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EX-32.1 - 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - PDC ENERGY, INC.a2017_10q3xexx321.htm
EX-31.2 - 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - PDC ENERGY, INC.a2017_10q3xexx312.htm
EX-31.1 - 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - PDC ENERGY, INC.a2017_10q3xexx311.htm
EX-10.1 - SIXTH AMENDMENT TO THIRD AMENDED AND RESTATED CREDIT AGREEMENT - PDC ENERGY, INC.a2017_10q3xexx101.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 September 30, 2017

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 001-37419
logo123114a09.jpg
PDC ENERGY, INC.
(Exact name of registrant as specified in its charter)

Delaware
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 x No o

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 x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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  x
Accelerated filer  o
Non-accelerated filer  o
(Do not check if a smaller reporting company)
Smaller reporting company  o
 
Emerging growth company  o
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. o

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 65,872,790 shares of the Company's Common Stock ($0.01 par value) were outstanding as of October 20, 2017.



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"), Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"), and the United States ("U.S.") Private Securities Litigation Reform Act of 1995 regarding our business, financial condition, results of operations, and prospects. All statements other than statements of historical fact included in and incorporated by reference into this report are "forward-looking statements." 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. Forward-looking statements may include, among other things, statements regarding the closing of pending transactions and the effects of such transactions, including the fact that the pending acquisition of certain properties owned by Bayswater Exploration & Production, LLC and certain related parties and the pending acreage exchanges are subject to continuing diligence between the parties and may not occur within the expected timeframe or we may not successfully close such transactions; the potential sale of our Utica Shale properties and the timing of such sale; the level of non-operated well activity following the pending acreage exchanges; future reserves, production, costs, cash flows, and earnings; drilling locations and growth opportunities; capital investments and projects, including expected lateral lengths of wells, drill times and number of rigs employed; potential future impairments; the finalization of a consent decree resolving pending litigation; rates of return; operational enhancements and efficiencies; management of lease expiration issues; financial ratios; and midstream capacity and related curtailments and the estimated in-service date of the facilities being constructed by our midstream providers.

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. Forward-looking statements are always subject to risks and uncertainties, and become subject to greater levels of risk and uncertainty as they address matters further into the future. Throughout this report or accompanying materials, we may use the term “projection” or similar terms or expressions, or indicate that we have “modeled” certain future scenarios. We typically use these terms to indicate our current thoughts on possible outcomes relating to our business or our industry in periods beyond the current fiscal year. Because such statements relate to events or conditions further in the future, they are subject to increased levels of uncertainty.

Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to:

changes in worldwide production volumes and demand, including economic conditions that might impact demand and prices for the products we produce;
volatility of commodity prices for crude oil, natural gas, and natural gas liquids ("NGLs") and the risk of an extended period of depressed prices;
reductions in the borrowing base under our revolving credit facility;
impact of governmental policies and/or regulations, including changes in environmental and other laws, the interpretation and enforcement of those laws and regulations, liabilities arising thereunder, and the costs to comply with those laws and regulations;
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;
availability of sufficient pipeline, gathering, and other transportation facilities and related infrastructure to process and transport our production 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;
losses from our gas marketing business exceeding our expectations;
difficulties in integrating our operations as a result of any significant acquisitions, including our pending acquisitions and acreage exchanges in the Wattenberg Field;
increases or changes in operating costs, severance and ad valorem taxes, and increases or changes in drilling, completion, and facilities costs;
availability of supplies, materials, contractors, and services that may delay the drilling or completion of our wells;
potential losses of acreage due to lease expirations or otherwise;
increases or adverse changes in construction costs and procurement costs associated with future build out of midstream-related assets;



future cash flows, liquidity, and financial condition;
competition within the oil and gas industry;
availability and cost of capital;
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, including recent environmental litigation;
effect that acquisitions we may pursue have on our capital requirements;
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, 2016 (the "2016 Form 10-K"), filed with the U.S. Securities and Exchange Commission ("SEC") on February 28, 2017, 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.



PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

PDC ENERGY, INC.
Condensed Consolidated Balance Sheets
(unaudited; in thousands, except share and per share data)
 
 
September 30, 2017
 
December 31, 2016
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
136,429

 
$
244,100

Accounts receivable, net
 
167,276

 
143,392

Fair value of derivatives
 
22,916

 
8,791

Prepaid expenses and other current assets
 
8,081

 
3,542

Total current assets
 
334,702

 
399,825

Properties and equipment, net
 
3,882,700

 
4,002,994

Assets held-for-sale, net
 
41,484

 
5,272

Fair value of derivatives
 
4,605

 
2,386

Goodwill
 

 
62,041

Other assets
 
43,796

 
13,324

Total Assets
 
$
4,307,287

 
$
4,485,842

 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
Liabilities
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
164,080

 
$
66,322

Production tax liability
 
36,954

 
24,767

Fair value of derivatives
 
25,987

 
53,595

Funds held for distribution
 
94,387

 
71,339

Accrued interest payable
 
18,929

 
15,930

Other accrued expenses
 
33,451

 
38,625

Total current liabilities
 
373,788

 
270,578

Long-term debt
 
1,051,571

 
1,043,954

Deferred income taxes
 
326,472

 
400,867

Asset retirement obligations
 
78,188

 
82,612

Fair value of derivatives
 
7,261

 
27,595

Other liabilities
 
43,405

 
37,482

Total liabilities
 
1,880,685

 
1,863,088

 
 
 
 
 
Commitments and contingent liabilities
 

 

 
 
 
 
 
Stockholders' equity
 
 
 
 
Common shares - par value $0.01 per share, 150,000,000 authorized, 65,928,295 and 65,704,568 issued as of September 30, 2017 and December 31, 2016, respectively
 
659

 
657

Additional paid-in capital
 
2,500,532

 
2,489,557

Retained earnings (deficit)
 
(70,933
)
 
134,208

Treasury shares - at cost, 62,772 and 28,763
 as of September 30, 2017 and December 31, 2016, respectively
 
(3,656
)
 
(1,668
)
Total stockholders' equity
 
2,426,602

 
2,622,754

Total Liabilities and Stockholders' Equity
 
$
4,307,287

 
$
4,485,842




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 September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Revenues
 
 
 
 
 
 
 
 
Crude oil, natural gas, and NGLs sales
 
$
232,733

 
$
141,805

 
$
636,027

 
$
328,013

Commodity price risk management gain (loss), net of settlements
 
(52,178
)
 
19,397

 
86,458

 
(62,348
)
Other income
 
2,680

 
2,688

 
9,615

 
9,153

Total revenues
 
183,235

 
163,890

 
732,100

 
274,818

Costs, expenses and other
 
 
 
 
 
 
 
 
Lease operating expenses
 
25,353

 
14,001

 
65,170

 
43,006

Production taxes
 
15,516

 
9,568

 
42,957

 
19,682

Transportation, gathering and processing expenses
 
9,794

 
5,048

 
22,184

 
13,554

General and administrative expense
 
29,299

 
32,510

 
85,145

 
78,868

Exploration, geologic, and geophysical expense
 
41,908

 
241

 
43,895

 
688

Depreciation, depletion and amortization
 
125,238

 
112,927

 
360,567

 
317,329

Impairment of properties and equipment
 
252,740

 
933

 
282,499

 
6,104

Impairment of goodwill
 
75,121

 

 
75,121

 

Accretion of asset retirement obligations
 
1,472

 
1,777

 
4,906

 
5,400

Gain on sale of properties and equipment
 
(62
)
 
(219
)
 
(754
)
 
