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EX-31.2 - EX-31.2 - EARTHSTONE ENERGY INCeste-ex312_7.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

For the Quarterly Period Ended September 30, 2016

Or

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

Commission File No. 001-35049  

 

EARTHSTONE ENERGY, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

84-0592823

(State or other jurisdiction

 

(I.R.S Employer

of incorporation or organization)

 

Identification No.)

1400 Woodloch Forest Drive, Suite 300

The Woodlands, Texas 77380

(Address of principal executive offices)

Registrant’s telephone number, including area code:  (281) 298-4246

 

Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to post such filed).    Yes      No  

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

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

 

Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

As of November 4, 2016, 22,289,177 shares of common stock, $0.001 par value per share, were outstanding.

 

 

 

 

 


 

TABLE OF CONTENTS

 

 

 

 

 

Page

 

 

 

 

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements (unaudited)

 

5

 

 

Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015

 

5

 

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and 2015

 

6

 

 

Condensed Consolidated Statement of Equity for the Nine Months Ended September 30, 2016

 

7

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015

 

8

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

9

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

33

Item 4.

 

Controls and Procedures

 

34

 

 

 

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

35

Item 1A.

 

Risk Factors

 

35

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

35

Item 3.

 

Defaults Upon Senior Securities

 

35

Item 4.

 

Mine Safety Disclosures

 

35

Item 5.

 

Other Information

 

35

Item 6.

 

Exhibits

 

35

 

 

Signatures

 

36

 

 

 

2


 

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

Certain statements contained in this report may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts contained in this report are forward-looking statements. These forward-looking statements can generally be identified by the use of words such as “may,” “will,” “could,” “should,” “project,” “intends,” “plans,” “pursue,” “target,” “continue,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” or “potential,” the negative of such terms or variations thereon, or other comparable terminology. Statements that describe our future plans, strategies, intentions, expectations, objectives, goals or prospects are also forward-looking statements. Actual results could differ materially from those anticipated in these forward-looking statements. Readers should consider carefully the risks described under the “Risk Factors” section included in our previously filed Annual Report on Form 10-K for the fiscal year ended December 31, 2015, and the other disclosures contained herein and therein, which describe factors that could cause our actual results to differ from those anticipated in forward-looking statements, including, but not limited to, the following factors:

 

volatility and weakness in commodity prices for oil and natural gas and the effect of prices set or influenced by action of the Organization of Petroleum Exporting Countries (“OPEC”);

 

substantial changes in estimates of our proved reserves;

 

substantial declines in the values of our oil and natural gas reserves;

 

our ability to replace our oil and natural gas reserves;

 

the potential for production decline rates for our wells to be greater than we expect;

 

the timing and extent of our success in discovering, acquiring, developing and producing oil and natural gas reserves; 

 

the ability and willingness of our partners under our joint operating agreements to join in our future exploration, development and production activities;

 

our ability to acquire leases and quality services and supplies on a timely basis and at reasonable prices;

 

the cost and availability of high quality goods and services with fully trained and adequate personnel, such as drilling rigs and completion equipment;

 

risks in connection with potential acquisitions and the integration of significant acquisitions;

 

the possibility that acquisitions and divestitures may involve unexpected costs or delays, and that acquisitions may not achieve intended benefits and will divert management’s time and energy;

 

the possibility that anticipated divestitures may not occur or could be burdened with unforeseen costs;

 

reductions in the borrowing base under our credit facility;

 

risks incident to the drilling and operation of oil and natural gas wells including mechanical failures;

 

the presence or recoverability of estimated oil and natural gas reserves and the actual future production rates and associated costs;

 

the availability of sufficient pipeline and other transportation facilities to carry our production and the impact of these facilities on prices;

 

significant competition for acreage and acquisitions;

 

the effect of existing and future laws, governmental regulations and the political and economic climates of the United States;

 

our ability to retain key members of senior management and key technical and financial employees;

 

changes in environmental laws and the regulation and enforcement related to those laws;

 

the identification of and severity of environmental events and governmental responses to these or other environmental events;

 

legislative or regulatory changes, including retroactive royalty or production tax regimes, hydraulic-fracturing regulations, derivatives reform, and changes in state, and federal income taxes;

