September 30,

December 31,

ASSETS

2017

2016

Current assets:

Cash

$
11,047

$
10,200

Accounts receivable:

Oil, natural gas, and natural gas liquids revenues

15,093

13,998

Joint interest billings and other, net of allowance of $138 at September 30, 2017 and $163 at December 31, 2016

4,371

2,698

Derivative asset

147

—

Prepaid expenses and other current assets

1,299

446

Total current assets

31,957

27,342

Oil and gas properties, successful efforts method:

Proved properties

599,222

363,072

Unproved properties

291,364

51,723

Land

5,534

—

Total oil and gas properties

896,120

414,795

Accumulated depreciation, depletion and amortization

(122,842
)

(145,393
)
Net oil and gas properties

773,278

269,402

Other noncurrent assets:

Goodwill

17,620

17,620

Office and other equipment, net of accumulated depreciation of $1,973 and $1,600 at September 30, 2017 and December 31 2016, respectively

1,039

1,479

Other noncurrent assets

1,078

669

TOTAL ASSETS

$
824,972

$
316,512

LIABILITIES AND EQUITY

Current liabilities:

Accounts payable

$
19,343

$
11,927

Accrued expenses

16,516

5,392

Revenues and royalties payable

9,156

10,769

Advances

5,048

4,542

Derivative liability

1,986

4,595

Current portion of long-term debt

1,704

1,604

Total current liabilities

53,753

38,829

Noncurrent liabilities:

Long-term debt

71,400

12,693

Deferred tax liability

16,513

15,776

Asset retirement obligation

3,204

6,013

Derivative liability

422

1,575

Other noncurrent liabilities

143

169

Total noncurrent liabilities

91,682

36,226

Commitments and Contingencies (Note 13)

Equity:

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

—

—

Common stock, $0.001 par value, no shares authorized; none issued or outstanding at September 30, 2017 and 100,000,000 shares authorized; 22,289,177 issued and 22,273,820 outstanding at December 31, 2016

—

23

Class A Common stock, $0.001 par value, 200,000,000 shares authorized; 22,988,759 issued and outstanding at September 30, 2017 and none issue or outstanding at December 31, 2016

23

—

Class B Common Stock, $0.0001 par value, 50,000,000 shares authorized; 36,070,828 shares issued and outstanding at September 30, 2017; none issued or outstanding at December 31, 2016

36

—

Additional paid-in capital

463,009

454,202

Accumulated deficit

(227,146
)

(212,308
)
Treasury stock, no shares at September 30, 2017 and 15,357 shares at December 31, 2016

—

(460
)
Total Earthstone Energy, Inc. equity

235,922

241,457

Noncontrolling interest

443,615

—

Total equity

679,537

241,457

TOTAL LIABILITIES AND EQUITY

$
824,972

$
316,512

Three Months Ended September 30,

Nine Months Ended September 30,

2017

2016

2017

2016

REVENUES

Oil

$
25,733

$
8,262

$
59,815

$
21,898

Natural gas

2,513

1,417

6,338

3,376

Natural gas liquids

3,036

851

6,249

1,843

Total revenues

31,282

10,530

72,402

27,117

OPERATING COSTS AND EXPENSES

Lease operating expense

5,407

4,581

14,989

11,081

Severance taxes

1,588

522

3,705

1,418

Rig idle and termination expense

—

—

—

5,059

Impairment expense

92

—

66,740

—

Depreciation, depletion and amortization

10,330

5,149

28,258

16,252

General and administrative expense

5,608

2,285

14,838

6,961

Stock-based compensation

1,687

1,328

4,645

1,889

Transaction costs

109

846

4,676

1,641

Accretion of asset retirement obligation

72

143

378

404

Exploration expense

—

—

1

5

Total operating costs and expenses

24,893

14,854

138,230

44,710

Gain on sale of oil and gas properties

2,157

8

3,848

8

Income (loss) from operations

8,546

(4,316
)

(61,980
)

(17,585
)

OTHER INCOME (EXPENSE)

Interest expense, net

(903
)

(341
)

(1,873
)

(934
)
Write-off of deferred financing costs

-

—

(526
)

—

(Loss) gain on derivative contracts, net

(3,663
)

946

4,137

(2,517
)
Other (expense) income, net

(66
)

12

(34
)

(70
)
Total other income (expense)

(4,632
)

617

1,704

(3,521
)

Income (loss) before income taxes

3,914

(3,699
)

(60,276
)

(21,106
)
Income tax benefit (expense)

94

(201
)

10,046

(387
)
Net income (loss)

4,008

(3,900
)

(50,230
)

(21,493
)

Less: Net income (loss) attributable to noncontrolling interest

2,452

—

(35,392
)

—

Net income (loss) attributable to Earthstone Energy, Inc.

$
1,556

$
(3,900
)

$
(14,838
)

$
(21,493
)

Net income (loss) per common share attributable to Earthstone Energy, Inc.:

Basic and diluted

$
0.07

$
(0.17
)

$
(0.66
)

$
(1.23
)

Weighted average common shares outstanding:

Basic and diluted

22,905,023

22,289,177

22,638,977

17,433,079

~~The following table summarizes the consideration transferred, fair value of assets acquired and liabilities assumed (in thousands, except share and share price amounts~~):

Consideration:

Shares of Class A Common Stock issued pursuant to the Bold Contribution Agreement to certain employees of Bold

150,000

EEH Units issued to Bold Holdings

36,070,828

Total equity interest issued in the Bold Transaction

36,220,828

Closing per share price of Class A Common Stock as of May 9, 2017

$
13.58

Total consideration transferred ⁽¹⁾⁽²⁾

$
491,879

Fair value of assets acquired:

Cash and cash equivalents

$
2,355

Other current assets

10,078

Oil and gas properties ⁽³⁾

557,704

Amount attributable to assets acquired

$
570,137

Fair value of liabilities assumed:

Long-term debt ⁽⁴⁾

$
58,000

Current liabilities

17,042

Deferred tax liability

2,857

Noncurrent asset retirement obligations

359

Amount attributable to liabilities assumed

$
78,258

~~(1)~~

~~Consideration included 150,000 shares of Class A Common Stock recorded above based upon its fair value which was determined using its closing price of $13.58 per share on May 9, 2017.~~

~~(2)~~

Consideration was 36,070,828 EEH Units. Additionally, Bold Holdings purchased 36,070,828 shares of Class B Common Stock for $36,071. Each EEH Unit, together with one share of Class B Common Stock, is convertible into one share of Class A Common Stock. The fair value of the consideration was determined using the closing price of the Company’s Class A Common Stock of $13.58 per share on May 9, 2017.

~~(3)~~

The market assumptions as to the future commodity prices, projections of estimated quantities of oil and natural gas reserves, expectations for timing and amount of the future development and operating costs, projecting of future rates of production, expected recovery rate and risk adjusted discount rates used by the Company to estimate the fair value of the oil and natural gas properties represent Level 3 inputs; see ~~Note 3. Fair Value Measurements, below.~~

~~(4)~~

~~Concurrent with the closing of the Bold Transaction, EEH assumed Bold’s outstanding borrowings of $58 million under its credit agreement.~~

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

The following unaudited supplemental pro forma condensed results of operations present consolidated information as though the Bold Transaction had been completed as of January 1, 2016. The unaudited supplemental pro forma financial information was derived from the historical consolidated and combined statements of operations for Bold and Earthstone and adjusted to include: (i) depletion expense applied to the adjusted basis of the properties acquired and (ii) to eliminate non-recurring transaction costs directly related to the Bold Transaction that do not have a continuing impact on the Company’s operating results. These unaudited supplemental pro forma results of operations are provided for illustrative purposes only and do not purport to be indicative of the actual results that would have been achieved by the combined company for the periods presented or that may be achieved by the combined company in the future. Future results may vary significantly from the results reflected in this unaudited pro forma financial information (~~in thousands, except per share amounts~~):

Three Months Ended September 30,

Nine Months Ended September 30,

2016

2017

2016

Revenue

$
15,865

$
99,192

$
38,165

Loss before taxes

$
(4,860
)

$
(41,420
)

$
(31,723
)

Net loss

$
(5,061
)

$
(31,374
)

$
(32,109
)

Less: Net loss available to noncontrolling interest

$
(3,120
)

$
(19,253
)

$
(21,587
)

Net loss attributable to Earthstone Energy, Inc.

$
(1,941
)

$
(12,121
)

$
(10,522
)

Pro forma net loss per common share attributable to Earthstone Energy, Inc.:

Basic and diluted

$
(0.09
)

$
(0.53
)

$
(0.60
)

The Company has included in its Condensed Consolidated Statements of Operations, revenues of $17.7 million and direct operating expenses of $9.8 million for the three months ended September 30, 2017, and revenues of $28.6 million and direct operating expenses of $16.0 million for the period May 9, 2017 to September 30, 2017 related to the properties acquired in the Bold Transaction.

~~2017 Divestitures~~

~~For the three months ended September 30,~~ 2017, the Company sold certain non-core properties for a total cash consideration of approximately $2.7 million, while eliminating approximately $3.6 million of future abandonment obligations. The sales resulted in a net gain of approximately $2.2 million recorded in Gain on sale of oil and gas properties in the Condensed Consolidated Statements of Operations.

~~For the nine months ended September 30,~~ 2017, the Company sold certain non-core properties for a total cash consideration of approximately $5.1 million, while eliminating approximately $3.6 million of future abandonment obligations. The sales resulted in a net gain of approximately $3.8 million recorded in Gain on sale of oil and gas properties in the Condensed Consolidated Statements of Operations.

Note 3.2. 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~~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

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

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~~three months ended ~~September 30, 2017.~~

March 31, 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):

September 30, 2017

Level 1

Level 2

Level 3

Total

Financial assets

Derivative asset - current

$
—

$
147

$
—

$
147

Total financial assets

$
—

$
147

$
—

$
147

Financial liabilities

Derivative liability - current

$
—

$
1,986

$
—

$
1,986

Derivative liability - noncurrent

—

422

—

422

Total financial liabilities

$
—

$
2,408

$
—

$
2,408

December 31, 2016

Financial liabilities

Derivative liability - current

$
—

$
4,595

$
—

$
4,595

Derivative liability - noncurrent

—

1,575

—

1,575

Total financial assets

$
—

$
6,170

$
—

$
6,170

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



March 31, 2019	Level 1		Level 2		Level 3		Total
Financial assets
Derivative asset - current	$	—	$	6,605	$	—	$	6,605
Derivative asset - noncurrent	—		6,300		—		6,300
Total financial assets	$	—	$	12,905	$	—	$	12,905

Financial liabilities
Derivative liability - current	$	—	$	2,204	$	—	$	2,204
Derivative liability - noncurrent	—		1,367		—		1,367
Total financial liabilities	$	—	$	3,571	$	—	$	3,571

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 and goodwill. 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.

Proved Oil and Natural Gas Properties

Proved oil and natural gas properties are measured at fair value on a nonrecurring basis in order to review for impairment. 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.

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

Goodwill

Goodwill represents the excess of the purchase price of assets acquired over the fair value of those assets and is tested for impairment annually, or more frequently if events or changes in circumstances dictate that the fair value of goodwill may be less than its carrying amount. Such test includes an assessment of qualitative and quantitative factors.

Business Combinations

The Company ~~records~~accounts for its acquisitions of oil and gas properties not commonly controlled in accordance with FASB ASC Topic 805, Business Combinations, which, among other things, requires the ~~identifiable~~Company to determine if an asset or a business has been

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

acquired. If the Company determines an asset(s) has been acquired, the asset(s) acquired, as well as any liabilities assumed, are measured and recorded at the acquisition date cost. If the Company determines a business has been acquired, the assets acquired and liabilities assumed are measured and recorded at their fair value at the date of acquisition on a nonrecurring basis. Fair value may be estimated using comparable market data, a discounted cash flow method, or a combination of the two. In the discounted cash flow method, estimated future cash flows are based on management’s expectations for the future and include estimates of future oil and gas production, commodity prices based on NYMEX commodity futures price stripsvalues as of the acquisition date, recording goodwill for amounts paid in excess of ~~the estimate, operating and development costs, and a risk-adjusted discount rate.~~ fair value.

Asset Retirement Obligations

The ~~future oil and natural gas pricing used in the valuation is a Level 2 assumption. Significant Level 3 assumptions associated with the calculation of discounted cash flows used in the determination of~~estimated fair value of the acquisition include the Company’s estimate operating and development costs, anticipated production of proved reserves, appropriate risk-adjusted discount rates and other relevant data. The Company’s acquisitions are described in ~~Note 2. Acquisitions and Divestitures~~.

~~Asset Retirement Obligations~~

~~The~~Company's asset retirement obligation ~~estimates are derived from historical costs~~at inception is determined by utilizing the income approach by applying a credit-adjusted risk-free rate, which takes into account the Company's credit risk, and ~~management’s expectation~~the time value of ~~future cost environments; and therefore,~~money to the ~~Company has designated these liabilities as Level 3. The significant inputs to this fair value measurement include~~undiscounted expected abandonment cash flows, including estimates of plugging, abandonment and remediation costs and well ~~life, inflation and credit-adjusted risk free rate.~~life. Given the unobservable nature of the inputs, the measurement of the asset retirement obligations was classified as Level 3 in the fair value hierarchy. See Note ~~11.~~ 10.Asset Retirement Obligations for a reconciliation of the beginning and ending balances of the liability for the Company’s asset retirement obligations.

Performance Units

Stock-based compensation related to performance is estimated utilizing the Monte Carlo Simulation pricing model, which calculates multiple potential outcomes for an award and establishes fair value based on the most likely outcome, and has been classified as Level 3 in the fair value hierarchy. Stock-based compensation related to performance units is described in Note 8. Stock-Based Compensation.

Note 4.3. Derivative Financial Instruments

~~In connection with the closing of the Bold Transaction on May 9, 2017, all oil and natural gas derivative contracts were novated to EEH.~~

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 ~~for the remainder of 2017~~ through December 31, ~~2018.~~2020. 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.

