UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

~~_________________________________________________________~~

FORM 10-Q

~~_________________________________________________________~~

(Mark One)


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

For the Quarterly Period Ended ~~March 31,~~September 30, 2020


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

Commission File No. 001-35049

~~_________________________________________________________~~

EARTHSTONE ENERGY, INC.

(Exact name of registrant as specified in its charter)

_________________________________________________________

Delaware

84-0592823


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

1400 Woodloch Forest Drive, Suite 300

The Woodlands, Texas 77380

(Address of principal executive offices)

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

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Class A Common Stock, $0.001 par value per share	ESTE	New York Stock Exchange ~~(NYSE)~~

Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the ~~past~~preceding 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 x☒ 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~~submit such files). Yes x☒ 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, or an emerging growth 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~~Filer	x ☒
Non-accelerated filer	☐	Smaller reporting company	x ☒
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 x

☒

As of ~~May 1,~~October 29, 2020, ~~29,852,958~~30,210,749 shares of Class A Common Stock, $0.001 par value per share, and ~~35,060,687~~35,009,371 shares of Class B Common Stock, $0.001 par value per share, were outstanding.

Table of Contents

TABLE OF CONTENTS



			Page

		PART I – FINANCIAL INFORMATION

Item 1.		Financial Statements (Unaudited)	43
		Condensed Consolidated Balance Sheets as of ~~March 31,~~September 30, 2020 and December 31, 2019	43
		Condensed Consolidated Statements of Operations for the Three and Nine Months Ended ~~March 31,~~September 30, 2020 and 2019	64
		Condensed Consolidated Statements of Equity for the ~~Three~~Nine Months Ended ~~March 31,~~September 30, 2020 and 2019	75
		Condensed Consolidated Statements of Cash Flows for the ~~Three~~Nine Months Ended ~~March 31,~~September 30, 2020 and 2019	87
		Notes to Unaudited Condensed Consolidated Financial Statements	98
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	2019
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	2928
Item 4.		Controls and Procedures	2928

		PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	29
Item 1.1A.	Risk Factors	~~Legal Proceedings~~29	30
~~Item 1A.~~		~~Risk Factors~~	30
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	3029
Item 3.		Defaults Upon Senior Securities	3129
Item 4.		Mine Safety Disclosures	3129
Item 5.		Other Information	3129
Item 6.	Exhibits	~~Exhibits~~30	32
	Signatures	~~Signatures~~31	33

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share and per share amounts)

	*September 30,*			*December 31,*
ASSETS	*2020*			*2019*
Current assets:
Cash	$	5,311		$	13,822
Accounts receivable:
Oil, natural gas, and natural gas liquids revenues		12,097			29,047
Joint interest billings and other, net of allowance of $80 and $83 at September 30, 2020 and December 31, 2019, respectively		11,548			6,672
Derivative asset		25,097			8,860
Prepaid expenses and other current assets		1,560			1,867
Total current assets		55,613			60,268

Oil and gas properties, successful efforts method:
Proved properties		995,666			970,808
Unproved properties		236,482			260,271
Land		5,382			5,382
Total oil and gas properties		1,237,530			1,236,461
Accumulated depreciation, depletion and amortization		(271,012	)		(195,567	)
Net oil and gas properties		966,518			1,040,894

Other noncurrent assets:
Goodwill		0			17,620
Office and other equipment, net of accumulated depreciation and amortization of $3,558 and $3,180 at September 30, 2020 and December 31, 2019, respectively		1,044			1,311
Derivative asset		4,727			770
Operating lease right-of-use assets		2,769			3,108
Other noncurrent assets		1,331			1,572
TOTAL ASSETS	$	1,032,002		$	1,125,543
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	6,910		$	25,284
Revenues and royalties payable		28,047			35,815
Accrued expenses		12,844			19,538
Asset retirement obligation		308			308
Derivative liability		1,040			6,889
Advances		93			11,505
Operating lease liabilities		768			570
Finance lease liabilities		96			206
Other current liabilities		11			43
Total current liabilities		50,117			100,158

Noncurrent liabilities:
Long-term debt		130,000			170,000
Deferred tax liability		15,294			15,154
Asset retirement obligation		2,027			1,856
Derivative liability		577			0
Operating lease liabilities		2,001			2,539
Finance lease liabilities		15			85
Other noncurrent liabilities		138			0
Total noncurrent liabilities		150,052			189,634

Commitments and Contingencies (Note 13)

Equity:
Preferred stock, $0.001 par value, 20,000,000 shares authorized; none issued or outstanding		0			0
Class A Common Stock, $0.001 par value, 200,000,000 shares authorized; 30,210,749 and 29,421,131 issued and outstanding at September 30, 2020 and December 31, 2019, respectively		30			29
Class B Common Stock, $0.001 par value, 50,000,000 shares authorized; 35,009,371 and 35,260,680 issued and outstanding at September 30, 2020 and December 31, 2019, respectively		35			35
Additional paid-in capital		537,990			527,246
Accumulated deficit		(186,787	)		(181,711	)
Total Earthstone Energy, Inc. equity		351,268			345,599
Noncontrolling interest		480,565			490,152
Total equity		831,833			835,751
TOTAL LIABILITIES AND EQUITY	$	1,032,002		$	1,125,543

March 31, December 31,
ASSETS 2020 2019
Current assets:
Cash $ 5,101
$ 13,822
Accounts receivable:
Oil, natural gas, and natural gas liquids revenues 10,845
29,047
Joint interest billings and other, net of allowance of $80 and $83 at March 31, 2020 and December 31, 2019, respectively 11,094
6,672
Derivative asset 72,017
8,860
Prepaid expenses and other current assets 1,597
1,867
Total current assets 100,654
60,268

Oil and gas properties, successful efforts method:
Proved properties 991,209
970,808
Unproved properties 238,477
260,271
Land 5,382
5,382
Total oil and gas properties 1,235,068
1,236,461

Accumulated depreciation, depletion and amortization (219,823 ) (195,567 )
Net oil and gas properties 1,015,245
1,040,894

Other noncurrent assets:
Goodwill —
17,620
Office and other equipment, net of accumulated depreciation and amortization of $3,307 and $3,180 at March 31, 2020 and December 31, 2019, respectively 1,271
1,311
Derivative asset 20,769
770
Operating lease right-of-use assets 3,092
3,108
Other noncurrent assets 1,490
1,572
TOTAL ASSETS $ 1,142,521
$ 1,125,543
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable $ 24,010
$ 25,284
Revenues and royalties payable 41,455
35,815
Accrued expenses 25,495
19,538
Asset retirement obligation 308
308
Derivative liability —
6,889
Advances 2,690
11,505
Operating lease liabilities 759
570
Finance lease liabilities 153
206
Other current liabilities 14
43
Total current liabilities 94,884
100,158

Noncurrent liabilities:
Long-term debt 152,000
170,000
Deferred tax liability 16,246
15,154
Asset retirement obligation 1,911
1,856

Operating lease liabilities 2,333
2,539
Finance lease liabilities 62
85
Other noncurrent liabilities 139
—
Total noncurrent liabilities 172,691
189,634

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; 29,852,958 and 29,421,131 issued and outstanding at March 31, 2020 and December 31, 2019, respectively 30
29
Class B Common Stock, $0.001 par value, 50,000,000 shares authorized; 35,060,687 and 35,260,680 issued and outstanding at March 31, 2020 and December 31, 2019, respectively 35
35
Additional paid-in capital 532,623
527,246
Accumulated deficit (165,003 ) (181,711 )
Total Earthstone Energy, Inc. equity 367,685
345,599
Noncontrolling interest 507,261
490,152
Total equity 874,946
835,751

TOTAL LIABILITIES AND EQUITY $ 1,142,521
$ 1,125,543

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

Table of Contents

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except share and per share amounts)

	*Three Months Ended*						*Nine Months Ended*
	*September 30,*						*September 30,*
	*2020*			*2019*			*2020*			*2019*
REVENUES
Oil	$	33,158		$	35,443		$	93,017		$	111,657
Natural gas		2,642			903			4,855			2,126
Natural gas liquids		5,247			2,858			9,976			10,691
Total revenues		41,047			39,204			107,848			124,474

OPERATING COSTS AND EXPENSES
Lease operating expense		7,044			6,419			21,971			20,485
Production and ad valorem taxes		2,696			2,698			7,198			8,001
Rig termination expense		0			0			426			0
Depreciation, depletion and amortization		28,538			14,079			76,096			42,281
Impairment expense		2,115			0			62,548			0
General and administrative expense		5,796			6,057			19,615			19,948
Transaction costs		(705	)		215			(324	)		797
Accretion of asset retirement obligation		47			52			137			160
Exploration expense		0			0			298			0
Total operating costs and expenses		45,531			29,520			187,965			91,672

(Loss) gain on sale of oil and gas properties		0			(120	)		198			(446	)

(Loss) income from operations		(4,484	)		9,564			(79,919	)		32,356

OTHER INCOME (EXPENSE)
Interest expense, net		(1,186	)		(1,609	)		(4,207	)		(4,735	)
(Loss) gain on derivative contracts, net		(6,040	)		18,726			73,065			(19,672	)
Other income (expense), net		(18	)		21			120			(1	)
Total other income (expense)		(7,244	)		17,138			68,978			(24,408	)

(Loss) income before income taxes		(11,728	)		26,702			(10,941	)		7,948
Income tax expense		(130	)		(575	)		(112	)		(728	)
Net (loss) income		(11,858	)		26,127			(11,053	)		7,220

Less: Net (loss) income attributable to noncontrolling interest		(6,413	)		14,357			(5,977	)		3,877

Net (loss) income attributable to Earthstone Energy, Inc.	$	(5,445	)	$	11,770		$	(5,076	)	$	3,343

Net (loss) income per common share attributable to Earthstone Energy, Inc.:
Basic	$	(0.18	)	$	0.41		$	(0.17	)	$	0.12
Diluted	$	(0.18	)	$	0.41		$	(0.17	)	$	0.12

Weighted average common shares outstanding:
Basic		30,073,635			29,032,842			29,810,705			28,883,907
Diluted		30,073,635			29,032,842			29,810,705			28,883,907

Three Months Ended March 31,
2020 2019
REVENUES
Oil $ 41,012
$ 35,447
Natural gas 1,086
1,094
Natural gas liquids 3,040
4,187
Total revenues 45,138
40,728

OPERATING COSTS AND EXPENSES
Lease operating expense 9,339
6,061
Production and ad valorem taxes 3,023
2,594
Depreciation, depletion and amortization 24,656
14,005
Impairment expense 60,371
—
General and administrative expense 7,132
7,075
Transaction costs 844
370
Accretion of asset retirement obligation 44
54
Exploration expense 301
—
Total operating costs and expenses 105,710
30,159

Gain (loss) on sale of oil and gas properties 204
(125 )

(Loss) income from operations (60,368 ) 10,444

OTHER INCOME (EXPENSE)
Interest expense, net (1,736 ) (1,449 )
Gain (loss) on derivative contracts, net 99,784
(47,894 )
Other income (expense), net 126
(4 )
Total other income (expense) 98,174
(49,347 )

Income (loss) before income taxes 37,806
(38,903 )
Income tax (expense) benefit (1,092 ) 460
Net income (loss) 36,714
(38,443 )

Less: Net income (loss) attributable to noncontrolling interest 20,006
(21,239 )

Net income (loss) attributable to Earthstone Energy, Inc. $ 16,708
$ (17,204 )

Net income (loss) per common share attributable to Earthstone Energy, Inc.:
Basic $ 0.57
$ (0.60 )
Diluted $ 0.57
$ (0.60 )

Weighted average common shares outstanding:
Basic 29,497,428
28,719,542
Diluted 29,497,428
28,719,542

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

Table of Contents

EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)

(In thousands, except share amounts)

	*Issued Shares*
	*Class A Common Stock*			*Class B Common Stock*			*Class A Common Stock*		*Class B Common Stock*		*Additional Paid-in Capital*			*Accumulated Deficit*			*Total Earthstone Energy, Inc. Equity*			*Noncontrolling Interest*			*Total Equity*
At December 31, 2019		29,421,131			35,260,680		$	29	$	35	$	527,246		$	(181,711	)	$	345,599		$	490,152		$	835,751
Stock-based compensation expense		—			—			0		0		2,694			0			2,694						2,694
Vesting of restricted stock units, net of taxes paid		231,834			0			1		0		0			0			1			0			1
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings		75,695			0			0		0		(214	)		0			(214	)		0			(214	)
Cancellation of treasury shares		(75,695	)		0			—		—		—			—			—			—			—
Class B Common Stock converted to Class A Common Stock		199,993			(199,993	)		0		0		2,897			0			2,897			(2,897	)		0
Net income		—			—			0		0		0			16,708			16,708			20,006			36,714
At March 31, 2020		29,852,958			35,060,687		$	30	$	35	$	532,623		$	(165,003	)	$	367,685		$	507,261		$	874,946
Stock-based compensation expense		—			—			0		0		2,568			0			2,568			0			2,568
Vesting of restricted stock units, net of taxes paid		165,399			0			0		0		0			0			0			0			0
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings		57,810			0			0		0		(170	)		0			(170	)		0			(170	)
Cancellation of treasury shares		(57,810	)		0			—		—		—			—			—			—			—
Class B Common Stock converted to Class A Common Stock		2,000			(2,000	)		0		0		28			0			28			(28	)		0
Net loss		—			—			0		0		0			(16,339	)		(16,339	)		(19,570	)		(35,909	)
At June 30, 2020		30,020,357			35,058,687		$	30	$	35	$	535,049		$	(181,342	)	$	353,772		$	487,663		$	841,435
Stock-based compensation expense		—			—			0		0		2,403			0			2,403			0			2,403
Vesting of restricted stock units, net of taxes paid		141,076			0			0		0		0			0			0			0			0
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings		54,268			0			0		0		(147	)		0			(147	)		0			(147	)
Cancellation of treasury shares		(54,268	)		0			—		—		—			—			—			—			—
Class B Common Stock converted to Class A Common Stock		49,316			(49,316	)		0		0		685			0			685			(685	)		0
Net loss		—			—			0		0		0			(5,445	)		(5,445	)		(6,413	)		(11,858	)
At September 30, 2020		30,210,749			35,009,371		$	30	$	35	$	537,990		$	(186,787	)	$	351,268		$	480,565		$	831,833

Issued Shares
Class A Common Stock Class B Common Stock Class A Common Stock Class B Common Stock Additional Paid-in Capital Accumulated Deficit Total Earthstone Energy, Inc. Equity Noncontrolling Interest Total Equity
At December 31, 2019 29,421,131
35,260,680
$ 29
$ 35
$ 527,246
$ (181,711 ) $ 345,599
$ 490,152
$ 835,751
Stock-based compensation expense —
—
—
—
2,694
—
2,694
2,694
Vesting of restricted stock units, net of taxes paid 231,834
—
1
—
—
—
1
—
1
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings 75,695
—
—
—
(214 ) —
(214 ) —
(214 )
Cancellation of treasury shares (75,695 ) —
—
—
—
—
—
—
—
Class B Common Stock converted to Class A Common Stock 199,993
(199,993 ) —
—
2,897
—
2,897
(2,897 ) —
Net income —
—
—
—
—
16,708
16,708
20,006
36,714
At March 31, 2020 29,852,958
35,060,687
$ 30
$ 35
$ 532,623
$ (165,003 ) $ 367,685
$ 507,261
$ 874,946

Issued Shares
Class A Common Stock Class B Common Stock Class A Common Stock Class B Common Stock Additional Paid-in Capital Accumulated Deficit Total Earthstone Energy, Inc. Equity Noncontrolling Interest Total Equity
At December 31, 2018 28,696,321
35,452,178
$ 29
$ 35
$ 517,073
$ (182,497 ) $ 334,640
$ 491,852
$ 826,492
ASC 842 implementation —
—
—
—
—
67
67
99
166
Stock-based compensation expense —
—
—
—
2,212
—
2,212
2,212
Vesting of restricted stock units, net of taxes paid 166,140
—
—
—
—
—
—
—
—
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings 59,261
—
—
—
(396 ) —
(396 ) —
(396 )
Cancellation of treasury shares (59,261 ) —
—
—
—
—
—
—
—
Net loss —
—
—
—
—
(17,204 ) (17,204 ) (21,239 ) (38,443 )
At March 31, 2019 28,862,461
35,452,178
$ 29
$ 35
$ 518,889
$ (199,634 ) $ 319,319
$ 470,712
$ 790,031

