Note 1: Nature of operations and summary of significant accounting policies

Nature of operations

Chaparral Energy, Inc. and its subsidiaries (collectively, “we”, “our”, “us”, or the “Company”) are involved in the acquisition, exploration, development, production and operation of oil and natural gas properties. Our properties are located primarily in Oklahoma and our commodity products include crude oil, natural gas and natural gas liquids.

Reorganization, fresh start accounting and comparability of financial statements to prior periods

On May 9, 2016, the Company and ten of its subsidiaries filed voluntary petitions seeking relief under Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) commencing cases for relief under Chapter 11 of the Bankruptcy Code.

On March 10, 2017, the Bankruptcy Court confirmed our Reorganization Plan and on March 21, 2017 (the “Effective Date”), the Reorganization Plan became effective and we emerged from bankruptcy. Upon emergence, all existing equity was cancelled and we issued new common stock to the previous holders of our Senior Notes and certain general unsecured creditors whose claims were impaired as a result of our bankruptcy, as well as to certain other parties as set forth in the Reorganization Plan, including to parties participating in a rights offering.

Additionally, upon emergence we qualified for and applied fresh start accounting to our financial statements in accordance with the provisions set forth in FASB Accounting Standards Codification (ASC) 852: Reorganizations, as (i) the holders of existing voting shares of the Company prior to its emergence received less than 50% of the voting shares of the Company outstanding following its emergence from bankruptcy and (ii) the reorganization value of our assets immediately prior to confirmation of the Reorganization Plan was less than the post-petition liabilities and allowed claims.

As a result of the application of fresh start accounting, as well as the effects of the implementation of the Reorganization Plan, the Company’s consolidated financial statements after March 21, 2017, are not comparable with the consolidated financial statements prior to that date. To facilitate our financial statement presentations, we refer to the post-emergence reorganized company in these consolidated financial statements and footnotes as the “Successor” for periods subsequent to March 21, 2017, and to the pre-emergence company as “Predecessor” for periods prior to and including March 21, 2017.

Interim financial statements

The accompanying unaudited consolidated interim financial statements of the Company have been prepared in accordance with the rules and regulations of the SEC and do not include all of the financial information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements. These financial statements and the notes thereto should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2017.

The financial information as of March 31, 2018 (Successor), and for the three months ended March 31, 2018 (Successor), and the periods of March 22, 2017, through March 31, 2017 (Successor), and January 1, 2017, through March 21, 2017 (Predecessor), is unaudited. The financial information as of December 31, 2017, has been derived from the audited financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2017. In management’s opinion, such information contains all adjustments considered necessary for a fair presentation of the results of the interim periods. The results of operations for the three months ended March 31, 2018 (Successor) are not necessarily indicative of the results of operations that will be realized for the year ended December 31, 2018.

Certain reclassifications have been made to prior period financial statements to conform to current period presentation. The reclassifications had no effect on our previously reported results of operations.

Cash and cash equivalents

We maintain cash and cash equivalents in bank deposit accounts and money market funds which may not be federally insured. As of March 31, 2018, cash with a recorded balance totaling approximately $10,330 was held at JP Morgan Chase Bank, N.A. We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk on such accounts.

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(dollars in thousands, except per share amounts)

Accounts receivable

We have receivables from joint interest owners and oil and natural gas purchasers which are generally uncollateralized. Accounts receivable consisted of the following:

Oil and natural gas properties

Costs associated with unevaluated oil and natural gas properties are excluded from the amortizable base until a determination has been made as to the existence of proved reserves. Unevaluated leasehold costs are transferred to the amortization base with the costs of drilling the related well upon proving up reserves of a successful well or upon determination of a dry or uneconomic well under a process that is conducted each quarter. Furthermore, unevaluated oil and natural gas properties are reviewed for impairment if events and circumstances exist that indicate a possible decline in the recoverability of the carrying amount of such property. The impairment assessment is conducted at least once annually and whenever there are indicators that impairment has occurred. In assessing whether impairment has occurred, we consider factors such as intent to drill; remaining lease term; geological and geophysical evaluations; drilling results and activity; assignment of proved reserves; and economic viability of development if proved reserves are assigned. Upon determination of impairment, all or a portion of the associated leasehold costs are transferred to the full cost pool and become subject to amortization. The processes above are applied to unevaluated oil and natural gas properties on an individual basis or as a group if properties are individually insignificant. Our future depreciation, depletion and amortization rate would increase if costs are transferred to the amortization base without any associated reserves.

