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EX-31.1 - 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - PDC ENERGY, INC.a2014q2_exx311.htm
EX-10.1 - CONSULTING AGREEMENT WITH JAMES M. TRIMBLE, CHIEF EXECUTIVE OFFICER - PDC ENERGY, INC.a2014q2_exx101.htm
EX-31.2 - 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - PDC ENERGY, INC.a2014q2_exx312.htm
EXCEL - IDEA: XBRL DOCUMENT - PDC ENERGY, INC.Financial_Report.xls
EX-32.1 - 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - PDC ENERGY, INC.a2014q2_exx321.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

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

For the quarterly period ended June 30, 2014

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 000-07246
PDC ENERGY, INC.
(Exact name of registrant as specified in its charter)

Nevada
95-2636730
(State of incorporation)
(I.R.S. Employer Identification No.)
1775 Sherman Street, Suite 3000
Denver, Colorado 80203
(Address of principal executive offices) (Zip code)

Registrant's telephone number, including area code: (303) 860-5800

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 T No £

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  x
Accelerated filer  o
Non-accelerated filer  £
(Do not check if a smaller reporting company)
Smaller reporting company  o

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 35,870,665 shares of the Company's Common Stock ($0.01 par value) were outstanding as of July 18, 2014.



PDC ENERGY, INC.


TABLE OF CONTENTS

 
PART I – FINANCIAL INFORMATION
 
Page
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
PART II – OTHER INFORMATION
 
 
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 5.
 
Item 6.
 
 
 
 
 
 
 






SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 ("Securities Act") and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act") regarding our business, financial condition, results of operations and prospects. All statements other than statements of historical facts included in and incorporated by reference into this report are "forward-looking statements" within the meaning of the safe harbor provisions of the United States ("U.S.") Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements herein. These statements relate to, among other things: closing of the proposed PDC Mountaineer, LLC ("PDCM") divestiture; use of expected proceeds from such divestiture; estimated crude oil, natural gas and natural gas liquids (“NGLs”) reserves; future production (including the components of such production), sales, expenses, cash flows and liquidity; our evaluation method of our customers' and derivative counterparties' credit risk is appropriate; anticipated capital projects, expenditures and opportunities; future exploration, drilling and development activities; our drilling programs and number of locations; the effect of additional midstream facilities and services; availability of sufficient funding for our 2014 capital program and sources of that funding, including PDCM; expected 2014 capital budget allocations; acquisitions of additional acreage and other future transactions; the impact of high line pressures and our inability to control the timing and availability of additional facilities going forward; widening of the NYMEX differential through 2014 at our two primary sales hubs primarily due to current oversupply in the Appalachian region; compliance with debt covenants; expected funding sources for conversion of our 3.25% convertible senior notes due 2016; impact of litigation on our results of operations and financial position; our ability to recoup costs incurred to remediate environmental issues that occurred as a result of a mechanical failure on a Utica Shale horizontal well; effectiveness of our derivative program in providing a degree of price stability; that we do not expect to pay dividends in the foreseeable future; our expected tax liability for uncertain positions to decrease to zero in the next 12 months; and our future strategies, plans and objectives.

The above statements are not the exclusive means of identifying forward-looking statements herein. Although forward-looking statements contained in this report reflect our good faith judgment, such statements can only be based on facts and factors currently known to us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, including known and unknown risks and uncertainties incidental to the exploration for, and the acquisition, development, production and marketing of, crude oil, natural gas and NGLs, and actual outcomes may differ materially from the results and outcomes discussed in the forward-looking statements.

Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to:
potential impediments to completing the proposed PDCM divestiture on the expected timeframe or at all, or greater than expected purchase price adjustments;
changes in worldwide production volumes and demand, including economic conditions that might impact demand;
volatility of commodity prices for crude oil, natural gas and NGLs;
impact of governmental policies and/or regulations, including changes in environmental and other laws, the interpretation and enforcement related to those laws and regulations, liabilities arising thereunder and the costs to comply with those laws and regulations;
potential declines in the value of our crude oil, natural gas and NGLs properties resulting in impairments;
changes in estimates of proved reserves;
inaccuracy of reserve estimates and expected production rates;
potential for production decline rates from our wells being greater than expected;
timing and extent of our success in discovering, acquiring, developing and producing reserves;
our ability to secure leases, drilling rigs, supplies and services at reasonable prices;
availability of sufficient pipeline, gathering and other transportation facilities and related infrastructure to process and transport our production, particularly in the Wattenberg Field and the Utica Shale, and the impact of these facilities and regional capacity on the prices we receive for our production;
timing and receipt of necessary regulatory permits;
risks incidental to the drilling and operation of crude oil and natural gas wells;
our future cash flows, liquidity and financial condition;
competition within the oil and gas industry;
availability and cost of capital;
reductions in the borrowing base under our revolving credit facility;
our success in marketing crude oil, natural gas and NGLs;
effect of crude oil and natural gas derivatives activities;
impact of environmental events, governmental and other third-party responses to such events, and our ability to insure adequately against such events;
cost of pending or future litigation;
effect that acquisitions we may pursue have on our capital expenditures;
our ability to retain or attract senior management and key technical employees; and
success of strategic plans, expectations and objectives for our future operations.
 
Further, we urge you to carefully review and consider the cautionary statements and disclosures, specifically those under the heading "Risk Factors," made in this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for the year ended December 31, 2013 ("2013



Form 10-K"), filed with the U.S. Securities and Exchange Commission ("SEC") on February 20, 2014, and our other filings with the SEC for further information on risks and uncertainties that could affect our business, financial condition, results of operations and prospects, which are incorporated by this reference as though fully set forth herein. We caution you not to place undue reliance on the forward-looking statements, which speak only as of the date of this report. We undertake no obligation to update any forward-looking statements in order to reflect any event or circumstance occurring after the date of this report or currently unknown facts or conditions or the occurrence of unanticipated events. All forward-looking statements are qualified in their entirety by this cautionary statement.

REFERENCES

Unless the context otherwise requires, references in this report to "PDC Energy," "PDC," "the Company," "we," "us," "our" or "ours" refer to the registrant, PDC Energy, Inc. and all subsidiaries consolidated for the purposes of its financial statements, including our proportionate share of the financial position, results of operations, cash flows and operating activities of our affiliated partnerships and PDCM, a joint venture currently owned 50% each by PDC and Lime Rock Partners, LP. See Note 1, Nature of Operations and Basis of Presentation, to our condensed consolidated financial statements included elsewhere in this report for a description of our consolidated subsidiaries.



PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

PDC ENERGY, INC.
Condensed Consolidated Balance Sheets
(unaudited; in thousands, except share and per share data)
 
 
June 30, 2014
 
December 31, 2013
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
40,357

 
$
193,243

Restricted cash
 
49

 
2,214

Accounts receivable, net
 
116,928

 
94,085

Accounts receivable affiliates
 
6,424

 
6,614

Fair value of derivatives
 
785

 
2,572

Deferred income taxes
 
44,118

 
22,374

Prepaid expenses and other current assets
 
4,907

 
4,711

Total current assets
 
213,568

 
325,813

Properties and equipment, net
 
1,828,721

 
1,656,230

Fair value of derivatives
 
1,158

 
5,601

Other assets
 
42,978

 
37,559

Total Assets
 
$
2,086,425

 
$
2,025,203

 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
Liabilities
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
107,897

 
$
109,555

Accounts payable affiliates
 

 
41

Production tax liability
 
25,259

 
23,421

Fair value of derivatives
 
50,838

 
15,515

Funds held for distribution
 
40,411

 
32,578

Current portion of long-term debt
 
106,921

 

Accrued interest payable
 
9,182

 
9,251

Other accrued expenses
 
40,827

 
23,059

Total current liabilities
 
381,335

 
213,420

Long-term debt
 
562,000

 
656,990

Deferred income taxes
 
116,948

 
118,767

Asset retirement obligation
 
38,911

 
39,872

Fair value of derivatives
 
23,415

 
3,015

Other liabilities
 
20,545

 
25,545

Total liabilities
 
1,143,154

 
1,057,609

 
 
