Note 3. Acquisitions and Divestitures

Lynden Arrangement

On May 18, 2016, the Company acquired Lynden Energy Corp. (“Lynden”) in an all-stock transaction through an arrangement (the “Lynden Arrangement”) instead of a merger because Lynden is incorporated in British Columbia, Canada. The Company acquired all outstanding shares of Lynden’s common stock, through a newly formed subsidiary, with Lynden surviving as a wholly-owned subsidiary of the Company, issuing 3,700,279 shares of its common stock, $0.001 par value per share (the “Common Stock”), to the holders of the common stock of Lynden. The Lynden 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, an independent fair market valuation. The following is still preliminary with respect to final tax amounts and includes the use of estimates based on information that was available to management at the time these consolidated financial statements were prepared. We expect the purchase price allocation to be finalized in the first quarter of 2017. Based on our ongoing review of preliminary tax amounts, we adjusted the deferred tax liability recorded as a result of the acquisition and a corresponding change to goodwill in the fourth quarter of 2016.

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		1,915
Deferred tax liability⁽¹⁾		15,157
Asset retirement obligations		250
Total consideration plus liabilities assumed	$	99,617
Fair Value of Assets Acquired:
Cash and cash equivalents ⁽⁴⁾	$	5,263
Current assets		2,018
Proved oil and gas properties ⁽²⁾⁽³⁾		48,116
Unproved oil and gas properties		26,600
Amount attributable to assets acquired	$	81,997
Goodwill ⁽⁵⁾	$	17,620

(1)

This amount represents the difference between the recorded book value and the tax basis of the oil and natural gas properties as of the date of the closing of the Lynden Arrangement, tax-effected using a tax rate of approximately 34.5%.

(2)

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.

(3)

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

(4)

Concurrent with closing the Lynden 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 Lynden Arrangement.

(5)

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 results of operations present consolidated information assuming the Lynden Arrangement had been completed as of January 1, 2014. 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).

	Years ended December 31,
	2016			2015			2014
	(Unaudited)
Revenue	$	47,679		$	62,817		$	112,370
(Loss) income before taxes	$	(53,510	)	$	(148,609	)	$	32,912
Net (loss) income available to Earthstone common stockholders	$	(54,744	)	$	(122,598	)	$	19,518
Pro Forma net (loss) income per common share:
Basic	$	(2.73	)	$	(6.99	)	$	1.11
Diluted	$	(2.73	)	$	(6.99	)	$	1.11

Earthstone Energy Reverse Acquisition

On December 19, 2014, the Company acquired three operating subsidiaries of OVR, which included producing assets, undeveloped acreage and cash, in exchange for shares of Common Stock (the “Exchange”), which resulted in a change of control of the Company. Pursuant to the Exchange Agreement, OVR contributed to Earthstone the membership interests of its three subsidiaries, Earthstone Operating, LLC (formerly Oak Valley Operating, LLC (“OVO”)), EF Non-Op, LLC (“EF Non-Op”) and Sabine River Energy, LLC (“Sabine”), each a Texas limited liability company (collectively “Oak Valley”). OVR received approximately 9.124 million shares of the Common Stock of the Company. The Exchange resulted in a change of control of the Company. The Exchange was recorded in accordance with FASB ASC Topic 805 as a reverse acquisition whereby Oak Valley was considered the acquirer for accounting purposes although Earthstone was the acquirer for legal purposes. ASC 805 also requires that, among other things, assets acquired and liabilities assumed 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 December 31, 2014 reserve report prepared by Cawley, Gillespie and Associates, Inc. (“CG&A”), adjusted by the Company’s reserve engineering staff back to the December 19, 2014 acquisition date.

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 issued as consideration		1,753,388
Closing price of Common Stock as of December 19, 2014	$	19.08
Total purchase price	$	33,455
Estimated Fair Value of Liabilities Assumed:
Current liabilities	$	7,631
Long-term debt		7,000
Deferred tax liability ⁽¹⁾		2,880
Asset retirement obligation		1,035
Amount attributable to liabilities assumed		18,546
Total purchase price plus liabilities assumed	$	52,001
Estimated Fair Value of Assets Acquired:
Cash ⁽²⁾	$	2,920
Other current assets		3,466
Proved oil and natural gas properties ^{(3) (4)}		21,813
Unproved oil and natural gas properties		5,524
Other non-current assets		746
Amount attributable to assets acquired	$	34,469
Goodwill ⁽⁵⁾	$	17,532

(1)

This amount represents the difference between the recorded book value and the tax basis of the oil and natural gas properties as of the date of the closing of the Exchange, tax-effected using a tax rate of approximately 35%.

(2)

Net cash flow related to the Exchange was an outflow of $4.2 million which consisted of the $7.1 million repayment of long-term debt (plus accrued interest) less the cash acquired of $2.9 million.

(3)

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

(4)

The market assumptions as to future commodity prices, projections of estimated quantities of oil and natural gas reserves, expectations for timing and amount of future development and operating costs, projections of future rates of production, expected recovery rates 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. For additional information on Level 3 inputs, see Note 4. Fair Value Measurements.

(5)

Goodwill was determined to be the excess consideration exchanged over the fair value of the Company’s net assets on December 19, 2014. In 2016, due to the commodity price environment, the Company determined that the amount recorded was no longer recoverable and recognized a full impairment charge to Goodwill of $17.5 million in the Consolidated Statement of Operations. See Note 7.Goodwill.

2014 Eagle Ford Acquisition Properties

On December 19, 2014, immediately following the Exchange, Flatonia Energy, LLC (“Flatonia”), Parallel Resource Partners, LLC (“Parallel”), and Sabine, closed a contribution agreement (the “Flatonia Contribution Agreement”) by and among the Company, OVR, Sabine, OVO, 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 exchange for approximately 2.957 million shares of Common Stock. The assets subject to the Flatonia 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 Flatonia Contribution Agreement 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 December 31, 2014 reserve report prepared by CG&A that was adjusted by the Company’s reserve engineering staff back to December 19, 2014.

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 as of December 19, 2014	$	19.08
Total purchase price	$	56,425

Estimated Fair Value of Liabilities Assumed:
Deferred tax liability ⁽¹⁾	$	1,547
Asset retirement obligation		173
Amount attributable to liabilities assumed		1,720
Total purchase price plus liabilities assumed	$	58,145

Estimated Fair Value of Assets Acquired:
Proved oil and natural gas properties ^{(2) (3)}	$	34,745
Unproved oil and natural gas properties		21,853
Amount attributable to assets acquired	$	56,598
Goodwill ⁽⁴⁾	$	1,547

(1)

This amount represents the difference between the recorded book value and the tax basis of the oil and natural gas properties as of the date of the closing of the Flatonia Contribution Agreement, tax-effected using a tax rate of approximately 34%.

(2)

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.

(3)

(4)

Goodwill was determined as the excess consideration exchanged over the fair value of the 2014 Eagle Ford Acquisition Properties on December 19, 2014. In 2015, due to the commodity price environment, the Company determined that the goodwill balance was not recoverable and therefore fully impaired it, recording a goodwill impairment charge of $1.5 million. See Note 7.Goodwill.

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

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 were 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 its Louisiana properties located primarily in DeSoto and Caddo Parishes, Louisiana, for cash consideration of $3.4 million. The Company recorded a gain of $1.6 million on the sale. The effective date of the transaction was March 1, 2015.