In the past, the costs associated with unevaluated properties typically related to acquisition costs of unproved acreage. As a result of the application of fresh start accounting in the first quarter of 2017, a substantial portion of the carrying value of our unevaluated properties are the result of a fair value increase to reflect the value of our acreage in our STACK play.

The costs of unevaluated oil and natural gas properties consisted of the following:

Ceiling Test. In accordance with the full cost method of accounting, the net capitalized costs of oil and natural gas properties are not to exceed their related PV-10 value, net of tax considerations, plus the cost of unproved properties not being amortized.

Our estimates of oil and natural gas reserves as of March 31, 2018, and the related PV-10 value, were prepared using an average price for oil and natural gas on the first day of each month for the prior twelve months as required by the SEC.

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Producer imbala nces. We account for natural gas production imbalances using the sales method, whereby we recognize revenue on all natural gas sold to our customers regardless of our proportionate working interest in a well. Liabilities are recorded for imbalances greater than our proportionate share of remaining estimated natural gas reserves. Our aggregate imbalance positions at March 31, 2018, and December 31, 2017, were immaterial.

Income taxes

In December 2017, the President of the United States signed into law the Tax Cuts and Jobs Act of 2017 (the “Act”), making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a federal corporate tax rate of 21%, additional limitations on executive compensation, and limitations on the deductibility of interest.  The FASB issued Accounting Standards Update (“ASU”) 2018-05, Income Taxes (Topic 740): "Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (“SAB”) No. 118" to address the application of GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Act.

As of March 31, 2018, we had not completed our accounting with regard to Section 162(m) provisions under the Act, and anticipate completing our analysis prior to filing our 2017 tax return in the third quarter of 2018, which is within the one year measurement period required under SAB 118. As such, we have not made an adjustment to the provisional tax benefit recorded under SAB 118 at December 31, 2017. We have estimated our provision for income taxes in accordance with the Act and guidance available as of the date of this filing. 

Despite the Company’s net loss for the quarter ended March 31, 2018 we did not record any net deferred tax benefit for the quarter ended March 31, 2018, as any deferred tax asset arising from the benefit is reduced by a valuation allowance as utilization of the loss carryforwards and realization of other deferred tax assets cannot be reasonably assured.

A valuation allowance for deferred tax assets, including net operating losses, is recognized when it is more likely than not that some or all of the benefit from the deferred tax asset will not be realized. To assess that likelihood, we use estimates and judgment regarding our future taxable income, as well as the jurisdiction in which such taxable income is generated, to determine whether a valuation allowance is required. Such evidence can include our current financial position, our results of operations, both actual and forecasted, the reversal of deferred tax liabilities, and tax planning strategies as well as the current and forecasted business economics of our industry.

We will continue to evaluate whether the valuation allowance is needed in future reporting periods. The valuation allowance will remain until we can determine that the net deferred tax assets are more likely than not to be realized. Future events or new evidence which may lead us to conclude that it is more likely than not that our net deferred tax assets will be realized include, but are not limited to, cumulative historical pre-tax earnings,  improvements in oil prices, and taxable events that could result from one or more transactions. The valuation allowance does not prevent future utilization of the tax attributes if we recognize taxable income. As long as we conclude that the valuation allowance against our net deferred tax assets is necessary, we likely will not have any additional deferred income tax expense or benefit.

The benefit of an uncertain tax position taken or expected to be taken on an income tax return is recognized in the consolidated financial statements at the largest amount that is more likely than not to be sustained upon examination by the relevant taxing authority. Interest and penalties, if any, related to uncertain tax positions would be recorded in interest expense and other expense, respectively. There were no uncertain tax positions at March 31, 2018, or December 31, 2017.

Elements of the Reorganization Plan provided that our indebtedness related to Senior Notes and certain general unsecured claims were exchanged for Successor common stock in settlement of those claims. Absent an exception, a debtor recognizes cancellation of indebtedness income (“CODI”) upon discharge of its outstanding indebtedness for an amount of consideration that is less than its adjusted issue price. The Internal Revenue Code of 1986, as amended (“IRC”), provides that a debtor in a Chapter 11 bankruptcy case may exclude CODI from taxable income but must reduce certain of its tax attributes by the amount of any CODI realized as a result of the consummation of a plan of reorganization. The amount of CODI realized by a taxpayer is determined based on the fair market value of the consideration received by the creditors in settlement of outstanding indebtedness. As a result of the market value of equity upon emergence from Chapter 11 bankruptcy proceedings, the estimated amount of CODI is approximately $61,000, which will reduce the value of the Company’s net operating losses. The actual reduction in tax attributes does not occur until the first day of the Company’s tax year subsequent to the date of emergence, or January 1, 2018. The reduction of net operating losses is expected to be fully offset by a corresponding decrease in valuation allowance.