3


 

 

general economic conditions, whether internationally, nationally or in the regional and local market areas in which we conduct business, may be less favorable than expected, including the possibility that economic conditions in the United States will worsen and that capital markets will be disrupted or unavailable;

 

social unrest, political instability or armed conflict in major oil and natural gas producing regions outside the United States, such as Africa, the Middle East, and acts of terrorism or sabotage;

 

the insurance coverage maintained by us may not adequately cover all losses that may be sustained in connection with our business activities;

 

other economic, competitive, governmental, regulatory, legislative, including federal, state and tribal regulations and laws, geopolitical and technological factors that may negatively impact our business, operations or oil and natural gas prices;

 

the effect of our oil and natural gas derivative activities;

 

title to the properties in which we have an interest may be impaired by title defects; and

 

our dependency on the skill, ability and decisions of third party operators of oil and natural gas properties in which we have non-operated working interests.

All forward-looking statements are expressly qualified in their entirety by the cautionary statements in this section and elsewhere in this report. Other than as required under the securities laws, we do not assume a duty to update these forward-looking statements, whether as a result of new information, subsequent events or circumstances, changes in expectations or otherwise.

4


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited) 

 

 

 

September 30,

 

 

December 31,

 

ASSETS

 

2016

 

 

2015

 

Current assets:

 

(In thousands, except share amounts)

 

Cash and cash equivalents

 

$

23,809

 

 

$

23,264

 

Accounts receivable:

 

 

 

 

 

 

 

 

Oil, natural gas, and natural gas liquids revenues

 

 

9,205

 

 

 

13,529

 

Joint interest billings and other

 

 

2,108

 

 

 

4,924

 

Prepaid expenses and other current assets

 

 

2,376

 

 

 

498

 

Current derivative asset

 

 

185

 

 

 

3,694

 

Total current assets

 

 

37,683

 

 

 

45,909

 

Oil and gas properties, successful efforts method:

 

 

 

 

 

 

 

 

Proved properties

 

 

348,408

 

 

 

283,644

 

Unproved properties

 

 

59,942

 

 

 

34,609

 

Total oil and gas properties

 

 

408,350

 

 

 

318,253

 

 

 

 

 

 

 

 

 

 

Accumulated depreciation, depletion, and amortization

 

 

(135,823

)

 

 

(119,920

)

Net oil and gas properties

 

 

272,527

 

 

 

198,333

 

Other noncurrent assets:

 

 

 

 

 

 

 

 

Goodwill

 

 

20,549

 

 

 

17,532

 

Office and other equipment, less accumulated depreciation of $1,426 and $1,028 at

   September 30, 2016 and December 31, 2015

 

 

1,605

 

 

 

1,934

 

Other noncurrent assets

 

 

1,112

 

 

 

1,236

 

TOTAL ASSETS

 

$

333,476

 

 

$

264,944

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

12,529

 

 

$

11,580

 

Accrued expenses

 

 

10,445

 

 

 

12,975

 

Revenues and royalties payable

 

 

6,846

 

 

 

8,576

 

Advances

 

 

6,481

 

 

 

15,447

 

Current portion of long-term debt

 

 

1,591

 

 

 

 

Current derivative liability

 

 

1,237

 

 

 

 

Total current liabilities

 

 

39,129

 

 

 

48,578

 

 

 

 

 

 

 

 

 

 

Noncurrent liabilities:

 

 

 

 

 

 

 

 

Long-term debt

 

 

13,104

 

 

 

11,191

 

Asset retirement obligations

 

 

5,815

 

 

 

5,075

 

Noncurrent derivative liability

 

 

1,101

 

 

 

 

Deferred tax liability

 

 

1,051

 

 

 

 

Other noncurrent liabilities

 

 

183

 

 

 

227

 

Total noncurrent liabilities

 

 

21,254

 

 

 

16,493

 

 

 

 

 

 

 

 

 

 

Commitments and Contingencies (Note 10)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity:

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

Common stock, $0.001 par value, 100,000,000 shares authorized; 22,289,177 and 13,835,128 shares

   issued and outstanding at September 30, 2016 and December 31, 2015

 