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

~~EARTHSTONE ENERGY, INC.~~

~~CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)~~

~~(In thousands)~~

For the Three Months Ended
March 31,
2020 2019
Cash flows from operating activities:
Net income (loss) $ 36,714
$ (38,443 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation, depletion and amortization 24,656
14,005
Impairment of proved and unproved oil and gas properties 42,751
—
Impairment of goodwill 17,620
—
Accretion of asset retirement obligations 44
54
Settlement of asset retirement obligations —
(62 )
(Gain) loss on sale of oil and gas properties (204 ) 125
Total (gain) loss on derivative contracts, net (99,784 ) 47,894
Operating portion of net cash received in settlement of derivative contracts 9,739
5,362
Stock-based compensation 2,694
2,212
Deferred income taxes 1,092
(460 )
Amortization of deferred financing costs 80
103
Changes in assets and liabilities:
(Increase) decrease in accounts receivable 13,780
(6,811 )
(Increase) decrease in prepaid expenses and other current assets (312 ) (2,236 )
Increase (decrease) in accounts payable and accrued expenses 2,846
(7,427 )
Increase (decrease) in revenues and royalties payable 5,640
(5,383 )
Increase (decrease) in advances (8,814 ) (1,882 )
Net cash provided by operating activities 48,542
7,051
Cash flows from investing activities:
Additions to oil and gas properties (39,299 ) (48,412 )
Additions to office and other equipment (87 ) (75 )
Proceeds from sales of oil and gas properties 409
—
Net cash used in investing activities (38,977 ) (48,487 )
Cash flows from financing activities:
Proceeds from borrowings 17,500
85,244
Repayments of borrowings (35,500 ) (43,247 )
Cash paid related to the exchange and cancellation of Class A Common Stock (214 ) (397 )
Cash paid for finance leases (72 ) (114 )
Net cash (used in) provided by financing activities (18,286 ) 41,486
Net increase (decrease) in cash (8,721 ) 50
Cash at beginning of period 13,822
376
Cash at end of period $ 5,101
$ 426
Supplemental disclosure of cash flow information
Cash paid for:
Interest $ 1,676
$ 1,255
Non-cash investing and financing activities:
Accrued capital expenditures $ 31,011
$ 17,040
Lease asset additions - ASC 842 $ —
$ 1,801
Asset retirement obligations $ 21
$ 21

	*Issued Shares*
	*Class A Common Stock*			*Class B Common Stock*			*Class A Common Stock*		*Class B Common Stock*		*Additional Paid-in Capital*			*Accumulated Deficit*			*Total Earthstone Energy, Inc. Equity*			*Noncontrolling Interest*			*Total Equity*
At December 31, 2018		28,696,321			35,452,178		$	29	$	35	$	517,073		$	(182,497	)	$	334,640		$	491,852		$	826,492
ASC 842 implementation		—			—			0		0		0			67			67			99			166
Stock-based compensation expense		—			—			0		0		2,212			0			2,212			0			2,212
Vesting of restricted stock units, net of taxes paid		166,140			0			0		0		0			0			0			0			0
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings		59,261			0			0		0		(396	)		0			(396	)		0			(396	)
Cancellation of treasury shares		(59,261	)		0			—		—		—			—			—			—			—
Net loss		—			—			0		0		0			(17,204	)		(17,204	)		(21,239	)		(38,443	)
At March 31, 2019		28,862,461			35,452,178		$	29	$	35	$	518,889		$	(199,634	)	$	319,319		$	470,712		$	790,031
Stock-based compensation expense		—			—			0		0		2,261			0			2,261						2,261
Vesting of restricted stock units, net of taxes paid		133,311			0			0		0		0			0			0			0			0
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings		43,344			0			0		0		(265	)		0			(265	)		0			(265	)
Cancellation of treasury shares		(43,344	)		0			—		—		—			—			—			—			—
Class B Common Stock converted to Class A Common Stock		35,732			(35,732	)		0		0		476			0			476			(476	)		0
Net income		—			—			0		0		0			8,777			8,777			10,759			19,536
At June 30, 2019		29,031,504			35,416,446		$	29	$	35	$	521,361		$	(190,857	)	$	330,568		$	480,995		$	811,563
Stock-based compensation expense		—			—			0		0		2,207			0			2,207						2,207
Vesting of restricted stock units, net of taxes paid		118,716			0			0		0		0			0			0			0			0
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings		49,111			0			0		0		(166	)		0			(166	)		0			(166	)
Cancellation of treasury shares		(49,111	)		0			—		—		—			—			—			—			—
Class B Common Stock converted to Class A Common Stock		0			0			0		0		0			0			0			0			0
Net income		—			—			0		0		0			11,770			11,770			14,357			26,127
At September 30, 2019		29,150,220			35,416,446		$	29	$	35	$	523,402		$	(179,087	)	$	344,379		$	495,352		$	839,731

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

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EARTHSTONE ENERGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

	*For the Nine Months Ended*
	*September 30,*
	*2020*			*2019*
Cash flows from operating activities:
Net (loss) income	$	(11,053	)	$	7,220
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation, depletion and amortization		76,096			42,281
Impairment of proved and unproved oil and gas properties		44,928			0
Impairment of goodwill		17,620			0
Accretion of asset retirement obligations		137			160
Settlement of asset retirement obligations		0			(179	)
(Gain) loss on sale of oil and gas properties		(198	)		446
Total (gain) loss on derivative contracts, net		(73,065	)		19,672
Operating portion of net cash received in settlement of derivative contracts		47,599			13,660
Stock-based compensation		7,665			6,680
Deferred income taxes		112			728
Amortization of deferred financing costs		241			336
Changes in assets and liabilities:
(Increase) decrease in accounts receivable		12,102			(5,585	)
(Increase) decrease in prepaid expenses and other current assets		(264	)		(28	)
Increase (decrease) in accounts payable and accrued expenses		1,976			(8,330	)
Increase (decrease) in revenues and royalties payable		(7,768	)		(9,042	)
Increase (decrease) in advances		(11,412	)		17,720
Net cash provided by operating activities		104,716			85,739
Cash flows from investing activities:
Additions to oil and gas properties		(72,869	)		(120,685	)
Additions to office and other equipment		(111	)		(379	)
Proceeds from sales of oil and gas properties		409			2
Net cash used in investing activities		(72,571	)		(121,062	)
Cash flows from financing activities:
Proceeds from borrowings		93,923			165,272
Repayments of borrowings		(133,923	)		(119,099	)
Cash paid related to the exchange and cancellation of Class A Common Stock		(531	)		(827	)
Cash paid for finance leases		(125	)		(355	)
Deferred financing costs		0			(228	)
Net cash (used in) provided by financing activities		(40,656	)		44,763
Net (decrease) increase in cash		(8,511	)		9,440
Cash at beginning of period		13,822			376
Cash at end of period	$	5,311		$	9,816
Supplemental disclosure of cash flow information
Cash paid for:
Interest	$	3,613		$	4,235
Non-cash investing and financing activities:
Accrued capital expenditures	$	2,213		$	50,615
Lease asset additions - ASC 842	$	0		$	4,710
Asset retirement obligations	$	44		$	43

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

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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 2019 Annual Report on Form ~~10-K.~~

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, 2019 is derived from the audited Consolidated Financial Statements at that date.

Certain prior period amounts have been reclassified to conform to current period presentation within the Condensed Consolidated Financial Statements. Prior period ad valorem taxes which were previously included in Lease operating expenses within the Operating Costs and Expenses section of the Condensed Consolidated Statements of Operations have been reclassified from Lease operating expenses and combined with the previously presented Severance taxes line-item and the combined total presented as Production and ad valorem taxes, also within Operating Costs and Expenses, in order to conform to current period presentation. Additionally, prior period legal expenses related to a previously completed transaction and previously included in General and administrative expense within Operating Costs and Expenses have been reclassified to Transaction costs, also within Operating Costs and Expenses, to conform to current period presentation. These reclassifications had no effect on Income from operations or any other subtotal in the Condensed Consolidated Statements of Operations.

Recently Issued Accounting Standards

Intangibles – Goodwill and Other – In January 2017, the Financial Accounting Standards Board ~~("FASB"~~(“FASB”) issued updated guidance simplifying the test for goodwill impairment. The update eliminates the requirement to determine the implied value of goodwill in measuring an impairment loss. Upon adoption, the measurement of a goodwill impairment will represent the excess of the reporting unit’s carrying value over its fair value and will be limited to the carrying value of goodwill. 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 adopted the update effective January 1, 2020. See further discussion of goodwill in Note 15. Goodwill.

Fair Value Measurements – In August 2018, the FASB issued an Accounting Standards Update ~~("ASU"~~(“ASU”) 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 adopted the update effective January 1, 2020 and the impact was not material to the Condensed Consolidated Financial Statements.

Credit Losses - In June 2016, the FASB issued an update that requires changes to the recognition of credit losses on financial instruments not accounted for at fair value through net income, including loans, debt securities, trade receivables, net investments in leases and available-for-sale debt securities. The amended standard broadens the information that an entity must consider in developing its estimate of expected credit losses, requiring an entity to estimate credit losses over the life of an exposure based on historical information, current information and reasonable and supportable forecasts. The guidance is effective for interim and

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~~EARTHSTONE ENERGY, INC.~~

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

annual periods beginning after December 15, 2019. The Company adopted the update effective January 1, 2020 and the impact was not material to the Condensed Consolidated Financial Statements.

Income Taxes - In December 2019, the FASB issued an update that simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020 and early adoption is permitted. The Company is in the process of evaluating the impact of this update, if any, on its Condensed Consolidated Financial Statements.

Reference Rate Reform - In March 2020, the FASB issued an update that provides optional guidance for a limited period of time to ease the transition from LIBOR to an alternative reference rate. The ASU intends to address certain concerns relating to accounting for contract modifications and hedge accounting. These optional expedients and exceptions to applying GAAP, assuming certain criteria are met, are allowed through December 31, 2022. The Company is currently evaluating the provisions of this update and has not yet determined whether it will elect the optional expedients. The Company does not expect the transition to an alternative rate to have a material impact on its business, operations or liquidity.

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 2. Fair Value Measurements

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

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

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

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

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

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instrument’s complexity. The Company reflects transfers between the three levels at the beginning of the reporting period in which the availability of observable inputs no longer justifies classification in the original level. There were no transfers between fair value hierarchy levels for the ~~three~~nine months ended ~~March 31, 2020.~~

September 30, 2020.

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.~~gas and interest rate swaps. The Company’s commodity price hedges and interest rate swaps are valued based on a discounted future cash flow ~~model. The primary input for the model is~~models that are primarily based on published forward commodity price ~~curves. The swaps~~curves and published LIBOR forward curves; thus, these inputs are ~~also~~ designated as Level 2 within the valuation hierarchy.

The fair values of ~~commodity~~ derivative instruments in an asset ~~position~~positions include ~~a measure~~measures of counterparty nonperformance risk, and the fair values of ~~commodity~~ derivative instruments in a liability ~~position~~positions include ~~a measure~~measures 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)~~

March 31, 2020 Level 1 Level 2 Level 3 Total
Financial assets
Derivative asset - current $ —
$ 72,017
$ —
$ 72,017
Derivative asset - noncurrent —
20,769
—
20,769
Total financial assets $ —
$ 92,786
$ —
$ 92,786

Financial liabilities
Derivative liability - current $ —
$ —
$ —
$ —
Derivative liability - noncurrent —
—
—
—
Total financial liabilities $ —
$ —
$ —
$ —

December 31, 2019
Financial assets
Derivative asset - current $ —
$ 8,860
$ —
$ 8,860
Derivative asset - noncurrent

770

770
Total financial assets $ —
$ 9,630
$ —
$ 9,630

Financial liabilities
Derivative liability - current $ —
$ 6,889
$ —
$ 6,889
Derivative liability - noncurrent —
—
—
—
Total financial liabilities $ —
$ 6,889
$ —
$ 6,889

September 30, 2020	*Level 1*		*Level 2*		*Level 3*		*Total*
Financial assets
Derivative asset - current	$	0	$	25,097	$	0	$	25,097
Derivative asset - noncurrent		0		4,727		0		4,727
Total financial assets	$	0	$	29,824	$	0	$	29,824

Financial liabilities
Derivative liability - current	$	0	$	1,040	$	0	$	1,040
Derivative liability - noncurrent		0		577		0		577
Total financial liabilities	$	0	$	1,617	$	0	$	1,617

December 31, 2019
Financial assets
Derivative asset - current	$	0	$	8,860	$	0	$	8,860
Derivative asset - noncurrent		0		770		0		770
Total financial assets	$	0	$	9,630	$	0	$	9,630

Financial liabilities
Derivative liability - current	$	0	$	6,889	$	0	$	6,889
Derivative liability - noncurrent		0		0		0		0
Total financial liabilities	$	0	$	6,889	$	0	$	6,889

Other financial instruments include cash, accounts receivable and payable, and revenue royalties. The carrying amount of these instruments approximates fair value because of their short-term nature. The Company’s long-term debt obligation bears interest at floating market rates, therefore carrying amounts and fair value are approximately equal.

Fair Value on a Nonrecurring Basis

The Company applies the provisions of the fair value measurement standard on a non-recurring basis to its non-financial assets and liabilities, including oil and gas properties, goodwill, business combinations, asset retirement obligations and performance units. These assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments if events or changes in certain circumstances indicate that adjustments may be necessary. Due to significant declines in commodity prices and global demand for oil and natural gas products resulting from the ~~COVID-19~~COVID-19 pandemic, the Company assessed the fair values of its oil and natural gas properties and goodwill resulting in non-cash impairment charges during the ~~three~~nine months ended ~~March 31, 2020.~~September 30, 2020. See further discussion at in Note 4. Asset Impairments.

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 3. Derivative Financial Instruments

Commodity Derivative Instruments

The Company’s hedging activities primarily consist of derivative instruments entered into in order to hedge against changes in oil and natural gas prices through the use of fixed price swap agreements. Swaps exchange floating price risk in the future for a fixed price at the time of the hedge. Consistent with its hedging policy, the Company has entered into a series of derivative instruments to hedge a significant portion of its expected oil and natural gas production through December 31, 2021. Typically, these derivative instruments require payments to (receipts from) counterparties based on specific indices as required by the derivative agreements. Although not risk free, the Company believes these instruments reduce its exposure to oil and natural gas price fluctuations and, thereby, allow the Company to achieve a more predictable cash flow.

The Company’s derivative instruments are cash flow hedge transactions in which it is hedging the variability of cash flow related to a forecasted transaction. The Company does not enter into derivative instruments for trading or other speculative purposes. These transactions are recorded in the Condensed Consolidated Financial Statements in accordance with FASB ASC Topic 815. The Company has accounted for these transactions using the mark-to-market accounting method. Generally, the Company incurs accounting losses on derivatives during periods where prices are rising and gains during periods where prices are falling which may cause significant fluctuations in the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Operations.

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~~EARTHSTONE ENERGY, INC.~~

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

The Company nets its derivative instrument fair value amounts executed with each counterparty pursuant to an International Swap Dealers Association Master Agreement (“ISDA”), which provides for net settlement over the term of the contract. The ISDA is a standard contract that governs all derivative contracts entered into between the Company and the respective counterparty. The ISDA allows for offsetting of amounts payable or receivable between the Company and the counterparty, at the election of both parties, for transactions that occur on the same date and in the same currency.

The Company had the following open crude oil and natural gas derivative contracts as of ~~March 31, 2020:~~

Price Swaps
Period Commodity
Volume
(Bbls / MMBtu)

Weighted Average Price
($/Bbl / $/MMBtu)
Q2 - Q4 2020 Crude Oil 2,199,000
$ 57.00
Q1 - Q4 2021 Crude Oil 1,460,000
$ 55.16
Q2 - Q4 2020 Crude Oil Basis Swap(1) 1,925,000
$ (1.40 )
Q2 - Q4 2020 Crude Oil Basis Swap(2) 275,000
$ 2.55
Q1 - Q4 2021 Crude Oil Basis Swap(1) 1,825,000
$ 1.05
Q2 - Q4 2020 Natural Gas 1,925,000
$ 2.85
Q2 - Q4 2020 Natural Gas Basis Swap(3) 1,925,000
$ (1.07 )

September 30, 2020:

	*Price Swaps*
		*Volume*		*Weighted Average Price*
Period	*Commodity*	*(Bbls / MMBtu)*		*($/Bbl / $/MMBtu)*
Q4 2020	Crude Oil		552,000	$	60.65
Q1 - Q4 2021	Crude Oil		1,460,000	$	55.16
Q4 2020	Crude Oil Basis Swap (1)		598,000	$	(1.50	)
Q4 2020	Crude Oil Basis Swap (2)		92,000	$	2.55
Q4 2020	Crude Oil Roll Swap (3)		552,000	$	(1.79	)
Q1 - Q4 2021	Crude Oil Basis Swap (1)		1,825,000	$	1.05
Q4 2020	Natural Gas		644,000	$	2.85
Q1 - Q4 2021	Natural Gas		4,380,000	$	2.76
Q4 2020	Natural Gas Basis Swap (4)		644,000	$	(1.07	)
Q1 - Q4 2021	Natural Gas Basis Swap (4)		4,380,000	$	(0.45	)


~~(1)~~ (1)	The basis differential price is between WTI Midland Crude and the WTI NYMEX.


~~(2)~~ (2)	The basis differential price is between WTI Houston and the WTI NYMEX.

(3)

The swap is between WTI Roll and the WTI NYMEX.

~~(3)~~

(4)

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

Interest Rate Swaps

At times, the Company’s hedging activities include the use of interest rate swaps entered into in order to manage cash flow variability resulting from changes in interest rates. These derivative instruments are not accounted for under hedge accounting.