The IRC provides an annual limitation with respect to the ability of a corporation to utilize its tax attributes, as well as certain built-in-losses, against future taxable income in the event of a change in ownership. Emergence from Chapter 11 bankruptcy proceedings resulted in a change in ownership for purposes of the IRC Section 382. We analyzed alternatives available within the IRC

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t o taxpayers in Chapter 11 bankruptcy proceedings in order to minimize the impact of the ownership change and CODI on our tax attributes. Upon filing our 2017 U.S. Federal income tax return, we plan to elect an available alternative which would likely resul t in the Company experiencing a limitation that subjects existing tax attributes at emergence to an IRC Section 382 limitation that could result in some or all of the remaining net operating loss carryforwards expiring unused. However, we will continue to evaluate the remaining available alternatives which would not subject existing tax attributes to an IRC Section 382 limitation.

Loss on asset sale.

In November 2017, we closed on the sale of our EOR assets. In conjunction with this divestiture, we recorded a loss on sale of $25,163 during the fourth quarter of 2017, which was computed based on preliminary closing estimates. As a result of the final closing adjustments on the sale, we recorded an additional loss of $1,064 during the first quarter of 2018.

Other

Other includes certain expenses related to our restructuring and subleasing activities.

Restructuring . We incurred exit costs in conjunction with our EOR asset divestiture, which are predominantly comprised of one-time severance and termination benefits for the affected employees. During the three months ended March 31, 2018, we recorded $425 of expense as a result of termination benefits for the final slate of employees terminated as a result of the divestiture.

Subleases . Prior to the sale of our EOR assets in November 2017, we utilized CO ₂ compressors that were considered integral to our EOR operations and were leased under six lease agreements from U.S. Bank.  In conjunction with the sale, we continued to lease the compressors, but executed sublease agreements with the purchaser of our EOR assets (the “Sublessee”). Minimum payments under the subleases are equal to the original leases and hence we did not record any losses upon initiation of the subleases. Of the original lease agreements, three are classified as capital leases while the remaining three are classified as operating leases. Prior to the asset sale, the capital leases were included in our full cost amortization base and hence subject to amortization on a units-of-production basis, while also incurring interest expense. The payments under our operating leases were previously recorded as “Lease operating expense” in our statement of operations. All the subleases have been classified as operating leases from a lessor’s standpoint. Subsequent to the execution of the subleases, all payments received from the Sublessee are reflected as revenues on our statement of operations. Payments we make to U.S. Bank on the original operating leases, which were $403 for the three months ended March 31, 2018, are reflected in “Other” on our statement of operations. With respect to the capital leases, we have reclassified the amount associated with these leases from the full cost amortization base to plant, property and equipment on our balance sheet and are amortizing the asset on a straight line basis prospectively. We will continue incurring interest expense on the capital leases. Our sublease revenue is not within the scope of the new revenue recognition guidance discussed below.

Joint Venture

On September 25, 2017, we entered into a joint development agreement (“JDA”) with BCE Roadrunner LLC, a wholly-owned subsidiary of Bayou City Energy Management, LLC (“BCE”), pursuant to which BCE will fund 100 percent of our drilling, completion and equipping costs associated with 30 joint venture STACK wells, subject to average well cost caps that vary by well-type across location and targeted formations, approximately between $3,400 and $4,000 per gross well. The JDA wells, which will be drilled and operated by us, include 17 wells in Canadian County and 13 wells in Garfield County. The JDA provides us with a means to accelerate the delineation of our position within our Garfield and Canadian County acreage, realizing further efficiencies and holding additional acreage by production, and potentially adding reserves. In exchange for funding, BCE will receive wellbore-only interest in each well totaling an 85% carve-out working interest from our original working interest (and we retain 15%) until the program reaches a 14% internal rate of return. Once achieved, ownership interest in all JDA wells will revert such that we will own a 75% working interest and BCE will retain a 25% working interest. We will retain all acreage and reserves outside of the wellbore, with both parties entitled to revenues and paying lease operating expenses based on their working interest.

