10-Q 1 este10qseptember2019.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________________ 
FORM 10-Q
_________________________________________________________  
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2019
Or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 001-35049  
earthstone_logoa24.jpg
_________________________________________________________ 
EARTHSTONE ENERGY, INC.
(Exact name of registrant as specified in its charter)
 _________________________________________________________ 
 
Delaware
 
84-0592823
(State or other jurisdiction
 
(I.R.S Employer
of incorporation or organization)
 
Identification No.)
1400 Woodloch Forest Drive, Suite 300
The Woodlands, Texas 77380
(Address of principal executive offices)
Registrant’s telephone number, including area code:  (281) 298-4246
 
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, $0.001 par value per share
ESTE
New York Stock Exchange (NYSE)
Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.    Yes  ☒    No  ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to post such files).    Yes  ☒    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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
 
☐  
  
Smaller reporting company
 
☒
Emerging growth company  
 
☐
 
 
 
 
 


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 Exchange Act).    Yes  ☐    No  ☒
As of November 1, 2019, 29,305,986 shares of Class A Common Stock, $0.001 par value per share, and 35,260,680 shares of Class B Common Stock, $0.001 par value per share, were outstanding.


TABLE OF CONTENTS
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


3

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
EARTHSTONE ENERGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
 
 
September 30,
 
December 31,
ASSETS
 
2019
 
2018
Current assets:
 
 
 
 
Cash
 
$
9,816

 
$
376

Accounts receivable:
 
 
 
 
Oil, natural gas, and natural gas liquids revenues
 
14,990

 
13,683

Joint interest billings and other, both net of allowance of $134
 
8,001

 
4,166

Derivative asset
 
20,179

 
43,888

Prepaid expenses and other current assets
 
2,488

 
1,443

Total current assets
 
55,474

 
63,556

 
 
 
 
 
Oil and gas properties, successful efforts method:
 
 
 
 
Proved properties
 
904,323

 
755,443

Unproved properties
 
269,417

 
266,140

Land
 
5,382

 
5,382

Total oil and gas properties
 
1,179,122

 
1,026,965

 
 
 
 
 
Accumulated depreciation, depletion and amortization
 
(168,988
)
 
(127,256
)
Net oil and gas properties
 
1,010,134

 
899,709

 
 
 
 
 
Other noncurrent assets:
 
 
 
 
Goodwill
 
17,620

 
17,620

Office and other equipment, net of accumulated depreciation and amortization of $3,033 and $2,490 at September 30, 2019 and December 31, 2018, respectively
 
1,350

 
662

Derivative asset
 
9,246

 
21,121

Operating lease right-of-use assets
 
3,295

 
—

Other noncurrent assets
 
1,532

 
1,640

TOTAL ASSETS
 
$
1,098,651

 
$
1,004,308

LIABILITIES AND EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
37,405

 
$
26,452

Revenues and royalties payable
 
19,706

 
28,748

Accrued expenses
 
35,604

 
22,406

Asset retirement obligation
 
420

 
557

Advances
 
20,894

 
3,174

Derivative liability
 
137

 
528

Operating lease liabilities
 
586

 
—

Finance lease liabilities
 
256

 
—

Total current liabilities
 
115,008

 
81,865

 
 
 
 
 
Noncurrent liabilities:
 
 
 
 
Long-term debt
 
125,000

 
78,828

Deferred tax liability
 
14,217

 
13,489

Asset retirement obligation
 
1,833

 
1,672

Derivative liability
 
29

 
1,891

Operating lease liabilities
 
2,722

 
—


4

Finance lease liabilities
 
111

 
—

Other noncurrent liabilities
 
—

 
71

Total noncurrent liabilities
 
143,912

 
95,951

 
 
 
 
 
Commitments and Contingencies (Note 12)
 


 


 
 
 
 
 
Equity:
 
 
 
 
Preferred stock, $0.001 par value, 20,000,000 shares authorized; none issued or outstanding
 
—

 
—

Class A Common Stock, $0.001 par value, 200,000,000 shares authorized; 29,150,220 and 28,696,321 issued and outstanding at September 30, 2019 and December 31, 2018, respectively
 
29

 
29

Class B Common Stock, $0.001 par value, 50,000,000 shares authorized; 35,416,446 and 35,452,178 issued and outstanding at September 30, 2019 and December 31, 2018, respectively
 
35

 
35

Additional paid-in capital
 
523,402

 
517,073

Accumulated deficit
 
(179,087
)
 
(182,497
)
Total Earthstone Energy, Inc. equity
 
344,379

 
334,640

Noncontrolling interest
 
495,352

 
491,852

Total equity
 
839,731

 
826,492

 
 
 
 
 
TOTAL LIABILITIES AND EQUITY
 
$
1,098,651

 
$
1,004,308

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

5

EARTHSTONE ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except share and per share amounts)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2019
 
2018
 
2019
 
2018
REVENUES
 
 
 
 
Oil
 
$
35,443

 
$
38,791

 
$
111,657

 
$
105,111

Natural gas
 
903

 
1,790

 
2,126

 
6,257

Natural gas liquids
 
2,858

 
5,495

 
10,691

 
12,753

Total revenues
 
39,204

 
46,076

 
124,474

 
124,121

 
 
 
 
 
 
 
 
 
OPERATING COSTS AND EXPENSES
 
 
 
 
 
 
 
 
Lease operating expense
 
7,259

 
4,843

 
22,531

 
14,509

Severance taxes
 
1,858

 
2,254

 
5,955

 
6,115

Impairment expense
 
—

 
833

 
—

 
833

Depreciation, depletion and amortization
 
14,079

 
12,842

 
42,281

 
33,362

General and administrative expense
 
6,230

 
4,944

 
20,528

 
18,809

Transaction costs
 
42

 
892

 
217

 
892

Accretion of asset retirement obligation
 
52

 
44

 
160

 
128

Total operating costs and expenses
 
29,520

 
26,652

 
91,672

 
74,648

 
 
 
 
 
 
 
 
 
(Loss) gain on sale of oil and gas properties
 
(120
)
 
4,096

 
(446
)
 
4,608

 
 
 
 
 
 
 
 
 
Income from operations
 
9,564

 
23,520

 
32,356

 
54,081

 
 
 
 
 
 
 
 
 
OTHER INCOME (EXPENSE)
 
 
 
 
 
 
 
 
Interest expense, net
 
(1,609
)
 
(565
)
 
(4,735
)
 
(1,788
)
Gain (loss) on derivative contracts, net
 
18,726

 
(17,481
)
 
(19,672
)
 
(33,606
)
Litigation settlement
 
—

 
(4,775
)
 
—

 
(4,775
)
Other income (expense), net
 
21

 
37

 
(1
)
 
434

Total other income (expense)
 
17,138

 
(22,784
)
 
(24,408
)
 
(39,735
)
 
 
 
 
 
 
 
 
 
Income before income taxes
 
26,702

 
736

 
7,948

 
14,346

Income tax expense
 
(575
)
 
(172
)
 
(728
)
 
(119
)
Net income
 
26,127

 
564

 
7,220

 
14,227

 
 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interest
 
14,357

 
340

 
3,877

 
8,032

 
 
 
 
 
 
 
 
 
Net income attributable to Earthstone Energy, Inc.
 
$
11,770

 
$
224

 
$
3,343

 
$
6,195

 
 
 
 
 
 
 
 
 
Net income per common share attributable to Earthstone Energy, Inc.:
 
 
 
 
 
 
 
 
Basic
 
$
0.41

 
$
0.01

 
$
0.12

 
$
0.22

Diluted
 
$
0.41

 
$
0.01

 
$
0.12

 
$
0.22

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
29,032,842

 
28,257,376

 
28,883,907

 
28,011,298

Diluted
 
29,032,842

 
28,311,759

 
28,883,907

 
28,108,365

 
 
 
 
 
 
 
 
 
 
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

6

EARTHSTONE ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)
(In thousands, except share amounts)

 
Issued Shares
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Class A Common Stock
 
Class B Common Stock
 
Class A Common Stock
 
Class B Common Stock
 
Additional Paid-in Capital
 
Accumulated Deficit
 
Total Earthstone Energy, Inc. Equity
 
Noncontrolling Interest
 
Total Equity
At December 31, 2018
28,696,321

 
35,452,178

 
$
29

 
$
35

 
$
517,073

 
$
(182,497
)
 
$
334,640

 
$
491,852

 
$
826,492

ASC 842 implementation
—

 
—

 
—

 
—

 
—

 
67

 
67

 
99

 
166

Stock-based compensation expense
—

 
—

 
—

 
—

 
2,212

 
—

 
2,212

 
 
 
2,212

Vesting of restricted stock units, net of taxes paid
166,140

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings
59,261

 
—

 
—

 
—

 
(396
)
 
—

 
(396
)
 
—

 
(396
)
Cancellation of treasury shares
(59,261
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Net loss
—

 
—

 
—

 
—

 
—

 
(17,204
)
 
(17,204
)
 
(21,239
)
 
(38,443
)
At March 31, 2019
28,862,461

 
35,452,178

 
$
29

 
$
35

 
$
518,889

 
$
(199,634
)
 
$
319,319

 
$
470,712

 
$
790,031

Stock-based compensation expense
—

 
—

 
—

 
—

 
2,261

 
—

 
2,261

 
 
 
2,261

Vesting of restricted stock units, net of taxes paid
133,311

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings
43,344

 
—

 
—

 
—

 
(265
)
 
—

 
(265
)
 
—

 
(265
)
Cancellation of treasury shares
(43,344
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Class B Common Stock converted to Class A Common Stock
35,732

 
(35,732
)
 
—

 
—

 
476

 
—

 
476

 
(476
)
 
—

Net income
—

 
—

 
—

 
—

 
—

 
8,777

 
8,777

 
10,759

 
19,536

At June 30, 2019
29,031,504

 
35,416,446

 
$
29

 
$
35

 
$
521,361

 
$
(190,857
)
 
$
330,568

 
$
480,995

 
$
811,563

Stock-based compensation expense
—

 
—

 
—

 
—

 
2,207

 
—

 
2,207

 
 
 
2,207

Vesting of restricted stock units, net of taxes paid
118,716

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings
49,111

 
—

 
—

 
—

 
(166
)
 
—

 
(166
)
 
—

 
(166
)
Cancellation of treasury shares
(49,111
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Net income
—

 
—

 
—

 
—

 
—

 
11,770

 
11,770

 
14,357

 
26,127

At September 30, 2019
29,150,220

 
35,416,446

 
$
29

 
$
35

 
$
523,402

 
$
(179,087
)
 
$
344,379

 
$
495,352

 
$
839,731


7


 
Issued Shares
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Class A Common Stock
 
Class B Common Stock
 
Class A Common Stock
 
Class B Common Stock
 
Additional Paid-in Capital
 
Accumulated Deficit
 
Total Earthstone Energy, Inc. Equity
 
Noncontrolling Interest
 
Total Equity
At December 31, 2017
27,584,638

 
36,052,169

 
$
28

 
$
36

 
$
503,932

 
$
(224,822
)
 
$
279,174

 
$
446,558

 
$
725,732

Stock-based compensation expense
—

 
—

 
—

 
—

 
1,940

 
—

 
1,940

 
 
 
1,940

Vesting of restricted stock units, net of taxes paid
86,272

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings
28,664

 
—

 
—

 
—

 
(466
)
 
—

 
(466
)
 
—

 
(466
)
Cancellation of treasury shares
(28,664
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Class B Common Stock converted to Class A Common Stock
194,046

