UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒  Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31,September 30, 2019

or

☐  Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ___________ to ____________

Commission File Number: 000-02040

Registrant’s telephone number, including area code:(720) 407-7030

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES ☒               NO ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

YES ☒               NO ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ☐               NO ☒

Securities registered pursuant to Section 12(b) of the Act:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

At May 13,November 8, 2019, there were 7,816,0307,856,864 issued and outstanding shares of the Company’s common stock, $0.01 par value.

Carbon Energy Corporation

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

ITEM 1.Financial Statements

CARBON ENERGY CORPORATION

Condensed Consolidated Balance Sheets

See accompanying notes to Condensed Consolidated Financial Statements.

CARBON ENERGY CORPORATION

Condensed Consolidated Statements of Operations

(Unaudited)

See accompanying notes to Condensed Consolidated Financial Statements.

CARBON ENERGY CORPORATION

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited)

(in thousands)

See accompanying notes to Condensed Consolidated Financial Statements.

CARBON ENERGY CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)

See accompanying notes to Condensed Consolidated Financial Statements.

CARBON ENERGY CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NoteNOTE 1 – OrganizationORGANIZATION

Carbon Energy Corporation (formerly known as Carbon Natural Gas Company) is an independent oil and its subsidiaries (referred to herein asnatural gas company engaged in the acquisition, exploration, development and production of oil, natural gas and natural gas liquids properties located in the United States. The terms “we”, “us”, “our”, the “Company” or “Carbon”) business refer to Carbon Energy Corporation and our consolidated subsidiaries (described below). The following is comprisedan organization chart of the assets and propertieskey subsidiaries as of us and our subsidiaries.September 30, 2019 discussed in this report:

An illustrative organizational chart as of March 31, 2019, is below:

Appalachian and Illinois Basin Operations

In the Appalachian and Illinois Basins, operations are conducted by Nytis Exploration Company, LLC (“Nytis LLC”). The following organizational chart illustrates this relationship as of March 31, 2019.September 30, 2019:

In December 2018, we completed the acquisition of all of the Class A Units of Carbon Appalachian Company, LLC, a Delaware limited liability company (“Carbon Appalachia”), owned by Old Ironside Fund II-A Portfolio Holding Company, LLC, a Delaware limited liability company, (“OIE II-A”), and Old Ironside Fund II-B Portfolio Holding Company, LLC, a Delaware limited liability company, (“OIE II-B”), collectively (“Old Ironsides”) for a purchase price of $58.1 million, subject to customary and standard purchase price adjustments (“OIE Membership Acquisition”). As a result of the OIE Membership Acquisition, we now hold all of the issued and outstanding ownership interests of Carbon Appalachia, along with its direct and indirect subsidiaries (Carbon Appalachia Group, LLC, Carbon Tennessee Mining Company, LLC, Carbon Appalachia Enterprises, LLC, Carbon West Virginia Company, LLC, Cranberry Pipeline Corporation, Knox Energy, LLC, Coalfield Pipeline Company and Appalachia Gas Services Company, LLC).

Ventura Basin Operations

In California, Carbon California Operating Company, LLC (“CCOC”) conducts operations on behalf of Carbon California Company, LLC’sLLC, a Delaware limited liability company (“Carbon California”) operations.. On February 1, 2018, Yorktown Energy Partners XI, L.P. (“Yorktown”) exercised the California Warrant,a warrant, collectively resulting in our aggregate sharing percentage in Carbon California increasing from 17.81% to 56.40%. On May 1, 2018, Carbon California closed the acquisition with Seneca Acquisition.Resources Corporation (the “Seneca Acquisition”). Following the exercise of the California Warrantwarrant by Yorktown and the Seneca Acquisition, we own 53.92% of the voting and profits interests and Prudential Legacy Insurance Company of New Jersey and Prudential Insurance Company of America or its affiliates (collectively, “Prudential”) owns 46.08% of the voting and profits interest in Carbon California. As of February 1, 2018, we consolidate Carbon California for financial reporting purposes. The following organizational chart illustrates this relationship as of March 31, 2019.September 30, 2019:

NoteNOTE 2 – Summary of Significant Accounting PoliciesSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principlesthe rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with U.S. generally accepted in the United Statesaccounting principles (“GAAP”) forapplicable to 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 accompanyingThese unaudited condensed consolidated financial statements includereflect all normal recurring adjustments consideredthat are, in the opinion of management, necessary to present fairly our financial position asfor a fair presentation of March 31, 2019, and ourthe results of operations and cash flows for the three months ended March 31, 2019 and 2018.interim period. Operating results for the three months ended March 31, 2019interim periods presented require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes and are not necessarily indicative of the results that may be expected for the full year becauseyear. The condensed consolidated balance sheet data as 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. TheDecember 31, 2018 was derived from audited financial statements but does not include all disclosures required by GAAP. These 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, 2018. Except as disclosed herein, there have been no material changes toThe Company follows the information disclosed in the notes to the consolidated financial statements included in our 2018 Annual Report on Form 10-K.same accounting policies for preparing quarterly and annual reports.