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(dollars in thousands, except per share amounts)

Cost reduction initiatives

Cost reduction initiatives include expenses related to our efforts to reduce our capital, operating and administrative costs in response to the depressed commodity pricing environment. The expense consists of costs for one-time severance and termination benefits in connection with our reductions in force and third party legal and professional services we have engaged to assist in our cost savings initiatives as follows:

Reorganization items

Reorganization items reflect, where applicable, expenses, gains and losses incurred that are incremental and a direct result of the reorganization of the business. As a result of our emergence from bankruptcy, we have also recorded gains on the settlement of liabilities subject to compromise and gains from restating our balance sheet to fair values under fresh start accounting. “Professional fees” in the table below for periods subsequent to the Effective Date are comprised of legal fees for continuing work to resolve outstanding bankruptcy claims and fees to the U.S. Bankruptcy Trustee, which we will continue to incur until our bankruptcy case is closed. Reorganization items are as follows:

Recently adopted accounting pronouncements

In May 2014, the FASB issued authoritative guidance that supersedes previous revenue recognition requirements and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Please see “Note 5—Revenue recognition” for our disclosure regarding adoption of this update.

In January 2017, the FASB issued authoritative guidance that changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities constitutes a business. The guidance requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described under updated revenue recognition guidance. The guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those years. We adopted this update effective January 1, 2018, without a material impact to our financial statements. We expect that the new guidance, when applied to the facts and circumstances of a future transaction, may impact the likelihood whether a future transaction would be accounted for as a business combination.

In January 2016, the FASB issued authoritative guidance that amends existing requirements on the classification and measurement of financial instruments. The standard principally affects accounting for equity investments and financial liabilities where the fair value option has been elected. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods thereafter. We adopted this update effective January 1, 2018, with no material impact to our financial statements or results of operations.

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In August 2016, the FASB issued authoritative guidance which prov ides clarification on how certain cash receipts and cash payments are presented and classified on the statement of cash flows. This update provides guidance on eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zer o-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settle ment of insurance claims; proceeds from the settlement of corporate-owned life insurance policies including bank-owned life insurance policies; distributions received from equity method investees; beneficial interests in securitization transactions; and se parately identifiable cash flows and application of the predominance principle. The guidance is effective for fiscal years beginning after December 15, 2017, and is required to be adopted using a retrospective approach if practicable. We adopted this updat e effective January 1, 2018, without a material impact on our financial statements or results of operations.

In November 2016, the FASB issued authoritative guidance requiring that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years and should be applied using a retrospective transition method to each period presented. We adopted this update effective January 1, 2018, with no material impact to our financial statements or results of operations.

Recently issued accounting pronouncements

In February 2016, the FASB issued authoritative guidance significantly amending the current accounting for leases. Under the new provisions, all lessees will report a right-of-use asset and a liability for the obligation to make payments for all leases with the exception of those leases with a term of 12 months or less. Furthermore, all leases will fall into one of two categories: (i) a financing lease or (ii) an operating lease. Lessor accounting remains substantially unchanged with the exception that no leases entered into after the effective date will be classified as leveraged leases. For sale leaseback transactions, a sale will only be recognized if the criteria in the new revenue recognition standard are met. For public business entities, this guidance is effective for fiscal periods beginning after December 15, 2018 and interim periods thereafter, and should be applied using a modified retrospective approach. Early adoption is permitted. Our current operating leases are predominantly comprised of a limited number of leases for CO ₂ compressors. However, we also enter into contractual arrangements relating to rights of ways or surface use that are typical of upstream oil and gas operations. We are currently assessing whether such arrangements are included in the new guidance, especially in light of a guidance update issued in January 2018 which provides a practical expedient on land easements. The land easement practical expedient allows an entity to continue its legacy accounting policy for land easements that exist or expire before the new standard’s effective date and  which are not accounted for under the current lease standard. We are in the process of evaluating the impact of this guidance on our consolidated financial statements and related disclosures and as contracts are reviewed under the new standard, this analysis could result in an impact to our financial statements; however, that impact is currently not known.

In June 2016, the FASB issued authoritative guidance which modifies the measurement of expected credit losses of certain financial instruments. The guidance is effective for fiscal years beginning after December 15, 2020, however early adoption is permitted for fiscal years beginning after December 15, 2018. The updated guidance impacts our financial statements primarily due to its effect on our accounts receivables. Our history of accounts receivable credit losses almost entirely relates to receivables from joint interest owners in our operated oil and natural gas wells. Based on this history and on mitigating actions we are permitted to take to offset potential losses such as netting past due amounts against revenue and assuming title to the working interest, we do not expect this guidance to materially impact our financial statements or results of operations.