 
(194,046
)
 
—

 
—

 
2,409

 
—

 
2,409

 
(2,409
)
 
—

Net income
—

 
—

 
—

 
—

 
—

 
5,321

 
5,321

 
6,870

 
12,191

At March 31, 2018
27,864,956

 
35,858,123

 
$
28

 
$
36

 
$
507,815

 
$
(219,501
)
 
$
288,378

 
$
451,019

 
$
739,397

Stock-based compensation expense
—

 
—

 
—

 
—

 
2,073

 
—

 
2,073

 
 
 
2,073

Vesting of restricted stock units, net of taxes paid
255,313

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings
83,762

 
—

 
—

 
—

 
(648
)
 
—

 
(648
)
 
—

 
(648
)
Cancellation of treasury shares
(83,762
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Class B Common Stock converted to Class A Common Stock
11,195

 
(11,195
)
 
—

 
—

 
141

 
—

 
141

 
(141
)
 
—

Net income
—

 
—

 
—

 
—

 
—

 
650

 
650

 
822

 
1,472

At June 30, 2018
28,131,464

 
35,846,928

 
28

 
36

 
509,381

 
(218,851
)
 
290,594

 
451,700

 
742,294

Stock-based compensation expense
—

 
—

 
—

 
—

 
1,522

 
—

 
1,522

 
 
 
1,522

Vesting of restricted stock units, net of taxes paid
85,063

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings
30,511

 
—

 
—

 
—

 
(287
)
 
—

 
(287
)
 
—

 
(287
)
Cancellation of treasury shares
(30,511
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Class B Common Stock converted to Class A Common Stock
183,894

 
(183,894
)
 
—

 
—

 
2,344

 
—

 
2,344

 
(2,344
)
 
—

Net income
—

 
—

 
—

 
—

 
—

 
224

 
224

 
340

 
564

At September 30, 2018
28,400,421

 
35,663,034

 
$
28

 
$
36

 
$
512,960

 
$
(218,627
)
 
$
294,397

 
$
449,696

 
$
744,093

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

8

EARTHSTONE ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands) 
 
 
 
For the Nine Months Ended
September 30,
 
 
2019
 
2018
Cash flows from operating activities:
 
 
Net income
 
$
7,220

 
$
14,227

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Impairment of proved and unproved oil and gas properties
 
—

 
833

Depreciation, depletion and amortization
 
42,281

 
33,362

Accretion of asset retirement obligations
 
160

 
128

Settlement of asset retirement obligations
 
(179
)
 
(79
)
Loss (gain) on sale of oil and gas properties
 
446

 
(4,608
)
Total loss on derivative contracts, net
 
19,672

 
33,606

Operating portion of net cash received (paid) in settlement of derivative contracts
 
13,660

 
(13,643
)
Stock-based compensation
 
6,680

 
5,535

Deferred income taxes
 
728

 
119

Amortization of deferred financing costs
 
336

 
228

Changes in assets and liabilities:
 
 
 
 
(Increase) decrease in accounts receivable
 
(5,585
)
 
(1,476
)
(Increase) decrease in prepaid expenses and other current assets
 
(28
)
 
(372
)
Increase (decrease) in accounts payable and accrued expenses
 
(8,330
)
 
3,939

Increase (decrease) in revenues and royalties payable
 
(9,042
)
 
26,572

Increase (decrease) in advances
 
17,720

 
(1,816
)
Net cash provided by operating activities
 
85,739

 
96,555

Cash flows from investing activities:
 
 
 
 
Additions to oil and gas properties
 
(120,685
)
 
(120,124
)
Additions to office and other equipment
 
(379
)
 
(121
)
Proceeds from sales of oil and gas properties
 
2

 
5,840

Net cash used in investing activities
 
(121,062
)
 
(114,405
)
Cash flows from financing activities:
 
 
 
 
Proceeds from borrowings
 
165,272

 
70,308

Repayments of borrowings
 
(119,099
)
 
(60,308
)
Cash paid related to the exchange and cancellation of Class A Common Stock
 
(827
)
 
(1,402
)
Cash paid for finance leases
 
(355
)
 
—

Deferred financing costs
 
(228
)
 
(274
)
Net cash provided by financing activities
 
44,763

 
8,324

Net increase (decrease) in cash
 
9,440

 
(9,526
)
Cash at beginning of period
 
376

 
22,955

Cash at end of period
 
$
9,816

 
$
13,429

Supplemental disclosure of cash flow information
 
 
 
 
Cash paid for:
 
 
 
 
Interest
 
$
4,235

 
$
1,480

Non-cash investing and financing activities:
 
 
 
 
Accrued capital expenditures
 
$
50,615

 
$
11,314

Lease asset additions - ASC 842
 
$
4,710

 
$
—

Asset retirement obligations
 
$
43

 
$
(120
)
 The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

9

EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
Note 1. Basis of Presentation and Summary of Significant Accounting Policies
Earthstone Energy, Inc., a Delaware corporation ("Earthstone" and together with its consolidated subsidiaries, the "Company"), is a growth-oriented independent oil and natural gas development and production company. In addition, the Company is active in corporate mergers and the acquisition of oil and natural gas properties that have production and future development opportunities. The Company's operations are all in the upstream segment of the oil and natural gas industry and all its properties are onshore in the United States.
Earthstone is the sole managing member of Earthstone Energy Holdings, LLC, a Delaware limited liability company (together with its wholly-owned consolidated subsidiaries, “EEH”), with a controlling interest in EEH. Earthstone, together with its wholly-owned subsidiary, Lynden Energy Corp., a corporation organized under the laws of British Columbia (“Lynden Corp”), and Lynden Corp’s wholly-owned consolidated subsidiary, Lynden USA Inc., a Utah corporation (“Lynden US”) and also a member of EEH, consolidates the financial results of EEH and records a noncontrolling interest in the Condensed Consolidated Financial Statements representing the economic interests of EEH's members other than Earthstone and Lynden US.
The accompanying unaudited Condensed Consolidated Financial Statements and notes thereto have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial statements. Pursuant to such rules and regulations, certain disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted. The accompanying unaudited Condensed Consolidated Financial Statements and notes should be read in conjunction with the financial statements and notes included in Earthstone’s 2018 Annual Report on Form 10-K.
The information furnished herein reflects all adjustments that are, in the opinion of management, necessary for the fair presentation of the Company's financial position, results of operations and cash flows for the periods presented. The Company’s Condensed Consolidated Balance Sheet at December 31, 2018 is derived from the audited Consolidated Financial Statements at that date.
Recently Issued Accounting Standards
Leases – In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842): Amendments to the FASB Accounting Standards Codification (“ASU 2016-02”). In January 2018, the FASB issued ASU No. 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842 (“ASU 2018-01”). In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”). Together these related amendments to GAAP represent Accounting Standards Codification (“ASC”) Topic 842, Leases (“ASC Topic 842”).
ASU 2016-02 requires lessees to recognize lease assets and liabilities (with terms in excess of 12 months) on the balance sheet and disclose key quantitative and qualitative information about leasing arrangements. The Company completed a comprehensive assessment of existing contracts, as well as future potential contracts, to determine the impact of the new accounting guidance on its consolidated financial statements and related disclosures. The evaluation process included review of contracts for drilling rigs, office facilities, compression services, field vehicles and equipment, general corporate leased equipment, and other existing arrangements to support its operations that may contain a lease component. The Company's evaluation process did not include review of its mineral leases as they are outside the scope of ASC Topic 842.
The Company adopted this guidance on January 1, 2019, the transition date, using the simplified transition method described in ASU 2018-11 which allows entities to continue to apply historical accounting guidance in the comparative periods presented in the year of adoption. Accordingly, prior period amounts in our financial statements are not adjusted and continue to be reported in accordance with historical accounting guidance.
The Company elected the package of practical expedients within ASU 2016-02 that allows an entity to not reassess, prior to the effective date, (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases or (iii) initial direct costs for any existing leases. Additionally, the Company elected the practical expedient under ASU 2018-01 to not evaluate existing or expired land easements not previously accounted for as leases prior to the effective date.
The Company made an accounting policy election not to apply the lease recognition requirements to short-term leases.
The adoption of ASC Topic 842 did not have a material impact on the Company's financial statements, resulted in increases of less than 1% to each of its total assets and total liabilities on the balance sheet, and resulted in an immaterial decrease to accumulated deficit as of the beginning of 2019. See Note 14. Leases for further information.

10
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Intangibles - Goodwill and Other – In January 2017, the FASB issued updated guidance simplifying the test for goodwill impairment. The update eliminates Step 2 of the goodwill impairment test. Instead, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The update is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company is in the process of evaluating the impact of this guidance, if any, on its Consolidated Financial Statements.
Fair Value Measurements – In August 2018, the FASB issued an update which modifies the disclosure requirements on fair value measurements in Topic 820. The ASU is effective for fiscal years beginning after December 15, 2019 and early adoption is permitted. The Company is in the process of evaluating the impact of this update, if any, on its Consolidated Financial Statements.
Note 2. Fair Value Measurements
FASB ASC Topic 820, defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. ASC 820 provides a framework for measuring fair value, establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and requires consideration of the counterparty’s creditworthiness when valuing certain assets.
The three-level fair value hierarchy for disclosure of fair value measurements defined by ASC 820 is as follows:
Level 1 – Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. An active market is defined as a market where transactions for the financial instrument occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 – Inputs, other than quoted prices within Level 1, that are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
Level 3 – Prices or valuations that require unobservable inputs that are both significant to the fair value measurement and unobservable. Valuation under Level 3 generally involves a significant degree of judgment from management.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instrument’s complexity. The Company reflects transfers between the three levels at the beginning of the reporting period in which the availability of observable inputs no longer justifies classification in the original level. There were no transfers between fair value hierarchy levels for the nine months ended September 30, 2019.
Fair Value on a Recurring Basis
Derivative financial instruments are carried at fair value and measured on a recurring basis. The derivative financial instruments consist of swaps for crude oil and natural gas. The Company’s swaps are valued based on a discounted future cash flow model. The primary input for the model is published forward commodity price curves. The swaps are also designated as Level 2 within the valuation hierarchy.
The fair values of commodity derivative instruments in an asset position include a measure of counterparty nonperformance risk, and the fair values of commodity derivative instruments in a liability position include a measure of the Company’s nonperformance risk. These measurements were not material to the Condensed Consolidated Financial Statements.
The following table summarizes the fair value of the Company’s financial assets and liabilities, by level within the fair-value hierarchy (in thousands):

11
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 
September 30, 2019
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets
 
 
 
 
 
 
 
 
Derivative asset - current
 
$
—

 
$
20,179

 
$
—

 
$
20,179

Derivative asset - noncurrent
 
—

 
9,246

 
—

 
9,246

Total financial assets
 
$
—

 
$
29,425

 
$
—

 
$
29,425

 
 
 
 
 
 
 
 
 
Financial liabilities
 
 
 
 
 
 
 
 
Derivative liability - current
 
$
—

 
$
137

 
$
—

 
$
137

Derivative liability - noncurrent
 
—

 
29

 
—

 
29

Total financial liabilities
 
$
—

 
$
166

 
$
—

 
$
166

 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
Financial assets
 
 
 
 
 
 
 
 
Derivative asset - current
 
$
—

 
$
43,888

 
$
—

 
$
43,888

Derivative asset - noncurrent
 


 
21,121

 


 
21,121

Total financial assets
 
$
—

 
$
65,009

 
$
—

 
$
65,009

 
 
 
 
 
 
 
 