 
 
 
Commitments and contingent liabilities
 

 

 
 
 
 
 
Shareholders' equity
 
 
 
 
Preferred shares - par value $0.01 per share, 50,000,000 shares authorized, none issued
 

 

Common shares - par value $0.01 per share, 150,000,000 authorized, 35,857,560 and 35,675,656 issued as of June 30, 2014 and December 31, 2013, respectively
 
359

 
357

Additional paid-in capital
 
681,019

 
674,211

Retained earnings
 
262,953

 
293,267

Treasury shares - at cost, 18,580 and 5,508 as of June 30, 2014 and December 31, 2013, respectively
 
(1,060
)
 
(241
)
Total shareholders' equity
 
943,271

 
967,594

Total Liabilities and Shareholders' Equity
 
$
2,086,425

 
$
2,025,203




See accompanying Notes to Condensed Consolidated Financial Statements
1


PDC ENERGY, INC.
Condensed Consolidated Statements of Operations
(unaudited; in thousands, except per share data)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Revenues
 
 
 
 
 
 
 
 
Crude oil, natural gas and NGLs sales
 
$
139,924

 
$
77,537

 
$
269,768

 
$
156,976

Sales from natural gas marketing
 
22,415

 
18,079

 
49,352

 
31,749

Commodity price risk management gain (loss), net
 
(53,411
)
 
24,724

 
(80,566
)
 
2,369

Well operations, pipeline income and other
 
544

 
965

 
1,180

 
2,037

Total revenues
 
109,472

 
121,305

 
239,734

 
193,131

Costs, expenses and other
 
 
 
 
 
 
 
 
Production costs
 
26,754

 
16,176

 
47,958

 
32,034

Cost of natural gas marketing
 
22,428

 
18,065

 
49,298

 
31,801

Exploration expense
 
277

 
1,437

 
584

 
3,126

Impairment of crude oil and natural gas properties
 
938

 
1,502

 
1,917

 
47,961

General and administrative expense
 
40,665

 
15,783

 
64,277

 
30,898

Depreciation, depletion, and amortization
 
53,743

 
27,800

 
100,382

 
55,749

Accretion of asset retirement obligations
 
855

 
1,172

 
1,716

 
2,320

(Gain) loss on sale of properties and equipment
 
(363
)
 
(9
)
 
362

 
(47
)
Total cost, expenses and other
 
145,297

 
81,926

 
266,494

 
203,842

Income (loss) from operations
 
(35,825
)
 
39,379

 
(26,760
)
 
(10,711
)
Interest expense
 
(13,060
)
 
(13,089
)
 
(25,890
)
 
(26,446
)
Interest income
 
152

 
3

 
403

 
3

Income (loss) from continuing operations before income taxes
 
(48,733
)
 
26,293

 
(52,247
)
 
(37,154
)
Provision for income taxes
 
20,546

 
(9,791
)
 
21,933

 
12,701

Income (loss) from continuing operations
 
(28,187
)
 
16,502

 
(30,314
)
 
(24,453
)
Income from discontinued operations, net of tax
 

 
3,416

 

 
4,953

Net income (loss)
 
$
(28,187
)
 
$
19,918

 
$
(30,314
)
 
$
(19,500
)
 
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
 
Basic
 
 
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
(0.79
)
 
$
0.55

 
$
(0.85
)
 
$
(0.80
)
Income from discontinued operations, net of tax
 

 
0.11

 

 
0.16

Net income (loss)
 
$
(0.79
)
 
$
0.66

 
$
(0.85
)
 
$
(0.64
)
 
 
 
 
 
 
 
 
 
Diluted
 
 
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
(0.79
)
 
$
0.53

 
$
(0.85
)
 
$
(0.80
)
Income from discontinued operations, net of tax
 

 
0.11

 

 
0.16

Net income (loss)
 
$
(0.79
)
 
$
0.64

 
$
(0.85
)
 
$
(0.64
)
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
35,762

 
30,332

 
35,726

 
30,301

Diluted
 
35,762

 
31,014

 
35,726

 
30,301

 
 
 
 
 
 
 
 
 
 

See accompanying Notes to Condensed Consolidated Financial Statements
2


PDC ENERGY, INC.
Condensed Consolidated Statements of Cash Flows
(unaudited; in thousands)
 
 
Six Months Ended June 30,
 
 
2014
 
2013
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(30,314
)
 
$
(19,500
)
Adjustments to net loss to reconcile to net cash from operating activities:
 
 
 
 
Net change in fair value of unsettled derivatives
 
61,953

 
9,913

Depreciation, depletion and amortization
 
100,382

 
58,007

Impairment of crude oil and natural gas properties
 
1,917

 
47,964

Accretion of asset retirement obligation
 
1,716

 
2,481

Stock-based compensation
 
8,879

 
6,951

Loss on sale of properties and equipment
 
362

 
1,029

Amortization of debt discount and issuance costs
 
3,443

 
3,419

Deferred income taxes
 
(23,563
)
 
(11,075
)
Other
 
(90
)
 
(476
)
Changes in assets and liabilities
 
6,905

 
(56,687
)
Net cash from operating activities
 
131,590

 
42,026

Cash flows from investing activities:
 
 
 
 
Capital expenditures
 
(293,648
)
 
(139,462
)
Proceeds from acquisition adjustments
 

 
7,579

Proceeds from sale of properties and equipment
 
1,449

 
173,297

Net cash from investing activities
 
(292,199
)
 
41,414

Cash flows from financing activities:
 
 
 
 
Proceeds from revolving credit facility
 
17,000

 
227,750

Repayment of revolving credit facility
 
(7,000
)
 
(267,000
)
Other
 
(2,277
)
 
(3,435
)
Net cash from financing activities
 
7,723

 
(42,685
)
Net change in cash and cash equivalents
 
(152,886
)
 
40,755

Cash and cash equivalents, beginning of period
 
193,243

 
2,457

Cash and cash equivalents, end of period
 
$
40,357

 
$
43,212

 
 
 
 
 
Supplemental cash flow information:
 
 
 
 
Cash payments for (receipts from):
 
 
 
 
Interest, net of capitalized interest
 
$
23,724

 
$
25,787

Income taxes
 
1,800

 
(57
)
Non-cash investing activities:
 
 
 
 
Change in accounts payable related to purchases of properties and equipment
 
$
(6,962
)
 
$
(8,695
)
Change in asset retirement obligation, with a corresponding change to crude oil and natural gas properties, net of disposals
 
341

 
211

Change in accounts payable related to disposition of properties and equipment
 

 
(4,680
)
Change in accounts receivable affiliates related to disposition of properties and equipment
 

 
9,201


See accompanying Notes to Condensed Consolidated Financial Statements
3

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2014
(Unaudited)


NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION

PDC Energy, Inc. is a domestic independent exploration and production company that produces, develops, acquires and explores for crude oil, natural gas and NGLs with primary operations in the Wattenberg Field in Colorado, the Utica Shale in southeastern Ohio and the Marcellus Shale in northern West Virginia. Our operations in the Wattenberg Field are focused on the liquid-rich horizontal Niobrara and Codell plays and our Ohio operations are focused on the liquid-rich portion of the Utica Shale play. As of June 30, 2014, we owned an interest in approximately 2,900 gross wells. We are engaged in two business segments: Oil and Gas Exploration and Production and Gas Marketing.

The accompanying unaudited condensed consolidated financial statements include the accounts of PDC, our wholly owned subsidiaries, and our proportionate share of PDCM and our affiliated partnerships. Pursuant to the proportionate consolidation method, our accompanying condensed consolidated financial statements include our pro rata share of assets, liabilities, revenues and expenses of the entities which we proportionately consolidate. All material intercompany accounts and transactions have been eliminated in consolidation.

