EARTHSTONE ENERGY INC - Quarter Report: 2010 June (Form 10-Q)

e10q_6-10.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, 2010

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 1645, Denver, Colorado (Address of principal executive office)	80202-3625 (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 o 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 (Do not check if a smaller reporting company) Smaller reporting company þ

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 13, 2010: 17,081,132

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EARTHSTONE ENERGY, INC.

FORM 10-Q

INDEX

	PART I. FINANCIAL INFORMATION	Page

Item 1.	Financial Statements	4

	Consolidated Balance Sheets:
	June 30, 2010 (Unaudited) and March 31, 2010	4

	Consolidated Statements of Operations:
	Three Months Ended June 30, 2010 and 2009 (Unaudited)	6

	Consolidated Statements of Cash Flows:
	Three Months Ended June 30, 2010 and 2009 (Unaudited)	7

	Notes to Unaudited Consolidated Financial Statements:
	June 30, 2010 (Unaudited)	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	16

Item 4.	Controls and Procedures	16

	PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	17

Item 1A.	Risk Factors	17

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	17

Item 3.	Defaults Upon Senior Securities	17

Item 4.	Submission of Matters to a Vote of Security Holders	17

Item 5.	Other Information	17

Item 6.	Exhibits	18

	Signatures	19

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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. The use of any statements containing the words "anticipate," "intend," "believe," "estimate," "project," "expect," "plan," "should" or similar expressions are intended to identify such statements. Forward-looking statements relate to, among other things:

• our future financial position, including anticipated liquidity;

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

• amounts and nature of future capital expenditures;

• acquisitions and other business opportunities;

• operating costs and other expenses;

• wells expected to be drilled;

• asset retirement obligations; and

• estimates of proved oil and natural gas reserves, deferred tax liabilities, and depletion rates.

• our ability to meet additional acreage, seismic and/or drilling cost requirements arising from acquisition opportunities;

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

• oil and natural gas prices;

• our ability to replace oil and natural gas reserves;

• loss of senior management or technical personnel;

• inaccuracy in reserve estimates and expected production rates;

• exploitation, development and exploration results;

• the actual costs related to asset retirement obligations, and whether or not those retirements actually occur in the future;

• a lack of available capital and financing;

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

• the existence of unanticipated liabilities or problems relating to acquired properties;

• general economic, market or business conditions;

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

• permitting issues, workovers, and weather;

• the impact and costs related to compliance with or changes in laws or regulations governing our oil and natural gas operations;

• environmental liabilities;

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

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

• risk factors consistent with comparable companies within our industry, especially companies with similar market capitalization

and/or employee census.

• other factors, many of which are beyond our control.

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 the 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.

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Earthstone Energy, Inc.

Consolidated Balance Sheets

Page 1 of 2

	June 30,			March 31,
	2010			2010
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	4,972,000		$	4,905,000
Accounts receivable:
Oil and gas sales		1,003,000			1,021,000
Joint interest and other receivables, net of $86,000 in allowance		238,000			401,000
Other current assets		593,000			732,000

Total current assets		6,806,000			7,059,000

Oil and gas property, full cost method:
Proved property		34,268,000			33,915,000
Unproved property		2,195,000			1,555,000
Accumulated depletion and impairment		(23,832,000	)		(23,582,000	)

Net oil and gas property		12,631,000			11,888,000

Support equipment and other non-current assets, net of $362,000 and $374,000 in accumulated depreciation, respectively		443,000			451,000

Total non-current assets		13,074,000			12,339,000

Total assets	$	19,880,000		$	19,398,000

See accompanying notes to unaudited consolidated financial statements.

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Earthstone Energy, Inc.

Consolidated Balance Sheets

Page 2 of 2

	June 30,			March 31,
	2010			2010
	(Unaudited)
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable	$	330,000		$	161,000
Accrued liabilities		1,788,000			1,836,000

Total current liabilities		2,118,000			1,997,000

Long-term liabilities:
Deferred tax liability		2,218,000			2,217,000
Asset retirement obligation		1,687,000			1,674,000

Total long-term liabilities		3,905,000			3,891,000

Total liabilities		6,023,000			5,888,000

Shareholders’ Equity:
Preferred stock, $.001 par value, 3,000,000 authorized and none issued or outstanding		—			—
Common stock, $.001 par value, 32,000,000 shares authorized and 17,791,000 and 17,704,000 shares issued and outstanding, respectively		18,000			18,000
Additional paid-in capital		22,965,000			22,945,000
Treasury stock (694,000 and 646,000 shares respectively); at cost		(302,000	)		(251,000	)
Accumulated deficit		(8,824,000	)		(9,202,000	)

Total shareholders’ equity		13,857,000			13,510,000

Total liabilities and shareholders’ equity	$	19,880,000		$	19,398,000

See accompanying notes to unaudited consolidated financial statements.