The Company had the following interest rate swaps as of September 30, 2020:

Effective Dates	Notional Amount		Fixed Rate
May 5, 2020 to May 5, 2022	$	125,000,000		0.286	%
May 5, 2022 to May 5, 2023	$	100,000,000		0.286	%
May 5, 2023 to May 7, 2024	$	75,000,000		0.286	%

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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):

March 31, 2020 December 31, 2019
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 $ 73,846
$ (1,829 ) $ 72,017
$ 13,321
$ (4,461 ) $ 8,860
Commodity contracts Derivative liability - current $ 1,829
$ (1,829 ) $ —
$ 11,350
$ (4,461 ) $ 6,889
Commodity contracts Derivative asset - noncurrent $ 20,769
$ —
$ 20,769
$ 1,031
$ (261 ) $ 770
Commodity contracts Derivative liability - noncurrent $ —
$ —
$ —
$ 261
$ (261 ) $ —

		*September 30, 2020*							*December 31, 2019*
Derivatives not		*Gross*					*Net*		*Gross*					*Net*
designated as hedging	*Balance*	*Recognized*		*Gross*			*Recognized*		*Recognized*		*Gross*			*Recognized*
contracts under ASC	*Sheet*	*Assets /*		*Amounts*			*Assets /*		*Assets /*		*Amounts*			*Assets /*
Topic 815	*Location*	*Liabilities*		*Offset*			*Liabilities*		*Liabilities*		*Offset*			*Liabilities*
Commodity contracts	Derivative asset - current	$	26,773	$	(1,676	)	$	25,097	$	13,321	$	(4,461	)	$	8,860
Commodity contracts	Derivative liability - current	$	2,539	$	(1,676	)	$	863	$	11,350	$	(4,461	)	$	6,889
Interest rate swaps	Derivative liability - current	$	177	$	0		$	177	$	0	$	0		$	0
Commodity contracts	Derivative asset - noncurrent	$	4,727	$	0		$	4,727	$	1,031	$	(261	)	$	770
Commodity contracts	Derivative liability - noncurrent	$	355	$	0		$	355	$	261	$	(261	)	$	0
Interest rate swaps	Derivative liability - noncurrent	$	222	$	0		$	222	$	0	$	0		$	0

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

			*Three Months Ended*					*Nine Months Ended*
*Derivatives not designated as hedging contracts under ASC Topic 815*			*September 30,*					*September 30,*
	*Statement of Cash Flows Location*	*Statement of Operations Location*	*2020*			*2019*		*2020*		*2019*
Unrealized (loss) gain	Not separately presented	Not separately presented	$	(14,543	)	$	15,021	$	25,466	$	(33,332	)
Realized gain	Operating portion of net cash received in settlement of derivative contracts	Not separately presented		8,503			3,705		47,599		13,660
	Total (loss) gain on derivative contracts, net	(Loss) gain on derivative contracts, net	$	(6,040	)	$	18,726	$	73,065	$	(19,672	)

Included in Accounts receivable under the subheading of Joint interest billings and other in the Condensed Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 are $3.6 million and $0.6 million, respectively, related to commodity hedge contracts settled as of that date for which the cash has not been received.

Derivatives not designated as hedging contracts under ASC Topic 815 Three Months Ended
March 31,
Statement of Cash Flows Location Statement of Operations Location 2020 2019
Unrealized gain (loss) Not separately presented Not separately presented $ 90,045
$ (53,256 )
Realized gain Operating portion of net cash received in settlement of derivative contracts Not separately presented 9,739
5,362
Total gain (loss) on derivative contracts, net Gain (loss) on derivative contracts, net $ 99,784
$ (47,894 )

Note 4. Asset Impairments

The Company had the following non-cash asset impairment charges for the three and nine months ended ~~March 31,~~September 30, 2020 (in thousands):

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~~EARTHSTONE ENERGY, INC.~~

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

Three Months Ended March 31, 2020
Proved property $ 25,252
Unproved property 17,499
Goodwill 17,620
Impairment expense $ 60,371

	*Three Months Ended September 30, 2020*		*Nine Months Ended September 30, 2020*
Proved property	$	0	$	25,252
Unproved property		2,115		19,676
Goodwill		0		17,620
Impairment expense	$	2,115	$	62,548

See further discussion of non-cash asset impairment charges to Proved property and Unproved property in Note 5. Oil and Natural Gas Properties and non-cash asset impairment charges to Goodwill in Note 15. Goodwill.

The Company did not record any impairments during the three and nine months ended ~~March 31, 2019.~~September 30, 2019.

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 5. Oil and Natural Gas Properties

The Company follows the successful efforts method of accounting for its oil and natural gas properties. Under this method, costs to acquire oil and natural gas properties, drill and equip exploratory wells that find proved reserves, and drill and equip development wells are capitalized. Exploration costs, including unsuccessful exploratory wells and geological and geophysical costs, are charged to operations as incurred. Upon sale or retirement of oil and natural gas properties, the costs and related accumulated depreciation, depletion and amortization are eliminated from the accounts and the resulting gain or loss is recognized.

Costs incurred to maintain wells and related equipment, lease and well operating costs, and other exploration costs are charged to expense as incurred. Gains and losses arising from the sale of properties are included in Income from operations in the Condensed Consolidated Statements of Operations.

The Company’s lease acquisition costs and development costs of proved oil and natural gas properties are amortized using the units-of-production method, at the field level, based on total proved reserves and proved developed reserves, respectively. For the three and nine months ended ~~March 31,~~September 30, 2020 ~~and 2019,~~, depletion expense for oil and gas producing property and related equipment was ~~$24.5~~$28.4 million and ~~$13.8~~$75.7 million, respectively.

For the three and nine months ended September 30, 2019, depletion expense for oil and gas producing property and related equipment was $13.9 million and $41.7 million, respectively.

Proved Properties

Proved oil and natural gas properties are reviewed for impairment on a nonrecurring basis. The impairment charge reduces the carrying values to their estimated fair values. These fair value measurements are classified as Level 3 measurements and include many unobservable inputs. Fair value is calculated as the estimated discounted future net cash flows attributable to the assets. The Company’s primary assumptions in preparing the estimated discounted future net cash flows to be recovered from oil and gas properties are based on (i) proved reserves, (ii) forward commodity prices and assumptions as to costs and expenses, and (iii) the estimated discount rate that would be used by potential purchasers to determine the fair value of the assets.

Unproved Properties

Unproved properties consist of costs incurred to acquire undeveloped leases. Unproved oil and gas leases are generally for a primary term of three to five years. In most cases, the term of the unproved leases can be extended by paying a lease renewal fee, meeting contractual drilling obligations, or by the presence of producing wells on the leases. Unproved costs related to successful drilling on unproved leases are reclassified to proved properties.

The Company reviews its unproved properties periodically for impairment. In determining whether an unproved property is impaired, the Company considers numerous factors including, but not limited to, current exploration and development plans, favorable or unfavorable exploration activity on the property being evaluated and/or adjacent properties, the Company’s geologists' evaluation of the property, and the remaining months in the lease term for the property.

Impairments to Oil and Natural Gas Properties

During the three months ended March 31, 2020, as a result of the recent decline in crude oil price futures, the Company recorded non-cash impairment charges of $25.3 million to its proved oil and natural gas properties and $11.3 million to its ~~proved and~~ unproved oil and natural gas properties, ~~respectively,~~ located in the Eagle Ford Trend.No such impairments were recorded in the three months ended September 30, 2020. As a result of certain acreage expirations, the Company recorded non-cash impairment charges of ~~$6.2~~$2.1 million and $8.4 million to its unproved oil and natural gas properties during the three and nine months ended ~~March 31, 2020.~~

September 30, 2020, respectively.

The Company did not record any impairments to its oil and natural gas properties for the three and nine months ended ~~March 31, 2019.~~

September 30, 2019.

Capitalized costs, impairment, and depreciation, depletion and amortization relating to the Company’s oil and natural gas properties as of ~~March 31,~~September 30, 2020 and December 31, 2019, are summarized below (in thousands):

	*September 30,*			*December 31,*
	*2020*			*2019*
Oil and gas properties, successful efforts method:
Proved properties	$	1,096,318		$	1,046,208
Accumulated impairment to proved properties		(100,652	)		(75,400	)
Proved properties, net of accumulated impairments		995,666			970,808
Unproved properties		301,847			305,961
Accumulated impairment to Unproved properties		(65,365	)		(45,690	)
Unproved properties, net of accumulated impairments		236,482			260,271
Land		5,382			5,382
Total oil and gas properties, net of accumulated impairments		1,237,530			1,236,461
Accumulated depreciation, depletion and amortization		(271,012	)		(195,567	)
Net oil and gas properties	$	966,518		$	1,040,894

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EARTHSTONE ENERGY, INC.

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

March 31, December 31,
2020 2019
Oil and gas properties, successful efforts method:
Proved properties $ 1,091,861
$ 1,046,208
Accumulated impairment to proved properties (100,652 ) (75,400 )
Proved properties, net of accumulated impairments 991,209
970,808
Unproved properties 301,666
305,961
Accumulated impairment to Unproved properties (63,189 ) (45,690 )
Unproved properties, net of accumulated impairments 238,477
260,271
Land 5,382
5,382
Total oil and gas properties, net of accumulated impairments 1,235,068
1,236,461
Accumulated depreciation, depletion and amortization (219,823 ) (195,567 )
Net oil and gas properties $ 1,015,245
$ 1,040,894

Note 6. 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 (loss) income ~~(loss)~~ attributable to noncontrolling interest in the Condensed Consolidated Statements of Operations for the three and nine months ended ~~March 31,~~September 30, 2020 and 2019 represents the portion of net (loss) income ~~(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 Sheets as of ~~March 31,~~September 30, 2020 and December 31, 2019 represents the portion of net assets of the Company attributable to the members of EEH other than Earthstone and Lynden US.

The following table presents the changes in noncontrolling interest for the ~~three~~nine months ended ~~March 31, 2020:~~September 30, 2020:

	*EEH Units Held*											*Total EEH*
	*By Earthstone*					*EEH Units Held*						*Units*
	*and Lynden US*		%			*By Others*			%			*Outstanding*
As of December 31, 2019		29,421,131		45.5	%		35,260,680			54.5	%		64,681,811
EEH Units and Class B Common Stock converted to Class A Common Stock		251,309					(251,309	)					0
EEH Units issued in connection with the vesting of restricted stock units		538,309					0						538,309
As of September 30, 2020		30,210,749		46.3	%		35,009,371			53.7	%		65,220,120

EEH Units Held
By Earthstone
and Lynden US
%
EEH Units Held
By Others
%
Total EEH
Units
Outstanding
As of December 31, 2019 29,421,131
45.5 % 35,260,680
54.5 % 64,681,811
EEH Units and Class B Common Stock converted to Class A Common Stock 199,993
(199,993 ) —
EEH Units issued in connection with the vesting of restricted stock units 231,834
—
231,834
As of March 31, 2020 29,852,958
46.0 % 35,060,687
54.0 % 64,913,645

Note 7. 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. 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.

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~~EARTHSTONE ENERGY, INC.~~

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

A reconciliation of Net (loss) income ~~(loss)~~ per common share is as follows:

Three Months Ended
March 31,
(In thousands, except per share amounts) 2020 2019
Net income (loss) attributable to Earthstone Energy, Inc. $ 16,708
$ (17,204 )

Net income (loss) per common share attributable to Earthstone Energy, Inc.:
Basic $ 0.57
$ (0.60 )
Diluted $ 0.57
$ (0.60 )

Weighted average common shares outstanding
Basic 29,497,428
28,719,542
Add potentially dilutive securities:
Unvested restricted stock units (1) —
—
Unvested performance units (1) —
—
Diluted weighted average common shares outstanding 29,497,428
28,719,542

~~(1)~~

	*Three Months Ended*					*Nine Months Ended*
	*September 30,*					*September 30,*
(In thousands, except per share amounts)	*2020*			*2019*		*2020*			*2019*
Net (loss) income attributable to Earthstone Energy, Inc.	$	(5,445	)	$	11,770	$	(5,076	)	$	3,343

Net (loss) income per common share attributable to Earthstone Energy, Inc.:
Basic	$	(0.18	)	$	0.41	$	(0.17	)	$	0.12
Diluted	$	(0.18	)	$	0.41	$	(0.17	)	$	0.12

Weighted average common shares outstanding
Basic		30,073,635			29,032,842		29,810,705			28,883,907
Add potentially dilutive securities:
Unvested restricted stock units (1)		0			0		0			0
Unvested performance units (1)		0			0		0			0
Diluted weighted average common shares outstanding		30,073,635			29,032,842		29,810,705			28,883,907

(1) For the three and nine months ended ~~March 31,~~September 30, 2020 and 2019, the Company had no0 dilutive effect related to unvested restricted stock units or performance units as, under the treasury stock method, the proceeds from the average unrecognized expense for both during ~~the period~~these periods were in excess of the weighted average outstanding fair value for the unvested shares for the same ~~period.~~

periods.

Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and net loss attributable to noncontrolling interest of $6.4 million for the three months ended September 30, 2020 and net loss attributable to noncontrolling interest of $6.0 million for the nine months ended September 30, 2020 would be added back to Net (loss) income attributable to Earthstone Energy, Inc. for the periods then ended, having no dilutive effect on Net (loss) income per common share attributable to Earthstone Energy, Inc.

Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and net income ~~(loss)~~ attributable to noncontrolling interest of ~~$20.0~~$14.4 million for the three months ended ~~March 31, 2020~~ September 30, 2019 and net income attributable to noncontrolling interest of $3.9 million for the nine months ended September 30, 2019 would be added back to Net (loss) income ~~(loss)~~ attributable to Earthstone Energy, Inc. for the ~~period~~periods then ended, having no dilutive effect on Net (loss) income ~~(loss)~~ per common share attributable to Earthstone Energy, Inc.

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 8. Common Stock

Class A Common Stock

At ~~March 31,~~September 30, 2020 and December 31, 2019, there were ~~29,852,958~~30,210,749 and 29,421,131 shares of Class A Common Stock issued and outstanding, respectively. During the three and nine months ended ~~March 31,~~September 30, 2020, 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, as amended (the ~~“2014~~“2014 Plan”), Earthstone issued ~~307,529~~195,344 and 726,082 shares, respectively, of Class A Common Stock, of which ~~75,695~~54,268 and 187,773 shares, respectively, of Class A Common Stock were retained as treasury stock and canceled to satisfy the related employee income tax liability. During the three and nine months ended ~~March 31,~~September 30, 2019, as a result of the vesting and settlement of restricted stock units under the 2014 Plan, Earthstone issued ~~225,401~~167,827 and 569,883 shares, respectively, of Class A Common Stock, of which ~~59,261~~49,111 and 151,716 shares, respectively, of Class A Common Stock were retained as treasury stock and canceled to satisfy the related employee income tax liability.

Additionally, as discussed below, shares of Class A Common Stock were issued as the result of conversions of Class B Common Stock.

Class B Common Stock

At ~~March 31,~~September 30, 2020 and December 31, 2019, there were ~~35,060,687~~35,009,371 and 35,260,680 shares of Class B Common Stock issued and outstanding, respectively. Each share of Class B Common Stock, together with ~~one~~1 EEH Unit, is convertible into ~~one~~1 share of Class A Common Stock. During the three and nine months ended ~~March 31,~~September 30, 2020 ~~199,993~~, 49,316 and 251,309 shares, respectively, of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock. During the three and nine months ended September 30, 2019, 35,732 shares of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock. ~~No shares were converted during the three months ended March 31, 2019.~~

Note 9. Stock-Based Compensation

Restricted Stock Units

The 2014 Plan, allows, among other things, for the grant of restricted stock units (“RSUs”). As of ~~March 31,~~September 30, 2020, the maximum number of shares of Class A Common Stock that may be issued under the 2014 Plan was ~~6.4~~9.4 million shares.

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~~EARTHSTONE ENERGY, INC.~~

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

Each RSU represents the contingent right to receive ~~one~~1 share of Class A Common Stock. The holders of outstanding RSUs do not receive dividends or have voting rights prior to vesting and settlement. The Company determines the fair value of granted RSUs based on the market price of the Class A Common Stock on the date of the grant. Compensation expense for granted RSUs is recognized on a straight-line basis over the vesting and is net of forfeitures, as incurred. Stock-based compensation is included in General and administrative expense in the Condensed Consolidated Statements of Operations and is recorded with a corresponding increase in Additional paid-in capital within the Condensed Consolidated Balance Sheets.

The table below summarizes RSU award activity for the ~~three~~nine months ended ~~March 31, 2020:~~

Shares Weighted-Average Grant Date Fair Value
Unvested RSUs at December 31, 2019 1,107,796
$ 6.60
Granted 568,900
$ 5.15
Vested (307,529 ) $ 6.79
Unvested RSUs at March 31, 2020 1,369,167
$ 5.95

September 30, 2020:

	*Shares*			*Weighted-Average Grant Date Fair Value*
Unvested RSUs at December 31, 2019		1,107,796		$	6.60
Granted		568,900		$	5.15
Forfeited		(1,083	)	$	5.19
Vested		(726,082	)	$	6.43
Unvested RSUs at September 30, 2020		949,531		$	5.86

As of ~~March 31,~~September 30, 2020, there was ~~$8.0~~$5.4 million of unrecognized compensation expense related to the RSU awards which will be recognized over a weighted average period of ~~1.04~~0.85 years.

For the three and nine months ended ~~March 31,~~September 30, 2020, Stock-based compensation related to RSUs was ~~$1.7 million.~~$1.2 million and $4.2 million, respectively. For the three and nine months ended ~~March 31,~~September 30, 2019, Stock-based compensation related to RSUs was ~~$1.6 million.~~$1.4 million and $4.5 million, respectively.