In our opinion, the accompanying condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of our financial statements for interim periods in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the SEC. Accordingly, pursuant to such rules and regulations, certain notes and other financial information included in audited financial statements have been condensed or omitted. The information presented in this Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements and notes thereto included in our 2013 Form 10-K. Our results of operations and cash flows for the three and six months ended June 30, 2014 are not necessarily indicative of the results to be expected for the full year or any other future period.
 
Certain reclassifications have been made to prior period financial statements to conform to the current year presentation. These reclassifications had no impact on previously reported cash flows, net income, earnings per share or shareholders' equity.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Recently Adopted Accounting Standard

On January 1, 2014, we adopted changes issued by the Financial Accounting Standards Board ("FASB") regarding the accounting for income taxes. The change provides clarification on the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. Adoption of these changes had no impact on the condensed consolidated financial statements.

Recently Issued Accounting Standards

In April 2014, the FASB issued changes related to the criteria for determining which disposals can be presented as discontinued operations and modified related disclosure requirements. Under the new pronouncement, a discontinued operation is defined as a component of an entity that either has been disposed of or is classified as held for sale and represents a strategic shift that has a major effect on the entity's operations and financial results. These changes are to be applied prospectively for new disposals or components of an entity classified as held for sale during interim and annual periods beginning after December 15, 2014, with early adoption permitted. We are currently evaluating the impact these changes will have on our condensed consolidated financial statements.

In May 2014, the FASB and the International Accounting Standards Board ("IASB") issued their converged standard on revenue recognition that provides a single, comprehensive model that entities will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The standard outlines a five-step approach to apply the underlying principle: (a) identify the contract with the customer, (b) identify the separate performance obligations in the contract, (c) determine the transaction price, (d) allocate the transaction price to separate performance obligations and (e) recognize revenue when (or as) each performance obligation is satisfied. The revenue standard is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and can be adopted under the full retrospective method or simplified transition method. Early adoption is not permitted. We plan to adopt the revenue standard beginning January 1, 2017 and are currently evaluating the impact these changes will have on our condensed consolidated financial statements.

NOTE 3 - FAIR VALUE OF FINANCIAL INSTRUMENTS

Derivative Financial Instruments

Determination of fair value. Our fair value measurements are estimated pursuant to a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, giving the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable data (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The lowest level input that is significant to a fair value measurement in its entirety determines the

4

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

applicable level in the fair value hierarchy. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability, and may affect the valuation of the assets and liabilities and their placement within the fair value hierarchy levels. The three levels of inputs that may be used to measure fair value are defined as:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 – Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived from observable market data by correlation or other means.

Level 3 – Unobservable inputs for the asset or liability, including situations where there is little, if any, market activity.

Derivative Financial Instruments. We measure the fair value of our derivative instruments based on a pricing model that utilizes market-based inputs, including, but not limited to, the contractual price of the underlying position, current market prices, crude oil and natural gas forward curves, discount rates such as the LIBOR curve for a similar duration of each outstanding position, volatility factors and nonperformance risk. Nonperformance risk considers the effect of our credit standing on the fair value of derivative liabilities and the effect of our counterparties' credit standings on the fair value of derivative assets. Both inputs to the model are based on published credit default swap rates and the duration of each outstanding derivative position.

We validate our fair value measurement through the review of counterparty statements and other supporting documentation, the determination that the source of the inputs is valid, the corroboration of the original source of inputs through access to multiple quotes, if available, or other information and monitoring changes in valuation methods and assumptions. While we use common industry practices to develop our valuation techniques and believe our valuation method is appropriate and consistent with those used by other market participants, changes in our pricing methodologies or the underlying assumptions could result in significantly different fair values.

Our fixed-price swaps, basis swaps and physical purchases are included in Level 2 and our collars, calls and physical sales are included in Level 3. The following table presents, for each applicable level within the fair value hierarchy, our derivative assets and liabilities, including both current and non-current portions, measured at fair value on a recurring basis:

 
June 30, 2014
 
December 31, 2013
 
Significant Other
Observable
Inputs
(Level 2)
  
Significant
Unobservable
Inputs
(Level 3)
  
Total
 
Significant Other
Observable
Inputs
(Level 2)
  
Significant
Unobservable
Inputs
(Level 3)
  
Total
 
(in thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Commodity-based derivative contracts
$
1,226

 
$
611

 
$
1,837

 
$
5,325

   
$
2,385

   
$
7,710

Basis protection derivative contracts
104

 
2

 
106

 
463

 

 
463

Total assets
1,330

 
613

 
1,943

 
5,788

 
2,385

 
8,173

Liabilities:
 
 
 
 
 
 
 
   
 
   
 
Commodity-based derivative contracts
66,652

 
7,393

 
74,045

 
17,537

 
988

   
18,525

Basis protection derivative contracts
208

 

 
208

 
5

 

   
5

Total liabilities
66,860

 
7,393

 
74,253

 
17,542

 
988

 
18,530

Net asset (liability)
$
(65,530
)
 
$
(6,780
)
 
$
(72,310
)
 
$
(11,754
)
 
$
1,397

 
$
(10,357
)
 
 
 
 
 
 
 
 
 
 
 
 

5

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents a reconciliation of our Level 3 assets measured at fair value:

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
Fair value, net asset, beginning of period
 
$
105

 
$
7,663

 
$
1,397

 
$
13,669

Changes in fair value included in statement of operations line item:
 
 
 
 
 
 
 
 
Commodity price risk management gain (loss), net
 
(7,501
)
 
2,834

 
(8,896
)
 
103

Sales from natural gas marketing
 
(4
)
 
22

 
(26
)
 
6

Settlements included in statement of operations line items:
 
 
 
 
 
 
 
 
Commodity price risk management gain (loss), net
 
621

 
(2,246
)
 
740

 
(5,479
)
Sales from natural gas marketing
 
(1
)
 
(3
)
 
5

 
(29
)
Income (loss) from discontinued operations, net of tax
 

 
(4,366
)
 

 
(4,366
)
Fair value, net asset end of period
 
$
(6,780
)
 
$
3,904

 
$
(6,780
)
 
$
3,904

 
 
 
 
 
 
 
 
 
Net change in fair value of unsettled derivatives included in statement of operations line item:
 
 
 
 
 
 
 
 
Commodity price risk management loss, net
 
$
(3,041
)
 
$
(1,717
)
 
$
(4,327
)
 
$
(3,652
)
Sales from natural gas marketing
 
(2
)
 
22

 
(4
)
 
10

Total
 
$
(3,043
)
 
$
(1,695
)
 
$
(4,331
)
 
$
(3,642
)
 
 
 
 
 
 
 
 
 

The significant unobservable input used in the fair value measurement of our derivative contracts is the implied volatility curve, which is provided by a third-party vendor. A significant increase or decrease in the implied volatility, in isolation, would have a directionally similar effect resulting in a significantly higher or lower fair value measurement of our Level 3 derivative contracts.
    
Non-Derivative Financial Assets and Liabilities

The carrying value of the financial instruments included in current assets and current liabilities approximate fair value due to the short-term maturities of these instruments.

The liability associated with our non-qualified deferred compensation plan for non-employee directors may be settled in cash or shares of our common stock. The carrying value of this obligation is based on the quoted market price of our common stock, which is a Level 1 input.
 
The portion of our long-term debt related to our revolving credit facility, as well as our proportionate share of PDCM's credit facility and second lien term loan, approximates fair value due to the variable nature of related interest rates. We have not elected to account for the portion of our debt related to our senior notes under the fair value option; however, as of June 30, 2014, we estimate the fair value of the portion of our long-term debt related to our 3.25% convertible senior notes due 2016 to be $183.2 million, or 159.3% of par value, and the portion related to our 7.75% senior notes due 2022 to be $557.5 million, or 111.5% of par value. We determined these valuations based upon measurements of trading activity and broker and/or dealer quotes, respectively, which are published market prices, and therefore are Level 2 inputs.