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.

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Company had the following open crude oil and natural gas derivative contracts as of ~~September 30, 2017:~~

March 31, 2019:

Price Swaps

Period

Commodity

Volume
(Bbls / MMBtu)

Weighted Average Price
($/Bbl / $/MMBtu)

Q4 2017

Crude Oil

157,500

$
50.66

Q1 - Q4 2018

Crude Oil

1,279,000

$
50.16

Q4 2017

Natural Gas

645,000

$
3.167

Q1 - Q4 2018

Natural Gas

810,000

$
3.066

~~Additionally, on October 30, 2017,~~



	Price Swaps
Period	Commodity	Volume (Bbls / MMBtu)	Weighted Average Price ($/Bbl / $/MMBtu)
Q2 - Q4 2019	Crude Oil	1,769,100	$	65.60
Q1 - Q4 2020	Crude Oil	1,464,000	$	65.87
Q2 - Q4 2019	Crude Oil Basis Swap(1)	1,512,500	$	(5.29	)
Q2 - Q4 2019	Crude Oil (Basis Swap)(2)	275,000	$	4.50
Q1 - Q4 2020	Crude Oil Basis Swap(1)	1,464,000	$	(2.74	)
Q2 - Q4 2019	Natural Gas	2,795,500	$	2.86
Q1 - Q4 2020	Natural Gas	2,562,000	$	2.85
Q2 - Q4 2019	Natural Gas Basis Swap (3)	2,795,500	$	(1.14	)
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.

Subsequent to March 31, 2019, the Company entered into additional ~~fixed price oil swap agreements, hedging an additional 365,000 Bbls~~hedges consisting of ~~2019 oil production~~Crude Oil Swaps on 366 MBbls at a price of ~~$51.55/Bbl.~~

$59.75/Bbl for 2020 and WTI Midland Argus Crude Basis Swaps on 366 MBbls at a price of $0.25/Bbl for 2020.

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, 2017

December 31, 2016

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

$
327

$
(180
)

$
147

$
—

$
—

$
—

Commodity contracts

Derivative asset - noncurrent

$
24

$
(24
)

$
—

$
—

$
—

$
—

Commodity contracts

Derivative liability - current

$
(2,166
)

$
180

$
(1,986
)

$
4,595

$
—

$
4,595

Commodity contracts

Derivative liability - noncurrent

$
(446
)

$
24

$
(422
)

$
1,575

$
—

$
1,575



		March 31, 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	$	14,262	$	(7,657	)	$	6,605	$	48,662	$	(4,774	)	$	43,888
Commodity contracts	Derivative liability - current	$	9,861	$	(7,657	)	$	2,204	$	5,302	$	(4,774	)	$	528
Commodity contracts	Derivative asset - noncurrent	$	8,597	$	(2,297	)	$	6,300	$	23,605	$	(2,484	)	$	21,121
Commodity contracts	Derivative liability - noncurrent	$	3,664	$	(2,297	)	$	1,367	$	4,375	$	(2,484	)	$	1,891

The ~~follow~~following table summarizes the location and amounts of the Company’s realized and unrealized gains and losses on derivatives instruments in the ~~Company’s~~ Condensed Consolidated Statements of Operations (in thousands):

Three Months Ended September 30,

Nine Months Ended September 30,

2017

2016

2017

2016

Derivatives not designated as hedging contracts under ASC Topic 815

Statement of Operations Location

Total (loss) gain on commodity contracts

(Loss) gain on derivative contracts, net

$
(4,159
)

$
413

$
3,908

$
(5,847
)
Cash received in settlements on commodity contracts

(Loss) gain on derivative contracts, net

496

533

229

3,330

(Loss) gain on commodity contracts, net

$
(3,663
)

$
946

$
4,137

$
(2,517
)



Derivatives not designated as hedging contracts under ASC Topic 815			Three Months Ended March 31,
	Statement of Cash Flows Location	Statement of Operations Location	2019			2018
Unrealized (loss)	Not separately presented	Not separately presented	$	(53,256	)	$	(1,000	)
Realized gain (loss)	Operating portion of net cash paid in settlement of derivative contracts	Not separately presented	5,362			(4,275		)
	Total loss on derivative contracts, net	(Loss) on derivative contracts, net	$	(47,894	)	$	(5,275	)

Note 5.4. 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

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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 ~~Loss~~Income (loss) 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. ~~Depletion expense for oil and gas producing property and related equipment was $10.2 million and $5.0 million, for~~For the three months ended ~~September 30, 2017~~March 31, 2019 and ~~2016, respectively. For the nine months ended September 30, 2017 and 2016,~~2018, depletion expense for oil and gas producing property and related equipment was ~~$27.9~~$13.8 million and ~~$15.9~~$9.6 million, respectively.

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

Proved Properties

Proved oil and natural gas properties are ~~measured at fair value~~reviewed for impairment on a nonrecurring ~~basis in order to review for impairment.~~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 as well as the cost to acquire unproved reserves. Undeveloped lease costs and unproved reserve acquisition costs are capitalized. 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 delay rentals, meeting contractual drilling obligations, or by the presence of producing wells on the leases. Unproved costs related to successful exploratory drilling are reclassified to proved properties and depleted on a units-of-production basis.

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 months ended ~~September 30, 2017,~~March 31, 2019 and 2018, the Company recorded an impairment of $0.1 million to its unproved oil and natural gas properties as a result of acreage expirations to its properties located in the Eagle Ford shale trend of south Texas. As a result of both acreage expirations and forward commodity price declines, during the nine months ended September 30, 2017, the Company recorded impairments consisting of $63.0 million to its proved oil and natural gas properties and $3.7 million to its unproved oil and natural gas properties, primarily to its properties located in the Eagle Ford shale trend of south Texas.

~~The~~ Company did not record any impairments to its oil and natural gas ~~properties for the three and nine months ended September 30, 2016.~~

properties.

Note 6.5. Noncontrolling Interest

As a result of the Bold Transaction, Earthstone became the sole managing member of, and has a controlling interest in, EEH. As the sole managing member of EEH, Earthstone operates and controls all of the business and affairs of EEH and its subsidiaries. Immediately following the Bold Transaction, Earthstone and Lynden US owned a 38.6% membership interest in EEH while Bold Holdings owned the remaining 61.4%.

The Bold Transaction was recorded in accordance with FASB ASC Topic 805, Business Combinations, and is consolidated in these financial statements in accordance with FASB ASC Topic 810, Consolidation, which requires the recording of a noncontrolling interest component of net income (loss), as well as a noncontrolling interest component within equity, including changes to Additional paid-in capital to reflect the noncontrolling interest within equity in the Condensed Consolidated Balance Sheet as of September 30, 2017 at the noncontrolling interest’s respective membership interest in EEH. A reconciliation of the equity attributable to the noncontrolling interest as of May 9, 2017 is as follows (~~in thousands~~):

Total consideration transferred ⁽¹⁾

$
491,879

Change to Additional paid-in capital to reflect the noncontrolling interest within equity at their membership interest

(12,872
)
Portion of equity attributable to noncontrolling interest ⁽²⁾

$
479,007

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

~~(1)~~

~~See~~ ~~Note 2. Acquisitions and Divestitures~~.

~~(2)~~

~~Represents 61.4% of total equity attributable to EEH as of May 9, 2017.~~

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 ~~(loss)~~ attributable to noncontrolling interest in the Condensed Consolidated Statements of Operations for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2019 represents the portion of net income or loss 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 ~~Sheet~~Sheets as of ~~September 30, 2017~~March 31, 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.

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table presents the changes in noncontrolling interest for the ~~nine~~three months ended ~~September 30, 2017:~~

March 31, 2019:

EEH Units Held
By Earthstone
and Lynden US

%

EEH Units Held
By Others

%

Total EEH
Units
Outstanding

As of December 31, 2016

—

—

—

—

—

May 9, 2017 - Bold Transaction

22,656,624

38.6
%

36,070,828

61.4
%

58,727,452

EEH Units issued in connection with Class A Common Stock issued in connection with Bold Transaction

150,000

—

150,000

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

182,135

—

182,135

As of September 30, 2017

22,988,759

38.9
%

36,070,828

61.1
%

59,059,587



	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	—			—			—
EEH Units issued in connection with the vesting of restricted stock units	166,140			—			166,140
As of March 31, 2019	28,862,461	44.9	%	35,452,178	55.1	%	64,314,639

The following table summarizes the activity for the equity attributable to the noncontrolling interest for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 (in thousands):

2017

As of December 31, 2016

$
—

Noncontrolling interest recorded within equity in connection with the closing of the Bold Transaction

479,007

Net loss attributable to noncontrolling interest

(35,392
)
As of September 30, 2017

$
443,615

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~



	2019
As of December 31, 2018	$	491,852
EEH Units and Class B Common Stock converted to Class A Common Stock	—
ASC 842 implementation adjustment attributable to noncontrolling interest	99
Net loss attributable to noncontrolling interest	(21,239		)

As of March 31, 2019	$	470,712

Note 7.6. Net (Loss) Income ~~(Loss)~~ Per Common Share

Net (loss) income ~~(loss)~~ per common share—basic is calculated by dividing Net (loss) income ~~(loss)~~ by the weighted average number of shares of common stock outstanding during the ~~period (Common Stock through May 8, 2017 and Class A Common Stock from May 9, 2017 through September 30, 2017).~~period. Net (loss) income ~~(loss)~~ per common share—diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing Net (loss) income ~~(loss)~~ by the sum of the weighted average number of shares of common stock, as defined above, outstanding plus potentially dilutive securities. Net (loss) income ~~(loss)~~ 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 (loss) income ~~(loss)~~ per common share is as follows:

Three Months Ended September 30,

Nine Months Ended September 30,

(In thousands, except per share amounts)

2017

2016

2017

2016

Net income (loss) attributable to Earthstone Energy, Inc.

$
1,556

$
(3,900
)

$
(14,838
)

$
(21,493
)

Net income (loss) per common share attributable to Earthstone Energy, Inc.:

Basic

$
0.07

$
(0.17
)

$
(0.66
)

$
(1.23
)
Diluted

$
0.07

$
(0.17
)

$
(0.66
)

$
(1.23
)

Weighted average common shares outstanding

Basic

22,905,023

22,289,177

22,638,977

17,433,079

Add potentially dilutive securities:

Unvested restricted stock units

—

—

—

—

Diluted weighted average common shares outstanding

22,905,023

22,289,177

22,638,977

17,433,079



	Three Months Ended March 31,
(In thousands, except per share amounts)	2019			2018
Net (loss) income attributable to Earthstone Energy, Inc.	$	(17,204	)	$	5,321

Net (loss) income per common share attributable to Earthstone Energy, Inc.:
Basic	$	(0.60	)	$	0.19
Diluted	$	(0.60	)	$	0.19

Weighted average common shares outstanding
Basic	28,719,542			27,783,805
Add potentially dilutive securities:
Unvested restricted stock units	—			128,119
Diluted weighted average common shares outstanding	28,719,542			27,911,924

Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and Net ~~income (loss)~~loss attributable to noncontrolling interest of ~~$37.8~~$21.2 million would be added back to Net (loss) income ~~(loss)~~ attributable to Earthstone Energy, Inc., having no dilutive effect on Net (loss) income ~~(loss)~~ per common share attributable to Earthstone Energy, Inc. For the three months ended ~~September 30, 2017, the Company had no potentially dilutive restricted stock units (“RSUs”) in calculating diluted earnings per share, as the amount~~

Table of unrecognized compensation costs related to outstanding RSUs exceeded the weighted average fair value of the RSUs assumed converted under the treasury stock method. For the nine months ended September 30, 2017,Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2019, the Company excluded ~~137,345 RSUs,~~336,759 shares for the dilutive effect of performance units in calculating diluted earnings per share as the effect was anti-dilutive due to the net loss incurred ~~for~~ the period. For the three and nine months ended September 30, 2016, the Company excluded zero and 14,212 RSUs, respectively, in calculating diluted earnings per share as the effect was anti-dilutive due to the net loss incurred for these periods.

Note 8.7. Common Stock

~~On May 9, 2017, and in connection with the completion of the Bold Transaction, Earthstone recapitalized its Common Stock into two classes, as described in~~ ~~Note 1. – Basis of Presentation and Summary of Significant Accounting Policies~~,

Class A Common Stock

At March 31, 2019 and ~~Class B Common Stock. At that time, all of Earthstone’s existing outstanding Common Stock was automatically converted on a one-for-one basis into Class A Common Stock.~~

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

~~Class A Common Stock~~

~~At September 30, 2017,~~December 31, 2018, there were ~~22,988,759~~28,862,461 and 28,696,321 shares of Class A Common Stock issued and ~~outstanding. On July 1, 2017,~~outstanding, respectively. During the three months ended March 31, 2019, as a result of the vesting and settlement of restricted stock units under the Earthstone ~~retired~~Energy, Inc. Amended and ~~returned the 15,357 shares of treasury stock to authorized but unissued~~Restated 2014 Long-Term Incentive Plan (the "2014 Plan"), Earthstone issued 225,401 shares of Class A Common ~~Stock.~~Stock, of which 59,261 shares of Class A Common Stock were retained as treasury stock and canceled to satisfy the related employee income tax liability. During the ~~period January 1, 2017 through May 8, 2017, the Company issued 382,804 shares of Common Stock~~three months ended March 31, 2018, as a result of the vesting and settlement of restricted stock units under the 2014 ~~Plan. During the period May 9, 2017 through September 30, 2017, the Company~~Plan, Earthstone issued ~~182,135~~114,936 shares of Class A Common Stock ~~as a result~~ of ~~the vesting and settlement of restricted stock units under the 2014 Plan. Additionally, on May 9, 2017, under the Bold Contribution Agreement, Earthstone issued 150,000~~which 28,664 shares of Class A Common Stock ~~valued at approximately $2.0 million on that date. For additional information, see~~ ~~Note 2. Acquisitions~~were retained as treasury stock and ~~Divestitures~~.