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts of our consolidated subsidiaries. Upon the closing of the OIE Membership Acquisition on December 31, 2018, we own 100% of Carbon Appalachia. In addition, we own 100% of Nytis USA, which owns approximately 98.1%98.11% of Nytis LLC. Nytis LLC holds interests in various oil and gas partnerships.

Partnerships and subsidiaries in which we have a controlling interest are consolidated. We are currently consolidating 46 partnerships, Carbon Appalachia, and Carbon California, and we reflect the non-controlling ownership interest in partnerships and subsidiaries as non-controlling interests on our unaudited condensed consolidated statements of operations and also reflect the non-controlling ownership interest in the net assets of the partnerships as non-controlling interests within stockholders’ equity on our unaudited condensed 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 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.

Reclassifications

Certain prior period balances in the consolidated balance sheets and statements of operations have been reclassified to conform to the current year presentation.  Specifically, a portion of credit facilities and notes payable balances as of December 31, 2018 were reclassified from non-current liabilities to current liabilities. This reclassification had no impact on net income, cash flows or shareholders’stockholders’ equity previously reported.

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. In January 2019, we reached a settlement agreement and received an $800,000 final settlement payment from our insurance provider related to the damage caused by the California wildfires. As of March 31,September 30, 2019, we arewere in receipt of all funds associated with the claims.

Accounting for Oil and Gas OperationsRevenue

We use 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. We assess our 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 existingUpon completion interval, are charged to expense as incurred.

We perform 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 priceOIE Membership Acquisition, our revenue recognition policy was amended to account 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 bookadditional revenue we receive for transportation and tax basis of oilhandling 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 months ended March 31, 2019 and 2018, we did not recognize a ceiling test impairment as our full cost pool did not exceed the ceiling limitations. Future declines in oil and natural gas prices could result in impairments of our oil and gas properties in future periods. The effect of price declines will impact the ceiling test value until such time commodity prices stabilize or improve. Impairments are a non-cash charge and accordingly would not affect cash flows but would adversely affect our results of operations and members’ equity.

We capitalize the portion of general and administrative costs that is attributable to our acquisition, exploration and development activities.

Revenue

We recognize revenues for sales and services when persuasive evidence of an arrangement exists, when custody is transferred, or services are rendered, fees are fixed or determinable and collectability is reasonably assured.

Oil, Natural Gas and Natural Gas Liquid Sales

Oil, natural gas and natural gas liquid sales are recognized when production volumes are sold to a purchaser at a fixed or determinable price, delivery has occurred, title has transferred, and collectability is reasonably assured. Revenues are recognized based on our net revenue interest.

Marketing Gas Sales

We sell production purchased from third parties as well as production from our own oil and gas producing properties. Marketingmarketing gas sales, are recognized on a gross basis as we purchase and take control of the gas prior to sale and are the principal in the transaction.described below.

Storage

Under fee-based arrangements, we receive a fee for storing natural gas. The revenues earned are directly related to the volume of natural gas that flows through our systems and are not directly dependent on commodity prices.

Transportation gathering, and compressionHandling

We generally purchase natural gas from producers at the wellhead or other receipt points, gather the wellhead natural gas through our gathering systems, and then sell the natural gas based on published index market prices. We remit to the producers either an agreed-upon percentage of the actual proceeds that we receive from our sales of natural gas or an agreed-upon percentage of the proceeds based on index related prices for the natural gas, regardless of the actual amount of the sales proceeds we receive. Our revenues under percent-of-proceeds/index arrangements generally correlate to the price of natural gas. Under fee-based arrangements, we receive a fee for storing natural gas. The storage revenues earned are directly related to the volume of natural gas that flows through our systems and are not directly dependent on commodity prices.

Marketing Gas Sales

Investments in Affiliates

Investments in non-consolidated affiliates are accounted for under either the cost or equity method of accounting,We sell production purchased from third parties 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., throughwell as production from 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. We review equity method investments for impairment whenever events or changes in circumstances indicate that an other than temporary decline in value has occurred. Upon the exercise of the California Warrant on February 1, 2018 and the closing of the OIE Membership Acquisition on December 31, 2018, we consolidate Carbon California and Carbon Appalachia for financial reporting purposes and no longer account for these investments under the equity method.