 
Financial liabilities
 
 
 
 
 
 
 
 
Derivative liability - current
 
$
—

 
$
528

 
$
—

 
$
528

Derivative liability - noncurrent
 
—

 
1,891

 
—

 
1,891

Total financial liabilities
 
$
—

 
$
2,419

 
$
—

 
$
2,419

 
 
 
 
 
 
 
 
 
Other financial instruments include cash, accounts receivable and payable, and revenue royalties. The carrying amount of these instruments approximates fair value because of their short-term nature. The Company’s long-term debt obligation bears interest at floating market rates, therefore carrying amounts and fair value are approximately equal.
Fair Value on a Nonrecurring Basis
The Company applies the provisions of the fair value measurement standard on a non-recurring basis to its non-financial assets and liabilities, including oil and gas properties, goodwill, business combinations, asset retirement obligations and performance units. These assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances as described in the Notes to Consolidated Financial Statements included in Earthstone’s 2018 Annual Report on Form 10-K.
Note 3. Derivative Financial Instruments
The Company’s hedging activities consist of derivative instruments entered into in order to hedge against changes in oil and natural gas prices through the use of fixed price swap agreements. Swaps exchange floating price risk in the future for a fixed price at the time of the hedge. Consistent with its hedging policy, the Company has entered into a series of derivative instruments to hedge a significant portion of its expected oil and natural gas production through December 31, 2021. Typically, these derivative instruments require payments to (receipts from) counterparties based on specific indices as required by the derivative agreements. Although not risk free, the Company believes these instruments reduce its exposure to oil and natural gas price fluctuations and, thereby, allow the Company to achieve a more predictable cash flow.
The Company’s derivative instruments are cash flow hedge transactions in which it is hedging the variability of cash flow related to a forecasted transaction. The Company does not enter into derivative instruments for trading or other speculative purposes. These transactions are recorded in the Condensed Consolidated Financial Statements in accordance with FASB ASC Topic 815. The Company has accounted for these transactions using the mark-to-market accounting method. Generally, the Company incurs accounting losses on derivatives during periods where prices are rising and gains during periods where prices are falling which may cause significant fluctuations in the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Operations.

12
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Company nets its derivative instrument fair value amounts executed with each counterparty pursuant to an International Swap Dealers Association Master Agreement (“ISDA”), which provides for net settlement over the term of the contract. The ISDA is a standard contract that governs all derivative contracts entered into between the Company and the respective counterparty. The ISDA allows for offsetting of amounts payable or receivable between the Company and the counterparty, at the election of both parties, for transactions that occur on the same date and in the same currency.
The Company had the following open crude oil and natural gas derivative contracts as of September 30, 2019:    
 
 
Price Swaps
Period
 
Commodity
 
Volume
(Bbls / MMBtu)
 
Weighted Average Price
($/Bbl / $/MMBtu)
Q4 2019
 
Crude Oil
 
671,600

 
$
64.31

Q1 - Q4 2020
 
Crude Oil
 
2,562,000

 
$
61.26

Q1 - Q4 2021
 
Crude Oil
 
730,000

 
$
55.00

Q4 2019
 
Crude Oil Basis Swap(1)
 
506,000

 
$
(5.29
)
Q4 2019
 
Crude Oil Basis Swap(2)
 
92,000

 
$
4.50

Q1 - Q4 2020
 
Crude Oil Basis Swap(1)
 
2,562,000

 
$
(1.40
)
Q1 - Q4 2021
 
Crude Oil Basis Swap(1)
 
730,000

 
$
0.85

Q4 2019
 
Natural Gas
 
782,000

 
$
2.85

Q1 - Q4 2020
 
Natural Gas
 
2,562,000

 
$
2.85

Q4 2019
 
Natural Gas Basis Swap(3)
 
782,000

 
$
(1.15
)
Q1 - Q4 2020
 
Natural Gas Basis Swap(3)
 
2,562,000

 
$
(1.07
)
(1)
The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.
(2)
The basis differential price is between LLS Argus Crude and the WTI NYMEX.
(3)
The basis differential price is between W. Texas (WAHA) and the Henry Hub NYMEX.
The following table summarizes the location and fair value amounts of all derivative instruments in the Condensed Consolidated Balance Sheets as well as the gross recognized derivative assets, liabilities, and amounts offset in the Condensed Consolidated Balance Sheets (in thousands): 
 
 
 
 
September 30, 2019
 
December 31, 2018
Derivatives not
designated as hedging
contracts under ASC
Topic 815
 
Balance Sheet Location
 
Gross
Recognized
Assets /
Liabilities
 
Gross
Amounts
Offset
 
Net
Recognized
Assets /
Liabilities
 
Gross
Recognized
Assets /
Liabilities
 
Gross
Amounts
Offset
 
Net
Recognized
Assets /
Liabilities
Commodity contracts
 
Derivative asset - current
 
$
27,014

 
$
(6,835
)
 
$
20,179

 
$
48,662

 
$
(4,774
)
 
$
43,888

Commodity contracts
 
Derivative liability - current
 
$
6,972

 
$
(6,835
)
 
$
137

 
$
5,302

 
$
(4,774
)
 
$
528

Commodity contracts
 
Derivative asset - noncurrent
 
$
10,650

 
$
(1,404
)
 
$
9,246

 
$
23,605

 
$
(2,484
)
 
$
21,121

Commodity contracts
 
Derivative liability - noncurrent
 
$
1,433

 
$
(1,404
)
 
$
29

 
$
4,375

 
$
(2,484
)
 
$
1,891


13
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table summarizes the location and amounts of the Company’s realized and unrealized gains and losses on derivatives instruments in the Condensed Consolidated Statements of Operations and Condensed Consolidated Statements of Cash Flows (in thousands): 
Derivatives not designated as hedging contracts under ASC Topic 815
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
Statement of Cash Flows Location
 
Statement of Operations Location
 
2019
 
2018
 
2019
 
2018
Unrealized gain (loss)
 
Not separately presented
 
Not separately presented
 
$
15,021

 
$
(13,105
)
 
$
(33,332
)
 
$
(19,963
)
Realized gain (loss)
 
Operating portion of net cash paid in settlement of derivative contracts
 
Not separately presented
 
3,705

 
(4,376
)
 
13,660

 
(13,643
)
 
 
Total gain (loss) on derivative contracts, net
 
Gain (loss) on derivative contracts, net
 
$
18,726

 
$
(17,481
)
 
$
(19,672
)
 
$
(33,606
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Note 4. Oil and Natural Gas Properties
The Company follows the successful efforts method of accounting for its oil and natural gas properties. Under this method, costs to acquire oil and natural gas properties, drill and equip exploratory wells that find proved reserves, and drill and equip development wells are capitalized. Exploration costs, including unsuccessful exploratory wells and geological and geophysical costs, are charged to operations as incurred. Upon sale or retirement of oil and natural gas properties, the costs and related accumulated depreciation, depletion and amortization are eliminated from the accounts and the resulting gain or loss is recognized.
Costs incurred to maintain wells and related equipment, lease and well operating costs, and other exploration costs are charged to expense as incurred. Gains and losses arising from the sale of properties are included in Income from operations in the Condensed Consolidated Statements of Operations.
The Company’s lease acquisition costs and development costs of proved oil and natural gas properties are amortized using the units-of-production method, at the field level, based on total proved reserves and proved developed reserves, respectively. For the three and nine months ended September 30, 2019, depletion expense for oil and gas producing property and related equipment was $13.9 million and $41.7 million, respectively. For the three and nine months ended September 30, 2018, depletion expense for oil and gas producing property and related equipment was $12.7 million and $33.0 million, respectively.
Proved Properties
Proved oil and natural gas properties are reviewed for impairment on a nonrecurring basis. The impairment charge reduces the carrying values to their estimated fair values. These fair value measurements are classified as Level 3 measurements and include many unobservable inputs. Fair value is calculated as the estimated discounted future net cash flows attributable to the assets. The Company’s primary assumptions in preparing the estimated discounted future net cash flows to be recovered from oil and gas properties are based on (i) proved reserves, (ii) forward commodity prices and assumptions as to costs and expenses, and (iii) the estimated discount rate that would be used by potential purchasers to determine the fair value of the assets.
Unproved Properties
Unproved properties consist of costs incurred to acquire undeveloped leases. Unproved oil and gas leases are generally for a primary term of three to five years. In most cases, the term of the unproved leases can be extended by paying a lease renewal fee, meeting contractual drilling obligations, or by the presence of producing wells on the leases. Unproved costs related to successful drilling on unproved leases are reclassified to proved properties.
The Company reviews its unproved properties periodically for impairment. In determining whether an unproved property is impaired, the Company considers numerous factors including, but not limited to, current exploration and development plans, favorable or unfavorable exploration activity on the property being evaluated and/or adjacent properties, the Company’s geologists' evaluation of the property, and the remaining months in the lease term for the property.
Impairments to Oil and Natural Gas Properties
During the three and nine months ended September 30, 2019, the Company did not record any impairments to its oil and natural

14
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

gas properties. During the three and nine months ended September 30, 2018, the Company recorded an impairment of $0.8 million to its unproved oil and natural gas properties as a result of acreage expirations in its properties located in the Eagle Ford Trend of south Texas.
Note 5. Noncontrolling Interest
Earthstone consolidates the financial results of EEH and its subsidiaries and records a noncontrolling interest for the economic interest in Earthstone held by the members of EEH other than Earthstone and Lynden US. Net income attributable to noncontrolling interest in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2019 and 2018 represents the portion of net income attributable to the economic interest in the Company held by the members of EEH other than Earthstone and Lynden US. Noncontrolling interest in the Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018 represents the portion of net assets of the Company attributable to the members of EEH other than Earthstone and Lynden US.
The following table presents the changes in noncontrolling interest for the nine months ended September 30, 2019: 
 
 
EEH Units Held
By Earthstone
and Lynden US
 
%
 
EEH Units Held
By Others
 
%
 
Total EEH
Units
Outstanding
As of December 31, 2018
 
28,696,321

 
44.7
%
 
35,452,178

 
55.3
%
 
64,148,499

EEH Units and Class B Common Stock converted to Class A Common Stock
 
35,732

 
 
 
(35,732
)
 
 
 
—

EEH Units issued in connection with the vesting of restricted stock units
 
418,167

 
 
 
—

 
 
 
418,167

As of September 30, 2019
 
29,150,220

 
45.1
%
 
35,416,446

 
54.9
%
 
64,566,666

 
 
 
 
 
 
 
 
 
 
 
Note 6. Net Income Per Common Share
Net income per common share—basic is calculated by dividing Net income by the weighted average number of shares of common stock outstanding during the period. Net income per common share—diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing Net income by the sum of the weighted average number of shares of common stock, as defined above, outstanding plus potentially dilutive securities. Net income per common share—diluted considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares, as defined above, would have an anti-dilutive effect.
A reconciliation of Net income per common share is as follows:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(In thousands, except per share amounts)
 
2019
 
2018
 
2019
 
2018
Net income attributable to Earthstone Energy, Inc.
 
$
11,770

 
$
224

 
$
3,343

 
$
6,195

 
 
 
 
 
 
 
 
 
Net income per common share attributable to Earthstone Energy, Inc.:
 
 
 
 
 
 
 
 
Basic
 
$
0.41

 
$
0.01

 
$
0.12

 
$
0.22

Diluted
 
$
0.41

 
$
0.01

 
$
0.12

 
$
0.22

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
 
 
 
 
 
 
Basic
 
29,032,842

 
28,257,376

 
28,883,907

 
28,011,298

Add potentially dilutive securities:
 