~~Class A Common Stock Offering~~

~~In October 2017,~~canceled to satisfy the Company completed a public offering of 4,500,000 shares of Class A Common Stock, at an issue price of $9.25 per share. The Company received net proceeds from this offering of $39.2 million, after deducting underwriters’ fees and offering expenses of $2.4 million. The net proceeds from the offering were used to repay outstanding indebtedness under the EEH Credit Agreement.

related employee income tax liability.

Class B Common Stock

At ~~September 30, 2017,~~March 31, 2019 and December 31, 2018, there were ~~36,070,828~~35,452,178 shares of Class B Common Stock issued and outstanding. Earthstone did not have any Class B Common Stock issued at December 31, 2016. On May 9, 2017, in connection with Earthstone’s completion of the Bold Transaction, Earthstone issued 36,070,828 shares of Class B Common Stock in exchange for $36 thousand.outstanding, respectively. Each share of Class B Common Stock, together with one EEH Unit, is convertible into one share of Class A Common Stock. ~~For additional information, see~~ ~~Note 2. Acquisitions~~During the three months ended March 31, 2019, no shares of Class B Common Stock and ~~Divestitures~~.

~~On May 9, 2017, in connection with the closing~~EEH Units were exchanged for an equal number of ~~the Bold Transaction, Earthstone, EnCap, Oak Valley, and Bold Holdings entered into the Voting Agreement, pursuant to which EnCap, Oak Valley, and Bold Holdings agreed not to vote any~~ shares of Class A Common ~~Stock or~~Stock. During the three months ended March 31, 2018, 194,046 shares of Class B Common Stock ~~held by them in favor~~and EEH Units were exchanged for an equal number of ~~any action, or take any action that would in any way alter the composition~~shares of the Board from its composition immediately following the closing of the Bold Transaction as long as the Voting Agreement is in effect. The Voting Agreement terminates on the earlier of (i) the fifth anniversary of the closing date of the Bold Contribution Agreement and (ii) the date upon which EnCap, Oak Valley, and Bold Holdings collectively own, of record and beneficially, less than 20% of Earthstone’s outstanding voting stock.

Class A Common Stock.

Note 9.8. Stock-Based Compensation

Restricted Stock Units

The 2014 Plan, ~~as amended,~~ allows, among other things, for the grant of ~~RSUs. On May 9, 2017, and in connection with~~restricted stock units ("RSUs"). As of March 31, 2019, the ~~completion of the Bold Contribution Agreement, and upon approval by the stockholders of Earthstone, the 2014 Plan was amended to increase the~~maximum number of shares of Class A Common Stock ~~authorized to~~that may be issued under the 2014 Plan ~~by 4.3~~was 6.4 million ~~shares, to a total of 5.8 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. Prior to May 9, 2017, the~~settlement. The Company ~~determined the fair value of granted RSUs based on the market price of the Common Stock of the Company on the date of the grant. Beginning on May 9, 2017, the Company began determining~~determines the fair value of granted RSUs based on the market price of the Class A Common Stock ~~of Earthstone~~ 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.

~~The table below summarizes unvested RSU award activity for the nine months ended September 30, 2017:~~

Shares

Weighted-Average Grant Date Fair Value

Unvested RSUs at December 31, 2016

781,500

$
12.53

Granted

254,500

$
11.67

Forfeited

(36,000
)

$
13.30

Vested

(594,380
)

$
12.45

Unvested RSUs at September 30, 2017

405,620

$
12.03

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

The unrecognized compensation expense related to the RSU awards at September 30, 2017 was $4.3 million which will be amortized over the remaining vesting period. The weighted average remaining vesting period of the unrecognized compensation expense is 0.74 years.

Stock-based compensation ~~expense for the three~~is included in General and ~~nine months ended September 30, 2017 was $1.7 million and $4.6 million, respectively. For the three and nine months ended September 30, 2016, stock-based compensation~~administrative expense ~~was $1.3 million and $1.9 million, respectively. Stock-based compensation expense is recorded~~ in the Condensed Consolidated Statements of Operations and is recorded with a corresponding increase in Additional paid-in capital within the Condensed Consolidated Balance ~~Sheet.~~

~~During~~Sheets.

The table below summarizes RSU award activity for the ~~nine~~three months ended ~~September 30, 2016,~~March 31, 2019:



	Shares		Weighted-Average Grant Date Fair Value
Unvested RSUs at December 31, 2018	810,995		$	8.83
Granted	743,350		$	6.40
Forfeited	(13,750	)	$	7.70
Vested	(225,401	)	$	8.56
Unvested RSUs at March 31, 2019	1,315,194		$	7.51

As of March 31, 2019, there was $9.7 million of unrecognized compensation expense related to the RSU awards which will be recognized over a weighted average period of 1.10 years.

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

For the three months ended March 31, 2019 and 2018, Stock-based compensation related to RSUs was $1.6 million and $1.8 million, respectively.

Performance Units

The table below summarizes performance unit (“PSU”) activity for the three months ended March 31, 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 March 31, 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 ~~772,500 RSUs with~~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 ~~of $12.55.~~ per PSU to be $9.30.

As of ~~September 30, 2016, all 772,500 RSUs were unvested.~~

~~Note 10.~~ ~~Long-Term Debt~~

~~Credit Agreement~~

On May 9, 2017, in connection with the closing of the Bold Transaction, the Company exited its credit agreement dated December 19, 2014, by and among Earthstone, Oak Valley Operating, LLC, EF Non-OP, LLC, Sabine River Energy, LLC, Basic Petroleum Services, Inc., BOKF, NA dba Bank of Texas, and the Lenders party thereto (as amended, modified or restated from time to time, the “ESTE Credit Agreement”). At that time, all outstanding borrowings of $10.0 million under the ESTE Credit Agreement were repaid and $0.5March 31, 2019, there was $8.1 million of ~~remaining unamortized deferred financing costs were expensed~~unrecognized compensation expense related to the PSU awards which will be amortized over a weighted average period of 1.3 years.

For the three months ended March 31, 2019 and ~~included in Write-off~~2018, Stock-based compensation related to the PSUs was approximately $0.6 million and $0.1 million, respectively.

Note 9. Long-Term Debt

Credit Agreement

In May, 2017, Earthstone Energy Holdings, LLC (“EEH” or the “Borrower”), a subsidiary of ~~deferred financing costs in the Condensed Consolidated Statements~~Earthstone, each of ~~Operations.~~

~~On May 9, 2017, EEH (the “Borrower”),~~ Earthstone Operating, LLC, EF Non-Op, LLC, Sabine River Energy, LLC, Earthstone Legacy Properties, LLC, Lynden ~~Op,~~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~~lenders party thereto (the “Lenders”), entered into a credit agreement ~~(the~~(as amended, modified or restated from time to time, the “EEH Credit Agreement”).

The borrowing base under the EEH Credit Agreement is ~~$150.0 million, and is~~ subject to redetermination on or about ~~November~~May 1st and ~~May~~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 ~~2.25%~~1.75% to ~~3.25%~~2.75% or (b) the prime lending rate of Bank of Texas plus ~~1.25%~~0.75% to ~~2.25%~~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.

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

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, 2017,~~March 31, 2019, EEH was in compliance with ~~these~~the covenants under the EEH Credit Agreement.

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

As of ~~September 30, 2017,~~March 31, 2019, the Company had a ~~$150.0~~$275.0 million borrowing base under the EEH Credit Agreement, of which ~~$70.0~~$120.8 million was outstanding, bearing annual interest of ~~3.7311%~~4.486%, resulting in an additional ~~$80.0~~$154.2 million of borrowing base availability under the EEH Credit Agreement.

~~Promissory Note~~

~~In July 2016, Earthstone issued a $5.1~~ At December 31, 2018, there were $78.8 million ~~unsecured promissory note (the “Note”) to a drilling rig contractor in settlement~~ of rig idle charges and the termination amount of the contract. These expenses which were incurred from late January 2016 through September 30, 2016 were recorded in Rig idle and termination expense in the Condensed Consolidated Statements of Operations for the nine months ended September 30, 2016. The Note was assigned to EEH in connection with the closing of the Bold Transaction. The Note is payable in monthly installments over a three-year period maturing in July 2019, bearing an annualized interest rate of 8.0% for the first 12 months, 10.0% for the subsequent 12 months, and 12.0% for the last 12 months, with no prepayment penalty. Interest expense is recognized using the effective interest method of approximately 9.1% over the life of the note. As of September 30, 2017, the Company had $3.1 millionborrowings outstanding under the ~~Note with $1.7~~EEH Credit Agreement. On May 1, 2019, the borrowing base under the EEH Credit Agreement was increased from $275.0 million ~~included in the current portion of long-term debt.~~

~~Total Long-Term Debt~~

~~The following table below summarizes long term debt (in thousands~~):

to $325.0 million.

September 30,

December 31,

2017

2016

Borrowings under Credit Agreement

$
70,000

$
10,000

Promissory note

3,104

4,297

Total debt

73,104

14,297

Less: Current portion of long-term debt

(1,704
)

(1,604
)
Long-term debt

$
71,400

$
12,693

For the ~~nine~~three months ended ~~September 30, 2017,~~March 31, 2019, the Company had borrowings of ~~$70.0~~$85.2 million and ~~$11.2~~$43.2 million in repayments of borrowings. The borrowings included $58.0 million related to the repayment of all outstanding borrowings under Bold’s credit agreement which were assumed by EEH in connection with the closing of the Bold Transaction.

The following table summarizes the Company’s asset retirement obligation transactions recorded during the ~~nine~~three months ended ~~September 30,~~March 31, (in thousands):

2017

2016

Beginning asset retirement obligations

$
6,013

$
5,075

Liabilities incurred

64

114

Liabilities settled

—

(15
)
Acquisitions ⁽¹⁾

359

250

Accretion expense

378

404

Divestitures ⁽²⁾

(3,629
)

—

Revision of estimates

19

(13
)
Ending asset retirement obligations

$
3,204

$
5,815

~~(1)~~

~~The 2017 amount is related to the Bold Transaction. The 2016 amount is related to the Lynden Arrangement.~~

~~(2)~~

~~See~~ ~~Note 2. Acquisitions and Divestitures.~~



	2019			2018
Beginning asset retirement obligations	$	2,229		$	2,354
Liabilities incurred	21			1
Liabilities settled	(62		)	(52		)
Accretion expense	54			41
Divestitures	—			(385		)
Revision of estimates	—			(182		)
Ending asset retirement obligations	$	2,242		$	1,777

Note ~~12.~~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 ~~12.9%~~10.3% 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, 2017,~~March 31, 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~~Trend in Texas. In connection with the Operating Agreement, the Company made payments to Flatonia of ~~$6.4~~$4.3 million and ~~$20.8~~received payments from Flatonia $1.3 million for the three months ended March 31, 2019. For the three months ended March 31, 2018, the Company made payments to Flatonia of $6.2 million and received payments from Flatonia of ~~$0.8 million~~$2.1 million. At March 31, 2019 and $3.2 million for the three and nine months ended September 30, 2017, respectively. For the three and nine months ended September 30, 2016, the Company made payments to Flatonia of $5.1 million and $21.3 million and received payments from Flatonia of $5.8 million and $8.6 million, respectively. At September 30, 2017,December 31, 2018, amounts receivable from Flatonia in connection with the Operating Agreement were ~~$1.5 million. At December 31, 2016, Earthstone had $1.5~~$1.0 million ~~of outstanding receivables due from Flatonia. Amounts payable~~and $0.8 million, respectively. Payables related to ~~Flatonia in connection with the Operating Agreement were $3.1 million at December 31, 2016. There were no payables~~revenues outstanding and due to Flatonia as of ~~September 30, 2017.~~March 31, 2019 and December 31, 2018 were $1.3 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.

Note ~~13.~~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.

~~In July 2015, EF Non-Op, LLC, a subsidiary of Earthstone, filed suit in the 125~~^th ~~Judicial District Court of Harris County, Texas against the operator of its properties in LaSalle County, Texas. In the case~~

~~EF Non-Op, LLC vs. BHP Billiton Petroleum Properties (N.A.), LP (F/K/A Petrohawk Properties, LP),~~ the Company claims the operator has breached the applicable joint operating agreements in numerous ways, including, but not limited to, improper authorization for expenditure requests, improper and imprudent operations, misrepresentation of charges and excessive billings, as well as refusal to provide requested information. The Company also claims damages from negligent representation and fraud. The Company is seeking all relief to which it is entitled, including consequential damages and attorneys’ fees. BHP Billiton has claimed they are owed unpaid lease operating expenses and attorneys’ fees. With respect to a portion of the litigation associated with nine non-operated gas wells that were drilled in 2014 and placed on production in the first half of 2015, BHP Billiton in early 2016 elected to deem the Company as a non-consenting working interest owner regarding costs associated with the drilling, completing and operating of these nine wells, as BHP’s sole and exclusive remedy. The Company has accepted this “non-consent” status. The litigation is continuing with respect to the other disputes. The outcome of remaining disputes in this proceeding is uncertain, and while the Company is confident in its position, any potential monetary recovery or loss to the Company cannot be estimated at this time.

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 ~~the Company’s~~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.~~OVR. The complaint alleges that ~~the Company’s~~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 ~~Contribution Agreement.~~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

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

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 ~~the Company~~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 ~~Company~~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 ~~they~~ intend to mount a vigorous defense. The ultimate outcome of this suit is uncertain,

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

and while ~~the Company~~Earthstone is confident in its position, any potential monetary recovery or loss to ~~the Company~~Earthstone cannot be estimated at this time.

