UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

OR

☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-33801

APPROACH RESOURCES INC.

(Exact name of registrant as specified in its charter)

Delaware | 51-0424817
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.)
One Ridgmar Centre 6500 West Freeway, Suite 800 Fort Worth, Texas | 76116
(Address of principal executive offices) | (Zip Code)

(817) 989-9000

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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 such filing requirements for the past 90 days. ☒ Yes ☐ No

Indicate by check mark whether the registrant has submitted electronically if any, every Interactive Data File required to be submitted 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 such files) ☒ Yes ☐ No

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

Large accelerated filer | ☐ |  | Accelerated filer | ☒
Non-accelerated filer | ☐ |  | Smaller reporting company | ☒
Emerging growth company | ☐ |  |  |

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No

The number of shares of the registrant’s common stock, $0.01 par value, outstanding as of November 1, 2018, was 94,506,674.

PART I―FINANCIAL INFORMATION

Item 1. Financial Statements.

Approach Resources Inc. and Subsidiaries

Unaudited Consolidated Balance Sheets

(In thousands, except shares and per-share amounts)

|  | September 30, |  |  | December 31, |
|  | 2018 |  |  | 2017 |
ASSETS |  |  |  |  |  |  |  |
CURRENT ASSETS: |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 22 |  |  | $ | 21 |
Accounts receivable: |  |  |  |  |  |  |  |
Joint interest owners |  |  | 79 |  |  |  | 117 |
Oil, NGLs and gas sales |  |  | 10,687 |  |  |  | 9,678 |
Derivative instruments |  |  | 90 |  |  |  | 1,398 |
Prepaid expenses and other current assets |  |  | 3,618 |  |  |  | 5,486 |
Total current assets |  |  | 14,496 |  |  |  | 16,700 |
PROPERTIES AND EQUIPMENT: |  |  |  |  |  |  |  |
Oil and gas properties, at cost, using the successful efforts method of accounting |  |  | 1,976,842 |  |  |  | 1,930,577 |
Furniture, fixtures and equipment |  |  | 5,689 |  |  |  | 5,658 |
Total oil and gas properties and equipment |  |  | 1,982,531 |  |  |  | 1,936,235 |
Less accumulated depletion, depreciation and amortization |  |  | (899,686 | ) |  |  | (853,359 | )
Net oil and gas properties and equipment |  |  | 1,082,845 |  |  |  | 1,082,876 |
Total assets |  | $ | 1,097,341 |  |  | $ | 1,099,576 |
LIABILITIES AND STOCKHOLDERS’ EQUITY |  |  |  |  |  |  |  |
CURRENT LIABILITIES: |  |  |  |  |  |  |  |
Accounts payable |  | $ | 12,969 |  |  | $ | 9,450 |
Oil, NGLs and gas sales payable |  |  | 6,105 |  |  |  | 5,363 |
Derivative instruments |  |  | 4,117 |  |  |  | 2,181 |
Accrued liabilities |  |  | 18,061 |  |  |  | 8,073 |
Total current liabilities |  |  | 41,252 |  |  |  | 25,067 |
NON-CURRENT LIABILITIES: |  |  |  |  |  |  |  |
Senior secured credit facility, net |  |  | 294,321 |  |  |  | 289,275 |
Senior notes, net |  |  | 84,411 |  |  |  | 84,185 |
Derivative instruments |  |  | 80 |  |  |  | — |
Deferred income taxes |  |  | 77,361 |  |  |  | 82,102 |
Asset retirement obligations |  |  | 11,302 |  |  |  | 11,065 |
Other non-current liabilities |  |  | 819 |  |  |  | 466 |
Total liabilities |  |  | 509,546 |  |  |  | 492,160 |
COMMITMENTS AND CONTINGENCIES |  |  |  |  |  |  |  |
STOCKHOLDERS’ EQUITY: |  |  |  |  |  |  |  |
Preferred stock, $0.01 par value, 10,000,000 shares authorized, none outstanding |  | ― |  |  | ― |
Common stock, $0.01 par value, 180,000,000 shares authorized, 94,478,333 and 94,533,246 issued and outstanding, respectively |  |  | 945 |  |  |  | 945 |
Additional paid-in capital |  |  | 743,503 |  |  |  | 742,391 |
Accumulated other comprehensive income |  |  | 46 |  |  |  | — |
Accumulated deficit |  |  | (156,699 | ) |  |  | (135,920 | )
Total stockholders’ equity |  |  | 587,795 |  |  |  | 607,416 |
Total liabilities and stockholders’ equity |  | $ | 1,097,341 |  |  | $ | 1,099,576 |

See accompanying notes to these unaudited consolidated financial statements

1

Approach Resources Inc. and Subsidiaries

Unaudited Consolidated Statements of Operations

(In thousands, except shares and per-share amounts)

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2018 |  |  | 2017 |  |  | 2018 |  |  | 2017 |
REVENUES: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Oil, NGLs and gas sales |  | $ | 32,562 |  |  | $ | 25,608 |  |  | $ | 91,660 |  |  | $ | 76,932 |
EXPENSES: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Lease operating |  |  | 5,816 |  |  |  | 4,418 |  |  |  | 16,116 |  |  |  | 12,826 |
Production and ad valorem taxes |  |  | 2,120 |  |  |  | 1,816 |  |  |  | 7,189 |  |  |  | 6,425 |
Exploration |  |  | 6 |  |  |  | 100 |  |  |  | 9 |  |  |  | 3,251 |
General and administrative (1) |  |  | 5,576 |  |  |  | 6,366 |  |  |  | 18,229 |  |  |  | 18,842 |
Depletion, depreciation and amortization |  |  | 14,500 |  |  |  | 16,843 |  |  |  | 47,029 |  |  |  | 54,348 |
Total expenses |  |  | 28,018 |  |  |  | 29,543 |  |  |  | 88,572 |  |  |  | 95,692 |
OPERATING INCOME (LOSS) |  |  | 4,544 |  |  |  | (3,935 | ) |  |  | 3,088 |  |  |  | (18,760 | )
OTHER: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest expense, net |  |  | (6,452 | ) |  |  | (5,304 | ) |  |  | (18,522 | ) |  |  | (15,683 | )
Gain on debt extinguishment |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 5,053 |
Commodity derivative (loss) gain |  |  | (3,256 | ) |  |  | (3,560 | ) |  |  | (10,068 | ) |  |  | 1,115 |
Other (expense) income |  |  | (18 | ) |  |  | 29 |  |  |  | (30 | ) |  |  | 32 |
LOSS BEFORE INCOME TAX (BENEFIT) PROVISION |  |  | (5,182 | ) |  |  | (12,770 | ) |  |  | (25,532 | ) |  |  | (28,243 | )
INCOME TAX (BENEFIT) PROVISION |  |  | (921 | ) |  |  | (4,258 | ) |  |  | (4,753 | ) |  |  | 129,933 |
NET LOSS |  | $ | (4,261 | ) |  | $ | (8,512 | ) |  | $ | (20,779 | ) |  | $ | (158,176 | )
LOSS PER SHARE: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  | $ | (0.05 | ) |  | $ | (0.10 | ) |  | $ | (0.22 | ) |  | $ | (1.95 | )
Diluted |  | $ | (0.05 | ) |  | $ | (0.10 | ) |  | $ | (0.22 | ) |  | $ | (1.95 | )
WEIGHTED AVERAGE SHARES OUTSTANDING: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  |  | 94,486,395 |  |  |  | 86,501,242 |  |  |  | 94,527,831 |  |  |  | 81,142,672 |
Diluted |  |  | 94,486,395 |  |  |  | 86,501,242 |  |  |  | 94,527,831 |  |  |  | 81,142,672 |
(1) Includes non-cash share-based compensation expense as follows: |  |  | 640 |  |  |  | 1,330 |  |  |  | 2,124 |  |  |  | 3,518 |

See accompanying notes to these unaudited consolidated financial statements

2

Approach Resources Inc. and Subsidiaries

Unaudited Consolidated Statements of Comprehensive Loss

(In thousands)

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2018 |  |  | 2017 |  |  | 2018 |  |  | 2017 |
NET LOSS |  | $ | (4,261 | ) |  | $ | (8,512 | ) |  | $ | (20,779 | ) |  | $ | (158,176 | )
Other comprehensive income, net of tax |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net unrealized gain on cash flow hedges (1) |  |  | 202 |  |  |  | — |  |  |  | 46 |  |  |  | — |
Other comprehensive loss |  |  | 202 |  |  |  | — |  |  |  | 46 |  |  |  | — |
COMPREHENSIVE LOSS |  | $ | (4,059 | ) |  | $ | (8,512 | ) |  | $ | (20,733 | ) |  | $ | (158,176 | )
(1) Includes income tax expense as follows: |  | $ | (54 | ) |  | $ | — |  |  | $ | (13 | ) |  | $ | — |

See accompanying notes to these unaudited consolidated financial statements

3

Approach Resources Inc. and Subsidiaries

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

(In thousands, except shares)

|  | Common Stock |  |  | Additional Paid-in Capital |  |  | Accumulated Other Comprehensive Income (Loss) |  |  | Accumulated Deficit |  |  | Total |
|  | Shares |  |  | Amount |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
BALANCES, June 30, 2018 |  |  | 94,470,636 |  |  | $ | 945 |  |  | $ | 742,863 |  |  | $ | (156 | ) |  | $ | (152,438 | ) |  | $ | 591,214 |
Issuance of common shares to directors for compensation |  |  | 16,213 |  |  |  | — |  |  |  | 37 |  |  |  | — |  |  |  | — |  |  |  | 37 |
Restricted stock issuance, net of cancellations |  |  | (8,516 | ) |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Share-based compensation expense |  |  | — |  |  |  | — |  |  |  | 603 |  |  |  | — |  |  |  | — |  |  |  | 603 |
Net loss |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | (4,261 | ) |  |  | (4,261 | )
Other comprehensive income |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 202 |  |  |  | — |  |  |  | 202 |
BALANCES, September 30, 2018 |  |  | 94,478,333 |  |  | $ | 945 |  |  | $ | 743,503 |  |  | $ | 46 |  |  | $ | (156,699 | ) |  | $ | 587,795 |
BALANCES, January 1, 2018 |  |  | 94,533,246 |  |  | $ | 945 |  |  | $ | 742,391 |  |  | $ | — |  |  | $ | (135,920 | ) |  | $ | 607,416 |
Issuance of common shares to directors for compensation |  |  | 122,214 |  |  |  | 1 |  |  |  | 354 |  |  |  | — |  |  |  | — |  |  |  | 355 |
Restricted stock issuance, net of cancellations |  |  | 164,965 |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Share-based compensation expense |  |  | — |  |  |  | — |  |  |  | 1,769 |  |  |  | — |  |  |  | — |  |  |  | 1,769 |
Surrender of restricted shares for payment of income taxes |  |  | (199,730 | ) |  |  | — |  |  |  | (632 | ) |  |  | — |  |  |  | — |  |  |  | (632 | )
Retirement of common shares in connection with acquisition |  |  | (142,362 | ) |  |  | (1 | ) |  |  | (379 | ) |  |  | — |  |  |  | — |  |  |  | (380 | )
Net loss |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | (20,779 | ) |  |  | (20,779 | )
Other comprehensive income |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 46 |  |  |  | — |  |  |  | 46 |
BALANCES, September 30, 2018 |  |  | 94,478,333 |  |  | $ | 945 |  |  | $ | 743,503 |  |  | $ | 46 |  |  | $ | (156,699 | ) |  | $ | 587,795 |
BALANCES, June 30, 2017 |  |  | 86,480,629 |  |  | $ | 851 |  |  | $ | 722,696 |  |  | $ | — |  |  | $ | (173,225 | ) |  | $ | 550,322 |
Issuance of common shares to directors for compensation |  |  | 22,661 |  |  |  | — |  |  |  | 78 |  |  |  | — |  |  |  | — |  |  |  | 78 |
Restricted stock issuance, net of cancellations |  |  | (1,327 | ) |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Share-based compensation expense |  |  | — |  |  |  | — |  |  |  | 1,252 |  |  |  | — |  |  |  | — |  |  |  | 1,252 |
Equity issuance costs |  |  | — |  |  |  | — |  |  |  | (5 | ) |  |  | — |  |  |  | — |  |  |  | (5 | )
Surrender of restricted shares for payment of income taxes |  |  | (463 | ) |  |  | — |  |  |  | (1 | ) |  |  | — |  |  |  | — |  |  |  | (1 | )
Net loss |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | (8,512 | ) |  |  | (8,512 | )
BALANCES, September 30, 2017 |  |  | 86,501,500 |  |  | $ | 851 |  |  | $ | 724,020 |  |  | $ | — |  |  | $ | (181,737 | ) |  | $ | 543,134 |
BALANCES, January 1, 2017 |  |  | 41,764,770 |  |  | $ | 418 |  |  | $ | 586,095 |  |  | $ | — |  |  | $ | (23,561 | ) |  | $ | 562,952 |
Issuance of common shares to directors for compensation |  |  | 161,748 |  |  |  | 1 |  |  |  | 403 |  |  |  | — |  |  |  | — |  |  |  | 404 |
Restricted stock issuance, net of cancellations |  |  | 1,436,026 |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Share-based compensation expense |  |  | — |  |  |  | — |  |  |  | 3,114 |  |  |  | — |  |  |  | — |  |  |  | 3,114 |
Issuance of common shares in exchange for senior notes |  |  | 43,175,328 |  |  |  | 432 |  |  |  | 134,526 |  |  |  | — |  |  |  | — |  |  |  | 134,958 |
Surrender of restricted shares for payment of income taxes |  |  | (36,372 | ) |  |  | — |  |  |  | (118 | ) |  |  | — |  |  |  | — |  |  |  | (118 | )
Net loss |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | (158,176 | ) |  |  | (158,176 | )
BALANCES, September 30, 2017 |  |  | 86,501,500 |  |  | $ | 851 |  |  | $ | 724,020 |  |  | $ | — |  |  | $ | (181,737 | ) |  | $ | 543,134 |

