UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________________
FORM
_________________________________________________________
(Mark One)
| | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended
Or
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No.
_________________________________________________________
EARTHSTONE ENERGY, INC.
(Exact name of registrant as specified in its charter)
_________________________________________________________
| | |
| (State or other jurisdiction | (I.R.S Employer |
| of incorporation or organization) | Identification No.) |
(Address of principal executive offices)
Registrant’s telephone number, including area code: (
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| | | |
Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | | ☒ | |||
| Non-accelerated filer | ☐ | Smaller reporting company | | |||
| Emerging growth company | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
As of October 29, 2020,
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
| September 30, | December 31, | |||||||
| ASSETS | 2020 | 2019 | ||||||
| Current assets: | ||||||||
| Cash | $ | $ | ||||||
| Accounts receivable: | ||||||||
| Oil, natural gas, and natural gas liquids revenues | ||||||||
| Joint interest billings and other, net of allowance of and at September 30, 2020 and December 31, 2019, respectively | ||||||||
| Derivative asset | ||||||||
| Prepaid expenses and other current assets | ||||||||
| Total current assets | ||||||||
| Oil and gas properties, successful efforts method: | ||||||||
| Proved properties | ||||||||
| Unproved properties | ||||||||
| Land | ||||||||
| Total oil and gas properties | ||||||||
| Accumulated depreciation, depletion and amortization | ( | ) | ( | ) | ||||
| Net oil and gas properties | ||||||||
| Other noncurrent assets: | ||||||||
| Goodwill | ||||||||
| Office and other equipment, net of accumulated depreciation and amortization of and at September 30, 2020 and December 31, 2019, respectively | ||||||||
| Derivative asset | ||||||||
| Operating lease right-of-use assets | ||||||||
| Other noncurrent assets | ||||||||
| TOTAL ASSETS | $ | $ | ||||||
| LIABILITIES AND EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | $ | ||||||
| Revenues and royalties payable | ||||||||
| Accrued expenses | ||||||||
| Asset retirement obligation | ||||||||
| Derivative liability | ||||||||
| Advances | ||||||||
| Operating lease liabilities | ||||||||
| Finance lease liabilities | ||||||||
| Other current liabilities | ||||||||
| Total current liabilities | ||||||||
| Noncurrent liabilities: | ||||||||
| Long-term debt | ||||||||
| Deferred tax liability | ||||||||
| Asset retirement obligation | ||||||||
| Derivative liability | ||||||||
| Operating lease liabilities | ||||||||
| Finance lease liabilities | ||||||||
| Other noncurrent liabilities | ||||||||
| Total noncurrent liabilities | ||||||||
| Commitments and Contingencies (Note 13) | ||||||||
| Equity: | ||||||||
| Preferred stock, par value, shares authorized; issued or outstanding | ||||||||
| Class A Common Stock, par value, shares authorized; and issued and outstanding at September 30, 2020 and December 31, 2019, respectively | ||||||||
| Class B Common Stock, par value, shares authorized; and issued and outstanding at September 30, 2020 and December 31, 2019, respectively | ||||||||
| Additional paid-in capital | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Total Earthstone Energy, Inc. equity | ||||||||
| Noncontrolling interest | ||||||||
| Total equity | ||||||||
| TOTAL LIABILITIES AND EQUITY | $ | $ | ||||||
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except share and per share amounts)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| REVENUES | ||||||||||||||||
| Oil | $ | $ | $ | $ | ||||||||||||
| Natural gas | ||||||||||||||||
| Natural gas liquids | ||||||||||||||||
| Total revenues | ||||||||||||||||
| OPERATING COSTS AND EXPENSES | ||||||||||||||||
| Lease operating expense | ||||||||||||||||
| Production and ad valorem taxes | ||||||||||||||||
| Rig termination expense | ||||||||||||||||
| Depreciation, depletion and amortization | ||||||||||||||||
| Impairment expense | ||||||||||||||||
| General and administrative expense | ||||||||||||||||
| Transaction costs | ( | ) | ( | ) | ||||||||||||
| Accretion of asset retirement obligation | ||||||||||||||||
| Exploration expense | ||||||||||||||||
| Total operating costs and expenses | ||||||||||||||||
| (Loss) gain on sale of oil and gas properties | ( | ) | ( | ) | ||||||||||||
| (Loss) income from operations | ( | ) | ( | ) | ||||||||||||
| OTHER INCOME (EXPENSE) | ||||||||||||||||
| Interest expense, net | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| (Loss) gain on derivative contracts, net | ( | ) | ( | ) | ||||||||||||
| Other income (expense), net | ( | ) | ( | ) | ||||||||||||
| Total other income (expense) | ( | ) | ( | ) | ||||||||||||
| (Loss) income before income taxes | ( | ) | ( | ) | ||||||||||||
| Income tax expense | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Net (loss) income | ( | ) | ( | ) | ||||||||||||
| Less: Net (loss) income attributable to noncontrolling interest | ( | ) | ( | ) | ||||||||||||
| Net (loss) income attributable to Earthstone Energy, Inc. | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
| Net (loss) income per common share attributable to Earthstone Energy, Inc.: | ||||||||||||||||
| Basic | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
| Diluted | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
| Weighted average common shares outstanding: | ||||||||||||||||
| Basic | ||||||||||||||||
| Diluted | ||||||||||||||||
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
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 | $ | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | ||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units, net of taxes paid | ||||||||||||||||||||||||||||||||||||
| Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| Cancellation of treasury shares | ( | ) | — | — | — | — | — | — | — | |||||||||||||||||||||||||||
| Class B Common Stock converted to Class A Common Stock | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Net income | — | — | ||||||||||||||||||||||||||||||||||
| At March 31, 2020 | $ | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | ||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units, net of taxes paid | ||||||||||||||||||||||||||||||||||||
| Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| Cancellation of treasury shares | ( | ) | — | — | — | — | — | — | — | |||||||||||||||||||||||||||
| Class B Common Stock converted to Class A Common Stock | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Net loss | — | — | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
| At June 30, 2020 | $ | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | ||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units, net of taxes paid | ||||||||||||||||||||||||||||||||||||
| Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| Cancellation of treasury shares | ( | ) | — | — | — | — | — | — | — | |||||||||||||||||||||||||||
| Class B Common Stock converted to Class A Common Stock | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Net loss | — | — | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
| At September 30, 2020 | $ | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||||||||||||
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 |
$ | $ | $ | $ | ( |
) | $ | $ | $ | |||||||||||||||||||||||||||
| ASC 842 implementation |
— | — | ||||||||||||||||||||||||||||||||||
| Stock-based compensation expense |
— | — | ||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units, net of taxes paid |
||||||||||||||||||||||||||||||||||||
| Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings |
( |
) | ( |
) | ( |
) | ||||||||||||||||||||||||||||||
| Cancellation of treasury shares |
( |
) | — | — | — | — | — | — | — | |||||||||||||||||||||||||||
| Net loss |
— | — | ( |
) | ( |
) | ( |
) | ( |
) | ||||||||||||||||||||||||||
| At March 31, 2019 |
$ | $ | $ | $ | ( |
) | $ | $ | $ | |||||||||||||||||||||||||||
| Stock-based compensation expense |
— | — | ||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units, net of taxes paid |
||||||||||||||||||||||||||||||||||||
| Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings |
( |
) | ( |
) | ( |
) | ||||||||||||||||||||||||||||||
| Cancellation of treasury shares |
( |
) | — | — | — | — | — | — | — | |||||||||||||||||||||||||||
| Class B Common Stock converted to Class A Common Stock |
( |
) | ( |
) | ||||||||||||||||||||||||||||||||
| Net income |
— | — | ||||||||||||||||||||||||||||||||||
| At June 30, 2019 |
$ | $ | $ | $ | ( |
) | $ | $ | $ | |||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | ||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units, net of taxes paid |
||||||||||||||||||||||||||||||||||||
| Vested restricted stock units retained by the Company in exchange for payment of recipient mandatory tax withholdings |
( |
) | ( |
) | ( |
) | ||||||||||||||||||||||||||||||
| Cancellation of treasury shares |
( |
) | — | — | — | — | — | — | — | |||||||||||||||||||||||||||
| Class B Common Stock converted to Class A Common Stock |
||||||||||||||||||||||||||||||||||||
| Net income |
— | — | ||||||||||||||||||||||||||||||||||
| At September 30, 2019 |
$ | $ | $ | $ | ( |
) | $ | $ | $ | |||||||||||||||||||||||||||
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
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 | $ | ( | ) | $ | ||||
| Adjustments to reconcile net (loss) income to net cash provided by operating activities: | ||||||||
| Depreciation, depletion and amortization | ||||||||
| Impairment of proved and unproved oil and gas properties | ||||||||
| Impairment of goodwill | ||||||||
