Successor) was based on management projections and the valuation models as determined by the Company’s financial advisors in setting an estimated range of enterprise values. As set forth in the Plan and Disclosure Statement approved by the Bankruptcy Court, the valuation analysis resulted in an enterprise value between $1.1 billion and $1.5 billion, with a mid-point of $1.3 billion. For U.S. GAAP purposes, we valued the Successor’s individual assets, liabilities, and equity instruments and determined the value of the enterprise was approximately $1.3 billion as of the Emergence Date, which fell in line with the mid-point of the forecast enterprise value ranges approved by the Bankruptcy Court. Specific valuation approaches and key assumptions used to arrive at reorganization value, and the value of discrete assets and liabilities resulting from the application of fresh start accounting, are described below in greater detail within the valuation process.

The following table reconciles the enterprise value to the equity value of the Successor as of the Emergence Date:



In thousands	Sept. 18, 2020
Enterprise value	$	1,280,856
Plus: Cash and cash equivalents	45,585
Less: Total debt	(231,022		)
Equity value	$	1,095,419

The following table reconciles enterprise value to reorganization value of the Successor (i.e., value of the reconstituted entity) and total reorganization value:



In thousands	Sept. 18, 2020
Enterprise value	$	1,280,856
Plus: Cash and cash equivalents	45,585
Plus: Current liabilities excluding current maturities of long-term debt	239,738
Plus: Non-interest bearing noncurrent liabilities	185,228
Reorganization value of the reconstituted Successor	$	1,751,407

With the assistance of third-party valuation advisors, we determined the enterprise and corresponding equity value of the Successor using various valuation approaches and methods, including: (i) income approach using a calculation of the present value of future cash flows based on our financial projections, (ii) the market approach using selling prices of similar assets and (iii) the cost approach.

The enterprise value and corresponding equity value are dependent upon achieving the future financial results set forth in our valuation using an asset-based methodology of estimated proved reserves, undeveloped properties, and other financial information, considerations and projections, applying a combination of the income, cost and market approaches as of the fresh start reporting date of September 18, 2020. All estimates, assumptions, valuations and financial projections, including the fair value adjustments, the financial projections, the enterprise value and equity value projections, are inherently subject to significant uncertainties and the resolution of contingencies beyond our control. Accordingly, there is no assurance that the estimates, assumptions, valuations or financial projections will be realized, and actual results could vary materially, including variances when presented in our upcoming Form 10-K report for the year ended December 31, 2020.

Reorganization Items, Net

Reorganization items represent (i) expenses incurred during the Chapter 11 Restructuring subsequent to the Petition Date as a direct result of the Plan, (ii) gains or losses from liabilities settled and (iii) fresh start accounting adjustments and are recorded in “Reorganization items, net” in our Unaudited Condensed Consolidated Statements of Operations. Professional service provider charges associated with our restructuring that were incurred before the Petition Date and after the Emergence Date are recorded in “Other expenses” in our Unaudited Condensed Consolidated Statements of Operations. Contractual interest expense of $22.0 million from the Petition Date through the Emergence Date associated with our outstanding senior secured second lien notes, convertible senior notes, and senior subordinated notes was not accrued or recorded in the unaudited condensed consolidated statement of operations as interest expense.

The following table summarizes the losses (gains) on reorganization items, net:



	Predecessor
	Period from July 1, 2020 through
In thousands	Sept. 18, 2020
Gain on settlement of liabilities subject to compromise	$	(1,024,864	)
Fresh start accounting adjustments	1,834,423
Professional service provider fees and other expenses	11,267
Success fees for professional service providers	9,700
Loss on rejected contracts and leases	10,989
Valuation adjustments to debt classified as subject to compromise	757
DIP credit agreement fees	3,107
Acceleration of Predecessor stock compensation expense	4,601
Total reorganization items, net	$	849,980

Payments of professional service provider fees and success fees of $12.7 million and fees of $3.1 million related to the Senior Secured Superpriority Debtor-in-Possession Credit Agreement (“DIP Facility”) were included in cash outflows from operating activities and financing activities, respectively, in our Unaudited Condensed Consolidated Statements of Cash Flows for the period January 1, 2020 through September 18, 2020.