See accompanying notes to these unaudited consolidated financial statements

4

Approach Resources Inc. and Subsidiaries

Unaudited Consolidated Statements of Cash Flows

(In thousands)

|  | Nine Months Ended |
|  | September 30, |
|  | 2018 |  |  | 2017 |
OPERATING ACTIVITIES: |  |  |  |  |  |  |  |
Net loss |  | $ | (20,779 | ) |  | $ | (158,176 | )
Adjustments to reconcile net loss to cash provided by operating activities: |  |  |  |  |  |  |  |
Depletion, depreciation and amortization |  |  | 47,029 |  |  |  | 54,348 |
Amortization of debt issuance costs |  |  | 786 |  |  |  | 640 |
Gain on debt extinguishment |  |  | — |  |  |  | (5,053 | )
Commodity derivative loss (gain) |  |  | 10,068 |  |  |  | (1,115 | )
Settlements of commodity derivatives |  |  | (6,685 | ) |  |  | (1,481 | )
Exploration expense |  |  | — |  |  |  | 3,154 |
Share-based compensation expense |  |  | 2,124 |  |  |  | 3,518 |
Deferred income tax (benefit) provision |  |  | (4,753 | ) |  |  | 129,933 |
Other non-cash items |  |  | 30 |  |  |  | (32 | )
Changes in operating assets and liabilities: |  |  |  |  |  |  |  |
Accounts receivable |  |  | (966 | ) |  |  | 980 |
Prepaid expenses and other current assets |  |  | (1,573 | ) |  |  | (240 | )
Accounts payable |  |  | (1,418 | ) |  |  | (1,076 | )
Oil, NGLs and gas sales payable |  |  | 739 |  |  |  | 522 |
Accrued liabilities |  |  | 4,748 |  |  |  | 3,620 |
Cash provided by operating activities |  |  | 29,350 |  |  |  | 29,542 |
INVESTING ACTIVITIES: |  |  |  |  |  |  |  |
Additions to oil and gas properties |  |  | (46,493 | ) |  |  | (45,712 | )
Additions to furniture, fixtures and equipment, net |  |  | (31 | ) |  |  | (14 | )
Change in working capital related to investing activities |  |  | 14,513 |  |  |  | (968 | )
Cash used in investing activities |  |  | (32,011 | ) |  |  | (46,694 | )
FINANCING ACTIVITIES: |  |  |  |  |  |  |  |
Borrowings under credit facility |  |  | 90,100 |  |  |  | 76,750 |
Repayment of amounts outstanding under credit facility |  |  | (85,600 | ) |  |  | (57,750 | )
Equity issuance costs |  |  | — |  |  |  | (2,767 | )
Tax withholdings related to restricted stock |  |  | (632 | ) |  |  | (118 | )
Debt issuance costs |  |  | (14 | ) |  |  | — |
Change in working capital related to financing activities |  |  | (1,192 | ) |  |  | 1,037 |
Cash provided by financing activities |  |  | 2,662 |  |  |  | 17,152 |
CHANGE IN CASH AND CASH EQUIVALENTS |  |  | 1 |  |  |  | — |
CASH AND CASH EQUIVALENTS, beginning of period |  | $ | 21 |  |  | $ | 21 |
CASH AND CASH EQUIVALENTS, end of period |  | $ | 22 |  |  | $ | 21 |
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: |  |  |  |  |  |  |  |
Cash paid for interest |  | $ | 16,267 |  |  | $ | 14,024 |
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTION: |  |  |  |  |  |  |  |
Asset retirement obligations capitalized |  | $ | 19 |  |  | $ | 31 |

See accompanying notes to these unaudited consolidated financial statements

5

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

1. Summary of Significant Accounting Policies

Organization and Nature of Operations

Approach Resources Inc. (“Approach,” the “Company,” “we,” “us” or “our”) is an independent energy company engaged in the exploration, development, production and acquisition of oil and gas properties. We focus on finding and developing oil and natural gas reserves in oil shale and tight gas sands. Our properties are primarily located in the Permian Basin in West Texas. We also own interests in the East Texas Basin.

Consolidation, Basis of Presentation and Significant Estimates

The interim consolidated financial statements of the Company are unaudited and contain all adjustments (consisting primarily of normal recurring accruals) necessary for a fair statement of the results for the interim periods presented. Results for interim periods are not necessarily indicative of results to be expected for a full year, due in part to the volatility in prices for oil, natural gas liquids (“NGLs”) and gas, future commodity prices for commodity derivative contracts, global economic and financial market conditions, interest rates, access to sources of liquidity, estimates of reserves, drilling risks, geological risks, transportation restrictions, the timing of acquisitions, product supply and demand, market competition and interruptions of production. You should read these consolidated interim financial statements in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission on March 9, 2018.

The accompanying interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of the Company and its wholly owned subsidiaries. Intercompany accounts and transactions are eliminated. In preparing the accompanying financial statements, management has made certain estimates and assumptions that affect reported amounts in the financial statements and disclosures of contingencies. Actual results may differ from those estimates. Significant assumptions are required in the valuation of proved oil and gas reserves, which affect our estimate of depletion expense as well as our impairment analyses. Significant assumptions also are required in our estimation of accrued liabilities, commodity derivatives, income tax provision, share-based compensation and asset retirement obligations. It is at least reasonably possible these estimates could be revised in the near term, and these revisions could be material. Certain prior-year amounts have been reclassified to conform to current-year presentation. These classifications have no impact on the net loss reported.

Recent Accounting Pronouncements

On January 1, 2018, we adopted the Financial Accounting Standards Board (“FASB”) accounting standards update for “Revenue from Contracts with Customers,” which superseded the revenue recognition requirements in “Topic 605, Revenue Recognition,” using the modified retrospective method. Adoption of this standard did not have a significant impact on our consolidated statements of operations or cash flows. We implemented processes to ensure new contracts are reviewed for the appropriate accounting treatment and generate the disclosures required under the new standard. See Note 2 for additional disclosures required under this accounting standards update related to the nature, amount, timing and uncertainty of revenue and cash flows from contracts with customers including disaggregation of revenue.

In February 2016, FASB issued an accounting standards update for “Leases,” which amends existing guidance to require lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by long-term leases and to disclose additional quantitative and qualitative information about leasing arrangements. This new guidance is effective for interim and annual periods beginning after December 15, 2018, and we will adopt it using a modified retrospective approach. Currently, the Company is continuing to evaluate the standard’s applicability to our various contractual arrangements, and designing processes and internal controls necessary to adopt this standard. We believe that the adoption of this standard will result in recognition of assets and liabilities on the balance sheet for current operating leases. The Company is still evaluating the impact of this new guidance on its consolidated financial statements.

In January 2017, FASB issued an accounting standards update for “Clarifying the Definition of a Business,” which provides guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This standard requires entities to use a screen test to determine when an integrated set of assets and activities is not a business or if the integrated set of assets and activities needs to be further evaluated against the framework. We have adopted this standard as of January 1, 2018. Adoption of this standard did not impact our consolidated statements of operations or cash flows.

6

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

In August 2017, FASB issued an accounting standards update for “Derivatives and Hedging,” which amends existing guidance related to the recognition and presentation requirements of hedge accounting, including eliminating the requirement to separately measure and report hedge ineffectiveness, and presenting all items that affect earnings in the same income statement line item as the hedged item. This standard is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. We elected to early adopt this standard in the first quarter of 2018. Adoption of this standard did not impact our consolidated statements of operations or cash flows. Although we have not historically designated our derivative contracts as cash-flow hedges, we designated swap derivative contracts entered in April 2018 as cash-flow hedges. See Note 8 for additional information related to the derivative contracts designated as cash-flow hedges.

Prepaid Expenses and Other Assets

In April 2017, we entered into an agreement that secured pricing of a hydraulic fracturing services crew. Under this agreement, we made a prepayment of $5 million, to be used as we completed wells. We have used $1.2 million of this prepayment related to hydraulic fracturing services provided during the first year of the agreement. In March 2018, this agreement was terminated and $3.8 million of the unused prepaid balance was refunded to us.

Liquidity

Our revolving credit facility contains three principal financial covenants: (i) a consolidated interest coverage ratio, (ii) a consolidated modified current ratio and (iii) a consolidated total leverage ratio. See Note 5 to our consolidated financial statements in this report for additional information regarding the financial covenants under our revolving credit facility. At September 30, 2018, we were in compliance with all of our covenants, and there were no existing defaults or events of default, under our debt instruments.

At September 30, 2018, our leverage ratio was 6.4 to 1.0, which is currently above the level that will be required as of March 31, 2019, of 5.0 to 1.0. If we are unable to improve our total leverage ratio by March 31, 2019, the obligations of the Company under the revolving credit facility may be accelerated, which would have a material adverse effect on our business. Our total leverage ratio has decreased from 9.7 to 1.0 as of December 31, 2016, to 6.4 to 1.0 as of September 30, 2018. In order to continue to improve our leverage position to meet the financial covenants under the revolving credit facility, we are currently pursuing or considering a number of actions, which in certain cases may require the consent of current lenders, stockholders or bond holders, including without limitation (i) exchanging debt for equity, (ii) adjusting our capital budget, (iii) reducing general and administrative expenses, (iv) improving cash flows from operations, (v) more effectively managing working capital and (vi) acquiring assets with existing production and cash flows. On April 12, 2018, Wilks (defined below) disclosed on Schedule 13D/A that they intend to engage in discussions with the Company regarding their investment in the Company, including the possible acquisition of additional shares of common stock through the exchange of approximately $60 million of 7% Senior Notes due 2021 currently held by Wilks. We have engaged, and intend to continue to engage, in discussions with potential counterparties, including the Wilks, regarding a broad range of transactions to reduce our leverage as we continue to explore these alternatives. There is no assurance that we will be able to execute any one or more of these of these alternatives, or that these alternatives can be consummated within the period needed to meet our obligations.

2. Revenue Recognition

Revenues from the sale of oil, NGLs, and gas are recognized as the product is delivered to our customers’ custody transfer points and collectability is reasonably assured. We fulfill the performance obligations under our customer contracts through daily delivery of oil, NGLs and gas to our customers’ custody transfer points and revenues are recorded on a monthly basis. The prices received for oil, NGLs and natural gas sales under our contracts are generally derived from stated market prices which are then adjusted to reflect deductions including transportation, fractionation and processing. As a result, our revenues from the sale of oil, natural gas and NGLs will decrease if market prices decline. The sales of oil, NGLs and gas as presented on the Consolidated Statements of Operations represent the Company’s share of revenues net of royalties and excluding revenue interests owned by others. When selling oil, NGLs and gas on behalf of royalty owners or working interest owners, the Company is acting as an agent and thus reports the revenue on a net basis. To the extent actual volumes and prices of oil and natural gas sales are unavailable for a given reporting period because of timing or information not received from third parties, the expected sales volumes and prices for those properties are estimated and recorded.

7

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

The following table presents our disaggregated revenue by major source for the three and nine months ended September 30, 2018, and 2017 (in thousands).

|  | Three Months Ended |  |  | Nine Months Ended |
|  | September 30, |  |  | September 30, |
|  | 2018 |  |  | 2017 |  |  | 2018 |  |  | 2017 |
Revenues (in thousands): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Oil |  | $ | 18,160 |  |  | $ | 12,464 |  |  | $ | 52,547 |  |  | $ | 38,666 |
NGLs |  |  | 10,690 |  |  |  | 7,093 |  |  |  | 26,874 |  |  |  | 19,172 |
Gas |  |  | 3,797 |  |  |  | 6,051 |  |  |  | 12,262 |  |  |  | 19,094 |
Total revenue from contracts with customers |  |  | 32,647 |  |  |  | 25,608 |  |  |  | 91,683 |  |  |  | 76,932 |
Commodity derivatives designated as cash flow hedges |  |  | (85 | ) |  |  | — |  |  |  | (23 | ) |  |  | — |
Total oil, NGLs and gas sales |  | $ | 32,562 |  |  | $ | 25,608 |  |  | $ | 91,660 |  |  | $ | 76,932 |

3. Earnings Per Common Share

We report basic earnings per common share, which excludes the effect of potentially dilutive securities, and diluted earnings per common share, which includes the effect of all potentially dilutive securities unless their impact is antidilutive. The following table provides a reconciliation of the numerators and denominators of our basic and diluted earnings per share (dollars in thousands, except per-share amounts).

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2018 |  |  | 2017 |  |  | 2018 |  |  | 2017 |
Income (numerator): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net loss – basic |  | $ | (4,261 | ) |  | $ | (8,512 | ) |  | $ | (20,779 | ) |  | $ | (158,176 | )
Weighted average shares (denominator): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Weighted average shares – basic |  |  | 94,486,395 |  |  |  | 86,501,242 |  |  |  | 94,527,831 |  |  |  | 81,142,672 |
Dilution effect of share-based compensation, treasury method (1) |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Weighted average shares – diluted |  |  | 94,486,395 |  |  |  | 86,501,242 |  |  |  | 94,527,831 |  |  |  | 81,142,672 |
Net loss per share: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  | $ | (0.05 | ) |  | $ | (0.10 | ) |  | $ | (0.22 | ) |  | $ | (1.95 | )
Diluted |  | $ | (0.05 | ) |  | $ | (0.10 | ) |  | $ | (0.22 | ) |  | $ | (1.95 | )

(1) | Approximately 39,000 options to purchase our common stock were excluded from this calculation because they were antidilutive for the three and nine months ended September 30, 2017. No options were outstanding as of September 30, 2018, as they had expired.