(43
)
Provision for uncollectible notes receivable
 

 
(700
)
 
(40,203
)
 
44,038

Other expenses
 
2,947

 
3,092

 
10,365

 
7,795

Total costs, expenses and other
 
579,326

 
179,178

 
951,852

 
536,421

Loss from operations
 
(396,091
)
 
(15,288
)
 
(219,752
)
 
(261,603
)
Interest expense
 
(19,275
)
 
(20,193
)
 
(58,359
)
 
(42,759
)
Interest income
 
479

 
140

 
1,487

 
1,875

Loss before income taxes
 
(414,887
)
 
(35,341
)
 
(276,624
)
 
(302,487
)
Income tax benefit
 
122,350

 
12,032

 
71,483

 
112,198

Net loss
 
$
(292,537
)
 
$
(23,309
)
 
$
(205,141
)
 
$
(190,289
)
 
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
 
Basic
 
$
(4.44
)
 
$
(0.48
)
 
$
(3.12
)
 
$
(4.16
)
Diluted
 
$
(4.44
)
 
$
(0.48
)
 
$
(3.12
)
 
$
(4.16
)
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
65,865

 
48,839

 
65,825

 
45,741

Diluted
 
65,865

 
48,839

 
65,825

 
45,741

 
 
 
 
 
 
 
 
 
 

See accompanying Notes to Condensed Consolidated Financial Statements
2


PDC ENERGY, INC.
Condensed Consolidated Statements of Cash Flows
(unaudited; in thousands)
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(205,141
)
 
$
(190,289
)
Adjustments to net loss to reconcile to net cash from operating activities:
 
 
 
 
Net change in fair value of unsettled commodity derivatives
 
(64,307
)
 
230,177

Depreciation, depletion and amortization
 
360,567

 
317,329

Impairment of properties and equipment
 
282,499

 
6,104

Impairment of goodwill
 
75,121

 

Exploratory dry hole costs
 
41,187

 

Provision for uncollectible notes receivable
 
(40,203
)
 
44,038

Accretion of asset retirement obligations
 
4,906

 
5,400

Non-cash stock-based compensation
 
14,587

 
15,205

Gain on sale of properties and equipment
 
(754
)
 
(43
)
Amortization of debt discount and issuance costs
 
9,628

 
12,951

Deferred income taxes
 
(71,529
)
 
(114,136
)
Other
 
986

 
(526
)
Changes in assets and liabilities
 
3,855

 
34,621

Net cash from operating activities
 
411,402

 
360,831

Cash flows from investing activities:
 
 
 
 
Capital expenditures for development of crude oil and natural gas properties
 
(528,850
)
 
(352,213
)
Capital expenditures for other properties and equipment
 
(3,740
)
 
(1,509
)
Acquisition of crude oil and natural gas properties, including settlement adjustments and deposit for pending acquisition
 
(14,482
)
 
(100,000
)
Proceeds from sale of properties and equipment
 
3,322

 
4,945

Sale of promissory note
 
40,203

 

Restricted cash
 
(9,250
)
 

Sale of short-term investments
 
49,890

 

Purchase of short-term investments
 
(49,890
)
 

Net cash from investing activities
 
(512,797
)
 
(448,777
)
Cash flows from financing activities:
 
 
 
 
Proceeds from issuance of equity, net of issuance cost
 

 
855,072

Proceeds from senior notes
 

 
392,250

Proceeds from convertible senior notes
 

 
193,979

Proceeds from revolving credit facility
 

 
85,000

Repayment of revolving credit facility
 

 
(122,000
)
Redemption of convertible notes
 

 
(115,000
)
Purchase of treasury shares
 
(5,325
)
 
(5,106
)
Other
 
(951
)
 
593

Net cash from financing activities
 
(6,276
)
 
1,284,788

Net change in cash and cash equivalents
 
(107,671
)
 
1,196,842

Cash and cash equivalents, beginning of period
 
244,100

 
850

Cash and cash equivalents, end of period
 
$
136,429

 
$
1,197,692

 
 
 
 
 
Supplemental cash flow information:
 
 
 
 
Cash payments (receipts) for:
 
 
 
 
Interest, net of capitalized interest
 
$
45,719

 
$
19,499

Income taxes
 
(2,623
)
 
167

Non-cash investing and financing activities:
 
 
 
 
Change in accounts payable related to purchases of properties and equipment
 
$
89,974

 
$
(31,497
)
Change in asset retirement obligations, with a corresponding change to crude oil and natural gas properties, net of disposals
 
3,357

 
1,137

Purchase of properties and equipment under capital leases
 
3,363

 
1,231


See accompanying Notes to Condensed Consolidated Financial Statements
3


PDC ENERGY, INC.
Condensed Consolidated Statement of Equity
(unaudited; in thousands, except share data)

 
Common Stock
 
 
 
Treasury Stock
 
 
 
 
 
Shares
 
Amount
 
Additional Paid-in Capital
 
Shares
 
Amount
 
Retained Earnings (Deficit)
 
Total Stockholders' Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2016
65,704,568

 
$
657

 
$
2,489,557

 
(28,763
)
 
$
(1,668
)
 
$
134,208

 
$
2,622,754

Net loss

 

 

 

 

 
(205,141
)
 
(205,141
)
Purchase of treasury shares

 

 

 
(80,572
)
 
(5,325
)
 

 
(5,325
)
Issuance of treasury shares
(49,446
)
 

 
(3,513
)
 
49,446

 
3,513

 

 

Non-employee directors' deferred compensation plan

 

 

 
(2,883
)
 
(176
)
 

 
(176
)
Issuance of stock awards, net of forfeitures
273,173

 
2

 
(2
)
 

 

 

 

Stock-based compensation expense

 

 
14,587

 

 

 

 
14,587

Other

 

 
(97
)
 

 

 

 
(97
)
Balance, September 30, 2017
65,928,295

 
$
659

 
$
2,500,532

 
(62,772
)
 
$
(3,656
)
 
$
(70,933
)
 
$
2,426,602




See accompanying Notes to Condensed Consolidated Financial Statements
4

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION

PDC Energy, Inc. ("PDC", the "Company," "we," "us," or "our") is a domestic independent exploration and production company that produces, develops, and explores for crude oil, natural gas, and NGLs, with primary operations in the Wattenberg Field in Colorado and, beginning in December 2016, the Delaware Basin in Reeves and Culberson Counties, Texas. We also have operations in the Utica Shale in Southeastern Ohio. During the third quarter of 2017, as part of plans to divest the Utica Shale properties, we engaged an investment banking group and began actively marketing the properties for sale; therefore, these properties are classified as held-for-sale as they met the criteria for such classification during the third quarter of 2017. Our operations in the Wattenberg Field are focused in the horizontal Niobrara and Codell plays and our Delaware Basin operations are currently focused in the Wolfcamp zones. As of September 30, 2017, we owned an interest in approximately 2,900 gross productive wells. We are engaged in two operating segments: our oil and gas exploration and production segment and our gas marketing segment. Beginning in 2017, our gas marketing segment does not meet the quantitative thresholds to require disclosure as a separate reportable segment. All of our material operations are attributable to our exploration and production business; therefore, all of our operations are presented as a single segment for all periods presented.

The accompanying unaudited condensed consolidated financial statements include the accounts of PDC, our wholly-owned subsidiaries, and our proportionate share of our two 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 normal recurring adjustments, necessary for a fair statement 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 December 31, 2016 condensed consolidated balance sheet data was derived from audited statements, but does not include all disclosures required by U.S. GAAP. 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 2016 Form 10-K. Our results of operations and cash flows for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for the full year or any other future period.

