TABLE OF CONTENTS

				Page

		PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)	3

~~Item 1.~~		~~Financial Statements (unaudited)~~		3
		Condensed Consolidated Balance Sheets as of September 30, ~~2017~~2020 and December 31, ~~2016~~2019		3
		Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, ~~2017~~2020 and ~~2016~~2019		4
	Condensed Consolidated Statements of Equity for the Nine Months Ended September 30, 2020 and 2019	5
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, ~~2017~~2020 and ~~2016~~2019		57
		Notes to Unaudited Condensed Consolidated Financial Statements		68
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		2219
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		3328
Item 4.		Controls and Procedures		3428

		PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors			29
Item 1.	2.	~~Legal Proceedings~~		34
~~Item 1A.~~		~~Risk Factors~~		34
~~Item 2.~~		Unregistered Sales of Equity Securities and Use of Proceeds		3429
Item 3.		Defaults Upon Senior Securities		3429
Item 4.		Mine Safety Disclosures		3429
Item 5.		Other Information		3429
Item 6.		Exhibits		3530
		Signatures	31	36

PART I. ~~FINANCIAL~~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

2017

2016

Current assets:

Cash

$
11,047

$
10,200

Accounts receivable:

Oil, natural gas, and natural gas liquids revenues

15,093

13,998

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

4,371

2,698

Derivative asset

147

—

Prepaid expenses and other current assets

1,299

446

Total current assets

31,957

27,342

Oil and gas properties, successful efforts method:

Proved properties

599,222

363,072

Unproved properties

291,364

51,723

Land

5,534

—

Total oil and gas properties

896,120

414,795

Accumulated depreciation, depletion and amortization

(122,842
)

(145,393
)
Net oil and gas properties

773,278

269,402

Other noncurrent assets:

Goodwill

17,620

17,620

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

1,039

1,479

Other noncurrent assets

1,078

669

TOTAL ASSETS

$
824,972

$
316,512

LIABILITIES AND EQUITY

Current liabilities:

Accounts payable

$
19,343

$
11,927

Accrued expenses

16,516

5,392

Revenues and royalties payable

9,156

10,769

Advances

5,048

4,542

Derivative liability

1,986

4,595

Current portion of long-term debt

1,704

1,604

Total current liabilities

53,753

38,829

Noncurrent liabilities:

Long-term debt

71,400

12,693

Deferred tax liability

16,513

15,776

Asset retirement obligation

3,204

6,013

Derivative liability

422

1,575

Other noncurrent liabilities

143

169

Total noncurrent liabilities

91,682

36,226

Commitments and Contingencies (Note 13)

Equity:

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

—

—

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

—

23

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

23

—

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

36

—

Additional paid-in capital

463,009

454,202

Accumulated deficit

(227,146
)

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

—

(460
)
Total Earthstone Energy, Inc. equity

235,922

241,457

Noncontrolling interest

443,615

—

Total equity

679,537

241,457

TOTAL LIABILITIES AND EQUITY

$
824,972

$
316,512

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

~~EARTHSTONE ENERGY, INC.~~

~~CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS~~

~~(In thousands, except share and per share amounts)~~

Three Months Ended September 30,

Nine Months Ended September 30,

2017

2016

2017

2016

REVENUES

Oil

$
25,733

$
8,262

$
59,815

$
21,898

Natural gas

2,513

1,417

6,338

3,376

Natural gas liquids

3,036

851

6,249

1,843

Total revenues

31,282

10,530

72,402

27,117

OPERATING COSTS AND EXPENSES

Lease operating expense

5,407

4,581

14,989

11,081

Severance taxes

1,588

522

3,705

1,418

Rig idle and termination expense

—

—

—

5,059

Impairment expense

92

—

66,740

—

Depreciation, depletion and amortization

10,330

5,149

28,258

16,252

General and administrative expense

5,608

2,285

14,838

6,961

Stock-based compensation

1,687

1,328

4,645

1,889

Transaction costs

109

846

4,676

1,641

Accretion of asset retirement obligation

72

143

378

404

Exploration expense

—

—

1

5

Total operating costs and expenses

24,893

14,854

138,230

44,710

Gain on sale of oil and gas properties

2,157

8

3,848

8

Income (loss) from operations

8,546

(4,316
)

(61,980
)

(17,585
)

OTHER INCOME (EXPENSE)

Interest expense, net

(903
)

(341
)

(1,873
)

(934
)
Write-off of deferred financing costs

-

—

(526
)

—

(Loss) gain on derivative contracts, net

(3,663
)

946

4,137

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

(66
)

12

(34
)

(70
)
Total other income (expense)

(4,632
)

617

1,704

(3,521
)

Income (loss) before income taxes

3,914

(3,699
)

(60,276
)

(21,106
)
Income tax benefit (expense)

94

(201
)

10,046

(387
)
Net income (loss)

4,008

(3,900
)

(50,230
)

(21,493
)

Less: Net income (loss) attributable to noncontrolling interest

2,452

—

(35,392
)

—

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

$
1,556

$
(3,900
)

$
(14,838
)

$
(21,493
)

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

Basic and diluted

$
0.07

$
(0.17
)

$
(0.66
)

$
(1.23
)

Weighted average common shares outstanding:

Basic and diluted

22,905,023

22,289,177

22,638,977

17,433,079

	*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

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

Table of Contents

EARTHSTONE ENERGY, INC.

CONDENSED CO~~NSOLIDATED~~CONSOLIDATED STATEMENTS OF ~~CASH FLOWS~~OPERATIONS (UNAUDITED)

(In ~~thousands)~~ thousands, except share and per share amounts)

For the Nine Months Ended September 30,

2017

2016

Cash flows from operating activities:

Net loss

$
(50,230
)

$
(21,493
)
Adjustments to reconcile net loss to net cash provided by operating activities:

Impairment of proved and unproved oil and gas properties

66,740

—

Depreciation, depletion and amortization

28,258

16,252

Accretion of asset retirement obligations

378

404

Settlement of asset retirement obligations

—

(15
)
Gain on sale of oil and gas properties

(3,848
)

(8
)
Rig idle and termination expense

—

5,059

Total (gain) loss on derivative contracts, net

(4,137
)

2,517

Operating portion of net cash received in settlement of derivative contracts

229

3,330

Stock-based compensation

4,645

1,889

Deferred income taxes

(10,046
)

387

Write-off of deferred financing costs

526

—

Amortization of deferred financing costs

195

220

Changes in assets and liabilities:

Decrease in accounts receivable

6,964

9,141

Increase in prepaid expenses and other current assets

(455
)

(1,790
)
Decrease in accounts payable and accrued expenses

(11,522
)

(3,462
)
Decrease in revenues and royalties payable

(4,019
)

(1,730
)
Increase (decrease) in advances

506

(8,966
)
Net cash provided by operating activities

24,184

1,735

Cash flows from investing activities:

Bold Contribution Agreement, net of cash acquired

(55,609
)

—

Lynden Arrangement, net of cash acquired

—

(31,334
)
Additions to oil and gas properties

(29,958
)

(15,272
)
Additions to office and other equipment

(139
)

(63
)
Proceeds from sales of oil and gas properties

5,054

—

Net cash used in investing activities

(80,652
)

(46,669
)
Cash flows from financing activities:

Proceeds from borrowings

70,000

36,597

Repayments of borrowings

(11,193
)

(38,165
)
Common stock exchanged and cancelled

(324
)

—

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

—

47,125

Deferred financing costs

(1,168
)

(78
)
Net cash provided by financing activities

57,315

45,479

Net increase in cash and cash equivalents

847

545

Cash at beginning of period

10,200

23,264

Cash at end of period

$
11,047

$
23,809

Supplemental disclosure of cash flow information

Cash paid for:

Interest

$
1,555

$
688

Non-cash investing and financing activities:

Class B Common stock issued in Bold Contribution Agreement

$
489,842

$
—

Class A Common stock issued in Bold Contribution Agreement

$
2,037

$
—

Common stock issued in Lynden Arrangement

$
—

$
45,699

Accrued capital expenditures

$
19,519

$
8,938

Asset retirement obligations

$
83

$
101

Promissory Note

$
—

$
5,059

	*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

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

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

	*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.

Table of Contents

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.

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

~~We are~~

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. ~~Our~~The Company's operations are all in the upstream segment of the oil and natural gas industry and all ~~our~~its properties are onshore in the United States.

Earthstone ~~Energy, Inc. (“Earthstone”)~~ is the sole managing member of Earthstone Energy Holdings, LLC, a Delaware limited liability company (together with its wholly-owned consolidated subsidiaries, “EEH”), with a controlling interest in EEH. Earthstone, together with its wholly-owned subsidiary, Lynden Energy Corp., a corporation organized under the laws of British Columbia (“Lynden Corp”), and Lynden Corp’s wholly-owned consolidated subsidiary, Lynden USA Inc., a Utah corporation (“Lynden US”) and also a member of EEH, consolidates the financial results of EEH and records a noncontrolling interest in the Condensed Consolidated Financial Statements representing the economic interests of EEH's members other than Earthstone and Lynden ~~US (collectively, the “Company” “our,” “we,” “us,” or similar terms).~~US.

The accompanying unaudited Condensed Consolidated Financial Statements and notes thereto ~~of the Company,~~ have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial statements. Pursuant to such rules and regulations, certain disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted. The accompanying unaudited Condensed Consolidated Financial Statements and notes should be read in conjunction with the financial statements and notes included in Earthstone’s ~~2016~~2019 Annual Report on Form ~~10-K, as amended.~~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, ~~2016~~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 ~~Re-engineering~~ad valorem taxes which were previously included in Lease operating expenses within the Operating Costs and ~~workovers in~~Expenses section of the Condensed Consolidated Statements of Operations have been reclassified from ~~its own line item~~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 ~~Lease operating expenses,~~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. ~~This reclassification~~These reclassifications had no effect on Income ~~(loss)~~ from operations or any other subtotal in the Condensed Consolidated Statements of Operations.

~~Bold Contribution Agreement~~

~~On May 9, 2017, Earthstone completed~~ ~~a contribution agreement dated as of November 7, 2016 and as amended on March 21, 2017 (the “Bold Contribution Agreement”),~~ by and among Earthstone, EEH, Lynden US, Lynden USA Operating, LLC, a Texas limited liability company (“Lynden Op”), Bold Energy Holdings, LLC, a Texas limited liability company (“Bold Holdings”), and Bold Energy III LLC, a Texas limited liability company (“Bold”). The purpose of the Bold Contribution Agreement was to provide for, among other things described below, the business combination between Earthstone and Bold, which owned significant developed and undeveloped oil and natural gas properties in the Midland Basin of Texas (the “Bold Transaction”).

The Bold Transaction was structured in a manner commonly known as an “Up-C.” Under this structure and the Bold Contribution Agreement, (i) Earthstone recapitalized its common stock into two classes – Class A common stock, $0.001 par value per share (the “Class A Common Stock”), and Class B common stock, $0.001 par value per share (the “Class B Common Stock”), and all of Earthstone’s existing outstanding common stock, $0.001 par value per share (the “Common Stock”), was recapitalized on a one-for-one basis for Class A Common Stock (the “Recapitalization”); (ii) Earthstone transferred all of its membership interests in Earthstone Operating, LLC, Sabine River Energy, LLC, EF Non-Op, LLC and Earthstone Legacy Properties, LLC (formerly Earthstone GP, LLC) and $36,071 in cash from the sale of Class B Common Stock to Bold Holdings (collectively, the “Earthstone Assets”) to EEH, in exchange for 16,791,296 membership units of EEH (the “EEH Units”); (iii) Lynden US transferred all of its membership interests in Lynden Op to EEH in exchange for 5,865,328 EEH Units; (iv) Bold Holdings transferred all of its membership interests in Bold to EEH in exchange for 36,070,828 EEH Units and purchased 36,070,828 shares of Class B Common Stock issued by Earthstone for $36,071; and (v) Earthstone granted an aggregate of 150,000 fully vested shares of Class A Common Stock under Earthstone’s 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”), to certain employees of Bold. Each EEH Unit, together with one share of Class B Common Stock, are convertible into one share of Class A Common Stock.

Upon closing of the Bold Transaction on May 9, 2017, Bold Holdings owned approximately 61.4% of the outstanding shares of Class A Common Stock, on a fully diluted, as converted basis. The EEH Units and the shares of Class B Common Stock issued to Bold Holdings were not registered under the Securities Act of 1933, as amended (the “Securities Act”), but were issued by EEH and Earthstone in reliance on the exemption provided under Section 4(a)(2) of the Securities Act.

~~EARTHSTONE ENERGY, INC.~~

~~NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)~~Recently Issued Accounting Standards

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

On May 9, 2017, in connection with the closing of the Bold Transaction, Earthstone, EnCap Investments L.P. (“EnCap”), Oak Valley Resources, LLC (“Oak Valley”), and Bold Holdings entered into a voting agreement (the “Voting Agreement”), pursuant to which EnCap, Oak Valley, and Bold Holdings agreed not to vote any shares of Class A Common Stock or Class B Common Stock held by them in favor of any action, or take any action that would in any way alter the composition of the board of directors of Earthstone (the “Board”) from its composition immediately following the closing of the Bold Transaction as long as the Voting Agreement is in effect.