 

23

 

 

 

14

 

Additional paid-in capital

 

 

452,790

 

 

 

358,086

 

Accumulated deficit

 

 

(179,260

)

 

 

(157,767

)

Treasury stock, 15,357 shares at September 30, 2016 and December 31, 2015

 

 

(460

)

 

 

(460

)

Total equity

 

 

273,093

 

 

 

199,873

 

 

 

 

 

 

 

 

 

 

TOTAL LIABILITIES AND EQUITY

 

$

333,476

 

 

$

264,944

 

 

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

5


 

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

REVENUES

 

(In thousands, except share and per share amounts)

 

Oil, natural gas, and natural gas liquids revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil

 

$

8,262

 

 

$

10,385

 

 

$

21,898

 

 

$

31,586

 

Natural gas

 

 

1,417

 

 

 

1,971

 

 

 

3,376

 

 

 

5,483

 

Natural gas liquids

 

 

851

 

 

 

677

 

 

 

1,843

 

 

 

2,164

 

Total oil, natural gas, and natural gas liquids revenues

 

 

10,530

 

 

 

13,033

 

 

 

27,117

 

 

 

39,233

 

Gathering income

 

 

55

 

 

 

60

 

 

 

142

 

 

 

233

 

Gain (loss) on sales of oil and gas properties, net

 

 

8

 

 

 

(13

)

 

 

8

 

 

 

1,667

 

Total revenues

 

 

10,593

 

 

 

13,080

 

 

 

27,267

 

 

 

41,133

 

OPERATING COSTS AND EXPENSES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Production costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Lease operating expense

 

 

3,981

 

 

 

4,138

 

 

 

10,248

 

 

 

12,751

 

Severance taxes

 

 

522

 

 

 

746

 

 

 

1,418

 

 

 

2,122

 

Rig idle and contract termination expense

 

 

 

 

 

 

 

 

5,059

 

 

 

 

Depreciation, depletion, and amortization

 

 

5,149

 

 

 

8,107

 

 

 

16,252

 

 

 

22,705

 

Re-engineering and workovers

 

 

798

 

 

 

234

 

 

 

1,379

 

 

 

520

 

Exploration expense

 

 

 

 

 

 

 

 

5

 

 

 

142

 

General and administrative expense

 

 

3,131

 

 

 

2,450

 

 

 

8,602

 

 

 

7,505

 

General and administrative expense - stock-based compensation

 

 

1,328

 

 

 

 

 

 

1,889

 

 

 

 

Total operating costs and expenses

 

 

14,909

 

 

 

15,675

 

 

 

44,852

 

 

 

45,745

 

Loss from operations

 

 

(4,316

)

 

 

(2,595

)

 

 

(17,585

)

 

 

(4,612

)

OTHER INCOME (EXPENSE)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

 

(341

)

 

 

(169

)

 

 

(934

)

 

 

(507

)

Gain (loss) on derivative contracts, net

 

 

946

 

 

 

5,166

 

 

 

(2,517

)

 

 

4,522

 

Other income (expense), net

 

 

12

 

 

 

127

 

 

 

(70

)

 

 

384

 

Total other income (expense)

 

 

617

 

 

 

5,124

 

 

 

(3,521

)

 

 

4,399

 

(Loss) income before income taxes

 

 

(3,699

)

 

 

2,529

 

 

 

(21,106

)

 

 

(213

)

Income tax expense (benefit)

 

 

201

 

 

 

811

 

 

 

387

 

 

 

(69

)

Net (loss) income

 

$

(3,900

)

 

$

1,718

 

 

$

(21,493

)

 

$

(144

)

Net (loss) income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.17

)

 

$

0.12

 

 

$

(1.23

)

 

$

(0.01

)

Diluted

 

$

(0.17

)

 

$

0.12

 

 

$

(1.23

)

 

$

(0.01

)

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

22,289,177

 

 

 

13,835,128

 

 

 

17,433,079

 

 

 

13,835,128

 

Diluted

 

 

22,289,177

 

 

 

13,835,128

 

 

 

17,433,079

 

 

 

13,835,128

 

 

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

6


 

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENT OF EQUITY

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

 