4. Equity Exchange Transactions

Debt exchange

On November 2, 2016, we entered into an exchange agreement with Wilks Brothers, LLC and SDW Investments, LLC (collectively, “Wilks”) the largest holder of our 7% Senior Notes due 2021 (the “Senior Notes”), to exchange $130,552,000 principal amount of our Senior Notes for 39,165,600 newly issued shares of common stock, par value $0.01 per share (the “Initial Exchange”). On January 26, 2017, our stockholders approved the Exchange Transactions (defined below) and an increase in our authorized common stock from 90 million shares to 180 million shares. We closed the Initial Exchange on January 27, 2017, and paid $1.1 million of accrued interest on the Senior Notes held by Wilks. In connection with the Initial Exchange, a second supplemental indenture became effective, which removed certain covenants and events of default from the indenture governing our Senior Notes and eliminated certain restrictive covenants discussed in Note 5.

8

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

On March 22, 2017, we exchanged an additional $14,528,000 principal amount of outstanding Senior Notes for 4,009,728 shares of our common stock (the “Follow-On Exchange”).

The Initial Exchange and the Follow-On Exchange (together, the “Exchange Transactions”) reduced the principal amount of outstanding Senior Notes by $145.1 million and reduced interest payments by $44.3 million over the remaining term of the Senior Notes. The Exchange Transactions were accounted for as a debt extinguishment. A gain of $5.1 million was recognized on the Exchange Transactions for the difference between the fair market value of the shares issued, a Level 1 fair value measurement, and the net carrying value of the Senior Notes exchanged. We incurred equity issuance costs of $2.8 million related to the Exchange Transactions, which were recorded as a reduction to additional paid-in capital.

The Exchange Transactions triggered a cumulative change in ownership of our common stock by more than 50% under Section 382 of the Internal Revenue Code as of March 22, 2017. This established an annual limitation on the usage of our pre-change net operating losses (“NOLs”) in the future. Accordingly, we recognized a write-off of deferred tax assets of $139.1 million.

Acquisition

On November 1, 2017, we entered into a definitive agreement (the “Purchase Agreement”) to acquire producing properties directly adjacent to our acreage in the Permian Basin (the “Bolt-On Acquisition”). The Bolt-On Acquisition closed on November 20, 2017, and we issued 7,573,403 shares of common stock, par value $0.01 per share, with an effective date of September 1, 2017. The purchase price was finalized in April 2018, and we received 142,362 of the previously issued shares of our common stock, which were retired, pursuant to adjustments under the Purchase Agreement.

5. Long-Term Debt

The following table provides a summary of our long-term debt at September 30, 2018, and December 31, 2017 (in thousands).

|  | September 30, |  |  | December 31, |
|  | 2018 |  |  | 2017 |
Senior secured credit facility: |  |  |  |  |  |  |  |
Outstanding borrowings |  | $ | 295,500 |  |  | $ | 291,000 |
Debt issuance costs |  |  | (1,179 | ) |  |  | (1,725 | )
Senior secured credit facility, net |  |  | 294,321 |  |  |  | 289,275 |
Senior notes: |  |  |  |  |  |  |  |
Principal |  |  | 85,240 |  |  |  | 85,240 |
Debt issuance costs |  |  | (829 | ) |  |  | (1,055 | )
Senior notes, net |  |  | 84,411 |  |  |  | 84,185 |
Total long-term debt |  | $ | 378,732 |  |  | $ | 373,460 |

Senior Secured Credit Facility

At September 30, 2018, the borrowing base and aggregate lender commitments under our amended and restated senior secured credit facility (the “Credit Facility”) were $325 million, with maximum commitments from the lenders of $1 billion. The Credit Facility has a maturity date of May 7, 2020. The borrowing base is redetermined semi-annually based on our oil, NGLs and gas reserves. We, or the lenders, can each request one additional borrowing base redetermination each calendar year. Our semi-annual borrowing base redetermination is not yet final.

At September 30, 2018, borrowings under the Credit Facility bore interest based on the agent bank’s prime rate plus an applicable margin ranging from 2% to 3%, or the sum of the LIBOR rate plus an applicable margin ranging from 3% to 4%. In addition, we pay an annual commitment fee of 0.50% of unused borrowings available under the Credit Facility. Margins vary based on the borrowings outstanding compared to the borrowing base of the lenders.

We had outstanding borrowings of $295.5 million under the Credit Facility at September 30, 2018, compared to $291 million of outstanding borrowings at December 31, 2017. The weighted average interest rate applicable to borrowings under the Credit Facility for the three months ended September 30, 2018, was 6.1%. We had outstanding unused letters of credit under the Credit Facility totaling $0.3 million at September 30, 2018, and December 31, 2017, respectively, which reduce amounts available for borrowing under the Credit Facility.

9

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

Obligations under the Credit Facility are secured by mortgages on substantially all of the oil and gas properties of the Company and its subsidiaries. The Company is required to grant liens in favor of the lenders covering the oil and gas properties of the Company and its subsidiaries representing at least 95% of the total value of all oil and gas properties of the Company and its subsidiaries.

On December 21, 2017, we entered into a fourth amendment to the Credit Facility. The fourth amendment, among other things, (a) extended the maturity date of the Credit Facility from May 7, 2019, to May 7, 2020, (b) increased the applicable margin rates on borrowings by 50 basis points, (c) required the Company to hedge 50% of the Company’s estimated 2018 oil and gas production from proved developed producing reserves and (d) amended our financial covenants as described below. In connection with the fourth amendment to the Credit Facility, we incurred $1 million of debt issuance costs.

Covenants

The Credit Facility contains three principal financial covenants:

| • | a consolidated interest coverage ratio covenant that requires us to maintain a ratio of (i) consolidated EBITDAX for the period of four fiscal quarters then ending to (ii) Cash Interest Expense for such period as of the last day of any fiscal quarter of not less than 1.75 to 1.0 through December 31, 2018, a ratio of not less than 2.25 to 1.0 through December 31, 2019, and a ratio of not less than 2.5 to 1.0 thereafter. EBITDAX is defined as consolidated net (loss) income plus (i) interest expense, net, (ii) income tax provision (benefit), (iii) depreciation, depletion, amortization, (iv) exploration expenses and (v) other noncash loss or expense (including share-based compensation and the change in fair value of any commodity derivatives), less noncash income. Cash Interest Expense is calculated as interest expense, net less amortization of debt issuance costs. At September 30, 2018, our consolidated interest coverage ratio was 2.6 to 1.0;

| • | a consolidated modified current ratio covenant that requires us to maintain a ratio of not less than 1.0 to 1.0 as of the last day of any fiscal quarter. The consolidated modified current ratio is defined as the ratio of (i) current assets plus funds available under our revolving credit facility, less the current derivative asset, to (ii) current liabilities less the current derivative liability. At September 30, 2018, our consolidated modified current ratio was 1.2 to 1.0; and

| • | a consolidated total leverage ratio covenant that imposes a maximum permitted ratio of (i) Total Debt to (ii) EBITDAX for the period of four fiscal quarters then ending of not more than 5.0 to 1.0, as of the last day of any fiscal quarter from March 31, 2019, through June 30, 2019, thereafter not more than 4.75 to 1.0 as of the last day of any fiscal quarter through December 31, 2019, and not more than 4.0 to 1.0 as of the last day of any fiscal quarter thereafter. Total Debt is defined as the face or principal amount of debt. Our leverage ratio is currently above the level that will be required as of March 31, 2019. At September 30, 2018, our leverage ratio was 6.4 to 1.0.

The Credit Facility also contains covenants restricting cash distributions and other restricted payments, transactions with affiliates, incurrence of other debt, consolidations and mergers, the level of operating leases, asset sales, investment in other entities and liens on properties.

In addition, the obligations of the Company may be accelerated upon the occurrence of an Event of Default (as defined in the Credit Facility). Events of Default include customary events for a financing agreement of this type, including, without limitation, payment defaults, the inaccuracy of representations and warranties, defaults in the performance of affirmative or negative covenants, defaults on other indebtedness of the Company or its subsidiaries, bankruptcy or related defaults, defaults related to judgments and the occurrence of a Change of Control (as defined in the Credit Facility), which includes instances where a third party becomes the beneficial owner of more than 50% of the Company’s outstanding equity interests entitled to vote.

Senior Notes

At September 30, 2018, and December 31, 2017, $85.2 million of Senior Notes were outstanding. We issued the Senior Notes under a senior indenture dated June 11, 2013, among the Company, our subsidiary guarantors and Wilmington Trust, National Association, as successor trustee. The senior indenture, as supplemented by supplemental indentures dated June 11, 2013, and December 20, 2016, is referred to as the “Indenture.”

10

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

We may redeem some or all of the Senior Notes at specified redemption prices, plus accrued and unpaid interest to the redemption date. The Senior Notes are fully and unconditionally guaranteed on a senior unsecured basis by each of our subsidiaries, subject to certain customary release provisions. A subsidiary guarantor may be released from its obligations under the guarantee:

| • | in connection with any sale or other disposition of all or substantially all of the assets of that guarantor (including by way of merger or consolidation) to a person that is not (either before or after giving effect to such transaction) the Company or a subsidiary guarantor, if the sale or other disposition otherwise complies with the Indenture;

| • | in connection with any sale or other disposition of the capital stock of that guarantor to a person that is not (either before or after giving effect to such transaction) the Company or a subsidiary guarantor, if that guarantor no longer qualifies as a subsidiary of the Company as a result of such disposition and the sale or other disposition otherwise complies with the Indenture;

| • | if the Company designates any restricted subsidiary that is a guarantor to be an unrestricted subsidiary in accordance with the Indenture;

| • | upon defeasance or covenant defeasance of the notes or satisfaction and discharge of the Indenture, in each case, in accordance with the Indenture;

| • | upon the liquidation or dissolution of that guarantor, provided that no default or event of default occurs under the Indenture as a result thereof or shall have occurred and is continuing; or

| • | in the case of any restricted subsidiary that, after the issue date of the notes is required under the Indenture to guarantee the notes because it becomes a guarantor of indebtedness issued or an obligor under a credit facility with respect to the Company and/or its subsidiaries, upon the release or discharge in full from its (i) guarantee of such indebtedness or (ii) obligation under such credit facility, in each case, which resulted in such restricted subsidiary’s obligation to guarantee the notes.

The Indenture contains limited events of default.

Subsidiary Guarantors

The Senior Notes are guaranteed on a senior unsecured basis by each of our consolidated subsidiaries. Approach Resources Inc. is a holding company with no independent assets or operations. The subsidiary guarantees are full and unconditional and joint and several, and any subsidiaries of the Company other than the subsidiary guarantors are minor. There are no significant restrictions on the Company’s ability, or the ability of any subsidiary guarantor, to obtain funds from its subsidiaries through dividends, loans, advances or otherwise.

At September 30, 2018, we were in compliance with all of our covenants, and there were no existing defaults or events of default, under our debt instruments.

6. Commitments and Contingencies

Our contractual obligations include long-term debt, operating lease obligations, asset retirement obligations and employment agreements with our executive officers. At September 30, 2018, outstanding borrowings under the Credit Facility were $295.5 million, compared to $291 million at December 31, 2017. Since December 31, 2017, there have been no other material changes to our contractual obligations.

We are involved in various legal and regulatory proceedings arising in the normal course of business. While we cannot predict the outcome of these proceedings with certainty, we do not believe that an adverse result in any pending legal or regulatory proceeding, individually or in the aggregate, would be material to our consolidated financial condition or cash flows.

11

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

7. Income Taxes

For the three months ended September 30, 2018, our income tax benefit was $0.9 million, compared to $4.3 million for the three months ended September 30, 2017. The following table reconciles our income tax expense for the three and nine months ended September 30, 2018, and 2017, to the U.S. federal statutory rates of 21% and 35%, respectively (in thousands).

|  | Three Months Ended |  |  | Nine Months Ended |
|  | September 30, |  |  | September 30, |
|  | 2018 |  |  | 2017 |  |  | 2018 |  |  | 2017 |
Statutory tax at 21% and 35%, respectively |  | $ | (1,088 | ) |  | $ | (4,470 | ) |  | $ | (5,362 | ) |  | $ | (9,885 | )
State taxes, net of federal impact |  |  | 137 |  |  | 171 |  |  |  | 411 |  |  |  | 366 |
Share-based compensation tax shortfall |  |  | — |  |  |  | 8 |  |  |  | 70 |  |  |  | 320 |
Nondeductible compensation |  |  | 30 |  |  |  | — |  |  |  | 123 |  |  |  | — |
Other differences |  |  | — |  |  |  | 33 |  |  |  | 5 |  |  |  | 42 |
Write-off of deferred tax assets |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 139,090 |
Income tax (benefit) provision |  | $ | (921 | ) |  | $ | (4,258 | ) |  | $ | (4,753 | ) |  | $ | 129,933 |

On December 22, 2017, the Tax Cuts and Jobs Act was enacted which, among other things, lowered the U.S. Federal income tax rate applicable to corporations from 35% to 21% and repealed the corporate alternative minimum tax.

The Exchange Transactions triggered a cumulative change in ownership of our common stock by more than 50% under Section 382 of the Internal Revenue Code as of March 22, 2017. This established an annual limitation on the usage of our pre-change NOLs in the future. Accordingly, we recognized a write-off of our deferred tax assets of $139.1 million in the nine months ended September 30, 2017.