Pursuant to the terms of the Bold Contribution Agreement, at the closing of the Bold Transaction, Earthstone, Bold Holdings, and the unitholders of Bold Holdings entered into a registration rights agreement (the “Registration Rights Agreement”) relating to the shares of Class A Common Stock issuable upon the exchange of the EEH Units and Class B Common Stock held by Bold Holdings or its unitholders. In accordance with the Registration Rights Agreement, Earthstone filed a registration statement (the “Registration Statement”) with the SEC to permit the public resale of the shares of Class A Common Stock issued by Earthstone to Bold Holdings or its unitholders in connection with the exchange of Class B Common Stock and EEH Units in accordance with the terms of the First Amended and Restated Limited Liability Company Agreement of EEH. On October 18, 2017, the Registration Statement was declared effective by the SEC.

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

~~New significant accounting policy~~

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

~~Recently Issued Accounting Standards~~

~~Standards not yet adopted~~

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

~~Leases~~ ~~– In February 2016, the FASB issued updated guidance on accounting for leases.~~ The update requires that a lessee recognize in the statement of financial position a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. Similar to current guidance, the update continues to differentiate between finance leases and operating leases; however, this distinction now primarily relates to differences in the manner of expense recognition over time and in the classification of lease payments in the statement of cash flows. The standards

~~EARTHSTONE ENERGY, INC.~~

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

update is effective for interim and annual periods beginning after December 15, 2018 with early adoption permitted. Entities are required to use a modified retrospective adoption, with certain relief provisions, for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements when adopted. The Company expects to adopt this standards update, as required, beginning with the first quarter of 2019. ~~The Company is in the process of evaluating the impact, if any, of the adoption of this guidance on its Condensed Consolidated Financial Statements.~~

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

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

~~Intangibles - Goodwill and Other –~~ ~~In January 2017, the FASB~~ issued updated guidance simplifying the test for goodwill impairment. The update eliminates ~~Step 2~~the requirement to determine the implied value of goodwill in measuring an impairment loss. Upon adoption, the measurement of a goodwill impairment ~~test. Instead, an entity should perform its annual or interim goodwill impairment test by comparing~~will represent the ~~fair value~~excess of ~~a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds~~ the reporting unit’s carrying value over its fair ~~value; however,~~value and will be limited to the ~~loss recognized should not exceed the total amount~~carrying value of ~~goodwill allocated to that reporting unit.~~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”) 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 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.

~~Compensation – Stock Compensation –~~

Reference Rate Reform - In ~~May 2017,~~ March 2020, the FASB issued ~~updated guidance~~an update that provides ~~clarity about which changes~~optional guidance for a limited period of time to ease the ~~terms or conditions of a share-based payment award require~~transition from LIBOR to an ~~entity~~alternative reference rate. The ASU intends to ~~apply modification~~address certain concerns relating to accounting for contract modifications and hedge accounting. ~~The update is effective for annual periods beginning after~~ These optional expedients and exceptions to applying GAAP, assuming certain criteria are met, are allowed through December ~~15, 2017, and early adoption is permitted, including adoption in any interim period.~~ 31, 2022. The Company is currently evaluating the ~~impact, if any,~~provisions of this update ~~but~~and has not yet determined whether it will elect the optional expedients. The Company does not expect the ~~adoption~~transition to an alternative rate to have a material impact on its ~~Condensed Consolidated Financial Statements.~~business, operations or liquidity.

~~Note 2. Acquisitions and Divestitures~~

~~The Company accounts for its acquisitions that qualify as business combinations, under the acquisition method~~

Table of ~~accounting in accordance with FASB ASC Topic 805,~~ ~~Business Combinations~~, which, among other things, requires the assets acquired and liabilities assumed to be measured and recorded at their fair values as of the acquisition date. The initial accounting for acquisitions may not be complete and adjustments to provisional amounts, or recognition of additional assets acquired or liabilities assumed, may occur as additional information is obtained about the facts and circumstances that existed as of the acquisition dates.

~~Bold Transaction~~

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

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

Contents

EARTHSTONE ENERGY, INC.

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

Note 2. Fair Value Measurements

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

Consideration:

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

150,000

EEH Units issued to Bold Holdings

36,070,828

Total equity interest issued in the Bold Transaction

36,220,828

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

$
13.58

Total consideration transferred ⁽¹⁾⁽²⁾

$
491,879

Fair value of assets acquired:

Cash and cash equivalents

$
2,355

Other current assets

10,078

Oil and gas properties ⁽³⁾

557,704

Amount attributable to assets acquired

$
570,137

Fair value of liabilities assumed:

Long-term debt ⁽⁴⁾

$
58,000

Current liabilities

17,042

Deferred tax liability

2,857

Noncurrent asset retirement obligations

359

Amount attributable to liabilities assumed

$
78,258

~~(1)~~

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

~~(2)~~

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

~~(3)~~

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

~~(4)~~

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

~~EARTHSTONE ENERGY, INC.~~

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

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

Three Months Ended September 30,

Nine Months Ended September 30,

2016

2017

2016

Revenue

$
15,865

$
99,192

$
38,165

Loss before taxes

$
(4,860
)

$
(41,420
)

$
(31,723
)

Net loss

$
(5,061
)

$
(31,374
)

$
(32,109
)

Less: Net loss available to noncontrolling interest

$
(3,120
)

$
(19,253
)

$
(21,587
)

Net loss attributable to Earthstone Energy, Inc.

$
(1,941
)

$
(12,121
)

$
(10,522
)

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

Basic and diluted

$
(0.09
)

$
(0.53
)

$
(0.60
)

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

~~2017 Divestitures~~

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

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

~~Note 3. Fair Value Measurements~~

FASB ~~ASC~~Accounting Standards Codification (“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~~-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

~~EARTHSTONE ENERGY, INC.~~

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

some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instrument’s complexity. The Company reflects transfers between the three levels at the beginning of the reporting period in which the availability of observable inputs no longer justifies classification in the original level. There were no transfers between fair value hierarchy levels for the nine months ended September 30, ~~2017.~~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):

September 30, 2017	Level 1		Level 2		Level 3		Total
September 30, 2020									*Level 1*		*Level 2*		*Level 3*		*Total*
Financial assets
Derivative asset - current	$	—	$	147	$	—	$	147	$	0	$	25,097	$	0	$	25,097
Derivative asset - noncurrent										0		4,727		0		4,727
Total financial assets	$	—	$	147	$	—	$	147	$	0	$	29,824	$	0	$	29,824

Financial liabilities
Derivative liability - current	$	—	$	1,986	$	—	$	1,986	$	0	$	1,040	$	0	$	1,040
Derivative liability - noncurrent		—		422		—		422		0		577		0		577
Total financial liabilities	$	—	$	2,408	$	—	$	2,408	$	0	$	1,617	$	0	$	1,617

December 31, 2016
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	$	—	$	4,595	$	—	$	4,595	$	0	$	6,889	$	0	$	6,889
Derivative liability - noncurrent		—		1,575		—		1,575		0		0		0		0
Total financial assets	$	—	$	6,170	$	—	$	6,170
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 ~~goodwill.~~performance units. These assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments ~~only~~if events or changes in certain ~~circumstances.~~

~~Proved Oil~~circumstances indicate that adjustments may be necessary. Due to significant declines in commodity prices and ~~Natural Gas Properties~~

~~Proved~~global demand for oil and natural gas products resulting from the COVID-19 pandemic, the Company assessed the fair values of its oil and natural gas properties ~~are measured at fair value on a nonrecurring basis~~and goodwill resulting in ~~order to review for impairment. The~~non-cash impairment ~~charge reduces~~charges during 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 assumptionsnine months ended September 30, 2020. See further discussion 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 valueNote 4. Asset Impairments.

Table of ~~the assets.~~

Contents

EARTHSTONE ENERGY, INC.

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

Note 3. Derivative Financial Instruments

~~Goodwill~~

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

~~Business Combinations~~

The Company records the identifiable assets acquired and liabilities assumed at fair value at the date of acquisition on a nonrecurring basis. Fair value may be estimated using comparable market data, a discounted cash flow method, or a combination of the two. In the discounted cash flow method, estimated future cash flows are based on management’s expectations for the future and include estimates of future oil and gas production, commodity prices based on NYMEX commodity futures price strips as of the date of the estimate, operating and development costs, and a risk-adjusted discount rate. The future oil and natural gas pricing used in the valuation is a Level 2 assumption. Significant Level 3 assumptions associated with the calculation of discounted cash flows used in the determination of fair value of the acquisition include the Company’s estimate operating and development costs, anticipated production of proved reserves, appropriate risk-adjusted discount rates and other relevant data. The Company’s acquisitions are described in ~~Note 2. Acquisitions and Divestitures~~.

~~Asset Retirement Obligations~~

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

~~Note 4. Derivative Financial Instruments~~

~~In connection with the closing of the Bold Transaction on May 9, 2017, all oil and natural gas derivative contracts were novated to EEH.~~ The Company’s hedging activities 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 ~~for the remainder of 2017~~ through December 31, ~~2018.~~ 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.

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.

~~EARTHSTONE ENERGY, INC.~~

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

The Company had the following open crude oil and natural gas derivative contracts as of September 30, ~~2017:~~ 2020:

Price Swaps

Period

Commodity

Volume
(Bbls / MMBtu)

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

Q4 2017

Crude Oil

157,500

$
50.66

Q1 - Q4 2018

Crude Oil

1,279,000

$
50.16

Q4 2017

Natural Gas

645,000

$
3.167

Q1 - Q4 2018

Natural Gas

810,000

$
3.066

	*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)

The basis differential price is between WTI Midland 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.

(4)

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

~~Additionally, on October 30, 2017,~~Interest Rate Swaps

At times, the ~~Company~~Company’s hedging activities include the use of interest rate swaps entered into ~~additional fixed price oil swap agreements, hedging an additional 365,000 Bbls of 2019 oil production at a price of $51.55/Bbl.~~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	%

Table of Contents

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):

September 30, 2017

December 31, 2016

Derivatives not
designated as hedging
contracts under ASC
Topic 815

Balance Sheet Location

Gross
Recognized
Assets /
Liabilities

Gross
Amounts
Offset

Net
Recognized
Assets /
Liabilities

Gross
Recognized
Assets /
Liabilities

Gross
Amounts
Offset

Net
Recognized
Assets /
Liabilities

Commodity contracts

Derivative asset - current

$
327

$
(180
)

$
147

$
—

$
—

$
—

Commodity contracts

Derivative asset - noncurrent

$
24

$
(24
)

$
—

$
—

$
—

$
—

Commodity contracts

Derivative liability - current

$
(2,166
)

$
180

$
(1,986
)

$
4,595

$
—

$
4,595

Commodity contracts

Derivative liability - noncurrent

$
(446
)

$
24

$
(422
)

$
1,575

$
—

$
1,575

		*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 ~~follow~~following table summarizes the location and amounts of the Company’s realized and unrealized gains and losses on derivatives instruments in the ~~Company’s~~ Condensed Consolidated Statements of Operations 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.

Three Months Ended September 30,

Nine Months Ended September 30,

2017

2016

2017

2016

Derivatives not designated as hedging contracts under ASC Topic 815

Statement of Operations Location

Total (loss) gain on commodity contracts

(Loss) gain on derivative contracts, net

$
(4,159
)

$
413

$
3,908

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

(Loss) gain on derivative contracts, net

496

533

229

3,330

(Loss) gain on commodity contracts, net

$
(3,663
)

$
946

$
4,137

$
(2,517
)

Note 4. Asset Impairments

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

	*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 September 30, 2019.

Table of Contents

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 ~~Loss~~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. ~~Depletion expense for oil~~For the three and ~~gas producing property and related equipment was $10.2 million and $5.0 million, for the three~~nine months ended September 30, ~~2017 and 2016, respectively. For the nine months ended September 30, 2017 and 2016,~~2020, depletion expense for oil and gas producing property and related equipment was ~~$27.9~~$28.4 million and ~~$15.9~~$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.

~~EARTHSTONE ENERGY, INC.~~

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

~~Proved Properties~~

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

Unproved Properties

Unproved properties consist of costs incurred to acquire undeveloped ~~leases as well as the cost to acquire unproved reserves. Undeveloped lease costs and unproved reserve acquisition costs are capitalized.~~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 ~~delay rentals,~~a lease renewal fee, meeting contractual drilling obligations, or by the presence of producing wells on the leases. Unproved costs related to successful ~~exploratory~~ drilling on unproved leases are reclassified to proved ~~properties and depleted on a units-of-production basis.~~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 ~~September 30, 2017, the Company recorded an impairment of $0.1 million to its unproved oil and natural gas properties~~ March 31, 2020, as a result of ~~acreage expirations to its properties located~~the recent decline in ~~the Eagle Ford shale trend of south Texas. As a result of both acreage expirations and forward commodity~~crude oil price ~~declines, during the nine months ended September 30, 2017,~~futures, the Company recorded ~~impairments consisting~~non-cash impairment charges of ~~$63.0~~$25.3 million to its proved oil and natural gas properties and ~~$3.7~~$11.3 million to its unproved oil and natural gas properties, ~~primarily to its properties~~ located in the Eagle Ford ~~shale trend~~Trend. No such impairments were recorded in the three months ended September 30, 2020. As a result of ~~south Texas.~~certain acreage expirations, the Company recorded non-cash impairment charges of $2.1 million and $8.4 million to its unproved oil and natural gas properties during the three and nine months ended 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 September 30, ~~2016.~~ 2019.