Paid-in

 

 

Accumulated

 

 

Treasury Stock

 

 

Total

 

(In thousands, except share amounts)

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Deficit

 

 

Shares

 

 

Amount

 

 

Equity

 

At December 31, 2015

 

 

 

13,835,128

 

 

$

14

 

 

$

358,086

 

 

$

(157,767

)

 

 

(15,357

)

 

$

(460

)

 

$

199,873

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock issued, net of

   offering costs of $2.7 million

 

 

 

4,753,770

 

 

 

5

 

 

 

47,120

 

 

 

 

 

 

 

 

 

 

 

 

47,125

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

1,889

 

 

 

 

 

 

 

 

 

 

 

 

1,889

 

Shares issued in Lynden

   Arrangement

 

 

 

3,700,279

 

 

 

4

 

 

 

45,695

 

 

 

 

 

 

 

 

 

 

 

 

45,699

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

(21,493

)

 

 

 

 

 

 

 

 

(21,493

)

At September 30, 2016

 

 

 

22,289,177

 

 

$

23

 

 

$

452,790

 

 

$

(179,260

)

 

 

(15,357

)

 

$

(460

)

 

$

273,093

 

 

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

7


 

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine Months Ended September 30,

 

 

 

2016

 

 

2015

 

Cash flows from operating activities:

 

(In thousands)

 

Net loss

 

$

(21,493

)

 

$

(144

)

Adjustments to reconcile net loss to net cash provided by

   operating activities:

 

 

 

 

 

 

 

 

Depreciation, depletion, and amortization

 

 

16,252

 

 

 

22,705

 

Total loss (gain) on derivative contracts, net

 

 

2,517

 

 

 

(4,522

)

Operating portion of net cash received in settlement of derivative contracts

 

 

3,330

 

 

 

4,178

 

Rig idle and termination expense

 

 

5,059

 

 

 

 

Accretion of asset retirement obligations

 

 

404

 

 

 

425

 

Stock-based compensation

 

 

1,889

 

 

 

 

Deferred income taxes

 

 

387

 

 

 

(69

)

Amortization of deferred financing costs

 

 

220

 

 

 

195

 

Settlement of asset retirement obligations

 

 

(15

)

 

 

(65

)

Gain on sale of assets

 

 

(8

)

 

 

(1,667

)

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Decrease in accounts receivable

 

 

9,141

 

 

 

5,362

 

(Increase) decrease in prepaid expenses and other

 

 

(1,790

)

 

 

548

 

Decrease in accounts payable and accrued expenses

 

 

(3,462

)

 

 

(15,547

)

Decrease in revenue and royalties payable

 

 

(1,730

)

 

 

(7,318

)

(Decrease) increase in advances

 

 

(8,966

)

 

 

224

 

Net cash provided by operating activities

 

 

1,735

 

 

 

4,305

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Lynden Arrangement, net of cash acquired

 

 

(31,334

)

 

 

 

Acquisitions of oil and gas property

 

 

 

 

 

(8,706

)

Additions to oil and gas property and equipment

 

 

(15,272

)

 

 

(57,705

)

Additions to other property and equipment

 

 

(63

)

 

 

(328

)

Proceeds from sales of oil and gas properties

 

 

 

 

 

3,441

 

Net cash used in investing activities

 

 

(46,669

)

 

 

(63,298

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from borrowings

 

 

36,597

 

 

 

 

Repayments of borrowings

 

 

(38,165

)

 

 

 

Issuance of common stock, net of offering costs of $2.7 million

 

 

47,125

 

 

 

 

Deferred financing costs

 

 

(78

)

 

 

(127

)

Net cash provided by (used in) financing activities

 

 

45,479

 

 

 

(127

)

Net increase (decrease) in cash and cash equivalents

 

 

545

 

 

 

(59,120

)

Cash and cash equivalents at beginning of period

 

 

23,264

 

 

 

100,447

 

Cash and cash equivalents at end of period

 

$

23,809

 

 

$

41,327

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

 

 

Cash paid for:

 

 

 

 

 

 

 

 

Interest

 

$

688

 

 

$

284

 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

 

Common stock issued for Lynden Arrangement

 

$

45,698

 

 

$

 

Acquisitions of oil and gas property

 

$

 

 

$

2,130

 

Asset retirement obligations

 

$

101

 

 

$

128

 

 

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

 

 

8


 

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1. Basis of Presentation and Summary of Significant Accounting Policies

Earthstone Energy, Inc., a Delaware corporation (“Earthstone” or the “Company”) is an independent oil and gas exploration and production company focused on the acquisition, development, exploration and production of onshore, crude oil and natural gas reserves, with a current focus on the Eagle Ford trend and Midland Basin in Texas and the Williston Basin of North Dakota and Montana.