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Performance Units

The table below summarizes performance unit (“PSU”) activity for the ~~three~~nine months ended ~~March 31, 2020:~~

Shares Weighted-Average Grant Date Fair Value
Unvested PSUs at December 31, 2019 835,625
$ 10.51
Granted 1,043,800
$ 5.36
Unvested PSUs at March 31, 2020 1,879,425
$ 7.65

September 30, 2020:

	*Shares*		*Weighted-Average Grant Date Fair Value*
Unvested PSUs at December 31, 2019		835,625	$	10.51
Granted		1,043,800	$	5.36
Unvested PSUs at September 30, 2020		1,879,425	$	7.65

On January 30, 2020, ~~subject to approval of an amendment to the 2014 Plan to increase the number of available shares thereunder available for awards at the 2020 annual stockholder meeting,~~ the Board of Directors of Earthstone (the “Board”) granted 1,043,800 PSUs (the “2020 PSUs”) to certain officers pursuant to the 2014 ~~Plan.~~ Plan (the “2020 Grant”). The2020 Grant was subject to the approval of an amendment to the 2014 Plan to increase the number of available shares available thereunder (the “2014 Plan Amendment”). The 2014 Plan Amendment was approved at the 2020 annual meeting of stockholders held on June 3, 2020. The 2020 PSUs are payable in shares of Class A Common Stock based upon the achievement by the Company over a period commencing on February 1, 2020 and ending on January 31, 2023 ~~(the~~(the “Performance Period”) of certain performance criteria established by the Board.

The2020 PSUs are eligible to be earned based on the annualized Total Shareholder Return (“TSR”) of the Class A Common Stock during a ~~three-year~~three-year period beginning on February 1, 2020. Between 0x to 2.0x of the Performance Units are eligible to be earned based on ~~our~~Earthstone achieving an annualized TSR based on the following pre-established goals:

Company’s Annualized TSR TSR Multiplier
23.9% or greater 2.0
14.5% 1.0
8.4% 0.5
Less than 8.4% 0.0

Earthstone’s Annualized TSR		*TSR Multiplier*
23.9% or greater		2.0
14.5%		1.0
8.4%		0.5
Less than 8.4%		0.0

In the event that greater than 1.0x of the2020 PSUs are earned, such additional PSUs may be paid in cash rather than the issuance of shares of Class A Common Stock. Based on the ~~COVID-19~~COVID-19 pandemic and the recent commodity price crash, ~~we believe~~the Company believes that the target annualized TSR of 14.5% included in the 2020 PSU awards will be difficult to achieve.

The Company accounts for these awards as market-based awards which are valued utilizing the Monte Carlo Simulation pricing model, which calculates multiple potential outcomes for an award and establishes grant date fair value based on the most likely outcome. For the 2020PSUs, ~~granted on January 30, 2020,~~ assuming a risk-free rate of 1.4% and volatility of 62.0%, the Company calculated the weighted average grant date fair value per PSU to be $5.36.

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~~EARTHSTONE ENERGY, INC.~~

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

As of ~~March 31,~~September 30, 2020, there was ~~$9.7~~$7.3 million of unrecognized compensation expense related to the PSU awards which will be amortized over a weighted average period of ~~1.18~~0.98 years.

For the three and nine months ended ~~March 31,~~September 30, 2020, Stock-based compensation related to the PSUs was approximately ~~$1.0 million.~~$1.2 million and $3.5 million, respectively. For the three and nine months ended ~~March 31,~~September 30, 2019, Stock-based compensation related to the PSUs was approximately ~~$0.6 million.~~$0.8 million and $2.2 million, respectively.

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Long-Term Debt

Credit Facility

On November 21, 2019,Earthstone, EEH (the “Borrower”), Wells Fargo Bank, National Association, as Administrative Agent and Issuing Bank (“Wells Fargo”), Royal Bank of Canada, as Syndication Agent, BOKF, NA dba Bank of Texas (“BOKF”) as Issuing Bank with respect to Existing Letters of Credit, SunTrust Bank, as Documentation Agent, and the lenders party thereto (the “Lenders”) entered into a credit agreement (the “Credit Facility”), which replaced the Prior Credit Facility (as defined below), which was terminated on November 21, 2019.

Concurrently with the effectiveness of the Credit Facility, the Company terminated that certain credit agreement, dated as of May 9, 2017 ~~(the~~(the “Prior Credit Facility”), by and among the Borrower, 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, the guarantors party thereto, the lenders party thereto, and BOKF, as administrative agent.

On March 27, 2020, in connection with a redetermination of the borrowing base under the ~~Company's senior secured revolving credit facility (the “Credit Facility”),~~Credit Facility, the borrowing base was set at $275 million, representing a 15% decrease from the previous borrowing base of $325 million.

On September 28, 2020, Earthstone, EEH, Wells Fargo, the guarantors party thereto, and the Lenders entered into an amendment (the “Amendment”) to the Credit Facility. Among other things, the Amendment decreased the borrowing base from $275 million to $240 million, increased the interest rate on outstanding borrowings by 25 to 50 basis points, increased the flexibility to finance and make acquisitions, and added certain restrictions related to dividends and distributions.

The next regularly scheduled redetermination of the borrowing base is on or around ~~November~~April 1, ~~2020.~~

~~The borrowing base under the Credit Facility is subject to redetermination~~2021. Subsequent redeterminations will occur on or about each November 1st and May 1st ~~of each year.~~ thereafter. The amounts borrowed under the Credit Facility bear annual interest rates at either (a) the adjusted LIBO Rate (as customarily defined) (the “Adjusted LIBO Rate”) plus ~~1.75%~~2.00% to ~~2.75%~~3.25% or (b) the sum of (i) the greatest of (A) the prime rate of Wells Fargo, (B) the federal funds rate plus ½ of 1.0%, and (C) the Adjusted LIBO Rate for an interest rate period of one month plus 1.0%, (ii) plus ~~0.75%~~1.00% to ~~1.75%~~2.25%, depending on the amount borrowed under the ~~credit facility.~~Credit Facility. Principal amounts outstanding under the ~~credit facility~~Credit Facility are due and payable in full at maturity on November 21, 2024. All of the obligations under the Credit Facility, and the guarantees of those obligations, are secured by substantially all of EEH’s assets. Additional payments due under the Credit Facility include paying a commitment fee of 0.375% to 0.50% per year, depending on the amount borrowed under the ~~credit facility,~~Credit Facility, to the Lenders in respect of the unutilized commitments thereunder. EEH is also required to pay customary letter of credit fees.

Effective May 2020, the Company entered into certain interest rate swaps, exchanging the LIBO Rate for a fixed rate of 0.286% (the “Swap”). The initial notional amount of the Swap is $125 million through May 2022 and decreases to $100 million through May 2023 and $75 million through May 2024.

The Credit Facility 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, pay dividends and 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 Credit Facility requires EEH to maintain the following financial covenants: a current ratio of not less than 1.0 to 1.0 and a consolidated leverage ratio of not greater than 4.0 to 1.0. Consolidated 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 to (ii) EBITDAX for the applicable ~~period.~~period, which was calculated as EBITDAX for the four consecutive fiscal quarters ending on such date. 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) certain distributions to employees related to the stock compensation, (vii) certain transaction related expenses, (viii) reimbursed indemnification expenses related to certain dispositions and investments, (ix) non-cash extraordinary, usual, or nonrecurring expenses or losses, ~~(x)~~(x) other non-cash charges and minus (b) to the extent included in consolidated net income in such period: (i) non-cash income, ~~and~~ (ii) gains on asset dispositions, disposals and abandonments outside of the ordinary course of ~~business.~~

business and (iii) to the extent not otherwise deducted from consolidated net income, the aggregate amount of any pass-through cash distributions received by Borrower during such period in an amount equal to the aggregate amount of pass-through cash distributions actually made by Borrower during such period.

The Credit Facility 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 a change in control. Upon the occurrence and continuance of an event of default, the Lenders have the right to accelerate repayment of the loans and exercise

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~~EARTHSTONE ENERGY, INC.~~

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

their remedies with respect to the collateral. As of ~~March 31,~~September 30, 2020, EEH was in compliance with the covenants under the Credit Facility.

As of ~~March 31,~~September 30, 2020 ~~$152.0~~, $130.0 million of borrowings were outstanding, bearing annual interest of ~~2.870%~~2.658%, resulting in an additional ~~$123.0~~$110.0 million of borrowing base availability under the Credit Facility. At December 31, 2019, there were $170.0 million of borrowings outstanding under the Credit Facility.

For the ~~three~~nine months ended ~~March 31,~~September 30, 2020, under the Credit Facility, the Company had borrowings of ~~$17.5~~$93.9 million and ~~$35.5~~$133.9 million in repayments of borrowings.

For the three and nine months ended ~~March 31,~~September 30, 2020, interest on borrowings under the Credit Facility averaged ~~3.60%~~2.48% and 2.89% per annum, respectively, which excluded commitment fees of $0.2 million and $0.5 million, respectively, and amortization of deferred financing costs of $0.1 ~~million.~~million and $0.2 million, respectively. For the three and nine months ended ~~March 31,~~September 30, 2019, interest on borrowings under the Credit Facility averaged ~~4.64%~~4.38% and 4.53% per annum, respectively, which excluded commitment fees of $0.2 million and $0.5 million, respectively, and amortization of deferred financing costs of $0.1 ~~million.~~

million and $0.3 million, respectively.

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. These capitalized costs are included in Other noncurrent assets in the Condensed Consolidated Balance Sheets. NoNaN costs associated with the Credit Facility were capitalized during the three and nine months ended ~~March 31,~~September 30, 2020 nor ~~2019.~~2019.

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 11. 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.

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

	*2020*
Beginning asset retirement obligations	$	2,164
Liabilities incurred		46
Accretion expense		137
Divestitures		(10	)
Revision of estimates		(2	)
Ending asset retirement obligations	$	2,335

2020
Beginning asset retirement obligations $ 2,164
Liabilities incurred 23
Accretion expense 44
Divestitures (10 )
Revision of estimates (2 )
Ending asset retirement obligations $ 2,219

Note 12. 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 5.9% of the outstanding Class A Common Stock and approximately 2.7% of the combined voting power of the Company's outstanding Class A Common Stock and Class B Common Stock as of March 31, 2020, is a party to a joint operating agreement (the “Operating Agreement”) with a subsidiary of the Company. The Operating Agreement covers certain jointly owned oil and natural gas properties located in the Eagle Ford Trend in Texas. In connection with the Operating Agreement, the Company made payments to Flatonia of $3.3 million and received payments from Flatonia of $1.0 million for the three months ended March 31, 2020. For the three months ended March 31, 2019, the Company made payments to Flatonia of $4.3 million and received payments from Flatonia of $1.3 million. At March 31, 2020 and December 31, 2019, amounts receivable from Flatonia in connection with the Operating Agreement were $0.7 million and $0.6 million, respectively. Payables related to revenues outstanding and due to Flatonia as of March 31, 2020 and December 31, 2019 were $0.8 million and $1.1 million, respectively.

Earthstone's majority shareholder consists of various investment funds managed by a ~~venture capital~~private equity firm who may manage other investments in entities with which the Company interacts in the normal course of business. On February 12, 2020, the Company sold certain of its interests in oil and natural gas leases and wells in an arm’s length transaction to a portfolio company of Earthstone’s majority shareholder ~~(not~~(not under common control) for cash consideration of approximately $0.4 million.

In connection with the Olenik v. Lodzinski et al. ~~(described below),~~lawsuit described below in Note 13. Commitments and Contingencies, Earthstone’s majority shareholder was also named in the lawsuit. ~~The~~As a result of the Settlement Agreement (defined below), the Company ~~is currently in~~has concluded negotiations with its insurance carrier ~~around~~regarding an allocation of ~~litigation~~defense costs and settlement contributions above its deductible for all the parties named in

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~~EARTHSTONE ENERGY, INC.~~

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

the lawsuit. ~~Once the allocation is agreed upon, cost will be assigned to each party affected. As of March 31,~~In June 2020, the Company ~~has not~~ received $0.6 million in preliminary reimbursements from its majority shareholder and as of September 30, 2020 recorded a receivable ~~for prospective insurance settlement proceeds. Charges associated with this legal action are included in Transaction costs~~ in the ~~Condensed Consolidated Statements~~amount of ~~Operations. Any proceeds received~~$0.6 million from its majority shareholder based on estimated additional defense costs to finalize the ~~Company’s insurance carrier will be recorded as a reduction~~settlement and the respective allocated portion of ~~Transactions costs in~~ the ~~period received. See~~ settlement payments.

Note 13. Commitments and Contingencies.

~~Note 13. Commitments and Contingencies~~

Legal

From time to time, Earthstone and its subsidiaries may be involved in various legal proceedings and claims in the ordinary course of business.

Olenik v. Lodzinski 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 Holdings and Oak Valley Resources, LLC. The complaint alleges that Earthstone’s directors breached their fiduciary duties in connection with the contribution agreement dated as of November 7, 2016 and as amended on March 21, 2017 ~~(the~~(the “Bold Contribution Agreement”), by and among Earthstone, EEH, Lynden US, Lynden USA Operating, LLC, Bold Holdings and Bold. The Plaintiff asserts that the directors negotiated the business combination pursuant to the Bold Contribution Agreement (the “Bold ~~Transaction"~~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’s 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~~After engaging in extensive pre-trial discovery, the parties engaged in a mediation process that resulted in a non-binding settlement term sheet on September 21, 2020. The term sheet is being translated into a Stipulation and ~~each~~Agreement of Compromise, Settlement and Release Agreement (the “Settlement Agreement”) between the parties and will then be filed with the Delaware Court of Chancery for approval. The principal terms of the ~~other~~anticipated Settlement Agreement are as follows: (i) a $3.5 million all-in cash settlement payment (the “Fund”) to be funded by defendants ~~believe~~and/or their insurers into an escrow account, (ii) a bi-lateral complete and full release of all claims against defendants and plaintiffs, and (iii) that 55% of the claims are entirely without merit and intend to mount a vigorous defense. The ultimate outcome of this suit is uncertain, and while Earthstone is confident in its position, any potential monetary recovery or lossFund (the derivative payment) be paid to Earthstone to be used as determined by management, according to their fiduciary duties and business judgment, 45% of the Fund (the class payment) be paid to members of the class or current stockholders of Earthstone. The Company expects court approval of the Settlement Agreement and in addition estimates the insurance carriers and related affiliates to reimburse the Company in the amount of $2.8 million and $0.1 million, respectively. As described above, the Company expects to receive a portion of the derivative payment, however, the amount cannot be ~~estimated~~reasonably determined at this time.

Prior to September 30, 2020, due to uncertainty of reimbursement, the Company recorded and accrued litigation costs when incurred and recorded insurance reimbursements as an offset only when proceeds were received in Transactions costs. In light of the Settlement Agreement, insurance carrier agreement on allocation of defense costs and settlement payment combined with the history of reimbursements from insurance carriers and related affiliate, a high probability of reimbursement exists. Accordingly, the Company has accrued $3.75 million related to the Settlement Agreement and estimated final defense costs associated with this legal action included in Accrued expenses in the Condensed Consolidated Balance Sheets, offset by an accrued $5.7 million of estimated reimbursements from insurance carriers and the majority shareholder which are included in Accounts receivable: Joint interest billings and other, net in the Condensed Consolidated Balance Sheets, with the impact of both items included in Transaction costs in the Condensed Consolidated Statements of Operations.

Environmental and Regulatory

As of ~~March 31,~~September 30, 2020, 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.

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EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 14. Income Taxes

The Company’s corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns and one Canadian income tax return which include Lynden US, Earthstone, and Lynden Corp. As such, taxable income of Earthstone cannot be offset by tax attributes, including net operating losses, of Lynden US, nor can taxable income of Lynden US be offset by tax attributes of Earthstone. Earthstone and Lynden US record a tax provision, respectively, for their share of the book income or loss of EEH, net of the non-controlling interest. As EEH is treated as a partnership for U.S. Federal income tax purposes, it is not subject to income tax at the federal level and only recognizes the Texas Margin Tax.

During the ~~three~~nine months ended ~~March 31,~~September 30, 2020, the Company recorded income tax expense of approximately ~~$1.1~~$0.1 million which included ~~(1)~~(1) no income tax expense for Lynden US ~~of $0.7 million~~ as a result of its share of the distributable income from EEH, ~~(2)~~(2) a deferred income tax ~~expense~~benefit for Earthstone of ~~$2.9~~$0.8 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and ~~(3)~~(3) deferred income tax expense of ~~$0.4~~$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~~nine months ended ~~March 31, 2020.~~

September 30, 2020.

During the ~~three~~nine months ended ~~March 31,~~September 30, 2019, the Company recorded income tax ~~benefit~~expense of approximately ~~$0.5~~$0.7 million which included ~~(1)~~(1) income tax benefit for Lynden US of ~~$0.8~~$0.1 million as a result of its share of the distributable ~~income~~loss from EEH, ~~(2)~~(2) no net income tax benefit for Earthstone ~~of $2.9~~as the $0.6 million ~~as a result of~~income tax benefit resulting from its share of the distributable ~~income~~loss from EEH ~~which was used to reduce the~~had a full valuation allowance recorded against ~~its deferred tax asset~~it as future realization of the net deferred tax asset cannot be assured and

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~~EARTHSTONE ENERGY, INC.~~

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

~~(3)~~ (3) deferred income tax expense of ~~$0.3~~$0.6 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the ~~three~~nine months ended ~~March 31, 2019.~~September 30, 2019.