Certain immaterial reclassifications have been made to our prior period balance sheet and statement of operations to conform to the current period presentation. The reclassifications had no impact on previously reported cash flows, net earnings, earnings per share or stockholders' equity.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Recently Adopted Accounting Standard

In January 2017, the FASB issued an accounting update to simplify the measurement of goodwill. The update eliminates the two-step process that required identification of potential impairment and a separate measure of actual impairment. The annual and/or interim assessments are still required to be completed. The guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. We elected to early adopt this standard in the second quarter of 2017. Our annual evaluation of goodwill for impairment was expected to occur in the fourth quarter of 2017; however, we experienced an impairment triggering event as of September 30, 2017 and implemented the new guidance as part of the impairment evaluation. See the footnote titled Goodwill for a detailed description of the results of our impairment testing.

Recently Issued Accounting Standards

In May 2014, the FASB and the International Accounting Standards Board 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 standard has been updated and now includes technical corrections. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an

5

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


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: (1) identify the contract with the customer, (2) identify the separate performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to separate performance obligations, and (5) recognize revenue when or as each performance obligation is satisfied. The revenue standard is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period; we are adopting the standard effective January 1, 2018. The revenue standard can be adopted under the full retrospective method or modified retrospective method. In order to evaluate the impact that the adoption of the revenue standard will have on our consolidated financial statements, we are performing a comprehensive review of our significant revenue streams. The focus of this review includes, among other things, the identification of the significant contracts and other arrangements we have with our customers to identify performance obligations and principal versus agent considerations, and factors affecting the determination of transaction price. We are also reviewing our current accounting policies, procedures, and controls with respect to these contracts and arrangements to determine what changes, if any, may be required by the adoption of the revenue standard. We have determined that we will adopt the standard under the modified retrospective method. We have not made a complete determination regarding the impact that the adoption will have on our consolidated financial statements as of the time of this filing.

In February 2016, the FASB issued an accounting update aimed at increasing the transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about related leasing arrangements. For leases with terms of more than 12 months, the accounting update requires lessees to recognize a right-of-use asset and lease liability for its right to use the underlying asset and the corresponding lease obligation. Both the lease asset and liability will initially be measured at the present value of the future minimum lease payments over the lease term. Subsequent measurement, including the presentation of expenses and cash flows, will depend upon the classification of the lease as either a finance or operating lease. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted, and is to be applied as of the beginning of the earliest period presented using a modified retrospective approach. We are currently evaluating the impact these changes may have on our consolidated financial statements.

In August 2016, the FASB issued an accounting update on statements of cash flows to address diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact these changes may have on our consolidated financial statements.

In November 2016, the FASB issued an accounting update on statements of cash flows to address diversity in practice in the classification and presentation of changes in restricted cash. The accounting update requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash or restricted cash equivalents should be included with cash and cash equivalents when reconciling beginning-of-period and end-of-period amounts shown on the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact these changes may have on our consolidated financial statements.

In January 2017, the FASB issued an accounting update clarifying the definition of a business, with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. This guidance is to be applied using a prospective method and is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact these changes may have on our consolidated financial statements.

In May 2017, the FASB issued an accounting update clarifying when to account for a change to the terms or conditions of a share-based payment award as a modification. The guidance is effective for fiscal years beginning on or after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. Adoption of this standard is not expected to have a significant impact on our condensed consolidated financial statements.




6

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


NOTE 3 - BUSINESS COMBINATION

Delaware Basin Acquisition. On December 6, 2016, we closed on an acquisition which was accounted for as a business combination. The acquisition consisted of the purchase of stock of an entity and assets of other entities under common control. The transaction was for the purchase of approximately 57,900 net acres, approximately 30 completed and producing wells and related midstream infrastructure in Reeves and Culberson Counties, Texas, for an aggregate consideration to the sellers of approximately $1.64 billion, after preliminary post-closing adjustments. The total consideration to sellers was comprised of approximately $946.0 million in cash, including the payment of $40.0 million of debt of the sellers at closing and other purchase price adjustments, and 9.4 million shares of our common stock valued at approximately $690.7 million at the time the acquisition closed. The purchase accounting for the entity of which we acquired the stock reflected oil and gas assets that did not receive fair value step-up of the tax basis. As a result, a significant deferred income tax liability was calculated based on the acquired allocated fair value of the assets in excess of the tax basis of assets inside the entity. This calculation resulted in approximately $375.0 million of non-cash basis needing to be allocated to the acquired assets. No deferred tax liability was established for the calculated goodwill as the goodwill did not qualify as tax goodwill.

The final fair value allocation of the assets acquired and liabilities assumed in the acquisition are presented below and include customary post-closing adjustments. The most significant item to be completed during the final purchase price allocation in the third quarter of 2017 was the final allocation of value to the unproved oil and gas properties associated with the acquired acreage. Adjustments to the preliminary purchase price primarily stem from additional information we obtained about facts and circumstances that existed at the acquisition date that impact the underlying value of certain assets acquired and liabilities assumed, including detailed lease terms, location of the acreage, and intent to develop the acreage as of the date of closing. There were a significant number of leases acquired with complex lease terms and evaluation of these terms and the timing of the lease expirations impacted the manner in which the final purchase price was allocated. Our final determination of the value of goodwill has been adjusted for all post-closing adjustments.

The details of the final purchase price and the allocation of the purchase price for the transaction, are presented below (in thousands):
 
September 30, 2017
Acquisition costs:
 
       Cash, net of cash acquired
$
905,962

       Retirement of seller's debt
40,000

  Total cash consideration
945,962

        Common stock, 9.4 million shares
690,702

        Other purchase price adjustments
426

  Total acquisition costs
$
1,637,090

 
 
Recognized amounts of identifiable assets acquired and liabilities assumed:
 
Assets acquired:
 
       Current assets
$
6,401

       Crude oil and natural gas properties - proved
216,000

       Crude oil and natural gas properties - unproved
1,697,000

       Infrastructure, pipeline, and other
33,153

       Construction in progress
12,323

       Goodwill
75,121

Total assets acquired
2,039,998

Liabilities assumed:
 
       Current liabilities
(24,496
)
       Asset retirement obligations
(3,705
)
       Deferred tax liabilities, net
(374,707
)
Total liabilities assumed
(402,908
)
Total identifiable net assets acquired
$
1,637,090


7

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)



The fair value measurements of assets acquired and liabilities assumed are based on inputs that are not observable in the market, and therefore represent Level 3 inputs. The fair values of crude oil and natural gas properties and asset retirement obligations were measured using valuation techniques that convert future cash flows to a single discounted amount. Significant inputs to the valuation of crude oil and natural gas properties include estimates of reserves, future operating and development costs, future commodity prices, estimated future cash flows, lease terms and expirations, and a market-based weighted-average cost of capital rate. Within the unproven properties, the allocation of the value to the underlying leases also required significant judgment and was based on a combination of comparable market transactions, the term and conditions associated with the individual leases, our ability and intent to develop specific leases, and our initial assessment of the underlying relative value of the leases given our knowledge of the geology at the time of closing. These inputs require significant judgments and estimates by management at the time of the valuation and were the most sensitive and subject to change.

This acquisition was accounted for under the acquisition method. Accordingly, we conducted assessments of net assets acquired and recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values, while transaction and integration costs associated with the acquisition were expensed as incurred.