The accompanying Unaudited Condensed Consolidated Financial Statements of Earthstone and its wholly-owned subsidiaries, which we refer to as “we,” “our” or “us,” have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial statements. The information furnished herein reflects all adjustments that are, in the opinion of management, necessary for the fair presentation of the Company's financial position, results of operations and cash flows for the periods presented.  The Company’s Condensed Consolidated Balance Sheet at December 31, 2015 is derived from the audited consolidated financial statements at that date.

The preparation of financial statements in conformity with the generally accepted accounting principles of the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. For further information, see Note 2 in the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”).

Interim period results are not necessarily indicative of results of operations or cash flows for the full year and accordingly, certain information normally included in financial statements and the accompanying notes prepared in accordance with GAAP, has been condensed or omitted. These financial statements should be read in conjunction with the 2015 Form 10-K, and the Company’s other filings with the SEC.  

Certain prior-period amounts have been reclassified to conform to current-period presentation including amounts within the adjustments to reconcile net loss to net cash provided by from operating activities on the Condensed Consolidated Statements of Cash Flows.  Specifically, the non-cash changes in fair value of the Company’s commodity swaps have been reclassified from the changes in the Unrealized loss (gain) on derivative contracts caption (which resulted in the caption being eliminated) with offsetting reclassifications to the captions, Total loss (gain) on derivative contracts, net and Operating portion of net cash received in settlement of derivative contracts.  These reclassifications had no effect on Net cash provided by operating activities or any other subtotal in the Condensed Consolidated Statements of Cash Flows.  

Recently Issued Accounting Standards

Standards adopted in 2016

Debt Issuance Costs – In April 2015, the Financial Accounting Standards Board (“FASB”) issued updated guidance which changes the presentation of debt issuance costs in the financial statements.  Under this updated guidance, debt issuance costs are presented on the balance sheet as a direct deduction from the related debt liability rather than as an asset.  Amortization of the costs is reported as interest expense.  In August 2015, the FASB subsequently issued a clarification as to the handling of debt issuance costs related to line-of-credit arrangements that allows the presentation of these costs as an asset.  The standards update was effective for interim and annual periods beginning after December 15, 2015.  The Company adopted this standards update, as required, effective January 1, 2016.  The adoption of this standards update did not affect the Company’s method of amortizing debt issuance costs and did not have a material impact on its Condensed Consolidated Financial Statements.  

Measurement-Period Adjustments – In September 2015, the FASB issued updated guidance that eliminates the requirement to restate prior periods to reflect adjustments made to provisional amounts recognized in a business combination.  The updated guidance requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined.  The standards update was effective prospectively for interim and annual periods beginning after December 15, 2015, with early adoption permitted.  The Company adopted this standard update, as required, effective January 1, 2016, which did not have a material impact on its Condensed Consolidated Financial Statements.  

9


EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

Stock Compensation - In March 2016, the FASB issued updated guidance on share-based payment accounting.  The standards update is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures.  The standards update is effective for interim and annual periods beginning after December 15, 2016 with early adoption permitted.  The Company elected to early-adopt this standards update as of April 1, 2016 in connection with its initial grant of awards under the Company’s 2014 Long Term Incentive Plan. The Company has elected to record the impact of forfeitures on compensation cost as they occur.  The Company is also permitted to withhold income taxes upon settlement of equity-classified awards at up to the maximum statutory tax rates.  There was no retrospective adjustment as the Company did not have any outstanding equity awards prior to adoption. See Note 6 Stock-Based Compensation.