Concentration of Risk

Derivative Counterparties. Our derivative arrangements expose us to credit risk of nonperformance by our counterparties. We primarily use financial institutions who are also lenders under our revolving credit facility as counterparties to our derivative contracts. To date, we have had no counterparty default losses relating to our derivative arrangements. We have evaluated the credit risk of our derivative assets from our counterparties using relevant credit market default rates, giving consideration to amounts outstanding for each counterparty and the duration of each outstanding derivative position. Based on our evaluation, we have determined that the potential impact of nonperformance of our counterparties on the fair value of our derivative instruments was not significant at June 30, 2014, taking into account the estimated likelihood of nonperformance.

6

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents the counterparties that expose us to credit risk as of June 30, 2014 with regard to our derivative assets:

Counterparty Name
 
Fair Value of
Derivative Assets
 
 
(in thousands)
Wells Fargo Bank, N.A. (1)
 
$
518

Bank of Montreal (1)
 
432

JP Morgan Chase Bank, N.A (1)
 
412

Bank of Nova Scotia (1)
 
298

Other lenders in our revolving credit facility
 
239

Various (2)
 
44

Total
 
$
1,943

 
 
 
__________
(1)Major lender in our revolving credit facility. See Note 7, Long-Term Debt.
(2)Represents a total of 31 counterparties.

NOTE 4 - DERIVATIVE FINANCIAL INSTRUMENTS

Our results of operations and operating cash flows are affected by changes in market prices for crude oil, natural gas and NGLs. To manage a portion of our exposure to price volatility from producing crude oil and natural gas, we utilize the following economic hedging strategies for each of our business segments.

For crude oil and natural gas sales, we enter into derivative contracts to protect against price declines in future periods. While we structure these derivatives to reduce our exposure to changes in price associated with the derivative commodity, they also limit the benefit we might otherwise have received from price increases in the physical market; and
 
For natural gas marketing, we enter into fixed-price physical purchase and sale agreements that qualify as derivative contracts. In order to offset the fixed-price physical derivatives in our natural gas marketing, we enter into financial derivative instruments that have the effect of locking in the prices we will receive or pay for the same volumes and period, offsetting the physical derivative.

We believe our derivative instruments continue to be effective in achieving the risk management objectives for which they were intended. As of June 30, 2014, we had derivative instruments, which were comprised of collars, fixed-price swaps, basis protection swaps and physical sales and purchases, in place for a portion of our anticipated production through 2017 for a total of 53,234 BBtu of natural gas and 10,238 MBbls of crude oil. The majority of our derivative contracts are entered into at no cost to us as we hedge our anticipated production at the then-prevailing commodity market prices.

We have elected not to designate any of our derivative instruments as hedges and therefore do not qualify for use of hedge accounting. Accordingly, changes in the fair value of our derivative instruments are recorded in the statements of operations. Changes in the fair value of derivative instruments related to our Oil and Gas Exploration and Production segment are recorded in commodity price risk management, net. Changes in the fair value of derivative instruments related to our Gas Marketing segment are recorded in sales from and cost of natural gas marketing.


7

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents the location and fair value amounts of our derivative instruments on the condensed consolidated balance sheets as of June 30, 2014 and December 31, 2013:
 
 
 
 
 
Fair Value
Derivatives instruments:
 
Balance sheet line item
 
June 30, 2014
 
December 31, 2013
 
 
 
 
 
(in thousands)
Derivative assets:
Current
 
 
 
 
 
 
 
Commodity contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
$
519

 
$
2,016

 
Related to natural gas marketing
 
Fair value of derivatives
 
264

 
361

 
Basis protection contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 

 
195

 
Related to natural gas marketing
 
Fair value of derivatives
 
2

 

 
 
 
 
 
785

 
2,572

 
Non-current
 
 
 
 
 
 
 
Commodity contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
721

 
5,055

 
Related to natural gas marketing
 
Fair value of derivatives
 
190

 
278

 
Basis protection contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
247

 
268

 
 
 
 
 
1,158

 
5,601

Total derivative assets
 
 
 
 
$
1,943

 
$
8,173

 
 
 
 
 
 
 
 
Derivative liabilities:
Current
 
 
 
 
 
 
 
Commodity contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
$
50,434

 
$
15,263

 
Related to natural gas marketing
 
Fair value of derivatives
 
196

 
247

 
Basis protection contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
207

 

 
Related to natural gas marketing
 
Fair value of derivatives
 
1

 
5

 
 
 
 
 
50,838

 
15,515

 
Non-current
 
 
 
 
 
 
 
Commodity contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
23,255

 
2,782

 
Related to natural gas marketing
 
Fair value of derivatives
 
160

 
233

 
 
 
 
 
23,415

 
3,015

Total derivative liabilities
 
 
 
 
$
74,253

 
$
18,530


    
The following table presents the impact of our derivative instruments on our condensed consolidated statements of operations:

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Condensed consolidated statement of operations line item
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
Commodity price risk management income (loss), net
 
 
 
 
 
 
 
 
Net settlements
 
$
(10,429
)
 
$
3,903

 
$
(18,668
)
 
$
12,374

Net change in fair value of unsettled derivatives
 
(42,982
)
 
20,821

 
(61,898
)
 
(10,005
)
Total commodity price risk management income (loss), net
 
$
(53,411
)
 
$
24,724

 
$
(80,566
)
 
$
2,369

Sales from natural gas marketing
 
 
 
 
 
 
 
 
Net settlements
 
$
(110
)
 
$
(173
)
 
$
(586
)
 
$
28

Net change in fair value of unsettled derivatives
 
265

 
1,621

 
(47
)
 
651

Total sales from natural gas marketing
 
$
155

 
$
1,448

 
$
(633
)
 
$
679

Cost of natural gas marketing
 
 
 
 
 
 
 
 
Net settlements
 
$
149

 
$
225

 
$
684

 
$
63

Net change in fair value of unsettled derivatives
 
(304
)
 
(1,636
)
 
(8
)
 
(559
)
Total cost of natural gas marketing
 
$
(155
)
 
$
(1,411
)
 
$
676

 
$
(496
)
 
 
 
 
 
 
 
 
 

8

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued


All of our financial derivative agreements contain master netting provisions that provide for the net settlement of all contracts through a single payment in the event of early termination. Our fixed-price physical purchase and sale agreements that qualify as derivative contracts are not subject to master netting provisions and are not significant. We have elected not to offset the fair value positions recorded on our condensed consolidated balance sheets.

The following table reflects the impact of netting agreements on gross derivative assets and liabilities as of June 30, 2014 and December 31, 2013:
As of June 30, 2014
 
Derivatives instruments, recorded in condensed consolidated balance sheet, gross
 
Effect of master netting agreements
 
Derivative instruments, net
 
 
(in thousands)
Asset derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
1,943

 
$
(1,165
)
 
$
778

 
 
 
 
 
 
 
Liability derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
74,253

 
$
(1,165
)
 
$
73,088

 
 
 
 
 
 
 
As of December 31, 2013
 
Derivatives instruments, recorded in condensed consolidated balance sheet, gross
 
Effect of master netting agreements
 
Derivative instruments, net
 
 
(in thousands)
Asset derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
8,173

 
$
(5,623
)
 
$
2,550

 
 
 
 
 
 
 
Liability derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
18,530

 
$
(5,623
)
 
$
12,907

 
 
 
 
 
 
 

NOTE 5 - PROPERTIES AND EQUIPMENT

The following table presents the components of properties and equipment, net of accumulated depreciation, depletion and amortization ("DD&A"):

 
June 30, 2014
 
December 31, 2013
 
(in thousands)
Properties and equipment, net:
 
 
 
Crude oil and natural gas properties
 
 
 
Proved
$
2,000,264

 
$
1,784,466

Unproved
332,548

 
307,203

Total crude oil and natural gas properties
2,332,812

 
2,091,669

Pipelines and related facilities
21,765

 
21,781

Equipment and other
30,272

 
29,246

Land and buildings
13,620

 
13,617

Construction in progress
83,422

 
53,810

Properties and equipment, at cost
2,481,891

 
2,210,123

Accumulated DD&A
(653,170
)
 
