EARTHSTONE ENERGY INC - FORM 10-Q

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EX-31.1 - CERTIFICATION - EARTHSTONE ENERGY INC	este_ex311.htm
EX-31.2 - CERTIFICATION - EARTHSTONE ENERGY INC	este_ex312.htm
EX-32.2 - CERTIFICATION - EARTHSTONE ENERGY INC	este_ex322.htm
EXCEL - IDEA: XBRL DOCUMENT - EARTHSTONE ENERGY INC	Financial_Report.xls
EX-32.1 - CERTIFICATION - EARTHSTONE ENERGY INC	este_ex321.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2013

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 0-7914

(Exact Name of Registrant as Specified in its Charter)

Delaware

(State of Incorporation or Organization)

84-0592823

(I.R.S. Employer Identification No.)

633 17th Street, Suite 2320, Denver, Colorado

(Address of principal executive office)

80202-3619

(Zip Code)

(303) 296-3076

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o	Smaller reporting company þ
(Do not check if a smaller reporting company)

Check whether the issuer is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

Shares of common stock outstanding on August 12, 2013: 1,732,250

EARTHSTONE ENERGY, INC.

FORM 10-Q

INDEX

	PART I. FINANCIAL INFORMATION	Page

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets:
	June 30, 2013 (Unaudited) and March 31, 2013	5

	Condensed Consolidated Statements of Operations:
	Three Months Ended June 30, 2013 and 2012 (Unaudited)	7

	Condensed Consolidated Statements of Cash Flows:
	Three Months Ended June 30, 2013 and 2012 (Unaudited)	8

	Notes to Unaudited Condensed Consolidated Financial Statements:
	June 30, 2013	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19

Item 4.	Controls and Procedures	19

	PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	20

Item 1A.	Risk Factors	20

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	20

Item 3.	Defaults Upon Senior Securities	20

Item 4.	Mine Safety Disclosures	20

Item 5.	Other Information	20

Item 6.	Exhibits	21

	Signatures	22

FORWARD-LOOKING STATEMENTS

This Current Report on Form 10-Q, including information incorporated herein by reference, contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs, assumptions and information currently available to management. The use of any statements containing the words "anticipate," "intend," "believe," "estimate," "project," "expect," "predict," "plan," "should," "likely," "may," "will," "continue" or similar expressions are intended to identify such statements. All statements other than statements of historical facts that address activities that we anticipate will or may occur in the future are forward-looking statements. All forward-looking statements should be evaluated with the understanding of their inherent uncertainty. Forward-looking statements relate to, among other things:

●	our strategies, either existing or anticipated;

●	our future financial position, including anticipated liquidity;

●	our ability to satisfy obligations from cash generated from operations;

●	amounts and nature of future capital expenditures, including future share repurchases;

●	acquisitions and other business opportunities;

●	operating costs and other expenses, including asset retirement obligation expenses;

●	wells expected to be drilled, other anticipated exploration efforts and associated expenses;

●	estimates of proved oil and natural gas reserves, deferred tax assets, and depletion rates;

●	our ability to meet additional acreage, seismic and/or drilling cost requirements;

●	other estimates and assumptions we use in our accounting policies.

Factors that could cause actual results to differ materially from our expectations include, among others, such things as:

●	loss of senior management or technical personnel;

●	oil and natural gas prices and production costs;

●	our ability to replace oil and natural gas reserves, including changes in reserve estimates resulting from expected oil and gas prices, production rates, tax rates and production costs;

●

our ability to remain in compliance with the financial covenants related to our Credit Facility may be affected by events beyond our control, including market prices for our oil and gas. Any future inability to comply with these covenants, unless waived by the Bank, could adversely affect our liquidity by rendering us unable to borrow further under the Credit Facility.

●	exploitation, development, production and exploration results, including mechanical failure;

●	the estimated costs of asset retirement obligations, including whether or not those retirement costs, in whole or in part, are ever actually incurred in the future;

●	the potential unavailability of drilling rigs and other field equipment and services;

●	the existence of unanticipated liabilities relating to existing properties or those acquired in the future, including environmental liabilities;

●	factors affecting the nature and timing of our capital expenditures, including the availability of service contractors and equipment;

●	the willingness and ability of third parties to honor their contractual commitments;

●	permitting issues;

●	the nature, extent and duration of workovers;

●	the impact and costs related to compliance with or changes in laws governing our operations;

●	acquisitions and other business opportunities (or the lack thereof) that may be pursued by us;

●	competition for properties and the effect of such competition on the price of those properties;

●	economic, market or business conditions, including any change in interest rates or inflation;

●	the lack of available capital and financing;

●	risk factors consistent with comparable companies within our industry, especially companies with similar market capitalization and/or employee census; and

●	weather and other factors, many of which are beyond our control.