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Earthstone Energy, Inc.

Consolidated Statements of Operations

(Unaudited)

		Three Months Ended
		June 30,
		2010		2009

Revenues:
Oil and gas sales	$	1,763,000	$	1,460,000
Well service and water disposal revenue		1,000		16,000

Total revenues		1,764,000		1,476,000

Expenses:
Oil and gas production		501,000		468,000
Production tax		126,000		120,000
Well servicing expenses		3,000		15,000
Depreciation and depletion		259,000		238,000
Accretion of asset retirement obligation		40,000		42,000
Asset retirement expense		5,000		4,000
General and administrative		386,000		335,000

Total expenses		1,320,000		1,222,000

Income from operations		444,000		254,000

Other Income (Expense):
Interest and other income		3,000		―
Interest and other expenses		―		(15,000)

Total other income (expense)		3,000		(15,000)

Income before income taxes		447,000		239,000

Current income tax expense (benefit)		68,000		(58,000)
Deferred income taxes		1,000		48,000

Total income tax expense (benefit)		69,000		(10,000)

Net income	$	378,000	$	249,000

Per share amounts:
Basic	$	0.02	$	0.01
Diluted	$	0.02	$	0.01

Weighted average common shares outstanding:
Basic		16,867,674		17,024,579
Diluted		16,867,674		17,024,579

See accompanying notes to unaudited consolidated financial statements.

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Earthstone Energy, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

		Three Months Ended
		June 30,
		2010		2009

Cash flows from operating activities:
Net income	$	378,000	$	249,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and depletion		259,000		238,000
Deferred tax liability		1,000		48,000
Accretion of asset retirement obligation		40,000		42,000
Share based compensation		20,000		12,000
Change in:
Accounts receivable, net		181,000		(470,000)
Other current assets		139,000		1,000
Accounts payable and accrued liabilities		175,000		341,000

Net cash provided by operating activities		1,193,000		461,000

Cash flows from investing activities:
Oil and gas property		(1,074,000)		(333,000)
Support equipment		(1,000)		―

Net cash used in investing activities		(1,075,000)		(333,000)

Cash flows from financing activities:
Purchase of treasury shares		(51,000)		(162,000)

Net cash used in financing activities		(51,000)		(162,000)

Cash and cash equivalents:
Increase (decrease) in cash and cash equivalents		67,000		(34,000)
Balance, beginning of year		4,905,000		4,088,000

Balance, end of period	$	4,972,000	$	4,054,000

Supplemental disclosure of cash flow information:
Cash paid for interest	$	―	$	10,000
Cash paid for income tax	$	90,000	$	―
Non-cash:
Increase in oil and gas property due to asset retirement obligation	$	202,000	$	16,000
Vested shares issued as compensation	$	―	$	48,000
Additions to oil and gas also included in accrued liabilities	$	633,000	$	87,000

See accompanying notes to unaudited consolidated financial statements.

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Earthstone Energy, Inc.

Notes to Unaudited Consolidated Financial Statements

June 30, 2010

1. Presentation of Consolidated Financial Statements

The accompanying interim financial statements of Earthstone Energy, Inc. (formerly Basic Earth Science Systems, Inc. sometimes referred to as “the Company” “we” “our” or “us”) are unaudited. However, in the opinion of management, the interim data includes any applicable adjustments necessary for a fair presentation according to generally accepted accounting principles (GAAP) of the financial and operational results for the interim period.

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. When such terms are used in this manner throughout this document 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 footnote disclosures normally included in financial statements prepared in accordance with 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 our Annual Report on Form 10-K for the year ended March 31, 2010 and Quarterly Reports on Form 10-Q for the quarters ended December 31, 2009, September 30, 2009 and June 30, 2009.

For the period ended June 30, 2010, we determined that there were no subsequent events to recognize or disclose in these consolidated financial statements which would either impact the results reflected in this report or the Company’s results going forward.