(553,893
)
Properties and equipment, net
$
1,828,721

 
$
1,656,230

 
 
 
 


9

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents impairment charges recorded for crude oil and natural gas properties:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
Continuing operations:
 
 
 
 
 
 
 
Impairment of proved properties
$

 
$

 
$

 
$
45,000

Impairment of individually significant unproved properties

 
671

 

 
825

Amortization of individually insignificant unproved properties
938

 
831

 
1,917

 
2,136

Total continuing operations
938

 
1,502

 
1,917

 
47,961

Discontinued operations:
 
 
 
 
 
 
 
Amortization of individually insignificant unproved properties

 

 

 
3

Total discontinued operations

 

 

 
3

Total impairment of crude oil and natural gas properties
$
938

 
$
1,502

 
$
1,917

 
$
47,964

 
 
 
 
 
 
 
 

During the first quarter of 2013, we recognized an impairment charge of approximately $45.0 million related to all of our shallow Upper Devonian (non-Marcellus Shale) Appalachian Basin producing properties located in West Virginia and Pennsylvania previously owned directly by us, as well as through our proportionate share of PDCM. The impairment charge represented the excess of the carrying value of the assets over the estimated fair value, less cost to sell. The fair value of the assets was determined based upon estimated future cash flows from unrelated third-party bids, a Level 3 input. The impairment charge was included in the statement of operations line item impairment of crude oil and natural gas properties. See Note 12, Assets Held for Sale, Divestitures and Discontinued Operations, for additional information regarding these properties.

NOTE 6 - INCOME TAXES

We evaluate our estimated annual effective income tax rate on a quarterly basis based on current and forecasted operating results and tax laws. The estimated annual effective tax rate is adjusted quarterly based upon actual results and updated operating forecasts. Consequently, based upon the mix and timing of our actual earnings compared to annual projections, our effective tax rate may vary quarterly and may make quarterly comparisons not meaningful. A tax expense or benefit unrelated to the current year income or loss is recognized in its entirety as a discrete item of tax in the period identified. The quarterly income tax provision is generally comprised of tax expense on income or tax benefit on loss at the most recent estimated annual effective tax rate, adjusted for the effect of discrete items.

The effective tax rate for continuing operations for the three and six months ended June 30, 2014 was a 42.2% and 42.0% benefit on loss, respectively, compared to a 37.2% expense on income and 34.2% benefit on loss for the three and six months ended June 30, 2013, respectively. The effective tax rates for the three and six months ended June 30, 2014 are based upon a full year forecasted tax provision on income and are greater than the statutory rate primarily due to nondeductible officers' compensation, partially offset by percentage depletion deductions. The effective tax rates for the three and six months ended June 30, 2013 differ from the statutory rate primarily due to net permanent additions, largely nondeductible officers' compensation, partially offset by percentage depletion deductions. For the six months ended June 30, 2013, the nondeductible item for officers' compensation exceeded our deduction for percentage depletion, thereby reducing our tax benefit rate. Additionally, state statutory limits on the utilization of our net operating losses resulted in a reduced state tax benefit. There were no significant discrete items recorded during the three and six months ended June 30, 2014 or 2013.

As of June 30, 2014, our gross liability for unrecognized tax benefits continues to be immaterial and was unchanged from the amount recorded at December 31, 2013. We expect our remaining liability for uncertain tax positions to decrease to zero in the current year due to the expiration of the statute of limitations.

As of the date of this report, we are current with our income tax filings in all applicable state jurisdictions and are not currently under examination. We continue voluntary participation in the Internal Revenue Service’s Compliance Assurance Program for the 2013 and 2014 tax years. We received a full acceptance “no change” notice from the IRS for our filed 2012 federal tax return.


10

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 7 - LONG-TERM DEBT

Long-term debt consists of the following:

 
June 30, 2014
 
December 31, 2013
 
(in thousands)
Senior notes:
 
 
 
3.25% Convertible senior notes due 2016:
 
 
 
Principal amount
$
115,000

 
$
115,000

Unamortized discount
(8,079
)
 
(10,010
)
3.25% Convertible senior notes due 2016, net of discount
106,921

 
104,990

7.75% Senior notes due 2022
500,000

 
500,000

Total senior notes
606,921

 
604,990

Credit facilities:
 
 
 
Corporate

 

PDCM
47,000

 
37,000

Total credit facilities
47,000

 
37,000

PDCM second lien term loan
15,000

 
15,000

Total debt
668,921

 
656,990

Less: Current portion of long-term debt
106,921

 

Long-term debt
$
562,000

 
$
656,990

    
Senior Notes

3.25% Convertible Senior Notes Due 2016. In November 2010, we issued $115 million aggregate principal amount 3.25% convertible senior notes due May 15, 2016 (the "Convertible Notes") in a private placement to qualified institutional buyers. Interest is payable semi-annually in arrears on each May 15 and November 15. The indenture governing the notes contains certain non-financial covenants. We allocated the gross proceeds of the Convertible Notes between the liability and equity components of the debt. The initial $94.3 million liability component was determined based upon the fair value of similar debt instruments with similar terms, excluding the conversion feature, and priced on the same day we issued the Convertible Notes. The original issue discount and capitalized debt issuance costs are being amortized to interest expense over the life of the notes using an effective interest rate of 7.4%.

Upon conversion, the Convertible Notes may be settled, at our election, in shares of our common stock, cash or a combination of cash and shares of our common stock. We have initially elected a net-settlement method to satisfy our conversion obligation, which allows us to settle the principal amount of the Convertible Notes in cash and to settle the excess conversion value in shares, as well as cash in lieu of fractional shares.

The Convertible Notes were convertible at the option of holders as of June 30, 2014. The conversion right was triggered on June 20, 2014, when the closing sale price of our common stock on the NASDAQ Global Select Market exceeded $55.12 (130% of the applicable conversion price) for the 20th trading day in the 30 consecutive trading days ending on June 30, 2014. In the event a holder elects to convert its note, we expect to fund any cash settlement of any such conversion from working capital and/or borrowings under our revolving credit facility. As a result of the Convertible Notes becoming convertible, we have included the carrying value of the Convertible Notes, net of discount, in the current portion of long-term debt on our condensed consolidated balance sheet as of June 30, 2014. We will reassess the convertibility of the Convertible Notes, and the related balance sheet classification, on a quarterly basis. In the event that a holder exercises the right to convert its note, we will write-off a ratable portion of the remaining debt issuance costs and unamortized discount to interest expense. Based on a June 30, 2014 stock price of $63.15, the “if-converted” value of the Convertible Notes exceeded the principal amount by approximately $56.3 million. Through August 8, 2014, no holders of the Convertible Notes have elected to convert their notes.

7.75% Senior Notes Due 2022. In October 2012, we issued $500 million aggregate principal amount 7.75% senior notes due October 15, 2022 (the “2022 Senior Notes”) in a private placement to qualified institutional buyers. Interest on the 2022 Senior Notes is payable semi-annually in arrears on each April 15 and October 15. The indenture governing the notes contains customary restrictive incurrence covenants. Capitalized debt issuance costs are being amortized as interest expense over the life of the notes using the effective interest method.

As of June 30, 2014, we were in compliance with all covenants related to the Convertible Notes and the 2022 Senior Notes, and expect to remain in compliance throughout the next 12-month period.