Note 15. Goodwill

Goodwill represents the excess of the purchase price of assets acquired over the fair value of those assets. The fair value of Goodwill is classified as a Level 3 measurement according to the fair value hierarchy defined by ASC 820. Goodwill is tested for impairment annually, or more frequently if events or changes in circumstances dictate that the carrying value of goodwill may not be recoverable. Such test includes an assessment of qualitative and quantitative factors. If the results of such tests are such that the fair value of the reporting unit is less than the carrying value, goodwill is then reduced by an amount that is equal to the amount by which the carrying value exceeds the fair value.

A discounted future cash flow analysis of the ~~Midland~~ properties to which the Goodwill was associated was performed based on commodity price futures as of March 31, 2020. The resulting fair value was lower than the net book value of the associated properties. Additionally, the Company’s enterprise value, calculated as the combined market capitalization of the Company’s equity and ~~the fair value of the Company’s~~ long-term debt, was lower than the ~~fair~~book value of ~~the~~its assets, without allocating between the Company's two major properties, Midland properties and Eagle Ford properties. Accordingly, the entire $17.6 million balance of Goodwill was ~~impaired.~~

~~As such, the Company~~impaired on that date. No additional impairments have been recorded ~~a $17.6 million non-cash impairment charge during the three months ended March 31,~~ to Goodwill through September 30,2020. The Company did not have any non-cash impairment charges to ~~its goodwill~~Goodwill for the three and nine months ended ~~March 31,~~September 30, 2019.

Accumulated impairments to Goodwill as of ~~March 31,~~September 30, 2020 and December 31, 2019 were $36.7 million and $19.1 million, respectively.

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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 2019 Annual Report on Form 10-K and “Part II, Item 1A - Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 that ~~was~~were 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, 2019, which are included in our 2019 Annual Report on Form 10-K.

Overview

Earthstone Energy, Inc., a Delaware corporation (“Earthstone” and together with our consolidated subsidiaries, the “Company,” “our,” “we,” “us,” or similar terms), is a growth-oriented independent oil and gas company engaged in the acquisition and development of oil and gas reserves through activities that include the acquisition, drilling and development of undeveloped leases, asset and corporate acquisitions and mergers. Our operations are all in the upstream segment of the oil and natural gas industry and all our properties are onshore in the United States. At present, our assets are located in the Midland Basin of west Texas and the Eagle Ford Trend of south Texas.

~~Strategy~~

COVID-19

According to the United States (“U.S.”) Centers for ~~Addressing~~Disease Control and Prevention (the “CDC”), in March 2020, the ~~Effects~~U.S. entered the acceleration (or 4th) phase of ~~COVID-19~~

~~The ongoing~~the pandemic of the novel coronavirus (“COVID-19”) ~~outbreak,~~. On May 1, 2020 they indicated that there was still the potential for future acceleration. This conclusion was based on the Pandemic Intervals Framework created by the CDC, which describes the ~~World Health Organization declared as a~~progression of an influenza pandemic in six intervals or phases. The duration of each phase may vary depending on ~~March 11, 2020, has reached more than 200 countries and there is considerable uncertainty regarding~~ the ~~extent to which COVID-19 will continue to spread~~type of virus and the ~~extent~~public health response.

The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and ~~duration~~created significant volatility and disruption of ~~governmental~~financial and commodity markets. In addition, the pandemic has resulted in travel restrictions, business closures and the institution of quarantining and other ~~measures implemented to try to slow the spread of the virus, such as quarantines, shelter-in-place orders and business and government shutdowns and the economic impact of such actions.~~

~~One of the impacts of COVID-19~~restrictions on movement in many communities. As a result, there has been a significant reduction in demand for ~~crude oil.~~and prices of oil and natural gas, which has adversely affected our business. The ~~supply/demand imbalance driven by COVID-19, as well as recent production disagreements among members~~extent of the ~~Organization~~impact of ~~Petroleum Exporting Countries~~the COVID-19 pandemic on our operational and financial performance, including our ability to execute our business strategies and initiatives in the expected time frame, is uncertain and depends on various factors, including how the pandemic and measures taken in response to it impact demand for oil and natural gas, the availability of personnel, equipment and services critical to our ability to operate our properties and the impact of potential governmental restrictions on travel, transports and operations. There is uncertainty around the extent and duration of disruption, including any resurgence, and we expect that the longer the period of such disruption continues, the greater the adverse impact will be on our business. The degree to which the COVID-19 pandemic or any other ~~producer countries, has led~~public health crisis adversely impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, ~~significant global consumer demand contraction~~the duration and ~~is in turn having a major disruptive~~spread of the outbreak, its severity, the actions to contain the virus or treat its impact, its impact on the ~~oil~~U.S. and ~~gas industry. Consequently, crude oil prices have declined at unprecedented rates, which has led~~world economies, the U.S. capital markets and market conditions, and how quickly and to ~~production shut-ins,~~what extent normal economic and ~~may lead to more in the future, both voluntary and potentially involuntarily.~~

operating conditions can resume.

Operational Status

As a ~~result,~~producer of oil, natural gas and NGLs, we ~~have reduced our 2020 capital program~~are recognized as an essential business under various federal, state and local regulations related to preserve capital and cash flows. Our short-term strategy is to weather COVID-19 and be in a position, when the time comes, to execute our long-term business strategy to develop our properties efficiently, as well as being able to take advantage of unique growth opportunities as they arise. However, an extended period of severely depressed commodity prices and low demand may create more uncertainty with our ability to model and plan to participate in any economic recovery.

~~Operational Status~~

We continue to manage and produce our properties, as we wind down drilling and completion activities that were already in progress when the current industry conditions began, experiencing no complications arising from the COVID-19 pandemic. We have continued to operate as permitted under these regulations while taking mitigation ~~efforts.~~efforts and steps to protect the health and safety of our employees. The safety of our employees is paramount, and we have emphasized the respective guidelines to support ~~such~~our mitigation efforts. Our field personnel are performing their job responsibilities and practicing mitigation guidelines with no issues ~~so far. Non-field~~to date. Our non-field personnel ~~have~~had been working remotely, using information technology in which we previously ~~invested in.~~invested. More recently, the majority of our non-field personal have been working at our corporate offices while adhering to County and CDC guidelines. Upon returning to work at our corporate offices, we implemented protocols that consist of required mask wearing zones, installed sanitization equipment in various locations and practice social distancing in gathering areas such as conference rooms. We have ~~been able to manage~~managed and ~~conduct~~conducted both field and non-field functions effectively thus ~~far.~~far, including our day to day operations, our accounting and financial reporting systems and our internal control over financial reporting. We will continue to focus on the health and safety of our employees ~~and support~~in conformity with the respective jurisdictional mitigation guidelines.

~~Recent Developments~~

~~Financial Update~~

~~We have no material long-term contracts, relatively low leverage,~~

Commodity Market Challenges

The significant decline in commodity prices resulting from the COVID-19 pandemic has negatively impacted producers of oil, natural gas and NGLs in the U.S. and elsewhere. The COVID-19 pandemic resulted in global consumer demand contraction and the ensuing supply/demand imbalance is in turn having a ~~very strong hedge position, which affords us the flexibility to adjust our capital plan with no adverse~~disruptive impact on ~~our current financial position. We recently took action to reduce our capital program to $50 - $60 million for 2020. Additionally, due to the low~~oil and gas exploration and production. In April 2020, WTI crude oil prices ~~expected in May, we are~~averaged $16.55/Bbl and briefly fell below $0/Bbl, closing at -$36.98/Bbl on April 20, 2020. In response, management began to voluntarily ~~reducing our operated~~shut-in as much production ~~by 70-80% and estimate total Company production will be curtailed by 55-70% for the month of May. Based on oil prices in future months, we will determine curtailments~~ as ~~necessary, therefore, we expect to update our production guidance for the remainder of 2020 in the near future. We also initiated actions~~was feasible in an effort to ~~reduce our 2020 cash-basis general~~preserve reserves to sell in the future. As prices returned to acceptable levels, management returned those wells to production as quickly as possible, beginning in late May and ~~administrative expenses~~early June. Management estimates that total net production was curtailed by approximately 60% in May, with ~~a goal~~minimal volumes curtailed in April and June. Since early June, WTI crude oil prices have averaged over $40/Bbl and we have been operating at full production capacity.

While crude prices have recovered from recent lows, further recovery in demand and reductions in global oil inventories will be required to return oil prices to pre-pandemic and economic slowdown levels. Within the U.S., the combination of producer activity reduction and production curtailments was sufficient to reduce it by approximately 25% from our previous plan. Our oil swap position for the period April-December 2020 is approximately 8,000 Bopd, hedged at a WTI price of $57.00/Bbl. Based on the foregoing adjusted 2020 operating plan, we expect to generate Free Cash Flow (defined in “Non-GAAP Measures” below) beginning in the second quarter of 2020. Free Cash Flow would be utilized to improve our working capital and to reduce borrowings currently outstanding under our senior secured revolving credit facility (the “Credit Facility”). With the recent storage capacity constraints and forecasted single digit net oil prices at the wellhead, we have begun shutting in wells that have low operating margins. The impact of reduced production volumes on the remainder of 2020 will be dependent upon many industry factors, the most material of which include consumerdomestic supply below demand and ~~storage constraints.~~

~~With the comprehensive set of actions described above,~~prevent material infrastructure operational curtailments from occurring. However, with curtailed U.S. volumes returning, we ~~believe we are in a position~~may choose to operate effectively despite the consequences of the COVID-19 mitigation efforts. Additionally, we believe the economy will recover and the demand for oil will return as more developments occur in meeting and covering COVID-19 business challenges. Our current financial focus is to maintain the healthcurtail some or all of our ~~balance sheet~~estimated production due to future changes in supply and ~~continue limited operations so we are in a position to execute a business strategy that will provide an essential world commodity for years to come.~~demand fundamentals.

~~Consolidation Focus~~

As we believe we are in a position to operate effectively despite the COVID-19 induced low oil price, we continue to pursue value-accretive and scale-enhancing consolidation opportunities. We are focusing our attention on acquisition and corporate merger opportunities which would increase the scale

Table of our operations. In addition, we believe the current industry environment presents unique opportunities with distressed assets or corporations that will be distressed in the near future which would provide us the potential for further consolidation because of our financial strength. At the same time, we look to block up acreage that wouldContents

allow for longer horizontal laterals which would provide for higher economic returns when commodity prices recover and we return to asset development. In short, we believe we are well qualified to be a consolidator which could increase the scale of our operations and add value to our shareholders.

~~CARES Act~~

We have reviewed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) with respect to obtaining a small business loan but determined we are not eligible to participate in its current form. This does not have a material impact to our business and our strategy does not contemplate any benefits from the CARES Act as it is presently framed.

~~Continued Efforts to Fight COVID-19~~

Operational/Financial Challenges

It is difficult to model and predict how our operations and financial status may change as a result of ~~the continued efforts to fight~~ COVID-19. There is a range of possible outcomes, depending upon how quickly both economic activity and the demand for oil recovers which is a function onof how quickly solutions are developed to overcome the effects of COVID-19. In our industry, any forecast, plans and changes to operations and financial status are a function of commodity prices. Assuming that oil prices stay ~~severely~~ depressed or worsen, we believe we can continue to operate and produce our properties at a minimum in a cash flow neutral position for the next 12 ~~months, based upon the comprehensive actions described above in~~ ~~Financial Status~~.months. We will have to manage the possibility of well shut-ins, both voluntary and involuntary, to preserve our assets and cash flows. A significant driver in the future may be ~~with~~ the financial ~~institutions~~institutions’ view on commodity prices with respect to borrowing base redeterminations. ~~Any~~Since the beginning of 2020, our borrowing base has been reduced from $325 million to $240 million. Further significant reductions in the borrowing base under our Credit Facility could create a borrowing base deficiency which may lead to a default. We believe global, as well as national, mitigation efforts currently being implemented to fight COVID-19 have had, and may continue to have, a material impact on commodity prices and may continue to present significant challenges to our industry.

The ongoing effects of COVID-19, including a substantial decrease in economic activity, have contributed to equity market volatility and resulted in a global recession. Similar to other producers in our business, we experienced volatility and a decline in the price of our Class A common stock. While the price of our Class A common stock has recently stabilized somewhat, it remains historically low.

Liquidity

In March 2020, in response to the significant decrease in commodity prices, we significantly reduced our capital program for 2020 and halted all drilling and completion activity. In light of recent oil price recoveries and meaningful service cost reductions compared to earlier in the year, we have commenced completions of a six-well pad and currently expect total capital spending for 2020 to be in the range of $65 - $70 million. Additionally, we currently expect to begin completions of a five-well pad in January 2021. We expect to fund these completions with internally generated cash flows.

COVID-19 has adversely impacted our revenues in the three and nine months ended September 30, 2020 as a result of both low commodity prices and our voluntary shut-ins. However, due to our commodity hedging activities partially offsetting those reduced revenues, there has been no significant overall impact on our cash flows from producing activities.

Since the beginning of 2020, our borrowing base has been reduced through two sequential reductions from $325 million to $240 million. We continue remain in compliance with all covenants under our Credit Facility. If commodity prices continue to be depressed, we may experience future borrowing base reductions.

For further discussion of our liquidity as of September 30, 2020, see Liquidity and Capital Resources below.

Oil and Gas Reserves

In line with our borrowing base reductions, our oil and gas reserves have significantly been reduced primarily due to the significant decrease in commodity prices from year end. Further deterioration of commodity prices would further negatively impact our oil and gas reserves.

Impairments

The COVID-19 effects resulted in impairments in the first quarter on our proved developed properties and undeveloped properties in the amount of $25.3 million and $11.3 million, respectively. Further reductions in our oil and gas reserves and commodity prices may result in additional impairments on our oil and gas properties. Including impairments for certain acreage expirations, impairments on our proved developed properties and undeveloped properties for the nine months ended September 30, 2020 were $25.3 million and $19.7 million, respectively.

Government Assistance

Although management explored all assistance available under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), the Company was not eligible for any of the programs therein with the exception of the deferral of employment tax deposits and payments which management has currently not elected to pursue.

Impact on Capital Program

In light of the current economic environment, we have reduced our 2020 capital program in order to preserve capital and cash flows. Our short-term strategy is to weather COVID-19 and be in a position, when the time comes, to execute our long-term business strategy to develop our properties efficiently, as well as being able to take advantage of growth opportunities as they arise. However, an extended period of severely depressed commodity prices and low demand may create more uncertainty in our ability to model and make plans to participate in any economic recovery.

Employee Reduction Measures

In June 2020, management completed a workforce reduction effort that reduced the number of full-time employees from 68 to 60 by month end, resulting in over a 10% decrease in aggregate salaries and wages going forward. Severance related costs associated with these reduction measures resulted in operating expenses of $0.4 million in June 2020. At this time, management has no future plans for further workforce reductions; however, if adverse industry conditions persist, further employee reduction measures may be necessary.

Outlook

We do not expect commodity prices to return to pre-pandemic levels in the short term. In the longer term, we believe the U.S. and world economies will recover and the demand for oil will return in the range of pre-COVID-19 levels as more developments occur in meeting and addressing COVID-19 business challenges. Our current financial focus is to maintain the health of our balance sheet and continue limited capital expenditures with our internally generated cash flows to enable us to be in a position to execute a business strategy as commodity prices return to pre-pandemic levels.

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Recent Developments

Borrowing Base Redetermination

On September 28, 2020, Earthstone, EEH (the “Borrower”), Wells Fargo Bank, National Association as Administrative Agent (“Wells Fargo”), the guarantors party thereto, and the lenders party thereto (the “Lenders”) entered into an amendment (the “Amendment”) to the Credit Agreement dated November 21, 2019, by and among EEH, as Borrower, Earthstone, as Parent, Wells Fargo as Administrative Agent and Issuing Bank, BOKF, NA dba Bank of Texas, as Issuing Bank with respect to Existing Letters of Credit, Royal Bank of Canada, as Syndication Agent, Truist Bank, as successor by merger to SunTrust Bank, as Documentation Agent, and the Lenders (together with all amendments or other modifications, the “Credit Facility”). Among other things, the Amendment decreased the borrowing base from $275 million to $240 million, increased the interest rate on outstanding borrowings by 25 to 50 basis points, increased the flexibility to finance and make acquisitions, and added certain restrictions related to dividends and distributions.

As of September 30, 2020, we had outstanding borrowings under our Credit Facility of $130 million, which represents a reduction of 24% compared to the $170 million in outstanding borrowings as of December 31, 2019. Our only debt is borrowings under our Credit Facility.

Consolidation Focus

We believe that the current industry environment will move to more consolidations; however, execution may be hampered by producers with high debt levels and sellers unwilling to acknowledge persistent low commodity prices. We continue to pursue value-accretive and scale-enhancing consolidation opportunities, as we believe we are in a position to operate effectively despite the COVID-19 induced low oil price. We are focusing our attention on acquisition and corporate merger opportunities that would increase the scale of our operations. In addition, we believe the current industry environment presents unique opportunities with distressed assets or corporations that will be distressed in the near future which would provide us the potential for further consolidation because of our financial strength. At the same time, we will seek to block up acreage that would allow for longer horizontal laterals that would provide for higher economic returns when commodity prices recover and we return to asset development. In short, we believe we are well qualified to be a consolidator which could increase the scale of our operations and add value to our shareholders.

Officer Appointments

Effective April 1, 2020, our former Chairman and Chief Executive Officer, Mr. Frank A. Lodzinski, was appointed Executive Chairman and our former President, Mr. Robert J. Anderson, was appointed President and Chief Executive Officer.