Goodwill. Goodwill was calculated as the excess of the purchase price over the fair value of net assets acquired, including the additional value resulting from the creation of the deferred tax liability, and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Among the factors that contributed to a purchase price in excess of the fair value of the net tangible and intangible assets acquired were the acquisition of an element of a workforce and the expected value from operations of the Delaware Basin acquisition to be derived in the future, such as production from future development of additional producing zones. The amount of the final goodwill that was recorded in the third quarter of 2017 related to the Delaware Basin acquisition was $75.1 million and was higher than the initial estimated amount recorded as of December 31, 2016, primarily related to finalization of the aggregate acreage position acquired and the related lease terms and a final settlement with the sellers in connection with a revised valuation of certain acquired leases and the retirement of estimated environmental remediation liabilities. Any value assigned to goodwill was not expected to be deductible for income tax purposes.

The following table presents the changes in goodwill from the preliminary allocation at December 31, 2016, and the final allocation determined during the quarter ended September 30, 2017:
 
Amount
 
(in thousands)
 
 
Preliminary purchase price allocation
$
62,041

Adjustments
13,080

Final purchase price allocation
$
75,121


See the footnote titled Goodwill for the details regarding the impairment of goodwill as of September 30, 2017.

NOTE 4 - PENDING ACQUISITION AND ACREAGE EXCHANGES

Pending Acquisition. In September 2017, we entered into an acquisition agreement to acquire certain assets from Bayswater Exploration & Production, LLC ("Bayswater") and certain related parties, pursuant to which, subject to the terms and conditions of the agreement, we have agreed to acquire approximately 8,300 net acres, 30 operated drilled uncompleted wells ("DUCs"), and an estimated 240 gross drilling locations, for approximately $210 million in cash, subject to certain pre- and post-closing adjustments. We plan to turn-in-line 18 of these DUCs at approximately year-end 2017, with the completion costs expected to be treated as an increase to the purchase price. Upon executing the purchase and sale agreement, we paid a $21 million deposit toward the purchase price into an escrow account, which is included in other assets on our September 30, 2017 condensed consolidated balance sheet. Assuming all conditions required for closing are met, the acquisition is expected to close in December 2017 and is expected to be funded by a combination of available cash and debt.

Pending Acreage Exchanges. In September 2017, we entered into an acreage exchange transaction to consolidate certain acreage positions in the core area of the Wattenberg Field. Pursuant to the transaction, we will exchange leasehold acreage with some limited in-process development wells. Upon closing, we expect to receive approximately 11,700 net acres in exchange for approximately 12,100 net acres with minimal cash exchanged between the parties. The difference in net acres is

8

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


primarily due to variances in working and net revenue interests. The acreage exchange is expected to close in the fourth quarter of 2017; however, there can be no assurance that conditions to closing will be satisfied.

In June 2017, we entered into an acreage exchange transaction that also involves the consolidation of certain acreage positions in the core area of the Wattenberg Field. Pursuant to the transaction, we will exchange leasehold acreage with some limited in-process development wells. Upon closing, we estimate that we will receive approximately 3,900 net acres in exchange for approximately 4,100 net acres with minimal cash exchanged between the parties. The difference in net acres is primarily due to variances in working and net revenue interests. This acreage exchange is also expected to close in the fourth quarter 2017; however, there can be no assurance that conditions to closing will be satisfied.

    


9

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


NOTE 5 - EXPLORATION, GEOLOGIC, AND GEOPHYSICAL EXPENSE

The following table presents the major components of exploration, geologic, and geophysical expense:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
 
 
 
 
 
 
 
 
Exploratory dry hole costs
$
41,187

 
$

 
$
41,187

 
$

Geological and geophysical costs, including seismic purchases
463

 

 
1,790

 

Operating, personnel and other
258

 
241

 
918

 
688

Total exploration, geologic, and geophysical expense
$
41,908

 
$
241

 
$
43,895

 
$
688

 
 
 
 
 
 
 
 

Exploratory dry hole costs. During the three and nine months ended September 30, 2017, two exploratory dry hole wells, associated lease costs, and related infrastructure assets in the Delaware Basin were expensed at a cost of $41.2 million. The conclusion to expense these items was due to the conclusion that the acreage on which these wells were drilled was exploratory in nature and, following drilling, the lack of hydrocarbon production necessary for the wells to be deemed economically viable.

NOTE 6 - PROPERTIES AND EQUIPMENT AND ASSETS HELD-FOR-SALE

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

 
September 30, 2017
 
December 31, 2016
 
(in thousands)
Properties and equipment, net:
 
 
 
Crude oil and natural gas properties
 
 
 
Proved
$
3,759,501

 
$
3,499,718

Unproved
1,559,717

 
1,874,671

Total crude oil and natural gas properties
5,319,218

 
5,374,389

Infrastructure, pipeline, and other
104,568

 
62,093

Land and buildings
10,714

 
6,392

Construction in progress
177,341

 
122,591

Properties and equipment, at cost
5,611,841

 
5,565,465

Accumulated DD&A
(1,729,141
)
 
(1,562,471
)
Properties and equipment, net
$
3,882,700

 
$
4,002,994

 
 
 
 

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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)

 
 
 
 
 
 
 
Impairment of unproved properties
$
252,623

 
$
338

 
$
282,188

 
$
2,391

Amortization of individually insignificant unproved properties
117

 
595

 
311

 
681

Impairment of crude oil and natural gas properties
252,740

 
933

 
282,499

 
3,072

Land and buildings

 

 

 
3,032

Total impairment of properties and equipment
$
252,740

 
$
933

 
$
282,499

 
$
6,104


During the three months ended September 30, 2017, we recorded a charge related to two exploratory dry holes we had drilled in the western area of our Culberson County acreage in the Delaware Basin, as referenced previously.  We then assessed the impact of the dry holes and various factors related thereto, including (i) the operational and geologic data obtained, (ii) the

10

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


current increased cost environment for drilling and completion services in the Delaware Basin, (iii) our decreased future commodity price outlook, and (iv) the terms of  the related lease agreements.  Based on the results of this assessment, we concluded that the underlying geologic risk and the challenged economics of future capital expenditures reduced the likelihood that we would perform future development in this area over the remaining lease term for this acreage.  Accordingly, we recorded an impairment of $251.6 million covering approximately 13,400 acres during the third quarter of 2017.  The amount of the impairment of these unproved properties was based on the value assigned to individual lease acres in the final purchase price allocation of the business combination.  This allocation had included the consideration paid to the sellers, including the effect of the non-cash impact from the deferred tax liability created at the time of the acquisition. Due to the aforementioned events and circumstances in the third quarter of 2017, we evaluated our proved property for possible impairment and concluded that these assets were not impaired during the period.

Classification of Assets as Held-for-Sale. During the third quarter of 2017, as part of our plan to divest the Utica Shale properties, we engaged an investment banking group and began actively marketing the properties for sale; therefore, these properties are classified as held-for-sale as they met the criteria for such classification during the third quarter of 2017.