~~Note 6. Noncontrolling Interest~~

~~As a result of~~Capitalized costs, impairment, and depreciation, depletion and amortization relating to the ~~Bold Transaction, Earthstone became the sole managing member of,~~Company’s oil and has a controlling interest in, EEH. As the sole managing member of EEH, Earthstone operates and controls all of the business and affairs of EEH and its subsidiaries. Immediately following the Bold Transaction, Earthstone and Lynden US owned a 38.6% membership interest in EEH while Bold Holdings owned the remaining 61.4%.

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

Total consideration transferred ⁽¹⁾

$
491,879

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

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

$
479,007

Table of Contents

EARTHSTONE ENERGY, INC.

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

Note 6. Noncontrolling Interest

~~(1)~~

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

~~(2)~~

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

Earthstone consolidates the financial results of EEH and its subsidiaries and records a noncontrolling interest for the economic interest in Earthstone held by the members of EEH other than Earthstone and Lynden US. Net (loss) income ~~(loss)~~ attributable to noncontrolling interest in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, ~~2017~~2020 and 2019 represents the portion of net (loss) income ~~or loss~~ attributable to the economic interest in the Company held by the members of EEH other than Earthstone and Lynden US. Noncontrolling interest in the Condensed Consolidated Balance ~~Sheet~~Sheets as of September 30, ~~2017~~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 nine months ended September 30, ~~2017:~~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, 2016

—

—

—

—

—

May 9, 2017 - Bold Transaction

22,656,624

38.6
%

36,070,828

61.4
%

58,727,452

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

150,000

—

150,000

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

182,135

—

182,135

As of September 30, 2017

22,988,759

38.9
%

36,070,828

61.1
%

59,059,587

Note 7. Net (Loss) Income Per Common Share

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

2017

As of December 31, 2016

$
—

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

479,007

Net loss attributable to noncontrolling interest

(35,392
)
As of September 30, 2017

$
443,615

~~EARTHSTONE ENERGY, INC.~~

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

~~Note 7.~~ Net ~~Income (Loss) Per Common Share~~

~~Net~~(loss) income ~~(loss)~~ per common share—basic is calculated by dividing Net (loss) income ~~(loss)~~ by the weighted average number of shares of common stock outstanding during the ~~period (Common Stock through May 8, 2017 and Class A Common Stock from May 9, 2017 through September 30, 2017).~~period. Net (loss) income ~~(loss)~~ per common share—diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing Net (loss) income ~~(loss)~~ by the sum of the weighted average number of shares of common stock, as defined above, outstanding plus potentially dilutive securities. Net (loss) income ~~(loss)~~ per common share—diluted considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares, as defined above, would have an anti-dilutive effect.

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

												*Three Months Ended*					*Nine Months Ended*
	Three Months Ended September 30,					Nine Months Ended September 30,						*September 30,*					*September 30,*
(In thousands, except per share amounts)	2017		2016			2017			2016			*2020*			*2019*		*2020*			*2019*
Net income (loss) attributable to Earthstone Energy, Inc.	$	1,556	$	(3,900	)	$	(14,838	)	$	(21,493	)
Net (loss) income attributable to Earthstone Energy, Inc.												$	(5,445	)	$	11,770	$	(5,076	)	$	3,343

Net income (loss) per common share attributable to Earthstone Energy, Inc.:
Net (loss) income per common share attributable to Earthstone Energy, Inc.:
Basic	$	0.07	$	(0.17	)	$	(0.66	)	$	(1.23	)	$	(0.18	)	$	0.41	$	(0.17	)	$	0.12
Diluted	$	0.07	$	(0.17	)	$	(0.66	)	$	(1.23	)	$	(0.18	)	$	0.41	$	(0.17	)	$	0.12

Weighted average common shares outstanding
Basic		22,905,023		22,289,177			22,638,977			17,433,079			30,073,635			29,032,842		29,810,705			28,883,907
Add potentially dilutive securities:
Unvested restricted stock units		—		—			—			—
Unvested restricted stock units (1)													0			0		0			0
Unvested performance units (1)													0			0		0			0
Diluted weighted average common shares outstanding		22,905,023		22,289,177			22,638,977			17,433,079			30,073,635			29,032,842		29,810,705			28,883,907

(1) For the three and nine months ended September 30, 2020 and 2019, the Company had 0 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 these periods were in excess of the weighted average outstanding fair value for the unvested shares for the same periods.

Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and ~~Net income (loss)~~net loss attributable to noncontrolling interest of ~~$37.8~~$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 ~~(loss)~~ attributable to Earthstone Energy, Inc., for the periods then ended, having no dilutive effect on Net (loss) income ~~(loss)~~ per common share attributable to Earthstone Energy, Inc. ~~For~~

Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and net income attributable to noncontrolling interest of $14.4 million for the three months ended September 30, ~~2017,~~2019 and net income attributable to noncontrolling interest of $3.9 million for the Company had no potentially dilutive restricted stock units (“RSUs”) in calculating diluted earnings per share, as the amount of unrecognized compensation costs related to outstanding RSUs exceeded the weighted average fair value of the RSUs assumed converted under the treasury stock method. For the nine months ended September 30, ~~2017, the Company excluded 137,345 RSUs, in calculating diluted earnings per share as the effect was anti-dilutive due~~2019 would be added back to ~~the net loss incurred~~Net (loss) income attributable to Earthstone Energy, Inc. for the ~~period. For the three and nine months~~periods then ended, ~~September 30, 2016, the Company excluded zero and 14,212 RSUs, respectively, in calculating diluted earnings~~having no dilutive effect on Net (loss) income per common share ~~as the effect was anti-dilutive due~~attributable to ~~the net loss incurred for these periods.~~Earthstone Energy, Inc.

~~Note 8. Common Stock~~

~~On May 9, 2017, and in connection with the completion~~

Table of ~~the Bold Transaction, Earthstone recapitalized its Common Stock into two classes, as described in~~ ~~Note 1. – Basis of Presentation and Summary of Significant Accounting Policies, Class A Common Stock and Class B Common Stock. At that time, all of Earthstone’s existing outstanding Common Stock was automatically converted on a one-for-one basis into Class A Common Stock.~~

Contents

EARTHSTONE ENERGY, INC.

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

Note 8. Common Stock

Class A Common Stock

At September 30, ~~2017,~~2020 and December 31, 2019, there were ~~22,988,759~~30,210,749 and 29,421,131 shares of Class A Common Stock issued and ~~outstanding. On July 1, 2017, Earthstone retired and returned the 15,357 shares of treasury stock to authorized but unissued shares of Class A Common Stock.~~outstanding, respectively. During the ~~period January 1, 2017 through May 8, 2017, the Company issued 382,804 shares of Common Stock~~three and nine months ended September 30, 2020, as a result of the vesting and settlement of restricted stock units under the Earthstone Energy, Inc. Amended and Restated 2014 ~~Plan. During the period May 9, 2017 through September 30, 2017, the Company~~ Long-Term Incentive Plan, as amended (the “2014 Plan”), Earthstone issued ~~182,135~~195,344 and 726,082 shares, respectively, of Class A Common Stock, of which 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 September 30, 2019, as a result of the vesting and settlement of restricted stock units under the 2014 ~~Plan. Additionally, on May 9, 2017, under the Bold Contribution Agreement,~~ Plan, Earthstone issued ~~150,000~~167,827 and 569,883 shares, respectively, of Class A Common Stock, of which 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 ~~valued at approximately $2.0 million on that date. For additional information, see~~ ~~Note 2. Acquisitions and Divestitures~~.were issued as the result of conversions of Class B Common Stock.

~~Class A Common Stock Offering~~

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

Class B Common Stock

At September 30, ~~2017,~~2020 and December 31, 2019, there were ~~36,070,828~~35,009,371 and 35,260,680 shares of Class B Common Stock issued and outstanding. Earthstone did not have any Class B Common Stock issued at December 31, 2016. On May 9, 2017, in connection with Earthstone’s completion of the Bold Transaction, Earthstone issued 36,070,828 shares of Class B Common Stock in exchange for $36 thousand.outstanding, respectively. Each share of Class B Common Stock, together with ~~one~~1 EEH Unit, is convertible into ~~one~~1 share of Class A Common Stock. ~~For additional information, see~~ ~~Note 2. Acquisitions~~During the three and ~~Divestitures~~.

~~On May 9, 2017, in connection with the closing~~nine months ended September 30, 2020, 49,316 and 251,309 shares, respectively, of ~~the Bold Transaction, Earthstone, EnCap, Oak Valley,~~Class B Common Stock and ~~Bold Holdings entered into the Voting Agreement, pursuant to which EnCap, Oak Valley, and Bold Holdings agreed not to vote any~~EEH Units were exchanged for an equal number of shares of Class A Common ~~Stock or~~Stock. During the three and nine months ended September 30, 2019, 35,732 shares of Class B Common Stock ~~held by them in favor~~and EEH Units were exchanged for an equal number of ~~any action, or take any action that would in any way alter the composition~~shares of the Board from its composition immediately following the closing of the Bold Transaction as long as the Voting Agreement is in effect. The Voting Agreement terminates on the earlier of (i) the fifth anniversary of the closing date of the Bold Contribution Agreement and (ii) the date upon which EnCap, Oak Valley, and Bold Holdings collectively own, of record and beneficially, less than 20% of Earthstone’s outstanding voting stock.Class A Common Stock.

Note 9. Stock-Based Compensation

~~Note 9. Stock-Based Compensation~~Restricted Stock Units

The 2014 Plan, ~~as amended,~~ allows, among other things, for the grant of ~~RSUs. On May 9, 2017, and in connection with~~restricted stock units (“RSUs”). As of September 30, 2020, the ~~completion of the Bold Contribution Agreement, and upon approval by the stockholders of Earthstone, the 2014 Plan was amended to increase the~~maximum number of shares of Class A Common Stock ~~authorized to~~ that may be issued under the 2014 Plan ~~by 4.3~~was 9.4 million ~~shares, to a total of 5.8 million~~ shares.

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. Prior to May 9, 2017, the~~settlement. The Company ~~determined the fair value of granted RSUs based on the market price of the Common Stock of the Company on the date of the grant. Beginning on May 9, 2017, the Company began determining~~determines the fair value of granted RSUs based on the market price of the Class A Common Stock ~~of Earthstone~~ on the date of the grant. Compensation expense for granted RSUs is recognized on a straight-line basis over the vesting and is net of forfeitures, as incurred.

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

Shares

Weighted-Average Grant Date Fair Value

Unvested RSUs at December 31, 2016

781,500

$
12.53

Granted

254,500

$
11.67

Forfeited

(36,000
)

$
13.30

Vested

(594,380
)

$
12.45

Unvested RSUs at September 30, 2017

405,620

$
12.03

~~EARTHSTONE ENERGY, INC.~~

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

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

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

~~During~~The table below summarizes RSU award activity for the nine months ended September 30, ~~2016,~~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 September 30, 2020, there was $5.4 million of unrecognized compensation expense related to the RSU awards which will be recognized over a weighted average period of 0.85 years.

For the three and nine months ended September 30, 2020, Stock-based compensation related to RSUs was $1.2 million and $4.2 million, respectively. For the three and nine months ended September 30, 2019, Stock-based compensation related to RSUs was $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 nine months ended 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, the Board of Directors of Earthstone (the “Board”) granted 1,043,800 PSUs (the “2020 PSUs”) to certain officers pursuant to the 2014 Plan (the “2020 Grant”). The 2020 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 ~~granted 772,500 RSUs with~~over a period commencing on February 1, 2020 and ending on January 31, 2023 (the “Performance Period”) of certain performance criteria established by the Board.

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

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 the 2020 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 pandemic and the recent commodity price crash, 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 2020 PSUs, assuming a risk-free rate of 1.4% and volatility of 62.0%, the Company calculated the weighted average grant date fair value ~~of $12.55. As of September 30, 2016, all 772,500 RSUs were unvested.~~per PSU to be $5.36.

~~Note 10.~~ ~~Long-Term Debt~~As of September 30, 2020, there was $7.3 million of unrecognized compensation expense related to the PSU awards which will be amortized over a weighted average period of 0.98 years.

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

Table of Contents

EARTHSTONE ENERGY, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Long-Term Debt

Credit ~~Agreement~~Facility

On ~~May 9, 2017, in connection with the closing~~November 21, 2019, Earthstone, EEH (the “Borrower”), Wells Fargo Bank, National Association, as Administrative Agent and Issuing Bank (“Wells Fargo”), Royal Bank of the Bold Transaction, the Company exited its credit agreement dated December 19, 2014, by and among Earthstone, Oak Valley Operating, LLC, EF Non-OP, LLC, Sabine River Energy, LLC, Basic Petroleum Services, Inc.,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~~lenders party thereto (the “Lenders”) entered into a credit agreement (the “Credit Facility”), which replaced the Prior Credit Facility (as ~~amended, modified or restated from time to time,~~defined below), which was terminated on November 21, 2019.

Concurrently with the ~~“ESTE~~effectiveness of the Credit ~~Agreement”). At~~Facility, the Company terminated that ~~time, all outstanding borrowings~~certain credit agreement, dated as of $10.0 million under the ESTE Credit Agreement were repaid and $0.5 million of remaining unamortized deferred financing costs were expensed and included in Write-off of deferred financing costs in the Condensed Consolidated Statements of Operations.