11

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Credit Facilities

Revolving Credit Facility. In May 2013, we entered into a Third Amended and Restated Credit Agreement with JPMorgan Chase Bank, N.A. as administrative agent and other lenders party thereto. This agreement amends and restates the credit agreement dated November 2010 and expires in May 2018. The revolving credit facility is available for working capital requirements, capital expenditures, acquisitions, general corporate purposes and to support letters of credit. The revolving credit facility provides for a maximum of $1 billion in allowable borrowing capacity, subject to the borrowing base. As of June 30, 2014, the borrowing base was $450 million. The borrowing base is based on, among other things, the loan value assigned to the proved reserves attributable to our and our subsidiaries' crude oil and natural gas interests, excluding proved reserves attributable to PDCM and our affiliated partnerships. The borrowing base is subject to a semi-annual size redetermination based upon quantification of our reserves at June 30 and December 31, and is also subject to a redetermination upon the occurrence of certain events. The revolving credit facility is secured by a pledge of the stock of certain of our subsidiaries, mortgages of certain producing crude oil and natural gas properties and substantially all of our and such subsidiaries' other assets. Neither PDCM nor our affiliated partnerships are guarantors of our obligations under the revolving credit facility. We had no outstanding draws on our revolving credit facility as of June 30, 2014 or December 31, 2013.

As of June 30, 2014, Riley Natural Gas, a wholly-owned subsidiary of PDC, had an irrevocable standby letter of credit of approximately $11.7 million in favor of a third-party transportation service provider to secure firm transportation of the natural gas produced by third-party producers for whom we market production in the Appalachian Basin. The letter of credit expires in September 2014. The letter of credit reduces the amount of available funds under our revolving credit facility by an equal amount. As of June 30, 2014, the available funds under our revolving credit facility, including a reduction for the $11.7 million irrevocable standby letter of credit in effect, was $438.3 million.

The revolving credit facility contains covenants customary for agreements of this type, with the most restrictive being certain financial tests on a quarterly basis. The financial tests, as defined per the revolving credit facility, include requirements to: (a) maintain a minimum current ratio of 1.00 to 1.00 and (b) not exceed a maximum leverage ratio of 4.25 to 1.00.

As of June 30, 2014, we were in compliance with all the revolving credit facility covenants and expect to remain in compliance throughout the next 12-month period.

PDCM Credit Facility. PDCM has a credit facility dated April 2010, as amended in February 2014, with a borrowing base of $105 million, of which our proportionate share is approximately $53 million. The maximum allowable facility amount is $400 million. No principal payments are required until the credit agreement expires in April 2017, or in the event that the borrowing base falls below the outstanding balance. The credit facility is subject to and secured by PDCM's properties, including our proportionate share of such properties. The borrowing base is subject to size redetermination semi-annually based upon a valuation of PDCM's reserves at June 30 and December 31. Either PDCM or the lenders may request a redetermination upon the occurrence of certain events. The credit facility is utilized by PDCM for the exploration and development of its Marcellus Shale assets. In February 2014, PDCM entered into a sixth amendment to its credit agreement. The amendment increased the amount of future production from proved developed and producing properties that is permitted to be hedged. As of June 30, 2014, our proportionate share of PDCM's outstanding credit facility balance was $47.0 million compared to $37.0 million as of December 31, 2013. The weighted-average borrowing rate on PDCM's credit facility was 3.8% per annum as of June 30, 2014, compared to 3.7% as of December 31, 2013.

The credit facility contains covenants customary for agreements of this type, with the most restrictive being certain financial tests that must be met on a quarterly basis. The financial tests, as defined by the credit facility, include requirements to maintain a minimum current ratio of 1.0 to 1.0, not to exceed a debt to EBITDAX ratio of 4.25 to 1.0 (declining to 4.0 to 1.0 on July 1, 2014) and to maintain a minimum interest coverage ratio of 2.5 to 1.0.

 As of June 30, 2014, PDCM was in compliance with all credit facility covenants and expects to remain in compliance throughout the next 12-month period.

PDCM Second Lien Term Loan

In July 2013, PDCM entered into a Second Lien Credit Agreement ("Term Loan Agreement") with Wells Fargo Energy Capital as administrative agent and a syndicate of other lenders party thereto. The aggregate commitment under the Term Loan Agreement is $30 million, of which our proportionate share is $15 million. The aggregate commitment may increase periodically up to a maximum of $75 million, as PDCM's reserve value increases and the covenants under the Term Loan Agreement allow. The Term Loan Agreement matures in October 2017. Amounts borrowed accrue interest, at PDCM's discretion, at either an alternative base rate plus a margin of 6% per annum or an adjusted LIBOR for the interest period in effect plus a margin of 7% per annum. As of June 30, 2014, amounts borrowed and outstanding on the Term Loan Agreement were $30.0 million, of which our proportionate share is $15 million. The weighted-average interest rate on the term loan was 8.5% per annum as of both June 30, 2014 and December 31, 2013.

The Term Loan Agreement contains financial covenants, as defined in the agreement, that must be met on a quarterly basis, including requirements to maintain a minimum current ratio of 1.0 to 1.0, not to exceed a debt to EBITDAX ratio of 4.5 to 1.0, a minimum interest coverage ratio of 2.25 to 1.0 and a present value of future net revenues to total debt ratio of 1.50 to 1.00.


12

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

As of June 30, 2014, PDCM was in compliance with all Term Loan Agreement covenants and expects to remain in compliance throughout the next 12-month period.

NOTE 8 - ASSET RETIREMENT OBLIGATIONS

The following table presents the changes in carrying amounts of the asset retirement obligations associated with our working interest in crude oil and natural gas properties:
 
Amount
 
(in thousands)
 
 
Balance at beginning of period, January 1
$
41,030

Obligations incurred with development activities
341

Accretion expense
1,716

Revisions in estimated cash flows
(134
)
Obligations discharged with divestitures of properties and asset retirements
(2,884
)
Balance end of period, June 30
40,069

Less: Current portion
(1,158
)
Long-term portion
$
38,911

 
 


NOTE 9 - COMMITMENTS AND CONTINGENCIES

Firm Transportation, Processing and Sales Agreements. We enter into contracts that provide firm transportation, sales and processing services on pipeline systems through which we transport or sell natural gas. Satisfaction of the volume requirements includes volumes produced by us, purchased from third parties and produced by PDCM and other third-party working interest owners. We record in our financial statements only our share of costs based upon our working interest in the wells. These contracts require us to pay these transportation and processing charges whether or not the required volumes are delivered. With the exception of contracts entered into by PDCM, the costs of any volume shortfalls are borne by PDC.
        
The following table presents gross volume information, including our proportionate share of PDCM, related to our long-term firm transportation, sales and processing agreements for pipeline capacity as of June 30, 2014:
 
 
For the Twelve Months Ending June 30,
 
 
 
 
Area
 
2015
 
2016
 
2017
 
2018
 
2019 and
Through
Expiration
 
Total
 
Expiration
Date
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Natural gas (MMcf)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Appalachian Basin
 
19,033

 
19,862

 
20,987

 
20,987

 
114,928

 
195,797

 
January 31, 2026
Utica Shale
 
2,737

 
2,745

 
2,737

 
2,737

 
13,929

 
24,885

 
July 22, 2023
Total
 
21,770

 
22,607

 
23,724

 
23,724

 
128,857

 
220,682

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dollar commitment (in thousands)
 
$
7,356

 
$
7,530

 
$
7,746

 
$
7,092

 
$
35,075

 
$
64,799

 
 

On July 29, 2014, we signed a definitive agreement pursuant to which we agreed to sell our entire 50% ownership interest in PDCM to an unrelated third-party. Pursuant to the definitive agreement, approximately 137,865 MMcf and $31.1 million of our Appalachian Basin firm transportation obligation will be assumed by the buyer upon the closing of the transaction. There can be no assurance that we will be successful in closing the transaction. In addition, we may have greater than expected purchase price reductions. See Note 15, Subsequent Events, for additional information.

Litigation. The Company is involved in various legal proceedings that it considers normal to its business. The Company reviews the status of these proceedings on an ongoing basis and, from time to time, may settle or otherwise resolve these matters on terms and conditions that management believes are in the best interests of the Company. There is no assurance that settlements can be reached on acceptable terms or that adverse judgments, if any, in the remaining litigation will not exceed the amounts reserved. Although the results cannot be known with certainty, we currently believe that the ultimate results of such proceedings will not have a material adverse effect on our financial position, results of operations or liquidity.