 
 
 
 
 
 
 
Unvested restricted stock units
 
—

 
54,383

 
—

 
97,067

Unvested performance units
 
—

 
—

 
—

 
—

Diluted weighted average common shares outstanding
 
29,032,842

 
28,311,759

 
28,883,907

 
28,108,365

 
 
 
 
 
 
 
 
 

15
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and net income attributable to noncontrolling interest of $14.4 million for the three months ended September 30, 2019 and net income attributable to noncontrolling interest of $3.9 million for the nine months ended September 30, 2019 would be added back to Net income attributable to Earthstone Energy, Inc. for the periods then ended, having no dilutive effect on Net income per common share attributable to Earthstone Energy, Inc.
Note 7. Common Stock
Class A Common Stock
At September 30, 2019 and December 31, 2018, there were 29,150,220 and 28,696,321 shares of Class A Common Stock issued and outstanding, respectively. During the three and nine months ended September 30, 2019, as a result of the vesting and settlement of restricted stock units under the Earthstone Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan (the "2014 Plan"), Earthstone issued 167,827 and 569,883 shares, respectively, of Class A Common Stock, of which 49,111 and 151,716 shares, respectively, of Class A Common Stock were retained as treasury stock and canceled to satisfy the related employee income tax liability. During the three and nine months ended September 30, 2018, as a result of the vesting and settlement of restricted stock units under the 2014 Plan, Earthstone issued 115,574 and 569,585 shares, respectively, of Class A Common Stock, of which 30,511 and 142,937 shares, respectively, of Class A Common Stock were retained as treasury stock and canceled to satisfy the related employee income tax liability.
Class B Common Stock
At September 30, 2019 and December 31, 2018, there were 35,416,446 and 35,452,178 shares of Class B Common Stock issued and outstanding, respectively. Each share of Class B Common Stock, together with one EEH Unit, is convertible into one share of Class A Common Stock. No shares were converted during the three months ended September 30, 2019. During the nine months ended September 30, 2019, 35,732 shares of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock. During the three and nine months ended September 30, 2018, 183,894 and 389,135 shares, respectively, of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock.
Note 8. Stock-Based Compensation
Restricted Stock Units
The 2014 Plan, allows, among other things, for the grant of restricted stock units ("RSUs"). As of September 30, 2019, the maximum number of shares of Class A Common Stock that may be issued under the 2014 Plan was 6.4 million shares.
Each RSU represents the contingent right to receive one share of Class A Common Stock. The holders of outstanding RSUs do not receive dividends or have voting rights prior to vesting and settlement. The Company determines the fair value of granted RSUs based on the market price of the Class A Common Stock on the date of the grant. Compensation expense for granted RSUs is recognized on a straight-line basis over the vesting and is net of forfeitures, as incurred. Stock-based compensation is included in General and administrative expense in the Condensed Consolidated Statements of Operations and is recorded with a corresponding increase in Additional paid-in capital within the Condensed Consolidated Balance Sheets.
The table below summarizes RSU award activity for the nine months ended September 30, 2019:
 
 
Shares
 
Weighted-Average Grant Date Fair Value
Unvested RSUs at December 31, 2018
 
810,995

 
$
8.83

Granted
 
762,350

 
$
6.39

Forfeited
 
(23,084
)
 
$
7.64

Vested
 
(569,883
)
 
$
8.14

Unvested RSUs at September 30, 2019
 
980,378

 
$
7.36

 
 
 
 
 
As of September 30, 2019, there was $6.9 million of unrecognized compensation expense related to the RSU awards which will be recognized over a weighted average period of 0.94 years.

16
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

For the three and nine months ended September 30, 2019, Stock-based compensation related to RSUs was $1.4 million and $4.5 million, respectively. For the three and nine months ended September 30, 2018, Stock-based compensation related to RSUs was $1.2 million and $4.9 million, respectively.
Performance Units
The table below summarizes performance unit (“PSU”) activity for the nine months ended September 30, 2019:
 
 
Shares
 
Weighted-Average Grant Date Fair Value
Unvested PSUs at December 31, 2018
 
252,500

 
$
13.75

Granted
 
669,550

 
$
9.30

Unvested PSUs at September 30, 2019
 
922,050

 
$
10.52

 
 
 
 
 
On January 28, 2019, the Board of Directors of Earthstone (the "Board") granted 669,550 PSUs to certain executive officers pursuant to the 2014 Plan. The PSUs are payable in shares of Class A Common Stock based upon the achievement by the Company over a period commencing on February 1, 2019 and ending on January 31, 2022 (the “Performance Period”) of performance criteria established by the Board.  
The number of shares of Class A Common Stock that may be issued will be determined by multiplying the number of PSUs granted by the Relative Total Shareholder Return ("TSR") Percentage (0% to 200%).  The “Relative TSR Percentage” is the percentage, if any, achieved by attainment of a certain predetermined range of targets for the Performance Period.
TSR for the Company and each of the peer companies is generally determined by dividing (A) the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the last calendar day of the Performance Period minus the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the first day of the Performance Period plus cash dividends paid over the Performance Period by (B) the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the first day of the Performance Period.
The Company accounts for these awards as market-based awards which are valued utilizing the Monte Carlo Simulation pricing model, which calculates multiple potential outcomes for an award and establishes grant date fair value based on the most likely outcome. For the PSUs granted on January 28, 2019, assuming a risk-free rate of 2.6% and volatilities ranging from 40.1% to 114.1%, the Company calculated the weighted average grant date fair value per PSU to be $9.30.
As of September 30, 2019, there was $6.5 million of unrecognized compensation expense related to the PSU awards which will be amortized over a weighted average period of 1.09 years.
For the three and nine months ended September 30, 2019, Stock-based compensation related to the PSUs was approximately $0.8 million and $2.2 million, respectively. For the three and nine months ended September 30, 2018, Stock-based compensation related to the PSUs was approximately $0.3 million and $0.7 million, respectively.
Note 9. Long-Term Debt
Credit Agreement
In May, 2017, Earthstone Energy Holdings, LLC (“EEH” or the “Borrower”), a subsidiary of Earthstone, each of Earthstone Operating, LLC, EF Non-Op, LLC, Sabine River Energy, LLC, Earthstone Legacy Properties, LLC, Lynden USA Operating, LLC, Bold Energy III LLC ("Bold"), Bold Operating, LLC, as guarantors (the “Guarantors”), BOKF, NA dba Bank Of Texas, as Agent and Lead Arranger, Wells Fargo Bank, National Association, as Syndication Agent, and the lenders party thereto (the “Lenders”), entered into a credit agreement (as amended, modified or restated from time to time, the “EEH Credit Agreement”).
The borrowing base under the EEH Credit Agreement is subject to redetermination on or about May 1st and November 1st of each year. The amounts borrowed under the EEH Credit Agreement bear annual interest rates at either (a) the London Interbank Offered Rate (“LIBOR”) plus 1.75% to 2.75% or (b) the prime lending rate of Bank of Texas plus 0.75% to 1.75%, depending on the amounts borrowed under the EEH Credit Agreement. Principal amounts outstanding under the EEH Credit Agreement are due and payable in full at maturity on May 9, 2022. All of the obligations under the EEH Credit Agreement, and the guarantees of those obligations, are secured by substantially all of EEH’s assets. Additional payments due under the EEH Credit Agreement include

17
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

paying a commitment fee of 0.375% or 0.50%, depending on borrowing base utilization, per year to the Lenders in respect of the unutilized commitments thereunder, as well as certain other customary fees.
The EEH Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, EEH’s ability to incur additional indebtedness, create liens on assets, make investments, enter into sale and leaseback transactions, pay dividends and make distributions or repurchase its limited liability interests, engage in mergers or consolidations, sell certain assets, sell or discount any notes receivable or accounts receivable and engage in certain transactions with affiliates.
In addition, the EEH Credit Agreement requires EEH to maintain the following financial covenants: a current ratio, as defined by the EEH Credit Agreement, of not less than 1.0 to 1.0 and a leverage ratio of not greater than 4.0 to 1.0. Leverage ratio means the ratio of (i) the aggregate debt of EEH and its consolidated subsidiaries as at the last day of the fiscal quarter (excluding any debt from obligations relating to non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives) to (ii) the product of EBITDAX for such fiscal quarter multiplied by four. The term “EBITDAX” means, for any period, the sum of consolidated net income for such period plus (a) the following expenses or charges to the extent deducted from consolidated net income in such period: (i) interest, (ii) taxes, (iii) depreciation, (iv) depletion, (v) amortization, (vi) non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives, (vii) exploration expenses, (viii) impairment expenses, and (ix) non-cash compensation expenses and minus (b) to the extent included in consolidated net income in such period, non-cash gains under FASB ASC 815 as a result of changes in the fair market value of derivatives.
The EEH Credit Agreement contains customary affirmative covenants and defines events of default to include failure to pay principal or interest, breach of covenants, breach of representations and warranties, insolvency, judgment default, and if Frank A. Lodzinski ceases to serve and function as Chief Executive Officer of EEH and the majority of the Lenders do not approve of Mr. Lodzinski’s successor. Upon the occurrence and continuance of an event of default, the Lenders have the right to accelerate repayment of the loans and exercise their remedies with respect to the collateral. As of September 30, 2019, EEH was in compliance with the covenants under the EEH Credit Agreement.       
On May 1, 2019, the borrowing base under the EEH Credit Agreement was increased from $275.0 million to $325.0 million. As of September 30, 2019, $125.0 million of borrowings were outstanding, bearing annual interest of 4.044%, resulting in an additional $200.0 million of borrowing base availability under the EEH Credit Agreement. At December 31, 2018, there were $78.8 million of borrowings outstanding under the EEH Credit Agreement.
For the nine months ended September 30, 2019, the Company had borrowings of $165.3 million and $119.1 million in repayments of borrowings.
For the three and nine months ended September 30, 2019, interest on borrowings averaged 4.38% and 4.53% per annum, respectively, which excluded commitment fees of $0.2 million and $0.5 million, respectively, and amortization of deferred financing costs of $0.1 million and $0.3 million, respectively. For the three and nine months ended September 30, 2018, interest on borrowings averaged 3.94% and 3.91% per annum, respectively, which excluded commitment fees of $0.1 million and $0.6 million, respectively, and amortization of deferred financing costs of $0.1 million and $0.2 million, respectively.  
During the three and nine months ended September 30, 2019, $0.04 million and $0.2 million, respectively, of costs associated with the EEH Credit Agreement were capitalized. During the three and nine months ended September 30, 2018, the Company capitalized $0.1 million and $0.3 million, respectively, of costs associated with the EEH Credit Agreement. These capitalized costs are included in Other noncurrent assets in the Condensed Consolidated Balance Sheets. The Company’s policy is to capitalize the financing costs associated with its debt and amortize those costs on a straight-line basis over the term of the associated debt.  
Note 10. Asset Retirement Obligations
The Company has asset retirement obligations associated with the future plugging and abandonment of oil and gas properties and related facilities. Revisions to the liability typically occur due to changes in the estimated abandonment costs, well economic lives, and the discount rate.