On May 9, 2017 ~~EEH (the “Borrower”~~(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 ~~Op,~~USA Operating, LLC, Bold Energy III LLC (“Bold”), Bold Operating, LLC, ~~(the “Guarantors”), BOKF, NA dba Bank Of Texas, as Agent and Lead Arranger, Wells Fargo Bank, National Association as Syndication Agent and~~ the ~~Lenders~~guarantors party thereto, ~~(the “Lenders”), entered into~~the lenders party thereto, and BOKF, as administrative agent.

On March 27, 2020, in connection with a ~~credit agreement (the “EEH Credit Agreement”).~~

~~The~~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 an amendment (the “Amendment”) to the Credit ~~Agreement~~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 ~~$150.0 million, and is subject to redetermination~~on or around April 1, 2021. Subsequent redeterminations will occur on or about each November 1st and May 1st ~~of each year.~~ thereafter. The amounts borrowed under the ~~EEH~~ Credit ~~Agreement~~Facility bear annual interest rates at either (a) the ~~London Interbank Offered~~adjusted LIBO Rate ~~(“LIBOR”~~(as customarily defined) (the “Adjusted LIBO Rate”) plus ~~2.25%~~2.00% to 3.25% or (b) the sum of (i) the greatest of (A) the prime ~~lending~~ rate of ~~Bank~~Wells Fargo, (B) the federal funds rate plus ½ of ~~Texas~~1.0%, and (C) the Adjusted LIBO Rate for an interest rate period of one month plus ~~1.25%~~1.0%, (ii) plus 1.00% to 2.25%, depending on the ~~amounts~~amount borrowed under the ~~EEH~~ Credit ~~Agreement.~~Facility. Principal amounts outstanding under the ~~EEH~~ Credit ~~Agreement~~Facility are due and payable in full at maturity on ~~May 9, 2022.~~ November 21, 2024. All of the obligations under the ~~EEH~~ Credit ~~Agreement,~~Facility, and the guarantees of those obligations, are secured by substantially all of EEH’s assets. Additional payments due under the ~~EEH~~ Credit ~~Agreement~~Facility include paying a commitment fee of 0.375% to 0.50% per year, depending on the amount borrowed under the Credit Facility, to the Lenders in respect of the unutilized commitments ~~thereunder, as well as~~thereunder. EEH is also required to pay customary letter of credit fees.

Effective May 2020, the Company entered into certain ~~other customary fees.~~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 ~~EEH~~ Credit ~~Agreement~~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, ~~enter into sale and leaseback transactions,~~ pay dividends and ~~make~~ distributions or repurchase its limited liability interests, engage in mergers or consolidations, sell certain assets, sell or discount any notes receivable or accounts receivable and engage in certain transactions with affiliates.

In addition, the ~~EEH~~ Credit ~~Agreement~~Facility requires EEH to maintain the following financial covenants: a current ratio ~~as defined,~~ of not less than 1.0 to 1.0 and a consolidated leverage ratio of not greater than 4.0 to 1.0. ~~Leverage~~ 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 ~~(excluding any debt from obligations relating to non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives)~~ to (ii) ~~the product of~~ EBITDAX for the applicable period, which was calculated as EBITDAX for the four consecutive fiscal quarters ending on such ~~fiscal quarter multiplied by four.~~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) ~~non-cash losses under FASB ASC 815 as a result of changes in~~certain distributions to employees related to the ~~fair market value of derivatives,~~stock compensation, (vii) ~~exploration~~certain transaction related expenses, (viii) ~~impairment~~reimbursed indemnification expenses related to certain dispositions and investments, (ix) non-cash ~~compensation~~extraordinary, usual, or nonrecurring expenses or losses, (x) other non-cash charges and minus (b) to the extent included in consolidated net income in such period: (i) non-cash income, (ii) gains on asset dispositions, disposals and abandonments outside of the ordinary course of 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 ~~non-cash gains under FASB ASC 815 as a result~~in an amount equal to the aggregate amount of ~~changes in the fair market value of derivatives.~~pass-through cash distributions actually made by Borrower during such period.

The ~~EEH~~ Credit ~~Agreement~~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 ~~if Frank A. Lodzinski ceases to serve and function as Chief Executive Officer of EEH and the majority of the Lenders do not approve of Mr. Lodzinski’s successor.~~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 their remedies with respect to the collateral. As of September 30, ~~2017,~~2020, EEH was in compliance with ~~these~~the covenants under the ~~EEH~~ Credit ~~Agreement.~~

~~EARTHSTONE ENERGY, INC.~~

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

As of September 30, ~~2017, the Company had a $150.0~~2020, $130.0 million ~~borrowing base under the EEH Credit Agreement,~~ of ~~which $70.0 million was~~borrowings were outstanding, bearing annual interest of ~~3.7311%~~2.658%, resulting in an additional ~~$80.0~~$110.0 million of borrowing base availability under the ~~EEH~~ Credit ~~Agreement.~~

~~Promissory Note~~

~~In July 2016, Earthstone issued a $5.1~~Facility. At December 31, 2019, there were $170.0 million ~~unsecured promissory note (the “Note”) to a drilling rig contractor in settlement~~ of rig idle charges and the termination amount of the contract. These expenses which were incurred from late January 2016 through September 30, 2016 were recorded in Rig idle and termination expense in the Condensed Consolidated Statements of Operations for the nine months ended September 30, 2016. The Note was assigned to EEH in connection with the closing of the Bold Transaction. The Note is payable in monthly installments over a three-year period maturing in July 2019, bearing an annualized interest rate of 8.0% for the first 12 months, 10.0% for the subsequent 12 months, and 12.0% for the last 12 months, with no prepayment penalty. Interest expense is recognized using the effective interest method of approximately 9.1% over the life of the note. As of September 30, 2017, the Company had $3.1 millionborrowings outstanding under the ~~Note with $1.7 million included in the current portion of long-term debt.~~ Credit Facility.

~~Total Long-Term Debt~~

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

September 30,

December 31,

2017

2016

Borrowings under Credit Agreement

$
70,000

$
10,000

Promissory note

3,104

4,297

Total debt

73,104

14,297

Less: Current portion of long-term debt

(1,704
)

(1,604
)
Long-term debt

$
71,400

$
12,693

For the nine months ended September 30, ~~2017,~~2020, under the Credit Facility, the Company had borrowings of ~~$70.0~~$93.9 million and ~~$11.2~~$133.9 million in repayments of borrowings. The borrowings included $58.0 million related to the repayment of all outstanding borrowings under Bold’s credit agreement which were assumed by EEH in connection with the closing of the Bold Transaction.

For the three and nine months ended September 30, ~~2017,~~2020, interest on borrowings under the Credit Facility averaged ~~4.21%~~2.48% and ~~4.01%~~2.89% per annum, respectively, of which excluded commitment fees of ~~$0.1~~$0.2 million and ~~$0.2~~$0.5 million, respectively, and amortization of deferred financing costs of $0.1 million and $0.2 million, respectively. For the three and nine months ended September 30, ~~2016,~~2019, interest on borrowings under the Credit Facility averaged ~~3.78%~~4.38% and ~~5.40%~~4.53% per annum, respectively, of which excluded commitment fees of ~~$0.1~~$0.2 million and ~~$0.2~~$0.5 million, respectively, and amortization of deferred financing costs of $0.1 million and ~~$0.2~~$0.3 million, respectively.

The Company capitalized $0.1 million and $1.2 million, respectively, of costs associated with the ESTE Credit Agreement for the three and nine months ended September 30, 2017. The Company did not capitalize any costs associated with its borrowings for the three months ended September 30, 2016 and capitalized $0.1 million of costs associated with its borrowings for the nine months ended September 30, 2016. These capitalized costs are included in Other noncurrent assets in the Condensed Consolidated Balance Sheets.

The Company’s policy is to capitalize the financing costs associated with its debt and amortize those costs on a straight-line basis over the term of the associated debt. These capitalized costs are included in Other noncurrent assets in the Condensed Consolidated Balance Sheets. NaN costs associated with the Credit Facility were capitalized during the three and nine months ended September 30, 2020 nor 2019.

Table of Contents

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.

~~EARTHSTONE ENERGY, INC.~~

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

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

2017

2016

Beginning asset retirement obligations

$
6,013

$
5,075

Liabilities incurred

64

114

Liabilities settled

—

(15
)
Acquisitions ⁽¹⁾

359

250

Accretion expense

378

404

Divestitures ⁽²⁾

(3,629
)

—

Revision of estimates

19

(13
)
Ending asset retirement obligations

$
3,204

$
5,815

	*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

~~(1)~~

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

~~(2)~~

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

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”),~~Earthstone's majority shareholder consists of various investment funds managed by a private equity firm who may manage other investments in entities with which ~~owns approximately 12.9%~~the Company interacts in the normal course of business. On February 12, 2020, the ~~outstanding Class A Common Stock as~~Company sold certain of ~~September 30, 2017, is a party to a joint operating agreement (the “Operating Agreement”) with the Company. The Operating Agreement covers certain jointly owned~~its interests in oil and natural gas ~~properties located~~leases and wells in ~~the Eagle Ford trend in Texas.~~ an arm’s length transaction to a portfolio company of Earthstone’s majority shareholder (not under common control) for cash consideration of approximately $0.4 million.

In connection with the Operating Agreement, the Company made payments to Flatonia of $6.4 million and $20.8 million and received payments from Flatonia of $0.8 million and $3.2 million for the three and nine months ended September 30, 2017, respectively. For the three and nine months ended September 30, 2016, the Company made payments to Flatonia of $5.1 million and $21.3 million and received payments from Flatonia of $5.8 million and $8.6 million, respectively. At September 30, 2017, amounts receivable from FlatoniaOlenik v. Lodzinski et al. lawsuit described below in connection with the Operating Agreement were $1.5 million. At December 31, 2016, Earthstone had $1.5 million of outstanding receivables due from Flatonia. Amounts payable to Flatonia in connection with the Operating Agreement were $3.1 million at December 31, 2016. There were no payables outstanding and due to Flatonia as of September 30, 2017.

Note 13. Commitments and Contingencies, Earthstone’s majority shareholder was also named in the lawsuit. As a result of the Settlement Agreement (defined below), the Company has concluded negotiations with its insurance carrier regarding an allocation of defense costs and settlement contributions above its deductible for all the parties named in the lawsuit. In June 2020, the Company received $0.6 million in preliminary reimbursements from its majority shareholder and as of September 30, 2020 recorded a receivable in the amount of $0.6 million from its majority shareholder based on estimated additional defense costs to finalize the settlement and the respective allocated portion of the settlement payments.

Note 13. Commitments and Contingencies

Legal

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

~~In July 2015, EF Non-Op, LLC, a subsidiary of Earthstone, filed suit in the 125~~^th ~~Judicial District Court of Harris County, Texas against the operator of its properties in LaSalle County, Texas. In the case~~ ~~EF Non-Op, LLC vs. BHP Billiton Petroleum Properties (N.A.), LP (F/K/A Petrohawk Properties, LP),~~ the Company claims the operator has breached the applicable joint operating agreements in numerous ways, including, but not limited to, improper authorization for expenditure requests, improper and imprudent operations, misrepresentation of charges and excessive billings, as well as refusal to provide requested information. The Company also claims damages from negligent representation and fraud. The Company is seeking all relief to which it is entitled, including consequential damages and attorneys’ fees. BHP Billiton has claimed they are owed unpaid lease operating expenses and attorneys’ fees. With respect to a portion of the litigation associated with nine non-operated gas wells that were drilled in 2014 and placed on production in the first half of 2015, BHP Billiton in early 2016 elected to deem the Company as a non-consenting working interest owner regarding costs associated with the drilling, completing and operating of these nine wells, as BHP’s sole and exclusive remedy. The Company has accepted this “non-consent” status. The litigation is continuing with respect to the other disputes. The outcome of remaining disputes in this proceeding is uncertain, and while the Company is confident in its position, any potential monetary recovery or loss to the Company cannot be estimated at this time.

Olenik v. ~~Lodzinksi~~Lodzinski et al.: On June 2, 2017, Nicholas Olenik filed a purported shareholder class and derivative action in the Delaware Court of Chancery against ~~the Company’s~~Earthstone’s Chief Executive Officer, along with other members of the Board, EnCap Investments L.P. (“EnCap”), Bold, Bold Holdings and Oak ~~Valley.~~Valley Resources, LLC. The complaint alleges that ~~the Company’s~~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 “Bold Contribution Agreement”), by and among Earthstone, EEH, Lynden US, Lynden USA Operating, LLC, Bold ~~Contribution Agreement.~~Holdings and Bold. The Plaintiff asserts that the directors negotiated the business combination pursuant to the Bold ~~Transaction~~Contribution Agreement (the “Bold Transaction”) to benefit EnCap and its affiliates, failed to obtain adequate consideration for the Earthstone shareholders who were not affiliated with EnCap or Earthstone

~~EARTHSTONE ENERGY, INC.~~

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

management, did not follow an adequate process in negotiating and approving the Bold Transaction and made materially misleading or incomplete proxy disclosures in connection with the Bold Transaction. The suit seeks unspecified damages and purports to assert claims derivatively on behalf of ~~the Company~~Earthstone and as a class action on behalf of all persons who held ~~Common Stock~~common stock up to March 13, 2017, excluding defendants and their affiliates. On July 20, 2018, the Delaware Court of Chancery granted the defendants’ motion to dismiss and entered an order dismissing the action in its entirety with prejudice. The ~~Company and each~~Plaintiff filed an appeal with the Delaware Supreme Court. 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. 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 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 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~~Fund (the derivative payment) be paid to Earthstone to be used as determined by management, according to their fiduciary duties and ~~they intend~~business judgment, 45% of the Fund (the class payment) be paid to ~~mount a vigorous defense.~~members of the class or current stockholders of Earthstone. The ~~outcome~~Company expects court approval of ~~this suit is uncertain,~~the Settlement Agreement and ~~while~~in addition estimates the insurance carriers and related affiliates to reimburse the Company ~~is confident~~ in ~~its position, any potential monetary recovery or loss to~~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.