Valuation Process

The fair values of our principal assets, including oil and natural gas properties, CO₂ properties, pipelines, other property and equipment, long-term CO₂ customer contracts, favorable and unfavorable vendor contracts, pipeline financing liabilities and right-of-use assets, asset retirement obligations and warrants were estimated as of the Emergence Date.

Oil and Natural Gas Properties

The Company’s principal assets are its oil and natural gas properties, which are accounted for under the full cost accounting method as described in Note 1, Basis of Presentation – Oil and Natural Gas Properties. The Company determined the fair value of its oil and gas properties based on the discounted cash flows expected to be generated from these assets. The computations were based on market conditions and reserves in place as of the Emergence Date.

The fair value analysis was based on the Company’s estimated future production of proved and probable reserves as prepared by the Company’s independent petroleum engineering firm. Discounted cash flow models were prepared using the estimated future revenues and operating costs for all developed wells and undeveloped properties comprising the proved and probable reserves. Future revenues were based upon forward strip oil and natural gas prices as of the Emergence Date through 2024 and escalated for inflation thereafter, adjusted for differentials. Operating costs were adjusted for inflation beginning in year 2025. A risk adjustment factor was applied to each reserve category, consistent with the risk of the category. The discounted cash flow models also included adjustments for income tax expenses.

Discount factors utilized were derived using a weighted average cost of capital computation, which included an estimated cost of debt and equity for market participants with similar geographies and asset development type and varying corporate income tax rates based on the expected point of sale for each property’s produced assets. Cash flows were also adjusted for a market participant profit on CO₂ costs, since Denbury charges oil fields for CO₂ use on a cost basis. Finally, reserve values were adjusted for any asset retirement obligations as well as for CO₂ indirect costs not directly allocable to oil fields. Based on this analysis, the Company concluded the fair value of its proved and probable reserves was $865.4 million as of the Emergence Date (see footnote 10 to Fresh Start Adjustments discussion below).

CO₂ Properties

The fair value of CO₂ properties includes the value of CO₂ mineral rights and associated infrastructure and was determined using the discounted cash flow method under the income approach. After-tax cash flows were forecast based on expected costs to produce and transport CO₂ as provided by management, and income was imputed using a gross-up of costs based on a five-year average historical EBITDA margin for publicly traded companies that primarily develop or produce natural gas. Cash flows were then discounted using a rate considering reduced risk associated with CO₂ industrial sales.

Pipelines

The fair values of our pipelines were determined using a combination of the replacement cost method under the cost approach and the discounted cash flow method under the income approach. The replacement cost method considers historical acquisition costs for the assets adjusted for inflation, as well as factors in any potential obsolescence based on the current condition of the assets and the ability of those assets to generate cash flow. For assets valued using the discounted cash flow method, after-tax cash flows were forecast based on expected costs provided by management, and profits were imputed using a gross-up of costs based on a five-year average historical EBITDA margin for publicly traded companies that primarily transport natural gas. Pipeline depreciable lives represent the remaining estimated useful lives of the pipelines, which will be depreciated on a straight-line basis ranging from 20 to 43 years.

Other Property and Equipment

The fair value of the non-reserve related property and equipment such as land, buildings, equipment, leasehold improvements and software was determined using the replacement cost method under the cost approach which considers historical acquisition costs for the assets adjusted for inflation, as well as factors in any potential obsolescence based on the current condition of the assets and the ability of those assets to generate cash flow.

Long-Term CO₂ Customer Contracts

The fair value of long-term CO₂ customer contracts was determined using the multi-period excess earnings method (“MPEEM”) under the income approach. MPEEM attributes cash flow to a specific intangible asset based on residual cash flows from a set of assets generating revenues after accounting for appropriate returns on and of other assets contributing to that revenue generation. Cash flows were forecast based on expected changes in pricing, volumes, renewal rates, and costs using volumes and prices through and beyond the initial contract terms. After-tax cash flows were discounted using a rate considering reduced risk of these industrial contracts relative to overall oil and gas production risks. The contracts will be depreciated over a useful life of seven to 14 years.