Organization and Nature of Operations. Earthstone Energy, Inc. was originally organized in July 1969 as Basic Earth Science Systems, Inc. We are principally engaged in the acquisition, exploitation, development, operation and production of crude oil and natural gas. Our primary areas of operation are the Williston basin in North Dakota and Montana, south Texas and the Denver-Julesburg basin in Colorado.

Principles of Consolidation. The consolidated financial statements include our accounts and those of our wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The Company does not have any off-balance sheet financing arrangements or any unconsolidated special purpose entities.

2. Summary of Significant Accounting Policies and Recent Accounting Pronouncements

Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the actual amounts of assets and liabilities at the date of the financial statements and the actual amounts of revenues and expenses during the reporting period. We base these estimates on assumptions that we understand are reasonable under the circumstances. The estimated results that are produced by this effort will differ under different assumptions or conditions. We understand that these estimates are necessary, and we caution that actual results could vary significantly from the estimated amounts for the current and future periods.

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There are many factors, including global events, which may influence the production, processing, marketing, and valuation of crude oil and natural gas. A reduction in the valuation of oil and gas properties resulting from declining prices or production could adversely impact depletion rates and ceiling test limitations. We understand the following accounting policies and estimates are necessary in the preparation of our consolidated financial statements: the carrying value of our oil and gas property, the accounting for oil and gas reserves, the estimate of our asset retirement obligations, the estimate of our income tax assets and liabilities and estimates of accrued quantities and prices in our oil and gas receivable.

Oil and Gas Reserves. Oil and gas reserves represent theoretical, estimated quantities of crude oil and natural gas which geological and engineering data estimate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. There are numerous uncertainties inherent in estimating oil and gas reserves and their values, including many factors beyond our control. Accordingly, reserve estimates are different from the future quantities of oil and gas that are ultimately recovered and the corresponding lifting costs associated with the recovery of these reserves. As of our year end, March 31, 2010, ninety-three percent of our reported oil and gas reserves are based on estimates prepared by Ryder Scott Company, L.P, a nationally recognized, independent petroleum engineering firm. The remaining seven percent of our oil and gas reserves were prepared by our technical in-house staff.

Each quarter, we update reserve estimates by substituting the prices that were used by our independent petroleum engineers with average first-of-the-month prices for each of the three months of the quarter. In conducting this “re-pricing” no changes are made to the decline rates, tax rates or lifting costs used by our independent petroleum engineers. The determinations of depletion expense, as well as the results of ceiling tests and corresponding write-downs, if any, are highly dependent on these reserve and quarterly “re-pricing” estimates.

Oil and Gas Sales. We derive revenue primarily from the sale of produced natural gas and crude oil. We report revenue on a gross basis for the amounts received before taking into account production taxes and transportation costs, which are reported as separate expenses. Revenue is recorded using the sales method, which occurs in the month production is delivered to the purchaser, at which time title changes hands. Payment is generally received between 30 and 90 days after the date of production. We make estimates of the amount of production delivered to purchasers and the prices we will receive. We use our knowledge of our properties, their historical performance, NYMEX and local spot market prices, and other factors as the basis for these estimates. Variances between estimates and the actual amounts received are recorded when payment is received, or when better information is available.

Oil and Gas Property. We follow the full cost method of accounting for our oil and gas property. Accordingly, all costs associated with the acquisition, exploration and development of oil and gas properties are capitalized. These capitalized costs are subject to a ceiling test that limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved oil and gas reserves discounted at 10 percent plus the lower of cost or fair value of unproved properties less any associated tax effects. If the full cost pool of capitalized oil and gas property costs exceeds the ceiling, we will record a ceiling test write-down to the extent of such excess. This write-down is a non-cash charge to earnings. If required, it reduces earnings and impacts stockholders’ equity in the period of occurrence. The write-down may not be reversed in future periods, even though higher oil and gas prices in the future may subsequently and significantly increase reserve estimates in future periods. As of the balance sheet date, our capitalized costs did not exceed the ceiling test limit.

Cash and Cash Equivalents. For purposes of the Consolidated Balance Sheets and Statements of Cash Flows, we consider all highly liquid investments with a maturity of ninety days or less when purchased to be cash equivalents. The carrying amount of cash equivalents approximates fair value because of the short-term maturity of those instruments. During the period and at the balance sheet date, balances of cash and cash equivalents exceeded the federally insured limit.

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Support Equipment and Other. Support equipment (including such items as vehicles, office furniture and equipment and well servicing equipment) is stated at cost. Depreciation of support equipment and other property is computed using the straight-line method over periods ranging from five to seven years.

Long-Lived Assets. We regularly evaluate all long-lived assets for possible impairment. Assets are reported at the lower of cost or their estimated recoverable amounts. During the periods ended June 30, 2010 and 2009 there was no impairment recorded for long-lived assets.

Fair Value Measurements. Effective April 1, 2009, we adopted the provisions for nonfinancial assets and liabilities that are not required to be measured at fair value on a recurring basis, which include, among others, those assets measured at fair value for impairment assessment and asset retirement obligations initially measured at fair value. Fair value used in the initial recognition of asset retirement obligations is determined based on the present value of expected future dismantlement costs incorporating our estimate of inputs used by industry participants when valuing similar liabilities. Accordingly, the fair value is based on unobservable pricing inputs and therefore, is considered a level 3 value input in the fair value hierarchy.

Asset Retirement Obligations. We have obligations related to the plugging and abandonment of our oil and gas wells. We estimate the future cost of these obligations, discount this cost to its present value, and record a corresponding asset and liability in our Consolidated Balance Sheets. The values ultimately derived are based on numerous and significant estimates, including the ultimate expected cost of the obligation, the expected future date of the required cash expenditures and inflation rates. The nature of these estimates requires us to make judgments based on historical experience and future expectations related to timing. We review the estimate of our future asset retirement obligations quarterly. These quarterly reviews may require revisions to these estimates based on such things as changes to cost estimates or the timing of future cash outlays. Any such changes that result in upward or downward revisions in the estimated obligation will result in an adjustment to the related capitalized asset and corresponding liability on a prospective basis.

We recognize two components on our consolidated statement of operations; accretion of asset retirement obligations and asset retirement expense. Accretion of asset retirement obligation reflects the periodic accretion of the present value of future plugging and abandonment costs. Asset retirement expense reflects the actual current period gains and losses on plugging and abandonment costs relative to previously estimated future costs. We have closed gains and losses on asset retirements to the Consolidated Statement of Operations as a component of asset retirement expense.

The information below reconciles the value of the asset retirement obligation for the period presented. This includes a short term obligation of $160,000, which is carried within the accrued liabilities line item of the balance sheet.

	Three Months Ended
	June 30,
	2010

Asset retirement obligation – April 1, 2010	$	1,774,000
Liabilities incurred		16,000
Liabilities settled		(169,000	)
Revisions to estimates		186,000
Accretion expense		40,000

Asset retirement obligation – June 30, 2010	$	1,847,000

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Commitments. We currently office in a 4,000 square foot office space located in downtown Denver, Colorado, and are committed to a total of $281,000 plus maintenance fees for the five-year lease term ending April 1, 2013. We have no off balance sheet transactions or arrangements.

Income Taxes. We account for income taxes with deferred tax liabilities and assets which are determined based on the temporary differences between the financial statements and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse.

Projections of future income taxes and their timing require significant estimates with respect to future operating results. Accordingly, the net deferred tax liability is continually re-evaluated and numerous estimates are revised over time. As such, the net deferred tax liability 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.

We are subject to U.S. federal income tax and income tax from multiple state jurisdictions. The tax years remaining subject to examination by tax authorities are fiscal years 2007 through 2009. We recognize interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2010, we made no provisions for interest or penalties related to uncertain tax positions.

Earnings Per Share. Our earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net income by the diluted weighted average number of common shares. The diluted weighted average number of common shares is computed using the treasury stock method for common stock that may be issued for outstanding stock options. As of the balance sheet date no dilutive securities were outstanding.

Reclassifications. Certain prior year amounts were reclassified to conform to current year presentation. Such reclassifications had no effect on net income.

Recent Accounting Pronouncements

In January 2010, guidance for fair value measurements and disclosure was updated to require additional disclosures related to transfers in and out of level 1 and 2 fair value measurements and enhanced detail in the level 3 reconciliation. The guidance was amended to clarify the level of disaggregation required for assets and liabilities and the disclosures required for inputs and valuation techniques used to measure the fair value of assets and liabilities that fall in either level 2 or level 3. The updated guidance was effective for the Company’s fiscal year beginning April 1, 2010, with the exception of the level 3 disaggregation which is effective for the Company’s fiscal year beginning April 1, 2011. The adoption had no impact on the Company’s consolidated financial position, results of operations or cash flows.

In June 2009, the FASB issued Accounting Standards Codification, “Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (Codification) which will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this Statement, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification will become non-authoritative. This Statement is effective for financial statements issued for interim and annual periods ended after September 15, 2009. The adoption of the Codification did not have a material impact on our consolidated financial statements or results of operations.

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In December 2008, the SEC announced final approval of new requirements for reporting oil and gas reserves. Among the changes to the disclosure requirements is a broader definition of reserves, which allows reporting of probable and possible reserves, in addition to consideration of new technologies and non-traditional resources. In addition, oil and gas reserves will be reported using an average price based on the first-day-of-the-month price during the prior 12-month period, rather than year-end prices. The new rules are effective for years ending on or after December 31, 2009. The adoption of the new rules is considered a change in accounting principle inseparable from a change in accounting estimate. The Company does not believe that provisions of the new guidance, other than pricing, significantly impacted the reserve estimates or financial statements which also impact the amount recorded for depreciation, depletion and amortization and the ceiling test calculation for oil and gas properties. Under the new guidance, subsequent price increases cannot be considered in the ceiling test calculation. The Company does not believe that it is practicable to estimate the effect of applying the new rules on net loss or the amounts recorded for depreciation, depletion and amortization and ceiling impairment.

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 fiscal year ended March 31, 2010, as well as the financial statements and related notes and other information appearing elsewhere in this report.

As a crude 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 substantially dependent upon the prevailing prices of crude oil and natural gas. Declines in commodity prices will materially and adversely affect our financial condition, liquidity, ability to obtain financing and operating results. Lower commodity prices may reduce the amount of crude oil and natural gas that we can produce economically. Prevailing prices for such commodities are subject to wide fluctuation in response to relatively minor changes in supply and demand and a variety of additional factors beyond our control, such as global, political and economic conditions. Historically, prices received for crude oil and natural gas production have been volatile and unpredictable, and such volatility is expected to continue. Most of our production is sold at market prices. Generally, if the commodity indexes fall, the price that we receive for our production will also decline. Therefore, the amount of revenue that we realize 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 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. Assuming that oil prices do not decline from current levels, we believe the cash generated from operations, along with existing cash balances, will enable us to meet our existing and normal recurring obligations during the next year and beyond.

Working Capital. At June 30, 2010, we had a working capital surplus of $4,688,000 (a current ratio of 3.21:1) compared to a working capital surplus at March 31, 2010 of $5,062,000 (a current ratio of 3.53:1). The decrease in current ratio is largely a result of the timing between payments made for payables and cash received for revenue.

Cash Flow. Net cash provided by operating activities increased 158.8% from $461,000 in the three months ended June 30, 2009 (“2009”) to $1,193,000 in the three months ended June 30, 2010 (“2010”) primarily due to increased oil and gas commodity prices and resulting increase in oil and gas revenues, the timing and collection of receivables, and the timing and application of prepaid costs.

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Net cash used in investing activities increased 222.8% from $333,000 in the three months ended June 30, 2009 to $1,075,000 in the three months ended June 30, 2010. The difference relates primarily to significantly more expenditures made during 2010 on DJ Basin wells in Colorado as well as a new Williston Basin well in North Dakota.

Net cash used in financing activities decreased 68.5% from $162,000 in the three months ended June 30, 2010 to $51,000 in the three months ended June 30, 2010. Cash used in financing activities related to the stock buyback program adopted in October 2008.

Credit Line. Our current banking relationship, established in March 2002, is with American National Bank (“the Bank”), located in Denver, Colorado. Subject to evaluation every six months, the line of credit amount was set at $20 million with a concurrent borrowing base of $4 million. Effective December 31, 2008, the loan agreement was amended to extend the maturity date of the credit agreement to December 31, 2010. We renewed the line with an interest rate of prime plus 0.25% or 6.5% whichever is higher. During the year ended March 31, 2010 and for the three months ended June 30, 2010, we did not utilize our credit facility. The loan contains several covenant restrictions. At June 30, 2010, we were in compliance with all covenants. This line may be used for purposes of borrowing funds to reduce payables, finance re-completion or drilling efforts, fund property acquisitions or pursue other opportunities that might arise.

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 Consolidated Statement of Cash Flows under investing activities for expenditures on oil and gas property, which are presented on a cash basis.

During the quarter ended June 30, 2010, we spent approximately $791,000 on various projects. This compares to $377,000 for the quarter ended June 30, 2009. During the quarter ended June 30, 2010, approximately 81.6% of capital expenditures were dedicated to drilling and completions, and 17.2% on leasing property in the Williston Basin. Of the drilling and completions, we spent approximately 71.4% on re-completing six of our DJ Basin wells in Colorado to the J-sand zone. The remaining expenditures primarily consisted of the drilling of the Pederson 10-3H, a new Williston Basin well in North Dakota. These projects were funded with cash flow from operations.

At present cash levels, and with the extension of our available borrowing capacity, we expect to have sufficient funds available for our share of any additional acreage, seismic and/or drilling cost requirements that might arise from these opportunities. We may alter or vary all or part of any planned capital expenditures for reasons including but not limited to: changes in circumstances, unforeseen opportunities, inability to negotiate favorable acquisition, farmout or joint venture terms, lack of cash flow and lack of additional funding.

We currently have no capital expenditure commitments. We are continually evaluating drilling and acquisition opportunities for possible participation. Typically, at any one time, several opportunities are in various stages of due diligence. 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

During the quarter ended June 30, 2010, we plugged two wells.

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Results of Operations

Overview. Net income for the three months ended June 30, 2010 was $378,000, compared to net income of $249,000 for the three months ended June 30, 2009. The following table shows selected financial information for the three months ended June 30 in the current and prior year. Certain prior year amounts may have been reclassified to conform to current year presentation.

		Three Months Ended
		June 30,
		2010		2009
Sales volume
Oil (barrels)		23,222		24,343
Gas (mcf) (1)		23,964		35,186

Revenue
Oil	$	1,577,000	$	1,270,000
Gas		186,000		190,000
Total revenue (2)		1,763,000		1,460,000

Total production expense (3)		627,000		588,000

Gross profit	$	1,136,000	$	872,000

Depletion expense	$	250,000	$	230,000

Average sales price (4)
Oil (per barrel)	$	67.91	$	52.17
Gas (per mcf)	$	7.76	$	5.40

Average per BOE
Production expense(3,4,5)	$	23.04	$	19.47
Gross profit (4,5)	$	41.74	$	28.87
Depletion expense (4,5)	$	9.19	$	7.61

(1)	Due to the timing and accuracy of sales information received from a third party operator as described in “Volumes and Prices” below, sales volume amounts may not be indicative of actual production or future performance.
(2)	Amount does not include water service and disposal revenue. For the quarter ended June 30, 2010 this revenue amount is net of $1,000 in water service and disposal revenue, which would otherwise total $1,764,000 in revenue, compared to $16,000 in 2009 to total $1,476,000 for the same period in 2009.
(3)	Overall lifting cost (oil and gas production expenses and production taxes)
(4)	Averages calculated based upon non-rounded figures
(5)	Per equivalent barrel (6 Mcf of gas is equivalent to 1 barrel of oil)

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Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009

Revenues. Oil and gas sales revenue increased $303,000 (20.8%) in 2010 from 2009 due to higher realized oil and gas prices. Oil sales revenue increased $307,000 (24.2%), and gas sales revenue decreased $4,000 (2.1%) in 2010 from 2009.

Volumes and Prices. Oil sales volume decreased 4.6%, from 24,343 barrels in 2009 to 23,222 barrels in 2010 while there was an increase of 30.2% in the average price per barrel from $52.17 in 2009 to $67.91 in 2010. Gas sales volume decreased 31.9% from 35,186 thousand cubic feet (Mcf) in 2009 to 23,964 Mcf in 2010, while the average price per Mcf increased 43.7%, from $5.40 in 2009 to $7.76 in 2010. The decrease in gas sales volume is primarily due to normal decline in production related to the Antenna Federal property in Weld County, Colorado. On an equivalent barrel of oil (BOE) basis, sales volume decreased 9.9% from 30,207 BOE in 2009 to 27,216 BOE in 2010.

Expenses. Oil and gas production expense increased $33,000 (7.1%) in 2010 over 2009, primarily due to routine lease operating expense increasing by $106,000 (31.3%) from $339,000 in 2009 to $445,000 in 2010, and workover expense decreasing $73,000 (56.6%) from $129,000 in 2009 to $56,000 in 2010. Routine lease operating expense per BOE increased 45.7% from $11.22 in 2009 to $16.35 in 2010 due to the recovering oil and gas prices and corresponding increases in operating costs, while workover expense per BOE decreased 51.8% from $4.27 in 2009 to $2.06 in 2010 due to fewer workover operations in 2010.

Production taxes, which are generally a percentage of sales revenue, increased $6,000 (5.0%) in 2010 compared to 2009. Production taxes, as a percent of sales revenue decreased from 8.1% in 2009 to 7.1% in 2010. The overall lifting cost (oil and gas production expense and production taxes) per BOE increased 18.4% from $19.47 in 2009 to $23.04 in 2010.

Depreciation and depletion expense increased $21,000 (8.8%) in 2010 compared to 2009 as a result of volumes produced as described above coupled with the increase in our full cost pool, and more specifically, our depletable base during this past year as compared to 2009.

General and administrative (G&A) expense increased $51,000 (15.2%) in 2010 over 2009. This rise in G&A expense is comprised of $134,000 in increases and $83,000 in decreases in various expense categories. Of the increases, $45,000 relates to the timing of expensing executive bonus which we now perform quarterly rather than annually, $22,000 in employee compensation expense, $21,000 in legal expense, $20,000 in other expenses including office, insurance and tax expenses, $15,000 in oil and gas incentive compensation expense, and $11,000 in shareholder related expenses including the timing of proxy statement costs and board of director compensation expense. Decreases in G&A costs related to decreases of $83,000 in professional fees including consulting and contractor expenses related to investor relations, accounting and Sarbanes-Oxley. G&A expense per BOE increased 27.9% from $11.09 in 2009 to $14.18 in 2010. As a percent of total sales revenue, G&A expense decreased from 22.7% in 2009 to 21.9% in 2010.

Income Tax Expense (Benefit). For the three months ended June 30, 2010, we recorded an income tax expense of $69,000 as compared to an income tax benefit of $10,000 for the three months ended June 30, 2009. Our effective income tax rate decreased from 25.62% for the three months ended June 30, 2009 to 15.47% for the three months ended June 30, 2010. Our effective income tax rate was lower for the three month period ended June 30, 2010 primarily due to an increase in estimated deductions for statutory depletion.

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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

The Company maintains a system of disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for the purpose of providing reasonable assurance that information required to be disclosed in its SEC reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and the Principal Accounting Officer, as appropriate to allow timely decisions regarding required disclosures.

For the quarter ended June 30, 2010, we evaluated under the supervision and with the participation of the Company’s Chief Executive Officer and Principal Accounting Officer, the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, we concluded that the Company’s disclosure controls and procedures are effective for the purposes discussed above.

There have been no changes in the Company’s internal control over financial reporting that occurred during the Company’s quarter ended June 30, 2010 that have materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.

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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 table summarizes stock repurchase activity for the three months ended June 30, 2010:

	Total Number of Shares Purchased (1)		Average Price Paid Per Share		Number of Shares Purchased as Part of a Publicly Announced Plan (1)		Maximum Shares that May Yet be Purchased under the Plan (1)

April 1, 2010 - April 30, 2010		30,984	$	1.03		30,984		1,173,386
May 1, 2010 - May 31, 2010		10,300	$	1.05		10,300		1,163,086
June 1, 2010 - June 30, 2010		6,800	$	0.95		6,800		1,156,286

Total		48,084				48,084

(1)

On October 22, 2008, the Company’s board of directors authorized a stock buyback program for the Company to repurchase up to 500,000 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 1,500,000. On February 10, 2010, the board extended the termination date of the program from April 22, 2010 to October 22, 2011. During the three months ended June 30, 2010, 48,084 shares were repurchased under the stock buyback program and 1,156,286 shares remain available for future repurchase.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

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Item 6. Exhibits

Exhibit No.		Document

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

31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Joseph Young, Principal Accounting 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, 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 (Joseph Young, Principal Accounting Officer).

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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.
By: /s/ Ray Singleton
Ray Singleton
President and Chief Executive Officer

By: /s/ Joseph Young
Joseph Young
Principal Accounting Officer

Date: August 13, 2010