8. Derivative Instruments and Fair Value Measurements

We enter commodity derivative contracts to reduce our exposure to fluctuations in commodity prices related to our oil, NGLs and gas production. We record our open derivative instruments at fair value on our consolidated balance sheets as either current or non-current assets or liabilities based on the anticipated timing of cash settlements under the related contracts. Changes in the fair value of our commodity derivative contracts, not designated as cash-flow hedges, and cash settlements are recorded in earnings as they occur on our consolidated statements of operations under the caption entitled “commodity derivative (loss) gain.”

In April 2018, we entered into swaps for the NYMEX Calendar Monthly Average Roll (the “CMA Roll”) covering 2,000 Bbls of oil per day for May 2018 through December 2018 at $0.66/bbl. Swaps for the CMA Roll are pricing adjustments to the trade month versus the delivery month for contract pricing. These derivative contracts were designated as cash-flow hedges. The changes in fair value of the derivative contracts designated as cash-flow hedges, to the extent the hedge is effective, will be recognized in other comprehensive income until the hedged item is recognized in revenue.

12

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

The following table provides our outstanding commodity derivative positions at September 30, 2018.

Commodity and Period |  | Contract Type |  | Volume Transacted |  | Contract Price
Crude Oil |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 300 Bbls/day |  | $50.00/Bbl
October 2018 – December 2019 |  | Collar |  | 500 Bbls/day |  | $65.00/Bbl - $71.00/Bbl
CMA Roll |  |  |  |  |  |
October 2018 – December 2018 (1) |  | Swap |  | 2,000 Bbls/day |  | $0.66/Bbl
Natural Gas |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 200,000 MMBtu/month |  | $3.085/MMBtu
October 2018 – December 2018 |  | Swap |  | 250,000 MMBtu/month |  | $3.084/MMBtu
NGLs (C2 - Ethane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 1,000 Bbls/day |  | $11.424/Bbl
October 2018 – December 2018 |  | Swap |  | 400 Bbls/day |  | $14.70/Bbl
NGLs (C3 - Propane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 600 Bbls/day |  | $32.991/Bbl
October 2018 – December 2018 |  | Swap |  | 400 Bbls/day |  | $40.74/Bbl
October 2018 – June 2019 |  | Swap |  | 75 Bbls/day |  | $42.00/Bbl
NGLs (IC4 - Isobutane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 50 Bbls/day |  | $38.262/Bbl
NGLs (NC4 - Butane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 200 Bbls/day |  | $38.22/Bbl
NGLs (C5 - Pentane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 200 Bbls/day |  | $56.364/Bbl
January 2019 – December 2019 |  | Swap |  | 100 Bbls/day |  | $65.10/Bbl
January 2019 – December 2019 |  | Swap |  | 100 Bbls/day |  | $65.31/Bbl

(1) | Designated as a cash flow hedge

After September 30, 2018, we entered into the following commodity derivative positions:

Commodity and Period |  | Contract Type |  | Volume Transacted |  | Contract Price
NGLs (C2 - Ethane) |  |  |  |  |  |
January 2019 – March 2019 |  | Swap |  | 900 Bbls/day |  | $14.123/Bbl
NGLs (C3 - Propane) |  |  |  |  |  |
January 2019 – March 2019 |  | Swap |  | 600 Bbls/day |  | $35.165/Bbl
NGLs (NC4 - Butane) |  |  |  |  |  |
January 2019 – March 2019 |  | Swap |  | 200 Bbls/day |  | $38.63/Bbl

The following table summarizes the fair value of our open commodity derivatives as of September 30, 2018, and December 31, 2017 (in thousands).

13

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

|  | Balance Sheet Location |  | Fair Value |
|  |  |  | September 30, |  |  | December 31, |
|  |  |  | 2018 |  |  | 2017 |
Derivatives not designated as hedging instruments |  |  |  |  |  |  |  |  |  |
Commodity derivatives |  | Derivative assets |  | $ | 31 |  |  | $ | 1,398 |
Commodity derivatives |  | Derivative liabilities |  |  | (4,197 | ) |  |  | (2,181 | )
Total derivatives not designated as hedging instruments |  |  |  |  | (4,166 | ) |  |  | (783 | )
Derivatives designated as cash flow hedges |  |  |  |  |  |  |  |  |  |
Commodity derivatives |  | Derivative assets |  | $ | 59 |  |  |  | — |

The following table summarizes the commodity derivatives (loss) gain (in thousands).

|  |  |  | Three Months Ended |  |  | Nine Months Ended |
| Income Statement Location |  | September 30, |  |  | September 30, |
|  |  |  | 2018 |  |  | 2017 |  |  | 2018 |  |  | 2017 |
Derivatives not designated as hedging instruments |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net cash payment on derivative settlements |  | $ | (3,172 | ) |  | $ | (523 | ) |  | $ | (6,685 | ) |  | $ | (1,481 | )
Non-cash fair value (loss) gain on derivatives |  |  | (84 | ) |  |  | (3,037 | ) |  |  | (3,383 | ) |  |  | 2,596 |
| Commodity derivative (loss) gain | $ | (3,256 | ) |  | $ | (3,560 | ) |  | $ | (10,068 | ) |  | $ | 1,115 |
Derivatives designated as cash flow hedges |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| Oil, NGLs and gas sales | $ | (85 | ) |  | $ | — |  |  | $ | (23 | ) |  | $ | — |

The following table summarizes the changes in accumulated other comprehensive income (“AOCI”) for the three months ended September 30, 2018 (in thousands).

|  | Pre-Tax |  |  | Tax Effect |  |  | Net-of Tax |
Balance at June 30, 2018 |  | $ | (197 | ) |  | $ | 41 |  |  | $ | (156 | )
Other comprehensive income before reclassifications |  |  | 171 |  |  |  | (36 | ) |  |  | 135 |
Amounts reclassified from AOCI |  |  | 85 |  |  |  | (18 | ) |  |  | 67 |
Net other comprehensive income |  |  | 256 |  |  |  | (54 | ) |  |  | 202 |
Balance at September 30, 2018 |  | $ | 59 |  |  | $ | (13 | ) |  | $ | 46 |

The following table summarizes the changes in AOCI for the nine months ended September 30, 2018 (in thousands).

|  | Pre-Tax |  |  | Tax Effect |  |  | Net-of Tax |
Balance at December 31, 2017 |  | $ | — |  |  | $ | — |  |  | $ | — |
Other comprehensive income before reclassifications |  |  | 36 |  |  |  | (8 | ) |  |  | 28 |
Amounts reclassified from AOCI |  |  | 23 |  |  |  | (5 | ) |  |  | 18 |
Net other comprehensive income |  |  | 59 |  |  |  | (13 | ) |  |  | 46 |
Balance at September 30, 2018 |  | $ | 59 |  |  | $ | (13 | ) |  | $ | 46 |

We estimate the fair values of swap contracts based on the present value of the difference in exchange-quoted forward price curves and contractual settlement prices multiplied by notional quantities. We internally valued the option contracts using industry-standard option pricing models and observable market inputs. We use our internal valuations to determine the fair values of the contracts that are reflected on our consolidated balance sheets.

14

Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

We are exposed to credit losses in the event of nonperformance by the counterparties on our commodity derivatives positions and have considered the exposure in our internal valuations. However, we do not anticipate nonperformance by the counterparties over the term of the commodity derivatives positions.

To estimate the fair value of our commodity derivatives positions, we use market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. We primarily apply the market approach for recurring fair value measurements and attempt to use the best available information. We determine the fair value based upon the hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and lowest priority to unobservable inputs (Level 3 measurement). The three levels of fair value hierarchy are as follows:

| • | Level 1 — Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. The shares of our common stock issued in the Exchange Transactions were valued as a Level 1 measurement. At September 30, 2018, we had no Level 1 measurements.

| • | Level 2 — Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Our derivatives, which consist primarily of commodity swaps and collars, are valued using commodity market data, which is derived by combining raw inputs and quantitative models and processes to generate forward curves. Where observable inputs are available, directly or indirectly, for substantially the full term of the asset or liability, the instrument is categorized in Level 2. At September 30, 2018, all of our commodity derivatives were valued using Level 2 measurements.

| • | Level 3 — Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. At September 30, 2018, we had no recurring Level 3 measurements.

Financial Instruments Not Recorded at Fair Value

The following table sets forth the fair values of financial instruments that are not recorded at fair value on our financial statements (in thousands).

|  | September 30, 2018 |
|  | Carrying Amount |  |  | Fair Value |
Senior Notes |  | $ | 84,411 |  |  | $ | 82,855 |

The fair value of the Senior Notes is based on quoted market prices, but the Senior Notes are not actively traded in the public market. Accordingly, the fair value of the Senior Notes would be classified as Level 2 in the fair value hierarchy.

9. Share-Based Compensation

In March 2018, we issued 774,590 cash-settled performance awards, subject to certain performance conditions, and 387,295 restricted shares subject to three-year total shareholder return (“TSR”) conditions, assuming maximum TSR, to our executive officers. The aggregate fair market value of the cash-settled performance awards and TSR restricted shares on the date of grant was approximately $2.4 million and $0.8 million, respectively, to be expensed over a service period of approximately three years.

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Approach Resources Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2018

Cash-settled performance awards

As of September 30, 2018, we had 1,508,285 unvested cash-settled performance awards, subject to certain performance conditions outstanding. The cash-settled performance awards represent a non-equity unit with a conversion value equal to the fair market value of a share of the Company’s common stock at the vesting date. These awards are classified as liability awards due to the cash settlement feature. Compensation costs associated with the cash-settled performance awards are re-measured at each interim reporting period and an adjustment is recorded in general and administrative expenses on our consolidated statements of operations. For the three and nine months ended September 30, 2018, we recognized an expense of $27,000 and $0.8 million, respectively. For the three and nine months ended September 30, 2017, we recognized an expense of $0.2 million and $0.5 million, respectively. At September 30, 2018, we recorded a current liability of $1.1 million and a non-current liability of $0.8 million related to the cash-settled performance awards on our consolidated balance sheets. During the nine months ended September 30, 2018, we paid $1 million related to vested cash-settled performance awards.

10. Related Party Transactions

Wilks, a related party, purchased a portion of our outstanding Senior Notes in the open market subsequent to the Exchange Transactions. The Company believes that Wilks held approximately $60 million of our outstanding Senior Notes as of September 30, 2018. The Senior Notes held by Wilks are included in Senior Notes, net on our consolidated balance sheets. Our interest expense includes interest attributable to any Senior Notes held by Wilks on our consolidated statements of operations.

In April 2018, we engaged ProFrac Services, LLC (“ProFrac”) to perform completion services to the Company. There is no required minimum or maximum number of wells committed, and we intend to use ProFrac on a well-by-well basis throughout 2018. Matthew D. Wilks, a member of our Board of Directors, serves as the Chief Financial Officer of ProFrac, and Wilks has an equity ownership interest in ProFrac. During the nine months ended September 30, 2018, we incurred capital expenditures of $8.1 million for hydraulic fracturing services with Profrac, which is included in additions to oil and gas properties on our consolidated statements of cash flows. As of September 30, 2018, there is no recorded liability due to ProFrac.

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

The following discussion is intended to assist in understanding our financial condition, changes in financial condition and results of operations. This section should be read in conjunction with management’s discussion and analysis contained in our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission (“SEC”) on March 9, 2018. Our consolidated financial statements and the accompanying notes included elsewhere in this report contain additional information that should be referred to when reviewing this material. Certain statements in this discussion may be forward-looking. These forward-looking statements involve risks and uncertainties, which could cause actual results to differ from those expressed in this report. A glossary containing the meaning of the oil and gas industry terms used in this management’s discussion and analysis follows the “Results of Operations” table in this Item 2.

Cautionary Statement Regarding Forward-Looking Statements

Various statements in this report, including those that express a belief, expectation or intention, as well as those that are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The forward-looking statements may include projections and estimates concerning the timing and success of specific projects, typical well economics and our future reserves, production, revenues, costs, income, capital spending, 3-D seismic operations, interpretation and results and obtaining permits and regulatory approvals. When used in this report, the words “will,” “believe,” “intend,” “expect,” “may,” “should,” “anticipate,” “could,” “estimate,” “plan,” “predict,” “project,” “potential” or their negatives, other similar expressions or the statements that include those words, are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words.

These forward-looking statements are largely based on our expectations, which reflect estimates and assumptions made by our management. These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors. Although we believe such estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control. In addition, management’s assumptions about future events may prove to be inaccurate. We caution all readers that the forward-looking statements contained in this report are not guarantees of future performance, and we cannot assure any reader that such statements will be realized or the forward-looking events and circumstances will occur. Actual results may differ materially from those anticipated or implied in the forward-looking statements due to the factors listed or referred to in the “Risk Factors” section and elsewhere in this report. All forward-looking statements speak only as of the date of this report. We disclaim any obligation to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise, unless required by law. These cautionary statements qualify all forward-looking statements attributable to us, or persons acting on our behalf. The risks, contingencies and uncertainties relate to, among other matters, the following:

| • | uncertainties in drilling, exploring for and producing oil and gas;

| • | oil, NGLs and natural gas prices;

| • | overall United States and global economic and financial market conditions;

| • | our leverage negatively affecting our semi-annual redetermination of our revolving credit facility;

| • | our ability to comply with the covenants in our revolving credit facility;

| • | domestic and foreign demand and supply for oil, NGLs, natural gas and the products derived from such hydrocarbons;

| • | actions of the Organization of Petroleum Exporting Countries, its members and other state-controlled oil companies relating to oil price and production controls;

| • | our ability to obtain additional financing necessary to fund our operations and capital expenditures and to meet our other obligations;

| • | our ability to maintain a sound financial position;

| • | issuance of our common stock in connection with potential refinancing transactions that may cause substantial dilution;

| • | our cash flows and liquidity;

| • | the effects of government regulation and permitting and other legal requirements, including laws or regulations that could restrict or prohibit hydraulic fracturing;

| • | disruption of credit and capital markets;

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| • | disruptions to, capacity constraints in or other limitations on the pipeline systems that deliver our oil, NGLs and natural gas and other processing and transportation considerations;

| • | marketing of oil, NGLs and natural gas;

| • | high costs, shortages, delivery delays or unavailability of drilling and completion equipment, materials, labor or other services;

| • | competition in the oil and gas industry;

| • | uncertainty regarding our future operating results;

| • | profitability of drilling locations;

| • | interpretation of 3-D seismic data;

| • | replacing our oil, NGLs and natural gas reserves;

| • | our ability to retain and attract key personnel;

| • | our business strategy, including our ability to recover oil, NGLs and natural gas in place associated with our Wolfcamp shale oil resource play in the Permian Basin;

| • | development of our current asset base or property acquisitions;

| • | estimated quantities of oil, NGLs and natural gas reserves and present value thereof;

| • | plans, objectives, expectations and intentions contained in this report that are not historical; and

| • | other factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 9, 2018.