Related Party Transactions

Management Reimbursements

In our role as manager of Carbon California and Carbon Appalachia we receive reimbursements for management services. Prior to consolidation of Carbon California and Carbon Appalachia effective February 1, 2018 and December 31, 2018, respectively, these management service reimbursements were included in general and administrative – related party reimbursement on our unaudited consolidated statements of operations. As we now consolidate both Carbon California and Carbon Appalachia, these reimbursements are eliminated upon consolidation.

We received approximately $753,000 and $50,000 for the three months ended March 31, 2018, and for the one month ended January 31, 2018, from Carbon Appalachia and Carbon California, respectively. These reimbursements are included in general and administrative – related party reimbursement on our unaudited consolidated statements of operations. Effective February 1, 2018, the management reimbursements received from Carbon California were eliminated at consolidation. This elimination included $100,000 for the period February 1, 2018, through March 31, 2018.

In addition to the management reimbursements, approximately $299,000 and $14,000 in general and administrative expenses were reimbursed for the three months ended March 31, 2018, and for the one month ended January 31, 2018, by Carbon Appalachia and Carbon California, respectively. The elimination of Carbon California in consolidation includes approximately $28,000 for the period February 1, 2018, through March 31, 2018.

Operating Reimbursements

In our role as operator of Carbon California and Carbon Appalachia, we receive reimbursements of operating expenses. Prior to consolidation of Carbon California and Carbon Appalachia effective February 1, 2018 and December 31, 2018, respectively, these operating reimbursements were included in operating expenses on our unaudited consolidated statements of operations. As we now consolidate both Carbon California and Carbon Appalachia, any intercompany receivable and payable balances associated with these reimbursements are eliminated upon consolidation.

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 (see Note 7).

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and expenses and disclosure of contingent assets and liabilities. Significant items subject to such estimates and assumptions include the carrying value ofown oil and gas properties, estimatesproducing properties. Marketing gas sales are recognized on a gross basis as we purchase and take control of proved oilthe gas prior to sale and gas reserve volumes andare the related depletion and present value of estimated future net cash flows and the ceiling test applied to capitalized oil and gas properties, determining the amounts recorded for fair value of commodity derivative instruments, fair value of assets acquired and liabilities assumed qualifying as business combinations or asset acquisitions, estimated lives of other property and equipment, asset retirement obligations, fair value of Class B issuances and accrued liabilities and revenues. There have been no changes in our critical accounting estimates from those that were disclosedprincipal in the 2018 Annual Report on Form 10-K. Actual results could differ from these estimates.

Earnings (Loss) Per Common Sharetransaction.

Basic earnings per common share is computed by dividing the net income or loss attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period. The shares of restricted common 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 stock and the potential dilution that could occur upon exercise of options and warrants to acquire common stock computed using the treasury stock method, which assumes that the increase in the number of shares is reduced by the number of shares which could have been repurchased by us with the proceeds from the exercise of options and warrants (which were assumed to have been made at the average market price of the common shares during the reporting period).

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, approximately 269,000 potentially dilutive restricted stock awards are excluded from the calculation of diluted earnings per common share for the three months ended March 31, 2019. In addition, approximately 200,000 restricted performance units subject to future contingencies were excluded in the basic and diluted income per share calculations.

For the three months ended March 31, 2018, we had net income and the diluted income per common share calculation includes the dilutive effects of approximately 230,000 non-vested shares of restricted stock. In addition, approximately 254 ,000 restricted performance units subject to future contingencies were excluded in the basic and diluted income per share calculations.

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

Recently Adopted Accounting Pronouncement

In February 2016, the FASB issuedOn January 1, 2019, we adopted Accounting Standards Update No. 2016-02, Leases(“ASUTopic 842”) 2016-02,Leases (Topic 842)(ASU 2016-02), as amended, which establishes a comprehensive newsupersedes the lease standard designedaccounting guidance under Topic 840, and generally requires lessees to increase transparencyrecognize operating and comparability among organizations by recognizing lease assets andfinancing lease liabilities and corresponding right-of-use assets on the balance sheet and disclosing key information aboutto provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. The FASB subsequently issued various ASUs which provided additional implementationWe adopted the new guidance and these ASUs collectively make up FASB Accounting Standards Codification (“ASC”) Topic 842 – Leases (“ASC 842”). ASC 842 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The standard permits retrospective application through recognition of a cumulative-effect adjustment at the beginning of either the earliest reporting period presented or the period of adoption. The Company adopted ASC 842 effective January 1, 2019 using the modified retrospective method astransition approach by applying the new standard to all leases existing at the date of the adoption date. Adoption of the standard resulted ininitial application and not restating comparative periods. The most significant impact was the recognition of additional leaseright-of-use assets and lease liabilities on our unaudited consolidated balance sheet as well as additional disclosures. The adoption did not have a material impact to our unaudited consolidated statement of operations. Refer tofor operating leases. See Note 148 for further information on our implementation of this standard.