Furthermore, forward-looking statements are made based on our current assessment available at the time. Subsequently obtained information concerning the merits of any property, as well as changes in estimated exploration and development costs and ownership interest, may result in revisions to our expectations and intentions and, thus, we may alter our plans regarding any exploration and development activities.

Although we believe that the expectations reflected in such forward-looking statements are reasonable, those expectations may prove to be incorrect. As with comparable companies within our industry, there are numerous factors that could cause actual results to differ materially from our expectations. All forward-looking statements speak only as of the date made. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements. Except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated or unanticipated events or circumstances.

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Earthstone Energy, Inc.

Condensed Consolidated Balance Sheets

Page 1 of 2

	June 30,			March 31,
	2013			2013
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	2,202,000		$	2,180,000
Accounts receivable:
Oil and gas sales		2,833,000			3,055,000
Joint interest and other receivables
net of allowance of ($38,000) at June 30, 2013 and March 31, 2013		131,000			328,000
Other current assets		780,000			814,000

Total current assets		5,946,000			6,377,000

Oil and gas properties, full cost method:
Proved properties		58,374,000			53,265,000
Unproved properties		1,687,000			2,156,000
Accumulated depletion and impairment		(28,488,000	)		(27,729,000	)

Net oil and gas properties		31,573,000			27,692,000

Support equipment and other non-current assets
net of accumulated depreciation of ($442,000) and ($416,000), respectively		729,000			611,000

Total non-current assets		32,302,000			28,303,000

Total assets	$	38,248,000		$	34,680,000

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Earthstone Energy, Inc.

Condensed Consolidated Balance Sheets

Page 2 of 2

	June 30,			March 31,
	2013			2013
	(Unaudited)

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,099,000		$	1,631,000
Accrued liabilities		5,129,000			3,971,000

Total current liabilities		7,228,000			5,602,000

Long-term liabilities:
Long-term debt		5,000,000			4,000,000
Deferred tax liability		3,110,000			2,971,000
Asset retirement obligation, less current portion		1,872,000			1,809,000

Total long-term liabilities		9,982,000			8,780,000

Total liabilities		17,210,000			14,382,000

Shareholders’ equity:
Preferred shares, $0.001 par value, 600,000 authorized		-			-
and none issued or outstanding
Common shares, $0.001 par value, 6,400,000 shares authorized and		18,000			18,000
1,814,000 and 1,802,000 shares issued, respectively
Additional paid-in capital		23,325,000			23,278,000
Treasury stock, at cost, 82,000 shares		(457,000	)		(457,000	)
Accumulated deficit		(1,848,000	)		(2,541,000	)

Total shareholders’ equity		21,038,000			20,298,000

Total liabilities and shareholders’ equity	$	38,248,000		$	34,680,000

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Earthstone Energy, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

	Three Months Ended
	June 30,
	2013			2012
Revenues:
Oil and gas sales	$	3,582,000		$	2,220,000
Well service and water-disposal revenue		13,000			127,000

Total revenues		3,595,000			2,347,000

Expenses:
Oil and gas production		835,000			834,000
Production tax		309,000			196,000
Well service and water-disposal		37,000			23,000
Depletion and depreciation		786,000			294,000
Accretion of asset retirement obligation		49,000			43,000
General and administrative		693,000			681,000

Total expenses		2,709,000			2,071,000

Income from operations		886,000			276,000

Other income (expense):
Interest and other income		8,000			2,000
Interest and other expenses		(33,000	)		-

Total other income (expense)		(25,000	)		2,000

Income before income tax		861,000			278,000

Current income tax expense		27,000			12,000
Deferred income tax expense (benefit)		141,000			(4,000	)

Total income tax expense		168,000			8,000

Net income	$	693,000		$	270,000

Per share amounts:
Basic	$	0.40		$	0.16
Diluted	$	0.40		$	0.16

Weighted average common shares outstanding:
Basic		1,732,250			1,720,712
Diluted		1,732,250			1,720,712