18
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table summarizes the Company’s asset retirement obligation transactions recorded during the nine months ended September 30, (in thousands): 
 
 
2019
Beginning asset retirement obligations
 
$
2,229

Liabilities incurred
 
43

Liabilities settled
 
(179
)
Accretion expense
 
160

Ending asset retirement obligations
 
$
2,253

 
 
 
 
Note 11. Related Party Transactions
 FASB ASC Topic 850, Related Party Disclosures, requires that information about transactions with related parties that would make a difference in decision making shall be disclosed so that users of the financial statements can evaluate their significance.
 Flatonia Energy, LLC (“Flatonia”), which owns approximately 10.1% of the outstanding Class A Common Stock and approximately 4.6% of the combined voting power of the Company's outstanding Class A and Class B Common Stock as of September 30, 2019, is a party to a joint operating agreement (the “Operating Agreement”) with the Company. The Operating Agreement covers certain jointly owned oil and natural gas properties located in the Eagle Ford Trend in Texas. In connection with the Operating Agreement, the Company made payments to Flatonia of $3.8 million and $12.1 million and received payments from Flatonia of $2.0 million and $4.9 million for the three and nine months ended September 30, 2019, respectively. For the three and nine months ended September 30, 2018, the Company made payments to Flatonia of $0.0 million and $12.4 million and received payments from Flatonia of $0.7 million and $4.8 million, respectively. At September 30, 2019 and December 31, 2018, amounts receivable from Flatonia in connection with the Operating Agreement were $0.3 million and $0.8 million, respectively. Payables related to revenues outstanding and due to Flatonia as of September 30, 2019 and December 31, 2018 were $1.1 million and $1.6 million, respectively.
Earthstone's majority shareholder consists of various investment funds managed by a venture capital firm who may manage other investments in entities with which the Company interacts in the normal course of business. On October 31, 2019, the Company sold certain of its interests in oil and natural gas leases and wells located in Martin County, Texas in an arm’s length transaction to a portfolio company of Earthstone’s majority shareholder for cash consideration of approximately $3.6 million.
Note 12. Commitments and Contingencies  
Legal
From time to time, the Company and its subsidiaries may be involved in various legal proceedings and claims in the ordinary course of business.
Olenik v. Lodzinksi et al.:  On June 2, 2017, Nicholas Olenik filed a purported shareholder class and derivative action in the Delaware Court of Chancery against Earthstone’s Chief Executive Officer, along with other members of the Board, EnCap Investments L.P. ("EnCap"), Bold, Bold Energy Holdings, LLC ("Bold Holdings") and Oak Valley Resources, LLC. The complaint alleges that Earthstone’s directors breached their fiduciary duties in connection with the contribution dated as of November 7, 2016 and as amended on March 21, 2017 (the "Bold Contribution Agreement"), by and among Earthstone, EEH, Lynden US, Lynden USA Operating, LLC, Bold Holdings and Bold. The Plaintiff asserts that the directors negotiated the Bold Transaction to benefit EnCap and its affiliates, failed to obtain adequate consideration for the Earthstone shareholders who were not affiliated with EnCap or Earthstone management, did not follow an adequate process in negotiating and approving the Bold Transaction and made materially misleading or incomplete proxy disclosures in connection with the Bold Transaction. The suit seeks unspecified damages and purports to assert claims derivatively on behalf of Earthstone and as a class action on behalf of all persons who held Common Stock up to March 13, 2017, excluding defendants and their affiliates. On July 20, 2018, the Delaware Court of Chancery granted the defendants' motion to dismiss and entered an order dismissing the action in its entirety with prejudice. The Plaintiff filed an appeal with the Delaware Supreme Court. On February 6, 2019, the Delaware Supreme Court heard oral arguments from the Plaintiff and Defendants' counsel. On April 5, 2019, the Delaware Supreme Court affirmed the Delaware Court of Chancery’s dismissal of the proxy disclosure claims but reversed the Delaware Court of Chancery’s dismissal of the other claims, holding that the allegations with respect to those claims were sufficient for pleading purposes. Earthstone and each of the other defendants believe the claims are entirely without merit and intend to mount a vigorous defense. The ultimate outcome of this suit is uncertain,

19
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

and while Earthstone is confident in its position, any potential monetary recovery or loss to Earthstone cannot be estimated at this time.
Environmental and Regulatory
As of September 30, 2019, there were no known environmental or other regulatory matters related to the Company’s operations that are reasonably expected to result in a material liability to the Company.
Note 13. Income Taxes
The Company’s corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns and one Canadian income tax return which include Lynden US, Earthstone, and Lynden Corp. As such, taxable income of Earthstone cannot be offset by tax attributes, including net operating losses, of Lynden US, nor can taxable income of Lynden US be offset by tax attributes of Earthstone. Earthstone and Lynden US record a tax provision, respectively, for their share of the book income or loss of EEH, net of the non-controlling interest. As EEH is treated as a partnership for U.S. Federal income tax purposes, it is not subject to income tax at the federal level and only recognizes the Texas Margin Tax.
During the nine months ended September 30, 2019, the Company recorded income tax expense of approximately $0.7 million which included (1) income tax expense for Lynden US of $0.1 million as a result of its share of the distributable income from EEH, (2) deferred income tax expense for Earthstone of $0.6 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.6 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended September 30, 2019.
During the nine months ended September 30, 2018, the Company recorded income tax expense of approximately $0.1 million which included (1) income tax expense for Lynden US of $0.3 million as a result of its share of the distributable income from EEH, offset by a $0.5 million discrete income tax benefit related to refundable AMT tax credits resulting from the Tax Cuts and Jobs Act ("TCJA"), (2) income tax expense for Earthstone of $1.1 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.3 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended September 30, 2018.
Note 14. Leases
Our operating lease activities consist of leases for office space. Our finance lease activities consist of leases for vehicles. Leases with an initial term of 12 months or less are not recorded on the balance sheet. Most leases include one or more options to renew, with renewal terms generally ranging from one to three years. The exercise of lease renewal options is at our sole discretion. Certain leases also include options to purchase the leased property. The depreciable life of assets and leasehold improvements is limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain of exercise. None of our lease agreements include variable lease payments. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. See discussion of the January 1, 2019 implementation impact at Note 1. Basis of Presentation and Summary of Significant Accounting Policies.
Supplemental balance sheet information as of September 30, 2019 for our leases is as follows (in thousands):

20
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

Leases
 
Balance Sheet Location
 
 
Assets
 
 
 
 
Noncurrent:
 
 
 
 
Operating
 
Operating lease right-of-use assets
 
$
3,295

Finance
 
Office and other equipment, net of accumulated depreciation and amortization
 
630

Total lease assets
 
 
 
$
3,925

 
 
 
 
 
Liabilities
 
 
 
 
Current:
 
 
 
 
Operating
 
Operating lease liabilities
 
$
586

Finance
 
Finance lease liabilities
 
256

Noncurrent:
 
 
 
 
Operating
 
Operating lease liabilities
 
2,722

Finance
 
Finance lease liabilities
 
111

Total lease liabilities
 
 
 
$
3,675

 
 
 
 
 
*The difference between assets and liabilities includes a $0.1 million adjustment to NCI and a $0.07 million adjustment to accumulated deficit, both at the beginning of the period as part of the ASC 842 implementation adjustment.
Our operating lease expenses for the three and nine months ended September 30, 2019 were $0.2 million and $0.6 million, respectively, and are included in General and administrative expense in our Condensed Consolidated Statements of Operations. Our finance lease expenses for the three and nine months ended September 30, 2019 were $0.1 million and $0.3 million, respectively, and are included in depreciation, depletion and amortization expense and interest expense, net in our Condensed Consolidated Statements of Operations. Additionally, we capitalized as part of oil and gas properties $2.6 million and $6.7 million of short-term lease costs related to drilling rig contracts during the three and nine months ended September 30, 2019. All of our drilling rig contracts have enforceable terms of less than one year.
Minimum contractual obligations for our leases (undiscounted) as of September 30, 2019 are as follows (in thousands):
 
 
Operating
 
Finance
2019 (excluding nine months ended September 30, 2019)
 
$
207

 
$
81

2020
 
632

 
219

2021
 
791

 
84

2022
 
696

 
5

2023
 
596

 
—

Thereafter
 
757

 
—

Total lease payments
 
$
3,679

 
$
389

Less imputed interest
 
(371
)
 
(22
)
Total lease liability
 
$
3,308

 
$
367

 
 
 
 
 
Cash payments for our operating leases were $0.2 million and $0.6 million, respectively, for the three and nine months ended September 30, 2019. Cash payments for our finance leases were $0.1 million and $0.4 million, respectively, for the three and nine months ended September 30, 2019. For the three and nine months ended September 30, 2019 there were $2.6 million and $3.2 million of right-of-use assets obtained in exchange for lease obligations for our operating leases. The amounts related to our finance leases were not material to our consolidated financial statements.
As of September 30, 2019, the weighted average remaining lease terms of our operating and finance leases were 2.2 years and 1.6 years, respectively. The weighted average discount rates used to determine the lease liabilities as of September 30, 2019 for our operating and finance leases were 4.35% and 6.69%, respectively. The discount rate used for operating leases is based on the Company's incremental borrowing rate. The discount rate used for finance leases is based on the rates implicit in the leases.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

Statement Regarding Forward-Looking Information
This discussion and other items in this Quarterly Report on Form 10-Q contain forward-looking statements and information that are based on management’s beliefs, as well as assumptions made by, and information currently available to, management. When used in this document, the words “believe,” “anticipate,” “estimate,” “expect,” “intend,” “may,” “will,” “project,” “forecast,” “plan,” and similar expressions are intended to identify forward-looking statements. Although management believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to have been correct. These statements are subject to numerous risks, uncertainties and assumptions. Certain of these risks are summarized in this report and under “Item 1A. Risk Factors” in our 2018 Annual Report on Form 10-K that was filed with the Securities and Exchange Commission (“SEC”), which you should read carefully in connection with our forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated. We undertake no obligation to release publicly any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
You should read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in conjunction with the corresponding sections and our audited consolidated financial statements for the year ended December 31, 2018, which are included in our 2018 Annual Report on Form 10-K.
Overview
Earthstone Energy, Inc., a Delaware corporation ("Earthstone" and together with our consolidated subsidiaries, the "Company," "our," "we," "us," or similar terms), is a growth-oriented independent oil and gas company engaged in the acquisition and development of oil and gas reserves through activities that include the acquisition, drilling and development of undeveloped leases, asset and corporate acquisitions and mergers. Our operations are all in the upstream segment of the oil and natural gas industry and all our properties are onshore in the United States. At present, our primary assets are located in the Midland Basin of west Texas and the Eagle Ford Trend of south Texas.
Our primary focus is concentrated in the Midland Basin of west Texas where our acreage has multiple stacked pay intervals in the Wolfcamp and, to a lesser extent, the Spraberry formations. We believe the Midland Basin area is characterized by high oil and liquids-rich natural gas content, multiple vertical and horizontal target horizons and high drilling success rates.
Earthstone is the sole managing member of Earthstone Energy Holdings, LLC, a Delaware limited liability company (together with its wholly-owned consolidated subsidiaries, “EEH”), with a controlling interest in EEH. Earthstone, together with its wholly-owned subsidiary, Lynden Energy Corp., a corporation organized under the laws of British Columbia (“Lynden Corp”), and Lynden Corp’s wholly-owned consolidated subsidiary, Lynden USA Inc., a Utah corporation (“Lynden US”) and also a member of EEH, consolidates the financial results of EEH and records a noncontrolling interest in the Condensed Consolidated Financial Statements representing the economic interests of EEH's members other than Earthstone and Lynden US.
Management’s Plans
Our plans include a continued focus on the Midland Basin through the development of our properties and by further expansion of our acreage footprint as an operator. Our development program for 2019 presently includes drilling approximately 19.0 gross/14.7 net operated wells and completing 17.0 gross/12.6 net of these operated wells. In addition, we have assumed participating in drilling 20.0 gross/5.0 net wells and completing 5.0 gross/2.0 net wells where we have a non-operated working interest. At our Eagle Ford Trend properties, our development program includes drilling 10.0 gross/5.1 net operated wells and completing all of these operated wells. In order to achieve these plans, we have an approved annual budget of $205.0 million. Commodity prices continue to be volatile and we intend to be vigilant to adjust our business plans accordingly.
In addition to our capital development program for 2019, our plans also include an acreage expansion program that includes looking for opportunities where we can trade acreage with other operators or bolt on acreage through acquisitions. Our intent is to increase our overall operated locations and allow us to develop our acreage with long horizontal laterals (7,500 to 12,000+ foot lateral lengths). We will also remain active in seeking M&A transactions in this high economic return geographic area.
Areas of Operation
Our primary focus is concentrated in the Midland Basin of west Texas, a high oil and liquids rich resource which provides us with multiple horizontal targets with proven production results, long-lived reserves and historically high drilling success rates.

