Note 2. Acquisitions and Divestitures

Lynden Arrangement

In May 2016, the Company acquired Lynden Energy Corp. (“Lynden”) in an all-stock transaction. The acquisition was made through an arrangement (the “Arrangement”) instead of a merger because Lynden is incorporated in British Columbia, Canada. The Company acquired all the outstanding shares of common stock of Lynden through a newly formed Company subsidiary, with Lynden surviving in the transaction as a wholly-owned subsidiary of the Company. The Company issued 3,700,279 shares of its common stock to the holders of Lynden common stock in the transaction. The Arrangement was accounted for as a business combination in accordance with FASB ASC Topic 805, Business Combinations, which among other things requires the assets acquired and liabilities assumed to be measured and recorded at their fair values as of the acquisition date.

An allocation of the purchase price was prepared using, among other things, a reserve report prepared by qualified reserve engineers and priced as of the acquisition date. The following allocation is still preliminary with respect to final tax amounts and certain accruals and includes the use of estimates based on information that was available to management at the time these condensed consolidated financial statements were prepared. 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 transferred, fair value of assets acquired and liabilities assumed and resulting goodwill (in thousands, except share and share price amount):

Consideration:
Shares of Earthstone common stock issued in the Arrangement		3,700,279
Closing price of Earthstone common stock as of May 18, 2016	$	12.35
Total consideration to Lynden shareholders	$	45,698
Fair Value of Liabilities Assumed:
Credit facility ⁽⁴⁾	$	36,597
Current liabilities		1,895
Deferred tax liability⁽¹⁾		664
Asset retirement obligations		250
Total consideration plus liabilities assumed	$	85,104
Fair Value of Assets Acquired:
Cash and cash equivalents ⁽⁴⁾	$	5,263
Current assets		2,108
Proved oil and gas properties ⁽²⁾⁽³⁾		48,116
Unproved oil and gas properties		26,600
Amount attributable to assets acquired	$	82,087
Goodwill ⁽⁵⁾	$	3,017

1.	This amount represents the recorded book value to tax difference in the oil and natural gas properties as of the date of the Arrangement on a tax effected basis of approximately 34.5%.

The weighted average commodity prices utilized in the determination of the fair value of oil and natural gas properties was $64.73 per barrel of oil, $3.68 per Mcf of natural gas and $19.34 per barrel of oil equivalent for natural gas liquids, after adjustments for transportation fees and regional price differentials.

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.

4.	Concurrent with closing the Arrangement, the Company paid off the outstanding balance of $36.6 million on the Lynden credit facility. The settlement of the debt and the cash acquired is equal to the $31.3 million net cash outflow associated with the Arrangement.

Goodwill was determined to be the excess consideration exchanged over the fair value of the net assets of Lynden on May 18, 2016. The goodwill resulted from the expected synergies of the management team and balance sheet of the Company combined with the key assets acquired in the Midland Basin area. The goodwill recognized will not be deductible for tax purposes.

The following unaudited supplemental pro forma condensed results of operations present consolidated information as though the Arrangement had been completed as of January 1, 2015. The unaudited supplemental pro forma financial information was derived from the historical consolidated and combined statements of operations for the Company and Lynden and adjusted to include: (i) depletion expense applied to the adjusted basis of the properties acquired, (ii) accretion expense associated with the asset retirement obligations recorded using the Company’s assumptions about the future liabilities and (iii) interest expense based on the combined debt of the Company post-acquisition. These unaudited supplemental pro forma results of operations are provided for illustrative purposes only and do not purport to be indicative of the actual results that would have been achieved by the combined company for the periods presented or that may be achieved by the combined company in the future. Future results may vary significantly from the results reflected in this unaudited pro forma financial information (in thousands, except per share amounts).

	Three Months Ended September 30,		Nine Months Ended September 30,
	2015		2016			2015
(Unaudited)
Revenue	$	16,473	$	32,677		$	52,792
Income (loss) before taxes	$	1,698	$	(20,603	)	$	142
Income (loss) available to Earthstone common stockholders	$	1,165	$	(21,696	)	$	80
Pro Forma net income (loss) per common share:
Basic and diluted	$	0.07	$	(1.12	)	$	0.00

The results of operations attributable to Lynden are included in our Condensed Consolidated Statements of Operations beginning in May 2016. During the three and nine months ended September 30, 2016, the Company recognized $2.8 million and $4.3 million, respectively, of oil, natural gas and natural gas liquids sales related to the Lynden assets and $2.2 million and $3.1 million, respectively, of operating expenses, inclusive of depletion. During the three and nine months ended September 30, 2016, the Company recognized $0 and $0.7 million, respectively, of non-recurring transaction costs related to this acquisition.

Other Acquisitions

In June 2015, the Company acquired a 50% operated working interests in approximately 1,000 gross acres in southern Gonzales County, Texas. The acreage, acquired for future Eagle Ford development, is 100% held-by-production by two gross Austin Chalk wells with gross production of 44 barrels of oil equivalent per day as of the time of acquisition.

Also during June 2015, the Company acquired 400 gross acres in northern Karnes County, Texas, which is adjacent to the 1,000 gross acres in southern Gonzales County, Texas. Subsequent trades in Karnes County reduced the gross acreage from 400 to 350 gross acres (117 net acres).

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 Condensed Consolidated Financial Statements since the date of each acquisition.

Additionally, in June 2015, the Company acquired additional acreage and working interest in wells located within existing Bakken spacing units primarily located in the Banks Field of McKenzie County, North Dakota, for $1.4 million plus purchase price adjustments of $2.0 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.

Divestitures

In April 2015, the Company sold substantially all of its Louisiana properties located primarily in DeSoto and Caddo Parishes for cash consideration of $3.4 million, recording a gain of $1.6 million. The effective date of the transaction was March 1, 2015.