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Earthstone Energy, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Three Months Ended
	June 30,
	2013			2012
Cash flows from operating activities:
Net income	$	693,000		$	270,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Depletion and depreciation		786,000			294,000
Deferred income tax expense		141,000			(4,000	)
Accretion of asset retirement obligation		49,000			43,000
Share-based compensation		47,000			60,000
Amortization of deferred financing costs		3,000			-
Change in:
Accounts receivable, net		419,000			441,000
Other current assets		34,000			(772,000	)
Accounts payable, accrued and other liabilities		716,000			(374,000	)

Net cash provided by (used in) operating activities		2,888,000			(42,000	)

Cash flows from investing activities:
Oil and gas properties		(3,718,000	)		(2,122,000	)
Purchases of support equipment and other non-current assets		(144,000	)		(28,000	)

Net cash used in investing activities		(3,862,000	)		(2,150,000	)

Cash flows from financing activities:
Borrowings on long-term debt		1,000,000			-
Deferred financing fees		(4,000	)		-

Net cash provided by financing activities		996,000			-

Cash and cash equivalents:
Net increase (decrease) in cash and cash equivalents		22,000			(2,192,000	)
Cash and cash equivalents, beginning of year		2,180,000			6,778,000

Cash and cash equivalents, end of period	$	2,202,000		$	4,586,000

Supplemental disclosure of cash flow information:
Cash paid for interest	$	31,000		$	-
Cash paid for income tax	$	-		$	70,000
Non-cash:
Increase in oil and gas property due to asset retirement obligation	$	19,000		$	14,000
Accrued capital expenditures	$	903,000		$	267,000
Prepaid capital expenditures	$	-		$	345,000

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Earthstone Energy, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2013

1. Basis of Presentation

The accompanying interim financial statements of Earthstone Energy, Inc. (formerly Basic Earth Science Systems, Inc.) are unaudited. However, in the opinion of management, the interim data includes any applicable adjustments necessary for a fair presentation of the financial and operational results for the interim period according to generally accepted accounting principles in the United States of America (“U.S. GAAP”).

At the directive of the Securities and Exchange Commission to use “plain English” in public filings, the Company will use such terms as “we,” “our,” “us” or “the Company” in place of Earthstone Energy, Inc. and its wholly-owned subsidiary. When such terms are used in this manner throughout the notes to the unaudited condensed consolidated financial statements, they are in reference only to the corporation, Earthstone Energy, Inc. and its subsidiaries, and are not used in reference to the Board of Directors, corporate officers, management, or any individual employee or group of employees.

The financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. We believe the disclosures made are adequate to make the information not misleading and suggest that these financial statements be read in conjunction with the financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the previous fiscal year-end.

Further, the results of operations for the three months covered by this report, are not necessarily indicative of the operating results that may be expected for the full fiscal year.

Fair Value Measurements. The Company’s financial instruments consist of cash and cash equivalents, trade receivables, trade payables and accrued liabilities, all of which are considered to be representative of their fair market value, due to the short-term and highly liquid nature of these instruments. The carrying value of the Company’s Credit Facility approximates its fair value, interest rates are variable based on prevailing market rates.

Use of Estimates. The preparation of financial statements in conformity with U.S. GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions concern matters that are inherently uncertain. Estimates and assumptions are revised periodically and the effects of revisions are reflected in the financial statements in the period it is determined to be necessary. Actual results could differ from those estimates.

Recent Accounting Pronouncements. In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. This ASU requires the Company to disclose both net and gross information about assets and liabilities that have been offset. The disclosures under this new guidance are required to be provided retrospectively for all comparative periods presented. The Company was required to implement this guidance effective for the first quarter of fiscal 2014. The adoption of ASU 2011-11 did not have a material impact on its consolidated financial statements.

2. Other Assets

	06/30/13		03/31/13
	(Unaudited)
Lease and well equipment inventory	$	371,000	$	371,000
Drilling and completion cost prepayments		208,000		210,000
Prepaid income tax		82,000		112,000
Other current assets		60,000		33,000
Prepaid issuance premiums		59,000		88,000

Total other current assets	$	780,000	$	814,000

3. Accrued Liabilities

	06/30/13		03/31/13
	(Unaudited)
Accrued operations payable	$	3,862,000	$	2,933,000
Accrued compensation		539,000		429,000
Accrued income tax payable and other		319,000		213,000
Short-term asset retirement obligation		301,000		296,000
Revenue and production taxes payable		108,000		100,000

Total accrued liabilities	$	5,129,000	$	3,971,000

4. Oil and Gas Properties

	06/30/13			03/31/13
	(Unaudited)
Proved properties	$	58,374,000		$	53,265,000
Unproved properties		1,687,000			2,156,000
Less accumulated depletion and impairment		(28,488,000	)		(27,729,000	)

Total oil and gas properties	$	31,573,000		$	27,692,000

As of June 30, 2013, the Company has recorded $58,374,000 as proved property costs. As of March 31, 2013, the Company had recorded $53,265,000 as proved property costs. Additions of $4,640,000 have been recorded during the three months ended June 30, 2013, included in these additions are $4,613,000 related to intangible drilling and completion costs and tangible drilling and completion costs. Of the total additions recorded during the three months ended June 30, 2013, 92% relate to our work in North Dakota.