On August 18, 2017, litigation captioned Trinity Royal Partners, LP v. Bold Energy III LLC, et al. was filed with the 142nd Judicial District of the District Court in Midland County, Texas, asserting breach of contract and indemnity claims for alleged damages from loss of property relating to two oil and natural gas wells in which Bold was the operator. Trinity Royalty Partners, LP (“Trinity”) alleges that Bold is required to indemnify Trinity under the terms of an Assignment and a Participation and Joint Development Agreement between Bold and Trinity. Damages are alleged to include costs incurred in attempting to repair and restore an oil and natural gas well and for the loss of future reserves attributable to both wells. Trinity is seeking approximately $7.2 million in damages and attorneys’ fees. Earthstone and Bold believe the suit is without any merit and Bold intends to mount a vigorous defense. The outcome of this suit is uncertain, and while the Company is confident in its position, any potential monetary recovery or loss to the Company cannot be estimated at this time.

Environmental and Regulatory

As of ~~September 30, 2017,~~March 31, 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 ~~14.~~13. Income Taxes

~~Following the closing of the Bold Transaction, the Company continues to record an income tax provision consistent with its status as a corporation.~~

The Company’s corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns and one Canadian income tax return ~~resulting from the Lynden Arrangement that includes~~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. ~~Following the Bold Transaction,~~ 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 well as any standalone income or loss generated by each company.~~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~~three months ended ~~September 30, 2017,~~March 31, 2019, the Company recorded anincome tax benefit of approximately $0.5 million which included (1) income tax benefit for Lynden US of ~~$2.7~~$0.8 million as a result of its ~~standalone pre-tax loss incurred before~~share of the ~~Bold Transaction and~~distributable income from EEH, (2) income tax benefit for Earthstone of $2.9 million as a result of its share of the distributable ~~loss~~income from EEH, ~~after~~which was used to reduce the ~~Bold Transaction.~~

~~During the nine months ended September 30, 2017, the Company did not record an income~~valuation recorded against its deferred tax ~~benefit for Earthstone~~asset as ~~a result of its standalone pre-tax loss incurred before the Bold Transaction and its share of the distributable loss from EEH after the Bold Transaction, because the~~ future realization of ~~such loss cannot be reasonably assured and is subject to a full valuation allowance. Earthstone recorded a $7.5 million income tax benefit as a discrete item during~~ the ~~current reporting period, which resulted from a change in assessment of the realization of its~~ net deferred tax ~~assets due to the~~asset cannot be assured and (3) deferred ~~tax liability that was recorded with respect to its investment in EEH as part of the Bold Transaction as an adjustment to Additional paid-in capital within the Condensed Consolidated Balance Sheet.~~

~~Lynden Corp incurred no material net income (loss), or related~~ income tax expense ~~(benefit), for the three and nine months ended September 30, 2017.~~

~~EEH recorded deferred tax expense during nine months ended September 30, 2017~~ of ~~$0.2~~$0.3 million related to the Texas Margin ~~Tax~~Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the three months ended March 31, 2019.

During the three months ended March 31, 2018, the Company recorded an income tax expense for Lynden US of $0.2 million as a result of its share of the distributable income from EEH. During the three months ended March 31, 2018, the Company recorded an income tax expense for Earthstone of $0.9 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation recorded against its deferred tax asset as future realization of the net deferred tax asset cannot be assured. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the three months ended March 31, 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 March 31, 2019 for our leases is as follows (in thousands):

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Leases	Classification
Assets
Noncurrent:
Operating	Operating lease right-of-use assets	$	1,049
Finance	Office and other equipment, net of accumulated depreciation and amortization	752
Total lease assets		$	1,801

Liabilities
Current:
Operating	Operating lease liabilities	$	658
Finance	Finance lease liabilities	354
Noncurrent:
Operating	Operating lease liabilities	442
Finance	Finance lease liabilities	193
Total lease liabilities		$	1,647

*The difference between assets and liabilities includes a $0.1 million adjustment to NCI and a $0.07 million adjustment to accumulated deficit, ~~margin generated during~~both at the beginning of the period ~~cannot be carried forward to offset future taxable margin~~as part of the ASC 842 implementation adjustment.

Our operating lease expense for the three months ended March 31, 2019 was $0.2 million and is included in General and administrative expense in our Condensed Consolidated Statements of Operations. Our finance lease expense for the three months ended March 31, 2019 was $0.1 million and is 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 $2.1 million of short-term lease costs related to ~~state basis differences~~ drilling rig contracts. All of our drilling rig contracts have enforceable terms of less than one year.

Minimum contractual obligations for our leases (undiscounted) as of March 31, 2019 are as follows (in ~~EEH’s oil~~thousands):



	Operating			Finance
2019 (excluding three months ended March 31, 2019	$	619		$	295
2020	206			219
2021	215			65
2022	110			—
2023	—			—
Thereafter	—			—
Total lease payments	$	1,150		$	579
Less imputed interest	(50		)	(32		)
Total lease liability	$	1,100		$	547

Cash paid for our operating and ~~natural gas properties.~~

finance leases were $0.2 million and $0.1 million, respectively, for the three months ended March 31, 2019. Right-of-use assets obtained in exchange for lease obligations for our operating leases were $0.6 million for the three months ended March 31, 2019. The amount related to our finance leases was not material to our consolidated financial statements.

As of March 31, 2019, the weighted average remaining lease terms of our operating and finance leases were 1.9 years and 1.8 years, respectively. The weighted average discount rates used to determine the lease liabilities as of March 31, 2019 for our operating and finance leases were 4.35% and 6.57%, 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.

I~~tem~~

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 ~~2016~~2018 Annual Report on Form 10-K ~~as amended,~~ 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, ~~2016,~~2018, which are included in our ~~2016~~2018 Annual Report on Form ~~10-K, as amended.~~

10-K.

Overview

~~We are~~

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 and, to a lesser extent, exploration activities.~~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~~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 ~~Bakken/Three Forks formations of North Dakota~~.

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 ~~Energy, Inc. (“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 (collectively,~~US.

Management’s Plans

Our plans include a continued focus on the ~~“Company” “our,” “we,” “us,”~~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 16 operated wells and completing 13 of these operated wells. In addition, we have assumed participating in drilling 20 wells and completing 19 wells where we have a non-operated working interest. At our Eagle Ford Trend properties, our development program includes drilling approximately seven operated wells and completing seven wells. In order to achieve these plans, we have an approved annual budget of $190.0 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 ~~similar terms)~~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).

~~Recent Developments~~

~~Bold Contribution Agreement~~

~~On May 9, 2017, Earthstone completed a contribution agreement dated as~~ We will also remain active in seeking M&A transactions in this high economic return geographic area.

Areas 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, a Texas limited liability company (“Lynden Op”), Bold Energy Holdings, LLC, a Texas limited liability company (“Bold Holdings”), and Bold Energy III LLC, a Texas limited liability company (“Bold”). The purpose of the Bold Contribution Agreement was to provide for, among other things described below, the business combination between Earthstone and Bold, which owns significant developed and undeveloped oil and natural gas propertiesOperation

Our primary focus is concentrated in the Midland Basin of west Texas, ~~(the “Bold Transaction”)~~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.

Midland Basin

We completed six wells (three operated and three non-operated) and spud an additional 12 wells (three operated and nine non-operated) during the first quarter of 2019. We currently expect to complete approximately 10 operated wells over the latter half of 2019. We intend to continue to initiate completion activities when we accumulate an adequate inventory of wells for efficient operations.

Commencing in early 2018, market concerns about future take-away capacity adversely affected oil and gas price differentials in the Midland Basin. Since then, the market concerns have been abated as additional oil pipelines have been added to the take-away infrastructure in the area. Consequently, we have experienced significant improvement in these negative oil price differentials. Natural gas price differentials continue to grow as future take-away capacity in the area is being challenged. However, there are some additional gas pipelines expected to come on line on or about the fourth quarter of 2019. While we believe the economic returns from our operations are very attractive at current price levels and our wells are meeting or exceeding our type curves, our cashflows are being impacted by negative differentials, (excluding the impact of derivatives).

Increasing and sustained negative oil and gas price differentials will 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 have commenced drilling operations and expect to complete the seven well program by the end of 2019.

Critical Accounting Policies

The ~~Bold Transaction was structured~~preparation of financial statements in ~~a manner commonly known as an “Up-C.” Under this structure~~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 ~~Bold Contribution Agreement, (i) Earthstone recapitalized its common~~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. There have been no significant changes to our critical accounting policies during the three months ended March 31, 2019.

Results of Operations

Three Months Ended March 31, 2019, compared to the Three Months Ended March 31, 2018



	Three Months Ended March 31,
	2019			2018			Change
Sales volumes:
Oil (MBbl)	678			546			24	%
Natural gas (MMcf)	827			1,044			(21	)%
Natural gas liquids (MBbl)	193			150			29	%
Barrels of oil equivalent (MBOE)	1,009			870			16	%
Average Daily Production (Boepd)	11,209			9,664			16	%

Average prices:
Oil (per Bbl)	$	52.30		$	63.07		(17	)%
Natural gas (per Mcf)	$	1.32		$	2.57		(49	)%
Natural gas liquids (per Bbl)	$	21.66		$	25.30		(14	)%

Average prices adjusted for realized derivatives settlements:
Oil ($/Bbl)⁽¹⁾	$	59.81		$	55.11		9	%
Gas ($/Mcf)⁽¹⁾	$	1.66		$	2.63		(37	)%
NGL ($/Bbl)	$	21.66		$	25.30		(14	)%

(In thousands)
Oil revenues	$	35,447		$	34,417		3	%
Natural gas revenues	$	1,094		$	2,684		(59	)%
Natural gas liquids revenues	$	4,187		$	3,794		10	%

Lease operating expense	$	6,667		$	4,657		43	%
Severance taxes	$	1,988		$	2,037		(2	)%
Depreciation, depletion and amortization	$	14,005		$	9,708		44	%

General and administrative expense (excluding stock-based compensation)	$	5,058		$	4,639		9	%
Stock-based compensation	$	2,212		$	1,940		14	%
General and administrative expense	$	7,270		$	6,579		11	%

Interest expense, net	$	(1,449	)	$	(613	)	136	%

Unrealized loss on derivative contracts	$	(53,256	)	$	(1,000	)	NM
Realized gain (loss) on derivative contracts	$	5,362		$	(4,275	)	NM
Loss on derivative contracts, net	$	(47,894	)	$	(5,275	)	NM

Income tax benefit (expense)	$	460		$	(249	)	NM

(1) Includes $2.1 million of cash proceeds related to hedges unwound during the first quarter of 2019.

NM – Not Meaningful

Oil revenues

For the three months ended March 31, 2019, oil revenues increased by $1.0 million or 3% relative to the comparable period in 2018. Of the increase, $6.9 million was attributable to an increase in volume, partially offset by $5.9 million attributable to a decrease in our realized price. Our average realized price per Bbl decreased from $63.07 for the three months ended March 31, 2018 to $52.30 or 17% for the three months ended March 31, 2019. We had a net increase in the volume of oil sold of 132 MBbls or 24%, primarily due to new wells brought online in late 2018, partially offset by the impact of divestitures in the latter half of 2018.

Natural gas revenues

For the three months ended March 31, 2019, natural gas revenues decreased by $1.6 million or 59% relative to the comparable period in 2018. Of the decrease, $1.3 million was attributable to a decrease in our realized price and $0.3 million was attributable to a decrease in volume. Our average realized price per Mcf decreased from $2.57 for the three months ended March 31, 2018 to $1.32 or 49% for the three months ended March 31, 2019. The total volume of natural gas produced and sold decreased 217 MMcf or 21% primarily due to the impact of 2018 gas well divestitures.

Natural gas liquids revenues

For the three months ended March 31, 2019, natural gas liquids revenues increased by $0.4 million or 10% relative to the comparable period in 2018. Of the increase, $0.9 million was attributable to increased volume, partially offset by $0.5 million attributable to a decrease in our realized price. The volume of natural gas liquids produced and sold increased by 43 MBbls or 29%, primarily due to new wells brought online in late 2018, partially offset by the impact of divestitures in the latter half of 2018.

Lease operating expense (“LOE”)

LOE increased by $2.0 million or 43% for the three months ended March 31, 2019 relative to the comparable period in 2018. The increase was primarily due to additional producing wells brought online, which drove a 16% increase in production volume; in addition to a $1.0 million increase driven by a greater number of workover projects as compared to the prior year quarter.

Severance taxes

Severance taxes for the three months ended March 31, 2019 remained flat as compared to the comparable period in 2018, as the impact of increased volume was 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.

Depreciation, depletion and amortization (“DD&A”)

DD&A increased for the three months ended March 31, 2019 by $4.3 million, or 44% 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 March 31, 2019 increased by $0.7 million, or 11% relative to the comparable period in 2018. The total increase consisted of $0.4 million from increased staffing throughout 2018 and $0.3 million resulted from non-cash stock-based compensation expense related to restricted stock ~~into two classes – Class A common stock, $0.001 par value per share (the “Class A Common Stock”),~~units awarded to our executive officers on January 28, 2019.

Interest expense, net

Interest expense increased from $0.6 million for the three months ended March 31, 2018 to $1.4 million for the three months ended March 31, 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 three months ended March 31, 2019, we recorded a net loss on derivative contracts of $47.9 million, consisting of unrealized mark-to-market losses of $53.3 million, partially offset by net realized gains on settlements of $5.4 million. For the three months

ended March 31, 2018, we recorded a net loss on derivative contracts of $5.3 million, consisting of unrealized mark-to-market losses of $1.0 million and ~~Class B common stock, $0.001 par value per share (the “Class B Common Stock”), and all~~net realized losses on settlements of ~~Earthstone’s existing outstanding common stock, $0.001 par value per share (the “Common Stock”), was recapitalized on~~$4.3 million.

Income tax benefit (expense)

During the three months ended March 31, 2019, we recorded income tax benefit of approximately $0.5 million which included (1) income tax benefit for Lynden US of $0.8 million as a ~~one-for-one basis for Class A Common Stock (the “Recapitalization”); (ii) Earthstone transferred all~~result of its ~~membership interests in~~share of the distributable income from EEH, (2) income tax benefit for Earthstone ~~Operating, LLC, Sabine River Energy, LLC, EF Non-Op, LLC~~of $2.9 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation recorded against its deferred tax asset as future realization of the net deferred tax asset cannot be assured and ~~Earthstone Legacy Properties, LLC (formerly Earthstone GP, LLC) and $36,071 in cash from~~(3) deferred income tax expense of $0.3 million related to the ~~sale of Class B Common Stock to Bold Holdings (collectively,~~Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the ~~“Earthstone Assets”) to EEH, in exchange~~three months ended March 31, 2019.