Overview

Approach Resources Inc. is an independent energy company focused on the exploration, development, production and acquisition of unconventional oil and gas reserves in the Midland Basin of the greater Permian Basin in West Texas, where we leased approximately 150,000 net acres as of September 30, 2018. We believe our concentrated acreage position and extensive, integrated field infrastructure system provides us an opportunity to achieve cost, operating and recovery efficiencies in the development of our drilling inventory. Our long-term business strategy is to create value by growing reserves and production in a cost efficient manner and at attractive rates of return. We intend to pursue that strategy by developing resource potential from the Wolfcamp shale oil formation and pursuing acquisitions that meet our strategic and financial objectives. Additional drilling targets could include the Clearfork, Canyon Sands, Strawn and Ellenburger zones. We sometimes refer to our development project in the Permian Basin as “Project Pangea,” which includes “Pangea West.” Our management and technical team have a proven track record of finding and developing reserves through advanced drilling and completion techniques. As the operator of all of our estimated proved reserves and production, we have a high degree of control over capital expenditures and other operating matters.

At December 31, 2017, our estimated proved reserves were 181.5 million barrels of oil equivalent (“MMBoe”), made up of 28% oil, 32% NGLs and 40% gas. The proved developed reserves were 37% of our total proved reserves at December 31, 2017. Substantially all of our proved reserves are located in the Permian Basin in Crockett and Schleicher counties, Texas. At September 30, 2018, we owned working interests in 801 producing oil and gas wells.

Third Quarter 2018 Activity

During the three months ended September 30, 2018, we produced 1,043 MBoe, or 11.3 MBoe/d. During the quarter, we drilled six horizontal wells, and completed two horizontal wells. At September 30, 2018, we had seven horizontal Wolfcamp wells waiting on completion. We currently have no rigs running in Project Pangea.

2018 Capital Expenditures

For the three months ended September 30, 2018, our capital expenditures totaled $19.3 million, consisting of $17 million for drilling and completion activities, $2.2 million for infrastructure projects and equipment and $0.1 million for lease acquisitions and extensions. For the nine months ended September 30, 2018, our capital expenditures totaled $46.5 million, consisting of $40.6 million for drilling and completion activities, $5.5 million for infrastructure projects and equipment and $0.4 million for lease acquisitions and extensions. We do not expect significant additional capital expenditures for the remainder of the year.

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Our 2018 capital budget excludes acquisitions and lease extensions and renewals and is subject to change depending upon a number of factors, including prevailing and anticipated prices for oil, NGLs and gas, results of horizontal drilling and completions, economic and industry conditions at the time of drilling, the availability of sufficient capital resources for drilling prospects, our financial results and the availability of lease extensions and renewals on reasonable terms. Although the impact of changes in these collective factors in the current commodity price environment is difficult to estimate, we currently expect to execute our development plan based on current conditions. To the extent there is a significant increase or decrease in commodity prices in the future, we will assess the impact on our development plan at that time, and we may respond to such changes by altering our capital budget or our development plan.

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Results of Operations

The following table sets forth summary information regarding oil, NGLs and gas revenues, production, average product prices and average production costs and expenses for the three and nine months ended September 30, 2018 and 2017. We determine a barrel of oil equivalent using the ratio of six Mcf of natural gas to one Boe, and one barrel of NGLs to one Boe. The ratios of six Mcf of natural gas to one Boe and one barrel of NGLs to one Boe do not assume price equivalency and, given price differentials, the price for a Boe for natural gas or NGLs may differ significantly from the price for a barrel of oil.

|  | Three Months Ended |  |  | Nine Months Ended |
|  | September 30, |  |  | September 30, |
|  | 2018 |  |  | 2017 |  |  | 2018 |  |  | 2017 |
Revenues (in thousands): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Oil |  | $ | 18,075 |  |  | $ | 12,464 |  |  | $ | 52,524 |  |  | $ | 38,666 |
NGLs |  |  | 10,690 |  |  |  | 7,093 |  |  |  | 26,874 |  |  |  | 19,172 |
Gas |  |  | 3,797 |  |  |  | 6,051 |  |  |  | 12,262 |  |  |  | 19,094 |
Total oil, NGLs and gas sales |  |  | 32,562 |  |  |  | 25,608 |  |  |  | 91,660 |  |  |  | 76,932 |
Net cash payment on derivative settlements |  |  | (3,172 | ) |  |  | (523 | ) |  |  | (6,685 | ) |  |  | (1,481 | )
Total oil, NGLs and gas sales including derivative impact |  | $ | 29,390 |  |  | $ | 25,085 |  |  | $ | 84,975 |  |  | $ | 75,451 |
Production: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Oil (MBbls) |  |  | 269 |  |  |  | 278 |  |  |  | 819 |  |  |  | 837 |
NGLs (MBbls) |  |  | 377 |  |  |  | 374 |  |  |  | 1,105 |  |  |  | 1,109 |
Gas (MMcf) |  |  | 2,388 |  |  |  | 2,455 |  |  |  | 7,168 |  |  |  | 7,331 |
Total (MBoe) |  |  | 1,043 |  |  |  | 1,061 |  |  |  | 3,119 |  |  |  | 3,168 |
Total (MBoe/d) |  |  | 11.3 |  |  |  | 11.5 |  |  |  | 11.4 |  |  |  | 11.6 |
Average prices: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Oil (per Bbl) |  | $ | 67.28 |  |  | $ | 44.91 |  |  | $ | 64.13 |  |  | $ | 46.19 |
NGLs (per Bbl) |  |  | 28.38 |  |  |  | 18.96 |  |  |  | 24.31 |  |  |  | 17.28 |
Gas (per Mcf) |  |  | 1.59 |  |  |  | 2.46 |  |  |  | 1.71 |  |  |  | 2.60 |
Total (per Boe) |  |  | 31.21 |  |  |  | 24.14 |  |  |  | 29.39 |  |  |  | 24.28 |
Net cash payment on derivative settlements (per Boe) |  |  | (3.04 | ) |  |  | (0.49 | ) |  |  | (2.14 | ) |  |  | (0.47 | )
Total including derivative impact (per Boe) |  | $ | 28.17 |  |  | $ | 23.65 |  |  | $ | 27.25 |  |  | $ | 23.81 |
Costs and expenses (per Boe): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Lease operating |  | $ | 5.57 |  |  | $ | 4.16 |  |  | $ | 5.17 |  |  | $ | 4.05 |
Production and ad valorem taxes |  |  | 2.03 |  |  |  | 1.71 |  |  |  | 2.30 |  |  |  | 2.03 |
Exploration |  |  | — |  |  |  | 0.09 |  |  |  | — |  |  |  | 1.03 |
General and administrative |  |  | 5.35 |  |  |  | 6.00 |  |  |  | 5.84 |  |  |  | 5.95 |
Depletion, depreciation and amortization |  |  | 13.90 |  |  |  | 15.88 |  |  |  | 15.08 |  |  |  | 17.15 |

Glossary

Bbl. One stock tank barrel, of 42 U.S. gallons liquid volume, used herein to reference oil, condensate or NGLs.

Boe. Barrel of oil equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of oil equivalent, and one Bbl of NGLs to one Bbl of oil equivalent.

MBbl. Thousand barrels of oil, condensate or NGLs.

MBoe. Thousand barrels of oil equivalent.

Mcf. Thousand cubic feet of natural gas.

MMBoe. Million barrels of oil equivalent.

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MMBtu. Million British thermal units.

MMcf. Million cubic feet of natural gas.

NGLs. Natural gas liquids.

NYMEX. New York Mercantile Exchange.

/d. “Per day” when used with volumetric units or dollars.

Three Months Ended September 30, 2018 Compared to Three Months Ended September 30, 2017

Oil, NGLs and gas sales. Oil, NGLs and gas sales increased $7 million, or 27%, for the three months ended September 30, 2018, to $32.6 million, compared to $25.6 million for the three months ended September 30, 2017. The increase in oil, NGLs and gas sales was due to an increase in average realized commodity prices ($7.4 million) partially offset by a decrease in production volumes ($0.4 million). We expect oil, NGLs and gas sales to increase for the remainder of 2018 compared to the prior year period due to improved commodity prices.

Net loss. Net loss for the three months ended September 30, 2018, was $4.3 million, or $0.05 per diluted share, compared to $8.5 million, or $0.10 per diluted share, for the three months ended September 30, 2017. Net loss for the three months ended September 30, 2018, included a commodity derivative loss of $3.3 million. The decrease in the net loss for the three months ended September 30, 2018, was primarily due to the increase in revenue ($7 million), partially offset by a decrease in income tax benefit ($3.3 million).

Oil, NGLs and gas production. Production for the three months ended September 30, 2018, totaled 1,043 MBoe (11.3 MBoe/d), compared to production of 1,061 MBoe (11.5 MBoe/d) in the prior-year period, a 2% decrease. Production for the three months ended September 30, 2018, was 26% oil, 36% NGLs and 38% gas, compared to 26% oil, 35% NGLs and 39% gas in the 2017 period. Production volumes decreased during the three months ended September 30, 2018, due to natural production decline. We expect production to decrease from current levels through year end due to a decrease in capital expenditures.

Commodity derivative loss. The following table sets forth the components of our commodity derivative loss for the three months ended September 30, 2018, and 2017 (in thousands).

|  | Three Months Ended September 30, |
|  | 2018 |  |  | 2017 |
Net cash payment on derivative settlements |  | $ | (3,172 | ) |  | $ | (523 | )
Non-cash fair value loss on derivatives |  |  | (84 | ) |  |  | (3,037 | )
Commodity derivative loss |  | $ | (3,256 | ) |  | $ | (3,560 | )

Historically, we have not designated our derivative instruments as cash-flow hedges. Commodity derivative settlements are derived from the relative movement of commodity prices in relation to the fixed notional pricing in our derivative contracts for the respective years. As commodity prices increase or decrease, the fair value of the open portion of those positions decreases or increases, respectively. We record our open derivative instruments at fair value on our consolidated balance sheets as either derivative assets or liabilities. For commodity derivatives not designated as a cash-flow hedge, we record changes in such fair value in earnings on our consolidated statements of operations under the caption entitled “commodity derivative (loss) gain.”

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In April 2018, we entered into basis swaps for the NYMEX Calendar Monthly Average Roll (the “CMA Roll”) covering 2,000 Bbls per day for May 2018 through December 2018 at $0.66/bbl. Basis swaps for the CMA Roll are pricing adjustments to the trade month versus the delivery month for contract pricing. These derivative contracts were designated as cash-flow hedges. The changes in fair value of the derivative contracts designated as cash-flow hedges, to the extent the hedge is effective, will be recognized in other comprehensive income until the hedged item is recognized in revenue. Oil, NGLs and gas sales includes a reduction in revenue of $85,000 related to this cash flow hedge for the three months ended September 30, 2018.

Lease operating. Our lease operating expenses (“LOE”) increased $1.4 million, or 32%, for the three months ended September 30, 2018, to $5.8 million, or $5.57 per Boe, compared to $4.4 million, or $4.16 per Boe, for the three months ended September 30, 2017. The increase in LOE per Boe for the three months ended September 30, 2018, was primarily due to well repairs, workovers and maintenance, compressor rental and repair and water handling. The increase in well repairs, workovers and maintenance was due to an increase in workover activity for the three months ended September 30, 2018. We expect a decrease in LOE due to a decrease in workover activity. The following table summarizes LOE in millions and LOE per Boe.

|  | Three Months Ended September 30, |  |  |  |  |  |  |  |  |  |  |  |  |
|  | 2018 |  |  | 2017 |  |  | Change |  |  |  |  |
|  | $MM |  |  | Boe |  |  | $MM |  |  | Boe |  |  | $MM |  |  | Boe |  |  | % Change (Boe) |
Compressor rental and repair |  | $ | 1.9 |  |  | $ | 1.86 |  |  | $ | 1.8 |  |  | $ | 1.70 |  |  | $ | 0.1 |  |  | $ | 0.16 |  |  |  | 9.4 | %
Well repairs, workovers and maintenance |  |  | 1.9 |  |  |  | 1.82 |  |  |  | 0.9 |  |  |  | 0.81 |  |  |  | 1.0 |  |  |  | 1.01 |  |  |  | 124.7 |
Water handling and other |  |  | 1.2 |  |  |  | 1.10 |  |  |  | 1.0 |  |  |  | 0.92 |  |  |  | 0.2 |  |  |  | 0.18 |  |  |  | 19.6 |
Pumpers and supervision |  |  | 0.8 |  |  |  | 0.79 |  |  |  | 0.7 |  |  |  | 0.73 |  |  |  | 0.1 |  |  |  | 0.06 |  |  |  | 8.2 |
Total |  | $ | 5.8 |  |  | $ | 5.57 |  |  | $ | 4.4 |  |  | $ | 4.16 |  |  | $ | 1.4 |  |  | $ | 1.41 |  |  |  | 33.9 | %

Production and ad valorem taxes. Our production and ad valorem taxes increased $0.3 million, or 17%, for the three months ended September 30, 2018, to $2.1 million compared to $1.8 million for the three months ended September 30, 2017. Production and ad valorem taxes were $2.03 per Boe and $1.71 per Boe and approximately 6.5% and 7.1% of oil, NGLs and gas sales for the three months ended September 30, 2018 and 2017, respectively. The increase in production and ad valorem taxes was primarily a function of the increase in oil, NGLs and gas sales between the current and prior periods.