The following table presents balance sheet data related to assets held-for-sale, which include the Utica Shale properties, field office facilities, and a parcel of land that are being marketed for sale. Assets held-for-sale represents the assets that are expected to be sold, net of liabilities, that are expected to be assumed by the purchasers:    
 
September 30, 2017
 
December 31, 2016
 
(in thousands)
Assets
 
 
 
  Properties and equipment, net
$
41,983

 
$
5,272

Total assets
$
41,983

 
$
5,272

 
 
 
 
Liabilities
 
 
 
  Asset retirement obligation
$
499

 
$

Total liabilities
$
499

 
$

 
 
 
 
Net assets
$
41,484

 
$
5,272



NOTE 7 - GOODWILL

The final goodwill that resulted from the purchase price allocation of the assets acquired in the Delaware Basin was determined to be $75.1 million. With the creation of goodwill from this transaction, we expected to perform our evaluation of goodwill for impairment annually in the fourth quarter. However, primarily due to a combination of increases in per well development and operational costs and our drilling of two exploratory dry holes in the Delaware Basin since the time of the acquisition, in conjunction with our lower future commodity price outlook, we determined a triggering event had occurred in the quarter ended September 30, 2017. In addition to the factors mentioned above, we also considered our recent impairments of certain unproven leasehold costs, and the impact of these items on our internal expectations for acceptable rates of return. We evaluated goodwill for impairment by performing a quantitative test, which involves comparing the estimated fair value of the goodwill asset group, which we define as the Delaware Basin, to the carrying value. We determined the fair value of the goodwill at September 30, 2017 by using an estimated after-tax future discounted cash flow analysis, along with a combination of market-based pricing factors for similar acreage, reserve valuation techniques, and other fair value considerations. The discounted cash flow analysis used to estimate fair value was based on known or knowable information at the interim measurement date. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. The quantitative test resulted in a determination that a full impairment charge of $75.1 million was required; therefore, the charge was recorded in the quarter ended September 30, 2017.
 


11

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


NOTE 8 - COMMODITY 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, natural gas, and propane, which is an element of our NGLs, we enter into commodity derivative contracts to protect against price declines in future periods. While we structure these commodity derivatives to reduce our exposure to decreases in commodity prices, they also limit the benefit we might otherwise receive from price increases.
 
We believe our commodity derivative instruments continue to be effective in achieving the risk management objectives for which they were intended. As of September 30, 2017, we had derivative instruments, which were comprised of collars, fixed-price swaps, and basis protection swaps, in place for a portion of our anticipated 2017 and 2018 production for a total of 14,337 MBbls of crude oil, 69,715 BBtu of natural gas, and 412 MBbls of propane. Our commodity derivative contracts have been entered into at no cost to us as we hedge our anticipated production at the then-prevailing commodity market prices, without adjustment for premium or discount.

We have not elected to designate any of our derivative instruments as cash flow hedges, and therefore these instruments do not qualify for hedge accounting. Accordingly, changes in the fair value of our derivative instruments are recorded in the condensed consolidated statements of operations.

The following table presents the balance sheet location and fair value amounts of our derivative instruments on the condensed consolidated balance sheets:
 
 
 
 
 
Fair Value
Derivative instruments:
 
Condensed consolidated balance sheet line item
 
September 30, 2017
 
December 31, 2016
 
 
 
 
 
(in thousands)
Derivative assets:
Current
 
 
 
 
 
 
 
Commodity derivative contracts
 
Fair value of derivatives
 
$
19,042

 
$
8,490

 
Basis protection derivative contracts
 
Fair value of derivatives
 
3,874

 
301

 
 
 
 
 
22,916

 
8,791

 
Non-current
 
 
 
 
 
 
 
Commodity derivative contracts
 
Fair value of derivatives
 
3,942

 
1,123

 
Basis protection derivative contracts
 
Fair value of derivatives
 
663

 
1,263

 
 
 
 
 
4,605

 
2,386

Total derivative assets
 
 
 
$
27,521

 
$
11,177

 
 
 
 
 
 
 
 
Derivative liabilities:
Current
 
 
 
 
 
 
 
Commodity derivative contracts
 
Fair value of derivatives
 
$
25,895

 
$
53,565

 
Basis protection derivative contracts
 
Fair value of derivatives
 
92

 
30

 
 
 
 
 
25,987

 
53,595

 
Non-current
 
 
 
 
 
 
 
Commodity derivative contracts
 
Fair value of derivatives
 
7,244

 
27,595

 
Basis protection derivative contracts
 
Fair value of derivatives
 
17

 

 
 
 
 
 
7,261

 
27,595

Total derivative liabilities
 
 
 
$
33,248

 
$
81,190


    

12

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


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

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Condensed consolidated statement of operations line item
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
Commodity price risk management gain, net
 
 
 
 
 
 
 
 
Net settlements
 
$
9,585

 
$
47,728

 
$
22,151

 
$
167,859

Net change in fair value of unsettled derivatives
 
(61,763
)
 
(28,331
)
 
64,307

 
(230,207
)
Total commodity price risk management gain, net
 
$
(52,178
)
 
$
19,397

 
$
86,458

 
$
(62,348
)
 
 
 
 
 
 
 
 
 

Net settlements of commodity derivatives decreased for the three and nine months ended September 30, 2017 as compared to the three and nine months ended September 30, 2016.  We entered into agreements for the derivative instruments that settled throughout 2016 prior to commodity prices becoming depressed in late 2014.  Substantially all of these higher-value agreements settled by the end of 2016.  Net settlements for the three and nine months ended September 30, 2017 reflect derivative instruments entered into since 2015, which more closely approximate recent realized prices.  Based on forward strip pricing at September 30, 2017, we expect that settlements will continue to be substantially lower in 2017 on a relative basis as compared to those in 2016.

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. 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 September 30, 2017
 
Derivative 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
 
$
27,521

 
$
(15,010
)
 
$
12,511

 
 
 
 
 
 
 
Liability derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
33,248

 
$
(15,010
)
 
$
18,238

 
 
 
 
 
 
 
As of December 31, 2016
 
Derivative 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
 
$
11,177

 
$
(10,930
)
 
$
247

 
 
 
 
 
 
 
Liability derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
81,190

 
$
(10,930
)
 
$
70,260

 
 
 
 
 
 
 


13

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


NOTE 9 - FAIR VALUE OF 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 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 upon 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, determination that the source of the inputs is valid, 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 crude oil and natural gas fixed-price swaps are included in Level 2. Our collars and propane fixed-price swaps are included in Level 3. Our basis swaps are included in Level 2 and 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:

 
September 30, 2017
 
December 31, 2016
 
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:
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
24,553

 
$
2,968

 
$
27,521

 
$
6,350

 
$
4,827

 
$
11,177

Total liabilities
(23,811
)
 
(9,437
)
 
(33,248
)
 
(66,789
)
 
(14,401
)
 
(81,190
)
Net asset (liability)
$
742

 
$
(6,469
)
 
$
(5,727
)
 
$
(60,439
)
 
$
(9,574
)
 
$
(70,013
)
 
 
 
 
 
 
 
 
 
 
 
 

14

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


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

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
Fair value of Level 3 instruments, net asset (liability) beginning of period
 
$
8,619

 
$
27,375

 
$
(9,574
)
 
$
91,288

Changes in fair value included in condensed consolidated statement of operations line item:
 
 
 
 
 
 
 
 
Commodity price risk management gain (loss), net
 
(14,075
)
 
4,234

 
8,547

 
(16,023
)
Settlements included in condensed consolidated statement of operations line items:
 
 
 
 
 
 
 
 
Commodity price risk management gain (loss), net
 
(1,013
)
 
(15,587
)
 
(5,442
)
 
(59,243
)
Fair value of Level 3 instruments, net asset end of period
 
$
(6,469
)
 
$
16,022

 
$
(6,469
)
 
$
16,022

 
 
 
 
 
 
 
 
 
Net change in fair value of Level 3 unsettled derivatives included in condensed consolidated statement of operations line item:
 
 
 
 
 
 
 
 
Commodity price risk management gain (loss), net
 
$
(8,711
)
 
$
(2,240
)
 
$
(583
)
 
$
(8,273
)
 
 
 
 
 
 
 
 
 

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. There has been no change in the methodology we apply to measure the fair value of our Level 3 derivative contracts during the periods covered by this report.
        