~~Borrowing Base Redetermination~~

In addition, we accelerated and recently completed our regularly scheduled redetermination of our borrowing base under our Credit Facility with our borrowing base set at $275 million, representing a 15% decrease from our previous borrowing base of $325 million. As of March 31, 2020, we had outstanding borrowings under our Credit Facility of $152 million, which represents a reduction of 11% compared to the $170 million in outstanding borrowings as of December 31, 2019. Our only debt is borrowings under our Credit Facility.

~~Impairments~~

As an additional result of the severely depressed commodity prices discussed above, we recognized $60.4 million of non-cash asset impairments for the three months ended March 31, 2020 that have negatively impacted our results of operations and equity. Impairment expense for the three months ended March 31, 2020 consisted of $25.3 million reduction to Proved properties, $17.5 million reduction to Unproved properties and $17.6 million reduction to Goodwill, all in the Condensed Consolidated Balance Sheet as of March 31, 2020. If crude oil price futures continue to decline, we may incur additional impairments to our oil and natural gas properties.

Interest Rate Swap

Effective May 1, 2020, we entered into ~~certain~~an interest rate ~~swaps,~~swap, exchanging the LIBO Rate for a fixed rate of 0.286% (the “Swap”). The initial notional amount of the Swap is $125 million through May 2022 and decreases to $100 million through May 2023 and $75 million through May 2024.

~~Non-GAAP Measure~~

~~Free Cash Flow~~

Free cash flow is a measure that we use as an indicator of our ability to fund our development activities. We define free cash flow as Adjusted EBITDAX, less interest expense, less accrual-based capital expenditures. We define “Adjusted EBITDAX” as net income plus, when applicable, accretion of asset retirement obligations; impairment expense; depletion, depreciation and amortization; interest expense, net; transaction costs; (gain) loss on sale of oil and gas properties, net; exploration expense; unrealized (gain) loss on derivative contracts; stock-based compensation (non-cash); and income tax expense (benefit).

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~~

~~Having ended 2019 with~~

As previously disclosed, we completed three wells ~~waiting on completion, we completed~~in southeast Reagan County in late March and brought them online ~~those three gross~~in April, prior to voluntarily shutting the wells in for the duration of the month of May. In May, approximately 60% of our total production was shut-in. As oil prices have improved since then, we have returned to full production capacity. We have experienced no adverse effects from this short-term curtailment and ~~net operated wells during~~have incurred no significant costs in restoring production.

In late May, we concluded our 2020 drilling program and released our contracted rig operating in the Midland Basin. During the first ~~quarter~~half of ~~2020. Additionally,~~the year, we ~~had 15 gross / 3.1 net~~drilled a total of five wells ~~brought online at our non-operated Midland Basin properties during the first quarter of 2020. We finished drilling a five-well project on~~in our Hamman ~~30 Unit that was in-process at year-end, and, prior to~~Upton project along with six wells in our Ratliff unit, all located in Upton County, Texas. We have commenced completions of the ~~recent collapse of oil prices, we commenced drilling a~~ six-well pad in our Ratliff ~~project~~unit and expect to begin completions of the five-well Hamman Upton pad in ~~Upton County, Texas. We plan to finish drilling the six-well Ratliff pad, but we will delay all completions and drilling of future wells until there is improvement in the commodity price environment.~~

January 2021.

Despite the disruption in the oil markets resulting from the COVID-19 pandemic, we continue to seek acreage trade and acquisition opportunities in the Midland Basin which would allow for longer laterals, increased operated inventory and greater operating efficiency.

~~Eagle Ford Trend~~

~~We do not plan to drill any wells in our Eagle Ford Trend properties during 2020 but may consider drilling if there are significant improvements in oil and natural gas commodity prices.~~

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 ~~three~~nine months ended ~~March 31,~~September 30, 2020.

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Results of Operations

Three Months Ended ~~March 31,~~September 30, 2020, compared to the Three Months Ended ~~March 31,~~September 30, 2019

Three Months Ended March 31,
2020 2019 Change
Sales volumes:
Oil (MBbl) 880
678
30 %
Natural gas (MMcf) 1,670
827
102 %
Natural gas liquids (MBbl) 276
193
43 %
Barrels of oil equivalent (MBOE) 1,435
1,009
42 %
Average Daily Production (Boepd) 15,767
11,209
41 %

Average prices:
Oil (per Bbl) $ 46.59
$ 52.30
(11 )%
Natural gas (per Mcf) $ 0.65
$ 1.32
(51 )%
Natural gas liquids (per Bbl) $ 11.01
$ 21.66
(49 )%

Average prices adjusted for realized derivatives settlements:
Oil ($/Bbl)⁽¹⁾
$ 56.62
$ 59.81
(5 )%
Natural gas ($/Mcf)⁽¹⁾
$ 1.19
$ 1.66
(28 )%
Natural gas liquids ($/Bbl) $ 11.01
$ 21.66
(49 )%

(In thousands)
Oil revenues $ 41,012
$ 35,447
16 %
Natural gas revenues $ 1,086
$ 1,094
(1 )%
Natural gas liquids revenues $ 3,040
$ 4,187
(27 )%

Lease operating expense $ 9,339
$ 6,061
54 %
Production and ad valorem taxes $ 3,023
$ 2,594
17 %
Impairment expense $ 60,371
$ —
NM
Depreciation, depletion and amortization $ 24,656
$ 14,005
76 %

General and administrative expense (excluding stock-based compensation)
$ 4,438
$ 4,863
(9 )%
Stock-based compensation $ 2,694
$ 2,212
22 %
General and administrative expense $ 7,132
$ 7,075
1 %

Transaction costs $ 844
$ 370
NM
Gain (loss) on sale of oil and gas properties $ 204
$ (125 ) NM
Interest expense, net $ (1,736 ) $ (1,449 ) 20 %

Unrealized gain (loss) on derivative contracts $ 90,045
$ (53,256 ) NM
Realized gain on derivative contracts $ 9,739
$ 5,362
NM
Gain (loss) on derivative contracts, net $ 99,784
$ (47,894 ) NM

Income tax (expense) benefit $ (1,092 ) $ 460
NM

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

	Three Months Ended
	September 30,
	2020			2019			Change
Sales volumes:
Oil (MBbl)		839			646			30	%
Natural gas (MMcf)		2,010			1,248			61	%
Natural gas liquids (MBbl)		386			267			45	%
Barrels of oil equivalent (MBOE)		1,560			1,121			39	%
Average Daily Production (Boepd)		16,959			12,181			39	%

Average prices:
Oil (per Bbl)	$	39.50		$	54.89			(28	)%
Natural gas (per Mcf)	$	1.31		$	0.72			82	%
Natural gas liquids (per Bbl)	$	13.60		$	10.71			27	%

Average prices adjusted for realized derivatives settlements:
Oil ($/Bbl)(1)	$	49.34		$	59.43			(17	)%
Natural gas ($/Mcf)	$	1.45		$	1.34			8	%
Natural gas liquids ($/Bbl)	$	13.60		$	10.71			27	%

(In thousands)
Oil revenues	$	33,158		$	35,443			(6	)%
Natural gas revenues	$	2,642		$	903			193	%
Natural gas liquids revenues	$	5,247		$	2,858			84	%

Lease operating expense	$	7,044		$	6,419			10	%
Production and ad valorem taxes	$	2,696		$	2,698			(0	)%
Impairment expense	$	2,115		$	—			NM
Depreciation, depletion and amortization	$	28,538		$	14,079			103	%

General and administrative expense (excluding stock-based compensation)	$	3,393		$	3,850			(12	)%
Stock-based compensation	$	2,403		$	2,207			9	%
General and administrative expense	$	5,796		$	6,057			(4	)%

Transaction costs	$	(705	)	$	215			NM
Interest expense, net	$	(1,186	)	$	(1,609	)		(26	)%

Unrealized (loss) gain on derivative contracts	$	(14,543	)	$	15,021			NM
Realized gain on derivative contracts	$	8,503		$	3,705			NM
(Loss) gain on derivative contracts, net	$	(6,040	)	$	18,726			NM

Income tax expense	$	(130	)	$	(575	)		NM

NM – Not Meaningful

Oil revenues

For the three months ended ~~March 31,~~September 30, 2020, oil revenues ~~increased~~decreased by ~~$5.6~~$2.3 million or ~~16%~~6% relative to the comparable period in 2019. Of the ~~increase, $9.5~~decrease, $9.9 million was ~~attributable to an increase in volume, partially offset by $3.9 million attributable~~due to a decrease in our realized ~~price.~~price, partially offset by $7.6 million attributable to an increase in volume. Our average realized price per Bbl decreased from ~~$52.30~~$54.89 for the three months ended ~~March 31,~~September 30, 2019 to ~~$46.59~~$39.50 or ~~11%~~28% for the three months ended ~~March 31,~~September 30, 2020. We had a net increase in the volume of oil sold of ~~203~~194 MBbls or 30%, primarily due to new wells brought ~~online.~~

online in 2020.

Natural gas revenues

For the three months ended ~~March 31,~~September 30, 2020, natural gas revenues ~~remained flat~~increased by $1.7 million or 193% relative to the comparable period in ~~2019 as~~2019. Of the ~~$0.6~~increase, $1.0 million ~~impact of a 51% decline~~was attributable to increased sales volume and $0.7 million was due to an increase in realized price in the Midland Basin was almost entirely offset by a 102% increase in sales volume. Our average realized price per Mcf decreased 51% from $1.32 for the three months ended March 31, 2019 to $0.65 for the three months ended March 31, 2020. Approximately 96% of our natural gas sales volumes for the period was from the Midland Basin, which, since the fourth quarter of 2018, has been experiencing a lack of sufficient pipeline transportation that is connected to markets which are purchasing the gas. This has resulted in negative gas prices at times, whereby the seller is actually paying the purchaser to take the gas.price. The total volume of natural gas produced and sold increased ~~843~~by 762 MMcf or ~~102%~~61% primarily due to new wells brought ~~online.~~online in 2020. In the prior year's quarter, lack of sufficient pipeline transportation resulted in low natural gas prices, which have improved in the current year's quarter. Our average realized price per Mcf increased 82% from $0.72 for the three months ended September 30, 2019 to $1.31 for the three months ended September 30, 2020.

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Natural gas liquids revenues

For the three months ended ~~March 31,~~September 30, 2020, natural gas liquids revenues ~~decreased~~increased by ~~$1.1~~$2.4 million or ~~27%~~84% relative to the comparable period in 2019. Of the ~~decrease, $2.0~~increase, $1.6 million was due to increased volume and $0.8 million was attributable to ~~a decrease~~an increase in our realized price, partially offset by $0.9 million attributable to increased volume. Approximately 94% of our natural gas liquids sales volumes for the period was from the Midland Basin. Since the fourth quarter of 2018, the price for fractionated natural gas liquids has steadily decreased, and after also taking into account the cost to transport our natural gas liquids, has resulted in significant decreases in prices received.price. The volume of natural gas liquids produced and sold increased by 83119 MBbls or ~~43%~~45%, primarily due to new wells brought ~~online.~~

~~Lease operating expense (“LOE”)~~

~~LOE~~online in 2020. Our average realized price per Bbl increased ~~by $3.3 million or 54%~~27% from $10.71 for the three months ended ~~March 31,~~September 30, 2019 to $13.60 for the three months ended September 30, 2020.

Lease operating expense (“LOE”)

LOE increased by $0.6 million or 10% for the three months ended September 30, 2020 relative to the comparable period in 2019, primarily due to ~~additional producing~~new wells brought online, ~~which drove a 42% increase in production volume,~~ partially offset by ~~a $0.7 million decrease in~~lower workover project costs as compared to the prior year period.

Production and ad valorem taxes

Production and ad valorem taxes for the three months ended ~~March 31,~~September 30, 2020 ~~increased by $0.4 million or 17% relative~~were flat as compared to the ~~comparable~~prior year period ~~in 2019,~~ as the impact of ~~increased volume~~decreased oil prices was ~~largely~~ offset by ~~the impact of decreased commodity prices.~~increased production. As a percentage of revenues from oil, natural gas, and natural gas liquids, production taxes ~~declined slightly~~remained flat as compared to the prior ~~year primarily due to lower realized gas prices.~~

year.

Impairment expense

During the three months ended ~~March 31,~~September 30, 2020, we recorded non-cash impairments totaling ~~$60.4 million, which consisted of $25.3 million to proved oil and natural gas properties, $17.5~~$2.1 million to unproved oil and natural gas properties ~~and $17.6 million to goodwill.~~as the result of certain acreage expirations. No such impairments were recorded during the three months ended ~~March 31,~~September 30, 2019.

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

DD&A ~~increased~~ for the three months ended ~~March 31,~~September 30, 2020 increased by ~~$10.7~~$14.5 million, or ~~76%~~103% relative to the comparable period in 2019. The increase was primarily related to development and acquisition activity, partially offset by a first quarter 2020 impairment charge of $25.3 million, that resulted in increased costs subject to depletion. Other factors contributing to the increase were higher sales volumes and certain downward adjustments to estimated recoverable proved oil and natural gas reserves caused by lower commodity prices.

General and administrative expense (“G&A”)

G&A for the three months ended September 30, 2020 decreased by $0.3 million, or 4% relative to the comparable period in 2019, primarily due to ~~development and acquisition activity that resulted in increased costs subject to depletion and an increase in production primarily in the Midland Basin.~~

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

~~G&A for the three months ended March 31, 2020 decreased by $0.1 million, or 1% relative to the comparable period in 2019, primarily due to the suspension of~~lower cash-based incentive compensation expenses, including the impact of workforce reduction efforts in light of the drastic decline in commodity prices, partially offset by ~~increased employee costs in the current year resulting from a larger average headcount, as well as~~ non-cash stock-based compensation expense related to awards granted in January ~~2020.~~

2020, employee severance costs and increased director and officer insurance premium costs.

Transaction costs

For the three months ended ~~March 31,~~September 30, 2020, transaction costs ~~increased~~decreased by ~~$0.5~~$0.9 million primarily due to ~~increased legal fees for ongoing~~expected final defense costs and reimbursements from our major shareholder and insurance carrier associated with the anticipated settlement of litigation related to the Bold Transaction ~~which~~that closed on May 9, 2017.

See Note 13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements.

Interest expense, net

Interest expense ~~increased~~decreased from ~~$1.4~~$1.6 million for the three months ended ~~March 31,~~September 30, 2019 to ~~$1.7~~$1.2 million for the three months ended ~~March 31,~~September 30, 2020, primarily due to ~~higher average~~lower effective interest rates on borrowings outstanding compared to the prior year period. See Note 10. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.

~~Gain (loss)~~

(Loss) gain on derivative contracts, net

For the three months ended ~~March 31,~~September 30, 2020, we recorded a net loss on derivative contracts of $6.0 million, consisting of unrealized mark-to-market losses of $14.6 million related to our commodity hedges and unrealized gains of $0.1 million related to our interest rate swap, partially offset by net realized gains on settlements of our commodity hedges of $8.5 million. For the three months ended September 30, 2019, we recorded a net gain on derivative contracts of ~~$99.8~~$18.7 million, consisting of unrealized mark-to-market gains of ~~$90.0~~$15.0 million related to our commodity hedges and net realized gains on settlements of ~~$9.7~~our commodity hedges of $3.7 million.

Income tax expense

For the three months ended ~~March 31, 2019,~~September 30, 2020, 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.~~

~~Income tax (expense) benefit~~

~~During the three months ended March 31, 2020, we recorded~~an income tax expense of approximately ~~$1.1~~$0.1 million which included (1) no income tax expense for Lynden US ~~of $0.7 million~~ as a result of its share of the distributable income from EEH, (2) deferred income tax ~~expense~~benefit for Earthstone of ~~$2.9~~$0.9 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of ~~$0.4~~$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 ~~March 31,~~September 30, 2020.

During the three months ended ~~March 31,~~September 30, 2019, ~~the Company~~we recorded income tax ~~benefit~~expense of approximately ~~$0.5~~$0.6 million which included (1) income tax ~~benefit~~expense for Lynden US of ~~$0.8~~$0.6 million as a result of its share of the distributable income from EEH and (2) deferred income tax ~~benefit~~expense for Earthstone of ~~$2.9~~$2.2 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured.

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Nine Months Ended September 30, 2020, compared to the Nine Months Ended September 30, 2019

	Nine Months Ended
	September 30,
	2020			2019			Change
Sales volumes:
Oil (MBbl)		2,520			2,027			24	%
Natural gas (MMcf)		5,031			3,318			52	%
Natural gas liquids (MBbl)		870			705			23	%
Barrels of oil equivalent (MBOE)		4,229			3,285			29	%
Average Daily Production (Boepd)		15,433			12,033			28	%

Average prices:
Oil (per Bbl)	$	36.92		$	55.08			(33	)%
Natural gas (per Mcf)	$	0.96		$	0.64			50	%
Natural gas liquids (per Bbl)	$	11.46		$	15.17			(24	)%

Average prices adjusted for realized derivatives settlements:
Oil ($/Bbl)(1)	$	55.14		$	60.42			(9	)%
Natural gas ($/Mcf)(1)	$	1.31		$	1.49			(12	)%
Natural gas liquids ($/Bbl)	$	11.46		$	15.17			(24	)%

(In thousands)
Oil revenues	$	93,017		$	111,657			(17	)%
Natural gas revenues	$	4,855		$	2,126			128	%
Natural gas liquids revenues	$	9,976		$	10,691			(7	)%

Lease operating expense	$	21,971		$	20,485			7	%
Production and ad valorem taxes	$	7,198		$	8,001			(10	)%
Rig termination expense	$	426		$	—			NM
Impairment expense	$	62,548		$	—			NM
Depreciation, depletion and amortization	$	76,096		$	42,281			80	%

General and administrative expense (excluding stock-based compensation)	$	11,950		$	13,268			(10	)%
Stock-based compensation	$	7,665		$	6,680			15	%
General and administrative expense	$	19,615		$	19,948			(2	)%

Transaction costs	$	(324	)	$	797			NM
Interest expense, net	$	(4,207	)	$	(4,735	)		(11	)%

Unrealized gain (loss) on derivative contracts	$	25,466		$	(33,332	)		NM
Realized gain on derivative contracts	$	47,599		$	13,660			NM
Gain (loss) on derivative contracts, net	$	73,065		$	(19,672	)		NM

Income tax expense	$	(112	)	$	(728	)		NM

(1) Includes $5.7 million and $2.1 million of cash proceeds related to hedges unwound during the second quarter of 2020 and first quarter of 2019, respectively.