~~On August 18, 2017,~~Prior to September 30, 2020, due to uncertainty of reimbursement, the Company recorded and accrued litigation ~~captioned Trinity Royal Partners, LP v. Bold Energy III LLC, et al. was filed~~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 ~~142nd Judicial District~~history of ~~the District Court in Midland County, Texas, asserting breach~~reimbursements from insurance carriers and related affiliate, a high probability of contract and indemnity claims for alleged damages from loss of property relating to two oil and natural gas wells in which Bold was the operator. Trinity Royalty Partners, LP (“Trinity”) alleges that Bold is required to indemnify Trinity under the terms of an Assignment and a Participation and Joint Development Agreement between Bold and Trinity. Damages are alleged to include costs incurred in attempting to repair and restore an oil and natural gas well and for the loss of future reserves attributable to both wells. Trinity is seeking approximately $7.2 million in damages and attorneys’ fees. Earthstone and Bold believe the suit is without any merit and Bold intends to mount a vigorous defense. The outcome of this suit is uncertain, and whilereimbursement exists. Accordingly, the Company ~~is confident in its position, any potential monetary recovery or loss~~has accrued $3.75 million related to the ~~Company cannot be~~Settlement Agreement and estimated atfinal defense costs associated with this ~~time.~~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 September 30, ~~2017,~~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

~~Following the closing of the Bold Transaction, the Company continues to record an income tax provision consistent with its status as a corporation.~~ The Company’s corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns and one Canadian income tax return ~~resulting from the Lynden Arrangement that includes~~which include Lynden US, Earthstone, and Lynden Corp. As such, taxable income of Earthstone cannot be offset by tax attributes, including net operating losses, of Lynden US, nor can taxable income of Lynden US be offset by tax attributes of Earthstone. ~~Following the Bold Transaction,~~ Earthstone and Lynden US record a tax provision, respectively, for their share of the book income or loss of EEH, net of the non-controlling ~~interest, as well as any standalone income or loss generated by each company.~~interest. As EEH is treated as a partnership for U.S. Federal income tax purposes, it is not subject to income tax at the federal level and only recognizes the Texas Margin Tax.

During the nine months ended September 30, ~~2017,~~2020, the Company recorded anincome 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) deferred income tax expense of $0.1 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended September 30, 2020.

During the nine months ended September 30, 2019, the Company recorded income tax expense of approximately $0.7 million which included (1) income tax benefit for Lynden US of ~~$2.7~~$0.1 million as a result of ~~its standalone pre-tax loss incurred before the Bold Transaction and~~ its share of the distributable loss from EEH, ~~after the Bold Transaction.~~

~~During the nine months ended September 30, 2017, the Company did not record an~~(2) no net income tax benefit for Earthstone as ~~a result of its standalone pre-tax loss incurred before~~ the ~~Bold Transaction and~~$0.6 million income tax benefit resulting from its share of the distributable loss from EEH ~~after the Bold Transaction, because the~~had a full valuation allowance recorded against it as future realization of ~~such loss cannot be reasonably assured and is subject to a full valuation allowance. Earthstone recorded a $7.5 million income tax benefit as a discrete item during~~ the ~~current reporting period, which resulted from a change in assessment of the realization of its~~ net deferred tax ~~assets due to the~~asset cannot be assured and (3) deferred ~~tax liability that was recorded with respect to its investment in EEH as part of the Bold Transaction as an adjustment to Additional paid-in capital within the Condensed Consolidated Balance Sheet.~~

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

~~EEH recorded deferred tax expense during nine months ended September 30, 2017~~ of ~~$0.2~~$0.6 million related to the Texas Margin ~~Tax~~Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended 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 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 ~~deficit margin generated during~~combined market capitalization of the ~~period cannot be carried forward~~Company’s equity and long-term debt, was lower than the book value of 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 on that date. No additional impairments have been recorded to ~~offset future taxable margin related~~Goodwill through September 30,2020. The Company did not have any non-cash impairment charges to ~~state basis differences in EEH’s oil~~Goodwill for the three and ~~natural gas properties.~~nine months ended September 30, 2019.

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

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

Statement Regarding Forward-Looking Information

This discussion and other items in this Quarterly Report on Form 10-Q contain forward-looking statements and information that are based on management’s beliefs, as well as assumptions made by, and information currently available to, management. When used in this document, the words “believe,” “anticipate,” “estimate,” “expect,” “intend,” “may,” “will,” “project,” “forecast,” “plan,” and similar expressions are intended to identify forward-looking statements. Although management believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to have been correct. These statements are subject to numerous risks, uncertainties and assumptions. Certain of these risks are summarized ~~in this report and~~ under “Item 1A. Risk Factors” in our ~~2016~~2019 Annual Report on Form 10-K ~~as amended,~~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, ~~2016,~~2019, which are included in our ~~2016~~2019 Annual Report on Form ~~10-K, as amended.~~10-K.

Overview

~~We are~~

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

COVID-19

According to the ~~“Company” “our,~~United States (“U.S.” ~~“we,” “us,” or similar terms)~~) Centers for Disease Control and Prevention (the “CDC”), in March 2020, the U.S. entered the acceleration (or 4th) phase of the pandemic of the novel coronavirus (“COVID-19”).

~~Recent Developments~~

~~Bold Contribution Agreement~~

On May ~~9, 2017, Earthstone completed~~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 progression of an influenza pandemic in six intervals or phases. The duration of each phase may vary depending on the type of virus and the public health response.

The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption of financial and commodity markets. In addition, the pandemic has resulted in travel restrictions, business closures and the institution of quarantining and other restrictions on movement in many communities. As a ~~contribution agreement dated as~~result, there has been a significant reduction in demand for and prices of November 7, 2016 and as amended on March 21, 2017 (the “Bold Contribution Agreement”), by and among Earthstone, EEH, Lynden US, Lynden USA Operating, LLC, a Texas limited liability company (“Lynden Op”), Bold Energy Holdings, LLC, a Texas limited liability company (“Bold Holdings”), and Bold Energy III LLC, a Texas limited liability company (“Bold”). The purpose of the Bold Contribution Agreement was to provide for, among other things described below, the business combination between Earthstone and Bold, which owns significant developed and undeveloped oil and natural gas, ~~properties~~which has adversely affected our business. The extent of the impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute our business strategies and initiatives in the ~~Midland Basin~~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 ~~west Texas (the “Bold Transaction”).~~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 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, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, its impact on the U.S. and world economies, the U.S. capital markets and market conditions, and how quickly and to what extent normal economic and operating conditions can resume.

Operational Status

As a producer of oil, natural gas and NGLs, we are recognized as an essential business under various federal, state and local regulations related to the COVID-19 pandemic. We have continued to operate as permitted under these regulations while taking mitigation 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 our mitigation efforts. Our field personnel are performing their job responsibilities and practicing mitigation guidelines with no issues to date. Our non-field personnel had been working remotely, using information technology in which we previously 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 managed and conducted both field and non-field functions effectively thus 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 in conformity with the respective jurisdictional mitigation guidelines.

Commodity Market Challenges

The ~~Bold Transaction~~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 disruptive impact on oil and gas exploration and production. In April 2020, WTI crude oil prices 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 shut-in as much production as was ~~structured~~feasible in an effort to 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 early June. Management estimates that total net production was curtailed by approximately 60% in May, with 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 domestic supply below demand and prevent material infrastructure operational curtailments from occurring. However, with curtailed U.S. volumes returning, we may choose to curtail some or all of our estimated production due to future changes in supply and demand fundamentals.

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Operational/Financial Challenges

It is difficult to model and predict how our operations and financial status may change as a result of 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 of 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 depressed or worsen, we believe we can continue to operate and produce our properties at a minimum in a ~~manner commonly known~~cash flow neutral position for the next 12 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 the financial institutions’ view on commodity prices with respect to borrowing base redeterminations. 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 ~~an “Up-C.” Under this structure~~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 ~~Bold Contribution Agreement, (i) Earthstone recapitalized its~~price of our Class A common ~~stock into two classes –~~stock. While the price of our Class A common stock $0.001 par value per share (the “Class A Common Stock”), and Class B common stock, $0.001 par value per share (the “Class B Common Stock”), and all of Earthstone’s existing outstanding common stock, $0.001 par value per share (the “Common Stock”), was recapitalized on a one-for-one basis for Class A Common Stock (the “Recapitalization”); (ii) Earthstone transferred all of its membership interestshas recently stabilized somewhat, it remains historically low.

Liquidity

In March 2020, in Earthstone Operating, LLC, Sabine River Energy, LLC, EF Non-Op, LLC and Earthstone Legacy Properties, LLC (formerly Earthstone GP, LLC) and $36,071 in cash from the sale of Class B Common Stock to Bold Holdings (collectively, the “Earthstone Assets”) to EEH, in exchange for 16,791,296 membership units of EEH (the “EEH Units”); (iii) Lynden US transferred all of its membership interests in Lynden Op to EEH in exchange for 5,865,328 EEH Units; (iv) Bold Holdings transferred all of its membership interests in Bold to EEH in exchange for 36,070,828 EEH Units and purchased 36,070,828 shares of Class B Common Stock issued by Earthstone for $36,071; and (v) Earthstone granted an aggregate of 150,000 fully vested shares of Class A Common Stock under Earthstone’s 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”), to certain employees of Bold. Each EEH Unit, together with one share of Class B Common Stock, are convertible into one share of Class A Common Stock.

~~Pursuant~~response to the ~~terms of the Bold Contribution Agreement, at the closing of the Bold Transaction, Earthstone, Bold Holdings,~~significant decrease in commodity prices, we significantly reduced our capital program for 2020 and the unitholders of Bold Holdings entered into a registration rights agreement (the “Registration Rights Agreement”) relating to the shares of Class A Common Stock issuable upon the exchange of the EEH Units and Class B Common Stock held by Bold Holdings or its unitholders. In accordance with the Registration Rights Agreement, Earthstone filed a registration statement (the “Registration Statement”) with the SEC to permit the public resale of the shares of Class A Common Stock issued by Earthstone to Bold Holdings or its unitholders in connection with the exchange of Class B Common Stock and EEH Units in accordance with the terms of the First Amended and Restated Limited Liability Company Agreement of EEH. On October 18, 2017, the SEC issued a Notice of Effectiveness for the Registration Statement.

On May 9, 2017, in connection with the closing of the Bold Contribution Agreement, Earthstone, EnCap Investments L.P. (“EnCap”), Oak Valley Resources, LLC (“Oak Valley”), and Bold Holdings entered into a voting agreement (the “Voting Agreement”), pursuant to which EnCap, Oak Valley, and Bold Holdings agreed not to vote any shares of Class A Common Stock or Class B Common Stock held by them in favor of any action, or take any action that would in any way alter the composition of the board of directors of Earthstone (the “Board”) from its composition immediately following the closing of the Bold Contribution Agreement as long as the Voting Agreement is in effect.

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

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

~~Management’s Plans~~

Since establishing a substantial operated presence in the Midland Basin, we have been focused on integrating the operations, engineering, geology, land, accounting and personnel functions throughout the Company as well as continuing ahalted all drilling and completion ~~program. Although commodity prices have been volatile in 2017, our current business plan is~~activity. In light of recent oil price recoveries and meaningful service cost reductions compared to ~~continue to operate one rig primarily~~earlier in the ~~Midland Basin~~year, we have commenced completions of ~~west Texas throughout~~a six-well pad and currently expect total capital spending for 2020 to be in the ~~rest~~range of ~~2017 and through 2018. In the Eagle Ford trend,~~$65 - $70 million. Additionally, we ~~concluded an 11 well drilling program and~~currently expect to ~~start completion operations on those wells~~begin completions of a five-well pad in ~~November 2017.~~January 2021. We expect to fund these completions with internally generated cash flows.

~~We intend to focus on reducing~~
COVID-19 has adversely impacted our ~~lease operating expenses and general and administrative expense on a per unit of production basis, as well as improving the efficiency of our capital spending.~~

~~We will remain vigilant~~revenues in ~~assessing volatility in the commodity prices and adjust our business plan accordingly.~~

~~Credit Agreement~~

On May 9, 2017, in connection with the closing of the Bold Transaction, the Company exited its credit agreement dated December 19, 2014, by and among Earthstone, Oak Valley Operating, LLC, EF Non-OP, LLC, Sabine River Energy, LLC, Basic Petroleum Services, Inc., BOKF, NA dba Bank of Texas, and the Lenders party thereto (as amended, modified or restated from time to time, the “ESTE Credit Agreement”). At that time, all outstanding borrowings of $10.0 million under the ESTE Credit Agreement were repaid and $0.5 million of remaining unamortized deferred financing costs were expensed and included in Write-off of deferred financing costs in the Condensed Consolidated Statements of Operations.

