Table of Contents

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, 2018March 31, 2019
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 001-35049  
earthstone_logoa18.jpg
_________________________________________________________ 
EARTHSTONE ENERGY, INC.
(Exact name of registrant as specified in its charter)
 _________________________________________________________ 
 
Delaware 84-0592823
(State or other jurisdiction (I.R.S Employer
of incorporation or organization) Identification No.)
1400 Woodloch Forest Drive, Suite 300
The Woodlands, Texas 77380
(Address of principal executive offices)
Registrant’s telephone number, including area code:  (281) 298-4246
 
Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.    Yes  ☒    No  
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to post such files).    Yes  ☒    No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer   Accelerated filer 
Non-accelerated filer ☐  (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, 2018, 28,611,277April 26, 2019, 28,896,461 shares of Class A Common Stock, $0.001 par value per share, and 35,452,17835,422,178 shares of Class B Common Stock, $0.001 par value per share, were outstanding.

TABLE OF CONTENTS
 
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
EARTHSTONE ENERGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
 September 30, December 31, March 31, December 31,
ASSETS 2018 2017 2019 2018
Current assets:        
Cash $13,429
 $22,955
 $426
 $376
Accounts receivable:        
Oil, natural gas, and natural gas liquids revenues 14,600
 14,978
 19,433
 13,683
Joint interest billings and other, net of allowance of $111 and $138 at September 30, 2018 and December 31, 2017, respectively 6,047
 7,778
Joint interest billings and other, net of allowance of $133 and $134 at March 31, 2019 and December 31, 2018, respectively 19,740
 4,166
Derivative asset 
 184
 6,605
 43,888
Prepaid expenses and other current assets 1,440
 1,178
 3,679
 1,443
Total current assets 35,516
 47,073
 49,883
 63,556
        
Oil and gas properties, successful efforts method:        
Proved properties 684,862
 605,039
 797,964
 755,443
Unproved properties 268,426
 275,025
 266,289
 266,140
Land 5,382
 5,534
 5,382
 5,382
Total oil and gas properties 958,670
 885,598
 1,069,635
 1,026,965
        
Accumulated depreciation, depletion and amortization (115,382) (118,028) (141,077) (127,256)
Net oil and gas properties 843,288
 767,570
 928,558
 899,709
        
Other noncurrent assets:        
Goodwill 17,620
 17,620
 17,620
 17,620
Office and other equipment, net of accumulated depreciation of $2,378 and $2,093 at September 30, 2018 and December 31, 2017, respectively 725
 947
Office and other equipment, net of accumulated depreciation and amortization of $2,674 and $2,490 at March 31, 2019 and December 31, 2018, respectively 1,380
 662
Derivative asset 6,300
 21,121
Operating lease right-of-use assets 1,049
 
Other noncurrent assets 1,252
 1,207
 1,539
 1,640
TOTAL ASSETS $898,401
 $834,417
 $1,006,329
 $1,004,308
LIABILITIES AND EQUITY        
Current liabilities:        
Accounts payable $22,234
 $33,472
 $28,964
 $26,452
Revenues and royalties payable 32,459
 10,288
 23,365
 28,748
Accrued expenses 14,274
 8,707
 21,362
 22,406
Asset retirement obligation 494
 557
Advances 2,771
 4,587
 1,293
 3,174
Derivative liability 23,391
 11,805
 2,204
 528
Operating lease liabilities 658
 
Finance lease liabilities 354
 
Total current liabilities 95,129
 68,859
 78,694
 81,865
        
Noncurrent liabilities:        
Long-term debt 35,000
 25,000
 120,825
 78,828
Deferred tax liability 10,634
 10,515
 13,029
 13,489
Asset retirement obligation 1,635
 2,354
 1,748
 1,672
Derivative liability 10,019
 1,826
 1,367
 1,891
Other noncurrent liabilities 1,891
 131
Total noncurrent liabilities 59,179
 39,826
    
Commitments and Contingencies (Note 13) 

 

    
Equity:    
Preferred stock, $0.001 par value, 20,000,000 shares authorized; none issued or outstanding 
 
Class A Common Stock, $0.001 par value, 200,000,000 shares authorized; 28,400,421 issued and outstanding at September 30, 2018 and 27,584,638 issued and outstanding at December 31, 2017 28
 28

Class B Common Stock, $0.001 par value, 50,000,000 shares authorized; 35,663,034 shares issued and outstanding at September 30, 2018; 36,052,169 issued and outstanding at December 31, 2017 36
 36
Operating lease liabilities 442
 
Finance lease liabilities 193
 
Other noncurrent liabilities 
 71
Total noncurrent liabilities 137,604
 95,951
    
Commitments and Contingencies (Note 12) 

 

    
Equity:    
Preferred stock, $0.001 par value, 20,000,000 shares authorized; none issued or outstanding 
 
Class A Common Stock, $0.001 par value, 200,000,000 shares authorized; 28,862,461 issued and outstanding at March 31, 2019 and 28,696,321 issued and outstanding at December 31, 2018 29
 29
Class B Common Stock, $0.001 par value, 50,000,000 shares authorized; 35,452,178 issued and outstanding at March 31, 2019 and December 31, 2018 35
 35
Additional paid-in capital 512,960
 503,932
 518,889
 517,073
Accumulated deficit (218,627) (224,822) (199,634) (182,497)
Total Earthstone Energy, Inc. equity 294,397
 279,174
 319,319
 334,640
Noncontrolling interest 449,696
 446,558
 470,712
 491,852
Total equity 744,093
 725,732
 790,031
 826,492
        
TOTAL LIABILITIES AND EQUITY $898,401
 $834,417
 $1,006,329
 $1,004,308
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

EARTHSTONE ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except share and per share amounts)
 
 Three Months Ended September 30, Nine Months Ended September 30, Three Months Ended March 31,
 2018 2017 2018 2017 2019 2018
REVENUES      
Oil $38,791
 $25,733
 $105,111
 $59,815
 $35,447
 $34,417
Natural gas 1,790
 2,513
 6,257
 6,338
 1,094
 2,684
Natural gas liquids 5,495
 3,036
 12,753
 6,249
 4,187
 3,794
Total revenues 46,076
 31,282
 124,121
 72,402
 40,728
 40,895
            
OPERATING COSTS AND EXPENSES            
Lease operating expense 4,843
 5,407
 14,509
 14,990
 6,667
 4,657
Severance taxes 2,254
 1,588
 6,115
 3,705
 1,988
 2,037
Impairment expense 833
 92
 833
 66,740
Depreciation, depletion and amortization 12,842
 10,330
 33,362
 28,258
 14,005
 9,708
General and administrative expense 4,944
 7,295
 18,809
 19,483
 7,270
 6,579
Transaction costs 892
 109
 892
 4,676
 175
 
Accretion of asset retirement obligation 44
 72
 128
 378
 54
 41
Total operating costs and expenses 26,652
 24,893
 74,648
 138,230
 30,159
 23,022
            
Gain on sale of oil and gas properties 4,096
 2,157
 4,608
 3,848
(Loss) gain on sale of oil and gas properties (125) 449
            
Income (loss) from operations 23,520
 8,546
 54,081
 (61,980)
Income from operations 10,444
 18,322
            
OTHER INCOME (EXPENSE)            
Interest expense, net (565) (903) (1,788) (1,873) (1,449) (613)
Write-off of deferred financing costs 
 
 
 (526)
(Loss) gain on derivative contracts, net (17,481) (3,663) (33,606) 4,137
Litigation settlement (4,775) 
 (4,775) 
Other income, net 37
 (66) 434
 (34)
Loss on derivative contracts, net (47,894) (5,275)
Other income (expense), net (4) 6
Total other income (expense) (22,784) (4,632) (39,735) 1,704
 (49,347) (5,882)
            
Income (loss) before income taxes 736
 3,914
 14,346
 (60,276)
Income tax (expense) benefit (172) 94
 (119) 10,046
Net income (loss) 564
 4,008
 14,227
 (50,230)
(Loss) income before income taxes (38,903) 12,440
Income tax benefit (expense) 460
 (249)
Net (loss) income (38,443) 12,191
            
Less: Net income (loss) attributable to noncontrolling interest 340
 2,452
 8,032
 (35,392)
Less: Net (loss) income attributable to noncontrolling interest (21,239) 6,870
            
Net income (loss) attributable to Earthstone Energy, Inc. $224
 $1,556
 $6,195
 $(14,838)
Net (loss) income attributable to Earthstone Energy, Inc. $(17,204) $5,321
            
Net income (loss) per common share attributable to Earthstone Energy, Inc.:        
Net (loss) income per common share attributable to Earthstone Energy, Inc.:    
Basic $0.01
 $0.07
 $0.22
 $(0.66) $(0.60) $0.19
Diluted $0.01
 $0.07
 $0.22
 $(0.66) $(0.60) $0.19
            
Weighted average common shares outstanding:            
Basic 28,257,376
 22,905,023
 28,011,298
 22,638,977
 28,719,542
 27,783,805
Diluted 28,311,759
 22,905,023
 28,108,365
 22,638,977
 28,719,542
 27,911,924
            
 
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

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

Three Months Ended March 31, 2019:
 Issued Shares              
 Class A Common Stock Class B Common Stock Class A Common Stock Class B Common Stock Additional Paid-in Capital Accumulated Deficit Total Earthstone Energy, Inc. Stockholders' Equity Noncontrolling Interest Total Equity
At December 31, 201828,696,321
 35,452,178
 $29
 $35
 $517,073
 $(182,497) $334,640
 $491,852
 $826,492
ASC 842 implementation
 
 
 
 
 67
 67
 99
 166
Stock-based compensation expense
 
 
 
 2,212
 
 2,212
   2,212
Vesting of restricted stock units, net of taxes paid166,140
 
 
 
 
 
 
 
 
Class A Common Stock retained by the Company in exchange for payment of recipient mandatory tax withholdings59,261
 
 
 
 (396) 
 (396) 
 (396)
Cancellation of treasury shares(59,261) 
 
 
 
 
 
 
 
Net loss
 
 
 
 
 (17,204) (17,204) (21,239) (38,443)
At March 31, 201928,862,461
 35,452,178
 $29
 $35
 $518,889
 $(199,634) $319,319
 $470,712
 $790,031

Three Months Ended March 31, 2018:
 Issued Shares              
 Class A Common Stock Class B Common Stock Class A Common Stock Class B Common Stock Additional Paid-in Capital Accumulated Deficit Total Earthstone Energy, Inc. Stockholders' Equity Noncontrolling Interest Total Equity
At December 31, 201727,584,638
 36,052,169
 $28
 $36
 $503,932
 $(224,822) $279,174
 $446,558
 $725,732
Stock-based compensation expense
 
 
 
 1,940
 
 1,940
   1,940
Vesting of restricted stock units, net of taxes paid86,272
 
 
 
 
 
 
 
 
Class A Common Stock retained by the Company in exchange for payment of recipient mandatory tax withholdings28,664
 
 
 
 (466) 
 (466) 
 (466)
Cancellation of treasury shares(28,664) 
 
 
 
 
 
 
 
Class B Common Stock converted to Class A Common Stock194,046
 (194,046) 
 
 2,409
 
 2,409
 (2,409) 
Net loss
 
 
 
 
 5,321
 5,321
 6,870
 12,191
At March 31, 201827,864,956
 35,858,123
 $28
 $36
 $507,815
 $(219,501) $288,378
 $451,019
 $739,397


EARTHSTONE ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands) 
 
 For the Nine Months Ended
September 30,
 For the Three Months Ended
March 31,
 2018 2017 2019 2018
Cash flows from operating activities:    
Net income (loss) $14,227
 $(50,230)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:    
Impairment of proved and unproved oil and gas properties 833
 66,740
Net (loss) income $(38,443) $12,191
Adjustments to reconcile net (loss) income to net cash provided by operating activities:    
Depreciation, depletion and amortization 33,362
 28,258
 14,005
 9,708
Accretion of asset retirement obligations 128
 378
 54
 41
Settlement of asset retirement obligations (79) 
 (62) (52)
Gain on sale of oil and gas properties (4,608) (3,848)
Total loss (gain) on derivative contracts, net 33,606
 (4,137)
Operating portion of net cash paid in settlement of derivative contracts (13,643) 229
Loss (gain) on sale of oil and gas properties 125
 (449)
Total loss on derivative contracts, net 47,894
 5,275
Operating portion of net cash received (paid) in settlement of derivative contracts 5,362
 (4,275)
Stock-based compensation 5,535
 4,645
 2,212
 1,940
Deferred income taxes 119
 (10,046) (460) 249
Write-off of deferred financing costs 
 526
Amortization of deferred financing costs 228
 195
 103
 69
Changes in assets and liabilities:        
(Increase) decrease in accounts receivable (1,476) 6,964
 (6,811) 737
Increase in prepaid expenses and other current assets (372) (455)
(Increase) decrease in prepaid expenses and other current assets (2,236) (314)
Increase (decrease) in accounts payable and accrued expenses 3,939
 (11,522) (7,427) (17,611)
Increase (decrease) in revenues and royalties payable 26,572
 (4,019) (5,383) 8,595
Increase (decrease) in advances (1,816) 506
 (1,882) 662
Net cash provided by operating activities 96,555
 24,184
 7,051
 16,766
Cash flows from investing activities:        
Bold Contribution Agreement, net of cash acquired 
 (55,609)
Additions to oil and gas properties (120,124) (29,958) (48,412) (33,372)
Additions to office and other equipment (121) (139) (75) (15)
Proceeds from sales of oil and gas properties 5,840
 5,054
 
 195
Net cash used in investing activities (114,405) (80,652) (48,487) (33,192)
Cash flows from financing activities:        
Proceeds from borrowings 70,308
 70,000
 85,244
 20,000
Repayments of borrowings (60,308) (11,193) (43,247) (15,000)
Cash paid related to the exchange and cancellation of Class A Common Stock (1,402) (324) (397) (468)
Cash paid for finance leases (114) 
Deferred financing costs (274) (1,168) 
 (3)
Net cash provided by financing activities 8,324
 57,315
 41,486
 4,529
Net (decrease) increase in cash (9,526) 847
Net increase (decrease) in cash 50
 (11,897)
Cash at beginning of period 22,955
 10,200
 376
 22,955
Cash at end of period $13,429
 $11,047
 $426
 $11,058
Supplemental disclosure of cash flow information        
Cash paid for:        
Interest $1,480
 $1,555
 $1,255
 $383
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
Accrued capital expenditures $11,314
 $19,519
 $17,040
 $8,967
Lease asset additions - ASC 842 $1,801
 $
Asset retirement obligations $(120) $83
 $21
 $(181)
 The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
Note 1. Basis of Presentation and Summary of Significant Accounting Policies
Earthstone Energy, Inc., a Delaware corporation ("Earthstone" and together with its consolidated subsidiaries, the "Company"), is a growth-oriented independent oil and natural gas development and production company. In addition, the Company is active in corporate mergers and the acquisition of oil and natural gas properties that have production and future development opportunities. The Company's operations are all in the upstream segment of the oil and natural gas industry and all its properties are onshore in the United States.
Earthstone is the sole managing member of Earthstone Energy Holdings, LLC, a Delaware limited liability company (together with its wholly-owned consolidated subsidiaries, “EEH”), with a controlling interest in EEH. Earthstone, together with its wholly-owned subsidiary, Lynden Energy Corp., a corporation organized under the laws of British Columbia (“Lynden Corp”), and Lynden Corp’s wholly-owned consolidated subsidiary, Lynden USA Inc., a Utah corporation (“Lynden US”) and also a member of EEH, consolidates the financial results of EEH and records a noncontrolling interest in the Condensed Consolidated Financial Statements representing the economic interests of EEH's members other than Earthstone and Lynden US.
The accompanying unaudited Condensed Consolidated Financial Statements and notes thereto have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial statements. Pursuant to such rules and regulations, certain disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted. The accompanying unaudited Condensed Consolidated Financial Statements and notes should be read in conjunction with the financial statements and notes included in Earthstone’s 20172018 Annual Report on Form 10-K.
The information furnished herein reflects all adjustments that are, in the opinion of management, necessary for the fair presentation of the Company's financial position, results of operations and cash flows for the periods presented. The Company’s Condensed Consolidated Balance Sheet at December 31, 20172018 is derived from the audited Consolidated Financial Statements at that date.
Prior-period Stock-based compensation in the Condensed Consolidated Statements of Operations has been reclassified from its own line item and included in General and administrative expense, within Operating Costs and Expenses, to conform to current-period presentation. This reclassification had no effect on Income (loss) from operations, Income (loss)(Loss) income before income taxes, or Net (loss) income (loss) for the three and nine months ended September 30, 2018March 31, 2019 and 2017.
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, $0.001 par value per share (the “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 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 and restated (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.  