Favorable and Unfavorable Vendor Contracts

We recognized both favorable and unfavorable contracts using the incremental value method under the income approach. The incremental value method calculates value on the basis of the pricing differential between historical contracted rates and estimated pricing that the Company would most likely receive if it entered into similar contract conditions (other than the price) as of the Emergence Date. The differential is applied to expected contract volumes, tax-affected and discounted at a discount rate consistent with the risk of the associated cash flows.

Asset Retirement Obligations

The fair value of the asset retirement obligations was revalued based upon estimated current reclamation costs for our assets with reclamation obligations, an appropriate long-term inflation adjustment, and our revised credit adjusted risk-free rate (“CARFR”). The new CARFR was based on an evaluation of similar industry peers with similar factors such as emergence, new capital structure and current rates for oil and gas companies.

Pipeline Financing Liabilities

The fair value of the pipeline financing liabilities was measured as the present value of the remaining payments under the restructured pipeline agreements (see Note 6, Long-Term Debt – Pipeline Financing Transactions, for further discussion).

Warrants

The fair values of the warrants issued upon the Emergence Date were estimated by applying a Black-Scholes-Merton model. The Black-Scholes-Merton model is a pricing model used to estimate the fair value of a European-style call or put option/warrant based on a current stock price, strike price, time to maturity, risk-free rate, annual volatility rate, and annual dividend yield.

The model used the following assumptions: implied stock price (total equity divided by total shares outstanding) of the Successor’s shares of common stock of $22.14; initial strike price per share of $32.59 and $35.41 for series A and B warrants, respectively; expected volatility of 49.3% and 53.6% for series A and B warrants, respectively; risk-free interest rates of 0.3% and 0.2% for series A and B warrants, respectively, using the United States Treasury Constant Maturity rates; and an expected annual dividend yield of 0%. Expected volatility was estimated using volatilities of similar entities whose share or option prices and assumptions were publicly available. The time to maturity of the warrants was based on the contractual terms of the warrants of five and three years for series A and series B warrants, respectively. The values were also adjusted for potential dilution impacts.

Condensed Consolidated Balance Sheet

The following illustrates the effects on the Company’s consolidated balance sheet due to the reorganization and fresh start accounting adjustments. The explanatory notes following the table below provide further details on the adjustments, including the assumptions and methods used to determine fair value for its assets, liabilities, and warrants.



	As of September 18, 2020
In thousands	Predecessor			Reorganization Adjustments				Fresh Start Adjustments				Successor
Assets
Current assets
Cash and cash equivalents	$	73,372		$	(27,787	)	⁽¹⁾	$	—			$	45,585
Restricted cash	—			10,662			⁽²⁾	—				10,662
Accrued production receivable	112,832			—				—				112,832
Trade and other receivables, net	36,221			—				—				36,221
Derivative assets	32,635			—				—				32,635
Other current assets	12,968			(539		)	⁽³⁾	—				12,429
Total current assets	268,028			(17,664		)		—				250,364
Property and equipment
Oil and natural gas properties (using full cost accounting)
Proved properties	11,723,546			—				(10,941,313		)		782,233
Unevaluated properties	650,553			—				(538,570		)		111,983
CO₂ properties	1,198,515			—				(1,011,169		)		187,346
Pipelines	2,339,864			—				(2,207,246		)		132,618
Other property and equipment	201,565			—				(104,152		)		97,413
Less accumulated depletion, depreciation, amortization and impairment	(12,864,141		)	—				12,864,141				—
Net property and equipment	3,249,902			—				(1,938,309		)	⁽¹⁰⁾	1,311,593
Operating lease right-of-use assets	1,774			—				69			⁽¹⁰⁾	1,843
Derivative assets	501			—				—				501
Intangible assets, net	20,405			—				79,678			⁽¹¹⁾	100,083
Other assets	81,809			8,241			⁽⁴⁾	(3,027		)	⁽¹²⁾	87,023
Total assets	$	3,622,419		$	(9,423	)		$	(1,861,589	)		$	1,751,407