On May 9, 2017, EEH (the “Borrower”), Earthstone Operating, LLC, EF Non-Op, LLC, Sabine River Energy, LLC, Earthstone Legacy Properties, LLC, Lynden Op, Bold, Bold Operating, LLC (the “Guarantors”), BOKF, NA dba Bank of Texas, as Agent and Lead Arranger, Wells Fargo Bank, National Association as Syndication Agent and the Lenders party thereto (the “Lenders”), entered into a credit agreement (the “EEH Credit Agreement”).

The borrowing base under the EEH Credit Agreement is $150.0 million, and is subject to redetermination on or about November 1st and May 1st of each year. The amounts borrowed under the EEH Credit Agreement bear annual interest rates at either (a) the London

Interbank Offered Rate (“LIBOR”) plus 2.25% to 3.25% or (b) the prime lending rate of Bank of Texas plus 1.25% to 2.25%, depending on the amounts borrowed under the EEH Credit Agreement. Principal amounts outstanding under the EEH Credit Agreement are due and payable in full at maturity on May 9, 2022. All of the obligations under the EEH Credit Agreement, and the guarantees of those obligations, are secured by substantially all of EEH’s assets. Additional payments due under the EEH Credit Agreement include paying a commitment fee of 0.50% per year to the Lenders in respect of the unutilized commitments thereunder, as well as certain other customary fees.

The EEH Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, EEH’s ability to incur additional indebtedness, create liens on assets, make investments, enter into sale and leaseback transactions, pay dividends and make distributions or repurchase its limited liability interests, engage in mergers or consolidations, sell certain assets, sell or discount any notes receivable or accounts receivable and engage in certain transactions with affiliates.

In addition, the EEH Credit Agreement requires EEH to maintain the following financial covenants: a current ratio of not less than 1.0 to 1.0 and a leverage ratio of not greater than 4.0 to 1.0. Leverage ratio means the ratio of (i) the aggregate debt of EEH and its consolidated subsidiaries as at the last day of the fiscal quarter (excluding any debt from obligations relating to non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives) to (ii) the product of EBITDAX for such fiscal quarter multiplied by four. The term “EBITDAX” means, for any period, the sum of consolidated net income for such period plus (a) the following expenses or charges to the extent deducted from consolidated net income in such period: (i) interest, (ii) taxes, (iii) depreciation, (iv) depletion, (v) amortization, (vi) non-cash losses under FASB ASC 815 as a result of changes in the fair market value of derivatives, (vii) exploration expenses, (viii) impairment expenses, and (ix) non-cash compensation expenses and minus (b) to the extent included in consolidated net income in such period, non-cash gains under FASB ASC 815 as a result of changes in the fair market value of derivatives.

The EEH Credit Agreement contains customary affirmative covenants and defines events of default to include failure to pay principal or interest, breach of covenants, breach of representations and warranties, insolvency, judgment default, and if Frank A. Lodzinski ceases to serve and function as Chief Executive Officer of EEH and the majority of the Lenders do not approve of Mr. Lodzinski’s successor. Upon the occurrence and continuance of an event of default, the Lenders have the right to accelerate repayment of the loans and exercise their remedies with respect to the collateral. As of September 30, 2017, EEH was in compliance with these covenants under the EEH Credit Agreement.

As of September 30, 2017, the Company had a $150 million borrowing base under the EEH Credit Agreement, of which $70 million was outstanding, bearing annual interest of 3.7311%, resulting in an additional $80 million of borrowing base availability under the EEH Credit Agreement.

~~Class A Common Stock Offering~~

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

~~Divestiture of Assets~~

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

~~Uplisting of Class A Common Stock~~

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

~~Closing of Denver Office~~

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

~~Areas of Operation~~

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

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

~~In early 2016, we survived~~2020 as a result of both low commodity ~~price environment~~prices and ~~industry downturn by reducing~~ our ~~costs and capital expenditures.~~

~~On May 18, 2016, Earthstone acquired Lynden US giving rise~~voluntary shut-ins. However, due to our ~~Midland Basin operations.~~commodity hedging activities partially offsetting those reduced revenues, there has been no significant overall impact on our cash flows from producing activities.

~~Our pre-Lynden US inventory~~
Since the beginning of ~~wells that were drilled but not completed~~2020, our borrowing base has been reduced through two sequential reductions from $325 million to $240 million. We continue remain in ~~2014 and 2015 were completed in the fourth quarter of 2016 in an improved~~compliance with all covenants under our Credit Facility. If commodity ~~price environment compared to earlier in 2016.~~

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

~~Commodity~~ prices continue to be ~~volatile.~~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.

Table of Contents

~~Midland Basin~~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 ~~Midland Basin continues~~current industry environment will move to ~~have attractive economics~~more consolidations; however, execution may be hampered by producers with high debt levels and ~~we expect~~sellers unwilling to acknowledge persistent low commodity prices. We continue to ~~focus~~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 ~~growing~~acquisition and corporate merger opportunities that would increase the scale of our ~~footprint~~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.

Interest Rate Swap

Effective May 1, 2020, we entered into an interest rate 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 ~~acreage trades, acquisitions, development drilling~~May 2022 and ~~merger~~decreases to $100 million through May 2023 and ~~acquisition opportunities. We are acutely focused on expansion~~$75 million through May 2024.

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, ~~continue~~long-lived reserves and historically high drilling success rates.

As previously disclosed, we completed three wells in southeast Reagan County in late March and brought them online in April, prior to ~~be as good or better than~~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 ~~projected. Well results in the Wolfcamp formation~~ have ~~continued~~returned to ~~meet or exceed our expectations.~~

full production capacity. We have ~~been~~experienced no adverse effects from this short-term curtailment and have incurred no significant costs in restoring production.

In late May, we concluded our 2020 drilling program and released our contracted rig operating ~~a one drilling rig program~~ in the Midland Basin and plan to maintain a one rig program throughout the remainder of 2017 and 2018, with a view toward adding a second rig at some point in 2018 based upon commodity prices, our drilling results and liquidity. We recently completed drilling our seventh Midland Basin well (100% working interest) located in Reagan County and recently completed a three well pad (100% working interest) in Reagan County. We currently have a rig drillingBasin. During the first ~~well~~half of the year, we drilled a ~~two-well pad in Reagan County, and we anticipate that the rig will thereafter be moved to Midland County to drill a two well pad. There are currently~~total of five wells in ~~Reagan~~our Hamman Upton project along with six wells in our Ratliff unit, all located in Upton County, ~~waiting on completion for which~~Texas. We have commenced completions of the six-well pad in our Ratliff unit and expect to begin completions of the five-well Hamman Upton pad in January 2021.

Despite the disruption in the oil markets resulting from the COVID-19 pandemic, we ~~plan to initiate completion operations in November 2017.~~

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

~~Eagle Ford Trend~~

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

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

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to use our judgment to make estimates and assumptions that affect certain amounts reported in our financial statements. As additional information becomes available, these estimates and assumptions are subject to change and thus impact amounts reported in the future. Critical accounting policies are those accounting policies that involve judgment and uncertainties affecting the application of those policies and the likelihood that materially different amounts would be reported under different conditions or using differing assumptions. We periodically update our estimates used in the preparation of the financial statements based on our latest assessment of the current and projected business and general economic environment.

~~The following~~ There have been no significant ~~change has been made~~changes to our critical accounting policies during the nine months ended September 30, ~~2017:~~2020.

Table of Contents

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

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

Results of Operations

Three ~~months ended~~Months Ended September 30, ~~2017,~~2020, compared to the ~~three months ended~~Three Months Ended September 30, ~~2016~~2019

										Three Months Ended
	Three Months Ended September 30,									September 30,
	2017			2016			Change			2020			2019			Change
Sales volumes:
Oil (MBbl)		563			201			180	%		839			646			30	%
Natural gas (MMcf)		967			563			72	%		2,010			1,248			61	%
Natural gas liquids (MBbl)		166			71			134	%		386			267			45	%
Barrels of oil equivalent (MBOE)		890			366			143	%		1,560			1,121			39	%
Average Daily Production (Boepd)											16,959			12,181			39	%

Average prices realized: ⁽¹⁾
Average prices:
Oil (per Bbl)	$	45.73		$	41.11			11	%	$	39.50		$	54.89			(28	)%
Natural gas (per Mcf)	$	2.60		$	2.52			3	%	$	1.31		$	0.72			82	%
Natural gas liquids (per Bbl)	$	18.29		$	11.95			53	%	$	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	$	25,733		$	8,262			211	%	$	33,158		$	35,443			(6	)%
Natural gas revenues	$	2,513		$	1,417			77	%	$	2,642		$	903			193	%
Natural gas liquids revenues	$	3,036		$	851			257	%	$	5,247		$	2,858			84	%

Lease operating expense	$	5,407		$	4,581			18	%	$	7,044		$	6,419			10	%
Severance taxes	$	1,588		$	522			204	%
Production and ad valorem taxes										$	2,696		$	2,698			(0	)%
Impairment expense										$	2,115		$	—			NM
Depreciation, depletion and amortization	$	10,330		$	5,149			101	%	$	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	$	5,608		$	2,285			145	%	$	5,796		$	6,057			(4	)%
Stock-based compensation	$	1,687		$	1,328			27	%

Transaction costs	$	109		$	846			-87	%	$	(705	)	$	215			NM
Gain on sale of oil and gas properties	$	2,157		$	8		NM
Interest expense, net	$	(903	)	$	(341	)		165	%	$	(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	$	(3,663	)	$	946			-487	%	$	(6,040	)	$	18,726			NM
Income tax benefit (expense)	$	94		$	(201	)		-147	%

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

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

NM – Not Meaningful

Oil revenues

For the three months ended September 30, ~~2017,~~2020, oil revenues ~~increased~~decreased by ~~approximately~~ ~~$17.5~~$2.3 million or ~~211%~~6% relative to the comparable period in ~~2016.~~2019. Of the ~~increase,~~ ~~approximately~~ ~~$0.9~~decrease, $9.9 million was due to a decrease in our realized price, partially offset by $7.6 million attributable to an increase in ~~our realized price and $16.6 million was attributable to increased~~ volume. Our average realized price per Bbl ~~increased~~decreased from ~~$41.11~~$54.89 for the three months ended September 30, ~~2016~~2019 to ~~$45.73~~$39.50 or ~~11%~~28% for the three months ended September 30, ~~2017.~~ 2020. We had a net increase in the volume of oil sold of ~~362~~194 MBbls or ~~180%~~30%, primarily due to ~~the Midland Basin properties we acquired~~new wells brought online in ~~the Bold Transaction.~~ 2020.

Natural gas revenues

For the three months ended September 30, ~~2017,~~2020, natural gas revenues increased by ~~$1.1~~$1.7 million or ~~77%~~193% relative to the comparable period in ~~2016. The~~2019. Of the increase, $1.0 million was ~~primarily~~ attributable to increased sales volume and $0.7 million was due to an increase in ~~volume.~~ realized price. The total volume of natural gas produced and sold increased ~~404~~by 762 MMcf or ~~72%, driven by an additional 483 MMcf from our Midland Basin properties acquired~~61% primarily due to new wells brought 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 ~~Bold Transaction.~~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.

Table of Contents

Natural gas liquids revenues

For the three months ended September 30, ~~2017,~~2020, natural gas liquids revenues increased by ~~$2.2~~$2.4 million or ~~257%~~84% relative to the comparable period in ~~2016.~~2019. Of the increase, ~~approximately~~ ~~$0.5~~$1.6 million was due to increased volume and $0.8 million was attributable to an increase in our realized ~~price and $1.7 million was attributable to increased volume.~~ price. The volume of natural gas liquids produced and sold increased by 95119 MBbls or ~~134%~~45%, primarily due to ~~an additional 100 MBbls~~new wells brought online in 2020. Our average realized price per Bbl increased 27% from ~~our Midland Basin properties acquired in the Bold Transaction.~~

~~Lease operating expense (“LOE”)~~

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

~~LOE increased by $0.8 million or 18%~~$10.71 for the three months ended September 30, ~~2017~~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 ~~2016. The increase was~~2019, primarily ~~the result of the~~due to new wells brought online, partially offset by lower workover project costs compared to ~~operate the producing assets acquired in the Bold Transaction, that were not incurred in~~ the prior year period.

~~Severance~~

Production and ad valorem taxes

~~Severance~~

Production and ad valorem taxes for the three months ended September 30, ~~2017, increased by $1.1 million or 204% relative~~2020 were flat as compared to the ~~comparable~~prior year period ~~in 2016, primarily due to~~as the ~~increases in production volumes and~~impact of decreased oil ~~and natural gas prices. However, as~~prices was offset by increased production. As a percentage of revenues from oil, natural gas, and natural gas liquids, ~~severance~~production taxes remained flat ~~when~~as compared to the prior ~~year period.~~year.

Impairment expense

During the three months ended September 30, 2020, we recorded non-cash impairments totaling $2.1 million to unproved oil and natural gas properties as the result of certain acreage expirations. No such impairments were recorded during the three months ended September 30, 2019.