13

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Class Action Regarding 2010 and 2011 Partnership Purchases

In December 2011, the Company and its wholly-owned merger subsidiary were served with an alleged class action on behalf of certain former partnership unit holders, related to its partnership repurchases completed by mergers in 2010 and 2011. The action was filed in U.S. District Court for the Central District of California and is titled Schulein v. Petroleum Development Corp. The complaint primarily alleges that the disclosures in the proxy statements issued in connection with the mergers were inadequate, and a state law breach of fiduciary duty. In January 2014, the plaintiffs were certified as a class by the court. A jury trial originally scheduled for May 2014 has been rescheduled to begin in September 2014. We have held mediation meetings with plaintiffs and have proposed a settlement to resolve the alleged class action. Our proposed settlement includes a transfer of interests, primarily net profit interests which would generate cash in future years, in a certain number of future wells, plus a lesser value in an up-front cash payment. The mediation effort is ongoing; but there can be no assurance that the mediation meetings will continue or will result in a settlement on the terms we proposed or at all. During the quarter ended June 30, 2014, we recorded a litigation charge of $20.8 million, included in general and administrative expense in the condensed consolidated statements of operations, for a total accrued liability of $24.1 million at June 30, 2014, which is included in other accrued expenses in the condensed consolidated balance sheet. If the matter proceeds to trial, plaintiffs have indicated that they will seek damages of approximately $175 million, plus pre-judgment interest. We continue to believe we have good defenses to both the asserted claims and plaintiffs’ damage calculations.

Environmental. Due to the nature of the natural gas and oil industry, we are exposed to environmental risks. We have various policies and procedures designed to mitigate the risks of environmental contamination and related liabilities. We conduct periodic reviews to identify changes in our environmental risk profile. Liabilities are recorded when environmental damages resulting from past events are probable and the costs can be reasonably estimated. As of June 30, 2014 and December 31, 2013, we had accrued environmental liabilities in the amount of $6.2 million and $5.4 million, respectively, included in other accrued expenses on the condensed consolidated balance sheets. We are not aware of any environmental claims existing as of June 30, 2014 which have not been provided for or would otherwise be expected to have a material impact on our financial statements. However, there can be no assurance that current regulatory requirements will not change or unknown past non-compliance with environmental laws will not be discovered on our properties.

In June 2014, we received an information request from the Environmental Protection Agency (the "EPA") pursuant to Sections 308 and 311 of the Clean Water Act (the "CWA") regarding a discharge of oil and related materials that occurred in May related to a mechanical failure during drilling at an Ohio location. The requested information relates to the facility from which the discharge occurred and details regarding the discharge. To date, the EPA has not issued any notice that a violation of the CWA occurred or sought to impose any fine or other relief in connection with the discharge. While the results cannot be predicted with certainty, we do not expect the ultimate resolution of this information request or any subsequent proceedings to have a material adverse effect on our financial condition or results of operation.

Employment Agreements with Executive Officers. Each of our senior executive officers, except the current Chief Executive Officer, may be entitled to a severance payment and certain other benefits upon the termination of the officer's employment pursuant to the officer's employment agreement and/or the Company's executive severance compensation plan. The nature and amount of such benefits would vary based upon, among other things, whether the termination followed a change of control of the Company. In June 2014, we announced a leadership transition and entered into a consulting agreement with our current Chief Executive Officer pursuant to which he will provide consulting services to the Company in 2015. Under the agreement, the current Chief Executive Officer ceased to be a participant in our executive severance plan.

NOTE 10 - COMMON STOCK

Stock-Based Compensation Plans

The following table provides a summary of the impact of our outstanding stock-based compensation plans on the results of operations for the periods presented:

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Stock-based compensation expense
 
$
5,032

 
$
4,349

 
$
8,879

 
$
6,951

Income tax benefit
 
(1,912
)
 
(1,661
)
 
(3,374
)
 
(2,655
)
Net stock-based compensation expense
 
$
3,120

 
$
2,688

 
$
5,505

 
$
4,296

 
 
 
 
 
 
 
 
 

Stock Appreciation Rights ("SARs")

The SARs vest ratably over a three-year period and may be exercised at any point after vesting through 10 years from the date of issuance. Pursuant to the terms of the awards, upon exercise, the executive officers will receive, in shares of common stock, the excess of the market price of the award on the date of exercise over the market price of the award on the date of issuance.


14

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

In January 2014, the Compensation Committee awarded 88,248 SARs to our executive officers. The fair value of each SAR award was estimated on the date of grant using a Black-Scholes pricing model using the following assumptions:

 
Six Months Ended June 30,
 
2014
 
2013
 
 
 
 
Expected term of award
6 years

 
6 years

Risk-free interest rate
2.1
%
 
1.0
%
Expected volatility
65.6
%
 
65.5
%
Weighted-average grant date fair value per share
$
29.96

 
$
21.96


The expected life of the award was estimated using historical stock option exercise behavior data. The risk-free interest rate was based on the U.S. Treasury yields approximating the expected life of the award in effect at the time of grant. Expected volatilities were based on our historical volatility. We do not expect to pay or declare dividends in the foreseeable future.
    
The following table presents the changes in our SARs:
 
Six Months Ended June 30,
 
2014
 
2013
 
Number of
SARs
 
Weighted-Average
Exercise
Price
 
Average Remaining Contractual
Term (in years)
 
Aggregate Intrinsic
Value
(in thousands)
 
Number of
SARs
 
Weighted-Average
Exercise
Price
 
Average Remaining Contractual
Term
(in years)
 
Aggregate Intrinsic
Value
(in thousands)
Outstanding beginning of year, January 1,
190,763

 
$
33.77

 
 
 
 
 
118,832

 
$
30.80

 
 
 
 
Awarded
88,248

 
49.57

 
 
 
 
 
87,078

 
37.18

 
 
 
 
Outstanding at June 30,
279,011

 
38.77

 
8.3
 
6,803

 
205,910

 
33.50

 
8.6
 
3,703

Vested and expected to vest at June 30,
268,453

 
38.53

 
8.3
 
6,609

 
196,421

 
33.40

 
8.6
 
3,552

Exercisable at June 30,
109,920

 
32.71

 
7.3
 
3,346

 
67,069

 
29.99

 
7.6
 
1,441


Total compensation cost related to SARs granted, net of estimated forfeitures, and not yet recognized in our condensed consolidated statement of operations as of June 30, 2014 was $3.5 million. The cost is expected to be recognized over a weighted-average period of 2.0 years.
    
Restricted Stock Awards

Time-Based Awards. The fair value of the time-based restricted shares is amortized ratably over the requisite service period, primarily three years. The time-based shares vest ratably on each annual anniversary following the grant date if the participant is continuously employed.

In January 2014, the Compensation Committee awarded a total of 104,467 time-based restricted shares to our executive officers that vest ratably over a three-year period ending on January 16, 2017.

The following table presents the changes in non-vested time-based awards to all employees, including executive officers, for the six months ended June 30, 2014:
 
Shares
 
Weighted-Average
Grant-Date
Fair Value
 
 
 
 
Non-vested at December 31, 2013
651,781

 
$
36.36

Granted
280,835

 
56.56

Vested
(202,587
)
 
36.73

Forfeited
(18,385
)
 
38.56

Non-vested at June 30, 2014
711,644

 
44.18

 
 
 
 


15

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

 
As of/Year Ended June 30,
 
2014
 
2013
 
(in thousands, except per share data)
 
 
 
 
Total intrinsic value of time-based awards vested
$
11,690

 
$
8,544

Total intrinsic value of time-based awards non-vested
44,940

 
37,082

Market price per common share as of June 30,
63.15

 
51.48

Weighted-average grant date fair value per share
56.56

 
44.24


Total compensation cost related to non-vested time-based awards, net of estimated forfeitures, and not yet recognized in our condensed consolidated statements of operations as of June 30, 2014 was $24.0 million. This cost is expected to be recognized over a weighted-average period of 2.2 years.