7

Table of Contents
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 American, LLC (formerly the NYSE MKT) (the “NYSE American”) 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, 2018 at the noncontrolling interest’s respective membership interest in EEH.2018.
Recently Issued Accounting Standards
Revenue RecognitionLeases On January 1, 2018, we adopted In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842): Amendments to the FASB accounting standards update for “Revenue from Contracts with Customers,” which superseded the revenue recognition requirements in “Topic 605, Revenue Recognition,” using the modified retrospective method. Adoption of this standard did not have a significant impact on our consolidated statements of operations or cash flows. We implemented processes to ensure new contracts are reviewed for the appropriate accounting treatment and generate the disclosures required under the new standard. Revenues for the sale of oil, natural gas and natural gas liquids are recognized as the product is delivered to our customers’ custody transfer points and collectability is reasonably assured. We fulfill the performance obligations under our customer contracts through daily delivery of oil, natural gas and natural gas liquids to our customers’ custody transfer points and revenues are recorded on a monthly basis. The prices received for oil, natural gas and natural gas liquids sales under our contracts are generally derived from stated market prices which are then adjusted to reflect deductions including transportation, fractionation and processing. As a result, our revenues from the sale of oil, natural gas and natural gas liquids will decrease if market prices decline. The sales of oil, natural gas and natural gas liquids as presented on the Consolidated Statements of Operations represent the Company’s share of revenues net of royalties and excluding revenue interests owned by others. When selling oil, natural gas and natural gas liquids on behalf of royalty owners or working interest owners, the Company is acting as an agent and thus reports the revenue on a net basis. To the extent actual volumes and prices of oil and natural gas sales are unavailable for a given reporting period because of timing or information not received from third parties, the expected sales volumes and prices for those properties are estimated and recorded.  
Statement of Cash Flows – Accounting Standards Codification (“ASU 2016-02”). In August 2016,January 2018, the FASB issued updatedASU No. 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842 (“ASU 2018-01”). In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”). Together these related amendments to GAAP represent ASC Topic 842, Leases (“ASC Topic 842”).
ASU 2016-02 requires lessees to recognize lease assets and liabilities (with terms in excess of 12 months) on the balance sheet and disclose key quantitative and qualitative information about leasing arrangements. The Company completed a comprehensive assessment of existing contracts, as well as future potential contracts, to determine the impact of the new accounting guidance on its consolidated financial statements and related disclosures. The evaluation process included review of contracts for drilling rigs, office facilities, compression services, field vehicles and equipment, general corporate leased equipment, and other existing arrangements to support its operations that clarifies how certain cash receipts and cash paymentsmay contain a lease component. The Company's evaluation process did not include review of its mineral leases as they are outside the scope of ASC Topic 842.
The Company adopted this guidance on January 1, 2019, the transition date, using the simplified transition method described in ASU 2018-11 which allows entities to continue to apply historical accounting guidance in the comparative periods presented in the statementyear of cash flows. This update provides guidance on eight specific cash flow issues. The standards update is effective for interimadoption. Accordingly, prior period amounts in our financial statements are not adjusted and annual periods beginning after December 15, 2017 and shouldcontinue to be applied retrospectively to all periods presented. Early adoption is permitted. reported in accordance with historical accounting guidance.
The Company adoptedelected the new standard, as required, beginning with the first quarterpackage of 2018, with no material impact on its Consolidated Financial Statements.
Business Combinations – In January 2017, the FASB issued updated guidancepractical expedients within ASU 2016-02 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 requiresallows 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 capitalizedreassess, prior to the cost basis ofeffective date, (i) whether any expired or existing contracts are or contain leases, (ii) the property acquired, andlease classification for any expired or existing leases or (iii) initial direct costs for any existing leases. Additionally, the tangible and intangible components acquired will be recorded based on their relative fair valuesCompany elected the practical expedient under ASU 2018-01 to not evaluate existing or expired land easements not previously accounted for as ofleases prior to the acquisitioneffective 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, withCompany made an accounting policy election not to apply the lease recognition requirements to short-term leases.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

earlyThe adoption permitted for periods for which financial statementsof ASC Topic 842 did not have not yet been issued. The Company adopted the new standard, as required, beginning with the first quarter of 2018, with noa material impact on the Company's financial statements, resulted in increases of less than 1% to each of its 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 adopted the new standard, as required, beginning with the first quarter of 2018, with no material impact on its 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 leasetotal assets and lease liabilities. Similartotal liabilities on the balance sheet, and resulted in an immaterial decrease to current guidance, the update continues to differentiate between finance leases and operating leases; however, this distinction now primarily relates to differences in the manneraccumulated deficit as 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 update, as required, beginning with the first quarter of 2019. See TheNote 14. LeasesCompany is in the process of evaluating the impact of this guidance, if any, of the adoption of this guidance on itsConsolidated Financial Statements. for further information.
Intangibles - Goodwill and Other – In January 2017, the FASB issued updated guidance simplifying the test for goodwill impairment. The update eliminates Step 2 of the goodwill impairment test. Instead, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The update is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company is in the process of evaluating the impact of this guidance, if any, on its Consolidated Financial Statements.
Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting In June 2018, the FASB issued updated guidance simplifying the guidance on nonemployee share-based payments. The update is effective for annual and interim periods beginning after December 15, 2018 and early adoption is permitted. The Company is in the process of evaluating the impact of this guidance, if any, on its Consolidated Financial Statements.
Codification Improvements – In July 2018, the FASB issued an update which does not prescribe any new accounting guidance, but instead makes minor improvements and clarifications of several different FASB Accounting Standards Codification areas based on comments and suggestions made by various stakeholders. Certain updates are applicable immediately while others provide for a transition period to adopt as part of the next fiscal year beginning after December 15, 2018. The Company is in the process of evaluating the impact of this update, if any, on its Consolidated Financial Statements.
Fair Value Measurements – In August 2018, the FASB issued an update which modifies the disclosure requirements on fair value measurements in Topic 820. The ASU is effective for fiscal years beginning after December 15, 2019 and early adoption is permitted. The Company is in the process of evaluating the impact of this update, if any, on its Consolidated Financial Statements.
Note 2. 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.

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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 unit, share and share price amounts): 
Consideration: 
Shares of Class A Common Stock issued pursuant to the Bold Contribution Agreement to certain employees of Bold150,000
EEH Units issued to Bold Holdings36,070,828
Total equity interest issued in the Bold Transaction36,220,828
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 assets10,078
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 liabilities17,042
Deferred tax liability2,857
Noncurrent asset retirement obligations359
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.


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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 and the Bakken Sale (discussed below) had been completed as of January 1, 2017. 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,
  2017 2017
Revenue $28,409
 $91,163
Income (loss) before taxes $3,408
 $(42,228)
Net income (loss) $3,502
 $(39,711)
Less: Net income (loss) available to noncontrolling interest $2,142
 $(24,316)
Net income (loss) attributable to Earthstone Energy, Inc. $1,360
 $(15,395)
Pro forma net income (loss) per common share attributable to Earthstone Energy, Inc.:    
Basic $0.06
 $(0.68)
Diluted $0.06
 $(0.68)
The Company has included in its Condensed Consolidated Statements of Operations, revenues of $31.6 million and $83.2 million, respectively, and direct operating expenses of $13.4 million and $35.5 million, respectively, for the three and nine months ended September 30, 2018 related to the properties acquired in the Bold Transaction.
On September 28, 2018, the Company sold certain of its non-operated oil and natural gas properties located in the Eagle Ford Trend of south Texas for cash consideration of approximately $5.5 million. The sale resulted in a net gain of approximately $4.6 million recorded in Gain on sale of oil and gas properties in the Consolidated Statements of Operations.
On December 20, 2017, the Company sold all of its oil and natural gas leases, oil and natural gas wells and associated assets located in the Williston Basin in North Dakota (the "Bakken Sale") for a net cash consideration of approximately $27.3 million after normal and customary purchase price adjustments of $0.3 million to account for net cash flows from the effective date to the closing date. The effective date of the sale was December 1, 2017.
Note 3.2. Fair Value Measurements
FASB ASC Topic 820, defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. ASC 820 provides a framework for measuring fair value, establishes a three-level 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

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instrument’s complexity. The Company reflects transfers between the three levels at the beginning of the reporting period in which the availability of observable inputs no longer justifies classification in the original level. There were no transfers between fair value hierarchy levels for the ninethree months ended September 30, 2018.March 31, 2019.
Fair Value on a Recurring Basis
Derivative financial instruments are carried at fair value and measured on a recurring basis. The derivative financial instruments consist of swaps for crude oil and natural gas. The Company’s swaps are valued based on a discounted future cash flow model. The primary input for the model is published forward commodity price curves. The swaps are also designated as Level 2 within the valuation hierarchy.
The fair values of commodity derivative instruments in an asset position include a measure of counterparty nonperformance risk, and the fair values of commodity derivative instruments in a liability position include a measure of the Company’s nonperformance risk. These measurements were not material to the Condensed Consolidated Financial Statements.
The following table summarizes the fair value of the Company’s financial assets and liabilities, by level within the fair-value hierarchy (in thousands):

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

 
September 30, 2018 Level 1 Level 2 Level 3 Total
March 31, 2019 Level 1 Level 2 Level 3 Total
Financial assets                
Derivative asset - current $
 $
 $
 $
 $
 $6,605
 $
 $6,605
Derivative asset - noncurrent 
 
 
 
 
 6,300
 
 6,300
Total financial assets $
 $
 $
 $
 $
 $12,905
 $
 $12,905
                
Financial liabilities                
Derivative liability - current $
 $23,391
 $
 $23,391
 $
 $2,204
 $
 $2,204
Derivative liability - noncurrent 
 10,019
 
 10,019
 
 1,367
 
 1,367
Total financial liabilities $
 $33,410
 $
 $33,410
 $
 $3,571
 $
 $3,571
                
December 31, 2017        
December 31, 2018        
Financial assets                
Derivative asset - current $
 $184
 $
 $184
 $
 $43,888
 $
 $43,888
Derivative asset - noncurrent 
 
 
 
 

 21,121
 

 21,121
Total financial assets $
 $184
 $
 $184
 $
 $65,009
 $
 $65,009
                
Financial liabilities                
Derivative liability - current $
 $11,805
 $
 $11,805
 $
 $528
 $
 $528
Derivative liability - noncurrent 
 1,826
 
 1,826
 
 1,891
 
 1,891
Total financial liabilities $
 $13,631
 $
 $13,631
 $
 $2,419
 $
 $2,419
                
Other financial instruments include cash, accounts receivable and payable, and revenue royalties. The carrying amount of these instruments approximates fair value because of their short-term nature. The Company’s long-term debt obligation bears interest at floating market rates, therefore carrying amounts and fair value are approximately equal.
Fair Value on a Nonrecurring Basis
The Company applies the provisions of the fair value measurement standard on a non-recurring basis to its non-financial assets and liabilities, including oil and gas properties and goodwill. These assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances. 

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

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

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

acquired. If the Company determines an asset(s) has been acquired, the asset(s) acquired, as well as any liabilities assumed, are measured and recorded at the acquisition date cost. If the Company determines a business has been acquired, the assets acquired and liabilities assumed are measured and recorded at their fair value at the date of acquisition on a nonrecurring basis. Fair value may be estimated using comparable market data, a discounted cash flow method, or a combination of the two. In the discounted cash flow method, estimated future cash flows are based on management’s expectations for the future and include estimates of future oil and gas production, commodity prices based on NYMEX commodity futures price stripsvalues as of the acquisition date, of the estimate, operating and development costs, and a risk-adjusted discount rate. The future oil and natural gas pricing usedrecording goodwill for amounts paid in the valuation is a Level 2 assumption. Significant Level 3 assumptions associated with the calculation of discounted cash flows used in the determinationexcess 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.value.
Asset Retirement Obligations
The estimated fair value of the Company's asset retirement obligation at inception is determined by utilizing the income approach by applying a credit-adjusted risk-free rate, which takes into account the Company's credit risk, and the time value of money to the undiscounted expected abandonment cash flows, including estimates of plugging, abandonment and remediation costs and well life. Given the unobservable nature of the inputs, the measurement of the asset retirement obligations was classified as Level 3 in the fair value hierarchy. See Note 11.10. Asset Retirement Obligations for a reconciliation of the beginning and ending balances of the liability for the Company’s asset retirement obligations.
Performance Units
Stock-based compensation related to performance is estimated utilizing the Monte Carlo Simulation pricing model, which calculates multiple potential outcomes for an award and establishes fair value based on the most likely outcome, and has been classified as Level 3 in the fair value hierarchy. Stock-based compensation related to performance units is described in Note 9.8. Stock-Based Compensation.
Note 4.3. Derivative Financial Instruments
The Company’s hedging activities consist of derivative instruments entered into in order to hedge against changes in oil and natural gas prices through the use of fixed price swap agreements. Swaps exchange floating price risk in the future for a fixed price at the time of the hedge. Consistent with its hedging policy, the Company has entered into a series of derivative instruments to hedge a significant portion of its expected oil and natural gas production through December 31, 2020. Typically, these derivative instruments require payments to (receipts from) counterparties based on specific indices as required by the derivative agreements. Although not risk free, the Company believes these instruments reduce its exposure to oil and natural gas price fluctuations and, thereby, allow the Company to achieve a more predictable cash flow.
The Company’s derivative instruments are cash flow hedge transactions in which it is hedging the variability of cash flow related to a forecasted transaction. The Company does not enter into derivative instruments for trading or other speculative purposes. These transactions are recorded in the Condensed Consolidated Financial Statements in accordance with FASB ASC Topic 815. The Company has accounted for these transactions using the mark-to-market accounting method. Generally, the Company incurs

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

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.

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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, 2018:March 31, 2019:    
  Price Swaps
Period Commodity 
Volume
(Bbls / MMBtu)
 
Weighted Average Price
($/Bbl / $/MMBtu)
Q4 2018 Crude Oil 413,700
 $54.05
Q1 - Q4 2019 Crude Oil 1,624,100
 $58.95
Q1 - Q4 2020 Crude Oil 732,000
 $63.08
Q4 2018 Crude Oil (Basis Swap)(1) 243,800
 $(1.90)
Q4 2018 Crude Oil (Basis Swap)(2) 92,000
 $6.35
Q1 - Q4 2019 Crude Oil Basis Swap(1) 1,277,500
 $(6.39)
Q1 - Q4 2019 Crude Oil (Basis Swap)(2) 365,000
 $4.50
Q1 - Q4 2020 Crude Oil Basis Swap(1) 732,000
 $(5.38)
Q4 2018 Natural Gas 610,000
 $2.95
  Price Swaps
Period Commodity 
Volume
(Bbls / MMBtu)
 
Weighted Average Price
($/Bbl / $/MMBtu)
Q2 - Q4 2019 Crude Oil 1,769,100
 $65.60
Q1 - Q4 2020 Crude Oil 1,464,000
 $65.87
Q2 - Q4 2019 Crude Oil Basis Swap(1) 1,512,500
 $(5.29)
Q2 - Q4 2019 Crude Oil (Basis Swap)(2) 275,000
 $4.50
Q1 - Q4 2020 Crude Oil Basis Swap(1) 1,464,000
 $(2.74)
Q2 - Q4 2019 Natural Gas 2,795,500
 $2.86
Q1 - Q4 2020 Natural Gas 2,562,000
 $2.85
Q2 - Q4 2019 Natural Gas Basis Swap (3) 2,795,500
 $(1.14)
Q1 - Q4 2020 Natural Gas Basis Swap (3) 2,562,000
 $(1.07)
(1)The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.
(2)The basis differential price is between LLS Argus Crude and the WTI NYMEX.
Subsequent to September 30, 2018, the Company entered into the following crude oil and natural gas derivative contracts:
  Price Swaps
Period Commodity 
Volume
(Bbls / MMBtu)
 
Weighted Average Price
($/Bbl / $/MMBtu)
Q1 - Q4 2019 Crude Oil 730,000
 $73.05
Q1 - Q4 2020 Crude Oil 732,000
 $68.67
Q1 - Q4 2019 Crude Oil Basis Swap(1) 730,000
 $(5.50)
Q1 - Q4 2020 Crude Oil Basis Swap(1) 732,000
 $(0.10)
Q1 - Q4 2019 Natural Gas 1,277,550
 $2.87
Q1 - Q4 2019 Natural Gas (Basis Swap)(2) 1,277,550
 $(1.28)
(1)The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.
(2)(3)The basis differential price is between W. Texas (WAHA) and the Henry Hub NYMEX.
Subsequent to March 31, 2019, the Company entered into additional hedges consisting of Crude Oil Swaps on 366 MBbls at a price of $59.75/Bbl for 2020 and WTI Midland Argus Crude Basis Swaps on 366 MBbls at a price of $0.25/Bbl for 2020.
The following table summarizes the location and fair value amounts of all derivative instruments in the Condensed Consolidated Balance Sheets as well as the gross recognized derivative assets, liabilities, and amounts offset in the Condensed Consolidated Balance Sheets (in thousands)
    September 30, 2018 December 31, 2017
Derivatives not
designated as hedging
contracts under ASC
Topic 815
 Balance Sheet Location 
Gross
Recognized
Assets /
Liabilities
 