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

DD&A for the three months ended September 30, ~~2017,~~2020 increased by ~~$5.2~~$14.5 million, or ~~101%~~103% relative to the comparable period in ~~2016,~~ ~~due~~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 ~~addition of the assets acquired in the both the Lynden Arrangement~~increase were higher sales volumes and ~~Bold Transaction~~certain downward adjustments to ~~the depletable base, as well as increased production volumes.~~estimated recoverable proved oil and natural gas reserves caused by lower commodity prices.

General and administrative expense (“G&A”)

G&A ~~consists~~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 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 non-cash stock-based compensation expense related to awards granted in January 2020, employee ~~remuneration, professional~~severance costs and ~~consulting fees~~increased director and ~~other overhead expenses. G&A increased~~officer insurance premium costs.

Transaction costs

For the three months ended September 30, 2020, transaction costs decreased by ~~$3.3~~$0.9 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 $1.6 million for the three months ended September 30, ~~2017 relative~~2019 to the comparable period in 2016. The increase was primarily due to both the retention of certain employees of Bold, as well as the payment and accrual of severance to certain Bold and Denver office employees. Additionally, ~~legal expenses increased due to litigation described in~~ ~~Note 13. Commitments and Contingencies~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements~~.

~~Stock-based compensation~~

Stock-based compensation includes the expense associated with grants under the 2014 Plan of restricted stock units (“RSUs”) to employees and non-employee directors. Stock-based compensation was $1.7$1.2 million for the three months ended September 30, ~~2017,~~2020, primarily due to lower effective interest rates on borrowings outstanding compared to ~~$1.3 million in~~ the prior year period.

~~Transaction costs~~

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

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

During the three months ended September 30, 2017, we sold certain of our non-core oil and gas properties in Texas, Montana, Oklahoma and North Dakota. In connection with these sales, we recorded gains totaling $2.2 million. See Note ~~2. Acquisitions and Divestitures~~ 10. Long-Term Debtin the Notes to Unaudited Condensed Consolidated Financial Statements.

~~Interest expense, net~~

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

(Loss) gain on derivative contracts, net

For the three months ended September 30, ~~2017,~~2020, we recorded a net loss on derivative contracts of ~~$3.7~~$6.0 million, consisting of ~~net realized gain on settlements of $0.5 million and~~ unrealized mark-to-market losses of ~~$4.2~~$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, ~~2016,~~2019, we recorded a net gain on derivative contracts of ~~$0.9~~$18.7 million, consisting of unrealized mark-to-market gains of $15.0 million related to our commodity hedges and net realized gains on settlements of ~~$0.5 million and unrealized mark-to-market gains~~our commodity hedges of ~~$0.4~~$3.7 million.

Income tax ~~benefit (expense)~~expense

~~Our corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns resulting from the Lynden Arrangement that includes Lynden US and Earthstone. During~~

For the three months ended September 30, ~~2017,~~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 ~~$0.2~~its share of the distributable income from EEH, (2) deferred income tax benefit for Earthstone of $0.9 million as a result of its share of the distributable income from EEH, ~~after~~which was used to reduce the ~~Bold Transaction and EEH~~valuation allowance recorded against its deferred tax ~~benefit~~asset which was previously recorded as future realization of ~~$0.3~~the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.1 million related to the Texas Margin ~~Tax as~~Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the ~~deficit margin generated during the period cannot be carried forward to offset future taxable margin related to state basis differences in EEH’s oil and natural gas properties.~~

~~Nine~~three months ended September 30, ~~2017, compared to~~2020.

During the ~~nine~~three months ended September 30, ~~2016~~2019, we recorded income tax expense of approximately $0.6 million which included (1) income tax expense for Lynden US of $0.6 million as a result of its share of the distributable income from EEH and (2) deferred income tax expense for Earthstone of $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.

Nine Months Ended September 30,

2017

2016

Change

Sales volumes:

Oil (MBbl)

1,300

607

114
%
Natural gas (MMcf)

2,328

1,593

46
%
Natural gas liquids (MBbl)

350

161

117
%
Barrels of oil equivalent (MBOE)

2,038

1,034

97
%

Average prices realized: ⁽¹⁾

Oil (per Bbl)

$
46.02

$
36.09

28
%
Natural gas (per Mcf)

$
2.72

$
2.12

28
%
Natural gas liquids (per Bbl)

$
17.86

$
11.43

56
%

(In thousands)

Oil revenues

$
59,815

$
21,898

173
%
Natural gas revenues

$
6,338

$
3,376

88
%
Natural gas liquids revenues

$
6,249

$
1,843

239
%

Lease operating expense

$
14,989

$
11,081

35
%
Severance taxes

$
3,705

$
1,418

161
%
Rid idle and termination expense

$
—

$
5,059

-100
%
Impairment expense

$
66,740

$
—

NM

Depreciation, depletion and amortization

$
28,258

$
16,252

74
%
General and administrative expense

$
14,838

$
6,961

113
%
Stock-based compensation

$
4,645

$
1,889

146
%
Transaction costs

$
4,676

$
1,641

185
%
Gain on sale of oil and gas properties

$
3,848

$
8

NM

Interest expense, net

$
(1,873
)

$
(934
)

101
%
Write-off of deferred financing costs

$
(526
)

$
—

NM

Gain (loss) on derivative contracts, net

$
4,137

$
(2,517
)

-264
%
Income tax benefit (expense)

$
10,046

$
(387
)

NM

Table of Contents

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) ~~Prices presented exclude any effects~~Includes $5.7 million and $2.1 million of ~~oil~~cash proceeds related to hedges unwound during the second quarter of 2020 and ~~natural gas derivatives.~~first quarter of 2019, respectively.

NM – Not Meaningful

Oil revenues

For the nine months ended September 30, ~~2017,~~2020, oil revenues ~~increased~~decreased by ~~approximately~~ ~~$37.9~~$18.6 million or ~~173%~~17% relative to the comparable period in ~~2016.~~2019. Of the ~~increase,~~ ~~approximately~~ ~~$6.0~~decrease, $36.8 million was attributable to a decrease in our realized price, partially offset by $18.2 million attributable to an increase in ~~our realized price and $31.9 million was attributable to increased~~ volume. Our average realized price per Bbl ~~increased~~decreased from ~~$36.09~~$55.08 for the nine months ended September 30, ~~2016~~2019 to ~~$46.02~~$36.92 or ~~28%~~33% for the nine months ended September 30, ~~2017.~~ 2020. We had a net increase in the volume of oil sold of ~~693~~492 MBbls or ~~114%~~24%, primarily due to ~~the Midland Basin properties we acquired~~new wells brought online offset by voluntary production shut-ins in ~~the Bold Transaction.~~May 2020.

Natural gas revenues

For the nine months ended September 30, ~~2017,~~2020, natural gas revenues increased by ~~$3.0~~$2.7 million or ~~88%~~128% relative to the comparable period in ~~2016.~~2019. Of the increase, ~~approximately~~ ~~$1.0~~$1.6 million was due to increased sales volume and $1.1 million was attributable to an increase in ~~our~~ realized ~~price and $2.0 million was attributable to increased volume.~~price. Our average realized price per Mcf increased 50% from ~~$2.12~~$0.64 for the nine months ended September 30, ~~2016~~2019 to ~~$2.72 or 28%~~$0.96 for the nine months ended September 30, ~~2017.~~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 ~~735~~1,713 MMcf or ~~46%~~52% primarily due to ~~the Midland Basin properties we acquired~~new wells brought online offset by voluntary production shut-ins in ~~the Bold Transaction.~~May 2020.

Natural gas liquids revenues

For the nine months ended September 30, ~~2017,~~2020, natural gas liquids revenues ~~increased~~decreased by ~~$4.4~~$0.7 million or ~~239%~~7% relative to the comparable period in ~~2016.~~2019. Of the ~~increase,~~ ~~approximately~~ ~~$1.0~~decrease, $2.6 million was attributable to ~~an increase~~a decrease in our realized price, ~~and $3.4~~partially offset by $1.9 million ~~was~~ attributable to increased volume. The volume of natural gas liquids produced and sold increased by ~~189~~166 MBbls or ~~117%~~23%, primarily due to ~~156 MBbls~~new wells brought online offset by voluntary production shut-ins in May 2020.

Table of ~~additional volume provided by the Midland Basin properties we acquired in the Bold Transaction.~~Contents

Lease operating expense (“LOE”)

LOE increased by ~~$3.9~~$1.5 million or ~~35%~~7% for the nine months ended September 30, ~~2017~~2020 relative to the comparable period in ~~2016,~~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 ~~operate the producing assets acquired in the Bold Transaction and the Lynden Arrangement that were not present in~~ the prior year period.

~~Severance~~Production and ad valorem taxes

~~Severance~~

Production and ad valorem taxes for the nine months ended September 30, ~~2017 increased~~2020 decreased by ~~$2.3~~$0.8 million or ~~161%~~10% relative to the comparable period in ~~2016, primarily due to~~2019, as the ~~increase in oil and natural gas~~impact of increased volume was more than offset by the impact of decreased commodity prices. ~~However, as~~As a percentage of revenues from oil, natural gas, and natural gas liquids, ~~severance~~production taxes ~~remained flat when~~declined slightly as compared to the prior year ~~period.~~primarily due to lower realized commodity prices.

Rig ~~idle and~~ termination ~~expense~~expenses

~~We incurred~~During the nine months ended September 30, 2020, we concluded our 2020 drilling program and released our contracted drilling rig ~~idle~~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 ~~contract termination expenses of $5.1~~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, ~~2016. In July 2016, we entered into an agreement with a rig contractor to terminate our contract with the contractor. Per the terms of the agreement, a termination fee~~2019.

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

DD&A for the remaining commitment on the contract was due and the termination fees were retroactively applied to January 2016, when we suspended drilling and temporarily idled the drilling rig. In connection with the termination, we issued a three-year amortizing promissory note with a principal amount of $5.1 million, which was equivalent to the idle charges and contract termination fee.

~~Impairment expense~~

~~As a result of significant forward commodity price declines, as described below in~~ ~~Liquidity and Capital Resources, Commodity Prices, and the recording of certain acreage expirations, we recognized $66.7 million of non-cash asset impairments during~~ the nine months ended September 30, ~~2017~~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 ~~have negatively impacted our results of operations~~resulted in increased costs subject to depletion. Other factors contributing to the increase were higher sales volumes and ~~equity. These impairments consisted of $63.0 million~~certain downward adjustments to ~~our~~estimated recoverable proved oil and natural gas ~~properties~~reserves caused by lower commodity prices.

General and ~~$3.7~~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 ~~unproved oil~~major shareholder and ~~natural gas properties, primarily~~insurance carrier associated with the anticipated settlement of litigation related to ~~our properties located in~~ the ~~Eagle Ford shale trend of south Texas.~~Bold Transaction that closed on May 9, 2017. See Note ~~3. Fair Value Measurements~~13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial ~~Statements for a discussion of how impairments are measured.~~

~~Depreciation, depletion and amortization~~Statements.

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

~~General and administrative~~

Interest expense ~~(“G&A”)~~

~~G&A increased by $7.9~~decreased from $4.7 million for the nine months ended September 30, ~~2017 relative~~2019 to the comparable period in 2016, primarily due to both the retention of certain employees of Bold, as well as the payment and accrual of severance to certain Bold and Denver office employees. Additionally, ~~legal expenses increased due to litigation described in~~ ~~Note 13. Commitments and Contingencies~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements~~.

~~Stock-based compensation~~

~~Stock-based compensation was $4.6~~$4.2 million for the nine months ended September 30, ~~2017, as~~2020, primarily due to lower effective interest rates on borrowings outstanding compared to ~~$1.9 million in~~ the prior year period. ~~However, the current year amount is not comparable to the prior year period as the initial grant was made near the end of the prior year period on May 20, 2016.~~

~~Transaction costs~~

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

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

During the nine months ended September 30, 2017, we sold certain of our non-core oil and gas properties in Texas, Montana, Oklahoma and North Dakota. In connection with these sales, we recorded gains totaling $3.8 million. See Note ~~2. Acquisitions and Divestitures~~ 10. Long-Term Debtin the Notes to Unaudited Condensed Consolidated Financial Statements.

~~Interest expense, net~~

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

~~Write-off of deferred financing costs~~

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

Gain (loss) on derivative contracts, net

For the nine months ended September 30, ~~2017,~~2020, we recorded a net gain on derivative contracts of ~~$4.1~~$73.1 million, consisting of unrealized mark-to-market gains of ~~$3.9~~$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 ~~$0.2~~our commodity hedges of $47.6 million. For the nine months ended September 30, ~~2016,~~2019, we recorded a net loss on derivative contracts of ~~$2.5~~$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 ~~$3.3 million offset by unrealized mark-to-market losses~~our commodity hedges of ~~$5.8~~$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 ~~(expense)~~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 $0.1 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended September 30, 2020.

During the nine months ended September 30, ~~2017, the Company~~2019, we recorded an income tax ~~benefit~~expense of approximately $0.7 million which included (1) income tax expense for Lynden US of ~~$2.7~~$0.1 million as a result of its ~~standalone pre-tax loss incurred before~~share of the ~~Bold Transaction and~~distributable income from EEH, (2) deferred income tax expense for Earthstone of $0.6 million as a result of its share of the distributable ~~loss~~income from EEH, ~~after~~which was used to reduce the ~~Bold Transaction.~~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.