| Accretion of asset retirement obligations | ||||||||
| Settlement of asset retirement obligations | ( | ) | ||||||
| (Gain) loss on sale of oil and gas properties | ( | ) | ||||||
| Total (gain) loss on derivative contracts, net | ( | ) | ||||||
| Operating portion of net cash received in settlement of derivative contracts | ||||||||
| Stock-based compensation | ||||||||
| Deferred income taxes | ||||||||
| Amortization of deferred financing costs | ||||||||
| Changes in assets and liabilities: | ||||||||
| (Increase) decrease in accounts receivable | ( | ) | ||||||
| (Increase) decrease in prepaid expenses and other current assets | ( | ) | ( | ) | ||||
| Increase (decrease) in accounts payable and accrued expenses | ( | ) | ||||||
| Increase (decrease) in revenues and royalties payable | ( | ) | ( | ) | ||||
| Increase (decrease) in advances | ( | ) | ||||||
| Net cash provided by operating activities | ||||||||
| Cash flows from investing activities: | ||||||||
| Additions to oil and gas properties | ( | ) | ( | ) | ||||
| Additions to office and other equipment | ( | ) | ( | ) | ||||
| Proceeds from sales of oil and gas properties | ||||||||
| Net cash used in investing activities | ( | ) | ( | ) | ||||
| Cash flows from financing activities: | ||||||||
| Proceeds from borrowings | ||||||||
| Repayments of borrowings | ( | ) | ( | ) | ||||
| Cash paid related to the exchange and cancellation of Class A Common Stock | ( | ) | ( | ) | ||||
| Cash paid for finance leases | ( | ) | ( | ) | ||||
| Deferred financing costs | ( | ) | ||||||
| Net cash (used in) provided by financing activities | ( | ) | ||||||
| Net (decrease) increase in cash | ( | ) | ||||||
| Cash at beginning of period | ||||||||
| Cash at end of period | $ | $ | ||||||
| Supplemental disclosure of cash flow information | ||||||||
| Cash paid for: | ||||||||
| Interest | $ | $ | ||||||
| Non-cash investing and financing activities: | ||||||||
| Accrued capital expenditures | $ | $ | ||||||
| Lease asset additions - ASC 842 | $ | $ | ||||||
| Asset retirement obligations | $ | $ | ||||||
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation and Summary of Significant Accounting Policies
Earthstone Energy, Inc., a Delaware corporation (“Earthstone” and together with its consolidated subsidiaries, the “Company”), is a growth-oriented independent oil and natural gas development and production company. In addition, the Company is active in corporate mergers and the acquisition of oil and natural gas properties that have production and future development opportunities. The Company's operations are all in the upstream segment of the oil and natural gas industry and all its properties are onshore in the United States.
Earthstone is the sole managing member of Earthstone Energy Holdings, LLC, a Delaware limited liability company (together with its wholly-owned consolidated subsidiaries, “EEH”), with a controlling interest in EEH. Earthstone, together with its wholly-owned subsidiary, Lynden Energy Corp., a corporation organized under the laws of British Columbia (“Lynden Corp”), and Lynden Corp’s wholly-owned consolidated subsidiary, Lynden USA Inc., a Utah corporation (“Lynden US”) and also a member of EEH, consolidates the financial results of EEH and records a noncontrolling interest in the Condensed Consolidated Financial Statements representing the economic interests of EEH's members other than Earthstone and Lynden US.
The accompanying unaudited Condensed Consolidated Financial Statements and notes thereto have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial statements. Pursuant to such rules and regulations, certain disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted. The accompanying unaudited Condensed Consolidated Financial Statements and notes should be read in conjunction with the financial statements and notes included in Earthstone’s 2019 Annual Report on Form 10-K.
The information furnished herein reflects all adjustments that are, in the opinion of management, necessary for the fair presentation of the Company's financial position, results of operations and cash flows for the periods presented. The Company’s Condensed Consolidated Balance Sheet at December 31, 2019 is derived from the audited Consolidated Financial Statements at that date.
Certain prior period amounts have been reclassified to conform to current period presentation within the Condensed Consolidated Financial Statements. Prior period ad valorem taxes which were previously included in Lease operating expenses within the Operating Costs and Expenses section of the Condensed Consolidated Statements of Operations have been reclassified from Lease operating expenses and combined with the previously presented Severance taxes line-item and the combined total presented as Production and ad valorem taxes, also within Operating Costs and Expenses, in order to conform to current period presentation. Additionally, prior period legal expenses related to a previously completed transaction and previously included in General and administrative expense within Operating Costs and Expenses have been reclassified to Transaction costs, also within Operating Costs and Expenses, to conform to current period presentation. These reclassifications had no effect on Income from operations or any other subtotal in the Condensed Consolidated Statements of Operations.
Recently Issued Accounting Standards
Intangibles – Goodwill and Other – In January 2017, the Financial Accounting Standards Board (“FASB”) issued updated guidance simplifying the test for goodwill impairment. The update eliminates the requirement to determine the implied value of goodwill in measuring an impairment loss. Upon adoption, the measurement of a goodwill impairment will represent the excess of the reporting unit’s carrying value over its fair value and will be limited to the carrying value of goodwill. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The update is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company adopted the update effective January 1, 2020. See further discussion of goodwill in Note 15. Goodwill.
Fair Value Measurements – In August 2018, the FASB issued an Accounting Standards Update (“ASU”) 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.
Reference Rate Reform - In March 2020, the FASB issued an update that provides optional guidance for a limited period of time to ease the transition from LIBOR to an alternative reference rate. The ASU intends to address certain concerns relating to accounting for contract modifications and hedge accounting. These optional expedients and exceptions to applying GAAP, assuming certain criteria are met, are allowed through December 31, 2022. The Company is currently evaluating the provisions of this update and has not yet determined whether it will elect the optional expedients. The Company does not expect the transition to an alternative rate to have a material impact on its business, operations or liquidity.
Note 2. Fair Value Measurements
FASB 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 hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and requires consideration of the counterparty’s creditworthiness when valuing certain assets.
The three-level fair value hierarchy for disclosure of fair value measurements defined by ASC 820 is as follows:
Level 1 – Unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. An active market is defined as a market where transactions for the financial instrument occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 – Inputs, other than quoted prices within Level 1, that are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
Level 3 – Prices or valuations that require unobservable inputs that are both significant to the fair value measurement and unobservable. Valuation under Level 3 generally involves a significant degree of judgment from management.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve 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, 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 and interest rate swaps. The Company’s commodity price hedges and interest rate swaps are valued based on discounted future cash flow models that are primarily based on published forward commodity price curves and published LIBOR forward curves; thus, these inputs are designated as Level 2 within the valuation hierarchy.
The fair values of derivative instruments in asset positions include measures of counterparty nonperformance risk, and the fair values of derivative instruments in liability positions include 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, 2020 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Financial assets | ||||||||||||||||
| Derivative asset - current | $ | $ | $ | $ | ||||||||||||
| Derivative asset - noncurrent | ||||||||||||||||
| Total financial assets | $ | $ | $ | $ | ||||||||||||
| Financial liabilities | ||||||||||||||||
| Derivative liability - current | $ | $ | $ | $ | ||||||||||||
| Derivative liability - noncurrent | ||||||||||||||||
| Total financial liabilities | $ | $ | $ | $ | ||||||||||||
| December 31, 2019 | ||||||||||||||||
| Financial assets | ||||||||||||||||
| Derivative asset - current | $ | $ | $ | $ | ||||||||||||
| Derivative asset - noncurrent | ||||||||||||||||
| Total financial assets | $ | $ | $ | $ | ||||||||||||
| Financial liabilities | ||||||||||||||||
| Derivative liability - current | $ | $ | $ | $ | ||||||||||||
| Derivative liability - noncurrent | ||||||||||||||||
| Total financial liabilities | $ | $ | $ | $ | ||||||||||||
Other financial instruments include cash, accounts receivable and payable, and revenue royalties. The carrying amount of these instruments approximates fair value because of their short-term nature. The Company’s long-term debt obligation bears interest at floating market rates, therefore carrying amounts and fair value are approximately equal.
Fair Value on a Nonrecurring Basis
The Company applies the provisions of the fair value measurement standard on a non-recurring basis to its non-financial assets and liabilities, including oil and gas properties, goodwill, business combinations, asset retirement obligations and performance units. These assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments if events or changes in certain circumstances indicate that adjustments may be necessary. Due to significant declines in commodity prices and global demand for oil and natural gas products resulting from the COVID-19 pandemic, the Company assessed the fair values of its oil and natural gas properties and goodwill resulting in non-cash impairment charges during the nine months ended September 30, 2020. See further discussion in Note 4. Asset Impairments.
Note 3. Derivative Financial Instruments
Commodity Derivative Instruments
The Company’s hedging activities primarily consist of derivative instruments entered into in order to hedge against changes in oil and natural gas prices through the use of fixed price swap agreements. Swaps exchange floating price risk in the future for a fixed price at the time of the hedge. Consistent with its hedging policy, the Company has entered into a series of derivative instruments to hedge a significant portion of its expected oil and natural gas production through December 31, 2021. Typically, these derivative instruments require payments to (receipts from) counterparties based on specific indices as required by the derivative agreements. Although not risk free, the Company believes these instruments reduce its exposure to oil and natural gas price fluctuations and, thereby, allow the Company to achieve a more predictable cash flow.
The Company’s derivative instruments are cash flow hedge transactions in which it is hedging the variability of cash flow related to a forecasted transaction. The Company does not enter into derivative instruments for trading or other speculative purposes. These transactions are recorded in the Condensed Consolidated Financial Statements in accordance with FASB ASC Topic 815. The Company has accounted for these transactions using the mark-to-market accounting method. Generally, the Company incurs accounting losses on derivatives during periods where prices are rising and gains during periods where prices are falling which may cause significant fluctuations in the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Operations.
The Company nets its derivative instrument fair value amounts executed with each counterparty pursuant to an International Swap Dealers Association Master Agreement (“ISDA”), which provides for net settlement over the term of the contract. The ISDA is a standard contract that governs all derivative contracts entered into between the Company and the respective counterparty. The ISDA allows for offsetting of amounts payable or receivable between the Company and the counterparty, at the election of both parties, for transactions that occur on the same date and in the same currency.
The Company had the following open crude oil and natural gas derivative contracts as of September 30, 2020:
| Price Swaps | ||||||||||
| Volume | Weighted Average Price | |||||||||
| Period | Commodity | (Bbls / MMBtu) | ($/Bbl / $/MMBtu) | |||||||
| Q4 2020 | Crude Oil | $ | ||||||||
| Q1 - Q4 2021 | Crude Oil | $ | ||||||||
| Q4 2020 | Crude Oil Basis Swap (1) | $ | ( | ) | ||||||
| Q4 2020 | Crude Oil Basis Swap (2) | $ | ||||||||
| Q4 2020 | Crude Oil Roll Swap (3) | $ | ( | ) | ||||||
| Q1 - Q4 2021 | Crude Oil Basis Swap (1) | $ | ||||||||
| Q4 2020 | Natural Gas | $ | ||||||||
| Q1 - Q4 2021 | Natural Gas | $ | ||||||||
| Q4 2020 | Natural Gas Basis Swap (4) | $ | ( | ) | ||||||
| Q1 - Q4 2021 | Natural Gas Basis Swap (4) | $ | ( | ) | ||||||
| (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. |
Interest Rate Swaps
At times, the Company’s hedging activities include the use of interest rate swaps entered into in order to manage cash flow variability resulting from changes in interest rates. These derivative instruments are not accounted for under hedge accounting.
The Company had the following interest rate swaps as of September 30, 2020:
| Effective Dates | Notional Amount | Fixed Rate | ||||||
| May 5, 2020 to May 5, 2022 | $ | % | ||||||
| May 5, 2022 to May 5, 2023 | $ | % | ||||||
| May 5, 2023 to May 7, 2024 | $ | % | ||||||
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, 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 | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||
| Commodity contracts | Derivative liability - current | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||
| Interest rate swaps | Derivative liability - current | $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Commodity contracts | Derivative asset - noncurrent | $ | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Commodity contracts | Derivative liability - noncurrent | $ | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Interest rate swaps | Derivative liability - noncurrent | $ | $ | $ | $ | $ | $ | |||||||||||||||||||
The following table summarizes the location and amounts of the Company’s realized and unrealized gains and losses on derivatives instruments in the Condensed Consolidated Statements of Operations and Condensed Consolidated Statements of Cash Flows (in thousands):
| Three Months Ended | Nine Months Ended | |||||||||||||||||||
| Derivatives not designated as hedging contracts under ASC Topic 815 | September 30, | September 30, | ||||||||||||||||||
| Statement of Cash Flows Location | Statement of Operations Location | 2020 | 2019 | 2020 | 2019 | |||||||||||||||
| Unrealized (loss) gain | Not separately presented | Not separately presented | $ | ( | ) | $ | $ | $ | ( | ) | ||||||||||
| Realized gain | Operating portion of net cash received in settlement of derivative contracts | Not separately presented | ||||||||||||||||||
| Total (loss) gain on derivative contracts, net | (Loss) gain on derivative contracts, net | $ | ( | ) | $ | $ | $ | ( | ) | |||||||||||
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 $
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 | $ | $ | ||||||
| Unproved property | ||||||||
| Goodwill | ||||||||
| Impairment expense | $ | $ | ||||||
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 record any impairments during the three and nine months ended September 30, 2019.
Note 5. Oil and Natural Gas Properties
The Company follows the successful efforts method of accounting for its oil and natural gas properties. Under this method, costs to acquire oil and natural gas properties, drill and equip exploratory wells that find proved reserves, and drill and equip development wells are capitalized. Exploration costs, including unsuccessful exploratory wells and geological and geophysical costs, are charged to operations as incurred. Upon sale or retirement of oil and natural gas properties, the costs and related accumulated depreciation, depletion and amortization are eliminated from the accounts and the resulting gain or loss is recognized.
Costs incurred to maintain wells and related equipment, lease and well operating costs, and other exploration costs are charged to expense as incurred. Gains and losses arising from the sale of properties are included in Income from operations in the Condensed Consolidated Statements of Operations.
The Company’s lease acquisition costs and development costs of proved oil and natural gas properties are amortized using the units-of-production method, at the field level, based on total proved reserves and proved developed reserves, respectively. For the three and nine months ended September 30, 2020, depletion expense for oil and gas producing property and related equipment was $
Proved Properties
Proved oil and natural gas properties are reviewed for impairment on a nonrecurring basis. The impairment charge reduces the carrying values to their estimated fair values. These fair value measurements are classified as Level 3 measurements and include many unobservable inputs. Fair value is calculated as the estimated discounted future net cash flows attributable to the assets. The Company’s primary assumptions in preparing the estimated discounted future net cash flows to be recovered from oil and gas properties are based on (i) proved reserves, (ii) forward commodity prices and assumptions as to costs and expenses, and (iii) the estimated discount rate that would be used by potential purchasers to determine the fair value of the assets.
Unproved Properties
Unproved properties consist of costs incurred to acquire undeveloped leases. Unproved oil and gas leases are generally for a primary term of to years. In most cases, the term of the unproved leases can be extended by paying a lease renewal fee, meeting contractual drilling obligations, or by the presence of producing wells on the leases. Unproved costs related to successful drilling on unproved leases are reclassified to proved properties.
The Company reviews its unproved properties periodically for impairment. In determining whether an unproved property is impaired, the Company considers numerous factors including, but not limited to, current exploration and development plans, favorable or unfavorable exploration activity on the property being evaluated and/or adjacent properties, the Company’s geologists' evaluation of the property, and the remaining months in the lease term for the property.
Impairments to Oil and Natural Gas Properties
During the three months ended March 31, 2020, as a result of the recent decline in crude oil price futures, the Company recorded non-cash impairment charges of $
The Company did record any impairments to its oil and natural gas properties for the three and nine months ended September 30, 2019.
Capitalized costs, impairment, and depreciation, depletion and amortization relating to the Company’s oil and natural gas properties as of September 30, 2020 and December 31, 2019, are summarized below (in thousands):
| September 30, | December 31, | |||||||
| 2020 | 2019 | |||||||
| Oil and gas properties, successful efforts method: | ||||||||
| Proved properties | $ | $ | ||||||
| Accumulated impairment to proved properties | ( | ) | ( | ) | ||||
| Proved properties, net of accumulated impairments | ||||||||
| Unproved properties | ||||||||
| Accumulated impairment to Unproved properties | ( | ) | ( | ) | ||||
| Unproved properties, net of accumulated impairments | ||||||||
| Land | ||||||||
| Total oil and gas properties, net of accumulated impairments | ||||||||
| Accumulated depreciation, depletion and amortization | ( | ) | ( | ) | ||||
| Net oil and gas properties | $ | $ | ||||||
Note 6. Noncontrolling Interest
Earthstone consolidates the financial results of EEH and its subsidiaries and records a noncontrolling interest for the economic interest in Earthstone held by the members of EEH other than Earthstone and Lynden US. Net (loss) income attributable to noncontrolling interest in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2020 and 2019 represents the portion of net (loss) income attributable to the economic interest in the Company held by the members of EEH other than Earthstone and Lynden US. Noncontrolling interest in the Condensed Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 represents the portion of net assets of the Company attributable to the members of EEH other than Earthstone and Lynden US.
The following table presents the changes in noncontrolling interest for the nine months ended September 30, 2020:
| EEH Units Held | Total EEH | |||||||||||||||||||
| By Earthstone | EEH Units Held | Units | ||||||||||||||||||
| and Lynden US | % | By Others | % | Outstanding | ||||||||||||||||
| As of December 31, 2019 | % | % | ||||||||||||||||||
| EEH Units and Class B Common Stock converted to Class A Common Stock | ( | ) | ||||||||||||||||||
| EEH Units issued in connection with the vesting of restricted stock units | ||||||||||||||||||||
| As of September 30, 2020 | % | % | ||||||||||||||||||
Note 7. Net (Loss) Income Per Common Share
Net (loss) income per common share—basic is calculated by dividing Net (loss) income by the weighted average number of shares of common stock outstanding during the period. Net (loss) income per common share—diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing Net (loss) income by the sum of the weighted average number of shares of common stock, as defined above, outstanding plus potentially dilutive securities. Net (loss) income per common share—diluted considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares, as defined above, would have an anti-dilutive effect.
A reconciliation of Net (loss) income per common share is as follows:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| (In thousands, except per share amounts) | 2020 | 2019 | 2020 | 2019 | ||||||||||||
| Net (loss) income attributable to Earthstone Energy, Inc. | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
| Net (loss) income per common share attributable to Earthstone Energy, Inc.: | ||||||||||||||||
| Basic | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
| Diluted | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
| Weighted average common shares outstanding | ||||||||||||||||
| Basic | ||||||||||||||||
| Add potentially dilutive securities: | ||||||||||||||||
| Unvested restricted stock units (1) | ||||||||||||||||
| Unvested performance units (1) | ||||||||||||||||
| Diluted weighted average common shares outstanding | ||||||||||||||||
(1) For the three and nine months ended September 30, 2020 and 2019, the Company had
Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and net loss attributable to noncontrolling interest of $
Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and net income attributable to noncontrolling interest of $
Note 8. Common Stock
Class A Common Stock
At September 30, 2020 and December 31, 2019, there were
Class B Common Stock
At September 30, 2020 and December 31, 2019, there were
Note 9. Stock-Based Compensation
Restricted Stock Units
The 2014 Plan, allows, among other things, for the grant of restricted stock units (“RSUs”). As of September 30, 2020, the maximum number of shares of Class A Common Stock that may be issued under the 2014 Plan was
Each RSU represents the contingent right to receive
The table below summarizes RSU award activity for the nine months ended September 30, 2020:
| Shares | Weighted-Average Grant Date Fair Value | |||||||
| Unvested RSUs at December 31, 2019 | $ | |||||||
| Granted | $ | |||||||
| Forfeited | ( | ) | $ | |||||
| Vested | ( | ) | $ | |||||
| Unvested RSUs at September 30, 2020 | $ | |||||||
As of September 30, 2020, there was $
For the three and nine months ended September 30, 2020, Stock-based compensation related to RSUs was $
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 | $ | |||||||
| Granted | $ | |||||||
| Unvested PSUs at September 30, 2020 | $ | |||||||
On January 30, 2020, the Board of Directors of Earthstone (the “Board”) granted
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 |
| |
| 14.5% |
| |
| 8.4% |
| |
| Less than 8.4% |
|
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
As of September 30, 2020, there was $
For the three and nine months ended September 30, 2020, Stock-based compensation related to the PSUs was approximately $
Note 10. Long-Term Debt
Credit Facility
On November 21, 2019, Earthstone, EEH (the “Borrower”), Wells Fargo Bank, National Association, as Administrative Agent and Issuing Bank (“Wells Fargo”), Royal Bank of Canada, as Syndication Agent, BOKF, NA dba Bank of Texas (“BOKF”) as Issuing Bank with respect to Existing Letters of Credit, SunTrust Bank, as Documentation Agent, and the lenders party thereto (the “Lenders”) entered into a credit agreement (the “Credit Facility”), which replaced the Prior Credit Facility (as defined below), which was terminated on November 21, 2019.
Concurrently with the effectiveness of the Credit Facility, the Company terminated that certain credit agreement, dated as of May 9, 2017 (the “Prior Credit Facility”), by and among the Borrower, Earthstone Operating, LLC, EF Non-Op, LLC, Sabine River Energy, LLC, Earthstone Legacy Properties, LLC, Lynden USA Operating, LLC, Bold Energy III LLC (“Bold”), Bold Operating, LLC, the guarantors party thereto, the lenders party thereto, and BOKF, as administrative agent.
On March 27, 2020, in connection with a redetermination of the borrowing base under the Credit Facility, the borrowing base was set at $
On September 28, 2020, Earthstone, EEH, Wells Fargo, the guarantors party thereto, and the Lenders entered into an amendment (the “Amendment”) to the Credit Facility. Among other things, the Amendment decreased the borrowing base from $275 million to $
The next regularly scheduled redetermination of the borrowing base is on or around April 1, 2021. Subsequent redeterminations will occur on or about each November 1st and May 1st thereafter. The amounts borrowed under the Credit Facility bear annual interest rates at either (a) the adjusted LIBO Rate (as customarily defined) (the “Adjusted LIBO Rate”) plus
Effective May 2020, the Company entered into certain interest rate swaps, exchanging the LIBO Rate for a fixed rate of
The Credit Facility contains a number of covenants that, among other things, restrict, subject to certain exceptions, EEH’s ability to incur additional indebtedness, create liens on assets, make investments, pay dividends and distributions or repurchase its limited liability interests, engage in mergers or consolidations, sell certain assets, sell or discount any notes receivable or accounts receivable and engage in certain transactions with affiliates.
In addition, the Credit Facility requires EEH to maintain the following financial covenants: a current ratio of not less than
The Credit Facility contains customary affirmative covenants and defines events of default to include failure to pay principal or interest, breach of covenants, breach of representations and warranties, insolvency, judgment default and a change in control. Upon the occurrence and continuance of an event of default, the Lenders have the right to accelerate repayment of the loans and exercise their remedies with respect to the collateral. As of September 30, 2020, EEH was in compliance with the covenants under the Credit Facility.
As of September 30, 2020, $
For the nine months ended September 30, 2020, under the Credit Facility, the Company had borrowings of $
For the three and nine months ended September 30, 2020, interest on borrowings under the Credit Facility averaged
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.
Note 11. Asset Retirement Obligations
The Company has asset retirement obligations associated with the future plugging and abandonment of oil and gas properties and related facilities. Revisions to the liability typically occur due to changes in the estimated abandonment costs, well economic lives, and the discount rate.
The following table summarizes the Company’s asset retirement obligation transactions recorded during the nine months ended September 30, (in thousands):
| 2020 | ||||
| Beginning asset retirement obligations | $ | |||
| Liabilities incurred | ||||
| Accretion expense | ||||
| Divestitures | ( | ) | ||
| Revision of estimates | ( | ) | ||
| Ending asset retirement obligations | $ | |||
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.
Earthstone's majority shareholder consists of various investment funds managed by a private equity firm who may manage other investments in entities with which the Company interacts in the normal course of business. On February 12, 2020, the Company sold certain of its interests in oil and natural gas leases and wells in an arm’s length transaction to a portfolio company of Earthstone’s majority shareholder (not under common control) for cash consideration of approximately $
In connection with the Olenik v. Lodzinski et al. lawsuit described below in 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 $
Note 13. Commitments and Contingencies
Legal
From time to time, Earthstone and its subsidiaries may be involved in various legal proceedings and claims in the ordinary course of business.
Olenik v. Lodzinski et al.: On June 2, 2017, Nicholas Olenik filed a purported shareholder class and derivative action in the Delaware Court of Chancery against Earthstone’s Chief Executive Officer, along with other members of the Board, EnCap Investments L.P. (“EnCap”), Bold, Bold Holdings and Oak Valley Resources, LLC. The complaint alleges that Earthstone’s directors breached their fiduciary duties in connection with the contribution agreement dated as of November 7, 2016 and as amended on March 21, 2017 (the “Bold Contribution Agreement”), by and among Earthstone, EEH, Lynden US, Lynden USA Operating, LLC, Bold Holdings and Bold. The Plaintiff asserts that the directors negotiated the business combination pursuant to the Bold Contribution Agreement (the “Bold Transaction”) to benefit EnCap and its affiliates, failed to obtain adequate consideration for the Earthstone shareholders who were not affiliated with EnCap or Earthstone management, did not follow an adequate process in negotiating and approving the Bold Transaction and made materially misleading or incomplete proxy disclosures in connection with the Bold Transaction. The suit seeks unspecified damages and purports to assert claims derivatively on behalf of Earthstone and as a class action on behalf of all persons who held common stock up to March 13, 2017, excluding defendants and their affiliates. On July 20, 2018, the Delaware Court of Chancery granted the defendants’ motion to dismiss and entered an order dismissing the action in its entirety with prejudice. The Plaintiff filed an appeal with the Delaware Supreme Court. On 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 $
Prior to September 30, 2020, due to uncertainty of reimbursement, the Company recorded and accrued litigation costs when incurred and recorded insurance reimbursements as an offset only when proceeds were received in Transactions costs. In light of the Settlement Agreement, insurance carrier agreement on allocation of defense costs and settlement payment combined with the history of reimbursements from insurance carriers and related affiliate, a high probability of reimbursement exists. Accordingly, the Company has accrued $
Environmental and Regulatory
As of September 30, 2020, there were no known environmental or other regulatory matters related to the Company’s operations that are reasonably expected to result in a material liability to the Company.
Note 14. Income Taxes
The Company’s corporate structure requires the filing of two separate consolidated U.S. Federal income tax returns and one Canadian income tax return which include Lynden US, Earthstone, and Lynden Corp. As such, taxable income of Earthstone cannot be offset by tax attributes, including net operating losses, of Lynden US, nor can taxable income of Lynden US be offset by tax attributes of Earthstone. Earthstone and Lynden US record a tax provision, respectively, for their share of the book income or loss of EEH, net of the non-controlling interest. As EEH is treated as a partnership for U.S. Federal income tax purposes, it is not subject to income tax at the federal level and only recognizes the Texas Margin Tax.
During the nine months ended September 30, 2020, the Company recorded income tax expense of approximately $
During the nine months ended September 30, 2019, the Company recorded income tax expense of approximately $
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 combined market capitalization of the 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 $
Accumulated impairments to Goodwill as of September 30, 2020 and December 31, 2019 were $
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 under “Item 1A. Risk Factors” in our 2019 Annual Report on Form 10-K and “Part II, Item 1A - Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 that were filed with the Securities and Exchange Commission (“SEC”), which you should read carefully in connection with our forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated. We undertake no obligation to release publicly any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
You should read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in conjunction with the corresponding sections and our audited consolidated financial statements for the year ended December 31, 2019, which are included in our 2019 Annual Report on Form 10-K.
Overview
Earthstone Energy, Inc., a Delaware corporation (“Earthstone” and together with our consolidated subsidiaries, the “Company,” “our,” “we,” “us,” or similar terms), is a growth-oriented independent oil and gas company engaged in the acquisition and development of oil and gas reserves through activities that include the acquisition, drilling and development of undeveloped leases, asset and corporate acquisitions and mergers. Our operations are all in the upstream segment of the oil and natural gas industry and all our properties are onshore in the United States. At present, our assets are located in the Midland Basin of west Texas and the Eagle Ford Trend of south Texas.
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.
COVID-19
According to the United States (“U.S.”) 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”). On May 1, 2020 they indicated that there was still the potential for future acceleration. This conclusion was based on the Pandemic Intervals Framework created by the CDC, which describes the 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 result, there has been a significant reduction in demand for and prices of oil and natural gas, 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 expected time frame, is uncertain and depends on various factors, including how the pandemic and measures taken in response to it impact demand for oil and natural gas, the availability of personnel, equipment and services critical to our ability to operate our properties and the impact of potential governmental restrictions on travel, transports and operations. There is uncertainty around the extent and duration of disruption, including any resurgence, and we expect that the longer the period of such disruption continues, the greater the adverse impact will be on our business. The degree to which the COVID-19 pandemic or any other 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 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 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.
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 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 well as national, mitigation efforts currently being implemented to fight COVID-19 have had, and may continue to have, a material impact on commodity prices and may continue to present significant challenges to our industry.
The ongoing effects of COVID-19, including a substantial decrease in economic activity, have contributed to equity market volatility and resulted in a global recession. Similar to other producers in our business, we experienced volatility and a decline in the price of our Class A common stock. While the price of our Class A common stock has recently stabilized somewhat, it remains historically low.
Liquidity
In March 2020, in response to the significant decrease in commodity prices, we significantly reduced our capital program for 2020 and halted all drilling and completion activity. In light of recent oil price recoveries and meaningful service cost reductions compared to earlier in the year, we have commenced completions of a six-well pad and currently expect total capital spending for 2020 to be in the range of $65 - $70 million. Additionally, we currently expect to begin completions of a five-well pad in January 2021. We expect to fund these completions with internally generated cash flows.
COVID-19 has adversely impacted our revenues in the three and nine months ended September 30, 2020 as a result of both low commodity prices and our voluntary shut-ins. However, due to our commodity hedging activities partially offsetting those reduced revenues, there has been no significant overall impact on our cash flows from producing activities.
Since the beginning of 2020, our borrowing base has been reduced through two sequential reductions from $325 million to $240 million. We continue remain in compliance with all covenants under our Credit Facility. If commodity prices continue to be depressed, we may experience future borrowing base reductions.
For further discussion of our liquidity as of September 30, 2020, see Liquidity and Capital Resources below.
Oil and Gas Reserves
In line with our borrowing base reductions, our oil and gas reserves have significantly been reduced primarily due to the significant decrease in commodity prices from year end. Further deterioration of commodity prices would further negatively impact our oil and gas reserves.
Impairments
The COVID-19 effects resulted in impairments in the first quarter on our proved developed properties and undeveloped properties in the amount of $25.3 million and $11.3 million, respectively. Further reductions in our oil and gas reserves and commodity prices may result in additional impairments on our oil and gas properties. Including impairments for certain acreage expirations, impairments on our proved developed properties and undeveloped properties for the nine months ended September 30, 2020 were $25.3 million and $19.7 million, respectively.
Government Assistance
Although management explored all assistance available under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), the Company was not eligible for any of the programs therein with the exception of the deferral of employment tax deposits and payments which management has currently not elected to pursue.
Impact on Capital Program
In light of the current economic environment, we have reduced our 2020 capital program in order to preserve capital and cash flows. Our short-term strategy is to weather COVID-19 and be in a position, when the time comes, to execute our long-term business strategy to develop our properties efficiently, as well as being able to take advantage of growth opportunities as they arise. However, an extended period of severely depressed commodity prices and low demand may create more uncertainty in our ability to model and make plans to participate in any economic recovery.
Employee Reduction Measures
In June 2020, management completed a workforce reduction effort that reduced the number of full-time employees from 68 to 60 by month end, resulting in over a 10% decrease in aggregate salaries and wages going forward. Severance related costs associated with these reduction measures resulted in operating expenses of $0.4 million in June 2020. At this time, management has no future plans for further workforce reductions; however, if adverse industry conditions persist, further employee reduction measures may be necessary.
Outlook
We do not expect commodity prices to return to pre-pandemic levels in the short term. In the longer term, we believe the U.S. and world economies will recover and the demand for oil will return in the range of pre-COVID-19 levels as more developments occur in meeting and addressing COVID-19 business challenges. Our current financial focus is to maintain the health of our balance sheet and continue limited capital expenditures with our internally generated cash flows to enable us to be in a position to execute a business strategy as commodity prices return to pre-pandemic levels.
Recent Developments
Borrowing Base Redetermination
On September 28, 2020, Earthstone, EEH (the “Borrower”), Wells Fargo Bank, National Association as Administrative Agent (“Wells Fargo”), the guarantors party thereto, and the lenders party thereto (the “Lenders”) entered into an amendment (the “Amendment”) to the Credit Agreement dated November 21, 2019, by and among EEH, as Borrower, Earthstone, as Parent, Wells Fargo as Administrative Agent and Issuing Bank, BOKF, NA dba Bank of Texas, as Issuing Bank with respect to Existing Letters of Credit, Royal Bank of Canada, as Syndication Agent, Truist Bank, as successor by merger to SunTrust Bank, as Documentation Agent, and the Lenders (together with all amendments or other modifications, the “Credit Facility”). Among other things, the Amendment decreased the borrowing base from $275 million to $240 million, increased the interest rate on outstanding borrowings by 25 to 50 basis points, increased the flexibility to finance and make acquisitions, and added certain restrictions related to dividends and distributions.
As of September 30, 2020, we had outstanding borrowings under our Credit Facility of $130 million, which represents a reduction of 24% compared to the $170 million in outstanding borrowings as of December 31, 2019. Our only debt is borrowings under our Credit Facility.
Consolidation Focus
We believe that the current industry environment will move to more consolidations; however, execution may be hampered by producers with high debt levels and sellers unwilling to acknowledge persistent low commodity prices. We continue to pursue value-accretive and scale-enhancing consolidation opportunities, as we believe we are in a position to operate effectively despite the COVID-19 induced low oil price. We are focusing our attention on acquisition and corporate merger opportunities that would increase the scale of our operations. In addition, we believe the current industry environment presents unique opportunities with distressed assets or corporations that will be distressed in the near future which would provide us the potential for further consolidation because of our financial strength. At the same time, we will seek to block up acreage that would allow for longer horizontal laterals that would provide for higher economic returns when commodity prices recover and we return to asset development. In short, we believe we are well qualified to be a consolidator which could increase the scale of our operations and add value to our shareholders.
Officer Appointments
Effective April 1, 2020, our former Chairman and Chief Executive Officer, Mr. Frank A. Lodzinski, was appointed Executive Chairman and our former President, Mr. Robert J. Anderson, was appointed President and Chief Executive Officer.
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 May 2022 and decreases to $100 million through May 2023 and $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, 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 voluntarily shutting the wells in for the duration of the month of May. In May, approximately 60% of our total production was shut-in. As oil prices have improved since then, we have returned to full production capacity. We have experienced no adverse effects from this short-term curtailment and have incurred no significant costs in restoring production.
In late May, we concluded our 2020 drilling program and released our contracted rig operating in the Midland Basin. During the first half of the year, we drilled a total of five wells in our Hamman Upton project along with six wells in our Ratliff unit, all located in Upton County, 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 continue to seek acreage trade and acquisition opportunities in the Midland Basin which would allow for longer laterals, increased operated inventory and greater operating efficiency.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to use our judgment to make estimates and assumptions that affect certain amounts reported in our financial statements. As additional information becomes available, these estimates and assumptions are subject to change and thus impact amounts reported in the future. Critical accounting policies are those accounting policies that involve judgment and uncertainties affecting the application of those policies and the likelihood that materially different amounts would be reported under different conditions or using differing assumptions. We periodically update our estimates used in the preparation of the financial statements based on our latest assessment of the current and projected business and general economic environment. There have been no significant changes to our critical accounting policies during the nine months ended September 30, 2020.
Results of Operations
Three Months Ended September 30, 2020, compared to the Three Months Ended September 30, 2019
| Three Months Ended |
||||||||||||
| September 30, |
||||||||||||
| 2020 |
2019 |
Change |
||||||||||
| Sales volumes: |
||||||||||||
| Oil (MBbl) |
839 | 646 | 30 | % | ||||||||
| Natural gas (MMcf) |
2,010 | 1,248 | 61 | % | ||||||||
| Natural gas liquids (MBbl) |
386 | 267 | 45 | % | ||||||||
| Barrels of oil equivalent (MBOE) |
1,560 | 1,121 | 39 | % | ||||||||
| Average Daily Production (Boepd) |
16,959 | 12,181 | 39 | % | ||||||||
| Average prices: |
||||||||||||
| Oil (per Bbl) |
$ | 39.50 | $ | 54.89 | (28 | )% | ||||||
| Natural gas (per Mcf) |
$ | 1.31 | $ | 0.72 | 82 | % | ||||||
| Natural gas liquids (per Bbl) |
$ | 13.60 | $ | 10.71 | 27 | % | ||||||
| Average prices adjusted for realized derivatives settlements: |
||||||||||||
| Oil ($/Bbl)(1) |
$ | 49.34 | $ | 59.43 | (17 | )% | ||||||
| Natural gas ($/Mcf) |
$ | 1.45 | $ | 1.34 | 8 | % | ||||||
| Natural gas liquids ($/Bbl) |
$ | 13.60 | $ | 10.71 | 27 | % | ||||||
| (In thousands) |
||||||||||||
| Oil revenues |
$ | 33,158 | $ | 35,443 | (6 | )% | ||||||
| Natural gas revenues |
$ | 2,642 | $ | 903 | 193 | % | ||||||
| Natural gas liquids revenues |
$ | 5,247 | $ | 2,858 | 84 | % | ||||||
| Lease operating expense |
$ | 7,044 | $ | 6,419 | 10 | % | ||||||
| Production and ad valorem taxes |
$ | 2,696 | $ | 2,698 | (0 | )% | ||||||
| Impairment expense |
$ | 2,115 | $ | — | NM | |||||||
| Depreciation, depletion and amortization |
$ | 28,538 | $ | 14,079 | 103 | % | ||||||
| General and administrative expense (excluding stock-based compensation) |
$ | 3,393 | $ | 3,850 | (12 | )% | ||||||
| Stock-based compensation |
$ | 2,403 | $ | 2,207 | 9 | % | ||||||
| General and administrative expense |
$ | 5,796 | $ | 6,057 | (4 | )% | ||||||
| Transaction costs |
$ | (705 | ) | $ | 215 | NM | ||||||
| Interest expense, net |
$ | (1,186 | ) | $ | (1,609 | ) | (26 | )% | ||||
| Unrealized (loss) gain on derivative contracts |
$ | (14,543 | ) | $ | 15,021 | NM | ||||||
| Realized gain on derivative contracts |
$ | 8,503 | $ | 3,705 | NM | |||||||
| (Loss) gain on derivative contracts, net |
$ | (6,040 | ) | $ | 18,726 | NM | ||||||
| Income tax expense |
$ | (130 | ) | $ | (575 | ) | NM | |||||
NM – Not Meaningful
Oil revenues
For the three months ended September 30, 2020, oil revenues decreased by $2.3 million or 6% relative to the comparable period in 2019. Of the decrease, $9.9 million was due to a decrease in our realized price, partially offset by $7.6 million attributable to an increase in volume. Our average realized price per Bbl decreased from $54.89 for the three months ended September 30, 2019 to $39.50 or 28% for the three months ended September 30, 2020. We had a net increase in the volume of oil sold of 194 MBbls or 30%, primarily due to new wells brought online in 2020.
Natural gas revenues
For the three months ended September 30, 2020, natural gas revenues increased by $1.7 million or 193% relative to the comparable period in 2019. Of the increase, $1.0 million was attributable to increased sales volume and $0.7 million was due to an increase in realized price. The total volume of natural gas produced and sold increased by 762 MMcf or 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 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.
Natural gas liquids revenues
For the three months ended September 30, 2020, natural gas liquids revenues increased by $2.4 million or 84% relative to the comparable period in 2019. Of the increase, $1.6 million was due to increased volume and $0.8 million was attributable to an increase in our realized price. The volume of natural gas liquids produced and sold increased by 119 MBbls or 45%, primarily due to new wells brought online in 2020. Our average realized price per Bbl increased 27% from $10.71 for the three months ended September 30, 2019 to $13.60 for the three months ended September 30, 2020.
Lease operating expense (“LOE”)
LOE increased by $0.6 million or 10% for the three months ended September 30, 2020 relative to the comparable period in 2019, primarily due to new wells brought online, partially offset by lower workover project costs compared to the prior year period.
Production and ad valorem taxes
Production and ad valorem taxes for the three months ended September 30, 2020 were flat as compared to the prior year period as the impact of decreased oil prices was offset by increased production. As a percentage of revenues from oil, natural gas, and natural gas liquids, production taxes remained flat as compared to the prior 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, 2020 increased by $14.5 million, or 103% relative to the comparable period in 2019. The increase was primarily related to development and acquisition activity, partially offset by a first quarter 2020 impairment charge of $25.3 million, that resulted in increased costs subject to depletion. Other factors contributing to the increase were higher sales volumes and certain downward adjustments to estimated recoverable proved oil and natural gas reserves caused by lower commodity prices.
General and administrative expense (“G&A”)
G&A for the three months ended September 30, 2020 decreased by $0.3 million, or 4% relative to the comparable period in 2019, primarily due to 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 severance costs and increased director and officer insurance premium costs.
Transaction costs
For the three months ended September 30, 2020, transaction costs decreased by $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, 2019 to $1.2 million for the three months ended September 30, 2020, primarily due to lower effective interest rates on borrowings outstanding compared to the prior year period. See Note 10. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.
(Loss) gain on derivative contracts, net
For the three months ended September 30, 2020, we recorded a net loss on derivative contracts of $6.0 million, consisting of unrealized mark-to-market losses of $14.6 million related to our commodity hedges and unrealized gains of $0.1 million related to our interest rate swap, partially offset by net realized gains on settlements of our commodity hedges of $8.5 million. For the three months ended September 30, 2019, we recorded a net gain on derivative contracts of $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 our commodity hedges of $3.7 million.
Income tax expense
For the three 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) deferred income tax benefit for Earthstone of $0.9 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.1 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the three months ended September 30, 2020.
During the three months ended September 30, 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, 2020, compared to the Nine Months Ended September 30, 2019
| Nine Months Ended |
||||||||||||
| September 30, |
||||||||||||
| 2020 |
2019 |
Change |
||||||||||
| Sales volumes: |
||||||||||||
| Oil (MBbl) |
2,520 | 2,027 | 24 | % | ||||||||
| Natural gas (MMcf) |
5,031 | 3,318 | 52 | % | ||||||||
| Natural gas liquids (MBbl) |
870 | 705 | 23 | % | ||||||||
| Barrels of oil equivalent (MBOE) |
4,229 | 3,285 | 29 | % | ||||||||
| Average Daily Production (Boepd) |
15,433 | 12,033 | 28 | % | ||||||||
| Average prices: |
||||||||||||
| Oil (per Bbl) |
$ | 36.92 | $ | 55.08 | (33 | )% | ||||||
| Natural gas (per Mcf) |
$ | 0.96 | $ | 0.64 | 50 | % | ||||||
| Natural gas liquids (per Bbl) |
$ | 11.46 | $ | 15.17 | (24 | )% | ||||||
| Average prices adjusted for realized derivatives settlements: |
||||||||||||
| Oil ($/Bbl)(1) |
$ | 55.14 | $ | 60.42 | (9 | )% | ||||||
| Natural gas ($/Mcf)(1) |
$ | 1.31 | $ | 1.49 | (12 | )% | ||||||
| Natural gas liquids ($/Bbl) |
$ | 11.46 | $ | 15.17 | (24 | )% | ||||||
| (In thousands) |
||||||||||||
| Oil revenues |
$ | 93,017 | $ | 111,657 | (17 | )% | ||||||
| Natural gas revenues |
$ | 4,855 | $ | 2,126 | 128 | % | ||||||
| Natural gas liquids revenues |
$ | 9,976 | $ | 10,691 | (7 | )% | ||||||
| Lease operating expense |
$ | 21,971 | $ | 20,485 | 7 | % | ||||||
| Production and ad valorem taxes |
$ | 7,198 | $ | 8,001 | (10 | )% | ||||||
| Rig termination expense |
$ | 426 | $ | — | NM | |||||||
| Impairment expense |
$ | 62,548 | $ | — | NM | |||||||
| Depreciation, depletion and amortization |
$ | 76,096 | $ | 42,281 | 80 | % | ||||||
| General and administrative expense (excluding stock-based compensation) |
$ | 11,950 | $ | 13,268 | (10 | )% | ||||||
| Stock-based compensation |
$ | 7,665 | $ | 6,680 | 15 | % | ||||||
| General and administrative expense |
$ | 19,615 | $ | 19,948 | (2 | )% | ||||||
| Transaction costs |
$ | (324 | ) | $ | 797 | NM | ||||||
| Interest expense, net |
$ | (4,207 | ) | $ | (4,735 | ) | (11 | )% | ||||
| Unrealized gain (loss) on derivative contracts |
$ | 25,466 | $ | (33,332 | ) | NM | ||||||
| Realized gain on derivative contracts |
$ | 47,599 | $ | 13,660 | NM | |||||||
| Gain (loss) on derivative contracts, net |
$ | 73,065 | $ | (19,672 | ) | NM | ||||||
| Income tax expense |
$ | (112 | ) | $ | (728 | ) | NM | |||||
(1) Includes $5.7 million and $2.1 million of cash proceeds related to hedges unwound during the second quarter of 2020 and first quarter of 2019, respectively.
NM – Not Meaningful
Oil revenues
For the nine months ended September 30, 2020, oil revenues decreased by $18.6 million or 17% relative to the comparable period in 2019. Of the decrease, $36.8 million was attributable to a decrease in our realized price, partially offset by $18.2 million attributable to an increase in volume. Our average realized price per Bbl decreased from $55.08 for the nine months ended September 30, 2019 to $36.92 or 33% for the nine months ended September 30, 2020. We had a net increase in the volume of oil sold of 492 MBbls or 24%, primarily due to new wells brought online offset by voluntary production shut-ins in May 2020.
Natural gas revenues
For the nine months ended September 30, 2020, natural gas revenues increased by $2.7 million or 128% relative to the comparable period in 2019. Of the increase, $1.6 million was due to increased sales volume and $1.1 million was attributable to an increase in realized price. Our average realized price per Mcf increased 50% from $0.64 for the nine months ended September 30, 2019 to $0.96 for the nine months ended September 30, 2020. In the prior year's period, lack of sufficient pipeline transportation resulted in low natural gas prices, which have improved in the current year period. The total volume of natural gas produced and sold increased 1,713 MMcf or 52% primarily due to new wells brought online offset by voluntary production shut-ins in May 2020.
Natural gas liquids revenues
For the nine months ended September 30, 2020, natural gas liquids revenues decreased by $0.7 million or 7% relative to the comparable period in 2019. Of the decrease, $2.6 million was attributable to a decrease in our realized price, partially offset by $1.9 million attributable to increased volume. The volume of natural gas liquids produced and sold increased by 166 MBbls or 23%, primarily due to new wells brought online offset by voluntary production shut-ins in May 2020.
Lease operating expense (“LOE”)
LOE increased by $1.5 million or 7% for the nine months ended September 30, 2020 relative to the comparable period in 2019, primarily due to additional producing wells brought online, which drove a 29% increase in production volume, offset by voluntary production shut-ins in May 2020, as well as a decrease in workover project costs as compared to the prior year period.
Production and ad valorem taxes
Production and ad valorem taxes for the nine months ended September 30, 2020 decreased by $0.8 million or 10% relative to the comparable period in 2019, as the impact of increased volume was more than offset by the impact of decreased commodity prices. As a percentage of revenues from oil, natural gas, and natural gas liquids, production taxes declined slightly as compared to the prior year primarily due to lower realized commodity prices.
Rig termination expenses
During the nine months ended September 30, 2020, we concluded our 2020 drilling program and released our contracted drilling rig operating in the Midland Basin, recording rig termination expense of $0.4 million.
Impairment expense
During the nine months ended September 30, 2020, we recorded non-cash impairments totaling $62.5 million, which consisted of $25.3 million to proved oil and natural gas properties, $19.7 million to unproved oil and natural gas properties and $17.6 million to goodwill. No such impairments were recorded during the nine months ended September 30, 2019.
Depreciation, depletion and amortization (“DD&A”)
DD&A for the nine months ended September 30, 2020 increased by $33.8 million, or 80% relative to the comparable period in 2019. The increase was primarily related to development and acquisition activity, partially offset by a first quarter 2020 impairment charge of $25.3 million, that resulted in increased costs subject to depletion. Other factors contributing to the increase were higher sales volumes and certain downward adjustments to estimated recoverable proved oil and natural gas reserves caused by lower commodity prices.
General and administrative expense (“G&A”)
G&A for the nine months ended September 30, 2020 decreased by $0.3 million, or 2% relative to the comparable period in 2019, as a reduction in cash-based compensation expenses was almost entirely offset by non-cash stock-based compensation expense related to awards granted in January 2020, employee severance costs and increased director and officer insurance premium costs.
Transaction costs
For the nine months ended September 30, 2020, transaction costs decreased by $1.1 million primarily due to expected final defense costs and reimbursements from our major shareholder and insurance carrier associated with the anticipated settlement of litigation related to the Bold Transaction that closed on May 9, 2017. See Note 13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements.
Interest expense, net
Interest expense decreased from $4.7 million for the nine months ended September 30, 2019 to $4.2 million for the nine months ended September 30, 2020, primarily due to lower effective interest rates on borrowings outstanding compared to the prior year period. See Note 10. Long-Term Debt in the Notes to Unaudited Condensed Consolidated Financial Statements.
Gain (loss) on derivative contracts, net
For the nine months ended September 30, 2020, we recorded a net gain on derivative contracts of $73.1 million, consisting of unrealized mark-to-market gains of $25.9 million related to our commodity hedges, unrealized mark-to-market losses of $0.4 million related to our interest rate swap and net realized gains on settlements of our commodity hedges of $47.6 million. For the nine months ended September 30, 2019, we recorded a net loss on derivative contracts of $19.7 million, consisting of unrealized mark-to-market losses of $33.3 million related to our commodity hedges, partially offset by net realized gains on settlements of our commodity hedges of $13.7 million.
Income tax expense
For the nine months ended September 30, 2020, we recorded an income tax expense of approximately $0.1 million which included (1) no income tax expense for Lynden US as a result of its share of the distributable income from EEH, (2) a deferred income tax benefit for Earthstone of $0.8 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) a deferred income tax expense of $0.1 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, we recorded income tax expense of approximately $0.7 million which included (1) income tax expense for Lynden US of $0.1 million as a result of its share of the distributable income from EEH, (2) deferred income tax expense for Earthstone of $0.6 million as a result of its share of the distributable income from EEH, which was used to reduce the valuation allowance recorded against its deferred tax asset which was previously recorded as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax expense of $0.6 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the nine months ended September 30, 2019.
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, 2020, we have reduced our outstanding bank debt by $40 million. Based on our production profile, cost structure, minimal capital program and the 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 at the same levels as in the third quarter, for the remainder of 2020. As a result, we believe we will have sufficient liquidity with cash flows from operations and borrowings under our Credit Facility to meet our cash requirements for the next 12 months.
Working Capital
Working capital (presented below) was $5.5 million as of September 30, 2020, compared to a working capital deficit of $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 a $23.3 million reduction of other net current items resulting primarily from reduced drilling activity.
The components of working 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 | ) | |||
Cash Flows from Operating Activities
Cash flows provided by operating activities for the nine months ended September 30, 2020 increased to $104.7 million compared to $85.7 million for the nine months ended September 30, 2019, primarily due to changes in timing of payments and receipts in addition to an increase in sales volumes and our settlements of derivative contracts as compared to the prior year period.
Cash Flows from Investing Activities
Cash flows used in investing activities for the nine months ended September 30, 2020 decreased to $72.6 million from $121.1 million for the nine months ended September 30, 2019, primarily due to decreased drilling and completion activity as compared to the prior year period in light of the current commodity price conditions.
Cash Flows from Financing Activities
Cash flows used in financing activities decreased to $40.7 million for the nine months ended September 30, 2020 as compared to cash flows provided by financing activities of $44.8 million for the nine months ended September 30, 2019, primarily due to higher repayments and lower borrowings under the Credit Facility (as defined below) in the current year period.
Capital Expenditures
Our accrual basis capital expenditures for the three and nine months ended September 30, 2020 were as follows (in thousands):
| Three Months Ended September 30, 2020 |
Nine Months Ended September 30, 2020 |
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| Drilling and completions |
$ | 1,329 | $ | 46,303 | ||||
| Leasehold costs |
49 | 139 | ||||||
| Total capital expenditures |
$ | 1,378 | $ | 46,442 | ||||
Credit Facility
On November 21, 2019, Earthstone, EEH (the “Borrower”), Wells Fargo, 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 regularly scheduled redetermination of the borrowing base under the Credit Facility, the borrowing base was set at $275 million, representing a 15% decrease from the previous borrowing base of $325 million.
On September 28, 2020, Earthstone, EEH, Wells Fargo, the guarantors party thereto, and the Lenders entered into the Amendment to the Credit Facility. Among other things, the Amendment decreased the borrowing base from $275 million to $240 million, increased the interest rate on outstanding borrowings by 25 to 50 basis points, increased the flexibility to finance and make acquisitions, and added certain restrictions related to dividends and distributions.
The next regularly scheduled redetermination of the borrowing base is on or around April 1, 2021.
As of September 30, 2020, $130.0 million of borrowings were outstanding, bearing annual interest of 2.658%, resulting in an additional $110.0 million of borrowing base availability under the Credit Facility.
Hedging Activities
The following table sets forth our outstanding derivative contracts at September 30, 2020. When aggregating multiple contracts, the weighted average contract price is disclosed.
| Volume |
Price |
|||||
| Period |
Commodity |
(Bbls / MMBtu) |
($/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. |
Obligations and Commitments
There have been no material changes from the obligations and commitments disclosed in the Obligations and Commitments section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2019 Annual Report on Form 10-K other than those described in Note 13. Commitments and Contingencies in the Notes to the Unaudited Condensed Consolidated Financial Statements.
Environmental Regulations
Our operations are subject to risks normally associated with the exploration for and the production of oil and natural gas, including blowouts, fires, and environmental risks such as oil spills or natural gas leaks that could expose us to liabilities associated with these risks.
In our acquisition of existing or previously drilled well bores, we may not be aware of prior environmental safeguards, if any, that were taken at the time such wells were drilled or during such time the wells were operated. We maintain comprehensive insurance coverage that we believe is adequate to mitigate the risk of any adverse financial effects associated with these risks.
However, should it be determined that a liability exists with respect to any environmental cleanup or restoration, the liability to cure such a violation could still accrue to us. No claim has been made, nor are we aware of any liability which we may have, as it relates to any environmental cleanup, restoration, or the violation of any rules or regulations relating thereto.
Recently Issued Accounting Standards
See Note 1. Basis of Presentation and Summary of Significant Accounting Policies in the Notes to Unaudited Condensed Consolidated Financial Statements in this report for discussion of recently issued and adopted accounting standards affecting us.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and therefore are not required to provide the information required under this item.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
In accordance with Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15(e) and 15d-15(e), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and our Principal Accounting Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Principal Accounting Officer concluded that our disclosure controls and procedures were effective as of September 30, 2020 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Principal Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
From time to time, we may be involved in various legal proceedings and claims in the ordinary course of business. As of September 30, 2020, and through the filing date of this report, we do not believe the ultimate resolution of any such actions or potential actions of which we are currently aware will have a material effect on our consolidated financial position or results of operations.
See Note 13. Commitments and Contingencies in the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item 1 of this report, which is incorporated herein by reference, for material matters that have occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2019.
In addition to the other information set forth in this report, you should carefully consider the risk factors and other cautionary statements described in the “Risk Factors” sections of our Annual Report on Form 10-K for the year ended December 31, 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, 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.
None.
| 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 |
X |
|||||
| 101 |
Interactive Data Files (formatted as Inline XBRL). |
X |
||||
| 104 |
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). |
X |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| EARTHSTONE ENERGY, INC. |
||||
| Date: |
November 4, 2020 |
By: |
/s/ Tony Oviedo |
|
| Tony Oviedo |
||||
| Executive Vice President – Accounting and Administration |
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