	As of September 18, 2020
In thousands	Predecessor			Reorganization Adjustments				Fresh Start Adjustments				Successor
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable and accrued liabilities	$	67,789		$	102,793		⁽⁵⁾	$	3,738		⁽¹³⁾	$	174,320
Oil and gas production payable	39,372			16,705			⁽⁶⁾	—				56,077
Derivative liabilities	8,613			—				—				8,613
Current maturities of long-term debt	—			73,199			⁽⁶⁾	364			⁽¹⁴⁾	73,563
Operating lease liabilities	—			757			⁽⁶⁾	(29		)	⁽¹⁰⁾	728
Total current liabilities	115,774			193,454				4,073				313,301
Long-term liabilities
Long-term debt, net of current portion	140,000			42,610			⁽⁶⁾	(25,151		)	⁽¹⁴⁾	157,459
Asset retirement obligations	2,727			180,408			⁽⁶⁾	(24,697		)	⁽¹⁰⁾	158,438
Derivative liabilities	295			—				—				295
Deferred tax liabilities, net	—			417,951			^(6)(15)	(414,120		)	⁽¹⁵⁾	3,831
Operating lease liabilities	—			515			⁽⁶⁾	10			⁽¹⁰⁾	525
Other liabilities	—			3,540			⁽⁶⁾	18,599			⁽¹⁶⁾	22,139
Total long-term liabilities not subject to compromise	143,022			645,024				(445,359		)		342,687
Liabilities subject to compromise	2,823,506			(2,823,506		)	⁽⁶⁾	—				—
Commitments and contingencies (Note 12)
Stockholders’ equity
Predecessor preferred stock	—			—				—				—
Predecessor common stock	510			(510		)	⁽⁷⁾	—				—
Predecessor paid-in capital in excess of par	2,764,915			(2,764,915		)	⁽⁷⁾	—				—
Predecessor treasury stock, at cost	(6,202		)	6,202			⁽⁷⁾	—				—
Successor preferred stock	—			—				—				—
Successor common stock	—			50			⁽⁸⁾	—				50
Successor paid-in-capital in excess of par	—			1,095,369			⁽⁸⁾	—				1,095,369
Accumulated deficit	(2,219,106		)	3,639,409			⁽⁹⁾	(1,420,303		)	⁽¹⁷⁾	—
Total stockholders’ equity	540,117			1,975,605				(1,420,303		)		1,095,419
Total liabilities and stockholders’ equity	$	3,622,419		$	(9,423	)		$	(1,861,589	)		$	1,751,407

Reorganization Adjustments


(1)	Represents the net cash payments that occurred on the Emergence Date as follows:



In thousands
Sources:
Cash proceeds from Successor Bank Credit Agreement	$	140,000
	140,000

Uses:
Payment in full of DIP Facility and pre-petition revolving bank credit facility	(140,000		)
Retained professional service provider fees paid to escrow account	(10,662		)
Non-retained professional service provider fees paid	(7,420		)
Accrued interest and fees on DIP Facility	(1,464		)
Debt issuance costs related to Successor Bank Credit Agreement	(8,241		)
	(167,787		)

Net uses	$	(27,787	)


(2)	Represents the transfer of funds to a restricted cash account utilized for the payment of fees to retained professional service providers assisting in the bankruptcy process.


(3)	Represents the write-off of costs related to the DIP Facility and a run-off policy for directors and officers’ insurance coverage, partially offset by the recording of prepaid amounts for non-retained professional service provider fees.


(4)	Represents debt issuance costs related to the Successor Bank Credit Agreement.


(5)	Adjustments to accounts payable and accrued liabilities as follows:



In thousands
Accrual of professional service provider fees	$	2,826
Payment of accrued interest and fees on DIP Facility	(1,464		)
Reinstatement of accounts payable and accrued liabilities from liabilities subject to compromise	101,431
Accounts payable and accrued liabilities	$	102,793


(6)	Liabilities subject to compromise were settled as follows in accordance with the Plan:



In thousands
Liabilities subject to compromise prior to the Emergence Date:
Settled liabilities subject to compromise
Senior secured second lien notes	$	1,629,417
Convertible senior notes	234,055
Senior subordinated notes	251,480
Total settled liabilities subject to compromise	2,114,952
Reinstated liabilities subject to compromise
Current maturities of long-term debt	73,199
Accounts payable and accrued liabilities	101,431
Oil and gas production payable	16,705
Operating lease liabilities, current	757
Long-term debt, net of current portion	42,610
Asset retirement obligations	180,408
Deferred tax liabilities	289,389
Operating lease liabilities, long-term	515
Other long-term liabilities	3,540
Total reinstated liabilities subject to compromise	708,554
Total liabilities subject to compromise	2,823,506