Gross
Amounts
Offset
 
Net
Recognized
Assets /
Liabilities
 
Gross
Recognized
Assets /
Liabilities
 
Gross
Amounts
Offset
 
Net
Recognized
Assets /
Liabilities
Commodity contracts Derivative asset - current $
 $
 $
 $184
 $
 $184
Commodity contracts Derivative liability - current $25,200
 $(1,809) $23,391
 $11,805
 $
 $11,805
Commodity contracts Derivative liability - noncurrent $10,025
 $(6) $10,019
 $1,826
 $
 $1,826

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

    March 31, 2019 December 31, 2018
Derivatives not
designated as hedging
contracts under ASC
Topic 815
 Balance Sheet Location 
Gross
Recognized
Assets /
Liabilities
 
Gross
Amounts
Offset
 
Net
Recognized
Assets /
Liabilities
 
Gross
Recognized
Assets /
Liabilities
 
Gross
Amounts
Offset
 
Net
Recognized
Assets /
Liabilities
Commodity contracts Derivative asset - current $14,262
 $(7,657) $6,605
 $48,662
 $(4,774) $43,888
Commodity contracts Derivative liability - current $9,861
 $(7,657) $2,204
 $5,302
 $(4,774) $528
Commodity contracts Derivative asset - noncurrent $8,597
 $(2,297) $6,300
 $23,605
 $(2,484) $21,121
Commodity contracts Derivative liability - noncurrent $3,664
 $(2,297) $1,367
 $4,375
 $(2,484) $1,891
The following table summarizes the location and amounts of the Company’s realized and unrealized gains and losses on derivatives instruments in the Condensed Consolidated Statements of Operations (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 2018 2017 2018 2017
Total (loss) gain on commodity contracts (Loss) gain on derivative contracts, net $(13,105) $(4,159) $(19,963) $3,908
Cash (paid) received in settlements on commodity contracts (Loss) gain on derivative contracts, net (4,376) 496
 (13,643) 229
(Loss) gain on commodity contracts, net   $(17,481) $(3,663) $(33,606) $4,137
           
Derivatives not designated as hedging contracts under ASC Topic 815 Three Months Ended
March 31,
  Statement of Cash Flows Location Statement of Operations Location 2019 2018
Unrealized (loss) Not separately presented Not separately presented $(53,256) $(1,000)
Realized gain (loss) Operating portion of net cash paid in settlement of derivative contracts Not separately presented 5,362
 (4,275)
  Total loss on derivative contracts, net (Loss) on derivative contracts, net $(47,894) $(5,275)
         
Note 5.4. Oil and Natural Gas Properties
The Company follows the successful efforts method of accounting for its oil and natural gas properties. Under this method, costs to acquire oil and natural gas properties, drill and equip exploratory wells that find proved reserves, and drill and equip development wells are capitalized. Exploration costs, including unsuccessful exploratory wells and geological and geophysical costs, are charged

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

to operations as incurred. Upon sale or retirement of oil and natural gas properties, the costs and related accumulated depreciation, depletion and amortization are eliminated from the accounts and the resulting gain or loss is recognized.
Costs incurred to maintain wells and related equipment, lease and well operating costs, and other exploration costs are charged to expense as incurred. Gains and losses arising from the sale of properties are included in Income (loss) from operations in the Condensed Consolidated Statements of Operations.
The Company’s lease acquisition costs and development costs of proved oil and natural gas properties are amortized using the units-of-production method, at the field level, based on total proved reserves and proved developed reserves, respectively. For the three months ended September 30,March 31, 2019 and 2018, and 2017, depletion expense for oil and gas producing property and related equipment was $12.7$13.8 million and $10.2 million, respectively. For the nine months ended September 30, 2018 and 2017, depletion expense for oil and gas producing property and related equipment was $33.0 million and $27.9$9.6 million, respectively.
Proved Properties
Proved oil and natural gas properties are measured at fair valuereviewed for impairment on a nonrecurring basis in order to review for impairment.basis. The impairment charge reduces the carrying values to their estimated fair values. These fair value measurements are classified as Level 3 measurements and include many unobservable inputs. Fair value is calculated as the estimated discounted future net cash flows attributable to the assets. The Company’s primary assumptions in preparing the estimated discounted future net cash flows to be recovered from oil and gas properties are based on (i) proved reserves, (ii) forward commodity prices and assumptions as to costs and expenses, and (iii) the estimated discount rate that would be used by potential purchasers to determine the fair value of the assets.
Unproved Properties
Unproved properties consist of costs incurred to acquire undeveloped leases as well as the cost to acquire unproved reserves. Undeveloped lease costs and unproved reserve acquisition costs are capitalized. Unproved oil and gas leases are generally for a primary term of three to five years. In most cases, the term of the unproved leases can be extended by paying delay rentals, meeting contractual drilling obligations, or by the presence of producing wells on the leases. Unproved costs related to successful exploratory drilling are reclassified to proved properties and depleted on a units-of-production basis.
The Company reviews its unproved properties periodically for impairment. In determining whether an unproved property is impaired, the Company considers numerous factors including, but not limited to, current exploration and development plans, favorable or unfavorable exploration activity on the property being evaluated and/or adjacent properties, the Company’s geologists' evaluation of the property, and the remaining months in the lease term for the property.

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Impairments to Oil and Natural Gas Properties
During the three months ended September 30,March 31, 2019 and 2018, the Company recorded an impairment of $0.8 milliondid not record any impairments to its unproved oil and natural gas properties as a result of acreage expirations to its properties located in the Eagle Ford Trend of south Texas.
During the three months ended September 30, 2017, the Company recorded an impairment of $0.1 million to its unproved oil and natural gas properties as a result of acreage expirations to its properties located in the Eagle Ford Trend of south Texas.  As a result of acreage expirations and forward commodity price declines, during the nine months ended September 30, 2017, the Company recorded impairments consisting of $63.0 million to its proved oil and natural gas properties and $3.7 million to its unproved oil and natural gas properties, primarily to properties located in the Eagle Ford Trend of south Texas.properties.
Note 6.5. Noncontrolling Interest
Earthstone consolidates the financial results of EEH and its subsidiaries and records a noncontrolling interest for the economic interest in Earthstone held by the members of EEH other than Earthstone and Lynden US. Net income attributable to noncontrolling interest in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2018March 31, 2019 represents the portion of net income or loss attributable to the economic interest in the Company held by the members of EEH other than Earthstone and Lynden US. Noncontrolling interest in the Condensed Consolidated Balance SheetSheets as of September 30, 2018March 31, 2019 and December 31, 20172018 represents the portion of net assets of the Company attributable to the members of EEH other than Earthstone and Lynden US.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table presents the changes in noncontrolling interest for the ninethree months ended September 30, 2018:March 31, 2019: 
 
EEH Units Held
By Earthstone
and Lynden US
 % 
EEH Units Held
By Others
 % 
Total EEH
Units
Outstanding
 
EEH Units Held
By Earthstone
and Lynden US
 % 
EEH Units Held
By Others
 % 
Total EEH
Units
Outstanding
As of December 31, 2017 27,584,638
 43.3% 36,052,169
 56.7% 63,636,807
As of December 31, 2018 28,696,321
 44.7% 35,452,178
 55.3% 64,148,499
EEH Units and Class B Common Stock converted to Class A Common Stock 389,135
   (389,135)   
 
   
   
EEH Units issued in connection with the vesting of restricted stock units 426,648
   
   426,648
 166,140
   
   166,140
As of September 30, 2018 28,400,421
 44.3% 35,663,034
 55.7% 64,063,455
As of March 31, 2019 28,862,461
 44.9% 35,452,178
 55.1% 64,314,639
          
The following table summarizes the activity for the equity attributable to the noncontrolling interest for the ninethree months ended September 30, 2018March 31, 2019 (in thousands):
 2018
As of December 31, 2017$446,558
EEH Units and Class B Common Stock converted to Class A Common Stock(4,894)
Net income attributable to noncontrolling interest8,032
  
As of September 30, 2018$449,696

 2019
As of December 31, 2018$491,852
EEH Units and Class B Common Stock converted to Class A Common Stock
ASC 842 implementation adjustment attributable to noncontrolling interest99
Net loss attributable to noncontrolling interest(21,239)
  
As of March 31, 2019$470,712
  
Note 7.6. Net (Loss) Income (Loss) Per Common Share
Net (loss) income (loss) per common share—basic is calculated by dividing Net (loss) income (loss) by the weighted average number of shares of common stock outstanding during the period (Common Stock for the period from January 1, 2017 through May 8, 2017 and Class A Common Stock thereafter).period. Net (loss) income (loss) per common share—diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing Net (loss) income (loss) by the sum of the weighted average number of shares of common stock, as defined above, outstanding plus potentially dilutive securities. Net (loss) income (loss) per common share—diluted considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares, as defined above, would have an anti-dilutive effect.
A reconciliation of Net (loss) income per common share is as follows:
  Three Months Ended
March 31,
(In thousands, except per share amounts) 2019 2018
Net (loss) income attributable to Earthstone Energy, Inc. $(17,204) $5,321
     
Net (loss) income per common share attributable to Earthstone Energy, Inc.:    
Basic $(0.60) $0.19
Diluted $(0.60) $0.19
     
Weighted average common shares outstanding    
Basic 28,719,542
 27,783,805
Add potentially dilutive securities:    
Unvested restricted stock units 
 128,119
Diluted weighted average common shares outstanding 28,719,542
 27,911,924
     
Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and Net loss attributable to noncontrolling interest of $21.2 million would be added back to Net (loss) income attributable to Earthstone Energy, Inc., having no dilutive effect on Net (loss) income per common share attributable to Earthstone Energy, Inc. For the three months ended

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

A reconciliation of Net income (loss) per common share is as follows:
  Three Months Ended
September 30,
 Nine Months Ended
September 30,
(In thousands, except per share amounts) 2018 2017 2018 2017
Net income (loss) attributable to Earthstone Energy, Inc. $224
 $1,556
 $6,195
 $(14,838)
         
Net income (loss) per common share attributable to Earthstone Energy, Inc.:        
Basic $0.01
 $0.07
 $0.22
 $(0.66)
Diluted $0.01
 $0.07
 $0.22
 $(0.66)
         
Weighted average common shares outstanding        
Basic 28,257,376
 22,905,023
 28,011,298
 22,638,977
Add potentially dilutive securities:        
Unvested restricted stock units 54,383
 
 97,067
 
Diluted weighted average common shares outstanding 28,311,759
 22,905,023
 28,108,365
 22,638,977
Class B Common Stock has beenMarch 31, 2019, the Company excluded as its conversion would eliminate noncontrolling interest and Net income (loss) attributable to noncontrolling interest of $0.3 million and $8.0 million336,759 shares for the three and nine months ended September 30, 2018, respectively, would be added back to Net income (loss) attributable to Earthstone Energy, Inc., having no dilutive effect on Net income (loss)of performance units in calculating diluted earnings per common share attributableas the effect was anti-dilutive due to Earthstone Energy, Inc.the net loss incurred the period.
Note 8.7. Common Stock
On May 9, 2017, and in connection with the completion of the Bold Transaction, Earthstone recapitalized its Common Stock into two classes, as described in Note 1. – Basis of Presentation and Summary of Significant Accounting Policies, Class A Common Stock and Class B Common Stock. At that time, all of Earthstone’s existing outstanding Common Stock was automatically converted on a one-for-one basis into Class A Common Stock.
Class A Common Stock
At September 30, 2018March 31, 2019 and December 31, 2017,2018, there were 28,400,42128,862,461 and 27,584,63828,696,321 shares of Class A Common Stock issued and outstanding, respectively. During the three and nine months ended September 30, 2018,March 31, 2019, as a result of the vesting and settlement of restricted stock units under the Earthstone Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan (the "2014 Plan"), Earthstone issued 115,574 and 569,585225,401 shares of Class A Common Stock, respectively, of which 30,511 and 142,937 shares of Class A Common Stock, respectively, were retained as treasury stock and canceled to satisfy the related employee income tax liability. During the three and nine months ended September 30, 2017, as a result of the vesting and settlement of restricted stock units under the 2014 Plan, Earthstone issued 126,751 and 594,380 shares of common stock and Class A Common Stock, respectively, of which 29,44159,261 shares of Class A Common Stock were retained as treasury stock and canceled to satisfy the related employee income tax liability. Additionally, on May 9, 2017,During the three months ended March 31, 2018, as a result of the vesting and settlement of restricted stock units under the Bold Contribution Agreement,2014 Plan, Earthstone issued 150,000114,936 shares of Class A Common Stock valued at approximately $2.0 million on that date. For additional information, see Note 2. Acquisitionsof which 28,664 shares of Class A Common Stock were retained as treasury stock and Divestitures.canceled to satisfy the related employee income tax liability.
Class B Common Stock
At September 30, 2018March 31, 2019 and December 31, 2017,2018, there were 35,663,034 and 36,052,16935,452,178 shares of Class B Common Stock issued and outstanding, respectively. Each share of Class B Common Stock, together with one EEH Unit, is convertible into one share of Class A Common Stock. During the three and nine months ended September 30, 2018, 183,894March 31, 2019, no shares and 389,135 shares, respectively, of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock. In OctoberDuring the three months ended March 31, 2018, an additional 210,856194,046 shares of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock.

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Note 9.8. Stock-Based Compensation
Restricted Stock Units
The 2014 Plan, allows, among other things, for the grant of restricted stock units ("RSUs"). On June 6, 2018, atAs of March 31, 2019, the annual meetingmaximum number of stockholders, Earthstone's stockholders approved an amendment and restatement of the 2014 Plan, including increasing the shares of Class A Common Stock that may be issued under the 2014 Plan by 600,000 shares, to a total ofwas 6.4 million shares.
On May 9, 2017, and in connection with the completion of the Bold Contribution Agreement, and upon approval by the stockholders of Earthstone, the 2014 Plan was amended to increase the number of shares of Class A Common Stock authorized to be issued under the 2014 Plan by 4.3 million shares, to a total of 5.8 million shares. Each RSU represents the contingent right to receive one share of Class A Common Stock. The holders of outstanding RSUs do not receive dividends or have voting rights prior to vesting and settlement. Prior to May 9, 2017, theThe Company determined the fair value of granted RSUs based on the market price of the Common Stock on the date of the grant. Beginning on May 9, 2017, the Company began determiningdetermines the fair value of granted RSUs based on the market price of the Class A Common Stock on the date of the grant. Compensation expense for granted RSUs is recognized on a straight-line basis over the vesting and is net of forfeitures, as incurred. Stock-based compensation is included in General and administrative expense in the Condensed Consolidated Statements of Operations and is recorded with a corresponding increase in Additional paid-in capital within the Condensed Consolidated Balance Sheet.Sheets.
The table below summarizes unvested RSU award activity for the ninethree months ended September 30, 2018:March 31, 2019:
 Shares Weighted-Average Grant Date Fair Value Shares Weighted-Average Grant Date Fair Value
Unvested RSUs at December 31, 2017 969,245
 $9.89
Unvested RSUs at December 31, 2018 810,995
 $8.83
Granted 359,500
 $9.33
 743,350
 $6.40
Forfeited (44,165) $10.87
 (13,750) $7.70
Vested (569,585) $9.89
 (225,401) $8.56
Unvested RSUs at September 30, 2018 714,995
 $9.55
Unvested RSUs at March 31, 2019 1,315,194
 $7.51
    
For the three and nine months ended September 30, 2018, Stock-based compensation related to RSUsAs of March 31, 2019, there was $1.2$9.7 million and $4.9 million, respectively. Theof unrecognized compensation expense related to the RSU awards at September 30, 2018 was $6.4 million which will be amortizedrecognized over the remaining vesting period. Thea weighted average remaining vesting period of the unrecognized compensation expense is 0.931.10 years.
The table below summarizes unvested RSU award activity for the nine months ended September 30, 2017:
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
  Shares Weighted-Average Grant Date Fair Value
Unvested RSUs at December 31, 2016 781,500
 $12.53
Granted 254,500
 $11.67
Forfeited (36,000) $13.30
Vested (594,380) $12.45
Unvested RSUs at September 30, 2017 405,620
 $12.03

For the three and nine months ended September 30, 2017,March 31, 2019 and 2018, Stock-based compensation related to RSUs was $1.7$1.6 million and $4.6$1.8 million, respectively.
Performance Units
The table below summarizes performance unit (“PSU”) activity for the three months ended March 31, 2019:
  Shares Weighted-Average Grant Date Fair Value
Unvested PSUs at December 31, 2018 252,500
 $13.75
Granted 669,550
 $9.30
Unvested PSUs at March 31, 2019 922,050
 $10.52
     
On FebruaryJanuary 28, 2018,2019, the Board of Directors of Earthstone (the "Board") granted 252,500 performance units (“PSUs”)669,550 PSUs to certain named executive officers pursuant to the 2014 Plan. The PSUs are payable in shares of Class A Common Stock based upon the achievement by the Company over a period commencing on February 28, 20181, 2019 and ending on February 28, 2021January 31, 2022 (the “Performance Period”) of performance criteria established by the Board.  
The number of shares of Class A Common Stock that may be issued will be determined by multiplying the number of PSUs granted by the Relative Total Shareholder Return ("TSR") Percentage (0% to 200%).  The “Relative TSR Percentage” is the percentage, if any, achieved by attainment of a certain predetermined range of targets for the Performance Period. Accordingly, the potential aggregate number of shares of Class A Common Stock issuable under the outstanding PSU awards range from zero to 505,000.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

