Note 2. Acquisitions and Divestitures

Earthstone Energy Reverse Acquisition

On December 19, 2014, the Company and OVR closed the Exchange. In this transaction, OVR contributed to the Company the membership interests of its three wholly-owned subsidiaries, which included producing assets, undeveloped acreage and cash. OVR received approximately 9.124 million shares of newly issued common stock, $0.001 par value per share (the “Common Stock”), of the Company. The Exchange resulted in a change of control of the Company. The Exchange has been accounted in accordance with FASB Accounting Standards Codification (“ASC”) 805, Business Combinations (“ASC 805”) as a reverse acquisition whereby Oak Valley is considered the acquirer for accounting purposes although Earthstone is the acquirer for legal purposes. ASC 805 also requires, that among other things, assets acquired and liabilities assumed to be measured at their acquisition date fair values. The results of operations from Earthstone’s legacy assets are reflected in the Company’s consolidated statement of operations beginning December 19, 2014.

An allocation of the purchase price was prepared using, among other things, the 2014 year-end reserve report prepared by Cawley, Gillespie and Associates, Inc. that was adjusted and re-priced by the Company’s reserve engineering staff back to the December 19, 2014 acquisition date. The following allocation is still preliminary with respect to final tax amounts, pending the completion of the 2014 Earthstone tax return and certain accruals and includes the use of estimates based on information that was available to management at the time these consolidated financial statements were prepared. Additional changes to the purchase price allocation may result in a corresponding change to goodwill in the period of the change.

The following table summarizes the consideration paid to acquire the legacy Earthstone net assets and the estimated values of those net assets (in thousands, except share and share price amounts):

Shares of Common Stock outstanding before the Exchange		1,734,988
Company director and officer restricted shares that vested in the Exchange		18,400
Shares of Common Stock issued in the Exchange		9,124,452
Total shares of Common Stock outstanding following the Exchange		10,877,840
Shares of Common Stock issued as consideration		1,753,388
Closing price of Common Stock ⁽¹⁾	$	19.08
Total purchase price	$	33,455
Estimated Fair Value of Liabilities Assumed:
Current liabilities	$	7,852
Long-term debt		7,000
Deferred tax liability ⁽²⁾		2,880
Asset retirement obligation		2,227
Amount attributable to liabilities assumed		19,959
Total purchase price plus liabilities assumed	$	53,414
Estimated Fair Value of Assets Acquired:
Cash⁽³⁾	$	2,920
Other current assets		3,466
Proved oil and natural gas properties^{(4) (5)}		21,813
Unproved oil and natural gas properties		5,524
Other non-current assets		745
Amount attributable to assets acquired	$	34,468
Goodwill ⁽⁶⁾	$	18,946

(1)	The share price used for the determination of the purchase price was $19.08, which was the closing price of the Common Stock on December 19, 2014.

(2)

This amount represents the recorded book value versus tax value difference in oil and natural gas properties and other net assets as of the date of the Exchange on a tax effected basis of approximately 35%. The tax basis of the legacy Earthstone assets were not adjusted in the Exchange. As noted above, however, ASC 805 requires that the Company in a reverse acquisition record the legacy Earthstone net assets at fair value on the date of the Exchange; the fair value of the net assets was in excess of the tax basis and as such required the recognition of a deferred tax liability.

(3)	The components of cash flow in the Exchange in which the legacy Earthstone assets were acquired were $7.1 million in notes payable and accrued interest that was paid in full in conjunction with the Exchange less the cash acquired of $2.9 million.

(4)	The weighted average commodity prices utilized in the determination of the fair value of oil and natural gas properties were $51.62 per barrel of oil and $4.58 per Mcf of natural gas after adjustments for transportation fees and regional price differentials.

(5)

The market assumptions as to the future commodity prices, projections of estimated quantities of oil and natural gas reserves, expectations for timing and amount of the future development and operating costs, projections of future rates of production, expected recovery rate and risk adjusted discount rates used by the Company to estimate the fair value of the oil and natural gas properties represent Level 3 inputs; see Note 4 Fair Value Measurements, below.