Standards not yet adopted

Revenue Recognition - In May 2014, the FASB issued updated guidance for recognizing revenue from contracts with customers. The objective of this guidance is to establish principles for reporting information about the nature, timing, and uncertainty of revenue and cash flows arising from an entity’s contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and change in judgments, and assets recognized from the costs to obtain or fulfill a contract. In August 2015, the FASB issued guidance deferring the effective date of this standards update for one year, to be effective for interim and annual periods beginning after December 15, 2017.  In March 2016, the FASB issued guidance which clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued further guidance on identifying performance obligations and clarification of the licensing implementation guidance. Early adoption of this updated guidance is permitted as of the original effective date of December 31, 2016.  The Company expects to adopt this standards update, as required, beginning with the first quarter of 2018. The Company is in the process of evaluating the impact, if any, of the adoption of this guidance on its Condensed Consolidated Financial Statements.

Leases – In February 2016, the FASB issued updated guidance on accounting for leases.  The update requires that a lessee recognize in the statement of financial position a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. Similar to current guidance, the update continues to differentiate between finance leases and operating leases; however, this distinction now primarily relates to differences in the manner of expense recognition over time and in the classification of lease payments in the statement of cash flows. The standards update is effective for interim and annual periods beginning after December 15, 2018 with early adoption permitted. Entities are required to use a modified retrospective adoption, with certain relief provisions, for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements when adopted. The Company expects to adopt this standards update, as required, beginning with the first quarter of 2019.  The Company is in the process of evaluating the impact, if any, of the adoption of this guidance on its Condensed Consolidated Financial Statements.

Statement of Cash Flows – In August 2016, the FASB issued updated guidance that clarifies how certain cash receipts and cash payments are presented in the statement of cash flows.  This update provides guidance on eight specific cash flow issues.  The standards update is effective for interim and annual periods beginning after December 15, 2017, and should be applied retrospectively to all periods presented.  Early adoption is permitted.  The Company expects to adopt this standards update, as required, beginning with the first quarter of 2018.  The Company is in the process of evaluating the impact, if any, of the adoption of this guidance on its Condensed Consolidated Financial Statements.

 

 

Note 2. Acquisitions and Divestitures

Lynden Arrangement

In May 2016, the Company acquired Lynden Energy Corp. (“Lynden”) in an all-stock transaction.  The acquisition was made through an arrangement (the “Arrangement”) instead of a merger because Lynden is incorporated in British Columbia, Canada.  The Company acquired all the outstanding shares of common stock of Lynden through a newly formed Company subsidiary, with Lynden surviving in the transaction as a wholly-owned subsidiary of the Company.  The Company issued 3,700,279 shares of its common stock to the holders of Lynden common stock in the transaction. The Arrangement was accounted for as a business combination in accordance with FASB ASC Topic 805, Business Combinations, which among other things requires the assets acquired and liabilities assumed to be measured and recorded at their fair values as of the acquisition date.    

An allocation of the purchase price was prepared using, among other things, a reserve report prepared by qualified reserve engineers and priced as of the acquisition date. The following allocation is still preliminary with respect to final tax amounts and certain accruals and includes the use of estimates based on information that was available to management at the time these condensed consolidated

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

financial statements were prepared. Additional changes to the purchase price allocation may result in a corresponding change to goodwill in the period of the change.

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

 

Consideration:

 

 

 

 

Shares of Earthstone common stock issued in the Arrangement

 

 

3,700,279

 

Closing price of Earthstone common stock as of May 18, 2016

 

$

12.35

 

Total consideration to Lynden shareholders

 

$

45,698

 

Fair Value of Liabilities Assumed:

 

 

 

 

Credit facility (4)

 

$

36,597

 

Current liabilities

 

 

1,895

 

Deferred tax liability (1)

 

 

664

 

Asset retirement obligations

 

 

250

 

Total consideration plus liabilities assumed

 

$

85,104

 

Fair Value of Assets Acquired:

 

 

 

 

Cash and cash equivalents (4)

 

$

5,263

 

Current assets

 

 

2,108

 

Proved oil and gas properties (2)(3)

 

 

48,116

 

Unproved oil and gas properties

 

 

26,600

 

Amount attributable to assets acquired

 

$

82,087

 

Goodwill (5)

 

$

3,017

 

 

1.