Table of Contents

Liquidity and Capital Resources

Our primary needs for capital are for working capital obligations with respect to operating our properties and for the development of our oil and natural gas assets. At September 30, 2020, we had approximately $5.3 million in cash and approximately $110.0 million in unused borrowing capacity under our Credit Facility (discussed below) for a total of approximately $115.3 million in funds available for operational and capital funding.

We have no material long-term contracts, relatively low leverage, and a strong hedge position, which affords us the flexibility to adjust our capital plan. In March 2020, we took action to significantly reduce our capital program for 2020 and made a decision to 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 - $70 million. Additionally, we currently expect to begin completions of a five-well pad in January 2021. We expect to fund this completion activity with internally generated funds.

COVID-19 has adversely impacted our revenues for the nine months ended September 30, 2020 as a result of 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 cash flows.

Since the beginning of 2020, our borrowing base has been reduced from $325 million to $240 million. Despite two sequential reductions in our borrowing base, we remain in compliance with all covenants under our Credit Facility. During the nine months ended September 30, ~~2017,~~2020, we have reduced our outstanding bank debt by $40 million. Based on our production profile, cost structure, minimal capital program and the ~~Company did~~hedge positions we have in place, we expect to generate adequate cash flows provided by operating activities to fund the completion activity for the six wells in progress and reduce debt, although not ~~record an income tax benefit~~at the same levels as in the third quarter, for ~~Earthstone as~~the remainder of 2020. As a result, of its standalone pre-tax loss incurred before the Bold Transaction and its share of the distributable loss from EEH after the Bold Transaction, because the future realization of such loss cannot be reasonably assured and is subject to a full valuation allowance. Earthstone recorded a $7.5 million income tax benefit as a discrete item during the current reporting period, which resulted from a

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

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

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

~~Liquidity and Capital Resources~~

~~We expect to finance future acquisition and development activities through available working capital,~~ cash flows from ~~operating activities,~~operations and borrowings under our Credit Facility to meet our cash requirements for the ~~EEH Credit Agreement, sale~~next 12 months.

Working Capital

Working capital (presented below) was $5.5 million as of ~~non-strategic assets, various means~~September 30, 2020, compared to a working capital deficit of ~~corporate~~$39.9 million as of December 31, 2019, representing an increase of $45.4 million. This increase consisted of a $22.1 million net increase in the fair value of our derivative contracts expected to settle in the 12 months subsequent to September 30, 2020 resulting from low oil price futures as of September 30, 2020 and ~~project financing, assuming we can access debt and equity markets. In addition, we may continue to partially finance our~~a $23.3 million reduction of other net current items resulting primarily from reduced drilling ~~activities through the sale~~activity.

The components of ~~participating rights to industry partners or financial institutions, and we could structure such arrangements on a promoted basis, whereby we may earn~~ working ~~interests in reserves and production greater than our proportionate share~~capital 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	)

Table of ~~capital costs.~~Contents

Cash Flows from Operating Activities

Cash flows provided by operating activities for the nine months ended September 30, ~~2017 were $24.2~~2020 increased to $104.7 million compared to ~~$1.7~~$85.7 million for the nine months ended September 30, ~~2016. The increase in operating cash flows from the prior period was~~2019, primarily due to changes in timing of payments and receipts in addition to an increase in sales volumes and our working capital resulting from commodity price volatility and the producing assets acquired in Bold Transaction and the Lynden Arrangement. We believe we have sufficient liquidity and capital resources to execute our business plan over the next 12 months and for the foreseeable future.

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

Cash Flows from Investing Activities

Cash flows used in investing activities for the nine months ended September 30, ~~2017 and 2016 were $80.7~~2020 decreased to $72.6 million ~~and $46.7~~from $121.1 million ~~respectively. Cash flows used in investing activities~~ for the nine months ended September 30, ~~2017~~ ~~included $55.6 million required~~2019, primarily due to ~~complete the Bold Transaction and $30.0 million in capital expenditures primarily related to the~~ decreased drilling and completion activity as compared to the prior year period in light of ~~wells in~~ the ~~Midland Basin on acreage acquired in the Bold Transaction, offset by $5.1 million in proceeds~~current commodity price conditions.

Cash Flows from ~~the divestiture of certain non-core assets~~. Financing Activities

Cash flows used in ~~investing~~financing activities decreased to $40.7 million for the nine months ended September 30, ~~2016~~ ~~related primarily~~2020 as compared to ~~the~~ cash ~~required to complete the Lynden Arrangement.~~

~~Cash Flows from Financing Activities~~

~~Cash~~ flows provided by financing activities of $44.8 million for the nine months ended September 30, ~~2017 were $57.3 million which consisted~~2019, primarily ofdue to higher repayments and lower borrowings under the ~~EEH~~ Credit ~~Agreement which were used to repay all outstanding borrowings under Bold’s credit agreement assumed by EEH~~Facility (as defined below) in the ~~Bold Transaction~~. ~~Cash flows provided by financing activities for the nine months ended September 30, 2016 were $45.5 million which consisted primarily of proceeds from the Common Stock offering completed in June 2016.~~current year period.

Capital Expenditures

~~We recently revised our estimated 2017~~

Our accrual basis capital expenditures downward from approximately $115 million to approximately $85 million, largely as a result of the reduction of approximately $17 million of drilling and completion capital based on our joint development agreements in the Eagle Ford and reduction by approximately $10 million in our land and infrastructure expenditures in the Midland Basin. Capital expenditures for the three and nine months ended September 30, ~~2017 are~~2020 were as ~~follows:~~follows (in thousands):

	Three Months Ended		Nine Months Ended
	September 30, 2017		September 30, 2017		Three Months Ended September 30, 2020		Nine Months Ended September 30, 2020
Drilling and completions	$	24,968	$	41,162	$	1,329	$	46,303
Leasehold costs		145		1,003		49		139
Other acquisition		1,202		1,457
Surface land		987		1,803
Total capital expenditures	$	27,302	$	45,425	$	1,378	$	46,442

~~Public Offering~~

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

~~Credit Agreement~~

On ~~May 9, 2017,~~November 21, 2019, Earthstone, EEH (the “Borrower”), Wells Fargo, as Administrative Agent and Issuing Bank, 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 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 ~~closing~~regularly scheduled redetermination of the ~~Bold Transaction,~~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, ~~became~~EEH, Wells Fargo, the guarantors party thereto, and the Lenders entered into the Amendment to the ~~EEH~~ Credit ~~Agreement described in~~ ~~Item 2. Management’s Discussion~~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 ~~Analysis~~make acquisitions, and added certain restrictions related to dividends and distributions.

The next regularly scheduled redetermination of ~~Financial Condition and Results of Operations, Recent Developments, Credit Agreement~~. the borrowing base is on or around April 1, 2021.

As of September 30, ~~2017, the Company had a $150~~2020, $130.0 million ~~borrowing base under the EEH Credit Agreement,~~ of ~~which $70 million was~~borrowings were outstanding, bearing an annual interest ~~rate~~ of ~~3.7311%~~2.658%, resulting in an additional ~~$80~~$110.0 million of borrowing base availability under the ~~EEH~~ Credit ~~Agreement.~~Facility.

~~Commodity Prices~~

~~Commodity prices are volatile and can fluctuate significantly. Through~~Hedging Activities

The following table sets forth our outstanding derivative contracts at September 30, ~~2017, oil prices have declined 8% and natural gas prices declined 15% compared to December 31, 2016. If~~2020. When aggregating multiple contracts, the ~~commodity~~weighted average contract price ~~environment continues to decline, it will have an adverse impact on our revenues, cash flows, estimated reserves and planned capital expenditures, and could result in further impairments~~is disclosed.

		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.

(4)

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

Table of ~~our proved and unproved oil and natural gas properties.~~Contents

~~Impairments to Oil and Natural Gas Properties~~

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

~~Hedging Activities~~

As of September 30, 2017, we had hedged a total of 157,500 Bbls of remaining 2017 oil production at an average price of $50.66/Bbl and 645,000 MMBtu of remaining 2017 natural gas production at average price of $3.167/MMBbtu. As of September 30, 2017, we had hedged a total of 1,279,000 Bbls of 2018 oil production at an average price of $50.16/Bbl and 810,000 MMBtu of 2018 natural gas production at average price of $3.066/MMBtu. Additionally, on October 30, 2017, we entered into additional fixed price oil swap agreements, hedging an additional 365,000 Bbls of 2019 oil production at a price of $51.55/Bbl.

Obligations and Commitments

There have been no material changes from the obligations and commitments disclosed in the Obligations and Commitments section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our ~~2016~~2019 Annual Report on Form ~~10-K.~~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 ~~exposed to market risks associated with interest rate risks, commodity price risk and credit risk. We have established risk management processes to monitor and manage these market risks.~~

~~Commodity Price Risk, Derivative Instruments and Hedging Activity~~

We are exposed to various risks including energy commodity price risk. When oil, natural gas, and natural gas liquids prices decline significantly our ability to finance our capital budget and operations may be adversely impacted. We expect energy prices to remain volatile and unpredictable. Our hedging activities consist of derivative instruments entered into in order to hedge against changes in oil and natural gas prices through the use of fixed price swap agreements. Swaps exchange floating price risk in the future for a ~~fixed price at the time~~smaller reporting company as defined by Rule 12b-2 of the ~~hedge.~~

~~In connection with~~Exchange Act and therefore are not required to provide the ~~closing of the Bold Transaction on May 9 2017, all oil and natural gas derivative contracts were novated to EEH. The Company has entered into a series of derivative instruments to hedge a significant portion of its expected oil and natural gas production for the remainder of 2017 through December 31, 2018. Typically, these derivative instruments require payments to (receipts from) counterparties based on specific indices as~~information required by the derivative agreements. Although not risk free, we believe these instruments reduce our exposure to oil and natural gas price fluctuations and, thereby, allow us to achieve a more predictable cash flow.

~~The following is a summary of our open oil and natural gas derivative contracts as of September 30, 2017:~~

~~Additionally, on October 30, 2017, we entered into additional fixed price oil swap agreements, hedging an additional 365,000 Bbls of 2019 oil production at a price of $51.55/Bbl.~~under this item.

Changes in fair value of commodity derivative instruments are reported in earnings in the period in which they occur. Our open commodity derivative instruments were in a net liability position with a fair value of $2.3 million at September 30, 2017. Based on the published commodity futures price curves for the underlying commodity as of September 30, 2017, a 10% increase in per unit commodity prices would cause the total fair value of our commodity derivative financial instruments to decrease by approximately $7.7 million to an overall net liability position of $10.0 million. A 10% decrease in per unit commodity prices would cause the total fair value of our commodity derivative financial instruments to increase by approximately $7.7 million to an overall net asset position of $5.4 million. There would also be a similar increase or decrease in Gain (loss) on derivative contracts, net in the Condensed Consolidated Statements of Operations.

~~Interest Rate Sensitivity~~

We are also exposed to market risk related to adverse changes in interest rates. Our interest rate risk exposure results primarily from fluctuations in short-term rates, which are based on LIBOR and the prime rate and may result in reductions of earnings or cash flows due to increases in the interest rates we pay on these obligations.

~~At September 30, 2017, the outstanding borrowings under the EEH Credit Agreement were $70.0 million bearing interest at rates described in~~ ~~Note 10. Long-Term Debt~~ ~~in the~~ ~~Notes to Unaudited Condensed Consolidated Financial Statements. Fluctuations in interest rates will cause our annual interest costs to fluctuate. At September 30, 2017, the interest rate on borrowings under the EEH~~

Credit Agreement was 3.7311% per year. If borrowings at September 30, 2017 were to remain constant, a 10% change in interest rates would impact our future cash flows by approximately $0.3 million per year.

~~Disclosure of Limitations~~

Because the information above included only those exposures that existed at September 30, 2017, it does not consider those exposures or positions which could arise after that date. As a result, our ultimate realized gain or loss with respect to interest rate and commodity price fluctuations will depend on the exposures that arise during future periods.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

In accordance with Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15(e) and 15d-15(e), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and our Principal Accounting Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Principal Accounting Officer concluded that our disclosure controls and procedures were effective as of September 30, ~~2017~~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 September 30, ~~2017,~~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 ~~arisen~~occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, ~~2016.~~2019.

Item 1A. Risk Factors

~~There have been no material changes from~~

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, ~~2016.~~2019 and our Quarterly Report on Form 10-Q for the 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 September 30, ~~2017.~~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
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 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.

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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	Interactive Data Files (formatted as Inline XBRL).	~~XBRL Instance Document~~		X
~~101.SCH~~104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).	~~XBRL Schema Document~~		X
~~101.CAL~~	~~XBRL Calculation Linkbase Document~~		X
~~101.DEF~~	~~XBRL Definition Linkbase Document~~		X
~~101.LAB~~	~~XBRL Label Linkbase Document~~		X
~~101.PRE~~	~~XBRL Presentation Linkbase Document~~		X

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~~SIGNATURES~~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.

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

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

Large accelerated filer	☐	Accelerated ~~filer~~Filer	☒
Non-accelerated filer	☐ ~~(Do not check if a smaller reporting company)~~	Smaller reporting company	☐☒
Emerging growth company	☐

EARTHSTONE ENERGY, INC.

November ~~2, 2017~~4, 2020

/s/ Tony Oviedo

Tony Oviedo

Executive Vice President – Accounting and Administration