TSR for the Company and each of the peer companies is generally determined by dividing (A) the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the last calendar day of the Performance Period minus the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the first day of the Performance Period plus cash dividends paid over the Performance Period by (B) the volume weighted average price of a share of stock for the trading days during the thirty calendar days ending on and including the first day of the Performance Period.
As of September 30, 2018, there were 252,500 PSUs outstanding. There were no PSUs outstanding as of December 31, 2017. The unrecognized compensation expense related to the PSU awards at September 30, 2018 was $2.8 million which will be amortized over the remaining vesting period. The weighted average remaining vesting period of the unrecognized compensation expense is 1.25 years.
The Company is accountingaccounts for this awardthese awards as a market-based awardawards which wasare valued utilizing the Monte Carlo Simulation pricing model, which calculates multiple potential outcomes for an award and establishes grant date fair value based on the most likely outcome. UnderFor the Monte Carlo Simulation pricing model,PSUs granted on January 28, 2019, assuming a risk-free rate of 2.6% and volatilities ranging from 40.1% to 114.1%, the Company calculated the weighted average grant date fair value per PSU to be $13.75. $9.30.
As of March 31, 2019, there was $8.1 million of unrecognized compensation expense related to the PSU awards which will be amortized over a weighted average period of 1.3 years.
For the three and nine months ended September 30,March 31, 2019 and 2018, Stock-based compensation related to the PSUs was approximately $0.3$0.6 million and $0.7$0.1 million, respectively. There was no Stock-based compensation related to the PSUs for the three and nine months ended September 30, 2017.
Note 10.9. Long-Term Debt
Credit Agreement
OnIn May, 23, 2018,2017, Earthstone Energy Holdings, LLC (“EEH” or the “Borrower”), a subsidiary of Earthstone, each of Earthstone Operating, LLC, EF Non-Op, LLC, Sabine River Energy, LLC, Earthstone Legacy Properties, LLC, Lynden USA Operating, LLC, Bold Energy III LLC ("Bold"), Bold Operating, LLC, as guarantors (the “Guarantors”), BOKF, NA dba Bank Of Texas, as Administrative Agent, and the lenders party thereto (the “Lenders”), entered into an amendment (the “Amendment”) to the Credit Agreement dated May 9, 2017, by and among EEH, as Borrower, the Guarantors, BOKF, NA dba Bank Of Texas, as Agent and Lead Arranger, Wells Fargo Bank, National Association, as Syndication Agent, and the Lenders (together with all amendments or other modifications, the “EEH Credit Agreement”lenders party thereto (the “Lenders”). Among other things, the Amendment increased the borrowing base from $185.0 million to $225.0 million, provided for, entered into a 50-basis point decrease in the interest rate on outstanding loans, increased flexibility related to hedging limitations and provided the ability to obtain short-term borrowings via a swingline as a part of the borrowing base.
On May 9, 2017, in connection with the closing of the Bold Transaction, the Company exited its credit agreement dated December 19, 2014, by and among Earthstone and its subsidiaries, BOKF, NA dba Bank of Texas, and the Lenders party thereto (as amended, modified or restated from time to time, the “ESTE“EEH Credit Agreement”). At that time, all outstanding borrowings of $10.0 million under the ESTE Credit Agreement were repaid and $0.5 million of remaining unamortized deferred financing costs were expensed.  
The borrowing base under the EEH Credit Agreement is subject to redetermination on or about NovemberMay 1st and MayNovember 1st of each year. The amounts borrowed under the EEH Credit Agreement bear annual interest rates at either (a) the London Interbank Offered Rate (“LIBOR”) plus 1.75% to 2.75% or (b) the prime lending rate of Bank of Texas plus 0.75% to 1.75%, depending on the amounts borrowed under the EEH Credit Agreement. Principal amounts outstanding under the EEH Credit Agreement are due and payable in full at maturity on May 9, 2022. All of the obligations under the EEH Credit Agreement, and the guarantees of those obligations, are secured by substantially all of EEH’s assets. Additional payments due under the EEH Credit Agreement include paying a commitment fee of 0.375% or 0.50%, depending on borrowing base utilization, per year to the Lenders in respect of the unutilized commitments thereunder, as well as certain other customary fees.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The EEH Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, EEH’s ability to incur additional indebtedness, create liens on assets, make investments, enter into sale and leaseback transactions, pay dividends and make distributions or repurchase its limited liability interests, engage in mergers or consolidations, sell certain assets, sell or discount any notes receivable or accounts receivable and engage in certain transactions with affiliates.
In addition, the EEH Credit Agreement requires EEH to maintain the following financial covenants: a current ratio, as defined by the EEH Credit Agreement, of not less than 1.0 to 1.0 and a leverage ratio of not greater than 4.0 to 1.0. Leverage ratio means the ratio of (i) the aggregate debt of EEH and its consolidated subsidiaries as at the last day of the fiscal quarter (excluding any debt from obligations relating to non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives) to (ii) the product of EBITDAX for such fiscal quarter multiplied by four. The term “EBITDAX” means, for any period, the sum of consolidated net income for such period plus (a) the following expenses or charges to the extent deducted from consolidated net income in such period: (i) interest, (ii) taxes, (iii) depreciation, (iv) depletion, (v) amortization, (vi) non-cash losses under FASB ASC 815 as a result of

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changes in the fair market value of derivatives, (vii) exploration expenses, (viii) impairment expenses, and (ix) non-cash compensation expenses and minus (b) to the extent included in consolidated net income in such period, non-cash gains under FASB ASC 815 as a result of changes in the fair market value of derivatives.
The EEH Credit Agreement contains customary affirmative covenants and defines events of default to include failure to pay principal or interest, breach of covenants, breach of representations and warranties, insolvency, judgment default, and if Frank A. Lodzinski ceases to serve and function as Chief Executive Officer of EEH and the majority of the Lenders do not approve of Mr. Lodzinski’s successor. Upon the occurrence and continuance of an event of default, the Lenders have the right to accelerate repayment of the loans and exercise their remedies with respect to the collateral. As of September 30, 2018,March 31, 2019, EEH was in compliance with the covenants under the EEH Credit Agreement.       
As of September 30, 2018,March 31, 2019, the Company had a $225.0$275.0 million borrowing base under the EEH Credit Agreement, of which $35.0$120.8 million was outstanding, bearing annual interest of 3.915%4.486%, resulting in an additional $190.0$154.2 million of borrowing base availability under the EEH Credit Agreement. At December 31, 2017,2018, there were $25.0$78.8 million of borrowings outstanding under the EEH Credit Agreement. On May 1, 2019, the borrowing base under the EEH Credit Agreement was increased from $275.0 million to $325.0 million.
For the ninethree months ended September 30, 2018,March 31, 2019, the Company had borrowings of $70.3$85.2 million and $60.3$43.2 million in repayments of borrowings.
For the three and nine months ended September 30, 2018,March 31, 2019, interest on borrowings averaged 3.94% and 3.91%4.64% per annum, respectively, which excluded commitment fees of $0.1$0.2 million and $0.6 million, respectively, and amortization of deferred financing costs of $0.1 million and $0.2 million, respectively.million. For the three and nine months ended September 30, 2017,March 31, 2018, interest on borrowings averaged 4.21% and 4.01%3.62% per annum, respectively, which excluded commitment fees of $0.1 million and $0.2 million respectively, and amortization of deferred financing costs of $0.1 million and $0.2 million, respectively.million.  
No costs associated with the EEH Credit Agreement were capitalized during the three months ended March 31, 2019. The Company capitalized $0.1 million and $0.3$0.003 million of costs associated with the EEH Credit Agreement for the three and nine months ended September 30, 2018, respectively. The Company capitalized $0.1 million and $1.2 million of costs associated with the ESTE Credit Agreement for the three and nine months ended September 30, 2017, respectively.March 31, 2018. These capitalized costs are included in Other noncurrent assets in the Condensed Consolidated Balance Sheets. The Company’s policy is to capitalize the financing costs associated with its debt and amortize those costs on a straight-line basis over the term of the associated debt.  
Note 11.10. Asset Retirement Obligations
The Company has asset retirement obligations associated with the future plugging and abandonment of oil and gas properties and related facilities. Revisions to the liability typically occur due to changes in the estimated abandonment costs, well economic lives, and the discount rate.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following table summarizes the Company’s asset retirement obligation transactions recorded during the ninethree months ended September 30,March 31, (in thousands)
 2018 2017 2019 2018
Beginning asset retirement obligations $2,354
 $6,013
 $2,229
 $2,354
Liabilities incurred 63
 64
 21
 1
Liabilities settled (79) 
 (62) (52)
Acquisitions 
 359
Accretion expense 128
 378
 54
 41
Divestitures (649) (3,629) 
 (385)
Revision of estimates (182) 19
 
 (182)
Ending asset retirement obligations $1,635
 $3,204
 $2,242
 $1,777
    
 
Note 12.11. Related Party Transactions
 FASB ASC Topic 850, Related Party Disclosures, requires that information about transactions with related parties that would make a difference in decision making shall be disclosed so that users of the financial statements can evaluate their significance.
 Flatonia Energy, LLC (“Flatonia”), which owns approximately 10.3% of the outstanding Class A Common Stock and approximately 4.6% of ourthe combined voting power of the Company's outstanding Class A Common Stock and Class B Common Stock combined together as a single class as of September 30, 2018,March 31, 2019, is a party to a joint operating agreement (the “Operating Agreement”) with the Company. The Operating Agreement covers certain jointly

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

owned oil and natural gas properties located in the Eagle Ford Trend in Texas. In connection with the Operating Agreement, the Company made payments to Flatonia of $0.0$4.3 million and $12.4received payments from Flatonia $1.3 million for the three months ended March 31, 2019. For the three months ended March 31, 2018, the Company made payments to Flatonia of $6.2 million and received payments from Flatonia of $0.7 million and $4.8 million for the three and nine months ended September 30, 2018, respectively. For the three and nine months ended September 30, 2017, the Company made payments to Flatonia of $6.4 million and $20.8 million and received payments from Flatonia of $0.8 million and $3.2 million, respectively.$2.1 million. At September 30, 2018March 31, 2019 and December 31, 2017,2018, amounts receivable from Flatonia in connection with the Operating Agreement were $1.0 million and $0.8 million, and $1.3 million, respectively. There were no payablesPayables related to revenues outstanding and due to Flatonia as of September 30, 2018 orMarch 31, 2019 and December 31, 2017.2018 were $1.3 million and $1.6 million, respectively.  
OurEarthstone's majority shareholder consists of various investment funds managed by a venture capital firm who may manage other investments in entities with which we interactthe Company interacts in the normal course of business.
Note 13.12. Commitments and Contingencies  
Legal
From time to time, the Company and its subsidiaries may be involved in various legal proceedings and claims in the ordinary course of business.
Olenik v. Lodzinksi et al.::On June 2, 2017, Nicholas Olenik filed a purported shareholder class and derivative action in the Delaware Court of Chancery against Earthstone’s Chief Executive Officer, along with other members of the Board, EnCap Investments L.P. ("EnCap"), Bold, Bold Energy Holdings, LLC ("Bold Holdings") and OVR. The complaint alleges that Earthstone’s directors breached their fiduciary duties in connection with the contribution dated as of November 7, 2016 and as amended on March 21, 2017 (the "Bold Contribution Agreement"), by and among Earthstone, EEH, Lynden US, Lynden USA Operating, LLC, Bold Contribution Agreement.Holdings and Bold. The Plaintiff asserts that the directors negotiated the Bold Transaction to benefit EnCap and its affiliates, failed to obtain adequate consideration for the Earthstone shareholders who were not affiliated with EnCap or Earthstone management, did not follow an adequate process in negotiating and approving the Bold Transaction and made materially misleading or incomplete proxy disclosures in connection with the Bold Transaction. The suit seeks unspecified damages and purports to assert claims derivatively on behalf of Earthstone and as a class action on behalf of all persons who held Common Stock up to March 13, 2017, excluding defendants and their affiliates. On July 20, 2018, the Delaware Court of Chancery granted the defendants' motion to dismiss and entered an order dismissing the action in its entirety with prejudice. The Plaintiff filed an appeal with the Delaware Supreme Court. On February 6, 2019, the Delaware Supreme Court heard oral arguments from the Plaintiff and Defendants' counsel. On April 5, 2019, the Delaware Supreme Court affirmed the Delaware Court of Chancery’s dismissal of the proxy disclosure claims but reversed the Delaware Court of Chancery’s dismissal of the other claims, holding that the allegations with respect to those claims were sufficient for pleading purposes. Earthstone and each of the other defendants believe the claims are entirely without merit and they intend to mount a vigorous defense. The ultimate outcome of this suit is uncertain,

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and while Earthstone is confident in its position, any potential monetary recovery or loss to Earthstone cannot be estimated at this time.
On August 18, 2017, litigation captioned Trinity Royal Partners, LP v. Bold Energy III LLC, et al. was filed with the 142nd Judicial District of the District Court in Midland County, Texas, asserting breach of contract and indemnity claims for alleged damages from loss of property relating to two oil and natural gas wells in which Bold was the operator. Trinity Royalty Partners, LP (“Trinity”) alleges that Bold is required to indemnify Trinity under the terms of an Assignment and a Participation and Joint Development Agreement between Bold and Trinity. Damages are alleged to include costs incurred in attempting to repair and restore an oil and natural gas well and for the loss of future reserves attributable to both wells. On October 23, 2018 Trinity and Bold entered into a Rule 11 Agreement whereby Trinity and Bold agreed in principle to settle the Lawsuit. Based on management’s current estimate, a $4.8 million expense has been recorded to Litigation settlement in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2018.
Environmental and Regulatory
As of September 30, 2018,March 31, 2019, there were no known environmental or other regulatory matters related to the Company’s operations that are reasonably expected to result in a material liability to the Company.
Note 14.13. Income Taxes
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act ("TCJA") that significantly changes the federal income taxation of business entities. The TCJA, among other things, reduces the corporate income tax rate to 21%, partially limits the deductibility of business interest expense and net operating losses, imposes a one-time tax on unrepatriated earnings from certain foreign subsidiaries, taxes offshore earnings at reduced rates regardless of whether they are repatriated and allows the immediate deduction of certain capital expenditures instead of deductions for depreciation expense over time. Consistent with Staff Accounting Bulletin No. 118 issued by the SEC, which provides for a measurement period of one year from the enactment date to finalize the accounting for effects of the TCJA, the Company provisionally recorded income tax expense of $7.8 million related to the TCJA in the fourth quarter of 2017. As of September 30, 2018, the Company has not yet completed its accounting