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.

We utilize fair value on a nonrecurring basis to review our crude oil and natural gas properties and goodwill for possible impairment when events and circumstances indicate a possible decline in the recoverability of the carrying value of such assets. The fair value of the properties is determined based upon estimated future discounted cash flow, a Level 3 input, using estimated production and prices at which we reasonably expect the crude oil and natural gas will be sold. The fair value of the goodwill is determined using either a qualitative method or a quantitative method, both of which utilize market data, a Level 3 input, in the derivation of the value estimation.
 
The portion of our long-term debt related to our revolving credit facility 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, we have determined an estimate of the fair values based on measurements of trading activity and broker and/or dealer quotes, respectively, which are published market prices, and therefore are Level 2 inputs. The table below presents these estimates of the fair value of the portion of our long-term debt related to our senior notes and convertible notes as of September 30, 2017.
 
 
Estimated Fair Value
 
Percent of Par
 
 
(in millions)
 
 
Senior notes:
 
 
 
 
2021 Convertible Notes
$
196.3

 
98.1
%
 
2022 Senior Notes
521.9

 
104.4
%
 
2024 Senior Notes
412.5

 
103.1
%

The carrying value of our capital lease obligations approximates fair value due to the variable nature of the imputed interest rates and the duration of the related vehicle lease.

15

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)



Concentration of Risk

Derivative Counterparties. A portion of our liquidity relates to commodity derivative instruments that enable us to manage a portion of our exposure to price volatility from producing crude oil and natural gas. These arrangements expose us to credit risk of nonperformance by our counterparties. We primarily use financial institutions who are also major lenders under our revolving credit facility as counterparties to our commodity derivative contracts. An insignificant portion of our commodity derivative instruments may be with other counterparties. To date, we have had no derivative counterparty default losses. 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 current counterparties on the fair value of our derivative instruments is not significant at September 30, 2017, taking into account the estimated likelihood of nonperformance.

Cash and Cash Equivalents. We consider all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents potentially subject us to a concentration of credit risk as substantially all of our deposits held in financial institutions were in excess of the FDIC insurance limits at September 30, 2017. We maintain our cash and cash equivalents in the form of money market and checking accounts with financial institutions that we believe are creditworthy and are also major lenders under our revolving credit facility.


NOTE 10 - NOTE RECEIVABLE

In October 2014, we sold our entire 50 percent ownership interest in PDC Mountaineer, LLC to an unrelated third-party. As part of the consideration, we received a promissory note (the “Promissory Note”) for a principal sum of $39.0 million, bearing variable interest rates. The interest was to be paid quarterly, in arrears and at the option of the issuer could be paid-in-kind (“PIK Interest”). Any such PIK Interest would be subject to the then current interest rate.

We regularly analyzed the Promissory Note for evidence of collectability, evaluating factors such as the creditworthiness of the issuer of the Promissory Note and the value of the issuer's assets. Based upon this analysis, during the quarter ended March 31, 2016, we recognized a provision and recorded an allowance for uncollectible notes receivable for the $44.0 million accumulated outstanding balance, including interest. Commencing in the second quarter of 2016, we ceased recognizing interest income on the Promissory Note and began accounting for the interest on the Promissory Note under the cash basis method.

We performed this analysis as of March 31, 2017 and evaluated preliminary 2016 year-end financial statements of the note issuer which were available at such time, related information about the operations of the issuer, and existing market conditions for natural gas. Based upon this evaluation, it was determined that collection of the Promissory Note and the PIK Interest continued to be doubtful and the full valuation allowance on the Promissory Note remained appropriate as of that date. This evaluation assumed that repayment of the Promissory Note would be made exclusively from the existing operations of the issuer of the Promissory Note based on the latest available information.

In April 2017, we sold the Promissory Note to an unrelated third-party buyer for approximately $40.2 million in cash. The sales agreement transferred all of our legal rights to collect from the issuer of the Promissory Note. Accordingly, we reversed $40.2 million of the provision for uncollectible notes receivable during the second quarter of 2017.


16

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


NOTE 11 - INCOME TAXES

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

The effective income tax rates for the three and nine months ended September 30, 2017 were 29.5 percent and 25.8 percent benefit on loss, respectively, compared to 34.0 percent and 37.1 percent benefit on loss for the three and nine months ended September 30, 2016. The most significant element related to the decrease in the effective income tax rate was the impact from the $75.1 million impairment of the goodwill in the quarter ended September 30, 2017. This goodwill did not have an associated deferred tax liability at the time it was created, therefore, no deferred tax benefit was realized upon the impairment of the goodwill. The effective income tax rates for the three and nine months ended September 30, 2017, are based upon a full year forecasted tax benefit on loss. In addition to the impact from the goodwill impairment, the effective income tax rate for the three months ended September 30, 2017 includes discrete income tax benefits of $0.8 million for additional deductions and credits claimed on the filed 2016 federal and state income tax returns. The effective income tax rate for the nine months ended September 30, 2017 includes discrete income tax benefits of $1.8 million relating to the excess income tax benefit recognized with the vesting of stock awards and $0.8 million for additional deductions and credits claimed on the filed 2016 federal and state tax returns. These discrete tax benefits during the three and nine months ended September 30, 2017 resulted in a 0.2 percent and 0.9 percent increase to our effective income tax rates. We anticipate the potential for increased periodic volatility in future effective income tax rates from the impact of stock-based compensation tax deductions as they are treated as discrete tax items.

The effective income tax rates for the three and nine months ended September 30, 2016, were based upon a full year forecasted income tax benefit on loss and were greater than the statutory federal income tax rate, primarily due to state income taxes and percentage depletion, partially offset by nondeductible officers’ compensation and nondeductible lobbying expenses. There were no significant discrete income tax items recorded during the three and nine months ended September 30, 2016.

As of September 30, 2017, there is no liability for unrecognized income tax benefits. 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 any state income tax examinations. We continue to voluntarily participate in the Internal Revenue Service's Compliance Assurance Program for the 2016 and 2017 tax years, and received final acceptance of our 2015 federal income tax return and partial acceptance of the recently filed 2016 federal income tax return that is now going through the IRS CAP post-filing review process.


17

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


NOTE 12 - LONG-TERM DEBT

Long-term debt consisted of the following as of:
 
September 30, 2017
 
December 31, 2016
 
(in thousands)
Senior notes:
 
 
 
1.125% Convertible Notes due 2021:
 
 
 
Principal amount
$
200,000

 
$
200,000

Unamortized discount
(32,153
)
 
(37,475
)
Unamortized debt issuance costs
(3,859
)
 
(4,584
)
1.125% Convertible Notes due 2021, net of unamortized discount and debt issuance costs
163,988

 
157,941

 
 
 
 
7.75% Senior Notes due 2022:
 
 
 
Principal amount
500,000

 
500,000

Unamortized debt issuance costs
(5,602
)
 
(6,443
)
7.75% Senior Notes due 2022, net of unamortized debt issuance costs
494,398

 
493,557

 
 
 
 
6.125% Senior Notes due 2024:
 
 
 
Principal amount
400,000

 
400,000

Unamortized debt issuance costs
(6,815
)
 
(7,544
)
6.125% Senior Notes due 2024, net of unamortized debt issuance costs
393,185

 
392,456

 
 
 
 
Total senior notes
1,051,571

 
1,043,954

 
 
 
 
Revolving credit facility

 

Total long-term debt, net of unamortized discount and debt issuance costs
$
1,051,571

 
$
1,043,954

    
Senior Notes

2021 Convertible Notes. In September 2016, we issued $200 million of 1.125% convertible notes due 2021 (the "2021 Convertible Notes") in a public offering. The maturity for the payment of principal is September 15, 2021. Interest at the rate of 1.125% per year is payable in cash semiannually in arrears on each March 15 and September 15. The conversion stock price at maturity is $85.39 per share. We allocated the gross proceeds of the 2021 Convertible Notes between the liability and equity components of the debt. The initial $160.5 million liability component was determined based on the fair value of similar debt instruments, excluding the conversion feature, priced on the same day we issued the 2021 Convertible Notes. Approximately $4.8 million in costs associated with the issuance of the 2021 Convertible Notes have been capitalized as debt issuance costs. As of September 30, 2017, the unamortized debt discount will be amortized over the remaining contractual term to maturity of the 2021 Convertible Notes using an effective interest rate of 5.8 percent.
 