During the three months ended March 31, 2018, we recorded an income tax expense for ~~16,791,296 membership units of EEH (the “EEH Units”); (iii)~~ Lynden US ~~transferred all~~of $0.2 million as a result of its ~~membership interests in Lynden Op to EEH in exchange~~share of the distributable income from EEH. During the three months ended March 31, 2018, we recorded an income tax expense for ~~5,865,328 EEH Units; (iv) Bold Holdings transferred all~~Earthstone of $0.9 million as a result of its membership interests in Bold to EEH in exchange for 36,070,828 EEH Units and purchased 36,070,828 shares of Class B Common Stock issued by Earthstone for $36,071; and (v) Earthstone granted an aggregate of 150,000 fully vested shares of Class A Common Stock under Earthstone’s 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”), to certain employees of Bold. Each EEH Unit, together with one share of ~~Class B Common Stock, are convertible into one share of Class A Common Stock.~~

~~Upon closing~~the distributable income from EEH, which was used to reduce the valuation recorded against its deferred tax asset as future realization of the Bold Transaction on May 9, 2017, Bold Holdings owned approximately 61.4% of the outstanding shares of Class A Common Stock, on a fully diluted, as converted basis. The EEH Units and the shares of Class B Common Stock issued to Bold Holdings were not registered under the Securities Act of 1933, as amended (the “Securities Act”), but were issued by EEH and Earthstone in reliance on the exemption provided under Section 4(a)(2) of the Securities Act.

Pursuant to the terms of the Bold Contribution Agreement, at the closing of the Bold Transaction, Earthstone, Bold Holdings, and the unitholders of Bold Holdings entered into a registration rights agreement (the “Registration Rights Agreement”) relating to the shares of Class A Common Stock issuable upon the exchange of the EEH Units and Class B Common Stock held by Bold Holdingsnet deferred tax asset cannot be assured. Lynden Corp incurred no material income or its unitholders. In accordance with the Registration Rights Agreement, Earthstone filed a registration statement (the “Registration Statement”) with the SEC to permit the public resale of the shares of Class A Common Stock issued by Earthstone to Bold Holdingsloss, or its unitholders in connection with the exchange of Class B Common Stock and EEH Units in accordance with the terms of the First Amended and Restated Limited Liability Company Agreement of EEH. On October 18, 2017, the SEC issued a Notice of Effectivenessrelated income tax expense or benefit, for the ~~Registration Statement.~~

~~On May 9, 2017, in connection with the closing~~three months ended March 31, 2018.

Liquidity and Capital Resources

We have significant undeveloped acreage and future drilling locations. Drilling horizontal wells, generally consisting of the Bold Contribution Agreement, Earthstone, EnCap Investments L.P. (“EnCap”), Oak Valley Resources, LLC (“Oak Valley”), and Bold Holdings entered into a voting agreement (the “Voting Agreement”), pursuant7,500 to which EnCap, Oak Valley, and Bold Holdings agreed not to vote any shares of Class A Common Stock or Class B Common Stock held by them in favor of any action, or take any action that would in any way alter the composition of the board of directors of Earthstone (the “Board”) from its composition immediately following the closing of the Bold Contribution Agreement as long as the Voting Agreement is in effect.

Immediately following the closing of the Bold Contribution Agreement, the Board was increased to nine members from eight members, four of which are designated by EnCap, three of which are independent, and two of which are members of management, including Earthstone’s Chief Executive Officer. At any time during the effectiveness of the Voting Agreement during which EnCap’s collective ownership of Earthstone exceeds 50% of the total issued and outstanding voting stock, EnCap may remove and replace one director that was not originally designated by EnCap, and his or her successors. Any such removal and replacement will be conducted in accordance with the provisions of Earthstone’s certificate of incorporation and bylaws then in effect. The Voting Agreement terminates on the earlier of (i) the fifth anniversary of the closing date of the Bold Contribution Agreement and (ii) the date upon which EnCap, Oak Valley, and Bold Holdings collectively own, of record and beneficially, less than 20% of Earthstone’s outstanding voting stock.

On May 9, 2017, the closing sale price of the Class A Common Stock was $13.58 per share. On May 10, 2017, the Class A Common Stock was uplisted from the NYSE MKT, LLC (the “NYSE MKT”) to the New York Stock Exchange (the “NYSE”) where it is listed under the symbol “ESTE.”

~~Management’s Plans~~

~~Since establishing a substantial operated presence~~12,000-foot lateral lengths, in the Midland Basin is capital intensive. At March 31, 2019, we ~~have~~had approximately $0.4 million in cash and approximately $154 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 $190 million, of which $48.5 million has been ~~focused on integrating the operations, engineering, geology, land, accounting and personnel functions throughout the Company as well as continuing~~spent through March 31, 2019. Our 2019 capital program assumes a ~~drilling and completion program. Although commodity prices have been volatile in 2017, our current business plan is to continue to operate~~16-well program running one rig ~~primarily~~for our operated acreage in the Midland Basin ~~of west Texas throughout the rest of 2017~~ and ~~through 2018. In the~~a seven-well program for our operated Eagle Ford ~~trend, we concluded an 11 well drilling program and expect to start completion operations on those wells in November 2017.~~

~~We intend to focus on reducing our lease operating expenses and general and administrative expense on a per unit of production basis,~~acreage as well as ~~improving~~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 ~~efficiency~~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 techniques or transactions, including but not limited to promoted drilling arrangements.

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 $28.8 million as of March 31, 2019 compared to a deficit of $18.3 million as of December 31, 2018. Our collection of receivables has historically been timely and losses associated with uncollectible receivables have historically not been significant. The increase in the deficit is primarily the result of a net decrease in fair value of our ~~capital spending.~~

derivative contracts expected to settle over the next 12 months partially offset by increased receivables and decreased payables. We ~~will remain vigilant~~expect that changes in ~~assessing volatility~~receivables and payables related to our pace of development, production volumes, changes in ~~the~~our hedging activities, realized commodity prices and ~~adjust~~differentials to NYMEX prices for our ~~business plan accordingly.~~

~~Credit Agreement~~

~~On May 9, 2017, in connection~~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 the closing of the Bold Transaction, the Company exited its credit agreement dated December 19, 2014, by and among Earthstone, Oak Valley Operating, LLC, EF Non-OP, LLC, Sabine River Energy, LLC, Basic Petroleum Services, Inc., BOKF, NA dba Bank of Texas, and the Lenders party thereto (as amended, modified or restatedcash flows from ~~time to time, the “ESTE Credit Agreement”). At that time, all outstanding~~operating activities, borrowings ~~of $10.0 million~~ under the ~~ESTE~~EEH Credit Agreement and, various means of corporate and project financing, assuming we can effectively access debt and equity markets. 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.

Cash Flows from Operating Activities

Cash flows provided by operating activities for the three months ended March 31, 2019 were ~~repaid~~$7.1 million compared to $16.8 million for the three months ended March 31, 2018. The decrease in operating cash flows from the prior year period was primarily due to use of cash from changes in payables and ~~$0.5~~receivables related to our operation of our oil and gas properties partially offset by sources of cash from changes in cash settlements of derivative contracts.

Cash Flows from Investing Activities

Cash flows used in investing activities for the three months ended March 31, 2019 and 2018 were $48.5 million and $33.2 million, respectively. The increase in cash flows used in investing activities was primarily due to increased drilling and completion activity as compared to the prior year quarter.

Cash Flows from Financing Activities

Cash flows provided by financing activities for the three months ended March 31, 2019 and 2018 were $41.5 million and $4.5 million, respectively. The increase was primarily due to higher net borrowings under the EEH Credit Agreement in the current year quarter which were used to fund our drilling and completion activities.

Capital Expenditures

Our 2019 capital budget assumes a one-rig operated program and non-operated activities as currently proposed by operators, for our acreage in the Midland Basin as well as a seven-well program on our operated Eagle Ford acreage. Our capital expenditures for 2019 are currently estimated at approximately $190.0 million, of ~~remaining unamortized deferred financing costs~~which we spent $48.5 million on a cash basis and incurred $42.7 million on an accrual basis during the first quarter of 2019 (the difference of $5.8 million representing a decrease in accrued but unpaid capital expenditures from December 31, 2018 to March 31, 2019).

Our accrual basis capital expenditures for the three months ended March 31, 2019 were ~~expensed and included~~ as follows (in ~~Write-off of deferred financing costs in~~thousands):



	Three Months Ended March 31, 2019
Drilling and completions	$	42,474
Leasehold costs	196
Total capital expenditures	$	42,670

Credit Agreement

In May, 2017, Earthstone Energy Holdings, LLC (“EEH” or the ~~Condensed Consolidated Statements of Operations.~~

~~On May 9, 2017, EEH (the~~ “Borrower”), a subsidiary of Earthstone, each of Earthstone Operating, LLC, EF Non-Op, LLC, Sabine River Energy, LLC, Earthstone Legacy Properties, LLC, Lynden ~~Op,~~USA Operating, LLC, Bold Energy III LLC, Bold Operating, LLC, as guarantors (the “Guarantors”), BOKF, NA dba Bank ofOf Texas, as Agent and Lead Arranger, Wells Fargo Bank, National Association, as Syndication Agent, and the ~~Lenders~~lenders party thereto (the “Lenders”), entered into a credit agreement ~~(the~~(as amended, modified or restated from time to time, the “EEH Credit Agreement”).

Interbank Offered Rate (“LIBOR”) plus ~~2.25%~~1.75% to ~~3.25%~~2.75% or (b) the prime lending rate of Bank of Texas plus ~~1.25%~~0.75% to ~~2.25%~~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.

As of ~~September 30, 2017, the Company~~March 31, 2019, we had a ~~$150~~$275.0 million borrowing base under the EEH Credit Agreement, of which ~~$70~~$120.8 million was outstanding, bearing annual interest of ~~3.7311%~~4.486%, resulting in an additional ~~$80~~$154.2 million of borrowing base availability under the EEH Credit Agreement.

~~Class A Common Stock Offering~~

In October 2017, the Company completed a public offering of 4,500,000 shares of Class A Common Stock, at a public offering price of $9.25 per share, receiving net proceeds of $39.2 million, after deducting underwriters’ fees and offering expenses of $2.4 million. The net proceeds were used to repay outstanding indebtedness under the EEH Credit Agreement. We also agreed to issue and sell to the underwriters, at their option, up to 675,000 additional shares of Class A Common Stock under an overallotment option expiring November 23, 2017. As of the date of the filing of this quarterly report, the option had not been exercised.

~~Divestiture of Assets~~

During the nine months ended September 30, 2017, we sold several small legacy properties for cash consideration of approximately $4.2 million. These properties were substantially non-operated, low margin properties which produced approximately 341 Boepd (64% gas) year to date. We may seek further sales of smaller, non-core assets through year-end pending economic prices. We are also considering a divestiture of our Bakken non-operated assets, which averaged approximately 876 Boepd (64% oil, 82% liquids) during the third quarter. A sale of these assets would allow us to further support our growth in the Midland Basin.

~~Uplisting of Class A Common Stock~~

On May ~~8, 2017,~~1, 2019, the Board approved (i) the transfer of the listing of the common stock, $0.001 par value per share (the “Common Stock”) of Earthstone, from the NYSE MKT to the NYSE, and (ii) the voluntary delisting of the Common Stock from the NYSE MKT. In connection with the closing of the Bold Transaction, all of the Common Stock was converted into Class A Common Stock, on a one-for-one basis. The Class A Common Stock began trading on the NYSE on May 10, 2017. The ticker symbol for the Class A Common Stock is the same as the Common Stock and trades under the symbol “ESTE.”

~~Closing of Denver Office~~

On June 30, 2017, Earthstone management informed the employees of its office located in Denver, Colorado, that it would be closing those offices and providing severance pay, consisting of both regular salary and benefits, for a specified period, if the employee agreed to stay through the transition period ended July 31, 2017.

~~Areas of Operation~~

~~Our core areas of operations are in the Midland Basin of west Texas, the Eagle Ford trend of south Texas and the Bakken/Three Forks formations of North Dakota.~~

~~Our operating results for the three and nine months ended September 30, 2017, were affected by the following factors:~~

~~In early 2016, we survived a low commodity price environment and industry downturn by reducing our costs and capital expenditures.~~

~~On May 18, 2016, Earthstone acquired Lynden US giving rise to our Midland Basin operations.~~

Our pre-Lynden US inventory of wells that were drilled but not completed in 2014 and 2015 were completed in the fourth quarter of 2016 in an improved commodity price environment compared to earlier in 2016.

~~On May 9, 2017, we completed the Bold Transaction, adding significant production to our operating results.~~

~~Commodity prices continue to be volatile.~~

~~Midland Basin~~

We believe that the Midland Basin continues to have attractive economics and we expect to continue to focus our attention on growing our footprint through acreage trades, acquisitions, development drilling and merger and acquisition opportunities. We are acutely focused on expansion in the Midland Basin and production results continue to be as good or better than we projected. Well results in the Wolfcamp formation have continued to meet or exceed our expectations.

We have been operating a one drilling rig program in the Midland Basin and plan to maintain a one rig program throughout the remainder of 2017 and 2018, with a view toward adding a second rig at some point in 2018 based upon commodity prices, our drilling results and liquidity. We recently completed drilling our seventh Midland Basin well (100% working interest) located in Reagan County and recently completed a three well pad (100% working interest) in Reagan County. We currently have a rig drilling the first well of a two-well pad in Reagan County, and we anticipate that the rig will thereafter be moved to Midland County to drill a two well pad. There are currently five wells in Reagan County waiting on completion for which we plan to initiate completion operations in November 2017.