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for the tax effects of the enactment of the TCJA. The Internal Revenue Service is expected to issue additional guidance clarifying provisions of the TCJA. As additional guidance is issued one or more of the provisional amounts may change.
The Company’s corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns and one Canadian income tax return which include Lynden US, Earthstone, and Lynden Corp. As such, taxable income of Earthstone cannot be offset by tax attributes, including net operating losses, of Lynden US, nor can taxable income of Lynden US be offset by tax attributes of Earthstone. Earthstone and Lynden US record a tax provision, respectively, for their share of the book income or loss of EEH, net of the non-controlling interest. As EEH is treated as a partnership for U.S. Federal income tax purposes, it is not subject to income tax at the federal level and only recognizes the Texas Margin Tax.
During the ninethree months ended September 30, 2018,March 31, 2019, the Company recorded income tax expensebenefit of approximately $0.1$0.5 million which included (1) income tax expensebenefit for Lynden US of $0.3$0.8 million as a result of its share of the distributable income from EEH, offset by a $0.5 million discrete(2) income tax benefit related to refundable AMT tax credits resulting from the TCJA, (2) income tax expense for Earthstone of $1.1$2.9 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation recorded against its deferred tax asset as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.3 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the ninethree months ended September 30, 2018.March 31, 2019.
During the ninethree months ended September 30, 2017,March 31, 2018, the Company (1) recorded an income tax benefitexpense for Lynden US of $2.7$0.2 million as a result of its standalone pre-tax incurred beforeshare of the Bold Transaction anddistributable income from EEH. During the three months ended March 31, 2018, the Company recorded an income tax expense for Earthstone of $0.9 million as a result of its share of the distributable lossincome from EEH, afterwhich was used to reduce the Bold Transaction, (2)valuation recorded a $7.5 million incomeagainst its deferred tax benefit for Earthstoneasset as a discrete item during the current reporting period, which resulted from a change in assessment of thefuture realization of itsthe net deferred tax assets due to the deferred tax liability that was recorded with respect to its investment in EEH as part of the Bold Transaction as an adjustment to Additional paid-in capital in the Condensed Consolidated Statement of Equity and (3) recorded deferred income tax expense of $0.2 million related to the Texas Margin Tax.asset cannot be assured. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the ninethree months ended September 30, 2017.March 31, 2018.
Note 15. Subsequent Events14. Leases
On October 8, 2018, the Company announced the closingOur operating lease activities consist of an acreage tradeleases for office space. Our finance lease activities consist of leases for vehicles. Leases with an undisclosed operator ininitial term of 12 months or less are not recorded on the Midland Basinbalance sheet. Most leases include one or more options to renew, with renewal terms generally ranging from one to three years. The exercise of Texas. Underlease renewal options is at our sole discretion. Certain leases also include options to purchase the termsleased property. The depreciable life of assets and leasehold improvements is limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain of exercise. None of our lease agreements include variable lease payments. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. See discussion of the acreage trade, the Company acquired 3,899 net operated acres January 1, 2019 implementation impact at Note 1. Basis of Presentation and Summary of Significant Accounting Policies.
Supplemental balance sheet information as of March 31, 2019 for our leases is as follows (in Reagan County with virtually a 100% working interest, in exchange for 1,222 net non-operated acres in Glasscock County with an average working interest of 39% and $27.8 million in cash, plus customary closing adjustments.
On October 17, 2018, Earthstone, EEH and Sabalo Holdings, LLC (“Sabalo Holdings”) entered into an agreement (the “Sabalo Contribution Agreement”) which provides for the contribution by Sabalo Holdings of all its interests in Sabalo Energy, LLC (“Sabalo Energy”) and Sabalo Energy, Inc. to EEH. Also, on October 17, 2018, Sabalo Energy entered into a letter agreement (the “Shad Letter Agreement”) to acquire certain wellbore interests and related equipment held by Shad Permian, LLC (“Shad”) that are part of a joint venture between Sabalo Energy and Shad involving certain acreage covered by the Sabalo Contribution Agreement. Under those agreements, EEH expects to acquire (the “Acquisition”) an aggregate of approximately 20,800 net acres located in the Midland Basin of Texas with approximately 488 gross operated and 349 gross non-operated horizontal drilling locations with approximately 125 gross (67.4 net) existing vertical and horizontal wells on the acreage (and associated equipment and gathering infrastructure) for an aggregate purchase price of approximately $950 million, subject to certain purchase price and post-closing adjustments as set forth in the Sabalo Contribution Agreement and the Shad Letter Agreement.
The aggregate purchase price of approximately $950 million for the Acquisition will include: (i) approximately $650 million in cash, which the Company intends to partially fund from (a) the net proceeds from the sale of Preferred Stock (as described below); (b) an unsecured bridge loan and/or an unsecured note offering (as described below); and (c) borrowings under an amended and restated five-year senior secured reserve-based revolving credit facility at EEH (the “New Credit Facility”); and (ii) approximately $300 million in equity comprised of the issuance of 32,315,695 EEH Units and 32,315,695 shares of Class B Common Stock. Upon the terms and conditions in the Sabalo Contribution Agreement, concurrently with closing of the Acquisition, EEH will amend its limited liability company agreement to admit Sabalo Holdings as a member. Each EEH Unit, together with a corresponding share of Class B Common Stock will be exchangeable, at the option of the holder any time after the closing of the Acquisition, for one share of Class A Common Stock.
On October 17, 2018, Earthstone and EIG ESTE Equity Aggregator, L.P. (“EIG”) entered into a Securities Purchase Agreement (the “Purchase Agreement”) relating to the sale by Earthstone and the purchase by EIG of $225 million of the Series A Redeemable Convertible Preferred Stock, $0.001 par value per share of Earthstone (the “Preferred Stock”), to be authorized by Earthstone, and up to $30 million of Class A Common Stock. The closing of the Purchase Agreement is expected to occur simultaneously with the closing of the Sabalo Contribution Agreement.thousands):

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On October 17, 2018, EEH entered into
Leases Classification  
Assets    
Noncurrent:    
Operating Operating lease right-of-use assets $1,049
Finance Office and other equipment, net of accumulated depreciation and amortization 752
Total lease assets   $1,801
     
Liabilities    
Current:    
Operating Operating lease liabilities $658
Finance Finance lease liabilities 354
Noncurrent:    
Operating Operating lease liabilities 442
Finance Finance lease liabilities 193
Total lease liabilities   $1,647
     
*The difference between assets and liabilities includes a commitment letter (the “Commitment Letter”) with Wells Fargo Bank, National Association (“Wells Fargo Bank”), Royal Bank$0.1 million adjustment to NCI and a $0.07 million adjustment to accumulated deficit, both at the beginning of Canada (“Royal Bank”), SunTrust Bank (“SunTrust”), BOKF, NA (“BOKF”) and PNC Bank National Association (“PNC Bank”) (collectively, the “Banks”) pursuant to which the Banks committed on a several, not joint, basis to provide, subject to customary closing conditions, New Credit Facility to the Company with a minimum initial borrowing base of $475 million. Borrowings under the facility may be used to payperiod as part of the cash portionASC 842 implementation adjustment.
Our operating lease expense for the three months ended March 31, 2019 was $0.2 million and is included in General and administrative expense in our Condensed Consolidated Statements of Operations. Our finance lease expense for the purchase price under the Sabalo Contribution Agreement, to refinance certain existing indebtednessthree months ended March 31, 2019 was $0.1 million and is included in depreciation, depletion and amortization expense and interest expense, net in our Condensed Consolidated Statements of the CompanyOperations. Additionally, we capitalized as part of oil and its subsidiaries and to pay fees and expenses in connection with the foregoing.
Further, Wells Fargo Bank, Royal Bank, SunTrust and Jefferies Finance LLC, severally and not jointly, committed to provide the Company with a senior unsecured term loan bridge facility (“Bridge Facility”) of up to $500 million. The Bridge Facility will mature on the date that is twelve months after the closing date of the Sabalo Contribution Agreement and, if not repaid in full on such date and subject to the satisfaction of conditions set forth in the Commitment Letter, will automatically be converted into an extended term loan facility that will mature on the eighth anniversary of the closing date of the Sabalo Contribution Agreement. The Bridge Facility may be used to close the Sabalo Contribution Agreement if a contemplated private sale of approximately $500gas properties $2.1 million of senior unsecured notes has not been completed at that time. Proceeds fromshort-term lease costs related to drilling rig contracts. All of our drilling rig contracts have enforceable terms of less than one year.
Minimum contractual obligations for our leases (undiscounted) as of March 31, 2019 are as follows (in thousands):
  Operating Finance
2019 (excluding three months ended March 31, 2019 $619
 $295
2020 206
 219
2021 215
 65
2022 110
 
2023 
 
Thereafter 
 
Total lease payments $1,150
 $579
Less imputed interest (50) (32)
Total lease liability $1,100
 $547
     
Cash paid for our operating and finance leases were $0.2 million and $0.1 million, respectively, for the sale of such unsecured notes are expected to repay any amounts drawn down under the Bridge Facility.
On November 2, 2018, the Company received commitments from a syndicate of banks, including the Banks,three months ended March 31, 2019. Right-of-use assets obtained in exchange for an increased minimum initial borrowing base of $550lease obligations for our operating leases were $0.6 million for the New Credit Facility.three months ended March 31, 2019. The amount related to our finance leases was not material to our consolidated financial statements.
On November 6, 2018, lenders underAs of March 31, 2019, the EEH Credit Agreement increasedweighted average remaining lease terms of our operating and finance leases were 1.9 years and 1.8 years, respectively. The weighted average discount rates used to determine the lease liabilities as of March 31, 2019 for our operating and finance leases were 4.35% and 6.57%, respectively. The discount rate used for operating leases is based on the Company's incremental borrowing base from $225 million to $275 million.rate. The discount rate used for finance leases is based on the rates implicit in the leases.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Statement Regarding Forward-Looking Information

This discussion and other items in this Quarterly Report on Form 10-Q contain forward-looking statements and information that are based on management’s beliefs, as well as assumptions made by, and information currently available to, management. When used in this document, the words “believe,” “anticipate,” “estimate,” “expect,” “intend,” “may,” “will,” “project,” “forecast,” “plan,” and similar expressions are intended to identify forward-looking statements. Although management believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to have been correct. These statements are subject to numerous risks, uncertainties and assumptions. Certain of these risks are summarized in this report and under “Item 1A. Risk Factors” in our 20172018 Annual Report on Form 10-K that was filed with the Securities and Exchange Commission (“SEC”), which you should read carefully in connection with our forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated. We undertake no obligation to release publicly any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
You should read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in conjunction with the corresponding sections and our audited consolidated financial statements for the year ended December 31, 2017,2018, which are included in our 20172018 Annual Report on Form 10-K.
Overview
Earthstone Energy, Inc., a Delaware corporation ("Earthstone" and together with itsour consolidated subsidiaries, the "Company," "our," "we," "us," or similar terms), is a growth-oriented independent oil and gas company engaged in the acquisition and development of oil and gas reserves through activities that include the acquisition, drilling and development of undeveloped leases, asset and corporate acquisitions and mergers. Our operations are all in the upstream segment of the oil and natural gas industry and all our properties are onshore in the United States. At present, our primary assets are located in the Midland Basin of west Texas and the Eagle Ford Trend of south Texas.
Since the closing of the Bold Transaction in May 2017 (described below), ourOur primary focus has been primarilyis concentrated in the Midland Basin of west Texas where our acreage has multiple stacked pay intervals in the Wolfcamp and, to a lesser extent, the Spraberry formations. We believe the Midland Basin area is characterized by high oil and liquids-rich natural gas content, multiple vertical and horizontal target horizons and high drilling success rates.
Earthstone is the sole managing member of Earthstone Energy Holdings, LLC, a Delaware limited liability company (together with its wholly-owned consolidated subsidiaries, “EEH”), with a controlling interest in EEH. Earthstone, together with its wholly-owned subsidiary, Lynden Energy Corp., a corporation organized under the laws of British Columbia (“Lynden Corp”), and Lynden Corp’s wholly-owned consolidated subsidiary, Lynden USA Inc., a Utah corporation (“Lynden US”) and also a member of EEH,

consolidates the financial results of EEH and records a noncontrolling interest in the Condensed Consolidated Financial Statements representing the economic interests of EEH's members other than Earthstone and Lynden US.
Sabalo Contribution Agreement
On October 17, 2018, Earthstone and EEH entered into a contribution agreement (the “Agreement”) with Sabalo Holdings, LLC (“Sabalo Holdings”), whereby EEH will acquire all of Sabalo Holdings’ interests in Sabalo Energy, LLC (“Sabalo”) and Sabalo Energy, Inc., whose assets include both producing and non-producing oil and gas assets in the Midland Basin. In addition, on October 17, 2018, Sabalo entered into an agreement to acquire certain wellbore interests held by Shad Permian, LLC (“Shad”), which were part of a drilling joint venture between Sabalo and Shad. As a result of these agreements, Earthstone expects to acquire approximately 20,800 net acres located in the Midland Basin and an estimated 488 gross operated and 349 gross non-operated horizontal drilling locations with approximately 125 gross (67.4 net) existing vertical and horizontal wells on the acreage (and associated equipment and gathering infrastructure) for an aggregate purchase price of approximately $950 million (the “Sabalo Acquisition”) which consists of $650 million in cash and $300 million in stock at approximately $9.28 per share comprised of 32,315,695 shares of Class B common stock, $0.001 par value per share of Earthstone (“Class B Common Stock”), and a corresponding number of membership units of EEH (“EEH Units”). We intend to fund the cash portion of the purchase price from the net proceeds of the Preferred Stock Financing (discussed below), the Notes Offering (discussed below), the Bridge Facility (discussed below) and the New Revolving Credit Facility (discussed below). The purchase price is subject to certain customary adjustments, including an increase in the purchase price of approximately $26 million to account for approximately 1,330 acres acquired after the effective date of the Agreement (and included in the net acres mentioned herein). All purchase price adjustments will be paid in cash. Sabalo’s and Shad’s combined average estimated production for the month of September 2018 was approximately 11,200 Boe/d with approximately 83% being oil. Sabalo is a privately-held oil and gas company based in Corpus Christi, Texas and is a portfolio company of EnCap Investments L.P. (“EnCap”).
The Sabalo Acquisition represents a large, contiguous acreage position comprised of approximately 20,800 net acres in the core of the Midland Basin, largely in Howard County, Texas, 86% held-by-production, with an average working interest of 90% in the operated units.
The Sabalo Acquisition is expected to close in late 2018 or in the first quarter of 2019, subject to the satisfaction of customary closing conditions, including the approval of Earthstone’s stockholders.
Preferred Stock Financing
On October 17, 2018, Earthstone entered into a securities purchase agreement (the “Securities Purchase Agreement”) with an affiliate of EIG Global Energy Partners (“EIG”) relating to the sale by Earthstone and the purchase by EIG of $225 million of Series A Redeemable Convertible Preferred Stock, $0.001 par value per share of Earthstone (the “Series A Preferred Stock”), and up to $30 million of Class A common stock, $0.001 par value per share of Earthstone (“Class A Common Stock”), (collectively, the “Preferred Stock Financing”). The closing of the Securities Purchase Agreement is anticipated to occur simultaneously with the closing of the Agreement. We intend to use the net proceeds of the Preferred Stock Financing to fund a portion of the cash component of the purchase price of the Agreement.
Financing Commitment Letter
In connection with the Sabalo Acquisition, EEH entered into a commitment letter dated October 17, 2018 (as amended, supplemented or otherwise modified, the “Commitment Letter”) with Wells Fargo Bank, National Association (“Wells Fargo Bank”), Wells Fargo Securities, LLC (“Wells Fargo Securities”), Royal Bank of Canada (“Royal Bank”), RBC Capital Markets (the capital markets businesses of Royal Bank and its affiliates) (“RBCCM”), SunTrust Bank (“SunTrust”), SunTrust Robinson Humphrey, Inc. (“STRH”), BOKF, NA dba Bank of Texas (“BOKF”), PNC Bank, National Association (“PNC Bank”), Jefferies Finance LLC (acting directly or through such of its affiliates or branches as it deems appropriate, “Jefferies”, and together with Wells Fargo Bank, Wells Fargo Securities, Royal Bank, SunTrust, STRH, BOKF, and PNC Bank, collectively, the “Commitment Parties”), pursuant to which (a) Wells Fargo Bank, Royal Bank, SunTrust and Jefferies committed to provide a senior unsecured term loan bridge facility (the “Bridge Facility”) in an aggregate amount of up to $500 million (which will be reduced by the aggregate gross proceeds from the proposed Notes Offering, if any) and (b) Wells Fargo Bank, Royal Bank, SunTrust, BOKF and PNC Bank committed to make available to EEH a five-year senior secured reserve-based revolving credit facility (the “New Revolving Credit Facility”) with a minimum initial borrowing base of $475 million (subject to the closing date borrowing base adjustment as set forth in the Commitment Letter). The Bridge Facility will mature on the date that is twelve months after the closing date of the Agreement and, if not repaid in full on or prior to such date and subject to the satisfaction of conditions set forth in the Commitment Letter, will automatically be converted into an extended term loan facility that will mature on the eighth anniversary of the closing of the Agreement.