NM – Not Meaningful

Oil revenues

For the nine months ended September 30, 2020, oil revenues decreased by $18.6 million or 17% relative to the comparable period in 2019. Of the decrease, $36.8 million was attributable to a decrease in our realized price, partially offset by $18.2 million attributable to an increase in volume. Our average realized price per Bbl decreased from $55.08 for the nine months ended September 30, 2019 to $36.92 or 33% for the nine months ended September 30, 2020. We had a net increase in the volume of oil sold of 492 MBbls or 24%, primarily due to new wells brought online offset by voluntary production shut-ins in May 2020.

Natural gas revenues

For the nine months ended September 30, 2020, natural gas revenues increased by $2.7 million or 128% relative to the comparable period in 2019. Of the increase, $1.6 million was due to increased sales volume and $1.1 million was attributable to an increase in realized price. Our average realized price per Mcf increased 50% from $0.64 for the nine months ended September 30, 2019 to $0.96 for the nine months ended September 30, 2020. In the prior year's period, lack of sufficient pipeline transportation resulted in low natural gas prices, which have improved in the current year period. The total volume of natural gas produced and sold increased 1,713 MMcf or 52% primarily due to new wells brought online offset by voluntary production shut-ins in May 2020.

Natural gas liquids revenues

For the nine months ended September 30, 2020, natural gas liquids revenues decreased by $0.7 million or 7% relative to the comparable period in 2019. Of the decrease, $2.6 million was attributable to a decrease in our realized price, partially offset by $1.9 million attributable to increased volume. The volume of natural gas liquids produced and sold increased by 166 MBbls or 23%, primarily due to new wells brought online offset by voluntary production shut-ins in May 2020.

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Lease operating expense (“LOE”)

LOE increased by $1.5 million or 7% for the nine months ended September 30, 2020 relative to the comparable period in 2019, primarily due to additional producing wells brought online, which drove a 29% increase in production volume, offset by voluntary production shut-ins in May 2020, as well as a decrease in workover project costs as compared to the prior year period.

Production and ad valorem taxes

Production and ad valorem taxes for the nine months ended September 30, 2020 decreased by $0.8 million or 10% relative to the comparable period in 2019, as the impact of increased volume was more than offset by the impact of decreased commodity prices. As a percentage of revenues from oil, natural gas, and natural gas liquids, production taxes declined slightly as compared to the prior year primarily due to lower realized commodity prices.

Rig termination expenses

During the nine months ended September 30, 2020, we concluded our 2020 drilling program and released our contracted drilling rig operating in the Midland Basin, recording rig termination expense of $0.4 million.

Impairment expense

During the nine months ended September 30, 2020, we recorded non-cash impairments totaling $62.5 million, which consisted of $25.3 million to proved oil and natural gas properties, $19.7 million to unproved oil and natural gas properties and $17.6 million to goodwill. No such impairments were recorded during the nine months ended September 30, 2019.

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

DD&A for the nine months ended September 30, 2020 increased by $33.8 million, or 80% relative to the comparable period in 2019. The increase was primarily related to development and acquisition activity, partially offset by a first quarter 2020 impairment charge of $25.3 million, that resulted in increased costs subject to depletion. Other factors contributing to the increase were higher sales volumes and certain downward adjustments to estimated recoverable proved oil and natural gas reserves caused by lower commodity prices.

General and administrative expense (“G&A”)

G&A for the nine months ended September 30, 2020 decreased by $0.3 million, or 2% relative to the comparable period in 2019, as a reduction in cash-based compensation expenses was almost entirely offset by non-cash stock-based compensation expense related to awards granted in January 2020, employee severance costs and increased director and officer insurance premium costs.

Transaction costs

For the nine months ended September 30, 2020, transaction costs decreased by $1.1 million primarily due to expected final defense costs and reimbursements from our major shareholder and insurance carrier associated with the anticipated settlement of litigation related to the Bold Transaction that closed on May 9, 2017. See Note 13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements.

Interest expense, net

Interest expense decreased from $4.7 million for the nine months ended September 30, 2019 to $4.2 million for the nine months ended September 30, 2020, primarily due to lower effective interest rates on borrowings outstanding compared to the prior year period. See Note 10. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.

Gain (loss) on derivative contracts, net

For the nine months ended September 30, 2020, we recorded a net gain on derivative contracts of $73.1 million, consisting of unrealized mark-to-market gains of $25.9 million related to our commodity hedges, unrealized mark-to-market losses of $0.4 million related to our interest rate swap and net realized gains on settlements of our commodity hedges of $47.6 million. For the nine months ended September 30, 2019, we recorded a net loss on derivative contracts of $19.7 million, consisting of unrealized mark-to-market losses of $33.3 million related to our commodity hedges, partially offset by net realized gains on settlements of our commodity hedges of $13.7 million.

Income tax expense

For the nine months ended September 30, 2020, we recorded an income tax expense of approximately $0.1 million which included (1) no income tax expense for Lynden US as a result of its share of the distributable income from EEH, (2) a deferred income tax benefit for Earthstone of $0.8 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) a deferred income tax expense of ~~$0.3~~$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~~nine months ended ~~March 31,~~September 30, 2020.

During the nine months ended September 30, 2019, we recorded income tax expense of approximately $0.7 million which included (1) income tax expense for Lynden US of $0.1 million as a result of its share of the distributable income from EEH, (2) deferred income tax expense for Earthstone of $0.6 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.6 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended September 30, 2019.

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Liquidity and Capital Resources

~~We have significant undeveloped acreage~~

Our primary needs for capital are for working capital obligations with respect to operating our properties and ~~future drilling locations. Drilling horizontal wells, generally consisting~~for the development of ~~7,500 to 12,000-foot lateral lengths, in the Midland Basin is capital intensive.~~our oil and natural gas assets. At ~~March 31,~~September 30, 2020, we had approximately ~~$5.1~~$5.3 million in cash and approximately ~~$123.0~~$110.0 million in unused borrowing capacity under our Credit Facility (discussed below) for a total of approximately ~~$128.1~~$115.3 million in funds available for operational and capital funding.

We have no material long-term contracts, relatively low leverage, and a ~~very~~ strong hedge position, which affords us the flexibility to adjust our capital ~~plan with no adverse impact on our current financial position. We recently~~plan. In March 2020, we took action to significantly reduce our capital program for 2020 and made a decision to ~~$50~~halt all drilling and completion activity. In light of recent oil price recoveries and meaningful service cost reductions compared to earlier in the year, we have commenced completions of a six-well pad and currently expect total capital spending for 2020 to be in the range of $65 - ~~$60 million for 2020.~~$70 million. Additionally, we currently expect to begin completions of a five-well pad in January 2021. We ~~also initiated actions in an effort~~expect to ~~reduce~~fund this completion activity with internally generated funds.

COVID-19 has adversely impacted our ~~2020 cash-basis general and administrative expenses with a goal to reduce it by approximately 25% from our previous plan. Our oil swap position~~revenues for the ~~period April-December~~nine months ended September 30, 2020 ~~is approximately 8,000 Bopd, hedged at~~as a ~~WTI price~~result of ~~$57.00/Bbl. Based~~both low commodity prices and voluntary shut-ins of our production. However, due to our commodity hedging activities offsetting those reduced revenues, there has been no significant overall impact on our ~~adjusted~~cash flows.

Since the beginning of 2020, ~~operating plan,~~our borrowing base has been reduced from $325 million to $240 million. Despite two sequential reductions in our borrowing base, we ~~expect to generate free cash flow beginning~~remain in ~~the second quarter of 2020. Free cash flow would be utilized to improve our working capital and to reduce borrowings currently outstanding~~compliance with all covenants under our Credit Facility.

Our adjusted capital budget would result in bringing online 3 (gross and net) operated wells and 3.1 (net) non-operated wells in 2020. With a reduction in projected capital expenditures and fewer new wells coming online, During the nine months ended September 30, 2020, we would expect lease operating expenses on a per Boe basis to increase. A portion of this increase would also result from acceleration of certain remedial well work which, to a limited extent, would offset expected production declines. This increase may be partially mitigatedhave reduced our outstanding bank debt by ~~our efforts to shut-in wells whose operating margins are negative.~~

$40 million. Based on our production profile, cost structure, minimal capital program and the hedge positions we have in place, we expect to generate ~~free~~adequate cash ~~flow~~flows provided by operating activities to fund the completion activity for the six wells in progress and reduce debt, although not at the same levels as in the ~~second half~~third quarter, for the remainder of ~~2020 should we significantly curtail our capital program.~~2020. As a result, we believe we will have sufficient liquidity with cash flows from operations and borrowings under our Credit Facility to meet our cash requirements for the next 12 months.

Working Capital

Working capital ~~defined herein as Total current assets less Total current liabilities as set forth in our Condensed Consolidated Balance Sheets,~~(presented below) was ~~$5.8~~$5.5 million as of ~~March 31,~~September 30, 2020, as compared to a working capital deficit of $39.9 million as of December 31, 2019, representing an increase of ~~$45.7~~$45.4 million. This increase ~~was primarily related to the~~consisted of a $22.1 million net increase in the fair value of our derivative contracts expected to settle in the 12 months ~~proceeding March 31,~~subsequent to September 30, 2020 resulting from ~~the deterioration of~~low oil price futures as of ~~March 31, 2020.~~ September 30, 2020 and a $23.3 million reduction of other net current items resulting primarily from reduced drilling activity.

The components of working capital ~~as of March 31, 2020, as defined above,~~ are presented below:

	September 30,		December 31,
	2020		2019
Current assets:
Cash	$	5,311	$	13,822
Accounts receivable:
Oil, natural gas, and natural gas liquids revenues		12,097		29,047
Joint interest billings and other, net of allowance of $80 and $83 at September 30, 2020 and December 31, 2019, respectively		11,548		6,672
Derivative asset		25,097		8,860
Prepaid expenses and other current assets		1,560		1,867
Total current assets		55,613		60,268

Current liabilities:
Accounts payable	$	6,910		25,284
Revenues and royalties payable		28,047		35,815
Accrued expenses		12,844		19,538
Asset retirement obligation		308		308
Derivative liability		1,040		6,889
Advances		93		11,505
Operating lease liabilities		768		570
Finance lease liabilities		96		206
Other current liabilities		11		43
Total current liabilities		50,117		100,158

Working Capital	$	5,496	$	(39,890	)

March 31, December 31,
2020 2019
Current assets:
Cash $ 5,101
$ 13,822
Accounts receivable:
Oil, natural gas, and natural gas liquids revenues 10,845
29,047
Joint interest billings and other, net of allowance of $80 and $83 at March 31, 2020 and December 31, 2019, respectively 11,094
6,672
Derivative asset 72,017
8,860
Prepaid expenses and other current assets 1,597
1,867
Total current assets 100,654
60,268

Current liabilities:
Accounts payable $ 24,010
$ 25,284
Revenues and royalties payable 41,455
35,815
Accrued expenses 25,495
19,538
Asset retirement obligation 308
308
Derivative liability —
6,889
Advances 2,690
11,505
Operating lease liabilities 759
570
Finance lease liabilities 153
206
Other current liabilities 14
43
Total current liabilities 94,884
100,158

Working Capital $ 5,770
$ (39,890 )

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Cash Flows from Operating Activities

Cash flows provided by operating activities for the ~~three~~nine months ended ~~March 31,~~September 30, 2020 ~~were $48.5~~increased to $104.7 million compared to ~~$7.1~~$85.7 million for the ~~three~~nine months ended ~~March 31,~~September 30, 2019, primarily due to changes in timing of payments and receipts in addition to an increase in sales volumes and our settlements of derivative contracts as compared to the prior year period.

Cash Flows from Investing Activities

Cash flows used in investing activities for the ~~three~~nine months ended ~~March 31,~~September 30, 2020 ~~and~~decreased to $72.6 million from $121.1 million for the nine months ended September 30, 2019, ~~were $39.0 million and $48.5 million, respectively,~~ primarily due to decreased drilling and completion activity as compared to the prior year period in light of the current ~~market~~commodity price conditions.

Cash Flows from Financing Activities

Cash flows used in financing activities ~~were $18.3~~decreased to $40.7 million for the ~~three~~nine months ended ~~March 31,~~September 30, 2020 as compared to cash flows provided by financing activities of ~~$41.5~~$44.8 million for the ~~three~~nine months ended ~~March 31, 2019. The change from the prior year period was~~September 30, 2019, primarily due to higher repayments and lower borrowings under the Credit Facility (as defined below) in the current year period.

Capital Expenditures

Our accrual basis capital expenditures for the three and nine months ended ~~March 31,~~September 30, 2020 were as follows (in thousands):

Three Months Ended March 31, 2020
Drilling and completions $ 41,891
Leasehold costs (65 )
Total capital expenditures $ 41,826

	Three Months Ended September 30, 2020		Nine Months Ended September 30, 2020
Drilling and completions	$	1,329	$	46,303
Leasehold costs		49		139
Total capital expenditures	$	1,378	$	46,442

Credit Facility

On November 21, 2019, Earthstone, EEH (the “Borrower”), Wells Fargo, ~~Bank, National Association,~~ as Administrative Agent and Issuing Bank, ~~(“Wells Fargo”),~~ Royal Bank of Canada, as Syndication Agent, BOKF, NA dba Bank of Texas (“BOKF”) as Issuing Bank with respect to Existing Letters of Credit, Truist Bank, as successor by merger to SunTrust Bank, as Documentation Agent, and the ~~lenders party thereto (the “Lenders”)~~Lenders entered into a credit agreement (the “Credit Facility”), which replaced the Company’s prior credit agreement, which was terminated on November 21, 2019.

On March 27, 2020, in connection with the regularly scheduled redetermination of the borrowing base under the Credit Facility, the borrowing base was set at $275 million, representing a 15% decrease from the previous borrowing base of $325 million.

On September 28, 2020, Earthstone, EEH, Wells Fargo, the guarantors party thereto, and the Lenders entered into the Amendment to the Credit Facility. Among other things, the Amendment decreased the borrowing base from $275 million to $240 million, increased the interest rate on outstanding borrowings by 25 to 50 basis points, increased the flexibility to finance and make acquisitions, and added certain restrictions related to dividends and distributions.

The next regularly scheduled redetermination of the borrowing base is on or around ~~November~~April 1, ~~2020.~~

2021.

As of ~~March 31,~~September 30, 2020, ~~$152.0~~$130.0 million of borrowings were outstanding, bearing annual interest of ~~2.870%~~2.658%, resulting in an additional ~~$123.0~~$110.0 million of borrowing base availability under the Credit Facility. ~~At December 31, 2019, there were $170.0 million of borrowings outstanding under the Credit Facility.~~

Hedging Activities

The following table sets forth our outstanding derivative contracts at ~~March 31,~~September 30, 2020. When aggregating multiple contracts, the weighted average contract price is disclosed.

Period Commodity
Volume
(Bbls / MMBtu)

Price
($/Bbl / $/MMBtu)
Q2 - Q4 2020 Crude Oil 2,199,000 $57.00
Q1 - Q4 2021 Crude Oil 1,460,000 $55.16
Q2 - Q4 2020 Crude Oil Basis Swap(1) 1,925,000 $(1.40)
Q2 - Q4 2020 Crude Oil Basis Swap(2) 275,000 $2.55
Q1 - Q4 2021 Crude Oil Basis Swap(1) 1,825,000 $1.05
Q2 - Q4 2020 Natural Gas 1,925,000 $2.85
Q2 - Q4 2020 Natural Gas Basis Swap(3) 1,925,000 $(1.07)

		Volume	Price
Period	Commodity	(Bbls / MMBtu)	($/Bbl / $/MMBtu)
Q4 2020	Crude Oil	552,000	$ 60.65
Q1 - Q4 2021	Crude Oil	1,460,000	$ 55.16
Q4 2020	Crude Oil Basis Swap (1)	598,000	$ (1.50)
Q4 2020	Crude Oil Basis Swap (2)	92,000	$ 2.55
Q4 2020	Crude Oil Roll Swap (3)	552,000	$ (1.79)
Q1 - Q4 2021	Crude Oil Basis Swap (1)	1,825,000	$ 1.05
Q4 2020	Natural Gas	644,000	$ 2.85
Q1 - Q4 2021	Natural Gas	4,380,000	$ 2.76
Q4 2020	Natural Gas Basis Swap (4)	644,000	$ (1.07)
Q1 - Q4 2021	Natural Gas Basis Swap (4)	4,380,000	$ (0.45)


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


(2)	The basis differential price is between WTI Houston and the WTI NYMEX.