Recently Issued Accounting Pronouncements

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.NOTE 3 – ACQUISITIONS

Note 3 – Acquisitions and Divestitures

Majority Control of Carbon Appalachia

On December 16, 2016, Carbon Appalachia was formed by us, entities managed by Yorktown and entities managed by31, 2018, we acquired all of 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 Appalachian 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 had 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 Carbon Appalachian Company, LLC, 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 was payable exclusively withIronsides’ Class A Units of Carbon Appalachia held by Yorktown. On November 1, 2017, Yorktown exercisedfor approximately $58.1 million. We paid $33.0 million in cash and delivered promissory notes in 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 agreedaggregate original principal amount of approximately $25.1 million 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 (the“Old Ironsides Notes”). See Note 7 for an aggregate cash consideration of $11.0 million.additional information.

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 customary and standard 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. A mandatory, one-time principal reduction payment in the aggregate amount of $2.0 million was made to Old Ironsides on February 1, 2019.

The OIE Membership Acquisition iswas 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, consisting of $33.0 million in cash and $25.1 million of Old Ironsides Notes, was paid for Old Ironsides’ 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:

Assets acquired and liabilities assumed are as follows:

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 OIE Membership Acquisition, we utilized the assistance of third-party valuation specialists to determine the fair value of the assets acquired, the Companyand liabilities acquired. We 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 CompanyWe used the income approach and made market assumptions as to projections of utilization, future operating costs and a market participant weighted average costscost 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.

The following summarizes the estimated fair values of the identifiable assets acquired and liabilities assumed in the acquisition based on their relative fair values at the acquisition date. These estimates of fair value of identifiable assets acquired and liabilities assumed are preliminary, pending final evaluation of certain assets and liabilities, and therefore are subject to revisions that may result in adjustments to the values presented below:

Assets acquired and liabilities assumed are as follows:

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.

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

Below are unaudited pro forma consolidated results of operations for the three and nine months ended March 31, 2019 andSeptember 30, 2018 as though the OIE Membership Acquisition had been completed as of January 1, 2018. Results for the three and nine months ended September 30, 2019 are reflected in the unaudited condensed consolidated statements of operations.

Consolidation of Carbon California Unaudited Pro Forma Results of Operations

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.

Below are unaudited pro forma consolidated results of operations for the three and nine months ended March 31, 2019 andSeptember 30, 2018 as though the Carbon California Acquisition had been completed as ofoccurred on January 1, 2018. The Carbon California Acquisition closed February 1, 2018,Results for the three and accordingly,nine months ended September 30, 2019 are reflected in the Company’s unaudited condensed consolidated statements of operations for the quarter ended March 31, 2018, includes the results of operations for the period February 1, 2018, through March 31, 2018.operations.

NoteNOTE 4 – Property and EquipmentPROPERTY AND EQUIPMENT

Net propertyProperty and equipment, as of March 31, 2019 and December 31, 2018net consists of the following:

As of March 31,September 30, 2019, and December 31, 2018, the Company had approximately $5.0 million and $5.4 million, respectively, of unproved oil and gas properties not subject to depletion. TheSuch costs not subject to depletion relate to unproved properties that are excluded from amortized capital coststhe full cost pool until it is determined if proved reserves can be assigned to suchthe related properties. The excluded properties are assessed for impairment at least annually. Subject to industry conditions, evaluation of most of these properties and the inclusion of their costs in amortized capital coststhe full cost pool is expected to be completed within five years.

During the three months ended March 31, 2019 and 2018, there were no expiring leasehold costs that were reclassified into proved property. The excluded Unproved properties are assessed for impairment at least annually. Subject to industry conditions, evaluationsDuring the three and nine months ended September 30, 2019, approximately $513,000 and $719,000 of most of these propertiesexpiring leasehold costs were reclassified into proved property. There were no expiring leasehold costs during the three and the inclusion of their costs in amortized capital costs is expected to be completed within five years.nine months ended September 30, 2018.