(6)	Goodwill was determined to be the excess consideration exchanged over the fair value of the Company’s net assets on December 19, 2014. The goodwill recognized will not be deductible for tax purposes.

2014 Eagle Ford Acquisition Properties

Also on December 19, 2014, immediately following the Exchange, Flatonia Energy, LLC (“Flatonia”), Parallel Resource Partners, LLC (“Parallel”), and Sabine, closed the transactions contemplated by the Contribution Agreement by and among the Company, OVR, Sabine, Oak Valley Operating, LLC, Parallel, and Flatonia, whereby Parallel contributed 28.57% of the oil and natural gas property interests held by Flatonia, a wholly owned subsidiary of Parallel, in consideration for approximately 2.96 million shares of Common Stock (the “Contribution”). The assets subject to the Contribution Agreement were oil and natural gas property interests in producing wells and acreage in the Eagle Ford trend of Texas (the “2014 Eagle Ford Acquisition Properties”). One of the subsidiaries included in the Exchange is the operator of the 2014 Eagle Ford Acquisition Properties. The only relationship that Flatonia or Parallel had with this subsidiary or the Company prior to the transaction was that the subsidiary is the operator of the 2014 Eagle Ford Acquisition Properties. The Contribution was accounted for as a business combination in accordance ASC 805 which among other things requires the assets acquired and liabilities assumed to be measured and recorded at their fair values as of the acquisition date.

An allocation of the purchase price was prepared using, the 2014 year-end reserve report prepared by Cawley, Gillespie and Associates, Inc. that was adjusted and re-priced by the Company’s reserve engineering staff back to December 19, 2014. The following allocation is still preliminary with respect to final tax amounts, pending the completion of the 2014 Flatonia tax return and certain accruals and it includes the use of estimates based on information that was available to management at the time these consolidated financial statements were prepared. The Company’s final allocation of purchase price is dependent on the seller’s tax return since Earthstone received carryover basis on Flatonia’s assets and liabilities because the Contribution Agreement was not a taxable transaction under the United States Internal Revenue Code of 1986, as amended. Additional changes to the purchase price allocation may result in a corresponding change to goodwill in the period of the change.

The following table summarizes the consideration paid to acquire the 2014 Eagle Ford Acquisition Properties and the estimated values of those net assets (in thousands, except share and share price amounts):

Shares of Common Stock issued as consideration in the Contribution		2,957,288
Closing price of Common Stock ⁽¹⁾	$	19.08
Total purchase price	$	56,425
Estimated Fair Value of Liabilities Assumed:
Deferred tax liability ⁽²⁾	$	4,046
Asset retirement obligation		173
Amount attributable to liabilities assumed		4,219
Total purchase price plus liabilities assumed	$	60,644
Estimated Fair Value of Assets Acquired:
Proved oil and natural gas properties ^{(3) (4)}	$	34,745
Unproved oil and natural gas properties		21,853
Amount attributable to assets acquired	$	56,598
Goodwill ⁽⁵⁾	$	4,046

(1)	The share price used for the determination of the purchase price was $19.08, which was the closing price of the Common Stock on December 19, 2014.

(2)

This amount represents the recorded book value to tax difference in the oil and natural gas properties as of the date of the Contribution Agreement on a tax effected basis of approximately 34%. As noted above, the Company received the net assets at Flatonia’s carryover tax basis and as such requires the recognition of a deferred tax liability.

(3)	The weighted average commodity prices utilized in the determination of the fair value of oil and natural gas properties was $56.36 per barrel of oil and $3.36 per Mcf of natural gas after adjustments for transportation fees and regional price differentials.

(4)

The market assumptions as to the future commodity prices, projections of estimated quantities of oil and natural gas reserves, expectations for timing and amount of the future development and operating costs, projecting of future rates of production, expected recovery rate and risk adjusted discount rates used by the Company to estimate the fair value of the oil and natural gas properties represent Level 3 inputs; see Note 4 Fair Value Measurements, below.