~~We continue to be active in acreage trades and acquisitions in the Midland Basin which generally allow for longer laterals, increased operated inventory and greater operating efficiency.~~

~~Eagle Ford Trend~~

We recently completed an 11 well drilling program for 2017 in southern Gonzales County, Texas by drilling six wells in our Crosby Unit. Completion operations on the 11 wells are expected to begin in November 2017. We expect our 2018 drilling program to be consistent with our 2017 program. Additionally, during each of the second and third quarters of 2017, we entered into a Joint Development Agreements ("JDA") in southern Gonzales County. In each of the two JDA’s, the financial partner is obligated to pay a promoted (higher) share of the capital expenditures to earn 50% of our interest in these units and adjacent acreage. Based on current estimates, the two JDA’s are expected to reduce the Company's overall capital expenditures by approximately $17 million, allowing the Company to shift capital resources from the Eagle Ford to the Midland Basin while still maintaining operating control over its Eagle Ford program.

Additionally, the impacts from Hurricane Harvey during the third quarter were relatively minimal for us in the Eagle Ford, with no significant damages to our operations there. Minor weather associated delays in initiating completion operations in southern Gonzales County may reduce the number of our wells brought online during the last quarter of 2017, pushing some completions into early 2018.

~~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.

~~The following significant change has been made to our critical accounting policies during the nine months ended September 30, 2017:~~

The Bold Transaction was recorded in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, and is consolidated in these financial statements in accordance with FASB ASC Topic 810, Consolidation, which requires the recording of a noncontrolling interest component of net income (loss), as well as a noncontrolling interest component within equity, including changes to additional paid-in capital to reflect the noncontrolling interest within equity in the Condensed Consolidated Balance Sheet as of September 30, 2017 at the noncontrolling interest’s respective membership interest in EEH.

~~Noncontrolling Interest~~ – represents third-party equity ownership of EEH and is presented as a component of equity in the Condensed Consolidated Balance Sheet as of September 30, 2017, as well as an adjustment to Net income (loss) in the Condensed Consolidated Statements of Operations for the three and nine months ended September30, 2017. As of September 30, 2017, Earthstone and Lynden US held 38.9% of the outstanding membership interests in EEH while Bold Holdings held the remaining 61.1%. See further discussion in ~~Note 6. Noncontrolling Interest~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements~~.

~~Results of Operations~~

~~Three months ended September 30, 2017, compared to the three months ended September 30, 2016~~

Three Months Ended September 30,

2017

2016

Change

Sales volumes:

Oil (MBbl)

563

201

180
%
Natural gas (MMcf)

967

563

72
%
Natural gas liquids (MBbl)

166

71

134
%
Barrels of oil equivalent (MBOE)

890

366

143
%

Average prices realized: ⁽¹⁾

Oil (per Bbl)

$
45.73

$
41.11

11
%
Natural gas (per Mcf)

$
2.60

$
2.52

3
%
Natural gas liquids (per Bbl)

$
18.29

$
11.95

53
%

(In thousands)

Oil revenues

$
25,733

$
8,262

211
%
Natural gas revenues

$
2,513

$
1,417

77
%
Natural gas liquids revenues

$
3,036

$
851

257
%

Lease operating expense

$
5,407

$
4,581

18
%
Severance taxes

$
1,588

$
522

204
%
Depreciation, depletion and amortization

$
10,330

$
5,149

101
%
General and administrative expense

$
5,608

$
2,285

145
%
Stock-based compensation

$
1,687

$
1,328

27
%
Transaction costs

$
109

$
846

-87
%
Gain on sale of oil and gas properties

$
2,157

$
8

NM

Interest expense, net

$
(903
)

$
(341
)

165
%
(Loss) gain on derivative contracts, net

$
(3,663
)

$
946

-487
%
Income tax benefit (expense)

$
94

$
(201
)

-147
%

~~(1) Prices presented exclude any effects of oil and natural gas derivatives.~~

~~NM – Not Meaningful~~

~~Oil revenues~~

~~For the three months ended September 30, 2017, oil revenues increased by~~ ~~approximately~~ ~~$17.5 million or 211% relative to the comparable period in 2016. Of the increase,~~ ~~approximately~~ ~~$0.9 million was attributable to an increase in our realized price and $16.6 million was attributable to increased volume.~~ ~~Our~~ ~~average realized price per Bbl increased from $41.11 for the three months ended September 30, 2016 to $45.73 or 11% for the three months ended September 30, 2017.~~ ~~We had a net increase in the volume of oil sold of 362 MBbls, or 180%, primarily due to the Midland Basin properties we acquired in the Bold Transaction.~~

~~Natural gas revenues~~

For the three months ended September 30, 2017, natural gas revenues increased by $1.1 million or 77% relative to the comparable period in 2016. The increase was primarily attributable to an increase in volume. ~~The total volume of natural gas produced and sold increased 404 MMcf, or 72%, driven by an additional 483 MMcf from our Midland Basin properties acquired in the Bold Transaction.~~

~~Natural gas liquids revenues~~

~~For the three months ended September 30, 2017, natural gas liquids revenues increased by $2.2 million or 257% relative to the comparable period in 2016. Of the increase,~~ ~~approximately~~ ~~$0.5 million was attributable to an increase in our realized price and $1.7 million was attributable to increased volume.~~ ~~The volume of natural gas liquids produced and sold increased by 95 MBbls, or 134%, primarily due to an additional 100 MBbls from our Midland Basin properties acquired in the Bold Transaction.~~

~~Lease operating expense (“LOE”)~~

LOE includes all costs incurred to operate wells and related facilities for both operated and non-operated properties. In addition to direct operating costs such as labor, repairs and maintenance, re-engineering and workovers, equipment rentals, materials and supplies, fuel and chemicals, LOE includes product marketing and transportation fees, insurance, ad valorem taxes and overhead charges provided for in operating agreements.

LOE increased by $0.8 million or 18% for the three months ended September 30, 2017 relative to the comparable period in 2016. The increase was primarily the result of the costs to operate the producing assets acquired in the Bold Transaction, that were not incurred in the prior year period.

~~Severance taxes~~

Severance taxes for the three months ended September 30, 2017, increased by $1.1 million or 204% relative to the comparable period in 2016, primarily due to the increases in production volumes and oil and natural gas prices. However, as a percentage of revenues from oil, natural gas, and natural gas liquids, severance taxes remained flat when compared to the prior year period.

~~Depreciation, depletion and amortization~~ ~~(“DD&A”)~~

~~DD&A for the three months ended September 30, 2017, increased by $5.2 million, or 101% relative to the comparable period in 2016,~~ ~~due to the addition of the assets acquired in the both the Lynden Arrangement and Bold Transaction to the depletable base, as well as increased production volumes.~~

~~General and administrative expense (“G&A”)~~

G&A consists primarily of employee remuneration, professional and consulting fees and other overhead expenses. G&A increased by $3.3 million for the three months ended September 30, 2017 relative to the comparable period in 2016. The increase was primarily due to both the retention of certain employees of Bold, as well as the payment and accrual of severance to certain Bold and Denver office employees. Additionally, ~~legal expenses increased due to litigation described in~~ ~~Note 13. Commitments and Contingencies~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements~~.

~~Stock-based compensation~~

Stock-based compensation includes the expense associated with grants under the 2014 Plan of restricted stock units (“RSUs”) to employees and non-employee directors. Stock-based compensation was $1.7 million for the three months ended September 30, 2017, compared to $1.3 million in the prior year period.

~~Transaction costs~~

~~Transaction costs consist primarily of professional and consulting fees associated with the Bold Transaction and the Lynden Arrangement.~~

~~Gain on sale of oil and gas properties~~

During the three months ended September 30, 2017, we sold certain of our non-core oil and gas properties in Texas, Montana, Oklahoma and North Dakota. In connection with these sales, we recorded gains totaling $2.2 million. ~~See Note 2. Acquisitions and Divestitures~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements.~~

~~Interest expense, net~~

Interest expense includes commitment fees, amortization of deferred financing costs, and interest on outstanding indebtedness. Interest expense increased from $0.3 million for the three months ended September 30, 2016 to $0.9 million for the three months ended September 30, 2017 primarily due to the increase in borrowings for the current period. ~~See Note 10. Long-Term Debt~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements~~.

~~(Loss) gain on derivative contracts, net~~

For the three months ended September 30, 2017, we recorded a net loss on derivative contracts of $3.7 million, consisting of net realized gain on settlements of $0.5 million and unrealized mark-to-market losses of $4.2 million. For the three months ended September 30, 2016, we recorded a net gain on derivative contracts of $0.9 million, consisting of net realized gains on settlements of $0.5 million and unrealized mark-to-market gains of $0.4 million.

~~Income tax benefit (expense)~~

Our corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns resulting from the Lynden Arrangement that includes Lynden US and Earthstone. During the three months ended September 30, 2017, we recorded an income tax expense for Lynden US of $0.2 million as a result of its share of the distributable income from EEH after the Bold Transaction and EEH recorded deferred tax benefit of $0.3 million related to the Texas Margin Tax as the deficit margin generated during the period cannot be carried forward to offset future taxable margin related to state basis differences in EEH’s oil and natural gas properties.

~~Nine months ended September 30, 2017, compared to the nine months ended September 30, 2016~~

Nine Months Ended September 30,

2017

2016

Change

Sales volumes:

Oil (MBbl)

1,300

607

114
%
Natural gas (MMcf)

2,328

1,593

46
%
Natural gas liquids (MBbl)

350

161

117
%
Barrels of oil equivalent (MBOE)

2,038

1,034

97
%

Average prices realized: ⁽¹⁾

Oil (per Bbl)

$
46.02

$
36.09

28
%
Natural gas (per Mcf)

$
2.72

$
2.12

28
%
Natural gas liquids (per Bbl)

$
17.86

$
11.43

56
%

(In thousands)

Oil revenues

$
59,815

$
21,898

173
%
Natural gas revenues

$
6,338

$
3,376

88
%
Natural gas liquids revenues

$
6,249

$
1,843

239
%

Lease operating expense

$
14,989

$
11,081

35
%
Severance taxes

$
3,705

$
1,418

161
%
Rid idle and termination expense

$
—

$
5,059

-100
%
Impairment expense

$
66,740

$
—

NM

Depreciation, depletion and amortization

$
28,258

$
16,252

74
%
General and administrative expense

$
14,838

$
6,961

113
%
Stock-based compensation

$
4,645

$
1,889

146
%
Transaction costs

$
4,676

$
1,641

185
%
Gain on sale of oil and gas properties

$
3,848

$
8

NM

Interest expense, net

$
(1,873
)

$
(934
)

101
%
Write-off of deferred financing costs

$
(526
)

$
—

NM

Gain (loss) on derivative contracts, net

$
4,137

$
(2,517
)

-264
%
Income tax benefit (expense)

$
10,046

$
(387
)

NM

~~(1)~~ ~~Prices presented exclude any effects of oil and natural gas derivatives.~~

~~NM – Not Meaningful~~

~~Oil revenues~~

~~For the nine months ended September 30, 2017, oil revenues increased by~~ ~~approximately~~ ~~$37.9 million or 173% relative to the comparable period in 2016. Of the increase,~~ ~~approximately~~ ~~$6.0 million was attributable to an increase in our realized price and $31.9 million was attributable to increased volume.~~ ~~Our~~ ~~average realized price per Bbl increased from $36.09 for the nine months ended September 30, 2016 to $46.02 or 28% for the nine months ended September 30, 2017.~~ ~~We had a net increase in the volume of oil sold of 693 MBbls or 114%, primarily due to the Midland Basin properties we acquired in the Bold Transaction.~~

~~Natural gas revenues~~

~~For the nine months ended September 30, 2017, natural gas revenues increased by $3.0 million or 88% relative to the comparable period in 2016. Of the increase,~~ ~~approximately~~ $1.0 million was attributable to an increase in our realized price and $2.0 million was attributable to increased volume. Our average realized price per Mcf increased from $2.12 for the nine months ended September 30, 2016 to $2.72 or 28% for the nine months ended September 30, 2017. ~~The total volume of natural gas produced and sold increased 735 MMcf or 46% primarily due to the Midland Basin properties we acquired in the Bold Transaction.~~

~~Natural gas liquids revenues~~

~~For the nine months ended September 30, 2017, natural gas liquids revenues increased by $4.4 million or 239% relative to the comparable period in 2016. Of the increase,~~ ~~approximately~~ ~~$1.0 million was attributable to an increase in our realized price and $3.4 million was attributable to increased volume.~~ The volume of natural gas liquids produced and sold increased by 189 MBbls or 117%, primarily due to 156 MBbls of additional volume provided by the Midland Basin properties we acquired in the Bold Transaction.

~~Lease operating expense (“LOE”)~~

LOE increased by $3.9 million or 35% for the nine months ended September 30, 2017 relative to the comparable period in 2016, primarily due to costs to operate the producing assets acquired in the Bold Transaction and the Lynden Arrangement that were not present in the prior year period.

~~Severance taxes~~

Severance taxes for the nine months ended September 30, 2017 increased by $2.3 million or 161% relative to the comparable period in 2016, primarily due to the increase in oil and natural gas prices. However, as a percentage of revenues from oil, natural gas, and natural gas liquids, severance taxes remained flat when compared to the prior year period.

~~Rig idle and termination expense~~

We incurred rig idle and contract termination expenses of $5.1 million during the nine months ended September 30, 2016. In July 2016, we entered into an agreement with a rig contractor to terminate our contract with the contractor. Per the terms of the agreement, a termination fee for the remaining commitment on the contract was due and the termination fees were retroactively applied to January 2016, when we suspended drilling and temporarily idled the drilling rig. In connection with the termination, we issued a three-year amortizing promissory note with a principal amount of $5.1 million, which was equivalent to the idle charges and contract termination fee.