This amount represents the recorded book value to tax difference in the oil and natural gas properties as of the date of the Arrangement on a tax effected basis of approximately 34.5%.

2.

The weighted average commodity prices utilized in the determination of the fair value of oil and natural gas properties was $64.73 per barrel of oil, $3.68 per Mcf of natural gas and $19.34 per barrel of oil equivalent for natural gas liquids, after adjustments for transportation fees and regional price differentials.     

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 4 Fair Value Measurements, below.

4.

Concurrent with closing the Arrangement, the Company paid off the outstanding balance of $36.6 million on the Lynden credit facility. The settlement of the debt and the cash acquired is equal to the $31.3 million net cash outflow associated with the Arrangement.

5

Goodwill was determined to be the excess consideration exchanged over the fair value of the net assets of Lynden on May 18, 2016. The goodwill resulted from the expected synergies of the management team and balance sheet of the Company combined with the key assets acquired in the Midland Basin area.  The goodwill recognized will not be deductible for tax purposes.

11


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 Arrangement had been completed as of January 1, 2015. The unaudited supplemental pro forma financial information was derived from the historical consolidated and combined statements of operations for the Company and Lynden and adjusted to include: (i) depletion expense applied to the adjusted basis of the properties acquired, (ii) accretion expense associated with the asset retirement obligations recorded using the Company’s assumptions about the future liabilities and (iii) interest expense based on the combined debt of the Company post-acquisition. 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,

 

 

 

2015

 

 

2016

 

 

2015

 

(Unaudited)

 

 

 

Revenue

 

$

16,473

 

 

$

32,677

 

 

$

52,792

 

Income (loss) before taxes

 

$

1,698

 

 

$

(20,603

)

 

$

142

 

Income (loss) available to Earthstone common

   stockholders

 

$

1,165

 

 

$

(21,696

)

 

$

80

 

Pro Forma net income (loss) per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

$

0.07

 

 

$

(1.12

)

 

$

0.00

 

 

The results of operations attributable to Lynden are included in our Condensed Consolidated Statements of Operations beginning in May 2016.  During the three and nine months ended September 30, 2016, the Company recognized $2.8 million and $4.3 million, respectively, of oil, natural gas and natural gas liquids sales related to the Lynden assets and $2.2 million and $3.1 million, respectively, of operating expenses, inclusive of depletion. During the three and nine months ended September 30, 2016, the Company recognized $0 and $0.7 million, respectively, of non-recurring transaction costs related to this acquisition.

Other Acquisitions

In June 2015, the Company acquired a 50% operated working interests in approximately 1,000 gross acres in southern Gonzales County, Texas. The acreage, acquired for future Eagle Ford development, is 100% held-by-production by two gross Austin Chalk wells with gross production of 44 barrels of oil equivalent per day as of the time of acquisition.  

Also during June 2015, the Company acquired 400 gross acres in northern Karnes County, Texas, which is adjacent to the 1,000 gross acres in southern Gonzales County, Texas.  Subsequent trades in Karnes County reduced the gross acreage from 400 to 350 gross acres (117 net acres).

The following table summarizes the consideration paid to acquire the properties and the estimated fair values of the assets acquired and liabilities assumed (in thousands):

 

Purchase price

 

$

4,066

 

Estimated fair value of assets acquired:

 

 

 

 

Proved oil and natural gas properties

 

$

588

 

Unproved oil and natural gas properties

 

 

3,496

 

Total assets acquired

 

$

4,084

 

Estimated fair value of liabilities assumed:

 

 

 

 

Asset retirement obligations

 

$

13

 

Other liabilities

 

 

5

 

Total liabilities assumed

 

$

18

 

Consideration paid

 

$

4,066

 

 

Pro forma financial information, assuming the acquisition occurred at the beginning of each period presented, has not been presented because the effect on the Company’s results for each of those periods is not material.  The results of the above acquisitions have been included in the Company’s Condensed Consolidated Financial Statements since the date of each acquisition.