Note 2: Earnings per share

We have not historically presented earnings per share (“EPS”) because our common stock did not previously trade on a public market, either on a stock exchange or in the over-the-counter (“OTC”) market. Accordingly, we were permitted under accounting guidance to omit such disclosure. However, the OTCQB tier of the OTC Markets Group Inc. began quoting our Class A common stock on May 26, 2017, under the symbol “CHPE”. From May 18, 2017, through May 25, 2017, our Class A common stock was quoted on the OTC Pink marketplace under the symbol “CHHP”. Our Class B common stock is not listed or quoted on the OTCQB or any other stock exchange or quotation system. Our Class A and Class B common stock shares equally in dividends and undistributed earnings. We are presenting basic and diluted EPS for all Successor periods subsequent to our emergence from bankruptcy but are not presenting EPS for any Predecessor period.

We are required under accounting guidance to compute EPS using the two-class method which considers multiple classes of common stock and participating securities. All securities that meet the definition of a participating security are to be included in the computation of basic EPS under the two-class method.

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A reconciliation of the components of basic and diluted EPS is presented below:

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New Credit Facility

The New Credit Facility is a $400,000 facility collateralized by our oil and natural gas properties and is scheduled to mature on December 21, 2022. Availability under our New Credit Facility is subject to a borrowing base based on the value of our oil and natural gas properties and set by the banks semi-annually on May 1 and November 1 of each year. Availability on the New Credit Facility as of March 31, 2018, after taking into account outstanding borrowings and letters of credit on that date, was $78,072.

As of March 31, 2018, our outstanding borrowings were accruing interest at the Adjusted LIBO Rate (as defined in the New Credit Facility), plus the Applicable Margin (as defined in the New Credit Facility), which resulted in a weighted average interest rate of 4.86%.

The New Credit Facility contains financial covenants that require, for each fiscal quarter, we maintain: (1) a Current Ratio (as defined in the New Credit Facility) of no less than 1.00 to 1.00, and (2) a Ratio of Total Debt to EBITDAX (as defined in the New Credit Facility) of no greater than 4.0 to 1.0 calculated on a trailing four-quarter basis. We were in compliance with these financials covenants as of March 31, 2018.

The New Credit Facility contains covenants and events of default customary for oil and natural gas reserve-based lending facilities. Please see “Note 8—Debt” in Item 8 Financial Statements and Supplementary Data of our Annual Report on Form 10-K for the year ended December 31, 2017, for a discussion of the material provisions of our New Credit Facility.

Effective May 9, 2018, we entered into the First Amendment to the Tenth Restated Credit Agreement, among the Company and its subsidiaries, as borrowers, certain financial institutions party thereto, as lenders, and JPMorgan Chase Bank, N.A., as administrative agent (the “Amendment”).  The Amendment reaffirmed our borrowing base at the same level of $285,000. In addition, the Amendment provided us with: (i) an increase from $150,000 to $250,000 to the aggregate amount of secured debt allowed, (ii) a waiver on the automatic reduction to the borrowing base calculation for the issuance of up to $300,000 in unsecured debt, (iii) the ability to offset the total debt calculation in the financial covenant calculations by up to $50,000 of unrestricted cash and cash equivalents whenever we do not have outstanding borrowings on the facility, and (iv) permission to make payments on account of the purchase, redemption, retirement, acquisition, cancellation or termination of our equity of up to $50,000.

Capital Leases

In 2013, we entered into lease financing agreements with U.S. Bank for $24,500 through the sale and subsequent leaseback of existing compressors owned by us. The carrying value of these compressors is included in our oil and natural gas full cost pool. The lease financing obligations are for 84-month terms and include the option to purchase the equipment for a specified price at 72 months as well as an option to purchase the equipment at the end of the lease term for its then-current fair market value. Lease payments related to the equipment are recognized as principal and interest expense based on a weighted average implicit interest rate of 3.8%. Minimum lease payments are approximately $3,181 annually. In conjunction with the sale of our EOR assets, these compressors were subleased to the buyer of those assets although we remain the primary obligor in relation to U.S. Bank.