As of June 30, 2013, the Company has recorded $1,687,000 as unproved property costs. As of March 31, 2013, the Company had recorded $2,156,000 as unproved property costs. For the three months ended June 30, 2013, the Company recorded additional unproved property costs of $138,000 related to wells in progress and $77,000 related to additional investments in unproved properties. During the three months ended June 30, 2013, $389,000 in well costs and $286,000 in costs related to acreage were transferred from unevaluated to depletable properties, in addition, there were leased acreage expirations of $9,000.

5. Long-Term Debt

During the quarter ended June 30, 2013, the Company drew $1 million on the Credit Facility. As of June 30, 2013, the Company had an outstanding balance under the Credit Facility of $5 million. As of June 30, 2013, we were not in compliance with the current ratio covenant as defined by the Credit Facility. In July 2013, a semiannual redetermination of the borrowing base was completed by the lender, subject to the satisfaction of increased collateral requirements being provided to the lender. The Company is in the process of providing the required documentation. The redetermination will result in an increase in the borrowing base from $6 million to $12 million. The increase in the borrowing base will result in the covenant violation being mitigated. The lender has not presented a notice of default related to this covenant violation to the Company. As of June 30, 2013 we were in compliance with all other covenants contained in the Credit Facility.

6. Income Tax

The provision for income tax is comprised of:

	Three Months Ended June 30,
	2013		2012
	(Unaudited)		(Unaudited)
Current:
Federal		20,000	$	11,000
State		7,000		1,000
Total current income tax		27,000		12,000

Deferred:
Federal		133,000		(4,000	)
State		8,000		-
Total deferred income tax		141,000		(4,000	)

Income tax expense		168,000	$	8,000

A reconciliation between the income tax provision at the statutory rate on income tax and the income tax provision for the three months ended is as follows:

	Three Months Ended June 30,
	2013			2012
	(Unaudited)			(Unaudited)
Federal tax at statutory rate	$	292,000		$	94,000
State taxes, net of federal benefit		9,000			-
Excess percentage depletion		(135,000	)		(93,000	)
Other adjustments, net		2,000			7,000

Income tax expense	$	168,000		$	8,000
Effective rate expressed as a percentage
of income before income tax		19.5	%		3	%

The overall effective tax rate expressed as a percentage of book income before income tax for the current three month period, as compared to the same period in the prior year, was higher due to a higher pre-tax income compared to the comparable prior period, coupled with a change in excess percentage depletion. For the current three month period, pre-tax income was $861,000 compared to $278,000 for the prior period.

Net deferred tax assets and liabilities were comprised of:

	June 30,			March 31,
	2013			2013
	(Unaudited)
Deferred tax assets:
Statutory depletion carry-forward	$	1,572,000		$	1,467,000
Other accruals		122,000			131,000
Allowance for doubtful accounts		14,000			14,000

Gross deferred tax assets		1,708,000			1,612,000

Deferred tax liabilities:
Depletion, depreciation and intangible drilling costs		(4,818,000	)		(4,583,000	)

Gross deferred tax liabilities		(4,818,000	)		(4,583,000	)

Deferred tax liabilities, net	$	(3,110,000	)	$	(2,971,000	)

Projections of future income taxes and their timing require significant estimates with respect to future operating results. Accordingly, deferred taxes may change significantly as more information and data is gathered with respect to such events as changes in commodity prices, their effect on the estimate of oil and gas reserves and the depletion of these long-lived reserves.

The Company is subject to U.S. federal income tax and income tax from multiple state jurisdictions.

The Company’s federal income tax returns for the prior three tax years of filings and state income tax returns for the prior four years of tax filings are still subject to examination by tax authorities.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended March 31, 2013, as well as the unaudited condensed consolidated financial statements and related notes and other information appearing in Item 1 of this report.

