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EX-32.2 - EX-32.2 - EARTHSTONE ENERGY INCeste-ex322_7.htm
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EX-31.2 - EX-31.2 - EARTHSTONE ENERGY INCeste-ex312_6.htm
EX-31.1 - EX-31.1 - EARTHSTONE ENERGY INCeste-ex311_9.htm

 

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, 2017

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 definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

Emerging growth company  

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.     

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

As of November 1, 2017, 27,488,759 shares of Class A Common Stock, $0.001 par value per share, and 36,070,828 shares of Class B Common Stock, $0.001 par value per share, were outstanding.

 

 

 


TABLE OF CONTENTS

 

 

 

 

 

Page

 

 

 

 

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements (unaudited)

 

3

 

 

Condensed Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016

 

3

 

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2017 and 2016

 

4

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016

 

5

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

6

Item 2.

 

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

 

22

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

33

Item 4.

 

Controls and Procedures

 

34

 

 

 

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

34

Item 1A.

 

Risk Factors

 

34

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

34

Item 3.

 

Defaults Upon Senior Securities

 

34

Item 4.

 

Mine Safety Disclosures

 

34

Item 5.

 

Other Information

 

34

Item 6.

 

Exhibits

 

35

 

 

Signatures

 

36

 

 

2


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

 

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

 

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

3


 

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

 

 

 

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

 

 

4


 

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands) 

 

 

 

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

 

 

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

 

 

5


 

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

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

We are a growth-oriented independent oil and natural gas development and production company. In addition, the Company is active in corporate mergers and the acquisition of oil and natural gas properties that have production and future development opportunities. 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.

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, the “Company” “our,” “we,” “us,” or similar terms).

The accompanying unaudited Condensed Consolidated Financial Statements and notes thereto of the Company, have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial statements. Pursuant to such rules and regulations, certain disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted. The accompanying unaudited Condensed Consolidated Financial Statements and notes should be read in conjunction with the financial statements and notes included in Earthstone’s 2016 Annual Report on Form 10-K, as amended.

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, 2016 is derived from the audited Consolidated Financial Statements at that date.

Certain prior period amounts have been reclassified to conform to current period presentation within the Condensed Consolidated Financial Statements. Prior period Re-engineering and workovers in the Condensed Consolidated Statements of Operations have been reclassified from its own line item and included in Lease operating expenses, within Operating Costs and Expenses, to conform to current period presentation. This reclassification had no effect on Income (loss) from operations or any other subtotal in the Condensed Consolidated Statements of Operations.

Bold Contribution Agreement

On May 9, 2017, Earthstone completed a contribution agreement 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, 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 owned significant developed and undeveloped oil and natural gas properties in the Midland Basin of Texas (the “Bold Transaction”).

The Bold Transaction was structured in a manner commonly known as an “Up-C.” Under this structure and the Bold Contribution Agreement, (i) Earthstone recapitalized its common stock into two classes – Class A common stock, $0.001 par value per share (the “Class A Common Stock”), and Class B common stock, $0.001 par value per share (the “Class B Common Stock”), and all of Earthstone’s existing outstanding common stock, $0.001 par value per share (the “Common Stock”), was recapitalized on a one-for-one basis for Class A Common Stock (the “Recapitalization”); (ii) Earthstone transferred all of its membership interests in Earthstone Operating, LLC, Sabine River Energy, LLC, EF Non-Op, LLC and Earthstone Legacy Properties, LLC (formerly Earthstone GP, LLC) and $36,071 in cash from the sale of Class B Common Stock to Bold Holdings (collectively, the “Earthstone Assets”) to EEH, in exchange for 16,791,296 membership units of EEH (the “EEH Units”); (iii) Lynden US transferred all of its membership interests in Lynden Op to EEH in exchange for 5,865,328 EEH Units; (iv) Bold Holdings transferred all 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 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.

6


EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

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.”

On May 9, 2017, in connection with the closing of the Bold Transaction, Earthstone, EnCap Investments L.P. (“EnCap”), Oak Valley Resources, LLC (“Oak Valley”), and Bold Holdings entered into a voting agreement (the “Voting Agreement”), pursuant 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 Transaction as long as the Voting Agreement is in effect.

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 Holdings 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 Holdings 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 Registration Statement was declared effective by the SEC.

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.

New significant accounting policy

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 September 30, 2017. As of September 30, 2017, Earthstone and Lynden US owned a 38.9% membership interest in EEH while Bold Holdings owned the remaining 61.1%. See further discussion in Note 6. Noncontrolling Interest.

Recently Issued Accounting Standards

Standards not yet adopted

Revenue Recognition - In May 2014, the FASB issued updated guidance for recognizing revenue from contracts with customers, which seeks to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within industries, across industries and across capital markets. The revenue standard contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. In addition, new and enhanced disclosures will be required. The amendment is effective prospectively for reporting periods beginning on or after December 15, 2017, and early adoption is permitted for periods beginning on or after December 15, 2016. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. The Company does not expect net income (loss) or cash flows to be materially impacted by the new standard; however, the Company is currently analyzing whether changes to total revenues and total expenses will be necessary to properly reflect revenue for certain gas processing agreements. The Company continues to evaluate the expected disclosure requirements, changes to relevant business practices, accounting policies and control activities as a result of adoption and has not yet developed estimates of the quantitative impact to the Company's Condensed Consolidated Financial Statements. The Company has selected the modified retrospective method and will adopt this guidance on the effective date of January 1, 2018.

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

7


EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

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.

Business Combinations – In January 2017, the FASB issued updated guidance that clarifies the definition of a business, which amends the guidance used in evaluating whether a set of acquired assets and activities represents a business. The guidance requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not considered a business. As a result, acquisition fees and expenses will be capitalized to the cost basis of the property acquired, and the tangible and intangible components acquired will be recorded based on their relative fair values as of the acquisition date. The standard is effective for all public business entities for annual periods beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted for periods for which financial statements have not yet been issued. The Company is in the process of evaluating the impact, if any, of the adoption of this guidance on its Condensed Consolidated Financial Statements.

Intangibles - Goodwill and Other In January 2017, the FASB issued updated guidance simplifying the test for goodwill impairment. The update eliminates Step 2 of the goodwill impairment test. Instead, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The update is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company is in the process of evaluating the impact, if any, on its Condensed Consolidated Financial Statements.

Compensation – Stock Compensation – In May 2017, the FASB issued updated guidance that provides clarity about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The update is effective for annual periods beginning after December 15, 2017, and early adoption is permitted, including adoption in any interim period. The Company is currently evaluating the impact, if any, of this update, but does not expect the adoption to have a material impact on its Condensed Consolidated Financial Statements.

 

Note 2. Acquisitions and Divestitures

The Company accounts for its acquisitions that qualify as business combinations, under the acquisition method of accounting 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. The initial accounting for acquisitions may not be complete and adjustments to provisional amounts, or recognition of additional assets acquired or liabilities assumed, may occur as additional information is obtained about the facts and circumstances that existed as of the acquisition dates.

 

Bold Transaction

On May 9, 2017, Earthstone completed the Bold Transaction described in Note 1. Basis of Presentation and Summary of Significant Accounting Policies.

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 Financial Statements were prepared.

8


EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

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.

9


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. Fair Value Measurements

FASB ASC Topic 820, defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. ASC 820 provides a framework for measuring fair value, establishes a three level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and requires consideration of the counterparty’s creditworthiness when valuing certain assets.

The three-level fair value hierarchy for disclosure of fair value measurements defined by ASC 820 is as follows:

Level 1 – Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. An active market is defined as a market where transactions for the financial instrument occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Inputs, other than quoted prices within Level 1, that are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level 3 – Prices or valuations that require unobservable inputs that are both significant to the fair value measurement and unobservable. Valuation under Level 3 generally involves a significant degree of judgment from management.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve

10


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 months ended September 30, 2017.

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

 

 

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.

11


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 the identifiable assets acquired and liabilities assumed at 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 strips as of the date of the estimate, operating and development costs, and a risk-adjusted discount rate. 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 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 asset retirement obligation estimates are derived from historical costs and management’s expectation of future cost environments; and therefore, the Company has designated these liabilities as Level 3. The significant inputs to this fair value measurement include estimates of plugging, abandonment and remediation costs, well life, inflation and credit-adjusted risk free rate. See Note 11. Asset Retirement Obligations for a reconciliation of the beginning and ending balances of the liability for the Company’s asset retirement obligations.

 

 

Note 4. 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. 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.

 

12


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:   

 

 

 

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

 

 

$