Upon conversion, the 2021 Convertible Notes may be settled, at our sole election, in shares of our common stock, cash, or a combination of cash and shares of our common stock. We have initially elected a combination settlement method to satisfy our conversion obligation, which allows us to settle the principal amount of the 2021 Convertible Notes in cash and to settle the excess conversion value, if any, in shares of our common stock, as well as cash in lieu of fractional shares.
 
2022 Senior Notes. In October 2012, we issued $500 million aggregate principal amount 7.75% senior notes due October 15, 2022 (the “2022 Senior Notes”). The 2022 Senior Notes accrue interest from the date of issuance and interest is payable semi-annually in arrears on April 15 and October 15. Approximately $11.0 million in costs associated with the issuance of the 2022 Senior Notes have been capitalized as debt issuance costs and are being amortized as interest expense over the life of the notes using the effective interest method.

2024 Senior Notes.  In September 2016, we issued $400 million aggregate principal amount of 6.125% senior notes due September 15, 2024 (the “2024 Senior Notes”) in a private placement to qualified institutional buyers. In May 2017, in accordance with the registration rights agreement that we entered into with the initial purchasers when we issued the 2024

18

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


Senior Notes, we filed a registration statement with the SEC relating to an offer to exchange the 2024 Senior Notes for registered notes with substantially identical terms, and we completed the exchange offer in September 2017. The 2024 Senior Notes accrue interest from the date of issuance and interest is payable semi-annually in arrears on March 15 and September 15. Approximately $7.8 million in costs associated with the issuance of the 2024 Senior Notes have been capitalized as debt issuance costs and are being amortized as interest expense over the life of the notes using the effective interest method.

In January 2017, pursuant to the filing of supplemental indentures for the 2021 Convertible Notes, 2022 Senior Notes, and the 2024 Senior Notes (collectively, the "Notes"), our wholly-owned subsidiary, PDC Permian, Inc. became a guarantor of our obligations under the Notes. Accordingly, condensed consolidating financial information for PDC and PDC Permian, Inc. is presented in the footnote titled Subsidiary Guarantor.

As of September 30, 2017, we were in compliance with all covenants related to the Notes, and expect to remain in compliance throughout the next 12-month period.

Revolving Credit Facility

Revolving Credit Facility. The revolving credit facility is available for working capital requirements, capital investments, acquisitions, general corporate purposes and to support letters of credit. The revolving credit facility matures in May 2020 and provides for a maximum of $1.0 billion in allowable borrowing capacity, subject to the borrowing base and certain limitations under our senior notes. The borrowing base is based on, among other things, the loan value assigned to the proved reserves attributable to our crude oil and natural gas interests. The borrowing base is subject to a semi-annual redetermination on November 1 and May 1 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. Our affiliated partnerships are not guarantors of our obligations under the revolving credit facility.

In May 2017, we entered into a Fifth Amendment to the Third Amended and Restated Credit Agreement. The amendment, among other things, amended the revolving credit facility to reflect an increase in the borrowing base from $700 million to $950 million. In addition, the Fifth Amendment made changes to certain of the financial and non-financial covenants in the existing agreement, as well as other administrative changes.

In October 2017, we entered into a Sixth Amendment to the Third Amended and Restated Credit Agreement. The amendment amends the revolving credit facility to allow the borrowing base to increase above the maximum allowable borrowing capacity of $1.0 billion. We have elected to increase the fall 2017 borrowing base to $1.1 billion and maintain a $700 million commitment level as of the date of this report. As of September 30, 2017, available funds under our revolving credit facility were $700 million based on our elected commitment level.

As of September 30, 2017 and December 31, 2016, debt issuance costs related to our revolving credit facility were $6.8 million and $8.8 million, respectively, and are included in other assets on the condensed consolidated balance sheets. We had no outstanding balance on our revolving credit facility as of September 30, 2017 or December 31, 2016. The outstanding principal amount under the revolving credit facility accrues interest at a varying interest rate that fluctuates with an alternate base rate (equal to the greatest of JPMorgan Chase Bank, N.A.'s prime rate, the federal funds rate plus a premium and the rate for dollar deposits in the London interbank market (“LIBOR”) for one month plus a premium), or at our election, a rate equal to LIBOR for certain time periods. Additionally, commitment fees, interest margin, and other bank fees, charged as a component of interest, vary with our utilization of the facility. As of September 30, 2017, the applicable interest margin is 1.25 percent for the alternate base rate option or 2.25 percent for the LIBOR option, and the unused commitment fee is 0.5 percent. No principal payments are generally required until the revolving credit facility expires in May 2020, or in the event that the borrowing base falls below the outstanding balance.

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 1.0:1.0 and (b) not exceed a maximum leverage ratio of 4.0:1.0. As of September 30, 2017, we were in compliance with all the revolving credit facility covenants and expect to remain in compliance throughout the next 12-month period. As defined by the revolving credit facility, our leverage ratio was 1.8 and our current ratio was 2.9 as of September 30, 2017.

19

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


NOTE 13 - OTHER ACCRUED EXPENSES

Other Accrued Expenses. The following table presents the components of other accrued expenses as of:

 
 
September 30, 2017
 
December 31, 2016
 
 
(in thousands)
 
 
 
 
 
Employee benefits
 
$
14,401

 
$
22,282

Asset retirement obligations
 
13,128

 
9,775

Other
 
5,922

 
6,568

Other accrued expenses
 
$
33,451

 
$
38,625

 
 
 
 
 

NOTE 14 - CAPITAL LEASES

We periodically enter into non-cancelable lease agreements for vehicles utilized by our operations and field personnel. These leases are being accounted for as capital leases, as the present value of minimum monthly lease payments, including the residual value guarantee, exceeds 90 percent of the fair value of the leased vehicles at inception of the lease.
 
The following table presents vehicles under capital lease as of:
 

 
September 30, 2017
 
December 31, 2016
 
 
(in thousands)
Vehicles
 
$
6,301

 
$
2,975

Accumulated depreciation
 
(1,435
)
 
(776
)
 
 
$
4,866

 
$
2,199

 
Future minimum lease payments by year and in the aggregate, under non-cancelable capital leases with terms of one year or more, consist of the following:
 
For the Twelve Months Ending September 30,
 
Amount
 
 
(in thousands)
2018
 
$
2,207

2019
 
1,617

2020
 
1,758

 
 
5,582

Less executory cost
 
(258
)
Less amount representing interest
 
(615
)
Present value of minimum lease payments
 
$
4,709

 
 
 

Short-term capital lease obligations
 
$
1,768

Long-term capital lease obligations
 
2,941

 
 
$
4,709


Short-term capital lease obligations are included in other accrued expenses on the condensed consolidated balance sheets and long-term capital lease obligations are included in other liabilities on the condensed consolidated balance sheets.