Subsequent to entering into the Commitment Letter, the Company received commitments from a syndicate of banks, including the Banks, for an increased minimum initial borrowing base of $550 million for the New Credit Facility.
Senior Notes Offering
EEH anticipates commencing a private placement of senior unsecured notes (the “Notes Offering”) prior to the closing of the Agreement in an aggregate principal amount of approximately $500 million (the “Senior Notes”). The Senior Notes would be offered in the Notes Offering by means of a separate offering memorandum. We cannot assure you that the Notes Offering will be completed or, if completed, on what terms it will be completed. The closing of the Notes Offering is anticipated to be contingent upon the closing of the Agreement. The closing of the Agreement is not conditioned upon the closing of the Notes Offering. Upon successful consummation of the Notes Offering, the Bridge Facility commitments will be reduced, on a dollar-for-dollar basis, by the aggregate principal amount of the Senior Notes.
Midland Basin Acreage Trade
On October 8, 2018, we announced the closing of an acreage trade with an operator in the Midland Basin of Texas. Under the terms of the acreage trade, we acquired 3,899 net operated acres in Reagan County with virtually a 100% working interest, in exchange for 1,222 net non-operated acres in Glasscock County with an average working interest of 39% and $27.8 million in cash, plus customary closing adjustments. The effective date of the transaction was September 1, 2018.
Along with the net increase of 2,677 acres, the trade also results in a net production increase of approximately 350 Boe/d. The producing wells acquired in this trade are connected into a third-party crude oil pipeline gathering system, which will assure flow capacity for this oil as well as any future volumes from producing wells on this acreage. In addition, in the near term we expect to finalize and close the acquisition of a mineral lease which will add approximately 760 net acres. With these acreage acquisitions, our total net acreage in the Midland Basin will increase to approximately 30,000 acres, of which approximately 23,300 acres are operated by us.
Bold Transaction
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 owns significant developed and undeveloped oil and natural gas properties in the Midland Basin of west 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 and 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 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.
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.
On May 9, 2017, in connection with the closing of the Bold Contribution Agreement, Earthstone, 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 Contribution Agreement as long as the Voting Agreement is in effect.
Immediately following the closing of the Bold Contribution Agreement, the Board was increased to nine members from eight members, four of which are designated by EnCap, three of which are independent, and two of which are members of management, including Earthstone’s Chief Executive Officer. At any time during the effectiveness of the Voting Agreement during which EnCap’s collective ownership of Earthstone exceeds 50% of the total issued and outstanding voting stock, EnCap may remove and replace one director that was not originally designated by EnCap, and his or her successors. Any such removal and replacement will be conducted in accordance with the provisions of Earthstone’s certificate of incorporation and bylaws then in effect. The Voting Agreement terminates on the earlier of (i) the fifth anniversary of the closing date of the Bold Contribution Agreement and (ii) the date upon which EnCap, Oak Valley, and Bold Holdings collectively own, of record and beneficially, less than 20% of Earthstone’s outstanding voting stock.
On May 9, 2017, the closing sale price of the Class A Common Stock was $13.58 per share. On May 10, 2017, the Class A Common Stock was uplisted from the NYSE American, LLC (formerly the NYSE MKT) (the “NYSE American”) to the New York Stock Exchange (the “NYSE”) where it is listed under the symbol “ESTE.”
Management’s Plans
Our plans for the remainder of 2018 include a continued focus on the Midland Basin through the development of our properties and by further expansion of our acreage footprint as an operator. Our development program for 20182019 presently includes drilling approximately 1516 operated wells and completing 13 of these operated wells. In addition, we have assumed participating in drilling 20 wells and completing 19 wells where we have a non-operated working interest. At our Eagle Ford Trend properties, our development program includes drilling approximately seven operated wells and completing seven wells. In order to achieve these plans, we have an approved annual budget of $190.0 million. Commodity prices continue to be volatile and we intend to be vigilant to adjust our business plans accordingly.
In addition to our capital development program for 2019, our plans also include an acreage expansion program that includes looking for opportunities where we can trade acreage with other operators or bolt on acreage through acquisitions. Our intent is to increase our overall operated locations and allow us to develop our acreage with long horizontal laterals (7,500 to 10,000+12,000+ foot lateral lengths). We will also remain active in seeking M&A transactions in this highlyhigh economic return geographic area. At our Eagle Ford Trend properties, our development program includes drilling approximately 10 operated wells. In order to achieve these plans, we have an approved annual budget of $170.0 million of which we plan to spend approximately $140.0 million during 2018. Commodity prices continue to be volatile and we intend to be vigilant to adjust our business plans accordingly.
Areas of Operation
Our primary focus is concentrated in the Midland Basin of west Texas, a high oil and liquids rich resource which provides us with multiple horizontal targets with proven production results, long-lived reserves and historically high drilling success rates.
Midland Basin
Although
We completed six wells (three operated and three non-operated) and spud an additional 12 wells (three operated and nine non-operated) during the first quarter of 2019. We currently expect to complete approximately 10 operated wells over the latter half of 2019. We intend to continue to initiate completion activities when we accumulate an adequate take-away capacity existedinventory of wells for efficient operations.

Commencing in the Midland Basin in the third quarter, we experienced increasing negative oil price differentials, which we believe are related toearly 2018, market concerns about future take-away capacity.capacity adversely affected oil and gas price differentials in the Midland Basin. Since then, the market concerns have been abated as additional oil pipelines have been added to the take-away infrastructure in the area. Consequently, we have experienced significant improvement in these negative oil price differentials. Natural gas price differentials continue to grow as future take-away capacity in the area is being challenged. However, there are some additional gas pipelines expected to come on line on or about the fourth quarter of 2019. While we believe the economic returns from our operations are very attractive at current price levels and our wells are meeting or exceeding our type curves, our cashflows are being impacted by these negative differentials, which averaged $12.66/Bbl and $5.81/Bbl for the three and nine months ended September 30, 2018, respectively (excluding the impact of derivatives). Increasing and sustained negative oil and gas price differentials will adversely affect our future cash flows and could cause us to reduce the pace of development of our properties.
We completed 22 wells (14 operated and eight non-operated) and spud an additional 10 wells (five operated and five non-operated) in 2018 through the third quarter. We currently expect to complete approximately six operated wells during the fourth quarter of 2018. We intend to continue to initiate completion activities when we accumulate an adequate inventory of wells for efficient operations.
Eagle Ford Trend
In our operated leasehold acreage located in the Eagle Ford Trend, we completed 11 operated wells throughhave commenced drilling operations and expect to complete the third quarterseven well program by the end of 2018.2019.

Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to use our judgment to make estimates and assumptions that affect certain amounts reported in our financial statements. As additional information becomes available, these estimates and assumptions are subject to change and thus impact amounts reported in the future. Critical accounting policies are those accounting policies that involve judgment and uncertainties affecting the application of those policies and the likelihood that materially different amounts would be reported under different conditions or using differing assumptions. We periodically update our estimates used in the preparation of the financial statements based on our latest assessment of the current and projected business and general economic environment. There have been no significant changes to our critical accounting policies during the ninethree months ended September 30, 2018.March 31, 2019.

Results of Operations
Three Months Ended September 30, 2018,March 31, 2019, compared to the Three Months Ended September 30, 2017March 31, 2018
 Three Months Ended September 30,   Three Months Ended March 31,  
 2018 2017 Change 2019 2018 Change
Sales volumes:            
Oil (MBbl) 645
 563
 15 % 678
 546
 24 %
Natural gas (MMcf) 947
 967
 (2)% 827
 1,044
 (21)%
Natural gas liquids (MBbl) 188
 166
 13 % 193
 150
 29 %
Barrels of oil equivalent (MBOE) 991
 890
 11 % 1,009
 870
 16 %
Average Daily Production (Boepd) 11,209
 9,664
 16 %
            
Average prices realized: (1)
      
Average prices:      
Oil (per Bbl) $60.12
 $45.73
 31 % $52.30
 $63.07
 (17)%
Natural gas (per Mcf) $1.89
 $2.60
 (27)% $1.32
 $2.57
 (49)%
Natural gas liquids (per Bbl) $29.31
 $18.29
 60 % $21.66
 $25.30
 (14)%
      
Average prices adjusted for realized derivatives settlements:      
Oil ($/Bbl)(1)
 $59.81
 $55.11
 9 %
Gas ($/Mcf)(1)
 $1.66
 $2.63
 (37)%
NGL ($/Bbl) $21.66
 $25.30
 (14)%
            
(In thousands)            
Oil revenues $38,791
 $25,733
 51 % $35,447
 $34,417
 3 %
Natural gas revenues $1,790
 $2,513
 (29)% $1,094
 $2,684
 (59)%
Natural gas liquids revenues $5,495
 $3,036
 81 % $4,187
 $3,794
 10 %
            
Lease operating expense $4,843
 $5,407
 (10)% $6,667
 $4,657
 43 %
Severance taxes $2,254
 $1,588
 42 % $1,988
 $2,037
 (2)%
Impairment expense $833
 $92
 NM
Depreciation, depletion and amortization $12,842
 $10,330
 24 % $14,005
 $9,708
 44 %
            
General and administrative expense (excluding stock-based compensation)
 $3,422
 $5,608
 (39)% $5,058
 $4,639
 9 %
Stock-based compensation $1,522
 $1,687
 (10)% $2,212
 $1,940
 14 %
General and administrative expense $4,944
 $7,295
 (32)% $7,270
 $6,579
 11 %
            
Transaction costs $892
 $109
 NM
Gain on sale of oil and gas properties $4,096
 $2,157
 NM
Interest expense, net $(565) $(903) (37)% $(1,449) $(613) 136 %
(Loss) gain on derivative contracts, net $(17,481) $(3,663) NM
Litigation settlement $(4,775) $
 NM
Income tax (expense) benefit $(172) $94
 NM
      
Unrealized loss on derivative contracts $(53,256) $(1,000) NM
Realized gain (loss) on derivative contracts $5,362
 $(4,275) NM
Loss on derivative contracts, net $(47,894) $(5,275) NM
      
Income tax benefit (expense) $460
 $(249) NM
(1) Prices presented exclude any effectsIncludes $2.1 million of oil and natural gas derivatives.cash proceeds related to hedges unwound during the first quarter of 2019.
NM – Not Meaningful

Oil revenues
For the three months ended September 30, 2018,March 31, 2019, oil revenues increased by $13.1$1.0 million or 51%3% relative to the comparable period in 2017.2018. Of the increase, $8.1$6.9 million was attributable to an increase in volume, partially offset by $5.9 million attributable to a decrease in our realized price and $5.0 million was attributable to increased volume.price. Our average realized price per Bbl increaseddecreased from $45.73$63.07 for the three months ended September 30, 2017March 31, 2018 to $60.12$52.30 or 31%17% for the three months ended September 30, 2018.March 31, 2019. We had a net increase in the volume of oil sold of 82132 MBbls or 15%24%, primarily due to increased production at our Midland Basin properties resulting from ournew wells brought online in late 2018, drilling and development program, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarterslatter half of 2017.2018.
Natural gas revenues
For the three months ended September 30, 2018,March 31, 2019, natural gas revenues decreased by $0.7$1.6 million or 29%59% relative to the comparable period in 2017, primarily due to a decrease in our realized price. Our average realized price per Mcf decreased from $2.60 for the three months ended September 30, 2017 to $1.89 or 27% for the three months ended September 30, 2018. The total volume of natural gas produced and sold decreased 20 MMcf or 2% primarily due to the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017, partially offset by increased production at our Midland Basin properties.
Natural gas liquids revenues
For the three months ended September 30, 2018, natural gas liquids revenues increased by $2.5 million or 81% relative to the comparable period in 2017. Of the increase, $1.8 million was attributable to an increase in our realized price and $0.6 million was attributable to increased volume. The volume of natural gas liquids produced and sold increased by 22 MBbls or 13%, primarily due to increased production at our Midland Basin properties, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017.
Lease operating expense (“LOE”)
LOE decreased by $0.6 million or 10% for the three months ended September 30, 2018 relative to the comparable period in 2017. Although sales volumes increased 11% over the prior year period, the relative increase in LOE was offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017.
Severance taxes
Severance taxes for the three months ended September 30, 2018 increased by $0.7 million or 42% relative to the comparable period in 2017, primarily due to the increased prices of oil and natural gas liquids, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017. However, as a percentage of revenues from oil, natural gas, and natural gas liquids, severance taxes remained relatively flat when compared to the prior year period.
Impairment expense
As a result of certain acreage expirations related to our Eagle Ford Trend properties, we recorded non-cash asset impairments of $0.8 million and $0.1 million for the three months ended September 30, 2018 and 2017, respectively. See Note 3. Fair Value Measurements in the Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of how impairments are measured.
Depreciation, depletion and amortization (“DD&A”)
DD&A increased for the three months ended September 30, 2018 by $2.5 million, or 24% relative to the comparable period in 2017, due to increased production volumes, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017.
General and administrative expense (“G&A”)
G&A consisted primarily of employee remuneration, as well as legal and other professional fees. Prior year period amounts were
$2.4 million higher than the three months ended September 30, 2018 primarily due to (1) the prior year period retention of certain employees of Bold, (2) the prior year period payment and accrual of severance to certain Bold and Denver office employees, and (3) the prior year period legal expenses resulting from the shareholder class and derivative action described in Note 13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements.

Transaction costs
For the three months ended September 30, 2018, transactions costs consisted of the $0.9 million non-capitalizable portion of legal and consulting fees associated with the Agreement which was executed on October 17, 2018. During the three months ended September 30, 2017, we recorded charges totaling $0.1 million for transaction costs associated with the Bold Transaction and non-core oil and gas property divestitures. See Note 2. Acquisitions and Divestitures in the Notes to Unaudited Condensed Consolidated Financial Statements.
Gain on sale of oil and gas properties
During the three months ended September 30, 2018, we sold the non-operated portion of our Eagle Ford Trend properties, recording a gain on the sale of $4.1 million. During the three months ended September 30, 2017, we sold certain non-core oil and gas properties, recording gains totaling $2.2 million. See Note 2. Acquisitions and Divestitures in the Notes to Unaudited Condensed Consolidated Financial Statements.
Interest expense, net
Interest expense decreased from $0.9 million for the three months ended September 30, 2017 to $0.6 million for the three months ended September 30, 2018, primarily due to lower average borrowings outstanding compared to the prior year period. See Note 10. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.
(Loss) gain on derivative contracts, net
For the three months ended September 30, 2018, we recorded a net loss on derivative contracts of $17.5 million, consisting of unrealized mark-to-market losses of $13.1 million and net realized losses on settlements of $4.4 million. For the three months ended September 30, 2017, we recorded a net loss on derivative contracts of $3.7 million, consisting of unrealized mark-to-market losses of $4.2 million, partially offset by net realized gains on settlements of $0.5 million.
Litigation settlement
During the three months ended September 30, 2018, we recorded an expense of $4.8 million related to the expected settlement of certain litigation. See Note 13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements.
Income tax (expense) benefit
During the three months ended September 30, 2018, we recorded income tax expense of approximately $0.2 million which included (1) income tax expense for Lynden US of $0.1 million as a result of its share of the distributable income from EEH, (2) income tax expense for Earthstone of $0.2 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation recorded against its deferred tax asset as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.1 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the three months ended September 30, 2018.
During the three months ended September 30, 2017, we (1) recorded an income tax benefit for Lynden US of $0.2 million as a result of its standalone pre-tax incurred before the Bold Transaction and its share of the distributable loss from EEH after the Bold Transaction and (2) recorded deferred income tax expense of $0.3 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the three months ended September 30, 2017.




Nine Months Ended September 30, 2018, compared to the Nine Months Ended September 30, 2017
  Nine Months Ended September 30,  
  2018 2017 Change
Sales volumes:      
Oil (MBbl) 1,696
 1,300
 30 %
Natural gas (MMcf) 2,883
 2,328
 24 %
Natural gas liquids (MBbl) 489
 350
 40 %
Barrels of oil equivalent (MBOE) 2,665
 2,038
 31 %
       
Average prices realized: (1)
      
Oil (per Bbl) $61.97
 $46.02
 35 %
Natural gas (per Mcf) $2.17
 $2.72
 (20)%
Natural gas liquids (per Bbl) $26.10
 $17.86
 46 %
       
(In thousands)      
Oil revenues $105,111
 $59,815
 76 %
Natural gas revenues $6,257
 $6,338
 (1)%
Natural gas liquids revenues $12,753
 $6,249
 104 %
       
Lease operating expense $14,509
 $14,990
 (3)%
Severance taxes $6,115
 $3,705
 65 %
Impairment expense $833
 $66,740
 NM
Depreciation, depletion and amortization $33,362
 $28,258
 18 %
       
General and administrative expense (excluding stock-based compensation)
 $13,274
 $14,838
 (11)%
Stock-based compensation $5,535
 $4,645
 19 %
General and administrative expense $18,809
 $19,483
 (3)%
       
Transaction costs $892
 $4,676
 NM
Gain on sale of oil and gas properties $4,608
 $3,848
 20 %
Interest expense, net $(1,788) $(1,873) (5)%
Write-off of deferred financing costs $
 $(526) NM
(Loss) gain on derivative contracts, net $(33,606) $4,137
 NM
Litigation settlement $(4,775) $
 NM
Income tax (expense) benefit $(119) $10,046
 NM
(1) Prices presented exclude any effects of oil and natural gas derivatives.
NM – Not Meaningful
Oil revenues
For the nine months ended September 30, 2018, oil revenues increased by $45.3 million or 76% relative to the comparable period in 2017. Of the increase, $20.7 million was attributable to an increase in our realized price and $24.6 million was attributable to increased volume. Our average realized price per Bbl increased from $46.02 for the nine months ended September 30, 2017 to $61.97 or 35% for the nine months ended September 30, 2018. We had a net increase in the volume of oil sold of 396 MBbls or 30%, primarily due to the timing of the Bold Transaction which substantially increased our Midland Basin properties on May 9, 2017, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017.
Natural gas revenues
For the nine months ended September 30, 2018, natural gas revenues decreased by $0.1 million or 1% relative to the comparable period in 2017. Of the decrease, $1.3 million was attributable to a decrease in our realized price partially offset by an increase of $1.2and $0.3 million was attributable to increaseda decrease in volume. Our average realized price per Mcf decreased from $2.72$2.57 for the ninethree months ended

September 30, 2017 March 31, 2018 to $2.17$1.32 or 20%49% for the ninethree months ended September 30, 2018.March 31, 2019. The total volume of natural gas produced and sold increased 555decreased 217 MMcf or 24%21% primarily due to increased production at our Midland Basin properties as well as the impact of the timing of the Bold Transaction, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017.2018 gas well divestitures.
Natural gas liquids revenues
For the ninethree months ended September 30, 2018,March 31, 2019, natural gas liquids revenues increased by $6.5$0.4 million or 104%10% relative to the comparable period in 2017.2018. Of the increase, $2.9 million was attributable to an increase in our realized price and $3.6$0.9 million was attributable to increased volume.volume, partially offset by $0.5 million attributable to a decrease in our realized price. The volume of natural gas liquids produced and sold increased by 13943 MBbls or 40%29%, primarily due to the timing of the Bold Transaction which substantially increased our Midland Basin properties on May 9, 2017,new wells brought online in late 2018, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarterslatter half of 2017.2018.
Lease operating expense (“LOE”)
LOE decreasedincreased by $0.5$2.0 million or 3%43% for the ninethree months ended September 30, 2018March 31, 2019 relative to the comparable period in 2017. Although sales volumes increased 31% over2018. The increase was primarily due to additional producing wells brought online, which drove a 16% increase in production volume; in addition to a $1.0 million increase driven by a greater number of workover projects as compared to the prior year period, the relative increase in LOE was offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017.quarter.
Severance taxes
Severance taxes for the ninethree months ended September 30, 2018 increased by $2.4 million or 65% relativeMarch 31, 2019 remained flat as compared to the comparable period in 2017, primarily due to2018, as the impact of increased volume was offset by the impact of decreased prices of oil and natural gas liquids, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017. However, asliquids. As a percentage of revenues from oil, natural gas, and natural gas liquids, severance taxes remained flat when compared to the prior year period.
Impairment expense
During the nine months ended September 30, 2018, we recorded non-cash asset impairments of $0.8 million to our unproved oil and natural gas properties resulting from certain acreage expirations related to our Eagle Ford Trend properties. During the nine months ended September 30, 2017, we recognized $66.7 million of non-cash asset impairments due to significant forward commodity price declines and the recording of certain acreage expirations. These impairments consisted of $63.0 million to our proved oil and natural gas properties and $3.7 million to our unproved oil and natural gas properties, primarily to our properties located in the Eagle Ford Trend of south Texas. See Note 3. Fair Value Measurements in the Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of how impairments are measured.
Depreciation, depletion and amortization (“DD&A”)
DD&A increased for the ninethree months ended September 30, 2018March 31, 2019 by $5.1$4.3 million, or 18%44% relative to the comparable period in 2017,2018, primarily due to the addition of the assets acquireddevelopment and acquisition activity that resulted in increased costs subject to depletion and an increase in production primarily in the Bold Transaction to the depletable base, as well as increased production volumes, partially offset by the impact of non-core asset divestitures that took place in the third and fourth quarters of 2017.Midland Basin.
General and administrative expense (“G&A”)
G&A consisted primarily of employee remuneration, as well as legal and other professional fees. Prior year period amounts were
$0.7 million higher thanfor the ninethree months ended September 30, 2018 primarily dueMarch 31, 2019 increased by $0.7 million, or 11% relative to (1) the prior yearcomparable period retention of certain employees of Bold, (2) the prior year period payment and accrual of severance to certain Bold and Denver office employees, and (3) the prior year period legal expenses resulting from the shareholder class and derivative action described in Note 13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements.
Transaction costs
For the nine months ended September 30, 2018, transactions costs2018. The total increase consisted of the $0.9$0.4 million non-capitalizable portion of legal and consulting fees associated with the Agreement which was executed on October 17, 2018. During the nine months ended September 30, 2017, we recorded charges totaling $4.7 million for transaction costs associated with the Bold Transaction and non-core oil and gas property divestitures. See Note 2. Acquisitions and Divestitures in the Notes to Unaudited Condensed Consolidated Financial Statements.

Gain on sale of oil and gas properties
During the nine months ended September 30,from increased staffing throughout 2018 and 2017, we sold certain non-core oil and gas properties, recording gains totaling $4.6$0.3 million and $3.8 million, respectively.resulted from non-cash stock-based compensation expense related to restricted stock units awarded to our executive officers on January 28, 2019.
Interest expense, net
Interest expense decreasedincreased from $1.9$0.6 million for the ninethree months ended September 30, 2017March 31, 2018 to $1.8$1.4 million for the ninethree months ended September 30, 2018,March 31, 2019, primarily due to lowerhigher average borrowings outstanding compared to the prior year period. See Note 10.9. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.Statements.
Write-off of deferred financing costs
On May 9, 2017, in connection with the closing of the Bold Transaction, we exited the ESTE Credit Agreement and $0.5 million of remaining unamortized deferred financing costs were written off. See Note 10. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.
Gain (loss)Loss on derivative contracts, net
For the ninethree months ended September 30,March 31, 2019, we recorded a net loss on derivative contracts of $47.9 million, consisting of unrealized mark-to-market losses of $53.3 million, partially offset by net realized gains on settlements of $5.4 million. For the three months

ended March 31, 2018, we recorded a net loss on derivative contracts of $33.6$5.3 million, consisting of unrealized mark-to-market losses of $20.0$1.0 million and net realized losses on settlements of $13.6$4.3 million. For the nine months ended September 30, 2017, we recorded a net gain on derivative contracts of $4.1 million, consisting of unrealized mark-to-market gains of $3.9 million and net realized gains on settlements of $0.2 million.
Litigation settlement
During the nine months ended September 30, 2018, we recorded an expense of $4.8 million related to the expected settlement of certain litigation. See Note 13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements.
Income tax benefit (expense) benefit
During the ninethree months ended September 30, 2018,March 31, 2019, we recorded income tax expensebenefit of approximately $0.1$0.5 million which included (1) income tax expensebenefit for Lynden US of $0.3$0.8 million as a result of its share of the distributable income from EEH, offset by a $0.5 million discrete(2) income tax benefit related to refundable AMT tax credits resulting from the TCJA, (2) income tax expense for Earthstone of $1.1$2.9 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation recorded against its deferred tax asset as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.3 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the ninethree months ended September 30, 2018.March 31, 2019.
During the ninethree months ended September 30, 2017,March 31, 2018, we (1) recorded an income tax benefitexpense for Lynden US of $2.7$0.2 million as a result of its standalone pre-tax incurred beforeshare of the Bold Transaction anddistributable income from EEH. During the three months ended March 31, 2018, we recorded an income tax expense for Earthstone of $0.9 million as a result of its share of the distributable lossincome from EEH, afterwhich was used to reduce the Bold Transaction, (2)valuation recorded a $7.5 million incomeagainst its deferred tax benefit for Earthstoneasset as a discrete item during the current reporting period, which resulted from a change in assessment of thefuture realization of itsthe net deferred tax assets due to the deferred tax liability that was recorded with respect to its investment in EEH as part of the Bold Transaction as an adjustment to Additional paid-in capital in the Condensed Consolidated Statement of Equity and (3) recorded deferred income tax expense of $0.2 million related to the Texas Margin Tax.asset cannot be assured. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the ninethree months ended September 30, 2017.March 31, 2018.
Liquidity and Capital Resources
With the Bold Transaction, we acquiredWe have significant undeveloped acreage and future drilling locations. Drilling horizontal wells, generally consisting of 7,500 to 10,000-foot12,000-foot lateral lengths, in the Midland Basin is capital intensive. At September 30, 2018,March 31, 2019, we had approximately $13$0.4 million in cash and approximately $190$154 million in unused borrowing capacity under the EEH Credit Agreement (discussed below) for a total of $203 million in cash available for operational and capital funding. We currently estimate 20182019 capital expenditures will be approximately $140$190 million, of which $48.5 million has been spent through March 31, 2019. Our 2019 capital program assumes an approximate 15 wella 16-well program running one rig for our operated acreage in the Midland Basin and an approximate 10 wella seven-well program for our operated Eagle Ford acreage as well as some activityestimated expenditures for our non-operated Midland Basin properties and land and infrastructure activities. We likely will continue to outspend our cash flows provided by operating activities over at least the next 12 months from the date of this report based on

current assumptions; however,assumptions. However, we believe we will have sufficient liquidity with cash flows from operations and borrowings under the EEH Credit Agreement for the next 12 months in order to meet our cash requirements. We may consider various financial arrangements or other techniques or transactions, including but not limited to promoted drilling arrangements.
Working Capital,capital, defined herein as Total current assets less Total current liabilities as set forth in our Condensed Consolidated Balance Sheets, was a deficit of $59.6$28.8 million as of September 30, 2018March 31, 2019 compared to a deficit of $21.8$18.3 million as of December 31, 2017. We used $120.1 million to fund our capital program that was facilitated by $96.6 million2018. Our collection of receivables has historically been timely and losses associated with uncollectible receivables have historically not been significant. The increase in the deficit is primarily the result of a net cash provided by our operating activities, net borrowings of $10.0 million under the EEH Credit Agreement and a reductiondecrease in fair value of our cash on handderivative contracts expected to settle over the next 12 months partially offset by $9.5 million. Due to the costs incurred related to our drilling program, we may incur additional working capital deficits in the future.increased receivables and decreased payables. We expect that changes in receivables and payables related to our pace of development, production volumes, changes in our hedging activities, realized commodity prices and differentials to NYMEX prices for our oil and natural gas production will continue to be the largest variables affecting our working capital.
We expect to finance future acquisition and development activities through available working capital,with cash flows from operating activities, borrowings under the EEH Credit Agreement and, various means of corporate and project financing, assuming we can effectively access debt and equity markets. In addition, as indicated above, we may continue to partially finance our drilling activities through the sale of participating rights to financial institutions or industry participants, and we could structure such arrangements on a promoted basis, whereby we may earn working interests in reserves and production greater than our proportionate share of capital costs.
Cash Flows from Operating Activities
Cash flows provided by operating activities for the ninethree months ended September 30, 2018March 31, 2019 were $96.6$7.1 million compared to $24.2$16.8 million for the ninethree months ended September 30, 2017.March 31, 2018. The increasedecrease in operating cash flows from the prior year period was primarily due to increaseduse of cash from changes in payables and receivables related to our operation of our oil prices, as well as increased production resultingand gas properties partially offset by sources of cash from our 2018 drilling and development program.changes in cash settlements of derivative contracts.
Cash Flows from Investing Activities
Cash flows used in investing activities for the ninethree months ended September 30,March 31, 2019 and 2018 and 2017 were $114.4$48.5 million and $80.7$33.2 million, respectively. CashThe increase in cash flows used in investing activities for the nine months ended September 30, 2018 included $120.1 million in capital expenditureswas primarily relateddue to ourincreased drilling program in the Midland Basin and Eagle Ford Trend. Cash flows used in investing activities for the nine months ended September 30, 2017 related primarilycompletion activity as compared to the cash required to complete the Bold Transaction and capital expenditures of $30.0 million.prior year quarter.

Cash Flows from Financing Activities
Cash flows provided by financing activities for the ninethree months ended September 30,March 31, 2019 and 2018 were $8.3$41.5 million which consisted of $10.0and $4.5 million, inrespectively. The increase was primarily due to higher net borrowings under the EEH Credit Agreement $1.4 million related toin the exchange and cancellation of Class A Common Stock and $0.3 million in deferred financing costs. Cash flows provided by financing activities for the nine months ended September 30, 2017current year quarter which were $57.3 million which consisted of $70.0 million in borrowings under the EEH Credit Agreement used to repay all outstanding borrowings under Bold's credit agreement assumed by EEH in the Bold Transaction, offset by $10.0 million in repayments of those borrowings, $1.2 million in repayment of borrowings under an unsecured promissory notefund our drilling and $1.2 million in deferred financing costs.completion activities.
Capital Expenditures
Our 20182019 capital budget assumes a one-rig operated program and non-operated activities as currently proposed by operators, for our operated acreage in the Midland Basin andas well as a 10 wellseven-well program foron our operated Eagle Ford acreage. Our capital expenditures for 20182019 are currently estimated to beat approximately $140.0$190.0 million, of which we have spent $111.8$48.5 million to-date.on a cash basis and incurred $42.7 million on an accrual basis during the first quarter of 2019 (the difference of $5.8 million representing a decrease in accrued but unpaid capital expenditures from December 31, 2018 to March 31, 2019).
Our accrual basis capital expenditures for the three and nine months ended September 30, 2018March 31, 2019 were as follows (in thousands):
 Three Months Ended September 30, 2018 Nine Months Ended September 30, 2018 Three Months Ended March 31, 2019
Drilling and completions $36,989
 $109,958
 $42,474
Leasehold costs 355
 1,850
 196
Total capital expenditures $37,344
 $111,808
 $42,670
  
Credit Agreement
OnIn May, 23, 2018,2017, Earthstone Energy Holdings, LLC (“EEH” or the “Borrower”), a subsidiary of Earthstone, Energy, Inc. (the “Company”), each of Earthstone Operating, LLC, EF Non-Op, LLC, Sabine River Energy, LLC, Earthstone Legacy Properties, LLC, Lynden USA Operating, LLC, Bold Energy III LLC, Bold Operating, LLC, as guarantors (the “Guarantors”), BOKF, NA

dba Bank Of Texas, as Administrative Agent, and the lenders party thereto (the “Lenders”), entered into an amendment (the “Amendment”) to the Credit Agreement dated May 9, 2017, by and among EEH, as Borrower, the Guarantors, BOKF, NA dba Bank Of Texas, as Agent and Lead Arranger, Wells Fargo Bank, National Association, as Syndication Agent, and the Lenders (together with all amendments or other modifications, the “EEH Credit Agreement”lenders party thereto (the “Lenders”). Among other things, the Amendment increased the borrowing base from $185.0 million to $225.0 million, provided for, entered into a 50-basis point decrease in the interest rate on outstanding loans, increased flexibility related to hedging limitations and provided the ability to obtain short-term borrowings via a swingline as a part of the borrowing base.
On May 9, 2017, in connection with the closing of the Bold Transaction, the Company exited its credit agreement dated December 19, 2014, by and among Earthstone, Oak Valley Operating, LLC, EF Non-OP, LLC, Sabine River Energy, LLC, Basic Petroleum Services, Inc., BOKF, NA dba Bank of Texas, and the Lenders party thereto (as amended, modified or restated from time to time, the “ESTE“EEH Credit Agreement”). At that time, all outstanding borrowings of $10.0 million under the ESTE Credit Agreement were repaid and $0.5 million of remaining unamortized deferred financing costs were expensed and included in Write-off of deferred financing costs in the Condensed Consolidated Statements of Operations.  
The borrowing base under the EEH Credit Agreement is subject to redetermination on or about NovemberMay 1st and MayNovember 1st of each year. The amounts borrowed under the EEH Credit Agreement bear annual interest rates at either (a) the London Interbank Offered Rate (“LIBOR”) plus 1.75% to 2.75% or (b) the prime lending rate of Bank of Texas plus 0.75% to 1.75%, depending on the amounts borrowed under the EEH Credit Agreement. Principal amounts outstanding under the EEH Credit Agreement are due and payable in full at maturity on May 9, 2022. All of the obligations under the EEH Credit Agreement, and the guarantees of those obligations, are secured by substantially all of EEH’s assets. Additional payments due under the EEH Credit Agreement include paying a commitment fee of 0.375% or 0.50%, depending on borrowing base utilization, per year to the Lenders in respect of the unutilized commitments thereunder, as well as certain other customary fees.
The EEH Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, EEH’s ability to incur additional indebtedness, create liens on assets, make investments, enter into sale and leaseback transactions, pay dividends and make distributions or repurchase its limited liability interests, engage in mergers or consolidations, sell certain assets, sell or discount any notes receivable or accounts receivable and engage in certain transactions with affiliates.
In addition, the EEH Credit Agreement requires EEH to maintain the following financial covenants: a current ratio, as defined by the EEH Credit Agreement, of not less than 1.0 to 1.0 and a leverage ratio of not greater than 4.0 to 1.0. Leverage ratio means the ratio of (i) the aggregate debt of EEH and its consolidated subsidiaries as at the last day of the fiscal quarter (excluding any debt from obligations relating to non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives) to (ii) the product of EBITDAX for such fiscal quarter multiplied by four. The term “EBITDAX” means, for any period, the sum of consolidated net income for such period plus (a) the following expenses or charges to the extent deducted from consolidated net income in such period: (i) interest, (ii) taxes, (iii) depreciation, (iv) depletion, (v) amortization, (vi) non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives, (vii) exploration expenses, (viii) impairment expenses, and (ix) non-cash compensation expenses and minus (b) to the extent included in consolidated net income in such period, non-cash gains under FASB ASC 815 as a result of changes in the fair market value of derivatives.
The EEH Credit Agreement contains customary affirmative covenants and defines events of default to include failure to pay principal or interest, breach of covenants, breach of representations and warranties, insolvency, judgment default, and if Frank A. Lodzinski ceases to serve and function as Chief Executive Officer of EEH and the majority of the Lenders do not approve of Mr. Lodzinski’s successor. Upon the occurrence and continuance of an event of default, the Lenders have the right to accelerate repayment of the loans and exercise their remedies with respect to the collateral. As of September 30, 2018,March 31, 2019, EEH was in compliance with these covenants under the EEH Credit Agreement.

As of September 30, 2018,March 31, 2019, we had a $225.0$275.0 million borrowing base under the EEH Credit Agreement, of which $35.0$120.8 million was outstanding, bearing annual interest of 3.915%4.486%, resulting in an additional $190.0$154.2 million of borrowing base availability under the EEH Credit Agreement. On November 6, 2018, lendersMay 1, 2019, the borrowing base under the EEH Credit Agreement was increased the borrowing base from $225$275.0 million to $275$325.0 million.
Hedging Activities
AsThe following table sets forth our outstanding derivative contracts at March 31, 2019. When aggregating multiple contracts, the weighted average contract price is disclosed.
Period Commodity 
Volume
(Bbls / MMBtu)
 
Price
($/Bbl / $/MMBtu)
Q2 - Q4 2019 Crude Oil 1,769,100 $65.60
Q1 - Q4 2020 Crude Oil 1,464,000 $65.87
Q2 - Q4 2019 Crude Oil Basis Swap(1) 1,512,500 $(5.29)
Q2 - Q4 2019 Crude Oil (Basis Swap)(2) 275,000 $4.50
Q1 - Q4 2020 Crude Oil Basis Swap(1) 1,464,000 $(2.74)
Q2 - Q4 2019 Natural Gas 2,795,500 $2.86
Q1 - Q4 2020 Natural Gas 2,562,000 $2.85
Q2 - Q4 2019 Natural Gas Basis Swap (3) 2,795,500 $(1.14)
Q1 - Q4 2020 Natural Gas Basis Swap (3) 2,562,000 $(1.07)
(1)The basis differential price is between LLS Argus Crude and the WTI NYMEX.
(2)The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.
(3)The basis differential price is between W. Texas (WAHA) and the Henry Hub NYMEX.

Subsequent to March 31, 2019, we entered into additional hedges consisting of September 30, 2018, we had hedgedCrude Oil Swaps on 366 MBbls at a total of 414 MBbls of remaining 2018 oil production at an average price of $54.05/$59.75/Bbl and 610 MMBtu of remaining 2018 natural gas production at average price of $2.95/MMBbtu. Additionally, we had 243.8 MBbls of WTI Midland Argus Crude Oil Basis Swaps at -$1.90/Bbl and 92 MBbls of LLS Crude Oil Basis Swaps at +$6.35/Bbl remaining for 2018 oil production. Related to 2019 production, we had hedged a total of 1,624 MBbls at an average price of $58.95/Bbl,2020 and we had 1,278 MBbls of WTI Midland Argus Crude Basis Swaps at -$6.39/Bbl and 365 MBbls of LLS Crude Oil Basis Swaps at +$4.50/Bbl. For 2020 production, we had hedged a total of 732on 366 MBbls at an averagea price of $63.08/$0.25/Bbl and we had 732 MBbls of WTI Midland Argus Crude Oil Swapsfor 2020.
The following table sets forth our outstanding derivative contracts at -$5.38/Bbl.May 1, 2019. When aggregating multiple contracts, the weighted average contract price is disclosed.

Period Commodity 
Volume
(Bbls / MMBtu)
 
Price
($/Bbl / $/MMBtu)
Q2 - Q4 2019 Crude Oil 1,769,100 $65.60
Q1 - Q4 2020 Crude Oil 1,830,000 $64.65
Q2 - Q4 2019 Crude Oil Basis Swap(1) 1,512,500 $(5.29)
Q2 - Q4 2019 Crude Oil (Basis Swap)(2) 275,000 $4.50
Q1 - Q4 2020 Crude Oil Basis Swap(1) 1,830,000 $(2.14)
Q2 - Q4 2019 Natural Gas 2,795,500 $2.86
Q1 - Q4 2020 Natural Gas 2,562,000 $2.85
Q2 - Q4 2019 Natural Gas Basis Swap (3) 2,795,500 $(1.14)
Q1 - Q4 2020 Natural Gas Basis Swap (3) 2,562,000 $(1.07)
(1)The basis differential price is between LLS Argus Crude and the WTI NYMEX.
(2)The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.
(3)The basis differential price is between W. Texas (WAHA) and the Henry Hub NYMEX.
Obligations and Commitments
There have been no material changes from the obligations and commitments disclosed in the Obligations and Commitments section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 20172018 Annual Report on Form 10-K other than those described in Note 13.12. Commitments and Contingencies in the Notes to the Unaudited Condensed Consolidated Financial Statements.
Environmental Regulations

Our operations are subject to risks normally associated with the exploration for and the production of oil and natural gas, including blowouts, fires, and environmental risks such as oil spills or natural gas leaks that could expose us to liabilities associated with these risks.
In our acquisition of existing or previously drilled well bores, we may not be aware of prior environmental safeguards, if any, that were taken at the time such wells were drilled or during such time the wells were operated. We maintain comprehensive insurance coverage that we believe is adequate to mitigate the risk of any adverse financial effects associated with these risks.
However, should it be determined that a liability exists with respect to any environmental cleanup or restoration, the liability to cure such a violation could still accrue to us. No claim has been made, nor are we aware of any liability which we may have, as it relates to any environmental cleanup, restoration, or the violation of any rules or regulations relating thereto.
Recently Issued Accounting Standards
See Note 1. Basis of Presentation and Summary of Significant Accounting Policies in the Notes to Unaudited Condensed Consolidated Financial Statements in this report for discussion of recently issued and adopted accounting standards affecting us.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks associated with interest rate risks, commodity price risk and credit risk. We have established risk management processes to monitor and manage these market risks.
Commodity Price Risk, Derivative Instruments and Hedging Activity
We are exposed to various risks including energy commodity price risk. When oil, natural gas, and natural gas liquids prices decline significantly our ability to finance our capital budget and operations may be adversely impacted. We expect energy prices to remain volatile and unpredictable. Our 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 timesmaller reporting company as defined by Rule 12b-2 of the hedge.
We have entered into a series of derivative instrumentsExchange Act and therefore are not required to hedge a significant portion of its expected oil and natural gas production for the remainder of 2018 through December 31, 2020. Typically, these derivative instruments require payments to (receipts from) counterparties based on specific indices as required by the derivative agreements. Although not risk free, we believe these instruments reduce our exposure to oil and natural gas price fluctuations and, thereby, allow us to achieve a more predictable cash flow.

The following is a summary of our open oil and natural gas derivative contracts as of September 30, 2018: 
  Price Swaps
Period Commodity 
Volume
(Bbls / MMBtu)
 
Weighted Average Price
($/Bbl / $/MMBtu)
Q4 2018 Crude Oil 413,700
 $54.05
Q1 - Q4 2019 Crude Oil 1,624,100
 $58.95
Q1 - Q4 2020 Crude Oil 732,000
 $63.08
Q4 2018 
Crude Oil (Basis Swap)(1)
 243,800
 $(1.90)
Q1 - Q4 2019 
Crude Oil (Basis Swap)(1)
 1,277,500
 $(6.39)
Q1 - Q4 2020 
Crude Oil (Basis Swap)(1)
 732,000
 $(5.38)
Q4 2018 
Crude Oil (Basis Swap)(2)
 92,000
 $6.35
Q1 - Q4 2019 
Crude Oil (Basis Swap)(2)
 365,000
 $4.50
Q4 2018 Natural Gas 610,000
 $2.95
(1)The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.
(2)The basis differential price is between LLS Argus Crude and the WTI NYMEX.
Subsequent to September 30, 2018, we entered into the following crude oil and natural gas derivative contracts:
  Price Swaps
Period Commodity 
Volume
(Bbls / MMBtu)
 
Weighted Average Price
($/Bbl / $/MMBtu)
Q1 - Q4 2019 Crude Oil 730,000
 $73.05
Q1 - Q4 2020 Crude Oil 732,000
 $68.67
Q1 - Q4 2019 Crude Oil Basis Swap(1) 730,000
 $(5.50)
Q1 - Q4 2020 Crude Oil Basis Swap(1) 732,000
 $(0.10)
Q1 - Q4 2019 Natural Gas 1,277,550
 $2.87
Q1 - Q4 2019 Natural Gas (Basis Swap)(2) 1,277,550
 $(1.28)
(1)The basis differential price is between WTI Midland Argus Crude and the WTI NYMEX.
(2)The basis differential price is between W. Texas (WAHA) and the Henry Hub NYMEX.
Changes in fair value of commodity derivative instruments are reported in earnings in the period in which they occur. Our open commodity derivative instruments were in a net liability position with a fair value of $33.4 million at September 30, 2018. Based on the published commodity futures price curves for the underlying commodity as of September 30, 2018, a 10% increase in per unit commodity prices would cause the total fair value of our commodity derivative financial instruments to decrease by approximately $18.5 million to an overall net liability position of $51.9 million. A 10% decrease in per unit commodity prices would cause the total fair value of our commodity derivative financial instruments to increase by approximately $18.5 million to an overall net liability position of $14.9 million. There would also be a similar increase or decrease in (Loss) gain on derivative contracts, net in the Condensed Consolidated Statements of Operations.
Interest Rate Sensitivity
We are also exposed to market risk related to adverse changes in interest rates. Our interest rate risk exposure results primarily from fluctuations in short-term rates, which are based on LIBOR and the prime rate and may result in reductions of earnings or cash flows due to increases in the interest rates we pay on these obligations.
At September 30, 2018, the outstanding borrowings under the EEH Credit Agreement were $35.0 million bearing interest at rates described in Note 10. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements. Fluctuations in interest rates will cause our annual interest costs to fluctuate. At September 30, 2018, the interest rate on borrowings under the EEH Credit Agreement was 3.915% per year. If borrowings at September 30, 2018 were to remain constant, a 10% change in interest rates would impact our future cash flows by approximately $0.1 million per year.
Disclosure of Limitations
Becauseprovide the information above included only those exposures that existed at September 30, 2018, it does not consider those exposures or positions which could arise after that date. As a result, our ultimate realized gain or loss with respect to interest rate and commodity price fluctuations will depend on the exposures that arise during future periods.required under this item. 

Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
In accordance with Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15(e) and 15d-15(e), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and our Principal Accounting Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Principal Accounting Officer concluded that our disclosure controls and procedures were effective as of September 30, 2018March 31, 2019 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Principal Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may be involved in various legal proceedings and claims in the ordinary course of business. As of September 30, 2018,March 31, 2019, and through the filing date of this report, we do not believe the ultimate resolution of any such actions or potential actions of which we are currently aware will have a material effect on our consolidated financial position or results of operations.  
See Note 13.12. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item 1 of this report, which is incorporated herein by reference, for material matters that have arisenoccurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2017.2018.
Item 1A. Risk Factors
There have been no material changes from the risk factors disclosed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2017, other than the risks described below relating to the proposed Sabalo Acquisition.2018.

Failure to complete the Sabalo Acquisition could negatively affect our stock price, future business and financial results.

Completion of the Sabalo Acquisition is not assured and is subject to risks, including the risks that approval of the Sabalo Acquisition by our stockholders will not be obtained or that certain other closing conditions will not be satisfied. If the Sabalo Acquisition is not completed, our ongoing business and financial results may be adversely affected and we will be subject to several risks, including:
having to pay certain significant transaction costs relating to the Sabalo Acquisition without receiving the benefits of the Sabalo Acquisition;

the potential payment of a termination fee of $16.0 million if (i) our board of directors, including the special committee withholds, withdraws or qualifies its recommendation that stockholders approve the Agreement or approves or announces its intention to accept an alternative proposal (as defined in the Agreement), and such is not withdrawn at the time of the date of the stockholders meeting; or (ii) (A) by Sabalo Holdings as a result of the closing of the Sabalo Acquisition not occurring by February 14, 2019, (or April 1, 2019, if extended) or (B) by Sabalo Holdings prior to the special meeting of stockholders if Earthstone or EEH breached or failed to perform any of their respective representations, warranties, covenants or agreements contained in the Agreement;

the fact that we are subject to certain restrictions on the conduct of our business prior to closing or termination which may prevent us from making certain acquisitions or dispositions or pursuing certain business opportunities while the Sabalo Acquisition is pending;

that the share price of our Class A Common Stock may decline to the extent that the current market prices reflect an assumption by the market that the Sabalo Acquisition will not be completed; and

that we may be subject to litigation related to any failure on our part to complete the Sabalo Acquisition, or litigation resulting from minority stockholder actions.

Delays in completing the Sabalo Acquisition may substantially reduce the expected benefits of the Sabalo Acquisition.

Satisfying the conditions to, and completion of, the Sabalo Acquisition may take longer than, and could cost more than, we expect. Any delay in completing or any additional conditions imposed in order to complete the Sabalo Acquisition may materially adversely affect the synergies and other benefits that we expect to achieve from the Sabalo Acquisition and the integration of our respective assets. In addition, each of us and Sabalo Holdings has the right to terminate the Agreement if the Sabalo Acquisition is not completed by February 14, 2019 (subject to limited circumstances to extend for 45 days).

We will incur substantial fees and costs in connection with the Sabalo Acquisition.

We expect to incur significant non-recurring expenses in connection with the Sabalo Acquisition. Additional unanticipated costs may be incurred, including, without limitation, unexpected costs and other expenses in the course of the integration of the assets of Sabalo and Shad with those of the Company. In addition, the companies cannot be certain that the elimination of duplicative

costs or the realization of other efficiencies related to the integration of the two businesses will offset the integration costs in the near term, or at all.

We will be subject to various uncertainties and contractual restrictions while the Sabalo Acquisition is pending that could adversely affect our financial results.

The pursuit of the Sabalo Acquisition and the preparation for the integration of the assets of Sabalo and Shad with our assets may place a significant burden on our management and internal resources. Any significant diversion of management attention away from ongoing business and any difficulties encountered in the transition and integration process could adversely affect our financial results.

In addition, the Agreement restricts us from taking certain specified actions while the Sabalo Acquisition is pending without first obtaining Sabalo Holdings’ prior written consent. These restrictions may limit us from pursuing attractive business opportunities and making other changes to our business prior to completion of the Sabalo Acquisition or termination of the Agreement.

If the Sabalo Acquisition is consummated, we may be unable to successfully integrate Sabalo’s operations or to realize anticipated cost savings, revenues or other benefits of the Sabalo Acquisition.

Our ability to achieve the anticipated benefits of the Sabalo Acquisition, if consummated, will depend in part upon whether we can successfully integrate Sabalo’s assets and operations into our existing business in a timely, efficient and effective manner. The beneficial acquisition of producing and non-producing properties and undeveloped acreage that can be economically developed, including the assets acquired from Sabalo, requires an assessment of several factors, including:
recoverable reserves;

future natural gas and oil prices and their appropriate differentials;

availability and cost of transportation of production to markets;

availability and cost of drilling and completion equipment and of skilled personnel;

development and operating costs and potential environmental and other liabilities; and

regulatory, permitting and similar matters.

The accuracy of these assessments is inherently uncertain. In connection with these assessments, we have performed, and will continue to perform, a review of the properties of Sabalo and Shad that we believe to be generally consistent with reasonable industry practices. Our review may not reveal all existing or potential problems or permit us to become sufficiently familiar with the properties to fully assess their deficiencies and potential recoverable reserves. Inspections will not always be performed on every well, and environmental problems are not necessarily observable even when an inspection is undertaken. Even if problems are identified, the contractual protection in the Agreement with respect to all or a portion of the underlying deficiencies may prove ineffective or insufficient. The integration process may be subject to delays or changed circumstances, and we can give no assurance that the acquired properties will perform in accordance with our expectations or that our expectations with respect to integration or cost savings resulting from added scale as a result of the Sabalo Acquisition will materialize. Significant acquisitions, including the Sabalo Acquisition, and other strategic transactions may involve other risks that may cause negative impacts on our business, including:

diversion of our management’s attention resulting in the inability to evaluate, negotiate and integrate other significant acquisitions and strategic transactions;

the challenge and cost of integrating the assets and operations acquired in the Sabalo Acquisition with existing assets and operations while carrying on our ongoing business; and

the failure to realize the full benefit that we expect in estimated proved reserves, production volume, cost savings from operating synergies or other benefits anticipated from an acquisition, or to realize these benefits within the expected time frame.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sale of Equity Securities
There were no unregistered sales of equity securities during the three and nine months ended September 30, 2018.March 31, 2019.
Repurchase of Equity Securities
The following table sets forth information regarding our acquisition of shares of Class A Common Stock for the periods presented:
  
Total Number of Shares Purchased (1)
 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plan or Programs
July 2018 
 
 
 
August 2018 
 
 
 
September 2018 30,511
 $9.38
 
 
  
Total Number of Shares Purchased (1)
 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plan or Programs
January 2019 8,972
 $4.52
 
 
February 2019 
 
 
 
March 2019 50,289
 $7.08
 
 
(1)All of the shares were surrendered by employees (via net settlement) in satisfaction of tax obligations upon the vesting of restricted stock unit awards. The acquisition of the surrendered shares was not part of a publicly announced program to repurchase shares of our Class A Common Stock.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information.
None.

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


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
     
    EARTHSTONE ENERGY, INC.
     
Date:November 7, 2018May 3, 2019 By:/s/ Tony Oviedo
   Tony Oviedo
   Executive Vice President – Accounting and Administration

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