We capitalized overhead applicable to acquisition, development and exploration activities of approximately $68,000$167,000 and $71,000$540,000 for the three and nine months ended March 31,September 30, 2019, respectively. For the three and nine months ended September 30, 2018, we capitalized overhead applicable to acquisition, development, and exploration activities of approximately $106,000 and $306,000, respectively.

Depletion expense related to oil and gas properties for the three and nine months ended March 31,September 30, 2019 was approximately $3.7 million and $10.7 million, respectively. Depletion expense related to oil and gas properties for the three and nine months ended September 30, 2018 was approximately $3.5$2.4 million or $0.54 per Mcfe, and $1.3$5.6 million, or $0.82 per Mcfe, respectively.

Note 5 – Asset Retirement Obligation

Asset Retirement Obligations

The Company’s asset retirement obligations (“ARO”) relate to future costs associated with the plugging and abandonment of oil and gas wells, removal of equipment and facilities from leased acreage and returning such land to its original condition. The fair value of a liability for an ARO is recorded in the period in which it is incurred and the cost of such liability is recorded as an increase in the carrying amount of the related long-lived asset by the same amount. The liability is accreted each period and the capitalized cost is depleted on a units-of-production basis as part of the full cost pool. Revisions to estimated AROs result in adjustments to the related capitalized asset and corresponding liability.

The estimated ARO liability is based on estimated economic lives, estimates as to the cost to abandon the wells in the future, and federal and state regulatory requirements. The liability is discounted using a credit-adjusted risk-free rate estimated at the time the liability is incurred or increased as a result of a reassessment of expected cash flows and assumptions inherent in the estimation of the liability. Upward revisions to the liability could occur due to changes in estimated abandonment costs or well economic lives, or if federal or state regulators enact new requirements regarding the abandonment of wells. AROs are valued utilizing Level 3 fair value measurement inputs.

The following table is a reconciliation of the ARO for the three months ended March 31, 2019 and 2018:

Note 6 – Investments in Affiliates

Carbon Appalachia

For the period April 3, 2017 (inception) through December 31, 2018, based on our 27.24% combined Class A, Class B and Class C interest (and our ability as of December 31, 2018 to earn up to an additional 14.7%) in Carbon Appalachia, our ability to appoint a member to the board of directors and our role of manager of Carbon Appalachia, we accounted for our investment in Carbon Appalachia under the equity method of accounting as we believed we exerted significant influence. We used the HLBV to determine our share of profits or losses in Carbon Appalachia and adjusted the carrying value of our investment accordingly. Our investment in Carbon Appalachia is represented by our Class A and C interests, which we acquired by contributing approximately $6.9 million in cash and unevaluated property. In the event of liquidation of Carbon Appalachia, available proceeds are first distributed to members holding Class C Units then to holders of Class A Units until their contributed capital is recovered with an internal rate of return of 10%. Any additional distributions would then be shared between holders of Class A, Class B and Class C Units.

On December 31, 2018, we acquired all of Old Ironsides’ Class A Units of Carbon Appalachia for approximately $58.1 million, subject to customary and standard closing adjustments. We paid $ 33.0 million in cash and issued the Old Ironsides Notes in the aggregate original principal amount of approximately $25.1 million to Old Ironsides.

Effective December 31, 2018, upon the closing of the OlE Membership Acquisition, we consolidate Carbon Appalachia in our consolidated financial statements.

Carbon California

For the period February 15, 2017 (inception) through January 31,three and nine months ended September 30, 2019 and 2018, based onwe did not recognize any ceiling test impairments as our 17.81% interest in Carbon California, our ability to appoint a member tofull cost pool did not exceed the board of directors and our role of manager of Carbon California, we accounted for our investment in Carbon California under the equity method of accounting as we believed we exerted significant influence. We used the Hypothetical Liquidation at Book Value Method (“HLBV”) to determine our share of profits or losses in Carbon California and adjusted the carrying value of our investment accordingly. The HLBV is a balance-sheet approach that calculates the amount each member of Carbon California would have received if Carbon California were liquidated at book value at the end of each measurement period. The change in the allocated amount to each member during the period represents the income or loss allocated to that member. In the event of liquidation of Carbon California, to the extent that Carbon California has net income, available proceeds are first distributed to members holding Class B Units and any remaining proceeds are then distributed to members holding Class A Units.ceiling limitations.

Effective February 1, 2018, upon the exercise of the California Warrant, we consolidate Carbon California in our consolidated financial statements.NOTE 5 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Other Affiliates

At March 31,Accounts payable and accrued liabilities at September 30, 2019 and December 31, 2018 we retained interests in two equity method investments associated withconsist of the development and transportation of oil and gas.following: