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 Texas and New Mexico.
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 2021 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. Any such adjustments are of a normal, recurring nature. The Company’s Condensed Consolidated Balance Sheet at December 31, 2021 is derived from the audited Consolidated Financial Statements at that date.
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 six months ended June 30, 2022.
Fair Value on a Recurring Basis
Derivative Financial Instruments
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Derivative financial instruments are carried at fair value and measured on a recurring basis. The derivative financial instruments consist of fixed price swap agreements, costless collars, deferred premium put options 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.
Share-based Compensation Liability
Certain of our performance-based stock awards (“PSUs” or “performance units”) may be payable in cash. The Company classifies the awards that may be settled in cash as liability awards. These awards are valued quarterly 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. The inputs for the Monte Carlo model are designated as Level 2 within the valuation hierarchy. The share-based compensation liability related to the PSU liability awards is included in Other noncurrent liabilities in the Condensed Consolidated Balance Sheet as of June 30, 2022.
The following table summarizes the fair value of the Company’s financial assets and liabilities, by level within the fair-value hierarchy (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
June 30, 2022 | | Level 1 | | Level 2 | | Level 3 | | Total |
Financial assets | | | | | | | | |
Derivative asset - current | | $ | — | | | $ | 3,327 | | | $ | — | | | $ | 3,327 | |
Derivative asset - noncurrent | | — | | | 3,523 | | | — | | | 3,523 | |
Total financial assets | | $ | — | | | $ | 6,850 | | | $ | — | | | $ | 6,850 | |
| | | | | | | | |
Financial liabilities | | | | | | | | |
Derivative liability - current | | $ | — | | | $ | 122,067 | | | $ | — | | | $ | 122,067 | |
Derivative liability - noncurrent | | — | | | 19,761 | | | — | | | 19,761 | |
Share-based compensation liability - noncurrent | | — | | | 12,898 | | | — | | | 12,898 | |
Total financial liabilities | | $ | — | | | $ | 154,726 | | | $ | — | | | $ | 154,726 | |
| | | | | | | | |
December 31, 2021 | | | | | | | | |
Financial assets | | | | | | | | |
Derivative asset - current | | $ | — | | | $ | 1,348 | | | $ | — | | | $ | 1,348 | |
Derivative asset - noncurrent | | — | | | 157 | | | — | | | 157 | |
Total financial assets | | $ | — | | | $ | 1,505 | | | $ | — | | | $ | 1,505 | |
| | | | | | | | |
Financial liabilities | | | | | | | | |
Derivative liability - current | | $ | — | | | $ | 45,310 | | | $ | — | | | $ | 45,310 | |
Derivative liability - noncurrent | | — | | | 571 | | | — | | | 571 | |
Share-based compensation liability - current | | — | | | 7,835 | | | — | | | 7,835 | |
Share-based compensation liability - noncurrent | | — | | | 6,324 | | | — | | | 6,324 | |
Total financial liabilities | | $ | — | | | $ | 60,040 | | | $ | — | | | $ | 60,040 | |
| | | | | | | | |
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.
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, business combinations and asset retirement obligations. 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
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
certain circumstances indicate that adjustments may be necessary. No triggering events that require assessment were observed during the six months ended June 30, 2022. See further discussion in Note 5. Oil and Natural Gas Properties.
Items Not Recorded at Fair Value
The carrying amounts reported on the unaudited consolidated balance sheets for cash, accounts receivable, prepaid expenses, other current assets accounts payable, revenues and royalties payable, accrued expenses and other current liabilities approximate their fair values.
The Company has not elected to account for its debt instruments at fair value. Borrowings under the Company’s revolving credit facility bear interest at floating market rates, therefore the carrying amount and fair value were approximately equal as of June 30, 2022 and December 31, 2021. The carrying value of EEH’s 8.000% Senior Notes due 2027, net of $12.2 million deferred financing costs, of $537.8 million and accrued interest of $9.5 million had an estimated fair value of $521.2 million as of June 30, 2022. There were no other debt instruments outstanding at December 31, 2021.
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, costless collars and deferred premium put options. Swaps exchange floating price risk in the future for a fixed price at the time of the hedge. Costless collars set both a maximum (sold ceiling) and a minimum (bought floor) future price. A deferred premium put option represents a bought floor except, unlike a standard put option, the premium is not paid until the expiration of the option. 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, 2024. 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 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 June 30, 2022:
| | | | | | | | | | | | | | | | | | | | |
| | Price Swaps |
Period | | Commodity | | Volume (Bbls / MMBtu) | | Weighted Average Price ($/Bbl / $/MMBtu) |
Q3 - Q4 2022 | | Crude Oil | | 2,162,000 | | | $ | 66.70 | |
Q1 - Q4 2023 | | Crude Oil | | 1,277,500 | | | $ | 76.20 | |
Q3 - Q4 2022 | | Crude Oil Basis Swap (1) | | 3,082,000 | | | $ | 0.61 | |
Q1 - Q4 2023 | | Crude Oil Basis Swap (1) | | 4,743,500 | | | $ | 0.59 | |
Q3 - Q4 2022 | | Natural Gas | | 5,159,500 | | | $ | 3.52 | |
Q1 - Q4 2023 | | Natural Gas | | 3,670,000 | | | $ | 3.35 | |
Q3 - Q4 2022 | | Natural Gas Basis Swap (2) | | 3,680,000 | | | $ | (0.33) | |
Q1 - Q4 2023 | | Natural Gas Basis Swap (2) | | 36,500,000 | | | $ | (1.47) | |
Q1 - Q4 2024 | | Natural Gas Basis Swap (2) | | 36,600,000 | | | $ | (1.05) | |
(1)The basis differential price is between WTI Midland Crude and the WTI NYMEX.
(2)The basis differential price is between W. Texas (WAHA) and the Henry Hub NYMEX.
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Costless Collars |
Period | | Commodity | | Volume (Bbls / MMBtu) | | Bought Floor ($/Bbl / $/MMBtu) | | Sold Ceiling ($/Bbl / $/MMBtu) |
Q3 - Q4 2022 | | Crude Oil Costless Collar | | 1,357,000 | | | $ | 71.86 | | | $ | 91.39 | |
Q1 - Q4 2023 | | Crude Oil Costless Collar | | 2,828,000 | | | $ | 65.74 | | | $ | 91.90 | |
Q3 - Q4 2022 | | Natural Gas Costless Collar | | 11,400,500 | | | $ | 4.08 | | | $ | 6.48 | |
Q1 - Q4 2023 | | Natural Gas Costless Collar | | 14,133,000 | | | $ | 3.46 | | | $ | 5.34 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Deferred Premium Puts |
Period | | Commodity | | Volume (Bbls / MMBtu) | | $/Bbl (Put Price) | | $/Bbl (Net of Premium) |
Q3 - Q4 2022 | | Crude Oil | | 253,000 | | | $ | 80.00 | | | $ | 75.79 | |
Q1 - Q4 2023 | | Crude Oil | | 638,000 | | | $ | 70.00 | | | $ | 62.85 | |
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):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | June 30, 2022 | | December 31, 2021 |
Derivatives not designated as hedging contracts under ASC Topic 815 | | Balance Sheet Location | | Gross Recognized Assets / Liabilities | | Gross Amounts Offset | | Net Recognized Assets / Liabilities | | Gross Recognized Assets / Liabilities | | Gross Amounts Offset | | Net Recognized Assets / Liabilities |
Commodity contracts | | Derivative asset - current | | $ | 18,502 | | | $ | (15,175) | | | $ | 3,327 | | | $ | 3,191 | | | $ | (1,843) | | | $ | 1,348 | |
Commodity contracts | | Derivative liability - current | | $ | 137,242 | | | $ | (15,175) | | | $ | 122,067 | | | $ | 47,153 | | | $ | (1,843) | | | $ | 45,310 | |
| | | | | | | | | | | | | | |
Commodity contracts | | Derivative asset - noncurrent | | $ | 15,819 | | | $ | (12,296) | | | $ | 3,523 | | | $ | 2,721 | | | $ | (2,564) | | | $ | 157 | |
Commodity contracts | | Derivative liability - noncurrent | | $ | 32,057 | | | $ | (12,296) | | | $ | 19,761 | | | $ | 3,135 | | | $ | (2,564) | | | $ | 571 | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
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):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Derivatives not designated as hedging contracts under ASC Topic 815 | | Three Months Ended June 30, | | Six Months Ended June 30, |
| | Statement of Cash Flows Location | | Statement of Operations Location | | 2022 | | 2021 | | 2022 | | 2021 |
Unrealized gain (loss) | | Not separately presented | | Not separately presented | | $ | 29,192 | | | $ | (36,653) | | | $ | (90,602) | | | $ | (59,011) | |
Realized loss | | Operating portion of net cash paid in settlement of derivative contracts | | Not separately presented | | (79,099) | | | (14,522) | | | (110,785) | | | (25,427) | |
| | Total loss on derivative contracts, net | | Loss on derivative contracts, net | | $ | (49,907) | | | $ | (51,175) | | | $ | (201,387) | | | $ | (84,438) | |
| | | | | | | | | | | | |
Note 4. Acquisitions and Divestitures
Titus Agreement
On June 27, 2022, Earthstone and EEH, together as buyer, and Titus Oil & Gas Production, LLC, a Delaware limited liability company, Titus Oil & Gas Corporation, a Delaware corporation, Lenox Minerals, LLC, a Delaware limited liability company and Lenox Mineral Title Holdings, Inc., a Delaware corporation (collectively, “Titus I”), as seller, entered into a purchase and sale agreement (the “Titus I Purchase Agreement”).
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Pursuant to the Titus I Purchase Agreement, EEH or its designated wholly-owned subsidiary will acquire (the “Titus I Acquisition”) interests in oil and gas leases and related property of Titus I located in the Northern Delaware Basin of New Mexico, for a purchase price (the “Titus I Purchase Price”) of approximately $270 million in cash and 1,811,132 shares (the “Titus I Shares”) of Class A common stock, $0.001 par value per share of Earthstone (the “Class A Common Stock”). The Titus I Purchase Price is subject to customary purchase price adjustments with an effective date of August 1, 2022, with closing anticipated in the third quarter of 2022. On June 29, 2022, in connection with the Titus I Purchase Agreement, EEH deposited approximately $18.8 million (the “Titus I Deposit”) in cash into a third-party escrow account as a deposit pursuant to the Titus I Purchase Agreement, which will be credited against the purchase price upon closing of the Titus I Acquisition. The Titus I Deposit is included in Other noncurrent assets in the Condensed Consolidated Balance Sheet as of June 30, 2022 and in Acquisition of oil and gas properties, net of cash acquired, on the Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2022.
Also on June 27, 2022, Earthstone and EEH, as buyer, and Titus Oil & Gas Production II, LLC, a Delaware limited liability company, Lenox Minerals II, LLC, a Delaware limited liability company and Lenox Mineral Holdings II, Inc., a Delaware limited liability company (collectively, “Titus II”), as seller, entered into a purchase and sale agreement (the “Titus II Purchase Agreement” and together with the Titus I Purchase Agreement, the “Purchase Agreements”).
Pursuant to the Titus II Purchase Agreement, EEH or its designated wholly-owned subsidiary will acquire (the “Titus II Acquisition” and together with the Titus I Acquisition, the “Acquisitions”) interests in oil and gas leases and related property of Titus II located in the Northern Delaware Basin of New Mexico, for a purchase price (the “Titus II Purchase Price”) of approximately $305 million in cash and 2,047,811 shares (the “Titus II Shares” and together with the Titus I Shares, the “Titus Shares”) of Class A Common Stock. The Titus II Purchase Price is subject to customary purchase price adjustments with an effective date of August 1, 2022, with closing anticipated in the third quarter of 2022. On June 29, 2022, in connection with the Titus II Purchase Agreement, EEH deposited approximately $21.2 million (the “Titus II Deposit”) in cash into a third-party escrow account as a deposit pursuant to the Titus II Purchase Agreement, which will be credited against the purchase price upon closing of the Titus II Acquisition. The Titus II Deposit is included in Other noncurrent assets in the Condensed Consolidated Balance Sheet as of June 30, 2022 and in Acquisition of oil and gas properties, net of cash acquired, on the Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2022.
Bighorn Acquisition
On January 30, 2022, Earthstone, EEH, and Bighorn Asset Company, LLC, a Delaware limited liability company (“Bighorn”), as seller, entered into a purchase and sale agreement (the “Bighorn Agreement”). Pursuant to the Bighorn Agreement, EEH acquired (the “Bighorn Acquisition”) interests in oil and gas leases and related property of Bighorn located in the Midland Basin, Texas (the "Bighorn Assets”).
On April 14, 2022, Earthstone, EEH and Bighorn consummated the transactions contemplated in the Bighorn Agreement whereby EEH acquired the Bighorn Assets for aggregate consideration of approximately $641.8 million in cash, net of preliminary and customary purchase price adjustments and remains subject to final post-closing settlement between EEH and Bighorn, and 5,650,977 shares Class A Common Stock.
The Bighorn Acquisition was accounted for as an asset acquisition. The fair value of the consideration paid by us and allocation of that amount to the underlying assets acquired, on a relative fair value basis, was recorded on our books as of the date of the closing of the Bighorn Acquisition. Additionally, costs directly related to the Bighorn Acquisition were capitalized as a component of the purchase price. Although the purchase price allocation is substantially complete as of the date of this filing, there may be further adjustments to the Company’s estimates of the acquired oil and gas properties resulting in changes to the purchase price allocation, on a relative fair value basis. These amounts will be finalized no later than one year from the acquisition date. The consideration transferred, fair value of assets acquired and liabilities assumed by Earthstone were recorded as follows (in thousands, except share amounts and stock price):
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
| | | | | | | | |
Consideration: | | |
Shares of Class A Common Stock issued | | 5,650,977 | |
Class A Common Stock price as of April 14, 2022 | | $ | 13.76 | |
Class A Common Stock consideration | | 77,757 | |
Cash consideration (1) | | 640,157 | |
Direct transaction costs (2) | | 1,619 | |
Total consideration transferred | | $ | 719,533 | |
| | |
Fair value of assets acquired: | | |
Current assets | | $ | 827 | |
Oil and gas properties | | 762,045 | |
Amount attributable to assets acquired | | $ | 762,872 | |
| | |
Fair value of liabilities assumed: | | |
Suspense payable | | 27,062 | |
Other current liabilities | | 3,083 | |
Noncurrent liabilities - ARO | | 13,194 | |
Amount attributable to liabilities assumed | | $ | 43,339 | |
| | |
(1)Includes preliminary customary purchase price adjustments.
(2)Represents $1.6 million of estimated transaction costs associated with the Bighorn Acquisition which have been capitalized in accordance with ASC 805-50.
Chisholm Acquisition
On December 15, 2021, Earthstone, EEH, as buyer, Chisholm Energy Operating, LLC (“OpCo”) and Chisholm Energy Agent, Inc. (“Agent” and collectively with OpCo, “Chisholm”), collectively as seller, entered into a Purchase and Sale Agreement (the “Chisholm Agreement”), which provided that EEH would acquire (the “Chisholm Acquisition”) interests in oil and gas leases and related property of Chisholm located in Lea County and Eddy County, New Mexico (the “Chisholm Assets”).
On February 15, 2022, Earthstone, EEH and Chisholm consummated the transactions contemplated in the Chisholm Agreement whereby EEH acquired the Chisholm Assets for aggregate consideration, as adjusted for preliminary and customary purchase price adjustments, consisting of: (i) approximately $313.8 million in cash, net of customary purchase price adjustments, paid at the closing of the Chisholm Acquisition, (ii) $70 million in cash paid on April 15, 2022 and (iii) 19,417,476 shares of the Class A Common Stock. The fair value of each share of Class A Common Stock was determined using the closing sales price of $12.85 per share on February 15, 2022. A Significant Shareholder, as identified below, was the majority shareholder of Chisholm as of the closing of the Chisholm Acquisition. See Note 12. Related Party Transactions for further discussion.
The Chisholm Acquisition has been accounted for as a business combination using the acquisition method of accounting, with Earthstone identified as the acquirer. The preliminary allocation of the total purchase price in the Chisholm Acquisition is based upon management’s estimates of and assumptions related to the fair value of assets acquired and liabilities assumed. Although the purchase price allocation is substantially complete as of the date of this filing, there may be further adjustments to the Company’s estimates of the acquired oil and gas properties resulting in changes to the purchase price allocation. These amounts will be finalized no later than one year from the acquisition date. The consideration transferred, fair value of assets acquired and liabilities assumed by Earthstone were recorded as follows (in thousands, except share amounts and stock price):
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
| | | | | |
Consideration: | |
Shares of Class A Common Stock issued | 19,417,476 | |
Class A Common Stock price as of February 15, 2022 | $ | 12.85 | |
Class A Common Stock consideration | 249,515 | |
Cash consideration | 383,843 | |
| |
Total consideration transferred | $ | 633,358 | |
| |
Fair value of assets acquired: | |
Oil and gas properties | $ | 641,398 | |
Amount attributable to assets acquired | $ | 641,398 | |
| |
Fair value of liabilities assumed: | |
Other current liabilities | $ | 2,069 | |
Asset retirement obligation - noncurrent | 5,971 | |
Amount attributable to liabilities assumed | $ | 8,040 | |
IRM Acquisition
On January 7, 2021, the Company completed the acquisition (the “IRM Acquisition”) of all of the issued and outstanding limited liability company interests of Independence Resources Management, LLC (“IRM”) and certain of its wholly owned subsidiaries for consideration consisting of the following: (i) net cash of approximately $140.5 million (the “Cash Consideration”) and (ii) 12,719,594 shares of Class A Common Stock. The fair value of each share of Class A Common Stock was determined using the closing price of $6.02 per share on January 7, 2021.
The IRM Acquisition has been accounted for as a business combination using the acquisition method of accounting, with Earthstone identified as the acquirer. The allocation of the total purchase price in the IRM Acquisition is based upon management’s estimates of and assumptions related to the fair value of assets acquired and liabilities assumed. The consideration transferred, fair value of assets acquired and liabilities assumed by Earthstone were recorded as follows (in thousands, except share amounts and stock price):
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
| | | | | |
Consideration: | |
Shares of Class A Common Stock issued | 12,719,594 | |
Class A Common Stock price as of January 7, 2021 | $ | 6.02 | |
Class A Common Stock consideration | 76,572 | |
Cash consideration | 140,507 | |
| |
Total consideration transferred | $ | 217,079 | |
| |
Fair value of assets acquired: | |
Cash | $ | 4,763 | |
Other current assets | 11,524 | |
Oil and gas properties | 224,112 | |
Other non-current assets | 252 | |
Amount attributable to assets acquired | $ | 240,651 | |
| |
Fair value of liabilities assumed: | |
Derivative liability | $ | 10,177 | |
Other current liabilities | 5,196 | |
Asset retirement obligation - noncurrent | 8,199 | |
Amount attributable to liabilities assumed | $ | 23,572 | |
Tracker/Sequel Acquisitions
On March 31, 2021, Earthstone, EEH, Tracker Resource Development III, LLC, a Delaware limited liability company (“Tracker”), and TRD III Royalty Holdings (TX), LP, a Delaware limited partnership (“RoyaltyCo” and collectively with Tracker, the “Seller”), entered into a purchase and sale agreement (the “Tracker Agreement”), which provided that EEH would acquire (the “Tracker Acquisition”) interests in oil and gas leases and related property of Tracker located in Irion County, Texas (the “Tracker Assets”). Also on March 31, 2021, Earthstone, EEH, SEG-TRD LLC, a Delaware limited liability company (“SEG-I”), and SEG-TRD II LLC, a Delaware limited liability company (“SEG-II” and collectively with SEG-I, “Sequel”) entered into a purchase and sale agreement (the “Sequel Agreement” and collectively with the Tracker Agreement, the “Tracker/Sequel Purchase Agreements”), which provided that EEH would acquire (the “Sequel Acquisition” and collectively with the Tracker Acquisition, the “Tracker/Sequel Acquisitions”) certain well-bore interests and related equipment (the “Sequel Assets”).
On July 20, 2021, Earthstone, EEH and the Seller consummated the transactions contemplated in the Tracker Agreement. At the closing of the Tracker Agreement, among other things, EEH acquired the Tracker Assets for aggregate consideration consisting of: (i) $18.8 million in cash, net of customary purchase price adjustments, and (ii) 4.7 million shares of Class A Common Stock. Also, on July 20, 2021, Earthstone, EEH and Sequel consummated the transactions contemplated in the Sequel Agreement. At the closing of the Sequel Agreement, among other things, EEH acquired the Sequel Assets for aggregate consideration consisting of: (i) $41.4 million in cash, net of customary purchase price adjustments, and (ii) 1.5 million shares of Class A Common Stock. A Significant Shareholder, as identified below, owned approximately 49% of Tracker as of the closing of the Tracker Acquisition. See Note 12. Related Party Transactions for further discussion.
The Tracker/Sequel Acquisitions have been accounted for as asset acquisitions. The preliminary allocation of the total purchase price in the Tracker/Sequel Acquisitions is based upon management’s estimates of and assumptions related to the relative fair value of assets acquired and liabilities assumed. Although the purchase price allocation is substantially complete as of the date of this filing, there may be further adjustments to the acquired oil and natural gas properties. These amounts will be finalized no later than one year from the acquisition date. The consideration transferred, fair value of assets acquired and liabilities assumed by Earthstone were recorded as follows (in thousands, except share amounts and stock price):
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
| | | | | | | | | | |
| | | | | | Total |
Consideration: | | | | | | |
Shares of Class A Common Stock issued | | | | | | 6,200,000 | |
Class A Common Stock price as of July 20, 2021 | | | | | | $ | 9.97 | |
Class A Common Stock consideration | | | | | | 61,814 | |
Cash consideration (1) | | | | | | 60,159 | |
Direct transaction costs (2) | | | | | | 1,715 | |
Total consideration transferred | | | | | | $ | 123,688 | |
| | | | | | |
Fair value of assets acquired: | | | | | | |
Oil and gas properties | | | | | | $ | 124,288 | |
Amount attributable to assets acquired | | | | | | $ | 124,288 | |
| | | | | | |
Fair value of liabilities assumed: | | | | | | |
Noncurrent liabilities - asset retirement obligations | | | | | | 600 | |
Amount attributable to liabilities assumed | | | | | | $ | 600 | |
| | | | | | |
(1)Includes customary purchase price adjustments.
(2)Represents $1.7 million of transaction costs associated with the Tracker Acquisition and the Sequel Acquisition that have been capitalized in accordance with ASC 805-50.
The following unaudited supplemental pro forma condensed results of operations present consolidated information as though the Bighorn Acquisition, Chisholm Acquisition, IRM Acquisition and Tracker/Sequel Acquisitions had been completed as of January 1, 2021. The unaudited supplemental pro forma financial information was derived from the historical consolidated and combined statements of operations for Bighorn, Chisholm, IRM, Tracker, Sequel and Earthstone and adjusted to include depletion expense applied to the adjusted basis of the properties acquired. These unaudited supplemental pro forma results of operations are provided for illustrative purposes only and do not purport to be indicative of the actual results that would have been achieved by the combined company for the periods presented or that may be achieved by the combined company in the future. Future results may vary significantly from the results reflected in this unaudited supplemental pro forma results of operations (in thousands, except per share amounts):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | June 30, | | June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Revenue | | $ | 501,601 | | | $ | 291,725 | | | $ | 893,604 | | | $ | 512,796 | |
Income (loss) before taxes | | 261,050 | | | (3,675) | | | 333,366 | | | (12,522) | |
Net income (loss) | | 238,362 | | | (3,544) | | | 312,211 | | | (12,319) | |
Less: Net income (loss) attributable to noncontrolling interest | | 76,673 | | | (1,528) | | | 102,865 | | | (5,454) | |
Net income (loss) attributable to Earthstone Energy, Inc. | | 161,689 | | | (2,016) | | | 209,346 | | | (6,865) | |
Pro forma net income (loss) per common share attributable to Earthstone Energy, Inc.: | | | | | | | | |
Basic | | $ | 2.07 | | | $ | (0.03) | | | $ | 2.95 | | | $ | (0.09) | |
Diluted | | $ | 1.62 | | | $ | (0.03) | | | $ | 2.54 | | | $ | (0.09) | |
| | | | | | | | |
The Company has included in its Condensed Consolidated Statements of Operations, revenues of $167.3 million and operating expenses of $50.9 million for the period April 14, 2022 to June 30, 2022 related to the Bighorn Acquisition. The Company has included in its Condensed Consolidated Statements of Operations, revenues of $128.1 million and operating expenses of $46.3 million for the period February 15, 2022 to June 30, 2022 related to the Chisholm Acquisition. During the three and six months ended June 30, 2022, the Company recorded $0.3 million and $10.3 million, respectively, of legal and professional fees related to the Chisholm Acquisition which are included in Transaction costs in the Condensed Consolidated Statements of Operations.
Foreland-BCC Acquisition
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
On November 2, 2021, Earthstone, EEH and Foreland Investments LP, a Delaware limited partnership (“Foreland”), consummated the transactions contemplated in the Purchase and Sale Agreement dated as of September 30, 2021 by and among Earthstone, EEH and Foreland (the “Foreland Purchase Agreement”). Net of customary purchase price adjustments, EEH acquired (the “Foreland Acquisition”) interests in oil and gas leases and related property of Foreland located in Irion County and Crockett County, Texas, for a purchase price consisting of: (i) $13.4 million in cash and (ii) 2,611,111 shares of Class A Common Stock.
Also, on November 2, 2021, Earthstone, EEH and BCC-Foreland LLC, a Delaware limited liability company (“BCC”), consummated the transactions contemplated in the Purchase and Sale Agreement dated as of September 30, 2021 by and among Earthstone, EEH and BCC (the “BCC Purchase Agreement”). Net of customary purchase price adjustments, EEH acquired (the “BCC Acquisition” and with the Foreland Acquisition, the “Foreland-BCC Acquisition”) certain well-bore interests and related equipment held by BCC that were part of a joint development agreement between Foreland, Foreland Operating, LLC, and BCC involving portions of the acreage covered by the Foreland Purchase Agreement for a purchase price of $20.5 million in cash.
Eagle Ford Acquisitions
In May and June 2021, the Company completed acquisitions of working interests in certain assets it operates located in southern Gonzales County, Texas (collectively, the “Eagle Ford Acquisitions”) from four separate sellers. The aggregate purchase price of the Eagle Ford Acquisitions was approximately $45.2 million. One of the four separate sellers was a related party. See Note 12. Related Party Transactions for further discussion. The Eagle Ford Acquisitions have been accounted for as asset acquisitions in accordance with ASC 805. The preliminary allocation of each purchase was based upon management’s estimates of and assumptions related to the relative fair value of assets acquired and liabilities assumed. Although the purchase price allocation is substantially complete as of the date of this filing, there may be further adjustments to the acquired oil and natural gas properties.
Eagle Ford Divestiture
On July 1, 2022, the Company sold certain non-operated oil and gas properties located in Fayette and Gonzales Counties of Texas. In connection with the sale, the Company received preliminary cash consideration of approximately $25.6 million which is subject to customary final purchase price adjustments.
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 six months ended June 30, 2022, depletion expense for oil and gas producing property and related equipment was $66.2 million and $100.3 million, respectively. For the three and six months ended June 30, 2021, depletion expense for oil and gas producing property and related equipment was $25.9 million and $50.1 million, respectively.
Our accrual basis capital expenditures for the three and six months ended June 30, 2022 were as follows (in thousands):
| | | | | | | | | | | | | | |
| | Three Months Ended June 30, 2022 | | Six Months Ended June 30, 2022 |
Drilling and completions | | $ | 119,300 | | | $ | 201,300 | |
Leasehold costs | | 151 | | | 260 | |
Total capital expenditures | | $ | 119,451 | | | $ | 201,560 | |
| | | | |
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Proved Properties
Proved oil and natural gas properties are reviewed for impairment on a nonrecurring basis. The impairment charge reduces the carrying values to their estimated fair values. These fair value measurements are classified as Level 3 measurements and include many unobservable inputs. Fair value is calculated as the estimated discounted future net cash flows attributable to the assets. The Company’s primary assumptions in preparing the estimated discounted future net cash flows to be recovered from oil and gas properties are based on (i) proved reserves, (ii) forward commodity prices and assumptions as to costs and expenses, and (iii) the estimated discount rate that would be used by potential purchasers to determine the fair value of the assets.
Unproved Properties
Unproved properties consist of costs incurred to acquire undeveloped leases. Unproved oil and gas leases are generally for a primary term of three to five years. In most cases, the term of the unproved leases can be extended by paying a lease renewal fee, meeting contractual drilling obligations, or by the presence of producing wells on the leases. Unproved costs related to successful drilling on unproved leases are reclassified to proved properties.
The Company reviews its unproved properties periodically for impairment. In determining whether an unproved property is impaired, the Company considers numerous factors including, but not limited to, current exploration and development plans, favorable or unfavorable exploration activity on the property being evaluated and/or adjacent properties, the Company’s geologists' evaluation of the property, and the remaining months in the lease term for the property.
Impairments to Oil and Natural Gas Properties
No impairments were recorded to the Company's oil and natural gas properties during the three and six months ended June 30, 2022 and 2021.
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 income (loss) attributable to noncontrolling interest in the Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2022 and 2021 represents the portion of net income (loss) attributable to the economic interest in the Company held by the members of EEH other than Earthstone and Lynden US. Noncontrolling interest in the Condensed Consolidated Balance Sheets as of June 30, 2022 and December 31, 2021 represents the portion of net assets of the Company attributable to the members of EEH other than Earthstone and Lynden US. The term “EEH Unit” means the units of limited liability company interests of EEH denominated as common units.
The following table presents the changes in noncontrolling interest for the six months ended June 30, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | EEH Units Held By Earthstone and Lynden US | | % | | EEH Units Held By Others | | % | | Total EEH Units Outstanding |
As of December 31, 2021 | | 53,467,307 | | | 60.9 | % | | 34,344,532 | | | 39.1 | % | | 87,811,839 | |
EEH Units issued in connection with the Chisholm Acquisition | | 19,417,476 | | | | | — | | | | | 19,417,476 | |
EEH Units issued in connection with the Bighorn Acquisition | | 5,650,977 | | | | | — | | | | | 5,650,977 | |
EEH Units and Class B Common Stock converted to Class A Common Stock | | 82,891 | | | | | (82,891) | | | | | — | |
EEH Units issued in connection with the vesting of restricted stock units and performance-based units | | 598,772 | | | | | — | | | | | 598,772 | |
As of June 30, 2022 | | 79,217,423 | | | 69.8 | % | | 34,261,641 | | | 30.2 | % | | 113,479,064 | |
| | | | | | | | | | |
Note 7. Net Income (Loss) Per Common Share
Net income (loss) per common share—basic is calculated by dividing Net income (loss) by the weighted average number of shares of common stock outstanding during the period. Net income (loss) per common share—diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing Net income (loss) by the sum of the weighted average number
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
of shares of common stock, as defined above, outstanding plus potentially dilutive securities. Net income (loss) per common share—diluted considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares, as defined above, would have an anti-dilutive effect.
A reconciliation of Net income (loss) per common share is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended June 30, | | Six Months Ended June 30, |
(In thousands, except per share amounts) | | 2022 | | 2021 | | 2022 | | 2021 |
Net income (loss) attributable to Earthstone Energy, Inc. | | $ | 144,885 | | | $ | (8,871) | | | $ | 111,407 | | | $ | (14,704) | |
| | | | | | | | |
Net income (loss) attributable to Earthstone Energy, Inc. from assumed conversion of Series A Preferred Stock (2) | | 4,351 | | | — | | | 4,351 | | | — | |
| | | | | | | | |
Net income (loss) attributable to Earthstone Energy, Inc. - Diluted | | $ | 149,236 | | | $ | (8,871) | | | $ | 115,758 | | | $ | (14,704) | |
| | | | | | | | |
Net income (loss) per common share attributable to Earthstone Energy, Inc.: | | | | | | | | |
Basic | | $ | 1.85 | | | $ | (0.20) | | | $ | 1.57 | | | $ | (0.34) | |
Diluted | | $ | 1.46 | | | $ | (0.20) | | | $ | 1.37 | | | $ | (0.34) | |
| | | | | | | | |
Weighted average common shares outstanding | | | | | | | | |
Basic | | 78,291,037 | | | 44,127,718 | | | 70,909,353 | | | 43,457,043 | |
Add potentially dilutive securities: | | | | | | | | |
Unvested restricted stock units (1) | | 493,600 | | | — | | | 506,760 | | | — | |
Unvested performance units (1) | | 2,003,778 | | | — | | | 1,979,770 | | | — | |
Series A Preferred Stock (2) | | 21,621,621 | | | — | | | 10,870,539 | | | — | |
Diluted weighted average common shares outstanding | | 102,410,036 | | | 44,127,718 | | | 84,266,422 | | | 43,457,043 | |
| | | | | | | | |
(1)For the three and six months ended June 30, 2022 and 2021, the 1,099,800 performance units granted on January 27, 2021 were excluded due to an assumed settlement in cash and the liability treatment described in Note 9. Stock-Based Compensation. For the three and six months ended June 30, 2021, there were no dilutive effects related to unvested restricted stock units or performance units due to the losses for those periods.
(2)On April 14, 2022, Earthstone issued 280,000 shares of Series A Convertible Preferred Stock which automatically converted into 25,225,225 shares of Class A Common Stock on July 6, 2022. Under the “If-Converted” method, the shares would have been assumed issued on April 14, 2022 which would have resulted in an additional allocation of Net income (loss) attributable to Earthstone Energy, Inc. of $4.4 million for both the three and six months ended June 30, 2022.
The Class B Common Stock, par value $0.001 per share of Earthstone (the “Class B Common Stock” and with the Class A Common Stock, the “Common Stock”) has been excluded, as its conversion would eliminate noncontrolling interest and net income attributable to noncontrolling interest of $73.1 million for the three months ended June 30, 2022 and net income attributable to noncontrolling interest of $54.7 million for the six months ended June 30, 2022 would be added back to Net income attributable to Earthstone Energy, Inc. for the periods then ended, having no dilutive effect on Net income per common share attributable to Earthstone Energy, Inc.
The Class B Common Stock has been excluded, as its conversion would eliminate noncontrolling interest and net loss attributable to noncontrolling interest of $7.0 million for the three months ended June 30, 2021 and net loss attributable to noncontrolling interest of $11.7 million for the six months ended June 30, 2021 would be added back to Net loss attributable to Earthstone Energy, Inc. for the periods then ended, having no dilutive effect on Net loss per common share attributable to Earthstone Energy, Inc.
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 8. Common Stock and Preferred Stock
Class A Common Stock
At June 30, 2022 and December 31, 2021, there were 79,217,423 and 53,467,307 shares of Class A Common Stock issued and outstanding, respectively. In connection with the Chisholm Acquisition, on February 15, 2022, Earthstone issued 19,417,476 shares of Class A Common Stock valued at approximately $249.5 million on that date. In connection with the Bighorn Acquisition, on April 14, 2022, Earthstone issued 5,650,977 shares of Class A Common Stock valued at approximately $77.8 million on that date.
During the three and six months ended June 30, 2022, as a result of the vesting and settlement of performance units and restricted stock units under the Earthstone Energy, Inc. Amended and Restated 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”), Earthstone issued 163,753 and 933,896 shares, respectively, of Class A Common Stock, of which 48,232 and 335,124 shares, respectively, of Class A Common Stock were retained as treasury stock and canceled to satisfy the related employee income tax liability. For further discussion, see Note 9. Stock-Based Compensation.
During the three and six months ended June 30, 2021, (1) in connection with the IRM Acquisition, on January 7, 2021, Earthstone issued 12,719,594 shares of Class A Common Stock valued at approximated $76.6 million on that date, (2) as a result of the vesting and settlement of performance units and restricted stock units under the 2014 Plan, Earthstone issued 221,401 and 487,660 shares, respectively, of Class A Common Stock, of which 66,343 and 145,654 shares, respectively, of Class A Common Stock were retained as treasury stock and canceled to satisfy the related employee income tax liability and (3) as discussed below, shares of Class A Common Stock were issued as the result of conversions of Class B Common Stock.
Class B Common Stock
At June 30, 2022 and December 31, 2021, there were 34,261,641 and 34,344,532 shares of Class B Common Stock issued and outstanding, respectively. Each share of Class B Common Stock, together with one EEH Unit, is convertible into one share of Class A Common Stock. During the three and six months ended June 30, 2022, 10,125 and 82,891 shares, respectively, of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock. During the three and six months ended June 30, 2021, 33,463 and 611,494 shares, respectively, of Class B Common Stock and EEH Units were exchanged for an equal number of shares of Class A Common Stock.
Series A Convertible Preferred Stock
On January 30, 2022, Earthstone entered into a securities purchase agreement (the “SPA”) with EnCap Energy Capital Fund XI, L.P. (“EnCap Fund XI”), an affiliate of EnCap Investments L.P. (“EnCap”), and Cypress Investments, LLC, a fund managed by Post Oak Energy Capital, LP (“Post Oak” and collectively with EnCap Fund XI, the “Investors”) to sell, in a private placement (the “Private Placement”), 280,000 shares of newly authorized convertible preferred stock, $0.001 par value per share (the “Series A Preferred Stock”), each share of which would be convertible into 90.0900900900901 shares of Class A Common Stock for anticipated gross proceeds of $280.0 million, at a price of $1,000.00 per share of Series A Preferred Stock (or $11.10 per share of Class A Common Stock on an as-converted basis). The Private Placement was contingent upon the closing of the Bighorn Acquisition. The Company used the net proceeds from the sale of the Series A Preferred Stock to partially fund the Bighorn Acquisition. See Note 12. Related Party Transactions for further discussion.
On April 14, 2022, Earthstone, EnCap Fund XI and Cypress consummated the sale and issuance of 280,000 shares of Series A Preferred Stock pursuant to the SPA in exchange for cash proceeds of $279.3 million, net of offering costs.
At June 30, 2022 and December 31, 2021, there were 280,000 and no shares of the Series A Preferred Stock issued and outstanding, respectively.
On July 6, 2022, the Series A Preferred Stock automatically converted into 25,225,225 shares of Class A Common Stock. As such, the Series A Preferred Stock is no longer outstanding and the Investors now hold the 25,225,225 shares of Class A Common Stock issued upon the conversion of the Series A Preferred Stock.
On July 15, 2022, Earthstone filed a certificate of elimination with the Secretary of State of the State of Delaware eliminating all provisions of the certificate of designations previously filed by Earthstone with the Secretary of State of the State of Delaware on April 13, 2022 related to the Series A Preferred Stock.
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 June 30, 2022, the maximum number of shares of Class A Common Stock that may be issued under the 2014 Plan was 12.0 million shares.
Each RSU represents the contingent right to receive one share of Class A Common Stock. The holders of outstanding RSUs do not receive dividends or have voting rights prior to vesting and settlement. The Company determines the fair value of granted RSUs based on the market price of the Class A Common Stock on the date of the grant. Compensation expense for granted RSUs is recognized on a straight-line basis over the vesting and is net of forfeitures, as incurred. Stock-based compensation is included in General and administrative expense in the Condensed Consolidated Statements of Operations and is recorded with a corresponding increase in Additional paid-in capital within the Condensed Consolidated Balance Sheets.
The table below summarizes RSU award activity for the six months ended June 30, 2022:
| | | | | | | | | | | | | | |
| | Shares | | Weighted-Average Grant Date Fair Value |
Unvested RSUs at December 31, 2021 | | 771,817 | | | $ | 5.91 | |
Granted | | 487,215 | | | $ | 11.20 | |
Forfeited | | (10,100) | | | $ | 7.08 | |
Vested | | (325,771) | | | $ | 7.70 | |
Unvested RSUs at June 30, 2022 | | 923,161 | | | $ | 8.06 | |
| | | | |
As of June 30, 2022, there was $8.4 million of unrecognized compensation expense related to the RSU awards which will be recognized over a weighted average period of 1.09 years.
For the three and six months ended June 30, 2022, Stock-based compensation related to RSUs was $1.5 million and $2.7 million, respectively. For the three and six months ended June 30, 2021, Stock-based compensation related to RSUs was $1.2 million and $2.7 million, respectively.
Performance Units
The table below summarizes PSU activity for the six months ended June 30, 2022:
| | | | | | | | | | | | | | |
| | Shares | | Weighted-Average Grant Date Fair Value |
Unvested PSUs at December 31, 2021 | | 2,751,725 | | | $ | 8.42 | |
Granted | | 472,485 | | | $ | 19.42 | |
| | | | |
Vested | | (608,125) | | | $ | 9.30 | |
Unvested PSUs at June 30, 2022 | | 2,616,085 | | | $ | 10.20 | |
| | | | |
On February 1, 2022, the Board of Directors of Earthstone (the “Board”) granted 472,485 PSUs (the “2022 PSUs”) to certain officers pursuant to the 2014 Plan (the “2022 Grant”). The 2022 PSUs are expected to be paid in shares of Class A Common Stock upon the achievement by Earthstone over a period commencing on January 1, 2022 and ending on December 31, 2024 (the “Performance Period”) of certain performance criteria established by the Board. The Company classifies these awards as equity awards as they are expected to be settled in shares. In the event that a PSU grant is expected to be settled in cash, it is alternatively classified as a liability award.
The 2022 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, 2022. 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 ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
| | | | | | | | |
Earthstone’s Annualized TSR | | TSR Multiplier |
23.9% or greater | | 2 |
14.5% | | 1 |
8.4% | | 0.5 |
Less than 8.4% | | 0 |
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 2022 PSUs, assuming a risk-free rate of 1.4% and volatility of 86.0%, the Company calculated the weighted average grant date fair value per PSU to be $19.42.
On January 27, 2021, the Board granted 1,099,800 PSUs to certain officers pursuant to the 2014 Plan (the “2021 PSUs”). The PSUs are payable in cash or shares of Class A Common Stock upon the achievement by the Company over a period commencing on January 1, 2021 and ending on December 31, 2023 of certain performance criteria established by the Board. The Company classifies these awards as liability awards as they are expected to be paid in cash. As of June 30, 2022 and December 31, 2021, $12.9 million and $6.3 million, respectively, have been included in Other noncurrent liabilities in the Condensed Consolidated Balance Sheets related to the 2021 PSUs.
On January 28, 2019, the Board granted 669,550 PSUs to certain named executive officers pursuant to the 2014 Plan (the “2019 PSUs”). The 2019 PSUs were payable in shares of Class A Common Stock based upon the achievement by Earthstone over a period commencing on February 1, 2019 and ending on January 31, 2022 of performance criteria established by the Board. On January 31, 2022, the Company settled the remaining 608,125 PSUs, net of forfeitures, at a rate of 1.97x. 1.0x was settled through the issuance of 608,125 shares of Class A Common Stock and the remainder was settled in cash.
As of June 30, 2022, there was $22.5 million of unrecognized compensation expense related to all PSU awards which will be amortized over a weighted average period of 0.94 years.
For the three and six months ended June 30, 2022, Stock-based compensation related to all PSUs was approximately $4.5 million and $9.1 million, respectively. For the three and six months ended June 30, 2021, Stock-based compensation related to all PSUs was approximately $3.2 million and $5.0 million, respectively. A liability of $12.9 million related to the PSU liability awards is included in Other noncurrent liabilities in the Condensed Consolidated Balance Sheet as of June 30, 2022.
Note 10. Long-Term Debt
Credit Agreement
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 Agreement”), which replaced the prior credit facility, which was terminated on November 21, 2019.
On January 30, 2022, Earthstone, EEH, as Borrower, Wells Fargo as Administrative Agent, the lenders party thereto (the “Lenders”) and the guarantors party thereto entered into an amended and restated Fifth Amendment (the “Fifth Amendment”) to the Credit Agreement. Among other things, the Amendment increased the borrowing base and corresponding elected commitments from $650 million to $825 million upon the closing of the Chisholm Agreement.
On April 12, 2022, EEH issued $550.0 million aggregate principal amount of unsecured 8.000% senior notes due 2027 (the “Notes”). EEH received net proceeds from the offering (the “Notes Offering”) which reduced the elected commitments by $500 million.
On April 14, 2022, in connection with the Notes Offering, the Company voluntarily elected to reduce commitments under the borrowing base of the Credit Agreement to $800 million.
On June 2, 2022, the Company, EEH, Wells Fargo, the Lenders and the guarantors party thereto entered into an amendment (the “Sixth Amendment”) to the Credit Agreement. Among other things, the Amendment extended the maturity of the Credit Agreement to June 2027, increased the borrowing base from $1.325 billion to $1.4 billion and reduced the interest rate for amounts outstanding. Elected commitments under the Credit Agreement remain at $800 million.
The next regularly scheduled redetermination of the borrowing base is expected to occur on or around November 1, 2022. Subsequent redeterminations are expected to occur on or about each May 1st and November 1st thereafter. The amounts
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
borrowed under the Credit Agreement bear annual interest rates at either (a) the adjusted SOFR Rate (the “Adjusted Term SOFR Rate”) plus 2.25% to 3.25% or (b) the sum of (i) the greatest of (A) the prime rate of Wells Fargo, (B) the federal funds rate plus ½ of 1.0%, and (C) the Adjusted Term SOFR Rate for an interest rate period of one month plus 1.0%, (ii) plus 1.25% to 2.25%, depending on the amount borrowed under the Credit Agreement. Principal amounts outstanding under the Credit Agreement are due and payable in full at maturity on June 2, 2027. All of the obligations under the Credit Agreement, and the guarantees of those obligations, are secured by substantially all of EEH’s assets. Additional payments due under the Credit Agreement include paying a commitment fee of 0.375% to 0.50% per year, depending on the amount borrowed under the Credit Agreement, to the Lenders in respect of the unutilized commitments thereunder. EEH is also required to pay customary letter of credit fees.
The Credit Agreement contains a number of covenants that, among other things, restrict, subject to certain exceptions, EEH’s ability to incur additional indebtedness, create liens on assets, make investments, 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 Agreement requires EEH to maintain the following financial covenants: a current ratio, (as such term is defined in the Credit Agreement) of not less than 1.0 to 1.0 and a consolidated leverage ratio of not greater than 3.5 to 1.0. Consolidated leverage ratio means the ratio of (i) the aggregate debt of EEH and its consolidated subsidiaries as at the last day of the fiscal quarter to (ii) EBITDAX for the applicable period, which, for the period ended June 30, 2022, was calculated by multiplying EBITDAX for the fiscal quarter ending on such date by four. The term “EBITDAX” means, for any period, the sum of consolidated net income (loss) for such period plus (a) the following expenses or charges to the extent deducted from consolidated net income (loss) in such period: (i) interest, (ii) taxes, (iii) depreciation, (iv) depletion, (v) amortization, (vi) certain distributions to employees related to the stock compensation, (vii) certain transaction related expenses, (viii) reimbursed indemnification expenses related to certain dispositions and investments, (ix) non-cash extraordinary, usual, or nonrecurring expenses or losses, (x) other non-cash charges and minus (b) to the extent included in consolidated net income (loss) in such period: (i) non-cash income, (ii) gains on asset dispositions, disposals and abandonments outside of the ordinary course of business and (iii) to the extent not otherwise deducted from consolidated net income (loss), the aggregate amount of any pass-through cash distributions received by Borrower during such period in an amount equal to the aggregate amount of pass-through cash distributions actually made by Borrower during such period.
The Credit Agreement contains customary affirmative covenants and defines events of default to include failure to pay principal or interest, breach of covenants, breach of representations and warranties, insolvency, judgment default and 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 June 30, 2022, EEH was in compliance with the covenants under the Credit Agreement.
As of June 30, 2022, $395.0 million of borrowings were outstanding under the Credit Agreement, bearing annual interest of 4.584%, resulting in an additional $405.0 million of borrowing base availability under the Credit Agreement. At December 31, 2021, there were $320.0 million of borrowings outstanding under the Credit Agreement.
For the three and six months ended June 30, 2022, interest on borrowings under the Credit Agreement averaged 4.42% and 4.04% per annum, respectively, which excluded commitment fees of $0.0 million and $0.2 million, respectively, and amortization of deferred financing costs of $0.9 million and $1.6 million, respectively. For the three and six months ended June 30, 2021, interest on borrowings under the Credit Agreement averaged 3.33% and 3.36% per annum, respectively, which excluded commitment fees of $0.2 million and $0.4 million, respectively, and amortization of deferred financing costs of $0.2 million and $0.3 million, respectively.
During the three and six months ended June 30, 2022, the Company capitalized $5.7 million and $11.6 million, respectively, of costs associated with the Credit Agreement. During the three and six months ended June 30, 2021, the Company capitalized $0.8 million and $1.8 million, respectively, of costs associated with the Credit Agreement.
Related to the Credit Agreement, the Company had debt issuance costs of $18.3 million and $6.7 million, net of accumulated amortization of $4.9 million and $3.3 million, as of June 30, 2022 and December 31, 2021, respectively. The Company’s policy is to capitalize the financing costs associated with the Credit Agreement and amortize those costs on a straight-line basis over the term of the associated debt. The capitalized costs related to the Credit Agreement are included in Other noncurrent assets in the Condensed Consolidated Balance Sheets.
8.000% Senior Notes
EEH received net proceeds from the Notes Offering of approximately $537.2 million (after deducting underwriting discounts and commissions) which was used primarily to fund the Bighorn Acquisition and the remainder for general corporate purposes.
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
On April 12, 2022, in connection with the completion of the Notes Offering, EEH entered into an indenture, dated as of April 12, 2022 (the “Indenture”), among EEH, the guarantors party thereto and U.S. Bank Trust Company, National Association, as trustee.
The Notes will mature on April 15, 2027 with interest accruing at a rate of 8.000% per annum payable semi-annually in cash in arrears on April 15 and October 15 of each year, commencing October 15, 2022. Before April 15, 2024, EEH may redeem some or all of the Notes at a redemption price equal to 100% of the aggregate principal amount of the Notes redeemed plus the “applicable premium” as of and accrued and unpaid interest, if any, to, but excluding, the date of redemption. EEH may redeem, at its option, all or part of the Notes at any time on or after April 15, 2024, at the applicable redemption price plus accrued and unpaid interest to, but not including, the date of redemption. Further, before April 15, 2024, EEH may on one or more occasions redeem up to 35% of the aggregate principal amount of the Notes in an amount not exceeding the net proceeds from one or more private or public equity offerings at a redemption price of 108.000% of the principal amount of the Notes, plus accrued and unpaid interest to the date of redemption, if at least 65% of the aggregate principal amount of the Notes remains outstanding immediately after such redemption and the redemption occurs within 180 days of the closing date of each such equity offering. Upon a Change of Control (as defined in the Indenture) EEH must offer to repurchase the Notes on terms and conditions set forth in detail in the Indenture.
The Notes are guaranteed on a senior unsecured basis by the Company and its subsidiaries (the “Guarantors”) and may be guaranteed by certain of EEH’s future restricted subsidiaries. The Notes are unsecured, rank equally in right of payment with all existing and future senior unsecured indebtedness of EEH and the Guarantors and rank senior in right of payment to any future subordinated indebtedness of EEH and the Guarantors. The Notes will rank effectively junior to all secured indebtedness of EEH and the Guarantors, including indebtedness under EEH’s revolving credit facility, to the extent of the value of the assets securing such indebtedness. The Notes will rank structurally junior in right of payment to all indebtedness and other liabilities, including trade payables, of any future subsidiary of EEH that are not guarantors.
The Indenture restricts EEH’s ability and the ability of its Restricted Subsidiaries (as defined in the Indenture), including the Guarantors, to: (i) incur or guarantee additional indebtedness or issue certain types of preferred stock; (ii) pay dividends on capital stock or redeem, repurchase or retire its capital stock or subordinated indebtedness; (iii) transfer or sell assets; (iv) make investments; (v) create certain liens; (vi) enter into agreements that restrict dividends or other payments from its Restricted Subsidiaries to EEH; (vii) consolidate, merge or transfer all or substantially all of its assets; (viii) engage in transactions with affiliates; and (ix) create unrestricted subsidiaries. These covenants are subject to important exceptions and qualifications set forth in the Indenture. If the Notes achieve an Investment Grade Rating (as defined in the Indenture) or better from two of three of Moody’s Investors Service, Inc., S&P Global Ratings, or Fitch Ratings, Inc., many of these covenants will be suspended.
The Indenture contains customary events of default (each an “Event of Default”). If an Event of Default occurs and is continuing, the Trustee or the holders of not less than 25% in aggregate principal amount of the outstanding Notes may declare the unpaid principal of, premium, if any, and accrued but unpaid interest on, all the Notes then outstanding to be due and payable. Upon such a declaration, such principal, premium, if any, and interest will be due and payable immediately. If an Event of Default relating to certain events of bankruptcy or insolvency of EEH or any Significant Subsidiary (as defined in the Indenture) occurs, the principal of, premium, if any, and the interest on, all the Notes will become immediately due and payable without any declaration or other act on the part of the Trustee or any holders of the Notes. Under certain circumstances, the holders of a majority in principal amount of the outstanding Notes may rescind any such acceleration with respect to the Notes and its consequences.
During the three and six months ended June 30, 2022, the Company capitalized $12.8 million of costs associated with the Notes. No costs associated with the Notes were capitalized during the three and six months ended June 30, 2021.
Related to the Notes, the Company had debt issuance costs of $12.2 million, net of accumulated amortization of $0.5 million, as of June 30, 2022. The Company’s policy is to capitalize the financing costs associated with the Notes and amortize those costs on a straight-line basis over the term of the Notes. The capitalized costs associated with the Notes are included in 8.000% Senior Notes due 2027, net in the Condensed Consolidated Balance Sheets.
As of June 30, 2022, accrued interest of $9.5 million associated with the Notes was included in Accrued expenses 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.
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table summarizes the Company’s asset retirement obligation transactions recorded during the six months ended June 30, 2022 (in thousands):
| | | | | | | | | | |
| | 2022 | | |
Beginning asset retirement obligations | | $ | 15,866 | | | |
Liabilities incurred | | 215 | | | |
Liabilities settled | | (475) | | | |
Acquisitions | | 19,165 | | | |
Accretion expense | | 1,105 | | | |
| | | | |
Revision of estimates | | 69 | | | |
Ending asset retirement obligations | | $ | 35,945 | | | |
| | | | |
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. The Audit Committee of the Board independently reviews and approves all related party transactions.
Earthstone has two significant shareholders that consist of various investment funds managed by each of the two private equity firms who may manage other investments in entities with which the Company interacts in the normal course of business (the “Significant Shareholders” or separately, each a “Significant Shareholder”).
As discussed in Note 4. Acquisitions, the Chisholm Acquisition was consummated on February 15, 2022, whereby the Company acquired the Chisholm Assets for a purchase price of $377.5 million in cash, net of preliminary and customary purchase price adjustments, and 19.4 million shares of Class A Common Stock. A Significant Shareholder was the majority owner of Chisholm as of the closing of the Chisholm Acquisition. The deferred payment of $70 million as of March 31, 2022 was paid on April 15, 2022 and included in Deferred acquisition payment – Chisholm in the Condensed Consolidated Balance Sheet as of March 31, 2022. The issuance of 19.4 million shares of Class A Common Stock in connection with the closing of the Chisholm Agreement was (1) approved by a majority of the voting power of all outstanding disinterested shares of the Common Stock and (2) increased the Significant Stockholder's beneficial ownership of Class A Common Stock from approximately 25% to 36% as of February 15, 2022.
As discussed in Note 4. Acquisitions, on March 31, 2021, Earthstone and EEH entered into the Tracker/Sequel Purchase Agreements. The Tracker/Sequel Acquisitions were consummated on July 20, 2021, whereby the Company acquired the Tracker Assets for a purchase price of $18.8 million in cash and 4.7 million shares of Class A Common Stock. A Significant Shareholder owned approximately 49% of Tracker as of the closing of the Tracker Acquisition. A majority of the non-affiliated stockholders of Earthstone approved the issuance of 6.2 million shares of Class A Common Stock in connection with the closing of the Tracker/Sequel Purchase Agreements at Earthstone’s Annual Meeting of Stockholders held on July 20, 2021.
As discussed in Note 4. Acquisitions, during the second quarter of 2021, the Company completed the Eagle Ford Acquisitions for a purchase price of approximately $45.2 million in cash. A Significant Shareholder controlled one of the four sellers. After participating in a competitive sales process, the Company acquired the aforementioned assets for $8.2 million in cash from that related party entity.
As described in Note 8. Common Stock and Preferred Stock, on January 30, 2022, Earthstone entered into the SPA with certain affiliates of EnCap and Post Oak (collectively, the “Investors”) to issue 220,000 shares and 60,000 shares, respectively, of the Series A Preferred Stock. On April 14, 2022, the SPA was consummated resulting in the issuance of the total of 280,000 shares of the Series A Preferred Stock in exchange for cash proceeds of $279.3 million, net of offering costs.
On July 6, 2022, the Series A Preferred Stock automatically converted into 25,225,225 shares of Class A Common Stock.
The Company paid $0.2 million to one of our Significant Shareholders for reimbursement of certain costs associated with the aforementioned SPA.
Note 13. Commitments and Contingencies
Legal
From time to time, the Company may be involved in various legal proceedings and claims in the ordinary course of business.
EARTHSTONE ENERGY, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Commitment to Purchase Materials
The Company entered into an agreement to purchase certain materials related to its drilling completion activities through 2024 (the “Materials Purchase Agreement”). The Company has already fulfilled its 2022 financial obligation under the Materials Purchase Agreement and the Company has committed to payments totaling $13.6 million and $3.7 million due on or before January 1, 2023 and 2024, respectively.
Environmental and Regulatory
As of June 30, 2022, 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.
On February 15, 2022, the Company completed the Chisholm Acquisition which included the issuance of 19,417,476 shares of Class A Common Stock. When there is a change in ownership, as defined under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), it results in a limitation that applies to all net operating losses (“NOLs”) and credits generated prior to the ownership change date that can be used to offset taxable income incurred after the ownership change date (the “382 Limitation”). The annual limitation is based on Earthstone’s stock value prior to the ownership change, multiplied by the applicable federal long-term, tax-exempt interest rate (the “FLTR”). Based on Earthstone’s stock price at the close of business on February 15, 2022 of $12.85 and the applicable FLTR of 1.46%, the current limitation is estimated to be $10.1 million per year. Additionally, unutilized 382 Limitation amounts can be carried forward to future years, cumulatively.
As of June, 2022 and December 31, 2021, a current liability of $0.8 million and $0.9 million, respectively, are included in Other current liabilities in the Condensed Consolidated Balance Sheets. The amounts represent current Texas Margin Tax payable.
During the six months ended June 30, 2022, the Company recorded income tax expense of approximately $21.2 million which included (1) a deferred income tax expense for Earthstone of $17.9 million, which included a deferred income tax expense of $24.3 million resulting from its share of the distributable income from EEH, offset by a $6.4 million release of valuation allowance, (2) a deferred income tax expense for Lynden US of $2.0 million as a result of its share of the distributable loss from EEH and (3) income tax expense of $1.3 million related to state taxes. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the six months ended June 30, 2022.
During the six months ended June 30, 2021, the Company recorded income tax benefit of approximately $0.8 million which included (1) a deferred income tax benefit for Lynden US of $0.4 million as a result of its share of the distributable loss from EEH, (2) no net income tax benefit for Earthstone as the $2.6 million income tax benefit resulting from its share of the distributable loss from EEH had a full valuation allowance recorded against it as future realization of the net deferred tax asset cannot be assured and (3) deferred income tax benefit of $0.8 million related to the Texas Margin Tax, offset by (4) current income tax expense of $0.4 million related to the Texas Margin Tax. Lynden Corp incurred no material income or loss, or related income tax expense or benefit, for the six months ended June 30, 2021.