~~Impairment expense~~

~~As a result of significant forward commodity price declines, as described below in~~ ~~Liquidity and Capital Resources, Commodity Prices, and the recording of certain acreage expirations, we recognized $66.7 million of non-cash asset impairments during~~ ~~the nine months ended September 30, 2017~~ that have negatively impacted our results of operations and equity. These impairments consisted of $63.0 million to our proved oil and natural gas properties and $3.7 million to our unproved oil and natural gas properties, primarily to our properties located in ~~the Eagle Ford shale trend of south Texas. See~~ ~~Note 3. Fair Value Measurements~~ ~~in the Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of how impairments are measured.~~

~~Depreciation, depletion and amortization~~

~~DD&A increased for the nine months ended September 30, 2017 by $12.0 million, or 74% relative to the comparable period in 2016,~~ ~~due to the addition of the assets acquired in the Bold Transaction and the Lynden Arrangement to the depletable base, as well as increased production volumes.~~

~~General and administrative expense (“G&A”)~~

G&A increased by $7.9 million for the nine months ended September 30, 2017 relative to the comparable period in 2016, primarily due to both the retention of certain employees of Bold, as well as the payment and accrual of severance to certain Bold and Denver office employees. Additionally, ~~legal expenses increased due to litigation described in~~ ~~Note 13. Commitments and Contingencies~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements~~.

~~Stock-based compensation~~

Stock-based compensation was $4.6 million for the nine months ended September 30, 2017, as compared to $1.9 million in the prior year period. However, the current year amount is not comparable to the prior year period as the initial grant was made near the end of the prior year period on May 20, 2016.

~~Transaction costs~~

~~Transaction costs consist primarily of professional and consulting fees associated with the Bold Transaction and the Lynden Arrangement.~~

~~Gain on sale of oil and gas properties~~

During the nine months ended September 30, 2017, we sold certain of our non-core oil and gas properties in Texas, Montana, Oklahoma and North Dakota. In connection with these sales, we recorded gains totaling $3.8 million. ~~See Note 2. Acquisitions and Divestitures~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements.~~

~~Interest expense, net~~

Interest expense increased from $0.9 million for the nine months ended September 30, 2016 to $1.9 million for the nine months ended September 30, 2017, primarily the increase in borrowings for the current period. ~~See Note 10. Long-Term Debt~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements~~.

~~Write-off of deferred financing costs~~

~~On May 9, 2017, in connection with the closing of the Bold Transaction, Earthstone exited the ESTE Credit Agreement and $0.5 million of remaining unamortized deferred financing costs were written off.~~

~~Gain (loss) on derivative contracts, net~~

For the nine months ended September 30, 2017, we recorded a net gain on derivative contracts of $4.1 million, consisting of unrealized mark-to-market gains of $3.9 million and net realized gains on settlements of $0.2 million. For the nine months ended September 30, 2016, we recorded a net loss on derivative contracts of $2.5 million, consisting of net realized gains on settlements of $3.3 million offset by unrealized mark-to-market losses of $5.8 million.

~~Income tax benefit (expense)~~

During the nine months ended September 30, 2017, the Company recorded an income tax benefit for Lynden US of $2.7 million as a result of its standalone pre-tax loss incurred before the Bold Transaction and its share of the distributable loss from EEH after the Bold Transaction.

During the nine months ended September 30, 2017, the Company did not record an income tax benefit for Earthstone as a result of its standalone pre-tax loss incurred before the Bold Transaction and its share of the distributable loss from EEH after the Bold Transaction, because the future realization of such loss cannot be reasonably assured and is subject to a full valuation allowance. Earthstone recorded a $7.5 million income tax benefit as a discrete item during the current reporting period, which resulted from a

change in assessment of the realization of its net deferred tax assets due to the deferred tax liability that was recorded with respect to its investment in EEH as part of the Bold Transaction as an adjustment to Additional paid-in capital within the Condensed Consolidated Balance Sheet.

~~Lynden Corp incurred no material net income (loss), or related income tax expense (benefit), for the three and nine months ended September 30, 2017.~~

EEH recorded deferred tax expense during nine months ended September 30, 2017 of $0.2 million related to the Texas Margin Tax as the deficit margin generated during the period cannot be carried forward to offset future taxable margin related to state basis differences in EEH’s oil and natural gas properties.

~~Liquidity and Capital Resources~~

We expect to finance future acquisition and development activities through available working capital, cash flows from operating activities, borrowings under the EEH Credit Agreement, sale of non-strategic assets, various means of corporate and project financing, assuming we can access debt and equity markets. In addition, we may continue to partially finance our drilling activities through the sale of participating rights to industry partners or financial institutions, 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.

~~Cash Flows from Operating Activities~~

Cash flows provided by operating activities for the nine months ended September 30, 2017 were $24.2 million compared to $1.7 million for the nine months ended September 30, 2016. The increase in operating cash flows from the prior period was primarily due to changes in our working capital resulting from commodity price volatility and the producing assets acquired in Bold Transaction and the Lynden Arrangement. We believe we have sufficient liquidity and capital resources to execute our business plan over the next 12 months and for the foreseeable future.

We had working capital, defined as Total current assets less Total current liabilities, as set forth in our Condensed Consolidated Balance Sheets, as a deficit of $21.8 million as of September 30, 2017 compared to a deficit of $11.5 million as of December 31, 2016. The working capital deficit, as defined above, is a result of the two-step drilling and completion process. Typically, we will drill numerous wells per pad and, once all the wells are drilled, they are completed and begin production. This process inherently involves timing differences between ultimate cash outflows and cash inflows.

~~Cash Flows from Investing Activities~~

Cash flows used in investing activities for the nine months ended September 30, 2017 and 2016 were $80.7 million and $46.7 million, respectively. Cash flows used in investing activities for the nine months ended September 30, 2017 ~~included $55.6 million required to complete the Bold Transaction and $30.0 million in capital expenditures primarily related to the~~ ~~drilling and completion of wells in the Midland Basin on acreage acquired in the Bold Transaction, offset by $5.1 million in proceeds from the divestiture of certain non-core assets~~. ~~Cash flows used in investing activities for the nine months ended September 30, 2016~~ ~~related primarily to the cash required to complete the Lynden Arrangement.~~

~~Cash Flows from Financing Activities~~

Cash flows provided by financing activities for the nine months ended September 30, 2017 were $57.3 million which consisted primarily of borrowings under the EEH Credit Agreement which were used to repay all outstanding borrowings under Bold’s credit agreement assumed by EEH in the Bold Transaction. ~~Cash flows provided by financing activities for the nine months ended September 30, 2016 were $45.5 million which consisted primarily of proceeds from the Common Stock offering completed in June 2016.~~

~~Capital Expenditures~~

We recently revised our estimated 2017 capital expenditures downward from approximately $115 million to approximately $85 million, largely as a result of the reduction of approximately $17 million of drilling and completion capital based on our joint development agreements in the Eagle Ford and reduction by approximately $10 million in our land and infrastructure expenditures in the Midland Basin. Capital expenditures for the three and nine months ended September 30, 2017 are as follows:

Three Months Ended

Nine Months Ended

September 30, 2017

September 30, 2017

Drilling and completions

$
24,968

$
41,162

Leasehold costs

145

1,003

Other acquisition

1,202

1,457

Surface land

987

1,803

Total capital expenditures

$
27,302

$
45,425

~~Public Offering~~

As described above, in October 2017, we completed a public offering of 4,500,000 shares of Class A Common Stock, at a public offering price of $9.25 per share, receiving net proceeds of $39.2 million, after deducting underwriters’ fees and offering expenses of $2.4 million. The net proceeds from the offering were used to repay outstanding indebtedness under the EEH Credit Agreement.

~~Credit Agreement~~

~~On May 9, 2017, in connection with the closing of the Bold Transaction, Earthstone became party to the EEH Credit Agreement described in~~ ~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Recent Developments, Credit Agreement. As of September 30, 2017, the Company had a $150 million~~ borrowing base under the EEH Credit Agreement ~~of which $70 million~~ was ~~outstanding, bearing an annual interest rate of 3.7311%, resulting in an additional $80 million of borrowing base availability under the EEH Credit Agreement.~~

~~Commodity Prices~~

Commodity prices are volatile and can fluctuate significantly. Through September 30, 2017, oil prices have declined 8% and natural gas prices declined 15% compared to December 31, 2016. If the commodity price environment continues to decline, it will have an adverse impact on our revenues, cash flows, estimated reserves and planned capital expenditures, and could result in further impairments of our proved and unproved oil and natural gas properties.

~~Impairments to Oil and Natural Gas Properties~~

As a result of significant forward commodity price declines, in the second quarter of 2017, we recognized $66.7 million of non-cash asset impairments that have negatively impacted our results of operations and equity. These impairments consisted of $63.0increased from $275.0 million to ~~our proved oil and natural gas properties and $3.7 million to our unproved oil and natural gas properties, primarily to our properties located in~~ ~~the Eagle Ford shale trend of south Texas. See~~ ~~Note 3. Fair Value Measurements~~ ~~in the Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of how impairments are measured.~~

$325.0 million.

Hedging Activities

~~As of September 30, 2017, we had hedged a total of 157,500 Bbls of remaining 2017 oil production~~

The following table sets forth our outstanding derivative contracts at anMarch 31, 2019. When aggregating multiple contracts, the weighted average contract price of $50.66/Bbl and 645,000 MMBtu of remaining 2017 natural gas production at average price of $3.167/MMBbtu. As of September 30, 2017, we had hedged a total of 1,279,000 Bbls of 2018 oil production at an average price of $50.16/Bbl and 810,000 MMBtu of 2018 natural gas production at average price of $3.066/MMBtu. Additionally, on October 30, 2017,is disclosed.



Period	Commodity	Volume (Bbls / MMBtu)	Price ($/Bbl / $/MMBtu)
Q2 - Q4 2019	Crude Oil	1,769,100	$65.60
Q1 - Q4 2020	Crude Oil	1,464,000	$65.87
Q2 - Q4 2019	Crude Oil Basis Swap(1)	1,512,500	$(5.29)
Q2 - Q4 2019	Crude Oil (Basis Swap)(2)	275,000	$4.50
Q1 - Q4 2020	Crude Oil Basis Swap(1)	1,464,000	$(2.74)
Q2 - Q4 2019	Natural Gas	2,795,500	$2.86
Q1 - Q4 2020	Natural Gas	2,562,000	$2.85
Q2 - Q4 2019	Natural Gas Basis Swap (3)	2,795,500	$(1.14)
Q1 - Q4 2020	Natural Gas Basis Swap (3)	2,562,000	$(1.07)


(1)	The basis differential price is between LLS Argus Crude and the WTI NYMEX.


(2)	The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.


(3)	The basis differential price is between W. Texas (WAHA) and the Henry Hub NYMEX.

Subsequent to March 31, 2019, we entered into additional ~~fixed price oil swap agreements, hedging an additional 365,000 Bbls~~hedges consisting of ~~2019 oil production~~Crude Oil Swaps on 366 MBbls at a price of ~~$51.55/Bbl.~~

$59.75/Bbl for 2020 and WTI Midland Argus Crude Basis Swaps on 366 MBbls at a price of $0.25/Bbl for 2020.

The following table sets forth our outstanding derivative contracts at May 1, 2019. When aggregating multiple contracts, the weighted average contract price is disclosed.



Period	Commodity	Volume (Bbls / MMBtu)	Price ($/Bbl / $/MMBtu)
Q2 - Q4 2019	Crude Oil	1,769,100	$65.60
Q1 - Q4 2020	Crude Oil	1,830,000	$64.65
Q2 - Q4 2019	Crude Oil Basis Swap(1)	1,512,500	$(5.29)
Q2 - Q4 2019	Crude Oil (Basis Swap)(2)	275,000	$4.50
Q1 - Q4 2020	Crude Oil Basis Swap(1)	1,830,000	$(2.14)
Q2 - Q4 2019	Natural Gas	2,795,500	$2.86
Q1 - Q4 2020	Natural Gas	2,562,000	$2.85
Q2 - Q4 2019	Natural Gas Basis Swap (3)	2,795,500	$(1.14)
Q1 - Q4 2020	Natural Gas Basis Swap (3)	2,562,000	$(1.07)


(1)	The basis differential price is between LLS Argus Crude and the WTI NYMEX.


(2)	The basis differential price is between WTI Midland 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 ~~2016~~2018 Annual Report on Form ~~10-K.~~

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.

~~Delaware~~		~~84-0592823~~

Delaware	84-0592823
(State or other jurisdiction	(I.R.S Employer
of incorporation or organization)	Identification No.)

			~~Page~~

		Page

	PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements ~~(unaudited)~~(Unaudited)	3
	Condensed Consolidated Balance Sheets as of ~~September 30, 2017~~March 31, 2019 and December 31, ~~2016~~2018	3
	Condensed Consolidated Statements of Operations for the Three ~~and Nine~~ Months Ended ~~September 30, 2017~~March 31, 2019 and ~~2016~~2018	4 5
	Condensed Consolidated Statements of Equity for the Three Months Ended March 31, 2019 and 2018	6
	Condensed Consolidated Statements of Cash Flows for the ~~Nine~~Three Months Ended ~~September 30, 2017~~March 31, 2019 and ~~2016~~2018	5 7
	Notes to Unaudited Condensed Consolidated Financial Statements	6 8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22 20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33 28
Item 4.	Controls and Procedures	34 28

	PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	34 29
Item 1A.	Risk Factors	34 29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34 29
Item 3.	Defaults Upon Senior Securities	34 29
Item 4.	Mine Safety Disclosures	34 29
Item 5.	Other Information	34 29
Item 6.	Exhibits	35 30
	Signatures	36 31

	For the Nine Months Ended September 30,
	2017			2016
Cash flows from operating activities:
Net loss	$	(50,230	)	$	(21,493	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Impairment of proved and unproved oil and gas properties		66,740			—
Depreciation, depletion and amortization		28,258			16,252
Accretion of asset retirement obligations		378			404
Settlement of asset retirement obligations		—			(15	)
Gain on sale of oil and gas properties		(3,848	)		(8	)
Rig idle and termination expense		—			5,059
Total (gain) loss on derivative contracts, net		(4,137	)		2,517
Operating portion of net cash received in settlement of derivative contracts		229			3,330
Stock-based compensation		4,645			1,889
Deferred income taxes		(10,046	)		387
Write-off of deferred financing costs		526			—
Amortization of deferred financing costs		195			220
Changes in assets and liabilities:
Decrease in accounts receivable		6,964			9,141
Increase in prepaid expenses and other current assets		(455	)		(1,790	)
Decrease in accounts payable and accrued expenses		(11,522	)		(3,462	)
Decrease in revenues and royalties payable		(4,019	)		(1,730	)
Increase (decrease) in advances		506			(8,966	)
Net cash provided by operating activities		24,184			1,735
Cash flows from investing activities:
Bold Contribution Agreement, net of cash acquired		(55,609	)		—
Lynden Arrangement, net of cash acquired		—			(31,334	)
Additions to oil and gas properties		(29,958	)		(15,272	)
Additions to office and other equipment		(139	)		(63	)
Proceeds from sales of oil and gas properties		5,054			—
Net cash used in investing activities		(80,652	)		(46,669	)
Cash flows from financing activities:
Proceeds from borrowings		70,000			36,597
Repayments of borrowings		(11,193	)		(38,165	)
Common stock exchanged and cancelled		(324	)		—
Issuance of common stock, net of offering costs of $2.7 million		—			47,125
Deferred financing costs		(1,168	)		(78	)
Net cash provided by financing activities		57,315			45,479
Net increase in cash and cash equivalents		847			545
Cash at beginning of period		10,200			23,264
Cash at end of period	$	11,047		$	23,809
Supplemental disclosure of cash flow information
Cash paid for:
Interest	$	1,555		$	688
Non-cash investing and financing activities:
Class B Common stock issued in Bold Contribution Agreement	$	489,842		$	—
Class A Common stock issued in Bold Contribution Agreement	$	2,037		$	—
Common stock issued in Lynden Arrangement	$	—		$	45,699
Accrued capital expenditures	$	19,519		$	8,938
Asset retirement obligations	$	83		$	101
Promissory Note	$	—		$	5,059



	For the Three Months Ended March 31,
	2019			2018
Cash flows from operating activities:
Net (loss) income	$	(38,443	)	$	12,191
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation, depletion and amortization	14,005			9,708
Accretion of asset retirement obligations	54			41
Settlement of asset retirement obligations	(62		)	(52		)
Loss (gain) on sale of oil and gas properties	125			(449		)
Total loss on derivative contracts, net	47,894			5,275
Operating portion of net cash received (paid) in settlement of derivative contracts	5,362			(4,275		)
Stock-based compensation	2,212			1,940
Deferred income taxes	(460		)	249
Amortization of deferred financing costs	103			69
Changes in assets and liabilities:
(Increase) decrease in accounts receivable	(6,811		)	737
(Increase) decrease in prepaid expenses and other current assets	(2,236		)	(314		)
Increase (decrease) in accounts payable and accrued expenses	(7,427		)	(17,611		)
Increase (decrease) in revenues and royalties payable	(5,383		)	8,595
Increase (decrease) in advances	(1,882		)	662
Net cash provided by operating activities	7,051			16,766
Cash flows from investing activities:
Additions to oil and gas properties	(48,412		)	(33,372		)
Additions to office and other equipment	(75		)	(15		)
Proceeds from sales of oil and gas properties	—			195
Net cash used in investing activities	(48,487		)	(33,192		)
Cash flows from financing activities:
Proceeds from borrowings	85,244			20,000
Repayments of borrowings	(43,247		)	(15,000		)
Cash paid related to the exchange and cancellation of Class A Common Stock	(397		)	(468		)
Cash paid for finance leases	(114		)	—
Deferred financing costs	—			(3		)
Net cash provided by financing activities	41,486			4,529
Net increase (decrease) in cash	50			(11,897		)
Cash at beginning of period	376			22,955
Cash at end of period	$	426		$	11,058
Supplemental disclosure of cash flow information
Cash paid for:
Interest	$	1,255		$	383
Non-cash investing and financing activities:
Accrued capital expenditures	$	17,040		$	8,967
Lease asset additions - ASC 842	$	1,801		$	—
Asset retirement obligations	$	21		$	(181	)

☒

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

☐

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	September 30,			December 31,
ASSETS	2017			2016
Current assets:
Cash	$	11,047		$	10,200
Accounts receivable:
Oil, natural gas, and natural gas liquids revenues		15,093			13,998
Joint interest billings and other, net of allowance of $138 at September 30, 2017 and $163 at December 31, 2016		4,371			2,698
Derivative asset		147			—
Prepaid expenses and other current assets		1,299			446
Total current assets		31,957			27,342

Oil and gas properties, successful efforts method:
Proved properties		599,222			363,072
Unproved properties		291,364			51,723
Land		5,534			—
Total oil and gas properties		896,120			414,795

Accumulated depreciation, depletion and amortization		(122,842	)		(145,393	)
Net oil and gas properties		773,278			269,402

Other noncurrent assets:
Goodwill		17,620			17,620
Office and other equipment, net of accumulated depreciation of $1,973 and $1,600 at September 30, 2017 and December 31 2016, respectively		1,039			1,479
Other noncurrent assets		1,078			669
TOTAL ASSETS	$	824,972		$	316,512
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	19,343		$	11,927
Accrued expenses		16,516			5,392
Revenues and royalties payable		9,156			10,769
Advances		5,048			4,542
Derivative liability		1,986			4,595
Current portion of long-term debt		1,704			1,604
Total current liabilities		53,753			38,829

Noncurrent liabilities:
Long-term debt		71,400			12,693
Deferred tax liability		16,513			15,776
Asset retirement obligation		3,204			6,013
Derivative liability		422			1,575
Other noncurrent liabilities		143			169
Total noncurrent liabilities		91,682			36,226

Commitments and Contingencies (Note 13)

Equity:
Preferred stock, $0.001 par value, 20,000,000 shares authorized; none issued or outstanding		—			—
Common stock, $0.001 par value, no shares authorized; none issued or outstanding at September 30, 2017 and 100,000,000 shares authorized; 22,289,177 issued and 22,273,820 outstanding at December 31, 2016		—			23
Class A Common stock, $0.001 par value, 200,000,000 shares authorized; 22,988,759 issued and outstanding at September 30, 2017 and none issue or outstanding at December 31, 2016		23			—
Class B Common Stock, $0.0001 par value, 50,000,000 shares authorized; 36,070,828 shares issued and outstanding at September 30, 2017; none issued or outstanding at December 31, 2016		36			—
Additional paid-in capital		463,009			454,202
Accumulated deficit		(227,146	)		(212,308	)
Treasury stock, no shares at September 30, 2017 and 15,357 shares at December 31, 2016		—			(460	)
Total Earthstone Energy, Inc. equity		235,922			241,457
Noncontrolling interest		443,615			—
Total equity		679,537			241,457

TOTAL LIABILITIES AND EQUITY	$	824,972		$	316,512



	March 31,			December 31,
ASSETS	2019			2018
Current assets:
Cash	$	426		$	376
Accounts receivable:
Oil, natural gas, and natural gas liquids revenues	19,433			13,683
Joint interest billings and other, net of allowance of $133 and $134 at March 31, 2019 and December 31, 2018, respectively	19,740			4,166
Derivative asset	6,605			43,888
Prepaid expenses and other current assets	3,679			1,443
Total current assets	49,883			63,556

Oil and gas properties, successful efforts method:
Proved properties	797,964			755,443
Unproved properties	266,289			266,140
Land	5,382			5,382
Total oil and gas properties	1,069,635			1,026,965

Accumulated depreciation, depletion and amortization	(141,077		)	(127,256		)
Net oil and gas properties	928,558			899,709

Other noncurrent assets:
Goodwill	17,620			17,620
Office and other equipment, net of accumulated depreciation and amortization of $2,674 and $2,490 at March 31, 2019 and December 31, 2018, respectively	1,380			662
Derivative asset	6,300			21,121
Operating lease right-of-use assets	1,049			—
Other noncurrent assets	1,539			1,640
TOTAL ASSETS	$	1,006,329		$	1,004,308
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	28,964		$	26,452
Revenues and royalties payable	23,365			28,748
Accrued expenses	21,362			22,406
Asset retirement obligation	494			557
Advances	1,293			3,174
Derivative liability	2,204			528
Operating lease liabilities	658			—
Finance lease liabilities	354			—
Total current liabilities	78,694			81,865

Noncurrent liabilities:
Long-term debt	120,825			78,828
Deferred tax liability	13,029			13,489
Asset retirement obligation	1,748			1,672
Derivative liability	1,367			1,891

	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
REVENUES
Oil	$	25,733		$	8,262		$	59,815		$	21,898
Natural gas		2,513			1,417			6,338			3,376
Natural gas liquids		3,036			851			6,249			1,843
Total revenues		31,282			10,530			72,402			27,117

OPERATING COSTS AND EXPENSES
Lease operating expense		5,407			4,581			14,989			11,081
Severance taxes		1,588			522			3,705			1,418
Rig idle and termination expense		—			—			—			5,059
Impairment expense		92			—			66,740			—
Depreciation, depletion and amortization		10,330			5,149			28,258			16,252
General and administrative expense		5,608			2,285			14,838			6,961
Stock-based compensation		1,687			1,328			4,645			1,889
Transaction costs		109			846			4,676			1,641
Accretion of asset retirement obligation		72			143			378			404
Exploration expense		—			—			1			5
Total operating costs and expenses		24,893			14,854			138,230			44,710

Gain on sale of oil and gas properties		2,157			8			3,848			8

Income (loss) from operations		8,546			(4,316	)		(61,980	)		(17,585	)

OTHER INCOME (EXPENSE)
Interest expense, net		(903	)		(341	)		(1,873	)		(934	)
Write-off of deferred financing costs		-			—			(526	)		—
(Loss) gain on derivative contracts, net		(3,663	)		946			4,137			(2,517	)
Other (expense) income, net		(66	)		12			(34	)		(70	)
Total other income (expense)		(4,632	)		617			1,704			(3,521	)

Income (loss) before income taxes		3,914			(3,699	)		(60,276	)		(21,106	)
Income tax benefit (expense)		94			(201	)		10,046			(387	)
Net income (loss)		4,008			(3,900	)		(50,230	)		(21,493	)

Less: Net income (loss) attributable to noncontrolling interest		2,452			—			(35,392	)		—

Net income (loss) attributable to Earthstone Energy, Inc.	$	1,556		$	(3,900	)	$	(14,838	)	$	(21,493	)

Net income (loss) per common share attributable to Earthstone Energy, Inc.:
Basic and diluted	$	0.07		$	(0.17	)	$	(0.66	)	$	(1.23	)

Weighted average common shares outstanding:
Basic and diluted		22,905,023			22,289,177			22,638,977			17,433,079



	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. Stockholders' 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		—	—		—		—			—			—			—			—
Class A Common Stock 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

Consideration:
Shares of Class A Common Stock issued pursuant to the Bold Contribution Agreement to certain employees of Bold		150,000
EEH Units issued to Bold Holdings		36,070,828

Total equity interest issued in the Bold Transaction		36,220,828
Closing per share price of Class A Common Stock as of May 9, 2017	$	13.58

Total consideration transferred ⁽¹⁾⁽²⁾	$	491,879

Fair value of assets acquired:
Cash and cash equivalents	$	2,355
Other current assets		10,078
Oil and gas properties ⁽³⁾		557,704
Amount attributable to assets acquired	$	570,137

Fair value of liabilities assumed:
Long-term debt ⁽⁴⁾	$	58,000
Current liabilities		17,042
Deferred tax liability		2,857
Noncurrent asset retirement obligations		359
Amount attributable to liabilities assumed	$	78,258

September 30, 2017	Level 1		Level 2		Level 3		Total
Financial assets
Derivative asset - current	$	—	$	147	$	—	$	147
Total financial assets	$	—	$	147	$	—	$	147

Financial liabilities
Derivative liability - current	$	—	$	1,986	$	—	$	1,986
Derivative liability - noncurrent		—		422		—		422
Total financial liabilities	$	—	$	2,408	$	—	$	2,408

December 31, 2016
Financial liabilities
Derivative liability - current	$	—	$	4,595	$	—	$	4,595
Derivative liability - noncurrent		—		1,575		—		1,575
Total financial assets	$	—	$	6,170	$	—	$	6,170

Total consideration transferred ⁽¹⁾	$	491,879
Change to Additional paid-in capital to reflect the noncontrolling interest within equity at their membership interest		(12,872	)
Portion of equity attributable to noncontrolling interest ⁽²⁾	$	479,007

	2017
As of December 31, 2016	$	—
Noncontrolling interest recorded within equity in connection with the closing of the Bold Transaction		479,007
Net loss attributable to noncontrolling interest		(35,392	)
As of September 30, 2017	$	443,615

	Shares			Weighted-Average Grant Date Fair Value
Unvested RSUs at December 31, 2016		781,500		$	12.53
Granted		254,500		$	11.67
Forfeited		(36,000	)	$	13.30
Vested		(594,380	)	$	12.45
Unvested RSUs at September 30, 2017		405,620		$	12.03

	Three Months Ended		Nine Months Ended
	September 30, 2017		September 30, 2017
Drilling and completions	$	24,968	$	41,162
Leasehold costs		145		1,003
Other acquisition		1,202		1,457
Surface land		987		1,803
Total capital expenditures	$	27,302	$	45,425



	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
January 2019	8,972	$	4.52	—	—
February 2019	—	—		—	—
March 2019	50,289	$	7.08	—	—


(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.




			EARTHSTONE ENERGY, INC.

Date:	~~November 2, 2017~~ May 3, 2019	By:	/s/ Tony Oviedo
			Tony Oviedo
			Executive Vice President – Accounting and Administration

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