Exploration. We recorded exploration expense of $6,000 for the three months ended September 30, 2018, compared to $0.1 million, or $0.09 per Boe for the three months ended September 30, 2017. The decrease in exploration expense was primarily due to no lease expirations in the third quarter of 2018.

General and administrative. Our general and administrative expenses (“G&A”) decreased $0.8 million, or 12%, to $5.6 million, or $5.35 per Boe, for the three months ended September 30, 2018, compared to $6.4 million, or $6.00 per Boe, for the three months ended September 30, 2017. The decrease in G&A and G&A per Boe was primarily due to a decrease in share-based compensation and salaries and benefits. For the three months ended September 30, 2018, G&A included an expense of $27,000 compared to an expense of $0.2 million for the three months ended September 30, 2017, related to cash-settled performance awards. These awards are re-measured each interim reporting period based on the fair market value of our common stock. Significant changes in the fair market value of our common stock will impact G&A and G&A per Boe. The following table summarizes G&A in millions and G&A per Boe.

|  | Three Months Ended September 30, |  |  |  |  |  |  |  |  |  |  |  |  |
|  | 2018 |  |  | 2017 |  |  | Change |  |  |  |  |
|  | $MM |  |  | Boe |  |  | $MM |  |  | Boe |  |  | $MM |  |  | Boe |  |  | % Change (Boe) |
Salaries and benefits |  | $ | 3.1 |  |  | $ | 3.00 |  |  | $ | 3.3 |  |  | $ | 3.08 |  |  | $ | (0.2 | ) |  | $ | (0.08 | ) |  |  | (2.6 | )%
Share-based compensation |  |  | 0.6 |  |  | $ | 0.61 |  |  |  | 1.3 |  |  | $ | 1.25 |  |  |  | (0.7 | ) |  |  | (0.64 | ) |  |  | (51.2 | )
Professional fees |  |  | 0.6 |  |  | $ | 0.54 |  |  |  | 0.6 |  |  | $ | 0.58 |  |  |  | - |  |  |  | (0.04 | ) |  |  | (6.9 | )
Other |  |  | 1.3 |  |  | $ | 1.20 |  |  |  | 1.2 |  |  | $ | 1.09 |  |  |  | 0.1 |  |  |  | 0.11 |  |  |  | 10.1 |
Total |  | $ | 5.6 |  |  | $ | 5.35 |  |  | $ | 6.4 |  |  | $ | 6.00 |  |  | $ | (0.8 | ) |  | $ | (0.65 | ) |  |  | (10.8 | )%

Depletion, depreciation and amortization. Our depletion, depreciation and amortization expense (“DD&A”) decreased $2.3 million, or 14%, to $14.5 million for the three months ended September 30, 2018, compared to $16.8 million for the three months ended September 30, 2017. Our DD&A per Boe decreased by $1.98, or 12%, to $13.90 per Boe for the three months ended September 30, 2018, compared to $15.88 per Boe for the three months ended September 30, 2017. The decrease in DD&A and DD&A per Boe over the prior-year period was primarily due to an increase in estimated proved developed reserves.

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Interest expense, net. Our interest expense, net, increased $1.2 million, or 22%, to $6.5 million for the three months ended September 30, 2018, compared to $5.3 million for the three months ended September 30, 2017. This increase was primarily due to increases in the applicable margin rates, outstanding borrowings and floating interest rates under our revolving credit facility. The weighted average interest rate applicable to borrowings under our revolving credit facility for the three months ended September 30, 2018, was 6.1% compared to 4.7% for the three months ended September 30, 2017.

Income taxes. For the three months ended September 30, 2018, our income tax benefit was $0.9 million, compared to an income tax benefit of $4.3 million for the three months ended September 30, 2017. The following table reconciles our income tax expense for the three months ended September 30, 2018, and 2017, to the U.S. federal statutory rates of 21% and 35%, respectively (in thousands).

|  | September 30, |  |  | September 30, |
|  | 2018 |  |  | 2017 |
Statutory tax at 21% and 35%, respectively |  | $ | (1,088 | ) |  | $ | (4,470 | )
State taxes, net of federal impact |  |  | 137 |  |  |  | 171 |
Share-based compensation tax shortfall |  |  | — |  |  |  | 8 |
Nondeductible compensation |  |  | 30 |  |  |  | — |
Other differences |  |  | — |  |  |  | 33 |
Write-off of deferred tax assets |  |  | — |  |  |  | — |
Income tax (benefit) provision |  | $ | (921 | ) |  | $ | (4,258 | )

On December 22, 2017, the Tax Cuts and Jobs Act was enacted which, among other things, lowered the U.S. federal income tax rate applicable to corporations from 35% to 21% and repealed the corporate alternative minimum tax. We expect our effective tax rate to be lower compared to the prior year due to the change in tax legislation.

Nine Months Ended September 30, 2018 Compared to Nine Months Ended September 30, 2017

Oil, NGLs and gas sales. Oil, NGLs and gas sales increased $14.8 million, or 19%, for the nine months ended September 30, 2018, to $91.7 million, compared to $76.9 million for the nine months ended September 30, 2017. The increase in oil, NGLs and gas sales was due to an increase in average realized commodity prices ($15.9 million) partially offset by a decrease in production volumes ($1.2 million). We expect oil, NGLs and gas sales to increase in 2018 compared to 2017 due to improved commodity prices.

Net loss. Net loss for the nine months ended September 30, 2018, was $20.8 million, or $0.22 per diluted share, compared to $158.2 million, or $1.95 per diluted share, for the nine months ended September 30, 2017. Net loss for the nine months ended September 30, 2018, included a commodity derivative loss of $10.1 million. The decrease in the net loss for the nine months ended September 30, 2018, was primarily due to the debt-for-equity exchange transactions completed in the nine months ended September 30, 2017. In connection with the exchange transactions, we recognized a gain on debt extinguishment of $5.1 million and a write-off of deferred tax assets of $139.1 million resulting from our cumulative change in ownership.

Oil, NGLs and gas production. Production for the nine months ended September 30, 2018, totaled 3,119 MBoe (11.4 MBoe/d), compared to production of 3,168 MBoe (11.6 MBoe/d) in the prior-year period, a 2% decrease. Production for the nine months ended September 30, 2018, was 26% oil, 36% NGLs and 38% gas, compared to 26% oil, 35% NGLs and 39% gas in the 2017 period. Production volumes decreased during the nine months ended September 30, 2018, due to natural production decline. We expect production to decrease from current levels through year end due to a decrease in capital expenditures.

Commodity derivative (loss) gain. The following table sets forth the components of our commodity derivative (loss) gain for the nine months ended September 30, 2018, and 2017 (in thousands).

|  | Nine Months Ended September 30, |
|  | 2018 |  |  | 2017 |
Net cash payment on derivative settlements |  | $ | (6,685 | ) |  | $ | (1,481 | )
Non-cash fair value (loss) gain on derivatives |  |  | (3,383 | ) |  |  | 2,596 |
Commodity derivative (loss) gain |  | $ | (10,068 | ) |  | $ | 1,115 |

In April 2018, we entered into basis swaps for the CMA Roll covering 2,000 Bbls per day for May 2018 through December 2018 at $0.66/bbl. Basis swaps for the CMA Roll are pricing adjustments to the trade month versus the delivery month for contract pricing. These derivative contracts were designated as cash-flow hedges. The changes in fair value of the derivative contracts designated as cash-flow hedges, to the extent the hedge is effective, will be recognized in other comprehensive income until the

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hedged item is recognized in revenue. Oil, NGLs and gas sales includes a reduction in revenue of $23,000 related to this cash flow hedge for the nine months ended September 30, 2018.

Lease operating. Our LOE increased $3.3 million, or 26%, for the nine months ended September 30, 2018, to $16.1 million, or $5.17 per Boe, compared to $12.8 million, or $4.05 per Boe, for the nine months ended September 30, 2017. The increase in LOE per Boe for the nine months ended September 30, 2018, was primarily due to well repairs, workovers and maintenance and water handling. The increase in well repairs, workovers and maintenance was due to an increase in workover activity for the nine months ended September 30, 2018. We expect a decrease in LOE due to a decrease in workover activity. The following table summarizes LOE in millions and LOE per Boe.

|  | Nine Months Ended September 30, |  |  |  |  |  |  |  |  |  |  |  |  |
|  | 2018 |  |  | 2017 |  |  | Change |  |  |  |  |
|  | $MM |  |  | Boe |  |  | $MM |  |  | Boe |  |  | $MM |  |  | Boe |  |  | % Change (Boe) |
Compressor rental and repair |  | $ | 5.3 |  |  | $ | 1.72 |  |  | $ | 5.3 |  |  | $ | 1.66 |  |  | $ | - |  |  | $ | 0.06 |  |  |  | 3.6 | %
Well repairs, workovers and maintenance |  |  | 4.9 |  |  |  | 1.57 |  |  |  | 2.7 |  |  |  | 0.85 |  |  |  | 2.2 |  |  |  | 0.72 |  |  |  | 84.7 |
Water handling and other |  |  | 3.5 |  |  |  | 1.12 |  |  |  | 2.6 |  |  |  | 0.83 |  |  |  | 0.9 |  |  |  | 0.29 |  |  |  | 34.9 |
Pumpers and supervision |  |  | 2.4 |  |  |  | 0.76 |  |  |  | 2.2 |  |  |  | 0.71 |  |  |  | 0.2 |  |  |  | 0.05 |  |  |  | 7.0 |
Total |  | $ | 16.1 |  |  | $ | 5.17 |  |  | $ | 12.8 |  |  | $ | 4.05 |  |  | $ | 3.3 |  |  | $ | 1.12 |  |  |  | 27.7 | %

Production and ad valorem taxes. Our production and ad valorem taxes increased $0.8 million, or 12%, for the nine months ended September 30, 2018, to $7.2 million compared to $6.4 million for the nine months ended September 30, 2017. Production and ad valorem taxes were $2.30 per Boe and $2.03 per Boe and approximately 7.8% and 8.4% of oil, NGLs and gas sales for the nine months ended September 30, 2018 and 2017, respectively. The increase in production and ad valorem taxes was primarily a function of the increase in oil, NGLs and gas sales between the two periods.

Exploration. We recorded exploration expense of $9,000 for the nine months ended September 30, 2018, compared to $3.3 million, or $1.03 per Boe for the nine months ended September 30, 2017. The decrease in exploration expense was primarily due to no lease expirations in the nine months ended September 30, 2018.

General and administrative. Our G&A decreased $0.6 million, or 3%, to $18.2 million, or $5.84 per Boe, for the nine months ended September 30, 2018, compared to $18.8 million, or $5.95 per Boe, for the nine months ended September 30, 2017. The decrease in G&A and G&A per Boe was primarily due a decrease in share-based compensation, partially offset by an increase in salaries and benefits. For the nine months ended September 30, 2018, G&A included an expense of $0.8 million compared to an expense of $0.5 million for the nine months ended September 30, 2017, related to cash-settled performance awards. These awards are re-measured each interim reporting period based on the fair market value of our common stock. Significant changes in the fair market value of our common stock will impact G&A and G&A per Boe. The following table summarizes G&A in millions and G&A per Boe.

|  | Nine Months Ended September 30, |  |  |  |  |  |  |  |  |  |  |  |  |
|  | 2018 |  |  | 2017 |  |  | Change |  |  |  |  |
|  | $MM |  |  | Boe |  |  | $MM |  |  | Boe |  |  | $MM |  |  | Boe |  |  | % Change (Boe) |
Salaries and benefits |  | $ | 10.5 |  |  | $ | 3.37 |  |  | $ | 10.0 |  |  | $ | 3.17 |  |  | $ | 0.5 |  |  | $ | 0.20 |  |  |  | 6.3 | %
Share-based compensation |  |  | 2.1 |  |  | $ | 0.68 |  |  |  | 3.5 |  |  | $ | 1.11 |  |  |  | (1.4 | ) |  |  | (0.43 | ) |  |  | (38.7 | )
Professional fees |  |  | 1.8 |  |  | $ | 0.57 |  |  |  | 1.8 |  |  | $ | 0.58 |  |  |  | - |  |  |  | (0.01 | ) |  |  | (1.7 | )
Other |  |  | 3.8 |  |  | $ | 1.22 |  |  |  | 3.5 |  |  | $ | 1.09 |  |  |  | 0.3 |  |  |  | 0.13 |  |  |  | 11.9 |
Total |  | $ | 18.2 |  |  | $ | 5.84 |  |  | $ | 18.8 |  |  | $ | 5.95 |  |  | $ | (0.6 | ) |  | $ | (0.11 | ) |  |  | (1.8 | )%

Depletion, depreciation and amortization. Our DD&A decreased $7.3 million, or 13%, to $47 million for the nine months ended September 30, 2018, compared to $54.3 million for the nine months ended September 30, 2017. Our DD&A per Boe decreased by $2.07, or 12%, to $15.08 per Boe for the nine months ended September 30, 2018, compared to $17.15 per Boe for the nine months ended September 30, 2017. The decrease in DD&A and DD&A per Boe over the prior-year period was primarily due to an increase in estimated proved developed reserves.

Interest expense, net. Our interest expense, net, increased $2.8 million, or 18%, to $18.5 million for the nine months ended September 30, 2018, compared to $15.7 million for the nine months ended September 30, 2017. This increase was primarily due to an increase in the applicable margin rates, outstanding borrowings and floating interest rates under our revolving credit facility. The

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weighted average interest rate applicable to borrowings under our revolving credit facility for the nine months ended September 30, 2018, was 5.8% compared to 4.4% for the nine months ended September 30, 2017.

Gain on debt extinguishment. In the nine months ended September 30, 2018, we did not repurchase or retire any outstanding debt. In the nine months ended September 30, 2017, we completed two debt-for-equity exchange transactions, which reduced the principal amount of our outstanding 7% Senior Notes due 2021 (the “Senior Notes”) by $145.1 million. We recognized a gain of $5.1 million on the exchange transactions for the difference between the fair market value of the shares issued, a Level 1 fair value measurement, and the net carrying value of the Senior Notes exchanged.

Income taxes. For the nine months ended September 30, 2018, our income tax benefit was $4.8 million, compared to an income tax expense of $129.9 million for the nine months ended September 30, 2017. The following table reconciles our income tax expense for the nine months ended September 30, 2018, and 2017, to the U.S. federal statutory rates of 21% and 35%, respectively (in thousands).

|  | September 30, |  |  | September 30, |
|  | 2018 |  |  | 2017 |
Statutory tax at 21% and 35%, respectively |  | $ | (5,362 | ) |  | $ | (9,885 | )
State taxes, net of federal impact |  |  | 411 |  |  |  | 366 |
Share-based compensation tax shortfall |  |  | 70 |  |  |  | 320 |
Nondeductible compensation |  |  | 123 |  |  |  | — |
Other differences |  |  | 5 |  |  |  | 42 |
Write-off of deferred tax assets |  |  | — |  |  |  | 139,090 |
Income tax (benefit) provision |  | $ | (4,753 | ) |  | $ | 129,933 |

On December 22, 2017, the Tax Cuts and Jobs Act was enacted which, among other things, lowered the U.S. Federal income tax rate applicable to corporations from 35% to 21% and repealed the corporate alternative minimum tax. We expect our effective tax rate to be lower compared to the prior year due to the change in tax legislation.

In the nine months ended September 30, 2017, in connection with the debt-for-equity exchange transactions, we recorded a write-off of deferred tax assets of $139.1 million resulting from our cumulative change in ownership.

Liquidity and Capital Resources

We generally will rely on cash generated from operations, to the extent available, borrowings under our revolving credit facility and, to the extent that credit and capital market conditions will allow, future equity and debt offerings to satisfy our liquidity needs. Our ability to fund planned capital expenditures and to make acquisitions depends upon commodity prices, our future operating performance, availability of borrowings under our revolving credit facility, and more broadly, on the availability of equity and debt financing, which is affected by prevailing economic conditions in our industry and financial, business and other factors, some of which are beyond our control. We cannot predict whether additional liquidity from equity or debt financings beyond our revolving credit facility will be available on acceptable terms, or at all, in the foreseeable future.

Our cash flow from operations is driven by commodity prices, production volumes and the effect of commodity derivatives. Cash flows from operations are primarily used to fund exploration and development of our oil and gas properties. If commodity prices decline from current levels, our operating cash flows will decrease and our lenders may reduce our borrowing base, thus limiting the amounts available to fund future capital expenditures. If we are unable to replace our oil, NGLs and gas reserves through acquisition, development and exploration, we may also suffer a reduction in operating cash flows and access to funds under our revolving credit facility. At September 30, 2018, we were in compliance with all required covenants under our revolving credit facility. If commodity prices remain or decline from current levels or we fail to reduce our total debt, we may trigger non-compliance with required financial covenants in the future and otherwise adversely impact our ability to operate.

We believe we have adequate liquidity from cash generated from operations and unused borrowing capacity under our revolving credit facility for current working capital needs and maintenance of our current development plan. However, we may determine to use various financing sources, including the issuance of common stock, preferred stock, debt, convertible securities and other securities for future development of reserves, acquisitions, additional working capital or other liquidity needs, including debt reduction, if such financing is available on acceptable terms. We cannot guarantee that such financing will be available on acceptable terms, or at all. Using some of these financing sources may require approval from the lenders under our revolving credit facility.

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Liquidity

We define liquidity as funds available under our revolving credit facility and cash and cash equivalents. Our liquidity is subject to our continued compliance with the financial covenants under our revolving credit facility. At September 30, 2018, we were in compliance with all of our covenants, and there were no existing defaults or events of default under our debt instruments.

Our revolving credit facility includes, among other financial covenants, a leverage covenant, which requires us to reduce our leverage as of the end of the first quarter of 2019. Our leverage is currently above the level required by the leverage covenant, and factors beyond our control may affect our ability to comply with the leverage covenant by the end of the first quarter of 2019. Failure to comply with the leverage covenant may result in an event of default. See Note 5 to our consolidated financial statements in this report for additional information regarding the leverage covenant and the other financial covenants under our revolving credit facility.

At September 30, 2018, we had $295.5 million in outstanding borrowings under our revolving credit facility and liquidity of $29.2 million, compared to $291 million in outstanding borrowings under our revolving credit facility and liquidity of $33.7 million at December 31, 2017. The table below summarizes our liquidity position at September 30, 2018, and December 31, 2017 (in thousands).

|  | Liquidity at |
|  | September 30, |  |  | December 31, |
|  | 2018 |  |  | 2017 |
Borrowing base |  | $ | 325,000 |  |  | $ | 325,000 |
Cash and cash equivalents |  | 22 |  |  |  | 21 |
Long-term debt – Credit Facility |  |  | (295,500 | ) |  |  | (291,000 | )
Undrawn letters of credit |  |  | (325 | ) |  |  | (325 | )
Liquidity |  | $ | 29,197 |  |  | $ | 33,696 |

Working Capital

Our working capital is affected primarily by our capital spending program. We had a working capital deficit of $26.8 million and $8.4 million at September 30, 2018, and December 31, 2017, respectively. The change in working capital was primarily due to an increase in accounts payable and accrued liabilities due to our capital spending program. To the extent we operate with a working capital deficit, we expect such deficit to be offset by liquidity available under our revolving credit facility.

Cash Flows

The following table summarizes our sources and uses of funds for the periods noted (in thousands).

|  | Nine Months Ended September 30, |
|  | 2018 |  |  | 2017 |
Cash provided by operating activities |  | $ | 29,350 |  |  | $ | 29,542 |
Cash used in investing activities |  |  | (32,011 | ) |  |  | (46,694 | )
Cash provided by financing activities |  |  | 2,662 |  |  |  | 17,152 |
Net increase in cash and cash equivalents |  | $ | 1 |  |  | $ | — |

Operating Activities

Cash provided by operating activities decreased by 1%, or $0.2 million, to $29.4 million during the nine months ended September 30, 2018, compared to the prior-year period. The decrease in our cash provided by operating activities was due to an increase in LOE ($3.3 million), interest expense ($2.8 million), net cash settlements under our commodity derivatives ($5.2 million) production and ad valorem taxes ($0.8 million), G&A excluding share-based compensation ($0.8 million), and changes in working capital related to operating activities ($2.3 million), partially offset by an increase in oil, NGLs and gas sales ($14.8 million) from higher commodity prices. We expect our operating cash flow to increase from prior year periods due to anticipated higher commodity prices.

Investing Activities

Cash used in investing activities decreased by $14.7 million for the nine months ended September 30, 2018, to $32 million, compared to the prior-year period. Cash used in investing activities for the nine months ended September 30, 2018, was primarily attributable to drilling and development ($40.6 million), infrastructure projects and equipment ($5.5 million) and lease acquisitions

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($0.4 million). Cash used in investing activities was partially offset by changes in working capital associated with investing activities ($14.5 million). The change in working capital associated with investing activities was due to an increase in accounts payable and accrued liabilities due to our capital spending program and the termination of a prepaid hydraulic fracturing services agreement. During the nine months ended September 30, 2018, we drilled six horizontal wells and completed nine horizontal wells. At September 30, 2018, we had seven horizontal Wolfcamp wells waiting on completion.

Financing Activities

Cash provided by financing activities was $2.7 million for the nine months ended September 30, 2018, compared to $17.2 million of cash provided by financing activities in the prior-year period. We had $295.5 million in outstanding borrowings under our revolving credit facility at September 30, 2018, compared to $291 million in outstanding borrowings as of December 31, 2017. During the nine months ended September 30, 2018, net cash provided by financing activities included net borrowings under our revolving credit facility of $4.5 million, tax withholdings related to restricted stock of $0.6 million and changes in working capital associated with financing activities of $1.2 million.

As market conditions warrant and subject to our contractual restrictions in our revolving credit facility or otherwise, liquidity position and other factors, we may from time to time seek to recapitalize, refinance or otherwise restructure our capital structure. We may accomplish this through open market or privately negotiated transactions, which may include, among other things, repurchases of our common stock or outstanding debt, debt for debt or debt for equity exchanges or refinancings, and private or public equity raises and rights offerings. Many of these alternatives may require the consent of current lenders, stockholders or bond holders, and there is no assurance that we will be able to execute any of these alternatives on acceptable terms or at all. The amounts involved in any such transaction, individually or in the aggregate, may be material.

Revolving Credit Facility

At September 30, 2018, the borrowing base and aggregate lender commitments under our revolving credit facility were $325 million, with maximum commitments from the lenders of $1 billion and a maturity date of May 7, 2020. We had outstanding borrowings of $295.5 million and $291 million under our revolving credit facility at September 30, 2018, and December 31, 2017, respectively. The weighted average interest rate applicable to borrowings under our revolving credit facility for the three months ended September 30, 2018, was 6.1%.

The borrowing base is redetermined semi-annually based upon a number of factors, including commodity prices and reserve levels. We or the lenders can each request one additional borrowing base redetermination each calendar year. Our semi-annual borrowing base redetermination process is underway, but not yet final.

At September 30, 2018, we were in compliance with all of our covenants, and there were no existing defaults or events of default under our debt instruments. See Note 5 to our consolidated financial statements in this report for additional information regarding our revolving credit facility and our principal financial covenants. At September 30, 2018, our leverage ratio was 6.4 to 1.0, which is currently above the level that will be required as of March 31, 2019, of 5.0 to 1.0. If we are unable to improve our total leverage ratio by March 31, 2019, the obligations of the Company under the revolving credit facility may be accelerated, which would have a material adverse effect on our business. Our total leverage ratio has decreased from 9.7 to 1.0 as of December 31, 2016, to 6.4 to 1.0 as of September 30, 2018. In order to continue to improve our leverage position to meet the financial covenants under the revolving credit facility, we are currently pursuing or considering a number of actions, which in certain cases may require the consent of current lenders, stockholders or bond holders, including without limitation (i) exchanging debt for equity, (ii) adjusting our capital budget, (iii) reducing general and administrative expenses, (iv) improving cash flows from operations, (v) more effectively managing working capital and (vi) acquiring assets with existing production and cash flows. There is no assurance that we will be able to execute any of these alternatives on acceptable terms, or at all.

To date, we have experienced no disruptions in our ability to access our revolving credit facility. However, our lenders have substantial ability to reduce our borrowing base on the basis of subjective factors, including the loan collateral value that each lender, in its discretion and using the methodology, assumptions and discount rates as such lender customarily uses in evaluating oil and gas properties, assigns to our properties.

Senior Notes

At September 30, 2018, and December 31, 2017, $85.2 million of our 7% Senior Notes were outstanding. See Note 5 to our consolidated financial statements in this report for additional information regarding the Senior Notes.

Wilks, a related party, purchased a portion of the outstanding Senior Notes in the open market in 2017 and 2018. The Company believes that Wilks held approximately $60 million of the outstanding Senior Notes as of September 30, 2018. The Senior Notes held

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by Wilks are included in Senior Notes, net on our consolidated balance sheets. Our interest expense includes interest attributable to any Senior Notes held by Wilks on our consolidated statements of operations. On April 12, 2018, Wilks disclosed on Schedule 13D/A that they intend to engage in discussions with the Company regarding their investment in the Company, including the possible acquisition of additional shares of common stock through the exchange of additional Senior Notes currently held by Wilks.

Contractual Obligations

Our contractual obligations include long-term debt, operating lease obligations, asset retirement obligations and employment agreements with our executive officers. At September 30, 2018, outstanding borrowings under our revolving credit facility were $295.5 million, compared to $291 million at December 31, 2017. Since December 31, 2017, there have been no other material changes to our contractual obligations.

Off-Balance Sheet Arrangements

From time to time, we enter into off-balance sheet arrangements and transactions that can give rise to off-balance sheet obligations. As of September 30, 2018, the off-balance sheet arrangements and transactions that we have entered into include undrawn letters of credit and operating lease agreements. We do not believe that these arrangements have, or are reasonably likely to have, a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

General Trends and Outlook

Our financial results depend upon many factors, particularly the price of oil, NGLs and gas. Commodity prices are affected by changes in market demand, which is impacted by factors outside of our control, including domestic and foreign supply of oil, NGLs and gas, overall domestic and global economic conditions, commodity processing, gathering and transportation availability and the availability of refining capacity, price and availability of alternative fuels, price and quantity of foreign imports, domestic and foreign governmental regulations, political conditions in or affecting other oil and gas producing countries, weather and technological advances affecting oil, NGLs and gas consumption. As a result, we cannot accurately predict future oil, NGLs and gas prices, and therefore, we cannot determine what effect increases or decreases will have on our capital program, production volumes and future revenues. If the current oil or natural gas prices decline from current levels, they could have a material adverse effect on our business, financial condition and results of operations and quantities of oil, natural gas and NGLs reserves that may be economically produced and liquidity that may be accessed through our borrowing base under our revolving credit facility and through capital markets.