(5)	Goodwill was determined to be the excess consideration exchanged over the fair value of the 2014 Eagle Ford Acquisition Properties on December 19, 2014. The goodwill recognized will not be deductible for tax purposes.

The following unaudited supplemental pro forma combined condensed results of operations present consolidated information as though the Exchange and Contribution had been completed as of January 1, 2014. 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. The pro forma results of operations do not include any cost savings or other synergies that resulted, or may result, from the Exchange or Contribution or any estimated costs that will be incurred to integrate the legacy Earthstone net assets and the 2014 Eagle Ford Acquisition Properties. Future results may vary significantly from the results reflected in this unaudited pro forma financial information (in thousands, except per share amounts).

	Three months ended September 30,		Nine months ended September 30,
	2014		2014
	(Unaudited)
Revenue	$	22,691	$	65,652
Income before taxes	$	10,506	$	26,340
Net income available to Earthstone common stockholders	$	6,832	$	17,256
Pro forma net income per common share:
Basic and diluted	$	0.49	$	1.25

For the three and nine months ended September 30, 2015, the Company recognized $2.0 million and $7.3 million, respectively, of oil, natural gas and natural gas liquids sales related to the legacy Earthstone assets and operating expenses including depletion of $2.5 million and $8.4 million, respectively. There were no material non-recurring transaction costs related to this acquisition incurred during the three and nine months ended September 30, 2015.

For the three and nine months ended September 30, 2015, the Company recognized $3.2 million and $9.8 million, respectively, of oil, natural gas and natural gas liquids related to the 2014 Eagle Ford Acquisition Properties and operating expenses including depletion of $2.5 million and $7.9 million, respectively. There were no material non-recurring transaction costs related to this acquisition incurred during the three and nine months ended September 30, 2015.

Other Acquisitions

In June 2015, the Company acquired a 50% operated interest in two gross Austin Chalk wells, which hold approximately 1,000 gross acres in southern Gonzales County, Texas. The acreage, acquired for future Eagle Ford development, is 100% held-by-production, with current gross production of 44 barrels of oil equivalent per day (“BOEPD”) all of which was oil. Also during June 2015, the Company acquired additional acreage in northern Karnes County, Texas, increasing its total leasehold position to approximately 400 gross acres. The Company currently has a 33% working interest in the Karnes acreage. These two positions are adjacent to one another and will provide for 17 gross Eagle Ford locations with expected development beginning in the fourth quarter of 2015.

The following table summarizes the consideration paid to acquire the properties and the estimated fair values of the assets acquired and liabilities assumed (in thousands):

Purchase price	$	4,066

Estimated fair value of assets acquired:
Proved oil and natural gas properties	$	588
Unproved oil and natural gas properties		3,496
Total assets acquired	$	4,084
Estimated fair value of liabilities assumed:
Asset retirement obligations	$	13
Other liabilities		5
Total liabilities assumed	$	18
Consideration paid	$	4,066

Pro forma financial information, assuming the acquisition occurred at the beginning of each period presented, has not been presented because the effect on the Company’s results for each of those periods is not material. The results of the above acquisitions have been included in the Company’s consolidated financials since the date of each acquisition.

In June 2015, the Company acquired additional acreage and increased the Company’s working interest in wells in existing Bakken spacing units primarily located in the Banks Field of McKenzie County, North Dakota, for $1.4 million plus purchase price adjustments of $2.1 million for the revenues, net of production taxes and operating expenses and capital costs incurred for the existing wells. The acquisition included 164 net acres which allowed the Company to increase its working interest in approximately 41 producing wells and 21 wells that are in the drilling and completion phase.

In August 2015, the Company acquired a 33% working interest in approximately 1,650 gross acres, in Southern Gonzales County, Texas for $3.3 million. This acreage supports 16 additional gross Eagle Ford locations.

Divestitures

In April 2015, the Company sold its Louisiana properties located primarily in DeSoto and Caddo Parishes for cash consideration of $3.4 million. The Company recorded a gain of $1.7 million on the sale. The effective date of the transaction was March 1, 2015.