12


EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

Additionally, in June 2015, the Company acquired additional acreage and working interest in wells located within existing Bakken spacing units primarily located in the Banks Field of McKenzie County, North Dakota, for $1.4 million plus purchase price adjustments of $2.0 million for the revenues, net of production taxes and operating expenses and capital costs incurred for the existing wells.  The acquisition included 164 net acres which allowed the Company to increase its working interest in approximately 41 producing wells and 21 wells that are in the drilling and completion phase.

In August 2015, the Company acquired a 33% working interest in approximately 1,650 gross acres, in southern Gonzales County, Texas for $3.3 million.

Divestitures

In April 2015, the Company sold substantially all of its Louisiana properties located primarily in DeSoto and Caddo Parishes for cash consideration of $3.4 million, recording a gain of $1.6 million.  The effective date of the transaction was March 1, 2015.

 

 

Note 3. Derivative Financial Instruments

The Company is exposed to certain risks relating to its ongoing business operations, such as commodity price risk. Derivative contracts are utilized to economically hedge the Company’s exposure to price fluctuations and reduce the variability in the Company’s cash flows associated with anticipated sales of future oil and natural gas production. The Company follows FASB ASC Topic 815, Derivatives and Hedging, to account for its derivative financial instruments. The Company does not enter into derivative contracts for speculative trading purposes. It is the Company’s policy to enter into derivative contracts only with counterparties that are creditworthy financial institutions deemed by management as competent and competitive. The Company did not post collateral under any of these contracts.

The Company’s crude oil and natural gas derivative positions consist of swaps. Swaps are designed so that the Company receives or makes payments based on a differential between fixed and variable prices for crude oil and natural gas. The Company has elected to not designate any of its derivative contracts for hedge accounting. Accordingly, the Company records the net change in the mark-to-market valuation of these derivative contracts, as well as all payments and receipts on settled derivative contracts, in “Gain (loss) on derivative contracts, net” on the Condensed Consolidated Statements of Operations. All derivative contracts are recorded at fair market value and are included in the Condensed Consolidated Balance Sheets as assets or liabilities.

With an individual derivative counterparty, the Company may have multiple hedge positions that expire at various points in the future and result in fair value asset and liability positions. At the end of each reporting period, those positions are offset to a single fair value asset or liability for each commodity by counterparty, and the netted balance is reflected in the Condensed Consolidated Balance Sheets as an asset or a liability.

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.

As of September 30, 2016, the Company had the following open crude oil derivative positions:

 

 

 

Price Swaps

 

Period

 

Commodity

 

Volume

(Bbls)

 

 

Weighted Average Price ($/Bbl)

 

Q4 2016

 

Crude Oil

 

 

135,000

 

 

$

49.35

 

Q1 - Q4 2017

 

Crude Oil

 

 

420,000

 

 

$

48.86

 

Q1 - Q4 2018

 

Crude Oil

 

 

270,000

 

 

$

50.70

 

 

13


EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

As of September 30, 2016, the Company had the following open natural gas derivative positions:

 

 

 

Price Swaps

 

Period

 

Commodity

 

Volume

(MMBtu)

 

 

Weighted Average Price ($/MMBtu)

 

Q4 2016

 

Natural Gas

 

 

300,000

 

 

$

2.604

 

Q1 - Q4 2017

 

Natural Gas

 

 

1,560,000

 

 

$

2.946

 

Q1 - Q4 2018

 

Natural Gas

 

 

600,000

 

 

$

2.907

 

 

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, 2016

 

 

December 31, 2015

 

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

 

Current derivative assets

 

$

484

 

 

$

(299

)

 

$

185

 

 

$

3,694

 

 

$

 

 

$

3,694

 

Commodity contracts

 

Current derivative liabilities

 

$

(1,536

)

 

$

299

 

 

$

(1,237

)

 

$

 

 

$

 

 

$

 

Commodity contracts

 

Noncurrent derivative liabilities

 

$

(1,101

)

 

$

 

 

$

(1,101

)

 

$

 

 

$

 

 

$

 

 

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

 

 

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

Derivatives not designated as hedging contracts under ASC Topic 815

 

Statement of Operations Location

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Unrealized gain (loss) on commodity contracts

 

Gain (loss) on derivative contracts, net