Note 5: Revenue Recognition

In May 2014, the FASB issued authoritative guidance that supersedes previous revenue recognition requirements which has been codified as Accounting Standards Codification 606: Revenue from Contracts with Customers (“ASC 606”). ASC 606 requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

Description of products and revenue disaggregation

Our revenue is predominantly derived from the production and sale of oil, natural gas and NGLs which, prior to January 1, 2018, was reported in the aggregate as “Commodity sales” on our statement of operations. Substantially all our oil and natural gas properties are located in Oklahoma and Texas and are sold to midstream gas processing plants or crude oil refineries in the vicinity. We have disaggregated revenue based on the separate commodities being sold: crude oil, natural gas and NGLs. In selecting the disaggregation categories, we considered a number of factors such as those affecting supply and demand and thus market prices, storage and the ability to transport the product, industry specific disclosures required by the SEC and FASB, other external disclosures we typically make, and information we have historically presented in the management discussion and analysis section of our annual and quarterly reports. As such, we believe that disaggregating revenue by commodity type appropriately depicts how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors.

The following table displays the revenue disaggregated and reconciles the disaggregated revenue to the revenue reported:

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Performance Obligations

Our oil, natural gas and natural gas liquids contracts typically contain only one type of performance obligation, which is for the delivery of the underlying commodity, and which is satisfied at the point in time the commodity is transferred to the customer. We consider each commodity (ex. barrel of oil or MMBtu of natural gas) to be a separate performance obligation. For natural gas and natural gas liquids, all our sales are to midstream processing entities engaged in the processing of gas and marketing the resulting residue gas and NGLs to third party customers. We transfer control of the product to the midstream processing customer at the wellhead and recognize revenue upon such delivery.

Under our oil sales contracts, we generally sell oil to the purchaser from storage tanks near the wellhead and collect a contractually agreed upon index price, net of pricing differentials. We transfer control of the product from the storage tanks to the purchaser and recognize revenue based on the contract price.

We do not engage in activities to purchase and sell third party natural gas and NGLs. As a result, the commodity revenues we recognize are only for our working interest share of the production.

Pricing and measurement

All of our contracts use market or index-based pricing resulting in the entire transaction price being variable. Since our sales transactions meet the variable allocation criteria in the standard, all consideration is allocated entirely to performance obligations satisfied by distinct commodity units delivered. We record revenue in the month production is delivered to the purchaser. However, settlement statements for our commodity sales are received one to three months after the date production is delivered, and as a result, we are required to estimate the amount of production that was delivered to the purchaser and the price that will be received for the sale of the product. We record the differences between our estimates and the actual amounts for product sales in the month that payment is received from the purchaser. Historically, differences between our revenue estimates and actual revenue received have not been significant. We receive payment for a majority of our sales receivables in the month following delivery and substantially all within three months following delivery. For the three months ended March 31, 2018, revenue recognized in the reporting period related to performance obligations satisfied in prior reporting periods was not material.

Transaction Price Allocated to Remaining Performance Obligations  

For our product sales that have a contract term greater than one year, we have utilized the practical expedient in ASC 606, which states that a company is not required to disclose the transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely to a wholly unsatisfied performance obligation. Since each unit of product delivered to the customer represents a separate performance obligation; therefore, future volumes are wholly unsatisfied and disclosure of the transaction price allocated to remaining performance obligations is not required. For our product sales that have a contract term of one year or less, we have utilized the practical expedient in ASC 606, which states that a company is not required to disclose the transaction price allocated to remaining performance obligations if the performance obligation is part of a contract that has an original expected duration of one year or less.

Nature of gas contracts

All our natural gas and NGL production is sold to midstream processing entities and we do not elect to take our residue gas and/or NGLs in-kind at the tailgate of processing plant. The midstream customer provides us with services such as compressing the gas, transporting the gas to the processing plant and processing it into the separate commodity streams for fees which are deducted from the revenue we receive. We previously reported fees for these services as “Transportation and processing” expenses in our statement of operations. Under ASC 606, since control and possession of the gas is transferred to the customer at the wellhead prior to the receipt of the aforementioned services, the customer is not deemed to be providing a distinct service and any fees paid to the customer are accounted for as a reduction in revenue. We have presented transportation and processing fees as a revenue deduction for the fiscal period beginning January 1, 2018, while our presentation for prior periods remains unchanged

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Contract assets and liabilities

We recognize a receivable for the unconditional right to receive consideration when the commodity is transferred to the customer, at which point the performance obligation is satisfied. All our contract assets are in the form of receivables which are presented as “Accrued commodity sales” in our tabular disclosure of accounts receivable in Note 1—Nature of operations and summary of significant accounting policies. Since we are not entitled to advance payments from our customers prior to the transfer of our commodities nor do receive such payments, we do not have contract liabilities .