22

Midland Basin
We completed 21 gross wells (8.0 gross/6.3 net operated and 13.0 gross/2.8 net non-operated) and spud an additional 30 gross wells (12.0 gross/12.0 net operated and 18.0 gross/4.5 net non-operated) through the first three quarters of 2019. We currently expect to complete approximately 9.0 gross/6.4 net operated wells in the fourth quarter of 2019. We intend to continue to initiate completion activities when we accumulate an adequate inventory of wells for efficient operations.
In July 2019, we entered into a Wellbore Development Agreement ("WDA") with a non-affiliated industry partner. This WDA will reduce our working interest in certain wells in Reagan County. The industry partner is obligated to pay a promoted (proportionately higher) share of the capital expenditures on an initial eight wells, with an option to participate, on the same basis, in up to 11 additional wells, to earn 35% of the working interest in these wells. Earned working interest is in the wellbore only and the industry partner does not earn rights to any of the acreage or adjacent targets.
Commencing in early 2018, market concerns regarding future take-away capacity adversely affected oil and gas price differentials in the Midland Basin. Although oil and gas pipelines have recently been placed into service in the area, with additional pipelines expected to be placed into service in the future, there are still future take-away capacity constraints. While we believe the economic returns from our operations are attractive at current price levels and our wells are meeting or exceeding our type curves, our cash flows have been negatively impacted by oil and gas price differentials (excluding the impact of derivatives). Increasing or sustained negative oil and gas price differentials would adversely affect our future cash flows and could cause us to reduce the pace of development of our properties.
Eagle Ford Trend
In our operated leasehold acreage located in the Eagle Ford Trend, we spud 10.0 gross/5.1 net wells in the first three quarters of 2019 and expect to have them all completed by the end of 2019.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to use our judgment to make estimates and assumptions that affect certain amounts reported in our financial statements. As additional information becomes available, these estimates and assumptions are subject to change and thus impact amounts reported in the future. Critical accounting policies are those accounting policies that involve judgment and uncertainties affecting the application of those policies and the likelihood that materially different amounts would be reported under different conditions or using differing assumptions. We periodically update our estimates used in the preparation of the financial statements based on our latest assessment of the current and projected business and general economic environment. Other than the adoption of ASC Topic 842 described in Note 1. Basis of Presentation and Summary of Significant Accounting Policies, there have been no significant changes to our critical accounting policies during the nine months ended September 30, 2019.

23

Results of Operations
Three Months Ended September 30, 2019, compared to the Three Months Ended September 30, 2018
 
 
Three Months Ended September 30,
 
 
 
 
2019
 
2018
 
Change
Sales volumes:
 
 
 
 
 
 
Oil (MBbl)
 
646

 
645

 
—
 %
Natural gas (MMcf)
 
1,248

 
947

 
32
 %
Natural gas liquids (MBbl)
 
267

 
188

 
42
 %
Barrels of oil equivalent (MBOE)
 
1,121

 
991

 
13
 %
Average Daily Production (Boepd)
 
12,181

 
10,766

 
13
 %
 
 
 
 
 
 
 
Average prices:
 
 
 
 
 
 
Oil (per Bbl)
 
$
54.89

 
$
60.12

 
(9
)%
Natural gas (per Mcf)
 
$
0.72

 
$
1.89

 
(62
)%
Natural gas liquids (per Bbl)
 
$
10.71

 
$
29.31

 
(63
)%
 
 
 
 
 
 
 
Average prices adjusted for realized derivatives settlements:
 
 
 
 
 
 
Oil ($/Bbl)
 
$
59.43

 
$
53.30

 
12
 %
Natural gas ($/Mcf)
 
$
1.34

 
$
1.92

 
(30
)%
Natural gas liquids ($/Bbl)
 
$
10.71

 
$
29.31

 
(63
)%
 
 
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
Oil revenues
 
$
35,443

 
38,791

 
(9
)%
Natural gas revenues
 
$
903

 
1,790

 
(50
)%
Natural gas liquids revenues
 
$
2,858

 
5,495

 
(48
)%
 
 
 
 
 
 
 
Lease operating expense
 
$
7,259

 
$
4,843

 
50
 %
Severance taxes
 
$
1,858

 
$
2,254

 
(18
)%
Impairment expense
 
$
—

 
$
833

 
NM

Depreciation, depletion and amortization
 
$
14,079

 
$
12,842

 
10
 %
 
 
 
 
 
 
 
General and administrative expense (excluding stock-based compensation)
 
$
4,023

 
$
3,422

 
18
 %
Stock-based compensation
 
$
2,207

 
$
1,522

 
45
 %
General and administrative expense
 
$
6,230

 
$
4,944

 
26
 %
 
 
 
 
 
 
 
Transaction costs
 
$
42

 
$
892

 
NM

(Loss) gain on sale of oil and gas properties
 
$
(120
)
 
4,096

 
NM

Interest expense, net
 
$
(1,609
)
 
$
(565
)
 
185
 %
 
 
 
 
 
 
 
Unrealized gain (loss) on derivative contracts
 
$
15,021

 
$
(13,105
)
 
NM

Realized gain (loss) on derivative contracts
 
$
3,705

 
$
(4,376
)
 
NM

Gain (loss) on derivative contracts, net
 
$
18,726

 
$
(17,481
)
 
NM

 
 
 
 
 
 
 
Litigation settlement
 
$
—

 
$
(4,775
)
 
NM

Income tax expense
 
$
(575
)
 
$
(172
)
 
NM

NM – Not Meaningful

24

Oil revenues
For the three months ended September 30, 2019, oil revenues decreased by $3.3 million or 9% relative to the comparable period in 2018, primarily due to a decrease in our realized price. Our average realized price per Bbl decreased from $60.12 for the three months ended September 30, 2018 to $54.89 or 9% for the three months ended September 30, 2019.
Natural gas revenues
For the three months ended September 30, 2019, natural gas revenues decreased by $0.9 million or 50% relative to the comparable period in 2018, primarily due to a drastic decrease in realized price in the Midland Basin. Our average realized price per Mcf decreased 62% from $1.89 for the three months ended September 30, 2018 to $0.72 for the three months ended September 30, 2019. Approximately 97% of our natural gas sales volumes for the period was from the Midland Basin, which, since the fourth quarter of 2018, has been experiencing a lack of sufficient pipeline transportation that is connected to markets which are purchasing the gas. This has resulted in negative gas prices at times, whereby the seller is actually paying the purchaser to take the gas. The total volume of natural gas produced and sold increased 301 MMcf or 32% primarily due to new wells brought online, partially offset by the impact of divestitures in the latter half of 2018.
Natural gas liquids revenues
For the three months ended September 30, 2019, natural gas liquids revenues decreased by $2.6 million or 48% relative to the comparable period in 2018. Of the decrease, $3.5 million was attributable to a decrease in our realized price, partially offset by an increase of $0.9 million due to increased volume. Approximately 95% of our natural gas liquids sales volumes for the period was from the Midland Basin. Since the fourth quarter of 2018, the price for fractionated natural gas liquids has steadily decreased, and after also taking into account the cost to transport our natural gas liquids, has resulted in significant decreases in prices received. The volume of natural gas liquids produced and sold increased by 79 MBbls or 42%, primarily due to new wells brought online, partially offset by the impact of divestitures in the latter half of 2018.
Lease operating expense (“LOE”)
LOE increased by $2.4 million or 50% for the three months ended September 30, 2019 relative to the comparable period in 2018, primarily due to additional producing wells brought online, which drove a 13% increase in production volume; in addition to a $1.1 million increase driven by a greater number of workover projects compared to the prior year quarter.
Severance taxes
Severance taxes for the three months ended September 30, 2019 decreased $0.4 million or 18% compared to the comparable period in 2018, primarily due to the impact of decreased prices of oil and natural gas liquids. As a percentage of revenues from oil, natural gas, and natural gas liquids, severance taxes remained flat compared to the prior year period.
Impairment expense
As a result of certain acreage expirations related to our Eagle Ford Trend properties, we recorded non-cash asset impairments of $0.8 million for the three months ended September 30, 2018.
Depreciation, depletion and amortization (“DD&A”)
DD&A increased for the three months ended September 30, 2019 by $1.2 million, or 10% relative to the comparable period in 2018, primarily due to development and acquisition activity that resulted in increased costs subject to depletion and an increase in production primarily in the Midland Basin.
General and administrative expense (“G&A”)
G&A for the three months ended September 30, 2019 increased by $1.3 million, or 26% relative to the comparable period in 2018 primarily due to employee costs in the current year resulting from a larger average headcount, as well as non-cash stock-based compensation expense related to the performance-based restricted stock units awarded to our executive officers on January 28, 2019, partially offset by lower legal and professional fees.
Transaction costs

25

For the three months ended September 30, 2019, we incurred nominal transaction costs as compared to the three months ended September 30, 2018, where transaction costs consisted of $0.9 million of legal and consulting fees associated with a contribution agreement executed on October 17, 2018. This contribution agreement was terminated in December 2018.
Interest expense, net
Interest expense increased from $0.6 million for the three months ended September 30, 2018 to $1.6 million for the three months ended September 30, 2019, primarily due to higher average borrowings outstanding compared to the prior year period. See Note 9. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.
Gain (loss) on derivative contracts, net
For the three months ended September 30, 2019, we recorded a net gain on derivative contracts of $18.7 million, consisting of unrealized mark-to-market gains of $15.0 million and net realized gains on settlements of $3.7 million. For the three months ended September 30, 2018, we recorded a net loss on derivative contracts of $17.5 million, consisting of unrealized mark-to-market losses of $13.1 million and net realized losses on settlements of $4.4 million.
Litigation Settlement
During the three months ended September 30, 2018, we recorded an expense of $4.8 million related to the expected settlement of certain litigation.
Income tax expense
During the three months ended September 30, 2019, we recorded income tax expense of approximately $0.6 million which included (1) income tax expense for Lynden US of $0.6 million as a result of its share of the distributable income from EEH and (2) deferred income tax expense for Earthstone of $2.2 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured.
During the three months ended September 30, 2018, we recorded income tax expense of approximately $0.2 million which included (1) income tax expense for Lynden US of $0.1 million as a result of its share of the distributable income from EEH, (2) income tax expense for Earthstone of $0.2 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.1 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the three months ended September 30, 2018.