The preparation of our unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires us to make estimates and assumptions that affect the reported amounts in the unaudited condensed consolidated financial statements and the accompanying notes including matters arising during the normal course of business. We apply our best judgment, our knowledge of existing facts and circumstances and our knowledge of actions that we may undertake in the future in determining the estimates that will affect our unaudited condensed consolidated financial statements. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effects cannot be determined with precision, actual results may differ from these estimates.

As used in this report, unless the context otherwise indicates, references to “we,” “our,” and “us” refer to Earthstone Energy, Inc. and its subsidiary collectively.

As an oil and natural gas producer, our revenue, cash flow from operations, other income and profitability, reserve values, access to capital and future rate of growth are influenced by the prevailing prices of crude oil and natural gas. Changes in commodity prices affect, both positively and negatively, our financial condition, liquidity, ability to obtain financing and operating results. Changes in commodity prices may influence, both positively and negatively, the amount of crude oil and natural gas that we choose to produce. Prevailing prices for such commodities fluctuate in response to changes in supply and demand and a variety of additional factors beyond our control, such as global, political and economic conditions. Inherently, the prices received for crude oil and natural gas production are unpredictable, and such volatility is expected. Most of our production is sold at market prices. Obviously, if the commodity indexes fluctuate, the price that we receive for our production will fluctuate. Therefore, the amount of revenue that we realize, as well as our estimates of future revenues, is to a large extent determined by factors beyond our control.

Liquidity and Capital Resources

Liquidity Outlook. Our primary source of funding is the net cash flow from the sale of our oil and natural gas production. The profitability and cash flow generated by our operations in any particular accounting period will be directly related to: (a) the volume of oil and gas produced and sold, (b) the average realized prices for oil and gas sold, and (c) lifting costs. At the current price of oil, we believe the cash generated from operations, along with existing cash balances and available line of credit, should enable us to meet our existing and normal recurring obligations during the next year and beyond.

On December 21, 2012, we entered into a $25 million senior secured revolving bank Credit Facility with the Bank of Oklahoma which is intended to provide an additional source of funds to pay our share of drilling and completion costs incurred on wells drilled and completed in the Williston Basin. The initial borrowing base on the Credit Facility is $6 million and, as of June 30, 2013, we had an outstanding balance of $5 million. Among other provisions, the Credit Facility contains certain affirmative and negative covenants, including restrictions on indebtedness and dividends, and requirements with respect to working capital and interest coverage ratios. As of June 30, 2013, we were not in compliance with the current ratio covenant as defined by the Credit Facility. In July 2013, a semiannual redetermination of the borrowing base was completed by the lender, subject to the satisfaction of increased collateral requirements being provided to the lender. The Company is in the process of providing the required documentation. The redetermination will result in an increase in the borrowing base from $6 million to $12 million. The increase in the borrowing base will result in the covenant violation being mitigated. The lender has not presented a notice of default related to this covenant violation to the Company. As of June 30, 2013 we were in compliance with all other covenants contained in the Credit Facility. Our ability to remain in compliance with the financial covenants may be affected by events and other factors beyond our control, including market prices for our oil and gas and the rate at which the operators of projects in which we participate drill. Any future inability to comply with these covenants, unless waived by the Bank, could adversely affect our liquidity by rendering us unable to borrow further under the Credit Facility. For further information concerning the Credit Facility and its terms, see our Form 8-K filed with the SEC on January 3, 2013.

Overview of our Capital Structure. We recognize the importance of developing our capital resource base in order to pursue our objectives. However, subsequent to our last public offering in 1980, debt financing has been the sole source of external funding. In addition to our routine production-related costs, general and administrative expenses and, when necessary, debt repayment requirements, we require capital to fund our exploratory and development drilling efforts and the acquisition of additional properties as well as the enhancement of existing and newly acquired properties.

We have received numerous inquiries regarding the possibility of funding our efforts through equity contributions. Given strong cash flows, we have thus far declined these overtures. Our primary concern in this area is the dilution of our existing shareholders. However, going forward, given that one of the key components of our growth strategy is to expand our oil and natural gas reserve base through drilling and/or acquisitions, if we were presented with a significant opportunity and available cash and bank debt financing were insufficient, it is possible we would consider alternative means of obtaining additional financing.

Hedging. During the three months ended June 30, 2013 and 2012, we did not participate in any hedging activities, nor did we have any open futures or option contracts.