(3)

The swap is between WTI Roll and the WTI NYMEX.

~~(3)~~

(4)

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

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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 2019 Annual Report on Form 10-K other than those described in Note 13. 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 a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and therefore are not required to provide the information required under this item.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

In accordance with Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15(e) and 15d-15(e), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and our Principal Accounting Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Principal Accounting Officer concluded that our disclosure controls and procedures were effective as of ~~March 31,~~September 30, 2020 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.

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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 ~~March 31,~~September 30, 2020, 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. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item 1 of this report, which is incorporated herein by reference, for material matters that have occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2019.

Item 1A. Risk Factors

~~The following risk factors should be considered in~~

In addition to the other information set forth in this report, you should carefully consider the risk factors ~~disclosed~~and other cautionary statements described in the “Risk Factors” ~~section~~sections of our Annual Report on Form 10-K for the year ended December 31, ~~2019.~~

~~The Company may be adversely affected by the recent decrease in demand~~2019 and ~~oversupply of oil and natural gas as a result of the coronavirus pandemic and actions by Saudi Arabia and Russia.~~

The spread of the COVID-19 has caused severe disruptions in the worldwide economy, including the global demand for oil and natural gas, the movement of people and services in the United States and the visibility into future conditions, which could in turn disrupt our business and operations. Moreover, recent actions by Saudi Arabia and Russia have caused a worldwide oversupply in oil and natural gas. The continued spread of the COVID-19, related government and other restrictions and oversupply of oil and natural gas are expected to result in a significant decrease in business activity and demand for oil and gas, and may cause our oil and natural gas purchasers to be unable to meet existing payment or other obligations to us, including the ability to purchase produced oil, natural gas, and NGLs from us. In April 2020, we completed our small remaining inventory of wells scheduled for completion and have suspended all future drilling and completion programs. We do not currently have plans to recommence our capital program. The loss of any one or all of our significant customers as a purchaser could materially and adversely affect our revenues and may require us to shut-in a portion or all of our wells. In such an event, restarting our wells may require significant cost, and we cannot guarantee that we would be able to restart at the same level of production. Moreover, due to the unprecedented nature of the current pandemic and market conditions, we are unable to predict the degree or duration of any adverse impactQuarterly Report on ~~our operations and financial condition and other risks described in this report may be enhanced by such conditions.~~

~~Concerns over economic, business or industry conditions may have a material adverse effect on our results of operations, liquidity and financial condition.~~

Concerns over global economic conditions, energy costs, geopolitical issues (including supply disputes between Saudi Arabia and Russia), inflation, the availability and cost of credit, the decline in the European, Asian and the United States financial markets and the COVID-19 pandemic have contributed to increased economic uncertainty and diminished expectationsForm 10-Q for the global economy. In addition, continued hostilities in the Middle East and the occurrence or threat of terrorist attacks in the United States or other countries could adversely affect the global economy. Concerns about global economic growth have had a significant adverse impact on global financial markets and commodity prices. If the economic climate in the United States or abroad deteriorates, worldwide demand for petroleum products could diminish further, which could impact the price at which we can sell our production, affect the ability of our vendors, suppliers and customers to continue operations and ultimately adversely impact our results of operations, liquidity and financial condition.

~~The failure by counterparties to the Company's derivative risk management activities to perform their obligations could have a material adverse effect on the Company's results of operations.~~

The use of derivative risk management transactions involves the risk that the counterparties will be unable to meet the financial terms of such transactions. The Company is unable to predict changes in a counterparty's creditworthiness or ability to perform. Even if the Company accurately predicts sudden changes, the Company's ability to negate the risk may be limited depending upon market conditions and the contractual terms of the transactions. During periods of declining commodity prices, the Company's derivative receivable positions generally increase, which increases the Company's counterparty credit exposure. If any of the Company's counterparties were to default on its obligations under the Company's derivative arrangements, such a default could have a material adverse effect on the Company's results of operations, could result in a larger percentage of the Company's future production being subject to commodity price changes and could increase the likelihood that the Company's derivative arrangements may not achieve their intended strategic purposes.

quarter ended March 31, 2020.

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 ~~March 31,~~September 30, 2020.

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
January 2020 19,399
$ 5.91
—
—
February 2020 —
—
—
—
March 2020 56,296
$ 1.77
—
—

	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 2020		—	$	—		—		—
August 2020		—		—		—		—
September 2020		54,268	$	2.74		—		—

(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 ~~were surrendered by employees (via net settlement) in satisfaction~~was not part of ~~tax obligations upon the vesting~~a publicly announced program to repurchase shares 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.

~~None.~~

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Item 6. Exhibits



Exhibit No.	Description	Filed Herewith	Furnished Herewith
31.1	Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act	X
31.2	Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act	X
32.1	Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act		X
32.2	Certification of the Executive Vice President - Accounting and Administration pursuant to Section 906 of the Sarbanes-Oxley Act		X
~~101.INS~~ 101	~~XBRL Instance Document~~ Interactive Data Files (formatted as Inline XBRL).	X
~~101.SCH~~ 104	Cover Page Interactive Data File (formatted as Inline XBRL ~~Schema Document~~and contained in Exhibit 101).	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

Table of Contents

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:	~~May 6,~~ November 4, 2020	By:	/s/ Tony Oviedo
			Tony Oviedo
			Executive Vice President – Accounting and Administration



	March 31,			December 31,
ASSETS	2020			2019
Current assets:
Cash	$	5,101		$	13,822
Accounts receivable:
Oil, natural gas, and natural gas liquids revenues	10,845			29,047
Joint interest billings and other, net of allowance of $80 and $83 at March 31, 2020 and December 31, 2019, respectively	11,094			6,672
Derivative asset	72,017			8,860
Prepaid expenses and other current assets	1,597			1,867
Total current assets	100,654			60,268

Oil and gas properties, successful efforts method:
Proved properties	991,209			970,808
Unproved properties	238,477			260,271
Land	5,382			5,382
Total oil and gas properties	1,235,068			1,236,461

Accumulated depreciation, depletion and amortization	(219,823		)	(195,567		)
Net oil and gas properties	1,015,245			1,040,894

Other noncurrent assets:
Goodwill	—			17,620
Office and other equipment, net of accumulated depreciation and amortization of $3,307 and $3,180 at March 31, 2020 and December 31, 2019, respectively	1,271			1,311
Derivative asset	20,769			770
Operating lease right-of-use assets	3,092			3,108
Other noncurrent assets	1,490			1,572
TOTAL ASSETS	$	1,142,521		$	1,125,543
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	24,010		$	25,284
Revenues and royalties payable	41,455			35,815
Accrued expenses	25,495			19,538
Asset retirement obligation	308			308
Derivative liability	—			6,889
Advances	2,690			11,505
Operating lease liabilities	759			570
Finance lease liabilities	153			206
Other current liabilities	14			43
Total current liabilities	94,884			100,158

Noncurrent liabilities:
Long-term debt	152,000			170,000
Deferred tax liability	16,246			15,154
Asset retirement obligation	1,911			1,856



Operating lease liabilities	2,333			2,539
Finance lease liabilities	62			85
Other noncurrent liabilities	139			—
Total noncurrent liabilities	172,691			189,634

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; 29,852,958 and 29,421,131 issued and outstanding at March 31, 2020 and December 31, 2019, respectively	30			29
Class B Common Stock, $0.001 par value, 50,000,000 shares authorized; 35,060,687 and 35,260,680 issued and outstanding at March 31, 2020 and December 31, 2019, respectively	35			35
Additional paid-in capital	532,623			527,246
Accumulated deficit	(165,003		)	(181,711		)
Total Earthstone Energy, Inc. equity	367,685			345,599
Noncontrolling interest	507,261			490,152
Total equity	874,946			835,751

TOTAL LIABILITIES AND EQUITY	$	1,142,521		$	1,125,543



	Three Months Ended March 31,
	2020			2019
REVENUES
Oil	$	41,012		$	35,447
Natural gas	1,086			1,094
Natural gas liquids	3,040			4,187
Total revenues	45,138			40,728

OPERATING COSTS AND EXPENSES
Lease operating expense	9,339			6,061
Production and ad valorem taxes	3,023			2,594
Depreciation, depletion and amortization	24,656			14,005
Impairment expense	60,371			—
General and administrative expense	7,132			7,075
Transaction costs	844			370
Accretion of asset retirement obligation	44			54
Exploration expense	301			—
Total operating costs and expenses	105,710			30,159

Gain (loss) on sale of oil and gas properties	204			(125		)

(Loss) income from operations	(60,368		)	10,444

OTHER INCOME (EXPENSE)
Interest expense, net	(1,736		)	(1,449		)
Gain (loss) on derivative contracts, net	99,784			(47,894		)
Other income (expense), net	126			(4		)
Total other income (expense)	98,174			(49,347		)

Income (loss) before income taxes	37,806			(38,903		)
Income tax (expense) benefit	(1,092		)	460
Net income (loss)	36,714			(38,443		)

Less: Net income (loss) attributable to noncontrolling interest	20,006			(21,239		)

Net income (loss) attributable to Earthstone Energy, Inc.	$	16,708		$	(17,204	)

Net income (loss) per common share attributable to Earthstone Energy, Inc.:
Basic	$	0.57		$	(0.60	)
Diluted	$	0.57		$	(0.60	)

Weighted average common shares outstanding:
Basic	29,497,428			28,719,542
Diluted	29,497,428			28,719,542



	Issued Shares
	Class A Common Stock		Class B Common Stock		Class A Common Stock		Class B Common Stock		Additional Paid-in Capital			Accumulated Deficit			Total Earthstone Energy, Inc. Equity			Noncontrolling Interest			Total Equity
At December 31, 2019	29,421,131		35,260,680		$	29	$	35	$	527,246		$	(181,711	)	$	345,599		$	490,152		$	835,751
Stock-based compensation expense	—		—		—		—		2,694			—			2,694						2,694
Vesting of restricted stock units, net of taxes paid	231,834		—		1		—		—			—			1			—			1
Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings	75,695		—		—		—		(214		)	—			(214		)	—			(214		)
Cancellation of treasury shares	(75,695	)	—		—		—		—			—			—			—			—
Class B Common Stock converted to Class A Common Stock	199,993		(199,993	)	—		—		2,897			—			2,897			(2,897		)	—
Net income	—		—		—		—		—			16,708			16,708			20,006			36,714
At March 31, 2020	29,852,958		35,060,687		$	30	$	35	$	532,623		$	(165,003	)	$	367,685		$	507,261		$	874,946



	For the Three Months Ended March 31,
	2020			2019
Cash flows from operating activities:
Net income (loss)	$	36,714		$	(38,443	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation, depletion and amortization	24,656			14,005
Impairment of proved and unproved oil and gas properties	42,751			—
Impairment of goodwill	17,620			—
Accretion of asset retirement obligations	44			54
Settlement of asset retirement obligations	—			(62		)
(Gain) loss on sale of oil and gas properties	(204		)	125
Total (gain) loss on derivative contracts, net	(99,784		)	47,894
Operating portion of net cash received in settlement of derivative contracts	9,739			5,362
Stock-based compensation	2,694			2,212
Deferred income taxes	1,092			(460		)
Amortization of deferred financing costs	80			103
Changes in assets and liabilities:
(Increase) decrease in accounts receivable	13,780			(6,811		)
(Increase) decrease in prepaid expenses and other current assets	(312		)	(2,236		)
Increase (decrease) in accounts payable and accrued expenses	2,846			(7,427		)
Increase (decrease) in revenues and royalties payable	5,640			(5,383		)
Increase (decrease) in advances	(8,814		)	(1,882		)
Net cash provided by operating activities	48,542			7,051
Cash flows from investing activities:
Additions to oil and gas properties	(39,299		)	(48,412		)
Additions to office and other equipment	(87		)	(75		)
Proceeds from sales of oil and gas properties	409			—
Net cash used in investing activities	(38,977		)	(48,487		)
Cash flows from financing activities:
Proceeds from borrowings	17,500			85,244
Repayments of borrowings	(35,500		)	(43,247		)
Cash paid related to the exchange and cancellation of Class A Common Stock	(214		)	(397		)
Cash paid for finance leases	(72		)	(114		)
Net cash (used in) provided by financing activities	(18,286		)	41,486
Net increase (decrease) in cash	(8,721		)	50
Cash at beginning of period	13,822			376
Cash at end of period	$	5,101		$	426
Supplemental disclosure of cash flow information
Cash paid for:
Interest	$	1,676		$	1,255
Non-cash investing and financing activities:
Accrued capital expenditures	$	31,011		$	17,040
Lease asset additions - ASC 842	$	—		$	1,801
Asset retirement obligations	$	21		$	21



March 31, 2020	Level 1		Level 2		Level 3		Total
Financial assets
Derivative asset - current	$	—	$	72,017	$	—	$	72,017
Derivative asset - noncurrent	—		20,769		—		20,769
Total financial assets	$	—	$	92,786	$	—	$	92,786

Financial liabilities
Derivative liability - current	$	—	$	—	$	—	$	—
Derivative liability - noncurrent	—		—		—		—
Total financial liabilities	$	—	$	—	$	—	$	—

December 31, 2019
Financial assets
Derivative asset - current	$	—	$	8,860	$	—	$	8,860
Derivative asset - noncurrent			770				770
Total financial assets	$	—	$	9,630	$	—	$	9,630

Financial liabilities
Derivative liability - current	$	—	$	6,889	$	—	$	6,889
Derivative liability - noncurrent	—		—		—		—
Total financial liabilities	$	—	$	6,889	$	—	$	6,889



	Price Swaps
Period	Commodity	Volume (Bbls / MMBtu)	Weighted Average Price ($/Bbl / $/MMBtu)
Q2 - Q4 2020	Crude Oil	2,199,000	$	57.00
Q1 - Q4 2021	Crude Oil	1,460,000	$	55.16
Q2 - Q4 2020	Crude Oil Basis Swap(1)	1,925,000	$	(1.40	)
Q2 - Q4 2020	Crude Oil Basis Swap(2)	275,000	$	2.55
Q1 - Q4 2021	Crude Oil Basis Swap(1)	1,825,000	$	1.05
Q2 - Q4 2020	Natural Gas	1,925,000	$	2.85
Q2 - Q4 2020	Natural Gas Basis Swap(3)	1,925,000	$	(1.07	)



		March 31, 2020							December 31, 2019
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	$	73,846	$	(1,829	)	$	72,017	$	13,321	$	(4,461	)	$	8,860
Commodity contracts	Derivative liability - current	$	1,829	$	(1,829	)	$	—	$	11,350	$	(4,461	)	$	6,889
Commodity contracts	Derivative asset - noncurrent	$	20,769	$	—		$	20,769	$	1,031	$	(261	)	$	770
Commodity contracts	Derivative liability - noncurrent	$	—	$	—		$	—	$	261	$	(261	)	$	—



Derivatives not designated as hedging contracts under ASC Topic 815			Three Months Ended March 31,
	Statement of Cash Flows Location	Statement of Operations Location	2020		2019
Unrealized gain (loss)	Not separately presented	Not separately presented	$	90,045	$	(53,256	)
Realized gain	Operating portion of net cash received in settlement of derivative contracts	Not separately presented	9,739		5,362
	Total gain (loss) on derivative contracts, net	Gain (loss) on derivative contracts, net	$	99,784	$	(47,894	)



	Three Months Ended March 31, 2020
Proved property	$	25,252
Unproved property	17,499
Goodwill	17,620
Impairment expense	$	60,371



	EEH Units Held By Earthstone and Lynden US	%		EEH Units Held By Others		%		Total EEH Units Outstanding
As of December 31, 2019	29,421,131	45.5	%	35,260,680		54.5	%	64,681,811
EEH Units and Class B Common Stock converted to Class A Common Stock	199,993			(199,993	)			—
EEH Units issued in connection with the vesting of restricted stock units	231,834			—				231,834
As of March 31, 2020	29,852,958	46.0	%	35,060,687		54.0	%	64,913,645



	Three Months Ended March 31,
(In thousands, except per share amounts)	2020		2019
Net income (loss) attributable to Earthstone Energy, Inc.	$	16,708	$	(17,204	)

Net income (loss) per common share attributable to Earthstone Energy, Inc.:
Basic	$	0.57	$	(0.60	)
Diluted	$	0.57	$	(0.60	)

Weighted average common shares outstanding
Basic	29,497,428		28,719,542
Add potentially dilutive securities:
Unvested restricted stock units (1)	—		—
Unvested performance units (1)	—		—
Diluted weighted average common shares outstanding	29,497,428		28,719,542



	Shares		Weighted-Average Grant Date Fair Value
Unvested RSUs at December 31, 2019	1,107,796		$	6.60
Granted	568,900		$	5.15
Vested	(307,529	)	$	6.79
Unvested RSUs at March 31, 2020	1,369,167		$	5.95



Company’s Annualized TSR	TSR Multiplier
23.9% or greater	2.0
14.5%	1.0
8.4%	0.5
Less than 8.4%	0.0



	Three Months Ended March 31, 2020
Drilling and completions	$	41,891
Leasehold costs	(65		)
Total capital expenditures	$	41,826



	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 2020	19,399	$	5.91	—	—
February 2020	—	—		—	—
March 2020	56,296	$	1.77	—	—