26

Nine Months Ended September 30, 2019, compared to the Nine Months Ended September 30, 2018
 
 
Nine Months Ended September 30,
 
 
 
 
2019
 
2018
 
Change
Sales volumes:
 
 
 
 
 
 
Oil (MBbl)
 
2,027

 
1,696

 
20
 %
Natural gas (MMcf)
 
3,318

 
2,883

 
15
 %
Natural gas liquids (MBbl)
 
705

 
489

 
44
 %
Barrels of oil equivalent (MBOE)
 
3,285

 
2,665

 
23
 %
Average Daily Production (Boepd)
 
12,033

 
9,762

 
23
 %
 
 
 
 
 
 
 
Average prices:
 
 
 
 
 
 
Oil (per Bbl)
 
$
55.08

 
$
61.97

 
(11
)%
Natural gas (per Mcf)
 
$
0.64

 
$
2.17

 
(71
)%
Natural gas liquids (per Bbl)
 
$
15.17

 
$
26.10

 
(42
)%
 
 
 
 
 
 
 
Average prices adjusted for realized derivatives settlements:
 
 
 
 
 
 
Oil ($/Bbl)(1)
 
$
60.42

 
$
53.82

 
12
 %
Natural gas ($/Mcf)(1)
 
$
1.49

 
$
2.23

 
(33
)%
Natural gas liquids ($/Bbl)
 
$
15.17

 
$
26.10

 
(42
)%
 
 
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
Oil revenues
 
$
111,657

 
$
105,111

 
6
 %
Natural gas revenues
 
$
2,126

 
$
6,257

 
(66
)%
Natural gas liquids revenues
 
$
10,691

 
$
12,753

 
(16
)%
 
 
 
 
 
 
 
Lease operating expense
 
$
22,531

 
$
14,509

 
55
 %
Severance taxes
 
$
5,955

 
$
6,115

 
(3
)%
Impairment expense
 
$
—

 
$
833

 
NM

Depreciation, depletion and amortization
 
$
42,281

 
$
33,362

 
27
 %
 
 
 
 
 
 
 
General and administrative expense (excluding stock-based compensation)
 
$
13,848

 
$
13,274

 
4
 %
Stock-based compensation
 
$
6,680

 
$
5,535

 
21
 %
General and administrative expense
 
$
20,528

 
$
18,809

 
9
 %
 
 
 
 
 
 
 
Transaction costs
 
$
217

 
$
892

 
NM

(Loss) gain on sale of oil and gas properties
 
$
(446
)
 
$
4,608

 
(110
)%
Interest expense, net
 
$
(4,735
)
 
$
(1,788
)
 
165
 %
 
 
 
 
 
 
 
Unrealized loss on derivative contracts
 
$
(33,332
)
 
$
(19,963
)
 
NM

Realized gain (loss) on derivative contracts
 
$
13,660

 
$
(13,643
)
 
NM

Loss on derivative contracts, net
 
$
(19,672
)
 
$
(33,606
)
 
NM

 
 
 
 
 
 
 
Litigation settlement
 
$
—

 
$
(4,775
)
 
NM

Income tax expense
 
$
(728
)
 
$
(119
)
 
NM

(1) Includes $2.1 million of cash proceeds related to hedges unwound during the first quarter of 2019.
NM – Not Meaningful

27

Oil revenues
For the nine months ended September 30, 2019, oil revenues increased by $6.5 million or 6% relative to the comparable period in 2018. Of the increase, $18.2 million was attributable to an increase in volume, partially offset by $11.7 million attributable to a decrease in our realized price. Our average realized price per Bbl decreased from $61.97 for the nine months ended September 30, 2018 to $55.08 or 11% for the nine months ended September 30, 2019. We had a net increase in the volume of oil sold of 331 MBbls or 20%, primarily due to new wells brought online, partially offset by the impact of divestitures in the latter half of 2018.
Natural gas revenues
For the nine months ended September 30, 2019, natural gas revenues decreased by $4.1 million or 66% relative to the comparable period in 2018 primarily due to a drastic decline in realized price in the Midland Basin. Our average realized price per Mcf decreased 71% from $2.17 for the nine months ended September 30, 2018 to $0.64 for the nine months ended September 30, 2019. Approximately 96% of our natural gas sales volumes for the period was from the Midland Basin, which, since the fourth quarter of 2018, has been experiencing a lack of sufficient pipeline transportation that is connected to markets which are purchasing the gas. This has resulted in negative gas prices at times, whereby the seller is actually paying the purchaser to take the gas. The total volume of natural gas produced and sold increased 435 MMcf or 15% primarily due to new wells brought online, partially offset by the impact of 2018 gas well divestitures.
Natural gas liquids revenues
For the nine months ended September 30, 2019, natural gas liquids revenues decreased by $2.1 million or 16% relative to the comparable period in 2018. Of the decrease, $5.4 million was attributable to a decrease in our realized price, partially offset by $3.3 million attributable to increased volume. Approximately 94% of our natural gas liquids sales volumes for the period was from the Midland Basin. Since the fourth quarter of 2018, the price for fractionated natural gas liquids has steadily decreased, and after also taking into account the cost to transport our natural gas liquids, has resulted in significant decreases in prices received. The volume of natural gas liquids produced and sold increased by 216 MBbls or 44%, primarily due to new wells brought online, partially offset by the impact of divestitures in the latter half of 2018.
Lease operating expense (“LOE”)
LOE increased by $8.0 million or 55% for the nine months ended September 30, 2019 relative to the comparable period in 2018, primarily due to additional producing wells brought online, which drove a 23% increase in production volume, in addition to a $3.5 million increase driven by a greater number of workover projects as compared to the prior year period.
Severance taxes
Severance taxes for the nine months ended September 30, 2019 decreased $0.2 million or 3% relative to the comparable period in 2018, as the impact of increased volume was largely offset by the impact of decreased prices of oil and natural gas liquids. As a percentage of revenues from oil, natural gas, and natural gas liquids, severance taxes remained flat when compared to the prior year period.
Impairment expense
During the nine months ended September 30, 2018, we recorded non-cash asset impairments of $0.8 million to our unproved oil and natural gas properties resulting from certain acreage expirations related to our Eagle Ford Trend properties.
Depreciation, depletion and amortization (“DD&A”)
DD&A increased for the nine months ended September 30, 2019 by $8.9 million, or 27% relative to the comparable period in 2018, primarily due to development and acquisition activity that resulted in increased costs subject to depletion and an increase in production primarily in the Midland Basin.
General and administrative expense (“G&A”)
G&A for the nine months ended September 30, 2019 increased by $1.7 million, or 9% relative to the comparable period in 2018, primarily due to employee costs in the current year resulting from a larger average headcount, as well as non-cash stock-based compensation expense related to the performance-based restricted stock units awarded to our executive officers on January 28, 2019, partially offset by lower legal and professional fees.

28

Transaction costs
For the nine months ended September 30, 2019, we incurred nominal transaction costs as compared to the nine months ended September 30, 2018, where transaction costs consisted of $0.9 million of legal and consulting fees associated with a contribution agreement executed on October 17, 2018. This contribution agreement was terminated in December 2018.
Interest expense, net
Interest expense increased from $1.8 million for the nine months ended September 30, 2018 to $4.7 million for the nine months ended September 30, 2019, primarily due to higher average borrowings outstanding compared to the prior year period. See Note 9. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.
Loss on derivative contracts, net
For the nine months ended September 30, 2019, we recorded a net loss on derivative contracts of $19.7 million, consisting of unrealized mark-to-market losses of $33.3 million, partially offset by net realized gains on settlements of $13.7 million. For the nine months ended September 30, 2018, we recorded a net loss on derivative contracts of $33.6 million, consisting of unrealized mark-to-market losses of $20.0 million and net realized losses on settlements of $13.6 million.
Litigation Settlement
During the nine months ended September 30, 2018, we recorded an expense of $4.8 million related to the expected settlement of certain litigation.
Income tax expense
During the nine months ended September 30, 2019, we recorded income tax expense of approximately $0.7 million which included (1) income tax expense for Lynden US of $0.1 million as a result of its share of the distributable income from EEH, (2) deferred income tax expense for Earthstone of $0.6 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.6 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended September 30, 2019.
During the nine months ended September 30, 2018, we recorded income tax expense of approximately $0.1 million which included (1) income tax expense for Lynden US of $0.3 million as a result of its share of the distributable income from EEH, offset by a $0.5 million discrete income tax benefit related to refundable AMT tax credits resulting from the TCJA, (2) income tax expense for Earthstone of $1.1 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.3 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended September 30, 2018.

Liquidity and Capital Resources
The oil and gas industry is capital intensive, requiring continued development of undeveloped acreage. We have significant undeveloped acreage and future drilling locations in the Midland Basin, generally consisting of 7,500 to 12,000-foot lateral lengths. At September 30, 2019, we had approximately $9.8 million in cash and approximately $200 million in unused borrowing capacity under the EEH Credit Agreement (discussed below) available for operational and capital funding. We currently estimate 2019 capital expenditures will be approximately $205.0 million, of which we have incurred $152.4 million on an accrual basis through September 30, 2019. Our 2019 capital program assumes a 19-well program for our operated acreage in the Midland Basin and a 10-well program for our operated Eagle Ford acreage as well as estimated expenditures for our non-operated Midland Basin properties and land and infrastructure activities. We likely will continue to outspend our cash flows provided by operating activities over at least the next 12 months from the date of this report based on current assumptions. However, we believe we will have sufficient liquidity with cash flows from operations and borrowings under the EEH Credit Agreement for the next 12 months in order to meet our cash requirements. We may consider various financial arrangements or other transactions, including but not limited to promoted drilling arrangements.

29

Working Capital
Working capital, defined herein as Total current assets less Total current liabilities as set forth in our Condensed Consolidated Balance Sheets, was a deficit of $59.5 million as of September 30, 2019 compared to a deficit of $18.3 million as of December 31, 2018 as presented below:
 
 
September 30,
 
December 31,
 
 
 
 
 
2019
 
2018
 
Change
 
Current assets:
 
 
 
 
 
 
 
Cash
 
$
9,816

 
$
376

 
9,440

 
Accounts receivable:
 
 
 
 
 


 
Oil, natural gas, and natural gas liquids revenues
 
14,990

 
13,683

 
1,307

 
Joint interest billings and other, both net of allowance of $134
 
8,001

 
4,166

 
3,835

 
Derivative asset
 
20,179

 
43,888

 
(23,709
)
(1)
Prepaid expenses and other current assets
 
2,488

 
1,443

 
1,045

 
Total current assets
 
55,474

 
63,556

 
 
 
 
 
 
 
 
 


 
Current liabilities:
 
 
 
 
 


 
Accounts payable
 
$
37,405

 
$
26,452

 
10,953

(2)
Revenues and royalties payable
 
19,706

 
28,748

 
(9,042
)
 
Accrued expenses
 
35,604

 
22,406

 
13,198

(2)
Asset retirement obligation
 
420

 
557

 
(137
)
 
Advances
 
20,894

 
3,174

 
17,720

(3)
Derivative liability
 
137

 
528

 
(391
)
 
Operating lease liabilities
 
586

 
—

 
586

 
Finance lease liabilities
 
256

 
—

 
256

 
Total current liabilities
 
115,008

 
81,865

 


 
 
 
 
 
 
 


 
Working Capital
 
$
(59,534
)
 
$
(18,309
)
 
(41,225
)
 
 
 
 
 
 
 
 
 
(1)
Primarily the result of a net decrease in fair value of our derivative contracts expected to settle over the next 12 months due to increased oil price futures.
(2)
Primarily the result of an increase in accrued but unpaid capital expenditures due to our current period drilling program.
(3)
At September 30, 2019, we had received advances of $12.4 million related to our Eagle Ford drilling and completion activities and $8.5 million related to our Midland drilling and completion activities.
We expect that changes in receivables and payables related to our pace of development, production volumes, changes in our hedging activities, realized commodity prices and differentials to NYMEX prices for our oil and natural gas production will continue to be the largest variables affecting our working capital.
We expect to finance future acquisition and development activities with cash flows from operating activities, borrowings under the EEH Credit Agreement and, various means of corporate and project financing. In addition, as indicated above, we may continue to partially finance our drilling activities through the sale of participating rights to financial institutions or industry participants, and we could structure such arrangements on a promoted basis, whereby we may earn working interests in reserves and production greater than our proportionate share of capital costs.
In July 2019, we entered into a Wellbore Development Agreement ("WDA") with a non-affiliated industry partner. This WDA will reduce the Company's working interest in certain wells in Reagan County. The industry partner is obligated to pay a promoted (proportionately higher) share of the capital expenditures on an initial eight wells, with an option to participate, on the same basis, in up to 11 additional wells, to earn 35% of the working interest in these wells.