Working Capital. At June 30, 2013, we had a working capital deficit of $1,282,000 (a current ratio of 0.82:1) compared to a working capital surplus at March 31, 2013 of $775,000 (a current ratio of 1.14:1). The decrease in current ratio is primarily a result of the use of accounts payable and accrued operations payable for the development and exploration of oil and gas properties and ongoing oil and gas operations.

Cash Flow. Cash provided by operating activities was $2,888,000 for the three months ended June 30, 2013, compared to cash used in operating activities $42,000 for the three months ended June 30, 2012. Changes in operating cash relate primarily to the increase in net income adjusted for non-cash expenses for the three months ended June 30, 2013 compared to the same period ended June 30, 2012. The fluctuation in deferred income tax expense, the increase in depletion primarily related to the increase in the oil and gas property balance, the timing and payment of accounts payable, accrued and other liabilities, especially pertaining to capital expenditure outlays, in addition to the application of prepaid balances were also factors in deriving net cash flows from operations.

Overall, net cash used in investing activities increased for the three months ended June 30, 2013, to $3,862,000 from $2,150,000 for the three months ended June 30, 2012. This was the result of an increase in the number of wells drilled and completed during the current period compared to the same period in the prior year, as explained in “Capital Expenditures” below.

Net cash provided by financing activities was $996,000 for the three months ended June 30, 2013 related to borrowing on our Credit Facility. No cash was provided by or used in financing activities for the three months ended June 30, 2012.

Capital Expenditures

The amounts presented herein are presented on an accrual basis, and as such may not be consistent with the amounts presented on the condensed consolidated statements of cash flows under investing activities for expenditures on oil and gas property, which are presented on a cash basis.

During the three months ended June 30, 2013, we spent $4,640,000 on various projects. This compares to $2,748,000 for the three months ended June 30, 2012. During the three months ended June 30, 2013, capital expenditures were comprised of the drilling and completions of our wells producing as of period end (24%), drilling of 16 wells to be completed as of calendar year end (72%), and acquiring leasehold acreage (4%). The majority (92%) of capital expenditures were spent in the Williston basin. The remainder was spent in other areas on property improvements and leasehold acreage.

We are continually evaluating drilling and acquisition opportunities for possible participation. Typically, at any one time, several opportunities are in various stages of evaluation. Our policy is to not disclose the specifics of a project or prospect, nor to speculate on such ventures, until such time as those various opportunities are finalized and undertaken. We caution that the absence of news and/or press releases should not be interpreted as a lack of development or activity.

Divestitures/Abandonments

We neither sold nor plugged any wells during the three months ended June 30, 2013.

Impact of Inflation and Pricing

Inflation has not had a material impact on us in recent years because of the relatively low rates of inflation in the United States. However, the oil and natural gas industry can be cyclical and the demand for production places pressure on the economic stability and pricing within the industry. Typically, as prices for oil and natural gas increase, associated costs rise. Conversely, cost declines are likely to lag and may not adjust downward in proportion to declining prices. Changes in prices impact our revenues, estimates of reserves, assessments of any impairment of oil and natural gas properties, as well as values of properties being acquired or sold. Price changes have the potential to affect our ability to raise capital, borrow money, and retain personnel. While we do not presently expect business costs to materially rise, higher prices for oil and natural gas could result in increases in the costs of materials, services and personnel.

Other Commitments

We do not have any other commitments beyond our office lease and software maintenance contracts.

Results of Operations

The following provides selected financial information and averages for the three months ended June 30, 2013 and 2012.

	Three Months Ended
	June 30,
	2013		2012
Revenue
Oil	$	3,380,000	$	2,128,000
Gas		202,000		92,000
Total revenue 1		3,582,000		2,220,000

Total production expense 2		1,144,000		1,030,000

Gross profit	$	2,438,000	$	1,190,000

Depletion expense	$	760,000	$	279,000

Sales volume
Oil (Bbls)		36,967		26,999
Gas (Mcfs) 3		28,223		14,566

Average sales price 4
Oil (per Bbl)	$	91.43	$	78.82
Gas (per Mcf)	$	7.16	$	6.32

Average per BOE 5
Production expense 3, 4	$	27.45	$	35.00
Gross profit 4	$	58.51	$	40.44
Depletion expense 4	$	18.24	$	9.48

1		Amount does not include water service and disposal revenue. For the three months ended June 30, 2013, this revenue amount is net of $13,000 in well service and water disposal revenue, which would otherwise total $3,595,000 in revenue, compared to $127,000 in the respective periods ended June 30, 2012 to total $2,347,000 for the comparable three month period ended June 30, 2012.
2		Overall lifting cost (oil and gas production costs, including production taxes and the cost of workovers)
3		Estimates of volumes are inherent in reported volumes to coincide with revenue accruals as a result of the timing of sales information reporting by third party operators.
4		Averages calculated based upon non-rounded figures.
5		Per equivalent barrel (6 thousand cubic feet, “Mcf”, of gas is equivalent to 1 barrel, “Bbl”, of oil)

Three months ended June 30, 2013 compared to three months ended June 30, 2012

Overview. Net income for the three months ended June 30, 2013, was $693,000 compared to net income of $270,000 for the three months ended June 30, 2012. The increase in net income resulted from the increase in oil and gas production volumes and prices as described in “Revenues” and “Volumes and Prices” below.

Revenues. Oil sales revenue increased $1,252,000 (59%) for the three months ended June 30, 2013 to $3,380,000 from $2,128,000 for the three months ended June 30, 2012, due to the increase in reported production and a higher realized price per barrel as described in “Volumes and Prices” below.

Gas sales revenue increased $110,000 (120%) for the three months ended June 30, 2013, compared to the three months edned June 30, 2012, as a result of the increase in reported production and a higher realized price per Mcf as described in "Volume and Prices"
below.

Volumes and Prices. Oil sales volumes increased by 37% for the three months ended June 30, 2013, compared to the three months ended June 30, 2012. In addition, the average price per barrel increased by 16% for the three months ended June 30, 2013, compared to the three months ended June 30, 2012. The increase in oil sales volumes for the three months ended June 30, 2013 when compared to the three months ended June 30, 2012 was the result of an increase in production from newly producing wells, offset partially by declines in existing wells.

Gas sales volumes increased by 94% for the three months ended June 30, 2013, compared to the three months ended June 30, 2012. In addition, the average price per Mcf increased by 13% for the three months ended June 30, 2013, compared to the three months ended June 30, 2012. The increase in gas sales volumes for the three months ended June 30, 2013 when compared to the three months ended June 30, 2012 was the result of an increase in production from newly producing wells, offset partially by declines in existing wells.

Production Expense. Production expense is comprised of the following items:

	Three Months Ended June 30,
	2013		2012

Lease operating costs	$	697,000	$	658,000
Workover costs		116,000		171,000
Production taxes		309,000		196,000
Transportation and other costs		22,000		5,000

Total production expense	$	1,144,000	$	1,030,000

Oil and gas production expense increased $114,000 (11%) for the three months ended June 30, 2013, as compared to the expenses for the three months ended June 30, 2012, primarily due to an increase in production tax expense related to the increased production volume.

Routine lease operating expense (“LOE”), consisting of field personnel, fuel/power, chemicals, disposal, transportation and other costs, per BOE was $17.25 for the three months ended June 30, 2013, compared to $22.53 for the three months ended June 30, 2012. While the total dollars spent on routine lease operating expense was 8% higher between the comparable periods, the costs are being divided over more BOE in the three months ended June 30, 2013 resulting in a lower cost per BOE.

As a percent of oil and gas sales revenue, routine LOE was 20% for the three months ended June 30, 2013, compared to 31% for the three months ended June 30, 2012. This decrease in cost in proportion to revenue was due to a combination of the increase in oil and gas prices, production volume, and the number of producing wells between the comparable periods, coupled with a lower percentage increase in LOE costs between the comparable periods.

Workover operations, which generally consist of downhole repairs on a producing well, are conducted to restore or increase production and are generally random in nature. Therefore, workovers account for unpredictable fluctuations in oil and gas expense from period to period. The number of wells on which workover costs are expended varies as does the extent of workover operations. Workover expenses decreased $55,000 (32%) for the three months ended June 30, 2013, compared to the respective period ended June 30, 2012. Consequently, workover costs in the first quarter of fiscal year 2014 decreased to $2.78 per BOE from $5.81 per BOE in the first quarter of fiscal 2013.

Production taxes for the three months ended June 30, 2013 increased 58% over the three months ended June 30, 2012. As a percent of oil and gas sales revenue, production taxes remained the same between the two periods at 9%. Because production tax rates vary from state to state our average production tax rate will vary depending on the quantities produced from each area and the production tax rates in effect for those jurisdictions.

While overall lifting costs (oil and gas production costs, including production taxes as well as workovers) increased during the current quarter in relation to the comparable period in the prior year, those costs are spread over larger reported volumes, per BOE, for the three months ended June 30, 2013, compared to the three months ended June 30, 2012, causing the costs per BOE to decrease from $35.00 to $27.45.

Other Expenses. Depletion and depreciation increased $492,000 (167%) for the three months ended June 30, 2013, compared to the three months ended June 30, 2012. The increase in expense was a result of the addition of capital costs for newly drilled wells transferred into the pool of depletable property costs, as well as an increase in costs related to future development of proved undeveloped wells, offset by a slight decrease in the depletion rate due to a smaller volume of BOE production to total reserves during the current quarter.

General and Administrative (“G&A”) expense increased $12,000 (2%) for the three months ended June 30, 2013, over the expense for the three months ended June 30, 2012. While G&A expense increased slightly during the current quarter in relation to the comparable period in the prior year, those costs are spread over larger reported volumes, per BOE, for the three months ended June 30, 2013, compared to the three months ended June 30, 2012, causing the costs per BOE to decrease from $23.14 to $16.63.

Income Tax. For the three months ended June 30, 2013, we recorded income tax expense of $168,000, as compared to $8,000 for the three months ended June 30, 2012. Our effective income tax rate was 19.5% for the three months ended June 30, 2013. The overall effective tax rate expressed as a percentage of book income before income tax for the three months ended June 30, 2013, as compared to the same period in 2012, was higher due primarily to a higher pre-tax income compared to the comparable prior period coupled with a change in excess percentage depletion. For the three months ended June 30, 2013, pre-tax income was $861,000 compared to $278,000 for the prior period.

Off Balance Sheet Arrangements

We have no significant off balance sheet transactions, arrangements or obligations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a “smaller reporting company,” we are not required to provide this information.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act, the phrase “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2013. This evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer and Interim Chief Financial Officer. Based on this evaluation, our Chief Executive Officer and Interim Chief Financial Officer concluded that, as of June 30, 2013, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during our last fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 1A. RISK FACTORS

As a “smaller reporting company,” we are not required to provide this information.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Unregistered Sales of Equity Securities

Not applicable.

Purchases of Equity Securities

The following summarizes monthly share repurchase activity for the first quarter of the fiscal year ending March 31, 2014:

	Total Number of Shares Purchased¹		Average Price Paid Per Share		Number of Shares Purchased as Part of a Publicly Announced Plan¹		Maximum Shares that May Yet be Purchased under the Plan¹

April 1, 2013 – April 30, 2013		—	$	—		—		103,284
May 1, 2013 – May 31, 2013		—	$	—		—		103,284
June 1, 2013 – June 30, 2013		—	$	—		—		103,284
Total		—				—

On October 22, 2008, the Company’s Board of Directors authorized a share buyback program for the Company to repurchase up to 50,000 pre-split shares of its common stock for a period of up to 18 months. The program does not require the Company to repurchase any specific number of shares, and the Company may terminate the repurchase program at any time. On November 13, 2009, the Board of Directors increased the number of shares authorized for repurchase to 150,000 pre-split shares. On February 10, 2010, the Board extended the termination date of the program from April 22, 2010 to October 22, 2011. On November 7, 2011, the Board further extended the termination date of the program from October 22, 2011 to October 22, 2013. During the quarter ended December 31, 2012, no shares were repurchased under the share buyback program and 103,284 shares (11,067 post-split shares) remain available for future repurchase.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibit No.		Document

31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Ray Singleton, President and Chief Executive Officer).

31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Paul D. Maniscalco, Interim Chief Financial Officer).

32.1		Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Ray Singleton, President and Chief Executive Officer).

32.2		Certification Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Paul D. Maniscalco, Interim Chief Financial Officer).

101		The following materials from the Company’s quarterly report on Form 10-Q for the quarter ended June 30, 2013, formatted in XBRL (Extensible Business Reporting Language): (i) the Unaudited Condensed Consolidated Statements of Operations, (ii) the Unaudited Condensed Consolidated Balance Sheets, (iii) the Unaudited Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Unaudited Condensed Consolidated Financial Statements, tagged as blocks of text.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed by the following authorized persons on behalf of Earthstone Energy, Inc.

	EARTHSTONE ENERGY, INC.

Date: August 12, 2013	By:	/s/ Ray Singleton
		Ray Singleton
		President and Chief Executive Officer

	By:	/s/ Paul D. Maniscalco
		Paul D. Maniscalco
		Interim Chief Financial Officer

Attached files

EARTHSTONE ENERGY INC Reports

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