While we face the challenge of financing exploration, development and future acquisitions, we believe that we have adequate liquidity for current, near-term working capital needs and execution of our current development plan from cash generated from operations and unused borrowing capacity under our revolving credit facility. In addition, we may determine to use various financing sources, including the issuance of common stock, preferred stock, debt, convertible securities and other securities for future development of reserves, acquisitions, additional working capital or other liquidity needs, if such financing is available on acceptable terms. We cannot guarantee that such financing will be available on acceptable terms or at all. Using some of these financing sources may require approval from the lenders under our revolving credit facility.

In addition to production volumes and commodity prices, finding and developing sufficient amounts of oil and gas reserves at economical costs are critical to our long-term success. Future finding and development costs are subject to changes in the industry, including the costs of acquiring, drilling and completing our projects. We focus our efforts on increasing oil and gas reserves and production while controlling costs at a level that is appropriate for long-term operations. As commodity prices improve, service costs in our industry may also increase. Our future cash flow from operations will depend on our ability to manage our overall cost structure.

Like all oil and gas production companies, we face the challenge of natural production declines. Oil and gas production from a given well naturally decreases over time. Additionally, our wells have a rapid initial production decline. We attempt to overcome this natural decline by drilling to develop and identify additional reserves, farm-ins or other joint drilling ventures, and by acquisitions. However, during times of severe price declines, we may from time to time reduce current capital expenditures and curtail drilling operations in order to preserve liquidity. A material reduction in capital expenditures and drilling activities could materially reduce our production volumes and revenues.

We believe the outlook for our business is favorable despite the continued uncertainty of oil, NGLs and gas prices. Our resource base, adequate current liquidity, risk management, including commodity derivative strategy, and disciplined investment of capital provide us with an opportunity to exploit and develop our positions and maximize efficiency in our key operating area.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Some of the information below contains forward-looking statements. The primary objective of the following information is to provide forward-looking quantitative and qualitative information about our potential exposure to market risks. The term “market risk” refers to the risk of loss arising from adverse changes in oil, NGLs and gas prices, and other related factors. The disclosure is not meant to be a precise indicator of expected future losses, but rather an indicator of reasonably possible losses. This forward-looking information provides an indicator of how we view and manage our ongoing market risk exposures. Our market risk sensitive instruments were entered into for commodity derivative and investment purposes, not for trading purposes.

Commodity Price Risk

Given the current economic outlook, we expect commodity prices to remain volatile. Even modest decreases in commodity prices can materially affect our revenues and cash flow. In addition, if commodity prices remain low for a significant amount of time, we could be required under successful efforts accounting rules to write down our oil and gas properties.

In the three months ended September 30, 2018, the NYMEX WTI prompt month price ranged from a low of $65.01 per barrel to a high of $74.15 per barrel. In the three months ended September 30, 2017, the NYMEX WTI prompt month price ranged from a low of $44.23 per barrel to a high of $52.22 per barrel.

In the three months ended September 30, 2018, the NYMEX Henry Hub natural gas prompt month price ranged from a low of $2.72 per MMBtu to a high of $3.08 per MMBtu. In the three months ended September 30, 2017, the NYMEX Henry Hub natural gas prompt month price ranged from a low of $2.77 per MMBtu to a high of $3.15 per MMBtu.

The following table provides our outstanding commodity derivative positions at September 30, 2018.

Commodity and Period |  | Contract Type |  | Volume Transacted |  | Contract Price
Crude Oil |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 300 Bbls/day |  | $50.00/Bbl
October 2018 – December 2019 |  | Collar |  | 500 Bbls/day |  | $65.00/Bbl - $71.00/Bbl
CMA Roll |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 2,000 Bbls/day |  | $0.66/Bbl
Natural Gas |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 200,000 MMBtu/month |  | $3.085/MMBtu
October 2018 – December 2018 |  | Swap |  | 250,000 MMBtu/month |  | $3.084/MMBtu
NGLs (C2 - Ethane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 1,000 Bbls/day |  | $11.424/Bbl
October 2018 – December 2018 |  | Swap |  | 400 Bbls/day |  | $14.70/Bbl
NGLs (C3 - Propane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 600 Bbls/day |  | $32.991/Bbl
October 2018 – December 2018 |  | Swap |  | 400 Bbls/day |  | $40.74/Bbl
October 2018 – June 2019 |  | Swap |  | 75 Bbls/day |  | $42.00/Bbl
NGLs (IC4 - Isobutane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 50 Bbls/day |  | $38.262/Bbl
NGLs (NC4 - Butane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 200 Bbls/day |  | $38.22/Bbl
NGLs (C5 - Pentane) |  |  |  |  |  |
October 2018 – December 2018 |  | Swap |  | 200 Bbls/day |  | $56.364/Bbl
January 2019 – December 2019 |  | Swap |  | 100 Bbls/day |  | $65.10/Bbl
January 2019 – December 2019 |  | Swap |  | 100 Bbls/day |  | $65.31/Bbl

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After September 30, 2018, we entered into the following commodity derivative positions:

Commodity and Period |  | Contract Type |  | Volume Transacted |  | Contract Price
NGLs (C2 - Ethane) |  |  |  |  |  |
January 2019 – March 2019 |  | Swap |  | 900 Bbls/day |  | $14.123/Bbl
NGLs (C3 - Propane) |  |  |  |  |  |
January 2019 – March 2019 |  | Swap |  | 600 Bbls/day |  | $35.165/Bbl
NGLs (NC4 - Butane) |  |  |  |  |  |
January 2019 – March 2019 |  | Swap |  | 200 Bbls/day |  | $38.63/Bbl

In April 2018, we entered into swaps for the NYMEX Calendar Monthly Average Roll (the “CMA Roll”) covering 2,000 Bbls per day for May 2018 through December 2018 at $0.66/bbl. Swaps for the CMA Roll are pricing adjustments to the trade month versus the delivery month for contract pricing. These derivative contracts were designated as cash-flow hedges. The changes in fair value of the derivative contracts designated as cash-flow hedges, to the extent the hedge is effective, will be recognized in other comprehensive income until the hedged item is recognized in revenue.

We enter into financial swaps and options to reduce the risk of commodity price fluctuations. Derivative assets and liabilities on our commodity derivative contracts, at fair value, are included on our consolidated balance sheets as current or non-current assets or liabilities based on the anticipated timing of cash settlements under the related contracts. For derivatives not designated as a hedge, cash settlements under our commodity derivative contracts and changes in the fair value of our commodity derivative contracts are recorded in earnings as they occur and included in commodity derivative (loss) gain on our consolidated statements of operations for derivatives not designated as cash-flow hedges. We estimate the fair values of swap or collar contracts based on the present value of the difference in exchange-quoted forward price curves and contractual settlement prices multiplied by notional quantities. We internally valued the option contracts using industry-standard option pricing models and observable market inputs. We use our internal valuations to determine the fair values of the contracts that are reflected on our consolidated balance sheets.

At September 30, 2018, the fair value of our open derivative contracts was a net liability of $4.1 million, compared to a net liability of $0.8 million at December 31, 2017.

We are exposed to credit losses in the event of nonperformance by counterparties on our commodity derivative positions. We do not anticipate nonperformance by the counterparties over the term of the commodity derivatives positions; however, we cannot be certain that we will not experience such losses in the future. All of the counterparties to our commodity derivative positions are participants in our revolving credit facility, and the collateral for the outstanding borrowings under our revolving credit facility is used as collateral for our commodity derivatives.

For the three months ended September 30, 2018 and 2017, we recognized a commodity derivative loss of $3.3 million and $3.6 million. A hypothetical 10% increase in commodity prices would have resulted in a $3.5 million decrease in the fair value of our commodity derivative positions recorded on our balance sheet at September 30, 2018, and a corresponding increase in the commodity derivatives loss recorded on our consolidated statement of operations for the three months ended September 30, 2018.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Such controls include those designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including the Chairman and Chief Executive Officer (“CEO”), and the Executive Vice President and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.

Our management, with the participation of our CEO and CFO, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act) as of September 30, 2018. Based on this evaluation, the CEO and CFO have concluded that, as of September 30, 2018, our disclosure controls and procedures were effective, in that they ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

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Internal Control over Financial Reporting

There were no changes made in our internal control over financial reporting (as defined in Rule 13a-15(f) promulgated under the Exchange Act) during the three months ended September 30, 2018, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations Inherent in All Controls

Our management, including the CEO and CFO, recognizes that the disclosure controls and procedures and internal controls (discussed above) cannot prevent all errors or all attempts at fraud. Any controls system, no matter how well-crafted and operated, can only provide reasonable, and not absolute, assurance of achieving the desired control objectives. Because of the inherent limitations in any control system, no evaluation or implementation of a control system can provide complete assurance that all control issues and all possible instances of fraud have been or will be detected.

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PART II―OTHER INFORMATION

Item 1. Legal Proceedings.

There have been no material developments in the legal proceedings described in Part I, Item 3. “Legal Proceedings” of our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 9, 2018.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the risks discussed in the following report that we have filed with the SEC, which risks could materially affect our business, financial condition and results of operations: Annual Report on Form 10-K for the year ended December 31, 2017, under the headings Item 1. “Business – Markets and Customers; Competition; and Regulation,” Item 1A. “Risk Factors,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” filed with the SEC on March 9, 2018.

There have been no material changes to the risk factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 9, 2018, which is accessible on the SEC’s website at www.sec.gov and our website at www.approachresources.com.

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

None.

Item 6. Exhibits.

The following documents are filed as exhibits to this report.

Exhibit Number |  | Exhibit title
3.1 |  | Certificate of Amendment of Restated Certificate of Incorporation of Approach Resources Inc. (filed as Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed March 10, 2017, and incorporated herein by reference).
3.2 |  | Restated Certificate of Incorporation of Approach Resources Inc. (filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed December 13, 2007, and incorporated herein by reference).
3.3 |  | Second Amended and Restated Bylaws of Approach Resources Inc. (filed as Exhibit 3.2 to the Company’s Current Report on Form 8-K filed November 8, 2013, and incorporated herein by reference).
4.1 |  | Specimen Common Stock Certificate (filed as Exhibit 4.1 to the Company’s Registration Statement on Form S-1/A filed October 18, 2007 (File No. 333-144512), and incorporated herein by reference).
4.2 |  | Second Supplemental Indenture, dated as of December 20, 2016, by and among Approach Resources Inc., the guarantors named therein and Wilmington Trust, National Association, as successor trustee under the Indenture (filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed December 22, 2016, and incorporated herein by reference).
4.3 |  | First Supplemental Indenture, dated as of June 11, 2013, among Approach Resources Inc., as issuer, the subsidiary guarantors named therein, as guarantors, and Wells Fargo Bank, National Association, as trustee (filed as Exhibit 4.2 to the Company’s Current Report on Form 8-K filed June 11, 2013, and incorporated herein by reference).
4.4 |  | Senior Indenture, dated as of June 11, 2013, among Approach Resources Inc., as issuer, the subsidiary guarantors named therein, as guarantors, and Wells Fargo Bank, National Association, as trustee (filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed June 11, 2013, and incorporated herein by reference).
4.5 |  | Agreement dated as of April 28, 2016, by and among Approach Resources, Inc., Wells Fargo Bank, National Association, and Wilmington Trust, National Association (filed as Exhibit 4.4 to the Company’s Quarterly Report on Form 10-Q filed August 4, 2016, and incorporated herein by reference).

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Exhibit Number |  | Exhibit title
4.6 |  | Registration Rights Agreement, dated as of January 27, 2017, by and among Approach Resources Inc., Wilks Brothers, LLC and SDW Investments, LLC (filed as Exhibit 4.2 to the Company’s Current Report on Form 8-K filed January 30, 2017, and incorporated herein by reference).
4.7 |  | Registration Rights Agreement, dated as of November 14, 2007, by and among Approach Resources Inc. and investors identified therein (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K/A filed December 3, 2007, and incorporated herein by reference).
4.8 |  | Registration Rights Agreement, dated as of November 20, 2017, by and among Approach Resources Inc. and Amistad Energy Partners, LLC (filed as Exhibit 4.8 to the Company’s Annual Report on Form 10-K filed March 9, 2018, and incorporated herein by reference).
*31.1 |  | Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*31.2 |  | Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*32.1 |  | Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*32.2 |  | Certification by the Chief Financial Officer Pursuant to U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*101.INS |  | XBRL Instance Document.
*101.SCH |  | XBRL Taxonomy Extension Schema Document.
*101.CAL |  | XBRL Taxonomy Extension Calculation Linkbase Document.
*101.LAB |  | XBRL Taxonomy Extension Label Linkbase Document.
*101.PRE |  | XBRL Taxonomy Extension Presentation Linkbase Document.
*101.DEF |  | XBRL Taxonomy Extension Definition Linkbase Document.

* | Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

| Approach Resources Inc.
Date: November 8, 2018 | By: |  | /s/ J. Ross Craft
|  |  | J. Ross Craft
|  |  | Chairman of the Board and Chief Executive Officer (Principal Executive Officer)

Date: November 8, 2018 | By: |  | /s/ Sergei Krylov
|  |  | Sergei Krylov
|  |  | Executive Vice President and Chief Financial Officer (Principal Financial Officer)