Method of adoption

W e adopted ASC 606 effective January 1, 2018 using the modified retrospective approach. Based on an assessment of our contracts, the new guidance did not have a material impact on prior net income and therefore we did not record a cumulative effect adjustment to the opening balance of accumulated deficit .

Note 6: Derivative instruments

Overview

Our results of operations, financial condition and capital resources are highly dependent upon the prevailing market prices of, and demand for, oil, natural gas and natural gas liquids. These commodity prices are subject to wide fluctuations and market uncertainties. To mitigate a portion of this exposure, we enter into various types of derivative instruments, including commodity price swaps, collars, put options, enhanced swaps and basis protection swaps. See “Note 9—Derivative Instruments” in Item 8. Financial Statement and Supplementary Data of our Annual Report on Form 10-K for the year ended December 31, 2017, for a description of the various kinds of derivatives we may enter into.

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The following table summarizes our crude oil derivatives outstanding as of March 31, 2018:

The following table summarizes our natural gas derivatives outstanding as of March 31, 2018:

In February 2018, we renegotiated the fixed pricing of certain crude oil swaps scheduled to settle during 2018 in exchange for entering crude oil swaps, scheduled to settle from 2020 through 2021, at lower-than-market pricing. The renegotiated swaps cover 1,086 MBbls and have a new fixed price of $60.00 per barrel, replacing the original weighted average fixed price of $54.80 per barrel. The new crude oil swaps scheduled to settle from 2020 through 2021 have weighted average fixed prices of $46.26 and $44.34 per barrel, respectively, and cover 543 MBbls each year.

Effect of derivative instruments on the consolidated balance sheets

All derivative financial instruments are recorded on the balance sheet at fair value. See “Note 7—Fair value measurements” for additional information regarding fair value measurements. The estimated fair values of derivative instruments are provided below. The carrying amounts of these instruments are equal to the estimated fair values.

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Condensed notes to consolidated financial statements (unaudited) – continued

(dollars in thousands, except per share amounts)

Effect of derivative instruments on the consolidated statements of operations

We do not apply hedge accounting to any of our derivative instruments. As a result, all gains and losses associated with our derivative contracts are recognized immediately as “Derivative (losses) gains” in the consolidated statements of operations.

“Derivative (losses) gains” in the consolidated statements of operations are comprised of the following:

Note 7: Fair value measurements

Fair value is defined by the FASB as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity.

Fair value measurements are categorized according to the fair value hierarchy defined by the FASB. The hierarchical levels are based upon the level of judgment associated with the inputs used to measure the fair value of the assets and liabilities as follows:

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the asset or liability is categorized based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and may affect the placement of assets and liabilities within the levels of the fair value hierarchy.

Recurring fair value measurements

As of March 31, 2018, and December 31, 2017, our financial instruments recorded at fair value on a recurring basis consisted of commodity derivative contracts (see “Note 6—Derivative instruments”). We had no Level 1 assets or liabilities. Our derivative contracts classified as Level 2 consisted of commodity price swaps which are valued using an income approach. Future cash flows from the commodity price swaps are estimated based on the difference between the fixed contract price and the underlying published forward market price. Our derivative contracts classified as Level 3 consisted of collars. The fair value of these contracts is developed by a third-party pricing service using a proprietary valuation model, which we believe incorporates the assumptions that market participants would have made at the end of each period. Observable inputs include contractual terms, published forward pricing curves, and yield curves. Significant unobservable inputs are implied volatilities. Significant increases (decreases) in implied volatilities in isolation would result in a significantly higher (lower) fair value measurement. We review these valuations and the changes in the fair value measurements for reasonableness. All derivative instruments are recorded at fair value and include a measure of our own nonperformance risk for derivative liabilities or our counterparty credit risk for derivative assets.

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Condensed notes to consolidated financial statements (unaudited) – continued

(dollars in thousands, except per share amounts)

The fair value hierarchy for our financial assets and liabilities is shown by the following table:

Changes in the fair value of our derivative instruments, classified as Level 3 in the fair value hierarchy, were as follows for the periods presented: