UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
ý    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2019
 
☐    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: 001-37712
 
ROSEHILL RESOURCES INC.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
47-5500436
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)
 
16200 Park Row, Suite 300
Houston, Texas 77084
(Address of principal executive offices)
 (281) 675-3400
 
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý   No ☐
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation 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 ý   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 the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
ý   
Smaller reporting company
ý
 
 
Emerging growth company
ý
 
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 provided 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 Securities Exchange Act of 1934). Yes ☐ No ý

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A Common Stock
ROSE
The NASDAQ Capital Market
Class A Common Stock Public Warrants
ROSEW
The NASDAQ Capital Market
Class A Common Stock Public Units
ROSEU
The NASDAQ Capital Market


As of May 10, 2019, 14,395,987 shares of Class A common stock, par value $0.0001 per share, and 29,807,692 shares of Class B common stock, par value $0.0001 per share, were issued and outstanding.




ROSEHILL RESOURCES INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2019
 
TABLE OF CONTENTS
 

 
 
Page
PART I – FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
PART II – OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2
 
 
 
Item 5
 
 
 
Item 6.
 
 
 


1



PART I - FINANCIAL INFORMATION 
Item 1. Financial Statements.


2



ROSEHILL RESOURCES INC. 
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share amounts)
 
 
March 31, 2019
 
December 31, 2018
ASSETS
 
 
 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
5,652

 
$
20,157

Accounts receivable
 
32,993

 
32,260

Accounts receivable, related parties
 

 
78

Derivative assets
 
2,293

 
30,819

Prepaid and other current assets
 
1,700

 
1,371

Total current assets
 
42,638

 
84,685

Property and equipment:
 
 

 
 

Oil and natural gas properties (successful efforts), net
 
703,474

 
666,797

Other property and equipment, net
 
2,426

 
2,592

Total property and equipment, net
 
705,900

 
669,389

Other assets, net
 
5,355

 
4,678

Derivative assets
 
13,796

 
58,314

Total assets
 
$
767,689

 
$
817,066

LIABILITIES, MEZZANINE EQUITY AND STOCKHOLDERS’ EQUITY
 
 
 
 

Current liabilities:
 
 

 
 

Accounts payable
 
$
20,525

 
$
21,013

Accounts payable, related parties
 
12

 
287

Derivative liabilities
 
29,680

 

Accrued liabilities and other
 
37,007

 
27,335

Accrued capital expenditures
 
35,147

 
30,529

Total current liabilities
 
122,371

 
79,164

Long-term liabilities:
 
 
 
 
Long-term debt, net
 
301,590

 
288,298

Asset retirement obligations
 
13,772

 
13,524

Deferred tax liabilities
 
12,272

 
9,278

Derivative liabilities
 
641

 
696

Other liabilities
 
3,654

 
3,658

Total long-term liabilities
 
331,929

 
315,454

Total liabilities
 
454,300

 
394,618

Commitments and contingencies (Note 16)
 


 


Mezzanine equity
 
 
 
 
Series B Preferred Stock; $0.0001 par value, 10.0% Redeemable, $1,000 per share liquidation preference; of the 1,000,000 shares of Preferred Stock authorized, 210,000 shares designated, 156,746 shares issued and outstanding as of March 31, 2019 and December 31, 2018
 
157,053

 
155,111

Stockholders’ equity
 
 

 
 

Series A Preferred Stock; $0.0001 par value, 8.0% Cumulative Perpetual Convertible, $1,000 per share liquidation preference; of the 1,000,000 shares of Preferred Stock authorized, 150,000 shares designated, 101,669 shares issued and outstanding as of March 31, 2019 and December 31, 2018
 
84,631

 
84,631

Class A Common Stock; $0.0001 par value, 250,000,000 shares authorized and 14,287,321 and 13,760,136 shares issued and outstanding as of March 31, 2019 and December 31, 2018
 
1

 
1

Class B Common Stock; $0.0001 par value, 30,000,000 shares authorized, 29,807,692 shares issued and outstanding as of March 31, 2019 and December 31, 2018
 
3

 
3

Additional paid-in capital
 
35,256

 
42,271

Retained earnings (accumulated deficit)
 
(3,502
)
 
26,661

Total common stockholders’ equity
 
31,758

 
68,936

Noncontrolling interest
 
39,947

 
113,770

Total stockholders’ equity
 
156,336

 
267,337

Total liabilities, mezzanine and stockholders’ equity
 
$
767,689

 
$
817,066


The accompanying notes are an integral part of these condensed consolidated financial statements.

3



ROSEHILL RESOURCES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts) 

 
 
Three Months Ended March 31,
 
 
2019
 
2018
Revenues:
 
 

 
 
Oil sales
 
$
65,853

 
$
51,554

Natural gas sales
 
1,474

 
1,745

Natural gas liquids sales
 
4,533

 
2,487

Total revenues
 
71,860

 
55,786

Operating expenses:
 
 

 
 

Lease operating expenses
 
10,370

 
8,885

Production taxes
 
3,503

 
2,640

Gathering and transportation
 
2,361

 
712

Depreciation, depletion, amortization and accretion
 
35,964

 
20,809

Exploration costs
 
1,255

 
436

General and administrative
 
9,055

 
7,097

Loss on disposition of property and equipment
 
9

 
133

Total operating expenses
 
62,517

 
40,712

Operating income
 
9,343

 
15,074

Other income (expense):
 
 

 
 

Interest expense, net
 
(5,600
)
 
(3,867
)
Loss on commodity derivative instruments, net
 
(104,571
)
 
(21,285
)
Other income, net
 
62

 
132

Total other expense, net
 
(110,109
)
 
(25,020
)
Loss before income taxes
 
(100,766
)
 
(9,946
)
Income tax expense (benefit)
 
3,306

 
(2,190
)
Net loss
 
(104,072
)
 
(7,756
)
Net loss attributable to noncontrolling interest
 
(73,909
)
 
(14,076
)
Net loss attributable to Rosehill Resources Inc. before preferred stock dividends
 
(30,163
)
 
6,320

Series A Preferred Stock dividends and deemed dividends
 
2,006

 
1,928

Series B Preferred Stock dividends, deemed dividends, and return
 
5,808

 
5,733

Net loss attributable to Rosehill Resources Inc. common stockholders
 
$
(37,977
)
 
$
(1,341
)
Loss per common share:
 
 

 
 

Basic
 
$
(2.75
)
 
$
(0.22
)
Diluted
 
$
(2.75
)
 
$
(0.22
)
Weighted average common shares outstanding:
 
 

 
 

Basic
 
13,830

 
6,222

Diluted
 
13,830

 
6,222


The accompanying notes are an integral part of these condensed consolidated financial statements.

4



ROSEHILL RESOURCES INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
(In thousands, except share amounts)

Three Months Ended March 31, 2019:
 
 
Preferred Stock Series A
 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Class A
 
Class B
 
 
 
 
 
 
 
 
 
 
 
 
Shares
 
Value
 
Shares
 
Value
 
Shares
 
Value
 
Additional
Paid-in Capital
 
Retained Earnings (Accumulated Deficit)
 
Total
Common Stockholders’ Equity
 
Non-
controlling
Interest
 
Total Equity
Balance at December 31, 2018
 
101,669

 
$
84,631

 
13,760,136

 
$
1

 
29,807,692

 
$
3

 
$
42,271

 
$
26,661

 
$
68,936

 
$
113,770

 
$
267,337

Net loss
 

 

 

 

 

 

 

 
(30,163
)
 
(30,163
)
 
(73,909
)
 
(104,072
)
Restricted stock issued
 

 

 
558,239

 

 

 

 

 

 

 

 

Restricted stock withheld for taxes
 

 

 
(31,054
)
 

 

 

 
(89
)
 

 
(89
)
 

 
(89
)
Stock-based compensation
 

 

 

 

 

 

 
974

 

 
974

 

 
974

Series A Preferred Stock dividends
 

 

 

 

 

 

 
(2,006
)
 

 
(2,006
)
 

 
(2,006
)
Series B Preferred Stock dividends, deemed dividends and return
 

 

 

 

 

 

 
(5,808
)
 

 
(5,808
)
 

 
(5,808
)
Equity shift
 

 

 

 

 

 

 
(86
)
 

 
(86
)
 
86

 

Balance at March 31, 2019
 
101,669

 
$
84,631

 
14,287,321

 
$
1

 
29,807,692

 
$
3

 
$
35,256

 
$
(3,502
)
 
$
31,758

 
$
39,947

 
$
156,336


Three Months Ended March 31, 2018:
 
 
Preferred Stock
Series A
 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Class A
 
Class B
 
 
 
 
 
 
 
 
 
 
 
 
Shares
 
Value
 
Shares
 
Value
 
Shares
 
Value
 
Additional
Paid-in Capital
 
Retained Earnings (Accumulated Deficit)
 
Total
Common Stockholders’ Equity
 
Non-controlling Interest
 
Total Equity
Balance at December 31, 2017
 
97,698

 
$
80,660

 
6,222,299

 
$
1

 
29,807,692

 
$
3

 
$
29,946

 
$

 
$
29,950

 
$
12,054

 
$
122,664

Net income (loss)
 

 

 

 

 

 

 

 
6,320

 
6,320

 
(14,076
)
 
(7,756
)
Stock based compensation
 

 

 

 

 

 

 
1,462

 

 
1,462

 

 
1,462

Series A Preferred stock dividends
 
964

 
964

 

 

 

 

 

 
(1,928
)
 
(1,928
)
 

 
(964
)
Series B Preferred stock dividends, deemed dividends and return
 

 

 

 

 

 

 
(1,341
)
 
(4,392
)
 
(5,733
)
 

 
(5,733
)
Equity Shift
 

 

 

 

 

 

 
(960
)
 

 
(960
)
 
960

 

Balance at March 31, 2018
 
98,662

 
$
81,624

 
6,222,299

 
$
1

 
29,807,692

 
$
3

 
$
29,107

 
$

 
$
29,111

 
$
(1,062
)
 
$
109,673


The accompanying notes are an integral part of these condensed consolidated financial statements. 

5



ROSEHILL RESOURCES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands) 
 
 
Three Months Ended March 31,
 
 
2019
 
2018
Cash flows from operating activities:
 
 

 
 

Net loss
 
$
(104,072
)
 
$
(7,756
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 

 
 

Depreciation, depletion, amortization, accretion and impairment of oil and gas properties
 
35,964

 
20,809

Deferred income taxes
 
2,994

 
(2,190
)
Stock-based compensation
 
974

 
1,462

Loss on sale of fixed assets
 
9

 
133

Loss on derivative instruments
 
104,490

 
21,185

Net cash received (paid) in settlement of derivative instruments
 
(1,821
)
 
(3,043
)
Amortization of debt issuance costs
 
427

 
943

Settlement of asset retirement obligations
 
(8
)
 
(8
)
Changes in operating assets and liabilities:
 
 
 
 
Increase in accounts receivable and accounts receivable, related parties
 
(650
)
 
(16,719
)
(Increase) decrease in prepaid and other assets
 
(329
)
 
105

Increase in accounts payable and accrued liabilities and other
 
13,670

 
4,162

Decrease in accounts payable, related parties
 
(275
)
 
(211
)
Net cash provided by operating activities
 
51,373

 
18,872

Cash flows from investing activities:
 
 

 
 

Additions to oil and natural gas properties
 
(75,825
)
 
(109,310
)
Acquisition of White Wolf
 

 
(4,005
)
Deposit received - Tatanka Asset sale
 
1,100

 

Additions to other property and equipment
 
(55
)
 
(799
)
Net cash used in investing activities
 
(74,780
)
 
(114,114
)
Cash flows from financing activities:
 
 

 
 

Proceeds from revolving credit facility
 
13,000

 
147,602

Repayment on revolving credit facility
 

 
(68,000
)
Debt issuance costs
 
(644
)
 
(1,547
)
Dividends paid on preferred stock
 
(3,362
)
 
(936
)
Restricted stock used for tax withholdings
 
(89
)
 

Payment on capital lease obligation
 
(3
)
 
(8
)
Net cash provided by financing activities
 
8,902

 
77,111

Net decrease in cash, cash equivalents, and restricted cash
 
(14,505
)
 
(18,131
)
Cash and cash equivalents beginning of period
 
20,157

 
24,682

Cash and cash equivalents end of period
 
$
5,652

 
$
6,551


The accompanying notes are an integral part of these condensed consolidated financial statements. 

6



ROSEHILL RESOURCES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited) 
(In thousands)

Supplemental cash flow information and noncash activity:
 
 
Three Months Ended March 31,
 
 
2019
 
2018
Supplemental disclosures:
 
 
 
 
Cash paid for interest
 
$
3,424

 
$
2,924

 
 
 
 
 
Supplemental noncash activity:
 
 
 
 
Asset retirement obligations incurred
 
$
66

 
$
1,307

Changes in accrued capital expenditures
 
(4,618
)
 
18,254

Changes in accounts payable for capital expenditures
 
8,264

 
(6,526
)
Series A Preferred Stock dividends paid-in-kind
 

 
964

Series A Preferred Stock cash dividends declared and payable
 
2,006

 
964

Series B Preferred Stock dividends paid-in-kind
 

 
1,486

Series B Preferred Stock cash dividends declared and payable
 
3,866

 
2,228

Series B Preferred Stock return
 
1,577

 
1,317

Series B Preferred Stock deemed dividend
 
365

 
291



The accompanying notes are an integral part of these consolidated financial statements.

7



ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1 – Organization and Basis of Presentation
 
Organization

Rosehill Resources Inc. (the “Company” or “Rosehill”) is an independent oil and natural gas company focused on the acquisition, exploration, development and production of unconventional oil and associated liquids-rich natural gas reserves in the Permian Basin. The Company’s assets are concentrated in the Delaware Basin, a sub-basin of the Permian Basin.

The Company was incorporated in Delaware on September 21, 2015 as a special purpose acquisition company under the name of KLR Energy Acquisition Corp. (“KLRE”) for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination involving the Company and one or more businesses. On April 27, 2017, the Company acquired a portion of the equity of Rosehill Operating Company, LLC (“Rosehill Operating”), in a transaction structured as a reverse recapitalization (the “Transaction”), into which Tema Oil & Gas Company (“Tema”), a wholly owned subsidiary of Rosemore, Inc. (“Rosemore”), contributed certain assets and liabilities. At the closing of the Transaction, the Company became the sole managing member of Rosehill Operating. Following the Transaction, the Company changed its name to Rosehill Resources Inc.

As the sole managing member of Rosehill Operating, the Company, through its officers and directors, is responsible for all operational and administrative decision-making and control of all of the day-to-day business affairs of Rosehill Operating without the approval of any other member, unless specified in the Second Amended and Restated Limited Liability Company Agreement of Rosehill Operating (the “LLC Agreement”).

Basis of Presentation

The condensed consolidated financial results of the Company consist of the financial results of Rosehill and Rosehill Operating, its consolidated subsidiary. As of March 31, 2019, the Company owns approximately 32.4% of the common units of Rosehill Operating (the “Rosehill Operating Common Units”) and Tema owns approximately 67.6% of the Rosehill Operating Common Units.

The unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. It is suggested that these condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest Annual Report on Form 10-K. The unaudited condensed consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary for the fair presentation of the results of operations for the interim periods.

Variable Interest Entities

Rosehill Operating is a variable interest entity. The Company determined that it is the primary beneficiary of Rosehill Operating as the Company is the sole managing member and has the power to direct the activities most significant to Rosehill Operating’s economic performance as well as the obligation to absorb losses and receive benefits that are potentially significant. The Company consolidated 100% of Rosehill Operating’s assets and liabilities and results of operations in the Company’s condensed consolidated financial statements. Although Tema had a larger ownership interest in Rosehill Operating, because it has disproportionately fewer voting rights, Tema is shown as a noncontrolling interest holder of Rosehill Operating. For further discussion, see Noncontrolling Interest in Note 13 - Stockholders’ Equity.

Note 2 – Summary of Significant Accounting Policies and Recently Issued Accounting Standards

The significant accounting policies followed by the Company are set forth in Note 2 – Summary of Significant Accounting Policies included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.
 

8

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Accounting Standards Adopted in 2019

Revenue Recognition. ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”), supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and industry-specific guidance in Subtopic 932-605, Extractive Activities-Oil and Gas-Revenue Recognition and requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, as clarifying guidance to improve the operability and understandability of the implementation guidance on principal versus agent considerations.

ASC 606 became effective for the Company on January 1, 2019, and the Company has elected to adopt it using the modified retrospective method. The Company has completed its review of the impact of ASC 606 on its significant contracts and determined that the Company was not required to record a cumulative effect adjustment to retained earnings. The implementation of ASC 606 did result in changes to the presentation of “Revenues” and “Gathering and transportation” on the Company’s Condensed Consolidated Statement of Operations. Prior to adoption, the Company recorded all gathering and processing fees incurred for natural gas and NGLs in “Gathering and transportation.” After adoption of ASC 606, where the Company delivers raw gas to midstream processing companies and retains control of its natural gas and plant products until tailgate of the plant, the cost of such gathering and processing will continue to be reflected in the Company’s “Gathering and transportation” as has been its practice historically. In the case where the Company delivers raw gas to the midstream processing companies and transfers control of its raw natural gas at the inlet to the midstream processing companies, such costs are being reported as a reduction to “Natural gas sales” and “Natural gas liquids sales.” Upon adoption, we have also expanded disclosures related to revenue recognition. See Note 17 - Revenue from Contracts with Customers.

Financial Assets and Financial Liabilities. In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The pronouncement requires, among other things, public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset. For the Company, these changes became effective on January 1, 2019. In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which clarifies certain aspects of the guidance issued in ASU 2016-01 including: the ability to irrevocably elect to change the measurement approach for equity securities measured using the practical expedient (at cost plus or minus observable transactions less impairment) to a fair value method in accordance with Topic 820, Fair Value Measurement; clarification that if an observable transaction occurs for such securities, the adjustment is as of the observable transaction date; clarification that the prospective transition approach for equity securities without a readily determinable fair value is meant only for instances in which the practical expedient is elected; and various other clarifications. The adoption of ASU 2016-01 and ASU 2018-03 has been evaluated by the Company and the adoption does not have a significant impact on the Company’s condensed consolidated financial statements.

Recently Issued Accounting Standards Not Yet Adopted

Leases. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under current U.S. GAAP. In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842, which provides clarifying guidance regarding land easements and adds practical expedients. In July 2018, further amendments were issued under ASU 2018-10, Codification Improvements to Topic 842, Leases. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which provides entities with an additional transition method in which an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. ASU 2016-02 and its related updates are effective for the Company for fiscal years beginning after December 15, 2019. The Company is currently evaluating the method of adoption and the impact of the adoption of this guidance on its condensed consolidated financial statements and disclosures.
 
Financial Instruments – Credit Losses. In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments requiring the measurement of all expected credit losses for financial assets, which include trade receivables, held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The guidance in this ASU is effective for the Company for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021 with early adoption permitted for

9

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

interim and annual periods beginning after December 15, 2018. The evaluation of this standard and its impact on the Company’s condensed consolidated financial statements and related disclosures is currently being assessed.

Derivatives and Hedging. In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which expands and refines hedge accounting for both financial and non-financial risk components, aligns the recognition and presentation of the effects of hedging instruments and hedge items in the financial statements, and includes certain targeted improvements to ease the application of current guidance related to the assessment of hedge effectiveness. ASU 2017-12 is effective for the Company for fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of this guidance on its condensed consolidated financial statements.

Fair Value Measurement Disclosures. In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, which removes, modifies and adds disclosure requirements on fair value measurements. ASU 2018-13 is effective for the Company for fiscal years beginning after December 15, 2019 and the Company is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The Company is currently evaluating the impact of the adoption of this guidance on its disclosures.

Note 3 – Loss Per Share 
 
The following table sets forth the calculation of basic and diluted weighted average shares outstanding and loss per share for the indicated periods:
 
 
Three Months Ended March 31,
 
2019
 
2018
 
(In thousands, except per share data)
Net loss (numerator):
 

 
 

Net loss attributable to common stockholders of Rosehill Resources Inc. - basic and diluted
$
(37,977
)
 
$
(1,341
)
 
 
 
 
Weighted average shares (denominator):
 

 
 

Weighted average shares – basic and diluted
13,830

 
6,222

 
 
 
 
Basic and diluted loss per share
$
(2.75
)
 
$
(0.22
)
 
For the three months ended March 31, 2019, the Company excluded 29.8 million shares of Class A Common Stock issuable upon exchange of the Company’s Class B Common Stock, 25.6 million shares of Class A Common Stock issuable upon exercise of the Company’s warrants, 8.8 million shares of Class A Common Stock issuable upon conversion of the Company’s 8% Series A Cumulative Perpetual Convertible Preferred Stock (the “Series A Preferred Stock”) and 2.3 million shares of Class A Common Stock issuable upon vesting under the Company’s Long-Term Incentive Plan from the computation of diluted earnings per share because the effect of such events was anti-dilutive.

For the three months ended March 31, 2018, the Company excluded 29.8 million shares of Class A Common Stock issuable upon exchange of the Company’s Class B Common Stock, 25.6 million shares of Class A Common Stock issuable upon exercise of the Company’s warrants, 8.5 million shares of Class A Common Stock issuable upon conversion of the Company’s Series A Preferred Stock and 1.7 million shares of Class A Common Stock issuable upon vesting under the Company’s Long-Term Incentive Plan from the computation of diluted earnings per share because the effect of such events was anti-dilutive.


10

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 4 – Accounts Receivable
 
Accounts receivable is comprised of the following:

 
 
March 31, 2019
 
December 31, 2018
 
 
(In thousands)
Revenue receivable
 
$
32,227

 
$
28,876

Realized derivative receivable
 
101

 
2,229

Joint interest billings
 
126

 
640

Other
 
539

 
515

Accounts receivable
 
$
32,993

 
$
32,260


Note 5 – Derivative Instruments
 
Commodity derivatives. The Company enters into various derivative instruments primarily to mitigate a portion of the exposure to potentially adverse market changes in oil and natural gas commodity prices and the associated impact on cash flows. All contracts are entered into for other-than-trading purposes. Oil and natural gas commodity derivative instruments are recorded on the condensed consolidated balance sheet at fair value as either an asset or a liability with changes in fair value recognized currently in earnings. While commodity derivative instruments are utilized to manage the price risk attributable to expected oil and natural gas production, the Company’s commodity derivative instruments are not designated as accounting hedges under the accounting guidance. The related cash flow impact of the commodity derivative activities is reflected as cash flows from operating activities unless they are determined to have a significant financing element at inception, in which case they are classified within financing activities.

Series B Preferred Stock bifurcated derivative - In the event of a change of control, the Company shall redeem in cash all of the outstanding shares of Series B Preferred Stock, excluding Series B PIK Shares, each as defined in Note 11 - 10% Series B Redeemable Preferred Stock, for a price per share equal to the Base Return Amount as defined in Note 11 - 10% Series B Redeemable Preferred Stock. The Company assessed the change of control feature and determined that the redemption of the outstanding shares of Series B Preferred Stock, excluding Series B PIK Shares, for a price per share equal to the Base Return Amount was a bifurcated derivative. See Note 11 - 10% Series B Redeemable Preferred Stock for defined terms and more detail.

The following tables summarize the location and fair value amounts of all the Company’s derivative instruments in the condensed consolidated balance sheets, as well as the gross recognized derivative assets, liabilities and offset amounts in the condensed consolidated balance sheets:

 
 
March 31, 2019
 
 
Gross Fair Value
 
Gross Amounts Offset (1)
 
Net Recognized Fair Value
 
 
(In thousands)
Assets
 
 
 
 
 
 
     Commodity derivatives - current
 
$
14,579

 
$
(12,286
)
 
$
2,293

     Commodity derivatives - non-current
 
40,624

 
(26,828
)
 
13,796

Total assets
 
$
55,203

 
$
(39,114
)
 
$
16,089

 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
     Commodity derivatives - current
 
$
(41,966
)
 
$
12,286

 
$
(29,680
)
     Commodity derivatives - non-current
 
(26,854
)
 
26,828

 
(26
)
Series B Preferred Stock bifurcated derivative - non-current
 
(615
)
 

 
(615
)
Total liabilities
 
$
(69,435
)
 
$
39,114

 
$
(30,321
)

(1)
The Company has agreements in place with all of its counterparties that allow for the financial right of offset for derivative assets and liabilities.

11

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
 
December 31, 2018
 
 
Gross Fair Value
 
Gross Amounts Offset (1)
 
Net Recognized Fair Value
 
 
(In thousands)
Assets
 
 
 
 
 
 
     Commodity derivatives - current
 
$
46,972

 
$
(16,153
)
 
$
30,819

     Commodity derivatives - non-current
 
88,008

 
(29,694
)
 
58,314

Total assets
 
$
134,980

 
$
(45,847
)
 
$
89,133

 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
     Commodity derivatives - current
 
$
(16,153
)
 
$
16,153

 
$

     Commodity derivatives - non-current
 
(29,694
)
 
29,694

 

Series B Preferred Stock bifurcated derivative - non-current
 
(696
)
 

 
(696
)
Total liabilities
 
$
(46,543
)
 
$
45,847

 
$
(696
)

(1)
The Company has agreements in place with all of its counterparties that allow for the financial right of offset for derivative assets and liabilities.


12

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

As of March 31, 2019, the open commodity derivative positions with respect to future production were as follows:

 
 
2019
 
2020
 
2021
 
2022
Commodity derivative swaps
Oil:
 
 
 
 
 
 
 
 
Notional volume (Bbls)
1,998,000

 
1,960,000

 
2,160,000

 
1,100,000

 
Weighted average fixed price ($/Bbl)
$
53.59

 
$
60.09

 
$
61.21

 
$
58.42

Natural gas:
 
 
 
 
 
 
 
 
Notional volume (MMBtu)
2,438,364

 
1,500,000

 
1,200,000

 
1,200,000

 
Weighted average fixed price ($/MMbtu)
$
2.87

 
$
2.84

 
$
2.85

 
$
2.87

Ethane:
 
 
 
 
 
 
 
 
Notional volume (Gallons)
9,960,552

 

 

 

 
Weighted average fixed price ($/Gallons)
$
0.28

 
$

 
$

 
$

Propane:
 
 
 
 
 
 
 
 
Notional volume (Gallons)
6,640,452

 

 

 

 
Weighted average fixed price ($/Gallons)
$
0.79

 
$

 
$

 
$

Pentanes:
 
 
 
 
 
 
 
 
Notional volume (Gallons)
2,213,820

 

 

 

 
Weighted average fixed price ($/Gallons)
$
1.47

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
Commodity derivative two-way collars
Oil:
 
 
 
 
 
 
 
 
Notional volume (Bbls)
406,000

 

 

 

 
Weighted average ceiling price ($/Bbl)
$
60.98

 
$

 
$

 
$

 
Weighted average floor price ($/Bbl)
$
54.68

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
Commodity derivative three-way collars
Oil:
 
 
 
 
 
 
 
 
Notional volume (Bbls)
1,332,039

 
3,294,000

 

 

 
Weighted average ceiling price ($/Bbl)
$
68.66

 
$
70.29

 
$

 
$

 
Weighted average floor price ($/Bbl)
$
57.61

 
$
57.50

 
$

 
$

 
Weighted average sold put option price ($/Bbl)
$
45.69

 
$
47.50

 
$

 
$

 
 
 
 
 
 
 
 
 
Crude oil basis swaps
Midland / Cushing:
 
 
 
 
 
 
 
 
Notional volume (Bbls)
3,736,039

 
5,254,000

 
2,160,000

 
1,100,000

 
Weighted average fixed price ($/Bbl)
$
(4.82
)
 
$
(0.83
)
 
$
0.39

 
$
0.39

 
 
 
 
 
 
 
 
 
Natural gas basis swaps
EP Permian:
 
 
 
 
 
 
 
 
Notional volume (MMBtu)
2,466,780

 
2,096,160

 

 

 
Weighted average fixed price ($/MMBtu)
$
(1.13
)
 
$
(1.03
)
 
$

 
$



13

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

For the three months ended March 31, 2019 and 2018, the effect of the derivative activity on the Company’s Condensed Consolidated Statements of Operations was as follows:
 
Three Months Ended March 31,
 
2019
 
2018
 
(In thousands)
Realized loss on derivatives
 

 
 

Commodity derivative options
$
1,500

 
$
19

Commodity derivative swaps
(2,523
)
 
(3,062
)
Total realized loss on derivatives
$
(1,023
)
 
$
(3,043
)
 
 
 
 
Unrealized loss on derivatives
 

 
 

Commodity derivative options
$
(25,566
)
 
$
(15,960
)
Commodity derivative swaps
(77,982
)
 
(2,282
)
Total
(103,548
)
 
(18,242
)
Series B Preferred Stock bifurcated derivative
81

 
100

Total unrealized loss on derivatives
$
(103,467
)
 
$
(18,142
)
 
The gains and losses resulting from the cash settlement and mark-to-market of the commodity derivatives are included within “Gain (loss) on commodity derivative instruments, net” in the Condensed Consolidated Statements of Operations. The gains and losses resulting from mark-to-market of the Series B Preferred Stock bifurcated derivative are included within “Other income (expense), net” in the Condensed Consolidated Statements of Operations.

Note 6 – Fair Value Measurements
 
Fair value is 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 (exit price). Fair value measurements are classified and disclosed within the following fair value hierarchy:
 
Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Active markets are those in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
 
Level 2 – Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that are valued using observable market data.
 
Level 3 – Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources. Pricing inputs are unobservable for the investment and include situations where there is little, if any, market activity for the investment.
 
Observable data is considered to be market data if it is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by multiple, independent sources that are actively involved in the relevant market. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on lowest level of input that is significant to the fair value measurement. The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment. However, the determination of what constitutes “observable” requires significant judgment. The categorization of an investment within the hierarchy is based upon the pricing transparency of the investment and does not necessarily correspond to the perceived risk of that investment.

14

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Financial Instruments
 
The financial instruments measured at fair value on a recurring basis consist of the following:
 
 
 
March 31,
 
December 31,
 
 
2019
 
2018

 
(In thousands)
Derivative assets (liabilities)
 
 

 
 

Derivative assets - current
 
$
2,293

 
$
30,819

Derivative assets - non-current
 
13,796

 
58,314

Total derivative assets
 
16,089

 
89,133

Derivative liabilities - current
 
(29,680
)
 

Derivative liabilities - non-current
 
(641
)
 
(696
)
Total derivative liabilities
 
(30,321
)
 
(696
)
Total derivative assets (liabilities), net
 
$
(14,232
)
 
$
88,437

 
Derivative assets and liabilities primarily represent unsettled amounts related to commodity derivative positions, including swaps and options. Derivative liabilities also include the Series B Preferred Stock bifurcated derivative for the various redemption amounts that the Company could incur if a change of control event occurs. The Company utilizes Level 3 assumptions to estimate the probability of a change of control occurring and when that would occur as the timing impacts the Base Return Amount as defined in Note 11 - 10% Series B Redeemable Preferred Stock.

The tables below, set forth by level within the fair value hierarchy, represent the net components of the assets and liabilities that were measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018. These net balances are intended solely to provide information on sources of inputs to fair value and proportions of fair value involving objective versus subjective valuations and do not represent either the actual credit exposure or net economic exposure.
 
 
 
March 31, 2019
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In thousands)
Derivative assets
 
 
 
 
 
 
 
 
Commodity derivative assets - current
 
$

 
$
2,293

 
$

 
$
2,293

Commodity derivative assets - non-current
 

 
13,796

 

 
13,796

Total derivative assets
 
$

 
$
16,089

 
$

 
$
16,089

 
 
 
 
 
 
 
 
 
Derivative liabilities
 
 
 
 
 
 
 
 
Commodity derivative liabilities - current
 
$

 
$
(29,680
)
 
$

 
$
(29,680
)
Commodity derivative liabilities - non-current
 

 
(26
)
 

 
(26
)
Series B Preferred Stock bifurcated derivative - non-current
 

 

 
(615
)
 
(615
)
Total derivative liabilities
 
$

 
$
(29,706
)
 
$
(615
)
 
$
(30,321
)


15

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
 
December 31, 2018
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In thousands)
Derivative assets
 
 
 
 
 
 
 
 
Commodity derivative assets- current
 
$

 
$
30,819

 
$

 
$
30,819

Commodity derivative assets - non-current
 

 
58,314

 

 
58,314

Series B Preferred Stock bifurcated derivative - non-current
 

 

 
(696
)
 
(696
)
Total derivative assets
 
$

 
$
89,133

 
$
(696
)
 
$
88,437

 
The table below sets forth a summary of changes in the fair value of the Company’s level 3 liabilities for the three months ended March 31, 2019.

Beginning balance
 
$
696

(Gains) losses reported in earnings
 
(81
)
Ending balance
 
$
615


Financing Arrangements
 
The carrying amounts of the Company’s cash, cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values because of the short-term maturities and/or liquid nature of these assets and liabilities. The Company’s revolving credit facility carrying value is representative of its fair value because the interest rate changes monthly based on the current market of the stated rates in the agreement. As of March 31, 2019 and December 31, 2018, the fair value of the 10% Senior Secured Second Lien Notes (the “Second Lien Notes”) was $95.2 million, which was determined using quoted prices for similar instruments, a Level 2 classification in the fair value hierarchy.
 
Non-Financial Assets and Liabilities
 
Non-financial assets and liabilities that are initially measured at fair value are comprised of asset retirement obligations and the corresponding increase to the related long-lived asset and are not remeasured at fair value in subsequent periods. Such initial measurements are classified as Level 3 because certain significant unobservable inputs are utilized in their determination. The fair value of additions to asset retirement obligation liability and certain changes in the estimated fair value of the liability are measured using valuation techniques consistent with the income approach, converting future cash flows to a single discounted amount. Significant inputs to the valuation include (i) estimated plug and abandonment cost per well based on historical experience and information from third-parties; (ii) estimated remaining life per well; (iii) future inflation factors; and (iv) average credit-adjusted risk-free rate. These inputs require significant judgments and estimates by management at the time of the valuation and are the most sensitive and subject to change.
 
If the carrying amount of oil and natural gas properties exceeds the estimated undiscounted future cash flows, the carrying amount of the oil and natural gas properties will be adjusted to their fair value. The fair value of oil and natural gas properties is determined using valuation techniques consistent with the income and market approach. The factors used to determine fair value are subject to management’s judgment and expertise and include, but are not limited to, (i) recent sales prices of comparable properties; (ii) the present value of future cash flows, net of estimated operating and development costs using estimates of proved oil and natural gas reserves; (iii) future commodity prices; (iv) future production estimates; (v) anticipated capital expenditures; and (vi) various discount rates commensurate with the risk and current market conditions associated with the projected cash flows. These assumptions represent “Level 3” inputs.


16

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7 – Property and equipment
 
Property and equipment is comprised of the following:
 
 
 
March 31,
 
December 31,
 
 
2019
 
2018
 
 
(In thousands)
Proved oil and natural gas properties
 
$
851,719

 
$
777,558

Unproved oil and natural gas properties
 
120,185

 
121,929

Land
 
1,575

 
1,575

Less: accumulated DD&A and impairment
 
(270,005
)
 
(234,265
)
    Total oil and natural gas properties (successful efforts), net
 
703,474

 
666,797

Other property and equipment
 
6,061

 
6,059

Less: accumulated DD&A
 
(3,635
)
 
(3,467
)
    Total other property and equipment
 
2,426

 
2,592

Total property and equipment, net
 
$
705,900

 
$
669,389


Depreciation, depletion, amortization, and accretion expense (“DD&A”) related to oil and natural gas properties was $35.6 million and $20.6 million for the three months ended March 31, 2019 and 2018, respectively. Depreciation and amortization expense related to other property and equipment was $0.2 million and $0.1 million for the three months ended March 31, 2019 and 2018, respectively. There were no impairment charges related to proved or unproved oil and natural gas properties recorded for the three months ended March 31, 2019 and 2018, respectively. Capitalized costs included in proved oil and natural gas properties not subject to DD&A totaled $80.9 million at March 31, 2019 and $87.1 million at December 31, 2018.

Acquisitions and Divestitures

Pecos County, Texas Exchange and Farm-in Agreement. On February 27, 2019, Rosehill closed a cashless acreage exchange in the Southern Delaware Basin receiving approximately 384 net undeveloped acres contiguous to its core areas in the Southern Delaware Basin in exchange for approximately 389 net undeveloped acres not contiguous to its core areas in the Southern Delaware Basin. No gain or loss was recognized on the exchange. In addition, Rosehill gained approximately 2,000 net acres contiguous to its core areas in the Southern Delaware Basin subject to its obligation to drill and complete up to seven wells through 2020 and carrying 25% of the drilling and completion costs for each of the seven wells and the costs of facilities and equipment.

Divestiture of Lea County, New Mexico Assets. On March 26, 2019, Rosehill signed a Purchase and Sale Agreement to sell all of its rights, title and interests to all leases, wells, facilities, easements and contracts located in Lea County, New Mexico (the “Tatanka Assets”) (the “Tatanka Assets PSA”) for cash consideration of $22.0 million, along with the assumption, by the purchaser, of all abandonment obligations associated with the properties. On April 4, 2019, Rosehill closed the transaction (the “Closing Date”) with an effective date of October 1, 2018. Rosehill received a deposit of $1.1 million upon signing the Tatanka Assets PSA and received the remaining $20.9 million on the Closing Date. The purchase price is subject to customary closing adjustments due within 120 days of the Closing Date. The carrying value of the Tatanka Assets at March 31, 2019, all of which was within Proved oil and natural gas properties, was approximately $10.8 million.


17

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 8 – Asset Retirement Obligations
 
The change in asset retirement obligations for the three months ended March 31, 2019 is set forth below (in thousands):
Asset retirement obligations, beginning of year
$
13,524

Additional liabilities incurred
66

Dispositions

Accretion expense
190

Liabilities settled upon plugging and abandoning wells
(8
)
Revision of estimates

Asset retirement obligations, end of year
$
13,772

 
Note 9 – Accrued Liabilities and Other
 
Accrued liabilities and other is comprised of the following as of the respective dates:

 
 
March 31,
 
December 31,
 
 
2019
 
2018
 
 
(In thousands)
Accrued payroll
 
$
4,676

 
$
3,764

Royalties payable
 
13,550

 
11,511

Accrued lease operating expense
 
5,292

 
3,992

Preferred Stock dividends payable
 
5,870

 
3,362

Accrued interest expense
 
2,665

 
925

Accrued production taxes
 
1,094

 
1,234

Accrued ad valorem taxes
 
739

 
1,066

Accrued debt issuance costs
 

 
631

Deposit received - Tatanka Asset sale
 
1,100

 

Other
 
2,021

 
850

Total accrued liabilities and other
 
$
37,007

 
$
27,335


Note 10 – Long-term debt, net
 
The Company’s long-term debt is comprised of the following:

 
 
March 31,
 
December 31,
 
 
2019
 
2018
 
 
(In thousands)
Second Lien Notes
 
$
100,000

 
$
100,000

Revolving credit facility
 
207,000

 
194,000

          Total debt
 
307,000

 
294,000

Debt issuance cost on Second Lien Notes, net
 
3,047

 
3,211

Discount on Second Lien Notes, net
 
2,363

 
2,491

          Total debt issuance cost and discounts
 
5,410

 
5,702

Total long-term debt, net
 
$
301,590

 
$
288,298



18

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Revolving Credit Facility

On March 28, 2018, the Company entered into an Amended and Restated Credit Agreement (the “Amended and Restated Credit Agreement”) by and among the Company, as borrower, JPMorgan Chase Bank, N.A., as administrative agent, and certain other financial institutions party thereto, as lenders. The borrowings under the Amended and Restated Credit Agreement bear interest at an adjusted base rate plus an applicable margin ranging from 1% to 2% or at an adjusted LIBO Rate plus an applicable margin ranging from 2% to 3%. As of March 31, 2019, the weighted average interest rate of outstanding borrowings under the Amended and Restated Credit Agreement was 5.0%. Pursuant to the Amended and Restated Credit Agreement, the lenders party thereto have agreed to provide the Company with a $500 million secured reserve-based revolving credit facility with an initial borrowing base of $150 million. The maturity date of the Amended and Restated Credit Agreement is August 31, 2022 and automatically extends to March 2023 upon the payment in full of the Second Lien Notes. The borrowing base is re-determined semi-annually, with the lenders and the Company each having the right to one interim unscheduled redetermination between any two consecutive semi-annual redeterminations. As of March 31, 2019, the borrowing base was $300 million. As of March 31, 2019, the Company had $207.0 million outstanding under the Amended and Restated Credit Agreement.

The amounts outstanding under the Amended and Restated Credit Agreement are secured by first priority liens on substantially all of Rosehill Operating’s oil and natural gas properties and associated assets and all of the stock of Rosehill Operating’s material operating subsidiaries that are guarantors of the Amended and Restated Credit Agreement. If an event of default occurs under the Amended and Restated Credit Agreement, JPMorgan Chase Bank, N.A. will have the right to proceed against the pledged capital stock and take control of substantially all of Rosehill Operating and Rosehill Operating’s material operating subsidiaries that are guarantors’ assets. There are currently no guarantors under the Amended and Restated Credit Agreement.

The Amended and Restated Credit Agreement contains various affirmative and negative covenants. These covenants may limit Rosehill Operating’s ability to, among other things: incur additional indebtedness; make loans to others; make investments; enter into mergers; make or declare dividends or distributions; enter into commodity hedges exceeding a specified percentage of Rosehill Operating’s expected production; enter into interest rate hedges exceeding a specified percentage of Rosehill Operating’s outstanding indebtedness; incur liens; sell assets; and engage in certain other transactions without the prior consent of JPMorgan Chase Bank, N.A. and/or the lenders.
 
The Amended and Restated Credit Agreement also requires Rosehill Operating to maintain the following financial ratios: (1) a current ratio, which is the ratio of consolidated current assets (including unused commitments under the Amended and Restated Credit Agreement, but excluding non-cash assets) to consolidated current liabilities (excluding non-cash obligations, current maturities under the Amended and Restated Credit Agreement and the Note Purchase Agreement (as defined below)), of not less than 1.0 to 1.0; (2) (x) a leverage ratio, which is the ratio of the sum of all of Rosehill Operating’s Total Debt to Annualized EBITDAX (as such terms are defined in the Amended and Restated Credit Agreement) for the four fiscal quarters then ended, of not greater than 4.0 to 1.0 and (y) commencing on and after repayment in full of the Second Lien Notes (other than surviving contingent indemnification obligations) and the repayment or redemption in full of the Series B Preferred Stock, a leverage ratio, which is the ratio of the sum of all of Rosehill Operating’s Net Debt to Annualized EBITDAX (as such terms are defined in the Amended and Restated Credit Agreement), of not greater than 4.0 to 1.0 and (3) for so long as the Series B Preferred Stock remains outstanding, a coverage ratio, which is the ratio of (i) EBITDAX (as defined in the Amended and Restated Credit Agreement) to (ii) the sum of (x) Interest Expense (as defined in the Amended and Restated Credit Agreement) plus (y) the aggregate amount of Restricted Payments (as defined in the Amended and Restated Credit Agreement) made in cash pursuant to Sections 9.04(a)(iv) and (v) of the Amended and Restated Credit Agreement during the preceding four fiscal quarters, of not less than 2.5 to 1.0. The Company was in compliance with the financial covenants in the Amended and Restated Credit Agreement for the measurement period ended March 31, 2019.
 
Second Lien Notes

On December 8, 2017, Rosehill Operating issued and sold $100,000,000 in aggregate principal amount of 10.00% Senior Secured Second Lien Notes due January 31, 2023 to EIG Global Energy Partners, LLC (“EIG”) under and pursuant to the terms of that certain Note Purchase Agreement, dated as of December 8, 2017 (as amended by the Limited Consent and First Amendment to Note Purchase Agreement, dated as of March 28, 2018, the “Note Purchase Agreement”), among Rosehill Operating, the Company, the holders of the Second Lien Notes party thereto (the “Holders”) and U.S. Bank National Association, as agent and collateral agent on behalf of the Holders. The Second Lien Notes were issued and sold to the Holders in a private placement exempt from the registration requirements under the Securities Act of 1933, as amended (such issuance and sale, the “Notes Purchase”).


19

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Under the Note Purchase Agreement, Rosehill Operating may, at its option, redeem the Second Lien Notes in whole or in part, together with accrued and unpaid interest thereon, (i) at any time after December 8, 2019 but on or prior to December 8, 2020, at a redemption price equal to 103% of the principal amount of the Second Lien Notes being redeemed, (ii) at any time after December 8, 2020 but on or prior to December 8, 2021, at a redemption price equal to 101.5% of the principal amount of the Second Lien Notes being redeemed and (iii) at any time after December 8, 2021, at a redemption price equal to the principal amount of the Second Lien Notes being redeemed. On or prior to December 8, 2019, Rosehill Operating may, at its option, redeem the Second Lien Notes in whole or in part, together with accrued and unpaid interest thereon, at a redemption price equal to 103% of the principal amount of the Second Lien Notes being redeemed plus an additional make-whole premium set forth in the Note Purchase Agreement.

The Second Lien Notes may become subject to redemption under certain other circumstances, including upon the incurrence of non-permitted debt or, subject to various exceptions, reinvestments rights and prepayment or redemption rights with respect to other debt or equity of Rosehill Operating, upon an asset sale, hedge termination or casualty event. Rosehill Operating will be further required to make an offer to redeem the Second Lien Notes upon a Change in Control (as defined in the Note Purchase Agreement) at a redemption price equal to 101% of the principal amount being redeemed. Other than in connection with a change in control or casualty event, the redemption prices and make-whole premium described in the foregoing paragraph shall also apply, at such times and to the extent set forth therein, to any mandatory redemption of the Second Lien Notes or any acceleration of the Second Lien Notes prior to the stated maturity thereof upon the occurrence of an event of default.

The Note Purchase Agreement requires Rosehill Operating to maintain a leverage ratio, which is the ratio of the sum of all of Rosehill Operating’s Total Debt to Annualized EBITDAX (as such terms are defined in the Note Purchase Agreement) for the four fiscal quarters then ended, of not greater than 4.00 to 1.00.

The Company was in compliance with the financial covenants in the Note Purchase Agreement for the measurement period ended March 31, 2019.

The Note Purchase Agreement contains various affirmative and negative covenants, events of default and other terms and provisions that are based largely on the Amended and Restated Credit Agreement, with a number of important modifications reflecting the second lien nature of the Second Lien Notes and certain other terms that were agreed to with the Holders. The negative covenants may limit Rosehill Operating’s ability to, among other things, incur additional indebtedness (including under senior unsecured notes), make investments, make or declare dividends or distributions, redeem its preferred equity, acquire or dispose of oil and gas properties and other assets or engage in certain other transactions without the prior consent of the Holders, subject to various exceptions, qualifications and value thresholds. Rosehill Operating is also required to meet minimum commodity hedging levels based on its expected production on an ongoing basis.

The Company is subject to certain limited restrictions under the Note Purchase Agreement, including (without limitation) a negative pledge with respect to its equity interests in Rosehill Operating and a contingent obligation to guarantee the Second Lien Notes upon request by the Holders in the event that the Company incurs debt obligations. The obligations of Rosehill Operating under the Note Purchase Agreement are secured on a second-lien basis by the same collateral that secures its first-lien obligations. In connection with the Notes Purchase, Rosehill Operating has granted first-lien and second-lien security interests over additional collateral to meet the minimum mortgage requirements under the Note Purchase Agreement.

Deferred Financing Costs and Debt Discount

The Company capitalizes discounts and certain direct costs associated with the issuance of debt and amortizes such costs over the lives of the respective debt instruments. The Company amortized debt issuance costs and discounts of $0.4 million and $0.9 million for the three months ended March 31, 2019 and 2018, respectively. The deferred financing costs related to the Amended and Restated Credit Agreement are classified in prepaid assets and the deferred financing costs and discounts related to the Second Lien Notes are netted against the long-term debt. The following table summarizes the Company’s deferred financing costs and debt discounts:
 

20

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
 
March 31,
 
December 31,
 
 
2019
 
2018
 
 
(In thousands)
Revolving credit facility
 
 
 
 
Debt issuance costs
 
$
3,012

 
$
2,368

Accumulated amortization of debt issuance costs
 
(496
)
 
(361
)
Net deferred costs - Revolving credit facility
 
$
2,516

 
$
2,007

 
 
 
 
 
Second Lien Notes
 
 
 
 
Debt discount
 
$
3,000

 
$
3,000

Accumulated amortization of debt discount
 
(637
)
 
(509
)
Debt issuance costs
 
3,868

 
3,868

Accumulated amortization of debt issuance costs
 
(821
)
 
(657
)
Net deferred costs - Second Lien Notes
 
$
5,410

 
$
5,702

Total deferred financing costs and debt discount, net
 
$
7,926

 
$
7,709

 
Note 11 – 10% Series B Redeemable Preferred Stock

On December 8, 2017, in connection with the acquisition of mineral rights, royalty interest and other associated assets in the Southern Delaware Basin (the “White Wolf Acquisition”), the Company entered into a Series B Redeemable Preferred Stock Purchase Agreement (the “Series B Preferred Stock Agreement”) to issue 150,000 shares of the Company’s 10.00% Series B Redeemable Preferred Stock, par value of $0.0001 per share (the “Series B Preferred Stock”), for an aggregate purchase price of $150.0 million, less transaction costs, advisory and up-front fees of approximately $10.0 million to certain private funds and accounts managed by EIG (collectively, the “Series B Preferred Stock Purchasers”). The Company had the option, subject to certain conditions, to sell from time to time up to an additional 50,000 shares of Series B Preferred Stock, in aggregate, to the Series B Preferred Stock Purchasers and their transferees for a purchase price of $1,000 per share of Series B Preferred Stock. Such option terminated on December 8, 2018 without the Company exercising the option.

Holders of the Series B Preferred Stock are entitled to receive, when, as and if declared by the Board of Directors of the Company (the “Board”), cumulative dividends in cash, at a rate of 10.00% per annum on the $1,000 liquidation preference per share of Series B Preferred Stock, payable quarterly in arrears on January 15, April 15, July 15 and October 15 of each year, commencing on January 15, 2018. With respect to dividends declared for any quarter ending on or prior to January 15, 2019, the Company had the option to pay as dividends additional shares of Series B Preferred Stock in kind (the “Series B PIK Shares”) in an amount up to 40% of that which would have been payable had the dividends been fully paid in cash.

Holders of the Series B Preferred Stock have no voting rights and have limited consent rights with respect to the taking of certain corporate actions by the Company. Upon the Company’s voluntary or involuntary liquidation, winding-up or dissolution, each holder of Series B Preferred Stock will be entitled to receive the Base Return Amount (as defined in the Series B Preferred Stock Agreement) plus accrued and unpaid dividends.

The shares of Series B Preferred Stock are redeemable by the Company at the election of the holders on or after December 8, 2023, and upon certain conditions and at any time at the Company’s option. As the holders of Series B Preferred Stock have an option to redeem the Series B Preferred Stock at a future date, the proceeds from the Series B Preferred Stock have been included in temporary, or “mezzanine” equity, between total liabilities and stockholders’ equity on the Condensed Consolidated Balance Sheets.  The Series B Preferred Stock, while not currently redeemable at the option of the holders, are considered probable of becoming redeemable and therefore will be subsequently remeasured each reporting period by accreting the initial value to the estimated redemption date of December 8, 2023 when the Series B Preferred Stock is redeemable in whole or in part at the election of the holders of Series B Preferred Stock. The accretion is presented as a deemed dividend and recorded in mezzanine equity on the Condensed Consolidated Balance Sheets and within preferred dividends on the Condensed Consolidated Statements of Operations.


21

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In addition to the 10.00% per annum cumulative dividend holders of the Series B Preferred Stock are entitled to receive, upon redemption of the Series B Preferred Stock, such holders are guaranteed a base return on the initial 150,000 shares purchased in an amount equal to (1) $1,250 per share of Series B Preferred Stock times the number of outstanding shares of Series B Preferred Stock had the Company redeemed the shares prior to the first anniversary of the date of issuance of such share of Series B Preferred Stock; (2) $1,350 per share of Series B Preferred Stock times the number of outstanding shares of Series B Preferred Stock if the Company redeems the shares on or after the first anniversary and prior to the second anniversary of the date of issuance of such share of Series B Preferred Stock; and (3) on or after the second anniversary of the date of issuance of such share of Series B Preferred Stock, the greater of (x) $1,500 per share of Series B Preferred Stock and (y) an amount necessary to achieve a 16% internal rate of return (“IRR”) (the “Base Return Amount”) with respect to such shares of Series B Preferred Stock. Since the Series B Preferred Stock can be redeemed by the holders on or after December 23, 2023 and management has no plans to redeem before that date, the Company has accrued a guaranteed return amount in order to achieve the 16% IRR.

In the event of a change of control, the Company shall redeem in cash all of the outstanding shares of Series B Preferred Stock, excluding Series B PIK Shares, for a price per share equal to the Base Return Amount and all Series B PIK Shares at the purchase price of $1,000 per share. The Company assessed the change of control feature and determined that the redemption of the outstanding shares of Series B Preferred Stock, excluding Series B PIK Shares, for a price per share equal to the Base Return Amount was an embedded derivative that required bifurcation and was accounted for at fair value. The Company measured the derivative liability and recorded a discount of $0.6 million upon initial measurement.

The Company reflected the following in mezzanine equity for the Series B Preferred Stock as of March 31, 2019:

 
Series B Preferred Shares
 
 Series B Preferred Stock
 
Guaranteed Return
 
Total
 
(In thousands, except share data)
Total Series B Preferred Stock at December 31, 2018
156,746

 
$
147,603

 
$
7,508

 
$
155,111

Return (16% IRR)

 

 
5,443

 
5,443

Dividends declared and paid or payable in cash

 

 
(3,866
)
 
(3,866
)
Accretion of discount - deemed dividend

 
365

 

 
365

Total Series B Preferred Stock at March 31, 2019
156,746

 
$
147,968

 
$
9,085

 
$
157,053


For each of the quarters ended March 31, 2019 and 2018, dividends per share on the Company’s Series B Preferred Stock was $24.66.

Note 12 – Income Taxes
 
In 2017, the Company became the sole managing member of Rosehill Operating, the Company’s accounting predecessor. Rosehill Operating is a limited liability company that is treated as a partnership for U.S. federal income tax purposes and is not subject to U.S. federal income tax. Any taxable income or loss generated by Rosehill Operating is passed through to and included in the taxable income or loss of its members, including the Company. The Company is a C corporation and is subject to U.S. federal income tax and state and local income taxes.

The Company’s income tax provision was an expense of $3.3 million and a benefit of $2.2 million for the three months ended March 31, 2019 and 2018, respectively. The Company’s effective tax rate was 3.3% and 22.0% for three months ended March 31, 2019 and 2018, respectively. The effective tax rate differs from the enacted statutory rate of 21% for the three months ended March 31, 2019 primarily due to the allocation of profits and losses to Rosehill and the noncontrolling interest holder in accordance with the LLC Agreement and the impact of state income taxes.

As of March 31, 2019, the Company had approximately $38.1 million of U.S. federal net operating loss carryovers, which will begin to expire in 2035. The Company periodically assesses whether it is more likely than not that it will generate sufficient taxable income to realize its deferred tax assets, including NOL carry forwards. A valuation allowance for deferred tax assets is recognized when it is more likely than not that some or all of the benefit from the deferred tax assets will not be realized. As of March 31, 2019, we have no valuation allowance because the Company thinks it is more likely than not that its deferred tax assets will be realized prior to their expiration. In making this determination, the Company considers all available positive and negative

22

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

evidence and makes certain assumptions. The Company considers, among other things, its deferred tax liabilities, the overall business environment, its historical earnings and losses, current industry trends and its outlook for future years.

The Company is subject to the following material taxing jurisdictions: the United States, Texas and New Mexico. As of March 31, 2019, the Company has no current tax years under audit. The Company remains subject to examination for federal income taxes and state income taxes for tax years 2015 to present.

The Company has evaluated all tax positions for which the statute of limitations remains open and believes that the material positions taken would more likely than not be sustained upon examination. Therefore, as of March 31, 2019, the Company had not established any reserves for, nor recorded any unrecognized benefits related to, uncertain tax positions. The Company’s policy is to recognize interest and penalties related to uncertain tax positions in income tax expense.

Tax Receivable Agreement

In connection with the Transaction, the Company entered into a tax receivable agreement (“Tax Receivable Agreement”) with the noncontrolling interest holder, Tema. The Tax Receivable Agreement provides that the Company will pay to Tema 90% of the net cash savings, if any, in U.S. federal, state and local income tax that the Company realizes (or is deemed to realize in certain circumstances) in periods beginning with and after the closing of the Transaction as a result of the following: (i) any tax basis increases in the assets of Rosehill Operating resulting from the distribution to Tema of $35 million in cash, the shares of Class B Common Stock and the issuance of 4,000,000 warrants to Rosehill Operating exercisable for shares of its Class A Common Stock, all in connection with the Transaction, and resulting from the assumption of Tema liabilities in connection with the Transaction, (ii) the tax basis increases in the assets of Rosehill Operating resulting from a redemption by Rosehill Operating with respect to Tema and (iii) imputed interest deemed to be paid by the Company as a result of, and additional tax basis arising from, payments it makes under the Tax Receivable Agreement.

The estimation of liability under the Tax Receivable Agreement is by its nature imprecise and subject to significant assumptions regarding the amount and timing of future taxable income.  The Company is not obligated to make any payments under the Tax Receivable Agreement until the tax benefits associated with the transaction that gave rise to the payment obligation are realized. Amounts payable under the Tax Receivable Agreement are contingent upon, among other things, (i) generation of future taxable income over the term of the Tax Receivable Agreement and (ii) future changes in tax laws. If the Company does not generate sufficient taxable income in the aggregate over the term of the Tax Receivable Agreement to utilize the tax benefits, then the Company would not be required to make the related Tax Receivable Agreement payment. As of March 31, 2019 and December 31, 2018, the Company recognized a Tax Receivable Agreement liability of approximately $3.5 million after concluding that it was probable that we would have sufficient future taxable income to utilize the related tax benefits.

If and when Tema exercises its right to cause the Company to redeem all or a portion of its Rosehill Operating Common Units, a liability under the Tax Receivable Agreement relating to such redemption will be recorded. The amount of liability will be based on 90% of the estimated future cash tax savings that the Company will realize as a result of increases in the basis of Rosehill Operating’s assets attributed to the Company resulting from such redemption. The amount of the increase in asset basis, the related estimated cash tax savings and the attendant Tax Receivable Agreement liability will depend, in part, on the price of the Class A Common Stock at the time of the relevant redemption. Due to the uncertainty surrounding the amount and timing of future redemptions of Rosehill Operating Common Units by Tema, the Company does not believe it is appropriate to record additional Tax Receivable Agreement liability until such time that Rosehill Operating Common Units are redeemed for shares of Class A Common Stock or cash.  


23

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 13 – Stockholders’ Equity
 
Class A Common Stock. Holders of the Company’s Class A Common Stock are entitled to one vote for each share held on all matters to be voted on by the stockholders. Holders of the Class A Common Stock and holders of the Class B Common Stock voting together as a single class have the exclusive right to vote for the election of directors and on all other matters properly submitted to a vote of the stockholders. Additionally, KLR Energy Sponsor, LLC (the “Sponsor”) and Tema agreed to restrictions on certain transfers of the Company’s securities, which include, subject to certain exceptions, restrictions on the transfer of (i) 33% of their common stock through the first anniversary of the closing date of the Transaction, which restrictions lapsed on April 27, 2018, and (ii) 67% of their common stock through the second anniversary of the closing date, provided that sales of common stock above $18.00 per share will be permitted between the first and second anniversaries of the closing date of the Transaction. Further, in connection with underwritten offerings by the Sponsor and Tema, and subject to certain conditions, sales of common stock at a price reasonably expected to equal or exceed $18.00 per share and in any case equal to or in excess of $16.00 per share will be permitted.

On October 2, 2018, the Company issued 6,150,000 shares of Class A Common Stock pursuant to an underwriting public offering (the “Class A Common Stock Offering”), and on October 5, 2018, the Company issued an additional 840,744 shares of Class A Common Stock pursuant to the exercise of the underwriters’ option. The Company contributed all of the $39.4 million net proceeds from the Class A Common Stock Offering and the exercise of the underwriters’ option to Rosehill Operating in exchange for Rosehill Operating Common Units.

Class B Common Stock. Shares of Class B Common Stock may be issued only to Tema, their respective successors and assignees, as well as any permitted transferees of Tema. A holder of Class B Common Stock may transfer shares of Class B Common Stock to any transferee (other than the Company) only if such holder also simultaneously transfers an equal number of such holder’s Rosehill Operating Common Units to such transferee in compliance with the LLC Agreement. Holders of the Company’s Class B Common Stock will vote together as a single class with holders of the Company’s Class A Common Stock on all matters properly submitted to a vote of the stockholders.

 Holders of Class B Common Stock generally have the right to cause the Company to redeem all or a portion of their Rosehill Operating Common Units in exchange for shares of the Company’s Class A Common Stock on a one-to-one basis or, at the Company’s option, an equivalent amount of cash. The Company may, however, at its option, affect a direct exchange of cash or Class A Common Stock for such Rosehill Operating Common Units in lieu of such a redemption. Upon the future redemption or exchange of Rosehill Operating Common Units, a corresponding number of shares of Class B Common Stock will be canceled.
 
In the Transaction, the Company issued to Rosehill Operating 29,807,692 shares of its Class B Common Stock and 4,000,000 warrants exercisable for shares of its Class A Common Stock in exchange for 4,000,000 warrants exercisable for Rosehill Operating Common Units. Rosehill Operating immediately distributed the warrants and shares of Class B Common Stock to Tema.
 
8% Series A Cumulative Perpetual Convertible Preferred Stock. Each share of Series A Preferred Stock has a liquidation preference of $1,000 per share and is convertible, at the holder’s option at any time, initially into 86.9565 shares of the Company’s Class A Common Stock (which is equivalent to an initial conversion price of approximately $11.50 per share of Class A Common Stock), subject to specified adjustments and limitations as set forth in the Certificate of Designation of Series A Preferred Stock (the “Certificate of Designation”). Under certain circumstances, the Company will increase the conversion rate upon a “fundamental change” as described in the Certificate of Designation.
 
The Company contributed the net proceeds of $70.8 million from its issuance to certain qualified institutional buyers and accredited investors (the “PIPE Investors) of 75,000 shares of Series A Preferred Stock and 5,000,000 warrants exercisable for shares of Class A Common Stock to Rosehill Operating. In connection with the issuance of the Series A Preferred Stock, the Sponsor transferred 476,540 shares of its Class A Common Stock to the PIPE Investors to consummate the Transaction. The net proceeds from the issuance of these shares of Series A Preferred Stock and warrants was attributed to the Series A Preferred Stock, warrants and Class A Common Stock contributed by the Sponsor to the PIPE Investors based on the relative fair value of those securities using, among other factors, the closing price of the Class A Common Stock and the closing price of the warrants on April 27, 2017.

Rosemore and the Sponsor backstopped redemptions by the public stockholders of the Company once 30% of the outstanding shares of Class A Common Stock were redeemed by purchasing 20,000 shares of Series A Preferred Stock for net proceeds of $20 million pursuant to a side letter entered into between Rosemore, the Sponsor and the Company. The Company contributed to

24

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Rosehill Operating the net proceeds from the issuance of 20,000 shares of Series A Preferred Stock to Rosemore Holdings, Inc. and the Sponsor.

Future issuances of Series A Preferred Stock resulting from dividends paid-in-kind may, depending on the trading price per share of the Company’s Class A Common Stock on the dividend date, contain a beneficial conversion option determined on the same basis as described above and, thus, result in additional non-cash deemed dividends which will reduce net income attributable to Rosehill Resources, Inc. common stockholders when such paid-in-kind shares of Series A Preferred Stock are granted.

The Company also ratably recognizes additional non-cash deemed dividends attributable to the Series A Preferred Stock discount which was created by the issuance of the warrants exercisable for shares of Class A Common Stock and the contribution of the Class A Common Stock, as the Series A Preferred Stock which was sold to the PIPE Investors is converted. Such non-cash deemed dividends will reduce net income attributable to Rosehill Resources Inc. common stockholders.

The table below summarizes the Series A Preferred Stock dividends reflected in the Company’s Condensed Consolidated Statements of Operations:

 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(In thousands)
Series A Preferred Stock paid-in-kind
 
$

 
$
964

Series A Preferred Stock paid or payable in cash
 
2,006

 
964

Series A Preferred Stock dividends and deemed dividends
 
$
2,006

 
$
1,928


For each of the quarters ended March 31, 2019 and 2018, dividends per share on the Company’s Series A Preferred Stock was $19.73.

Warrants. Each of the Company’s warrants entitles the registered holder to purchase one share of the Company’s Class A Common Stock at a price of $11.50 per share, subject to adjustment pursuant to the terms of the warrant agreement. The warrants have a five-year term which commenced on April 27, 2017, upon the completion of the Transaction, and will expire on April 27, 2022. The Company may call the warrants for redemption if the reported last sale price of the Class A Common Stock equals or exceeds $21.00 per share for any 20 trading days within a 30-trading day period ending on the third trading day prior to the date the Company sends the notice of redemption to the warrant holders.
 
There were 588,276 warrants issued in connection with the formation of the Company and 7,597,044 public warrants (the “Public Warrants”) issued in connection with KLRE’s initial public offering. Additionally, there were 8,408,838 warrants issued to the Sponsor and EarlyBirdCapital Inc. pursuant to a private placement (the “Private Placement Warrants”) in connection with the Company’s initial public offering. The Private Placement Warrants are not redeemable by the Company and are exercisable on a cashless basis so long as they are held by the initial holders or their permitted transferees. Otherwise, the Private Placement Warrants have terms and provisions that are identical to those of the warrants described above. If the Private Placement Warrants are held by holders other than the initial holders or their permitted transferees, the Private Placement Warrants will be redeemable by the Company and exercisable by the holders on the same basis as the warrants described above.
 
In connection with the closing of the Transaction, the Company issued 5,000,000 warrants to the PIPE Investors and 4,000,000 warrants to Tema. These warrants were issued on the same terms, and are subject to the same rights and obligations, as described above.
 
As of March 31, 2019, there were 25,594,158 warrants exercisable for shares of Class A Common Stock outstanding at a price of $11.50. All warrants expire on April 27, 2022.
 
Noncontrolling Interest. Noncontrolling interest represents the membership interest held by holders other than the Company. The Company has consolidated the financial position and results of operations of Rosehill Operating and reflected the proportionate interest held by Tema as a noncontrolling interest. The noncontrolling interest will change when shares of Series A Preferred Stock are converted into shares of Class A Common Stock, when shares of Class A Common Stock are issued in connection with the Company’s Long-Term Incentive Compensation plan and when Tema elects to exchange the Class B Common Stock received in

25

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

connection with the Transaction for shares of Class A Common Stock. At March 31, 2019, Tema held an approximate 67.6% noncontrolling interest in Rosehill Operating.
 
Note 14 - Stock-Based Compensation

Long-Term Incentive Plan

The Company’s Long-Term Incentive Plan (as amended and restated on May 22, 2018, the “LTIP”) permits the grant of a number of different types of equity, equity-based and cash awards to employees, directors and consultants, including grant options, SARs, restricted stock, restricted stock units, stock awards, dividend equivalents, other stock-based awards, substitute awards, performance awards or any combination of the foregoing, as determined by the Compensation Committee of the Board (the “Compensation Committee”), in its sole discretion. The purpose of the LTIP is to provide a means to attract and retain qualified service providers by affording such individuals a means to acquire and maintain stock ownership or awards, the value of which is tied to the performance of the Company. The LTIP also provides additional incentives and reward opportunities designed to strengthen such individuals’ concern for the welfare of the Company and their desire to remain in its employ. At the plan’s inception, 7,500,000 shares of Class A Common Stock were reserved for issuance under the LTIP.

As of March 31, 2019, the Company has granted restricted stock, restricted stock units and performance share units under the LTIP. Stock-based compensation expense for restricted stock and restricted stock units is recognized on a straight-line basis over the requisite service period for each separately vesting tranche of the award as if the award was, in substance, multiple awards. Stock-based compensation is included in general and administrative expense on the Company’s Condensed Consolidated Statements of Operations and forfeitures are recognized as they occur. The stock-based compensation expense recognized was $1.0 million and $1.5 million for the three months ended March 31, 2019 and 2018, respectively. As of March 31, 2019, 3,550,513 shares of Class A Common Stock remained available for issuance under the LTIP, subject to adjustment pursuant to the plan.

Restricted Stock

Restricted stock granted under the LTIP is issued on the grant date, but is restricted as to transferability until vesting. These restricted shares generally vest on the first anniversary of the date of grant. The following table sets forth the restricted stock transactions for the three months ended March 31, 2019:

 
Restricted Stock
 
Weighted-Average Grant Date Fair Value
Outstanding - December 31, 2018
246,653

 
$
6.24

Granted
403,816

 
3.13

Vested

 

Forfeited

 

Outstanding - March 31, 2019
650,469

 
$
4.31


As of March 31, 2019, there was $1.7 million of unrecognized compensation cost related to nonvested restricted stock which is expected to be recognized over a weighted-average period of 0.8 years.


26

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Stock-Settled Time-Based Restricted Stock Units

Stock-settled time-based restricted stock units entitle the holder to receive one share of Class A Common Stock for each restricted stock unit when such restricted stock unit vests. These stock-settled time-based restricted stock units generally vest in three substantially equal installments on the first three anniversaries of the date of grant. The following table sets forth stock-settled time-based restricted stock unit transactions for the three months ended March 31, 2019:

 
Restricted Stock Units
 
Weighted-Average Grant Date Fair Value
Nonvested - December 31, 2018
713,558

 
$
8.13

Granted
908,627

 
3.12

Vested
(154,423
)
 
7.28

Forfeited
(51,411
)
 
8.34

Nonvested - March 31, 2019
1,416,351

 
$
5.00


As of March 31, 2019, there was $5.7 million of unrecognized compensation cost related to nonvested stock-settled time-based restricted stock units which is expected to be recognized over a weighted-average period of 2.2 years.

Market Based Performance Share Units

On March 26, 2018 and March 27, 2019, the Company granted a target number of market based performance share units to certain employees. The market based performance share units cliff vest approximately 2.67 years from date of grant and will be settled in stock, provided that certain performance criteria are met. The performance criteria applicable to such awards is relative total shareholder return, which measures the Company’s total shareholder return as compared to the total shareholder return of the peer group identified by the Compensation Committee. The Company recognizes compensation expense for the performance share units subject to market conditions regardless of whether it becomes probable that these conditions will be achieved or not and compensation expense is not reversed if vesting does not actually occur. The following table sets forth market based performance share unit transactions for the three months ended March 31, 2019:
 
Performance Restricted Stock Units
 
Weighted-Average Grant Date Fair Value
Nonvested - December 31, 2018
284,415

 
$
8.99

Granted
634,683

 
4.32

Vested

 

Forfeited
(39,187
)
 
8.99

Nonvested - March 31, 2019
879,911

 
$
5.67


The grant-date fair value was estimated using a Monte Carlo valuation model. The Monte Carlo valuation model is based on random projections of stock price paths and must be repeated numerous times to achieve a probabilistic assessment. Expected volatility was calculated based on the historical volatility of the Class A Common Stock, and the risk-free interest rate is based on U.S. Treasury yield curve rates with maturities consistent with the three-year vesting period. The following assumptions were used to value the market based performance awards:

 
Three Months Ended March 31,
 
2019
 
2018
Expected volatility
68.1
%
 
89.5
%
Risk-free interest rate
2.2
%
 
2.4
%
Dividend yield
%
 
%
Expected life (years)
2.77

 
2.77



27

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

As of March 31, 2019, there was $4.1 million of unrecognized compensation cost related to shares of market based performance units which is expected to be recognized over a weighted average period of 2.5 years.

Cash-Settled Restricted Stock Units

The Company grants cash-settled restricted stock units to certain employees. Cash-settled restricted stock units entitle the holder to receive the cash equivalent of one share of Class A Common Stock for each restricted stock unit when such restricted stock unit vests. These cash-settled restricted stock units generally vest in three substantially equal installments on the first three anniversaries of the date of grant. Cash-settled restricted stock units are classified as liabilities and are remeasured at each reporting date until settled. The stock-based compensation expense for cash-settled restricted stock units is recognized on a straight-line basis over the requisite service period for each separately vesting tranche of the award as if the award was, in substance, multiple awards. The following table sets forth cash-settled restricted stock unit transactions for the three months ended March 31, 2019:

 
Cash-Settled Restricted Stock Units
 
Weighted-Average Grant Date Fair Value
Nonvested - December 31, 2018
78,224

 
$
6.63

Granted
409,390

 
3.12

Vested
(28,123
)
 
6.63

Forfeited

 

Nonvested - March 31, 2019
459,491

 
$
3.50


As of March 31, 2019, the Company had a liability for cash-settled restricted stock units of less than $0.1 million based on a closing price of $3.40 on March 29, 2019. As of March 31, 2019, there was $1.6 million of unrecognized compensation cost related to shares of cash-settled restricted stock units which is expected to be recognized over a weighted average period of 2.9 years.

Retirement Benefits

The Company has not maintained, and does not currently maintain, a defined benefit pension plan or nonqualified deferred compensation plan. The Company currently maintains a retirement plan pursuant to which employees are permitted to contribute portions of their base compensation to a tax-qualified retirement account. The Company provides matching contributions equal to 100% of elective deferrals up to 3% of eligible compensation and 50% of elective deferrals from 3% to a maximum of 5% of eligible compensation, subject to the applicable contributions limits. Beginning on January 1, 2019, the Company changed its matching contributions to 100% of elective deferrals up to 6% of eligible compensation. Matching contributions are immediately fully vested. The Company’s matching contributions under the plan totaled $0.2 million and $0.1 million for the three months ended March 31, 2019 and 2018 respectively.

Note 15 – Transactions with Related Parties

The Company is not entitled to compensation for its services as managing member of Rosehill Operating. The Company is entitled to reimbursement by Rosehill Operating for any costs, fees or expenses incurred on behalf of Rosehill Operating (including costs of securities offerings not borne directly by members, board of directors’ compensation and meeting costs, cost of periodic reports to its stockholders, litigation costs and damages arising from litigation, accounting and legal costs); provided that the Company will not be reimbursed for any of its income tax obligations.

Transition Service Agreement. On April 27, 2017 in connection with the closing of the Transaction, the Company entered into a Transition Service Agreement (“TSA”) with Tema to provide certain services to each other following the closing of the Transaction. Pursuant to the terms, the Company agreed to provide to Tema (i) operation services for the assets excluded from the Transaction, (ii) divestment assistance and (iii) office space to Gateway and Marketing (“Gateway”). Tema agreed to provide to the Company (i) human resources and benefits administration, (ii) information technology and telecommunications, (iii) general business insurance and (iv) legal services. The TSA terminated on October 27, 2018. Rosehill Operating incurred less than $0.1 million related to providing services to Tema under the TSA for the three months ended March 31, 2018.


28

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Gateway Gathering and Marketing (“Gateway”). Gateway is a subsidiary of Rosemore. A portion of Rosehill Operating’s oil production was sold to Gateway. There was no revenues from production sold to Gateway for the three months ended March 31, 2019. For the three months ended March 31, 2018, revenues from production sold to Gateway were approximately $51.5 million. As of March 31, 2019, there was no revenue receivable due from Gateway.

Rosehill Operating has a Crude Oil Gathering Agreement and a Gas Gathering Agreement with Gateway for a portion of its production. All of the costs incurred under the Crude Oil Gathering Agreement during the three months ended March 31, 2018 were netted against the revenues received from Gateway due to Gateway being the purchaser of the oil production. Costs incurred for the three months ended March 31, 2019 under the Crude Oil Gathering Agreement were $0.6 million. As of March 31, 2019 and December 31, 2018, there was $0.2 million and $0.3 million, respectively, due to Gateway under the Crude Oil Marketing Agreement. Costs incurred under the Gas Gathering Agreement with Gateway for the three months ended March 31, 2019 and 2018, were approximately $1.3 million and $0.3 million, respectively. As of March 31, 2019 and December 31, 2018, there was $0.5 million and no payable, respectively, due to Gateway related to the Gas Gathering Agreement.

In 2018, Rosehill Operating entered into a Crude Oil Marketing Consulting Agreement with Gateway to, among other things, develop marketing strategies aimed at increasing realized prices from the sale of Rosehill Operating’s production. For the three months ended March 31, 2019, the Company incurred costs of less than $0.1 million, respectively, related to the consulting agreement. The Company did not incur any costs related to the Crude Oil Marketing Consulting Agreement during the three months ended March 31, 2018. The Crude Oil Marketing Consulting Agreement was terminated in February 2019.

KLR Sponsor. In October 2018, Rosehill Operating entered into a Water Purchase Agreement with Seawolf Water Resources, LP (“Seawolf”), an affiliate of KLR Sponsor, to purchase water from Seawolf’s water wells for use in well completion operations. For the three months ended March 31, 2019, Rosehill Operating incurred costs of $0.2 million related to this agreement. As of March 31, 2019 and December 31, 2018, there was $0.1 million and $0.6 million, respectively, included in accrued capital expenditures due to Seawolf.

Distributions. The LLC Agreement requires Rosehill Operating to make a corresponding cash distribution to the Company at any time a dividend is to be paid by the Company to the holders of its Series A Preferred Stock and Series B Preferred Stock. The LLC Agreement allows for distributions to be made by Rosehill Operating to its members on a pro rata basis in accordance with the number of Rosehill Operating Common Units owned by each member out of funds legally available therefor. The Company expects Rosehill Operating may make distributions out of distributable cash periodically to the extent permitted by the Amended and Restated Credit Agreement as necessary to enable the Company to cover its operating expenses and other obligations, as well as to make dividend payments, if any, to the holders of its Class A Common Stock. In addition, the LLC Agreement generally requires Rosehill Operating to make (i) pro rata distributions (in accordance with the number of Rosehill Operating Common Units owned by each member) to its members, including the Company, in an amount at least sufficient to allow the Company to pay its taxes and satisfy its obligations under the Tax Receivable Agreement and (ii) tax advances, which will be repaid upon a redemption, in an amount sufficient to allow each of the members of Rosehill Operating to pay its respective taxes on such holder’s allocable share of Rosehill Operating’s taxable income after taking into account certain other distributions or payments received by the unitholder from Rosehill Operating or the Company.

Note 16 – Commitments and Contingencies

Commitments

Rights of Securities Holders. The holders of the Founder Shares, the Series A Preferred Stock, the Private Placement Warrants and unregistered Class A Common Stock are entitled to registration rights pursuant to certain agreements of the Company. In May 2017, the Company filed a registration statement registering the Founder Shares, the Series A Preferred Stock (and any shares of Class A Common Stock issuable upon conversion of the Series A Preferred Stock), the Private Placement Warrants (and any shares of Class A Common Stock issuable upon the exercise of the Private Placement Warrants), the unregistered Class A Common Stock and the shares of Class A Common Stock issuable upon exercise of the outstanding Public Warrants. The registration statement has been effective since June 19, 2017.
 
Rosehill Operating Common Unit Redemption Right. The LLC Agreement provides Tema with a redemption right, which entitles Tema to cause Rosehill Operating to redeem, from time to time, all or a portion of its Rosehill Operating Common Units (and a corresponding number of shares of Class B Common Stock) for, at Rosehill Operating’s option, newly issued shares of Class A Common Stock on a one-for-one basis or a cash payment equal to the average of the volume-weighted closing price of one share of Class A Common Stock for the twenty trading days prior to the date Tema delivers a notice of redemption for each

29

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Rosehill Operating Common Units redeemed (subject to customary adjustments, including for stock splits, stock dividends and reclassifications). In the event of a reclassification event (as defined in the LLC Agreement), the Company as managing member is required to ensure that each Rosehill Operating Common Unit (and a corresponding share of Class B Common Stock) is redeemable for the same amount and type of property, securities or cash that a share of Class A Common Stock becomes exchangeable for or converted into as a result of such reclassification event. Upon the exercise of the redemption right, Tema will surrender its Rosehill Operating Common Units (and a corresponding number of shares of Class B Common Stock) to Rosehill Operating and (i) Rosehill Operating shall cancel such Rosehill Operating Common Units and issue to the Company a number of Rosehill Operating Common Units equal to the number of surrendered Rosehill Operating Common Units and (ii) the Company shall cancel the surrendered shares of Class B Common Stock. The LLC Agreement requires that the Company contribute cash or shares of Class A Common Stock to Rosehill Operating in exchange for the issuance to the Company described in clause (i). Rosehill Operating will then distribute such cash or shares of Class A Common Stock to Tema to complete the redemption. Upon the exercise of the redemption right, the Company may, at its option, affect a direct exchange of cash or its Class A Common Stock for such Rosehill Operating Common Units in lieu of such a redemption.

Maintenance of One-to-One Ratios. The LLC Agreement includes provisions intended to ensure that the Company at all times maintains a one-to-one ratio between (a) (i) the number of outstanding shares of Class A Common Stock and (ii) the number of Rosehill Operating Common Units owned by the Company (subject to certain exceptions for certain rights to purchase equity securities of the Company under a “poison pill” or similar shareholder rights plan, if any, certain convertible or exchangeable securities issued under the Company’s equity compensation plans and certain equity securities issued pursuant to the Company’s equity compensation plans (other than a stock option plan) that are restricted or have not vested thereunder) and (b) (i) the number of other outstanding equity securities of the Company (including the Series A Preferred Stock and the warrants exercisable for shares of Class A Common Stock) and (ii) the number of corresponding outstanding equity securities of Rosehill Operating. These provisions are intended to result in Tema having a voting interest in the Company that is identical to Tema’s economic interest in Rosehill Operating.

Contingencies
 
Legal. In the ordinary course of business, the Company is party to various legal actions, which arise primarily from its activities as operator of oil and natural gas wells. In management’s opinion, the outcome of any such currently pending legal actions will not have a material adverse effect on the Company’s financial position or results of operation. There is no material litigation, arbitration or governmental proceeding currently pending against the Company or any members of its management team in their capacity as such requiring a contingent liability to be recognized as of the date of the condensed consolidated financial statements.
 
Note 17— Revenue from Contracts with Customers

The Company recognizes oil, natural gas and NGL revenue at the point in time when control of the product transfers to the customer, which differs depending on the contractual terms of each of the Company’s arrangements. Transfer of control drives the presentation of gathering, transportation, processing and other post-production expenses (“gathering and transportation expense”) within the Company’s Condensed Consolidated Statements of Operations. In these scenarios below, the Company evaluates whether it is the principal or the agent in the transaction, which analysis includes considerations of product redelivery, take-in-kind rights and risk of loss. For those contracts where the Company has concluded that control of the product transfers at the tailgate of the plant, meaning that the Company is the principal and the ultimate third party purchaser is its customer, the Company recognizes revenue on a gross basis, with transportation and gathering expenses presented within the Gathering and transportation line item on the Company’s Condensed Consolidated Statements of Operations. Alternatively, for those contracts where the Company has concluded control of the product transfers at or near the wellhead or inlet of the plant, meaning that the Company is the agent and the midstream processing company is the Company’s customer, the Company recognizes natural gas and NGL revenues based on the net amount of proceeds received from the midstream processing company. The Company has the following categories under which oil, natural gas and NGL revenue is generated:

The Company sells its crude oil and condensate production at the wellhead or further downstream at a contractually-specified delivery point. Revenue is recognized when control transfers to the customer based on contract terms, which reflects an agreed-upon index price, net of basis, quality and transportation differentials. Gathering and transportation fees incurred prior to control transfer are recorded within the Gathering and transportation line item on the Company’s Condensed Consolidated Statements of Operations, while gathering and transportation fees incurred subsequent to control transfer are recorded as a reduction of oil revenues.


30

ROSEHILL RESOURCES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The Company sells its liquids rich natural gas to a midstream processor at or near the wellhead. The midstream processor gathers and processes the liquids rich natural gas and remits the proceeds to the Company from the ultimate sale of the residue gas and NGLs to third parties. In such arrangements, the midstream processor obtains control of the product at the wellhead and is considered the customer. Proceeds received for the residue gas and NGLs from the midstream processor are reflected as natural gas and NGL revenue, respectively, and are recorded net of gathering and transportation fees incurred by the midstream processor after control has transferred.

The Company sells its liquids rich natural gas to a midstream processor at the inlet to the midstream processing facility. The midstream processor gathers and processes the liquids rich natural gas and remits the proceeds to the Company from the ultimate sale of the residue gas and NGLs to third parties. In such arrangements, the midstream processor obtains control of the product at the inlet to the processing facility and is considered the customer. Gathering and transportation fees incurred by the Company to deliver its liquids rich natural gas to the inlet of the facility occurs prior to the transfer of control to the customer and are recognized within the Gathering and transportation line item on the Company’s Condensed Consolidated Statements of Operations. Proceeds received for the residue gas and NGLs from the midstream processor are reflected as natural gas and NGL revenue, respectively, and are recorded net of gathering and transportation fees incurred by the midstream processor after control has transferred.

The Company has the option in certain midstream processing arrangements where liquids rich natural gas is delivered to the midstream processing facility, the midstream processor gathers and processes the liquids rich natural gas and then the processed residue gas and NGLs are redelivered to the Company in-kind at the tailgate of the processing facility. The Company sells its in-kind residue gas and NGLs to its customer at the tailgate of the processing facility. Gathering and transportation fees incurred prior to transfer of control at the tailgate of the processing facility are recognized within the Gathering and transportation line item on the Company’s Condensed Consolidated Statements of Operations. Proceeds received for the residue gas and NGLs from the customer are reflected as natural gas and NGL revenue, respectively, and are recorded net of gathering and transportation fees incurred by the customer after control has transferred.

The implementation of ASC 606 resulted in changes to the presentation of Revenues and Gathering and transportation on the Company’s Condensed Consolidated Statement of Operations, but it did not have any impact to net income (loss) or cash flows from operations. The impacts of the adoption of ASU 2014-09 for the three months ended March 31, 2019, were as follows:

 
 
As Reported
 
Amounts Without Adoption of ASU 2014-09
 
Effect of Change
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