Issuance of New Common Stock to second lien note holders	(1,014,608		)
Issuance of New Common Stock to convertible note holders	(53,400		)
Issuance of series A warrants to convertible note holders	(15,683		)
Issuance of series B warrants to senior subordinated note holders	(6,398		)
Reinstatement of liabilities subject to compromise	(708,553		)
Gain on settlement of liabilities subject to compromise	$	1,024,864


(7)	Represents the cancellation of the Predecessor’s common stock, treasury stock, and related components of the Predecessor’s paid-in capital in excess of par. Paid-in capital in excess of par includes $4.6 million as a result of terminated Predecessor stock compensation plans.


(8)	Represents the Successor’s common stock and additional paid-in capital as follows:



In thousands
Capital in excess of par value of 47,499,999 issued and outstanding shares of New Common Stock issued to holders of the senior secured second lien note claims	$	1,014,608
Capital in excess of par value of 2,500,000 issued and outstanding shares of New Common Stock issued to holders of the convertible senior note claims	53,400
Fair value of series A warrants issued to convertible senior note holders	15,683
Fair value of series B warrants issued to senior subordinated note holders	6,398
Fair value of series B warrants issued to Predecessor equity holders	5,330
Total change in Successor common stock and additional paid-in-capital	1,095,419
Less: Par value of Successor common stock	(50		)
Change in Successor additional paid-in-capital	$	1,095,369


(9)	Reflects the cumulative net impact of the effects on accumulated deficit as follows:



In thousands
Cancellation of Predecessor common stock, paid-in capital in excess of par, and treasury stock	$	2,763,824
Gain on settlement of liabilities subject to compromise	1,024,864
Acceleration of Predecessor stock compensation expense	(4,601		)
Recognition of tax expenses related to reorganization adjustments	(128,556		)
Professional service provider fees recognized at emergence	(9,700		)
Issuance of series B warrants to Predecessor equity holders	(5,330		)
Other	(1,092		)
Net impact to Predecessor accumulated deficit	$	3,639,409

Fresh Start Adjustments


(10)	Reflects fair value adjustments to our (i) oil and natural gas properties, CO₂ properties, pipelines, and other property and equipment, as well as the elimination of accumulated depletion, depreciation, and amortization, (ii) operating lease right-of-use assets and liabilities, and (iii) asset retirement obligations.


(11)	Reflects fair value adjustments to our long-term CO₂ customer contracts.


(12)	Reflects fair value adjustments to our other assets as follows:



In thousands
Fair value adjustment for CO₂ and oil pipeline line-fill	$	(3,698	)
Fair value adjustments for escrow accounts	671
Fair value adjustments to other assets	$	(3,027	)


(13)	Reflects fair value adjustments to accounts payable and accrued liabilities as follows:



In thousands
Fair value adjustment for the current portion of an unfavorable vendor contract	$	3,500
Fair value adjustment for the current portion of Predecessor asset retirement obligation	689
Write-off accrued interest on NEJD pipeline financing	(451		)
Fair value adjustments to accounts payable and accrued liabilities	$	3,738


(14)	Represents adjustments to current and long-term maturities of debt associated with pipeline lease financings. The cumulative effect is as follows:



In thousands
Fair value adjustment for Free State pipeline lease financing	$	(24,699	)
Fair value adjustment for NEJD pipeline lease financing	(88		)
Fair value adjustments to current and long-term maturities of debt	$	(24,787	)

Our pipeline lease financings were restructured in late October 2020 (see Note 6, Long-Term Debt – Pipeline Financing Transactions).

(15)

Represents (i) adjustment to deferred taxes, including the recognition of tax expenses related to reorganization adjustments as a result of the cancellation of debt and retaining tax attributes for the Successor and the reinstatement of deferred tax liabilities subject to compromise totaling $128.6 million and (ii) adjustments to deferred tax liabilities related to fresh start accounting of $414.1 million.


(16)	Represents a fair value adjustment for the long-term portion of an unfavorable vendor contract.

(17)

Represents the cumulative effect of the fresh start accounting adjustments discussed above.