30

Cash Flows from Operating Activities
Cash flows provided by operating activities for the nine months ended September 30, 2019 were $85.7 million compared to $96.6 million for the nine months ended September 30, 2018, primarily due to decreased oil prices from the prior year period, offset by an increase in our settlements of derivative contracts from the prior year period.
Cash Flows from Investing Activities
Cash flows used in investing activities for the nine months ended September 30, 2019 and 2018 were $121.1 million and $114.4 million, respectively, primarily due to increased drilling and completion activity as compared to the prior year period.
Cash Flows from Financing Activities
Cash flows provided by financing activities for the nine months ended September 30, 2019 and 2018 were $44.8 million and $8.3 million, respectively, primarily due to higher average borrowings outstanding under the EEH Credit Agreement in the current year period which were used to fund our drilling and completion activities.
Capital Expenditures
Our 2019 capital budget assumes a one-rig operated program, with a temporary second rig that was deployed for the third quarter, and non-operated activities as currently proposed by operators, for our acreage in the Midland Basin as well as a 10-well program on our operated Eagle Ford acreage. Our capital expenditures for 2019 are currently estimated at approximately $205.0 million, of which we have incurred $152.4 million on an accrual basis during the first three quarters of 2019.
Our accrual basis capital expenditures for the three and nine months ended September 30, 2019 were as follows (in thousands):
 
 
Three Months Ended September 30, 2019
 
Nine Months Ended September 30, 2019
Drilling and completions
 
$
77,887

 
$
144,332

Leasehold costs
 
716

 
8,066

Total capital expenditures
 
$
78,603

 
$
152,398

Credit Agreement
In May, 2017, Earthstone Energy Holdings, LLC (“EEH” or the “Borrower”), a subsidiary of Earthstone, each of Earthstone Operating, LLC, EF Non-Op, LLC, Sabine River Energy, LLC, Earthstone Legacy Properties, LLC, Lynden USA Operating, LLC, Bold Energy III LLC, Bold Operating, LLC, as guarantors (the “Guarantors”), BOKF, NA dba Bank Of Texas, as Agent and Lead Arranger, Wells Fargo Bank, National Association, as Syndication Agent, and the lenders party thereto (the “Lenders”), entered into a credit agreement (as amended, modified or restated from time to time, the “EEH Credit Agreement”).
The borrowing base under the EEH Credit Agreement is subject to redetermination on or about May 1st and November 1st of each year. The amounts borrowed under the EEH Credit Agreement bear annual interest rates at either (a) the London Interbank Offered Rate (“LIBOR”) plus 1.75% to 2.75% or (b) the prime lending rate of Bank of Texas plus 0.75% to 1.75%, depending on the amounts borrowed under the EEH Credit Agreement. Principal amounts outstanding under the EEH Credit Agreement are due and payable in full at maturity on May 9, 2022. All of the obligations under the EEH Credit Agreement, and the guarantees of those obligations, are secured by substantially all of EEH’s assets. Additional payments due under the EEH Credit Agreement include paying a commitment fee of 0.375% or 0.50%, depending on borrowing base utilization, per year to the Lenders in respect of the unutilized commitments thereunder, as well as certain other customary fees.
The EEH Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, EEH’s ability to incur additional indebtedness, create liens on assets, make investments, enter into sale and leaseback transactions, pay dividends and make distributions or repurchase its limited liability interests, engage in mergers or consolidations, sell certain assets, sell or discount any notes receivable or accounts receivable and engage in certain transactions with affiliates.
In addition, the EEH Credit Agreement requires EEH to maintain the following financial covenants: a current ratio, as defined by the EEH Credit Agreement, of not less than 1.0 to 1.0 and a leverage ratio of not greater than 4.0 to 1.0. Leverage ratio means the ratio of (i) the aggregate debt of EEH and its consolidated subsidiaries as at the last day of the fiscal quarter (excluding any debt from obligations relating to non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives) to (ii) the product of EBITDAX for such fiscal quarter multiplied by four. The term “EBITDAX” means, for any period, the sum of consolidated net income for such period plus (a) the following expenses or charges to the extent deducted from consolidated net income in such period: (i) interest, (ii) taxes, (iii) depreciation, (iv) depletion, (v) amortization, (vi) non-cash losses under

31

FASB ASC 815 as a result of changes in the fair market value of derivatives, (vii) exploration expenses, (viii) impairment expenses, and (ix) non-cash compensation expenses and minus (b) to the extent included in consolidated net income in such period, non-cash gains under FASB ASC 815 as a result of changes in the fair market value of derivatives.
The EEH Credit Agreement contains customary affirmative covenants and defines events of default to include failure to pay principal or interest, breach of covenants, breach of representations and warranties, insolvency, judgment default, and if Frank A. Lodzinski ceases to serve and function as Chief Executive Officer of EEH and the majority of the Lenders do not approve of Mr. Lodzinski’s successor. Upon the occurrence and continuance of an event of default, the Lenders have the right to accelerate repayment of the loans and exercise their remedies with respect to the collateral. As of September 30, 2019, EEH was in compliance with these covenants under the EEH Credit Agreement.
On May 1, 2019, the borrowing base under the EEH Credit Agreement was increased from $275.0 million to $325.0 million. As of September 30, 2019, $125.0 million of borrowings were outstanding, bearing annual interest of 4.044%, resulting in an additional $200.0 million of borrowing base availability under the EEH Credit Agreement.
Hedging Activities
The following table sets forth our outstanding derivative contracts at September 30, 2019. When aggregating multiple contracts, the weighted average contract price is disclosed.
Period
 
Commodity
 
Volume
(Bbls / MMBtu)
 
Price
($/Bbl / $/MMBtu)
Q4 2019
 
Crude Oil
 
671,600
 
$64.31
Q1 - Q4 2020
 
Crude Oil
 
2,562,000
 
$61.26
Q1 - Q4 2021
 
Crude Oil
 
730,000
 
$55.00
Q4 2019
 
Crude Oil Basis Swap(1)
 
506,000
 
$(5.29)
Q4 2019
 
Crude Oil Basis Swap(2)
 
92,000
 
$4.50
Q1 - Q4 2020
 
Crude Oil Basis Swap(1)
 
2,562,000
 
$(1.40)
Q1 - Q4 2021
 
Crude Oil Basis Swap(1)
 
730,000
 
$0.85
Q4 2019
 
Natural Gas
 
782,000
 
$2.85
Q1 - Q4 2020
 
Natural Gas
 
2,562,000
 
$2.85
Q4 2019
 
Natural Gas Basis Swap(3)
 
782,000
 
$(1.15)
Q1 - Q4 2020
 
Natural Gas Basis Swap(3)
 
2,562,000
 
$(1.07)
(1)
The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.
(2)
The basis differential price is between LLS Argus Crude and the WTI NYMEX.
(3)
The basis differential price is between W. Texas (WAHA) and the Henry Hub NYMEX.
Obligations and Commitments
There have been no material changes from the obligations and commitments disclosed in the Obligations and Commitments section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2018 Annual Report on Form 10-K other than those described in Note 12. Commitments and Contingencies in the Notes to the Unaudited Condensed Consolidated Financial Statements.
Environmental Regulations
Our operations are subject to risks normally associated with the exploration for and the production of oil and natural gas, including blowouts, fires, and environmental risks such as oil spills or natural gas leaks that could expose us to liabilities associated with these risks.
In our acquisition of existing or previously drilled well bores, we may not be aware of prior environmental safeguards, if any, that were taken at the time such wells were drilled or during such time the wells were operated. We maintain comprehensive insurance coverage that we believe is adequate to mitigate the risk of any adverse financial effects associated with these risks.
However, should it be determined that a liability exists with respect to any environmental cleanup or restoration, the liability to cure such a violation could still accrue to us. No claim has been made, nor are we aware of any liability which we may have, as it relates to any environmental cleanup, restoration, or the violation of any rules or regulations relating thereto.

32

Recently Issued Accounting Standards
See Note 1. Basis of Presentation and Summary of Significant Accounting Policies in the Notes to Unaudited Condensed Consolidated Financial Statements in this report for discussion of recently issued and adopted accounting standards affecting us.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and therefore are not required to provide the information required under this item. 
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
In accordance with Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15(e) and 15d-15(e), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and our Principal Accounting Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Principal Accounting Officer concluded that our disclosure controls and procedures were effective as of September 30, 2019 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Principal Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

33

PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may be involved in various legal proceedings and claims in the ordinary course of business. As of September 30, 2019, and through the filing date of this report, we do not believe the ultimate resolution of any such actions or potential actions of which we are currently aware will have a material effect on our consolidated financial position or results of operations.  
See Note 12. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item 1 of this report, which is incorporated herein by reference, for material matters that have occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2018.
Item 1A. Risk Factors
There have been no material changes from the risk factors disclosed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2018.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sale of Equity Securities
There were no unregistered sales of equity securities during the three and nine months ended September 30, 2019.
Repurchase of Equity Securities
The following table sets forth information regarding our acquisition of shares of Class A Common Stock for the periods presented:
 
 
Total Number of Shares Purchased (1)
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plan or Programs
July 2019
 
—

 
$
—

 
—

 
—

August 2019
 
—

 
—

 
—

 
—

September 2019
 
49,111

 
$
3.38

 
—

 
—

(1)
All of the shares were surrendered by employees (via net settlement) in satisfaction of tax obligations upon the vesting of restricted stock unit awards. The acquisition of the surrendered shares was not part of a publicly announced program to repurchase shares of our Class A Common Stock.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information.
None.

34

Item 6. Exhibits
Exhibit No.
 
Description
 
Filed Herewith
 
Furnished Herewith
31.1
 
 
X
 
 
31.2
 
 
X
 
 
32.1
 
 
 
 
X
32.2
 
 
 
 
X
101.INS
 
XBRL Instance Document
 
X
 
 
101.SCH
 
XBRL Schema Document
 
X
 
 
101.CAL
 
XBRL Calculation Linkbase Document
 
X
 
 
101.DEF
 
XBRL Definition Linkbase Document
 
X
 
 
101.LAB
 
XBRL Label Linkbase Document
 
X
 
 
101.PRE
 
XBRL Presentation Linkbase Document
 
X
 
 


35

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
 
 
 
 
EARTHSTONE ENERGY, INC.
 
 
 
 
 
Date:
November 6, 2019
 
By:
/s/ Tony Oviedo
 
 
 
Tony Oviedo
 
 
 
Executive Vice President – Accounting and Administration

36