Market-Based Awards. The fair value of the market-based restricted shares is amortized ratably over the requisite service period, primarily three years. The market-based shares vest if the participant is continuously employed throughout the performance period and the market-based performance measure is achieved, with a maximum vesting period of five years. All compensation cost related to the market-based awards will be recognized if the requisite service period is fulfilled, even if the market condition is not achieved.
In January 2014, the Compensation Committee awarded a total of 42,151 market-based restricted shares to our executive officers. In addition to continuous employment, the vesting of these shares is contingent on the Company's total shareholder return ("TSR"), which is essentially the Company’s stock price change including any dividends, as compared to the TSR of a set group of 15 peer companies. The shares are measured over a three-year period ending on December 31, 2016 and can result in a payout between 0% and 200% of the total shares awarded. The weighted-average grant date fair value per market-based share for these awards granted was computed using the Monte Carlo pricing model using the following assumptions:
 
 
Six Months Ended June 30,
 
 
2014
 
2013
 
 
 
 
 
Expected term of award
 
3 years

 
3 years

Risk-free interest rate
 
0.8
%
 
0.4
%
Expected volatility
 
55.2
%
 
56.6
%
Weighted-average grant date fair value per share
 
$
56.87

 
$
49.04


The expected term of the awards was based on the requisite service period. The risk-free interest rate was based on the U.S. Treasury yields in effect at the time of grant and extrapolated to approximate the life of the award. The expected volatility was based on our historical volatility.
    
The following table presents the change in non-vested market-based awards during six months ended June 30, 2014:

 
 
Shares
 
Weighted-Average
Grant-Date
Fair Value per Share
 
 
 
 
 
Non-vested at December 31, 2013
 
72,111

 
$
43.75

Granted
 
42,151

 
56.87

Non-vested at June 30, 2014
 
114,262

 
48.59

 
 
 
 
 

 
As of/Year Ended June 30,
 
2014
 
2013
 
(in thousands, except per share data)
 
 
 
 
Total intrinsic value of market-based awards non-vested
$
7,216

 
$
4,235

Market price per common share as of June 30,
63.15

 
51.48

Weighted-average grant date fair value per share
56.87

 
49.04



16

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Total compensation cost related to non-vested market-based awards, net of estimated forfeitures, and not yet recognized in our condensed consolidated statement of operations as of June 30, 2014 was $3.1 million. This cost is expected to be recognized over a weighted-average period of 2.0 years.

NOTE 11 - EARNINGS PER SHARE

Basic earnings per share is computed by dividing net earnings by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is similarly computed except that the denominator includes the effect, using the treasury stock method, of unvested restricted stock, outstanding SARs, stock options, Convertible Notes and shares held pursuant to our non-employee director deferred compensation plan, if including such potential shares of common stock is dilutive.

The following table presents a reconciliation of the weighted-average diluted shares outstanding:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding - basic
35,762

 
30,332

 
35,726

 
30,301

Dilutive effect of:
 
 
 
 
 
 
 
Restricted stock

 
313

 

 

SARs

 
26

 

 

Stock options

 
1

 

 

Non-employee director deferred compensation

 
4

 

 

Convertible notes

 
338

 

 

Weighted-average common shares and equivalents outstanding - diluted
35,762

 
31,014

 
35,726

 
30,301

 
 
 
 
 
 
 
 

We reported a net loss for the three and six months ended June 30, 2014 and for the six months ended June 30, 2013. As a result, our basic and diluted weighted-average common shares outstanding were the same due to the fact that the effect of the common share equivalents was anti-dilutive.

The following table presents the weighted-average common share equivalents excluded from the calculation of diluted earnings per share due to their anti-dilutive effect:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands)
 
 
 
 
 
 
 
 
Weighted-average common share equivalents excluded from diluted earnings
 
 
 
 
 
 
 
per share due to their anti-dilutive effect:
 
 
 
 
 
 
 
Restricted stock
896

 
5

 
859

 
893

SARs
92

 
20

 
96

 
54

Stock options
4

 

 
4

 
7

Non-employee director deferred compensation
5

 

 
5

 
4

Convertible notes
881

 

 
758

 
206

Total anti-dilutive common share equivalents
1,878

 
25

 
1,722

 
1,164

 
 
 
 
 
 
 
 

In November 2010, we issued our Convertible Notes, which give the holders the right to convert the aggregate principal amount into 2.7 million shares of our common stock at a conversion price of $42.40 per share. The Convertible Notes could be included in the dilutive earnings per share calculation using the treasury stock method if the average market share price exceeds the $42.40 conversion price during the period presented. Shares issuable upon conversion of the Convertible Notes were excluded from the diluted earnings per share calculation for the three and six months ended June 30, 2014 and the six months ended June 30, 2013 as the effect would be anti-dilutive to our earnings per share. Shares issuable upon conversion of the Convertible Notes were included in the diluted earnings per share calculation for the three months ended June 30, 2013 as the average market price during the period exceeded the conversion price.

NOTE 12 - ASSETS HELD FOR SALE, DIVESTITURES AND DISCONTINUED OPERATIONS
    
Appalachian Basin. In December 2013, we divested our shallow Upper Devonian (non-Marcellus Shale) Appalachian Basin crude oil and natural gas properties previously owned directly by us, as well as through our proportionate share of PDCM, for aggregate consideration of approximately $20.6 million, of which our share of the proceeds was approximately $5.1 million. We received our proportionate share of cash

17

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

proceeds of $0.9 million and recorded our proportionate share of a note receivable and account receivable from the buyer of $3.3 million and $0.8 million, respectively. Concurrent with the closing of the transaction, our $6.7 million irrevocable standby letter of credit and an agreement for firm transportation services was released and novated to the buyer. We, through our ownership in PDCM, retained all zones, formations and intervals below the Upper Devonian formation including the Marcellus Shale, Utica Shale and Huron Shale. The divestiture of these assets did not meet the requirements to be accounted for as discontinued operations. On July 29, 2014, we signed a definitive agreement to sell our entire 50% interest in PDCM to an unrelated third-party. See Note 15, Subsequent Events, for additional information.There can be no assurance we will be successful in closing the transaction. In addition, we may have greater than expected purchase price reductions.

Piceance Basin and NECO. In June 2013, we divested our Piceance Basin, NECO and certain other non-core Colorado oil and gas properties, leasehold mineral interests and related assets for total consideration of approximately $177.6 million, with an additional $17.0 million paid to our non-affiliated investor partners in our affiliated partnerships. The sale resulted in a pre-tax loss of $2.3 million. Additionally, certain firm transportation obligations and natural gas hedging positions were assumed by the buyer. Following the sale, we do not have significant continuing involvement in the operations of, or cash flows from, the Piceance Basin and NECO oil and gas properties. Accordingly, the results of operations related to these assets have been separately reported as discontinued operations in the condensed consolidated statement of operations for the three months ended June 30, 2013. The sale of our other non-core Colorado oil and gas properties did not meet the requirements to be accounted for as discontinued operations.

The following table presents statement of operations data related to our discontinued operations for the Piceance Basin and NECO divestitures:
Condensed consolidated statements of operations - discontinued operations
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
 
 
 
 
Revenues
 
 
 
 
Crude oil, natural gas and NGLs sales
 
$
10,182

 
$
20,456

Sales from natural gas marketing
 
586

 
1,036

Well operations, pipeline income and other
 
409

 
859

Total revenues
 
11,177

 
22,351

 
 
 
 
 
Costs, expenses and other
 
 
 
 
Production costs
 
2,564

 
7,957

Cost of natural gas marketing
 
540

 
994

Depreciation, depletion and amortization
 

 
2,258

Other
 
1,959

 
2,454

Loss on sale of properties and equipment
 
1,076

 
1,076

Total costs, expenses and other
 
6,139