20

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)



NOTE 15 - ASSET RETIREMENT OBLIGATIONS

The following table presents the changes in carrying amounts of the asset retirement obligations associated with our working interests in crude oil and natural gas properties:
 
Amount
 
(in thousands)
 
 
Balance at December 31, 2016
$
92,387

Obligations incurred with development activities
3,296

Accretion expense
4,906

Revisions in estimated cash flows
155

Obligations discharged with asset retirements
(8,929
)
Balance at September 30, 2017
91,815

Less liabilities held for sale
(499
)
Less current portion
(13,128
)
Long-term portion
$
78,188

 
 
Our estimated asset retirement obligations liability is based on historical experience in plugging and abandoning wells, estimated economic lives and estimated plugging and abandonment costs considering federal and state regulatory requirements in effect. The liability is discounted using the credit-adjusted risk-free rate estimated at the time the liability is incurred or revised. As of September 30, 2017, the credit-adjusted risk-free rates used to discount our plugging and abandonment liabilities ranged from 6.5 percent to 8.2 percent. In periods subsequent to initial measurement of the liability, we must recognize period-to-period changes in the liability resulting from the passage of time, revisions to either the amount of the original estimate of undiscounted cash flows or changes in inflation factors, and changes to our credit-adjusted risk-free rate as market conditions warrant. Short-term asset retirement obligations are included in other accrued expenses on the condensed consolidated balance sheets.

NOTE 16 - COMMITMENTS AND CONTINGENCIES

Firm Transportation and Processing Agreements. We enter into contracts that provide firm transportation and processing on pipeline systems through which we transport or sell crude oil and natural gas. Satisfaction of the volume requirements includes volumes produced by us, purchased from third parties, and produced by our affiliated partnerships and other third-party working, royalty, and overriding royalty interest owners whose volumes we market on their behalf. Our condensed consolidated statements of operations reflect our share of these firm transportation and processing costs. These contracts require us to pay these transportation and processing charges whether or not the required volumes are delivered.

The following table presents gross volume information related to our long-term firm transportation and processing agreements for pipeline capacity:
 
 
For the Twelve Months Ending September 30,
 
 
 
 
Area
 
2018
 
2019
 
2020
 
2021
 
2022 and
Through
Expiration
 
Total
 
Expiration
Date
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Natural gas (MMcf)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Wattenberg Field
 

 
16,760

 
30,850

 
31,025

 
131,287

 
209,922

 
March 31, 2026
Delaware Basin
 
14,600

 
14,600

 
14,640

 
3,680

 

 
47,520

 
December 31, 2020
Gas Marketing
 
7,117

 
7,117

 
7,136

 
7,117

 
6,227

 
34,714

 
August 31, 2022
Utica Shale
 
2,738

 
2,738

 
2,745

 
2,738

 
5,016

 
15,975

 
July 22, 2023
Total
 
24,455

 
41,215

 
55,371

 
44,560

 
142,530

 
308,131

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Crude oil (MBbls)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Wattenberg Field
 
2,413

 
2,413

 
1,812

 

 

 
6,638

 
June 30, 2020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dollar commitment (in thousands)
 
$
18,410

 
$
35,170

 
$
44,949

 
$
33,776

 
$
129,546

 
$
261,851

 
 

21

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


 
In anticipation of our future drilling activities in the Wattenberg Field, we entered into two facilities expansion agreements with our primary midstream provider to expand and improve its natural gas gathering pipelines and processing facilities. The midstream provider is expected to construct two new 200 MMcfd cryogenic plants. We will be bound to the volume requirements in these agreements on the first day of the calendar month after the actual in-service date of the plants, which in the above table is scheduled to be in the fourth quarter of 2018 for the first plant and April 2019 for the second plant. We are currently working with this midstream provider to identify opportunities to accelerate the completion of the first of these processing facilities. Both agreements require baseline volume commitments, consisting of our gross wellhead volume delivered in November 2016, to this midstream provider, and incremental wellhead volume commitments of 51.5 MMcfd and 33.5 MMcfd for the first and second agreements, respectively, for seven years. We may be required to pay shortfall fees for any volumes under the 51.5 MMcfd and 33.5 MMcfd incremental commitments. Any shortfall of these volume commitments may be offset by additional third party producers’ volumes sold to the midstream provider that are greater than a certain total baseline volume. We are also required for the first three years of the contracts to guarantee a certain target profit margin to the midstream provider on these incremental volumes. We currently expect that our future development plans will support the utilization of the incremental commitments.
    
In April 2017, we entered into a transportation service agreement for delivery of 40,000 dekatherms per day of our Delaware Basin natural gas production to the Waha market hub in West Texas. 

For each of the three and nine months ended September 30, 2017, commitments for long-term transportation volumes, net to our interest, for Wattenberg Field crude oil, Delaware Basin natural gas, and Utica Shale natural gas were $2.6 million and $7.4 million, respectively, and were recorded in transportation, gathering, and processing expenses in our condensed consolidated statements of operations. For each of the three and nine months ended September 30, 2016, commitments for long-term transportation volumes for Wattenberg Field crude oil and Utica Shale natural gas were $2.6 million and $7.2 million, respectively.

Litigation and Legal Items. The Company is involved in various legal proceedings. 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. Management has provided the necessary estimated accruals in the accompanying balance sheets where deemed appropriate for litigation and legal related items that are ongoing and not yet concluded. However, the liability ultimately incurred with respect to a matter may exceed the related accrual. 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.

Environmental. Due to the nature of the natural gas and oil industry, we are exposed to environmental risks. We have various policies and procedures to minimize and mitigate the risks from environmental contamination. We conduct periodic reviews and simulated drills 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. Except as discussed herein, we are not aware of any material environmental claims existing as of September 30, 2017 which have not been provided for or would otherwise have a material impact on our financial statements; however, there can be no assurance that current regulatory requirements will not change or that unknown potential past non-compliance with environmental laws will not be discovered on our properties. However, the liability ultimately incurred with respect to a matter may exceed the related accrual. Accrued environmental liabilities are recorded in other accrued expenses on the condensed consolidated balance sheets.

Clean Air Act Tentative Agreement and Related Consent Decree. In August 2015, we received a Clean Air Act Section 114 Information Request (the "Information Request") from the U.S. Environmental Protection Agency ("EPA"). The Information Request sought, among other things, information related to the design, operation, and maintenance of our Wattenberg Field production facilities in the Denver-Julesburg Basin of Colorado ("DJ Basin"). The Information Request focused on historical operation and design information for 46 of our production facilities and requested sampling and analyses at the identified 46 facilities. We responded to the Information Request with the requested data in January 2016.
 
In addition, in December 2015, we received a Compliance Advisory pursuant to C.R.S. 25-7-115(2) from the Colorado Department of Public Health and Environment's (“CDPHE”) Air Quality Control Commission's Air Pollution Control Division alleging that we failed to design, operate, and maintain certain condensate collection, storage, processing, and handling

22

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


operations to minimize leakage of volatile organic compounds at 65 facilities consistent with applicable standards under Colorado law.

For more than a year, we held a series of meetings with the EPA, Department of Justice (“DOJ”) and CDPHE on the above matters. On June 26, 2017, the DOJ on behalf of the EPA and the State of Colorado filed a complaint against us based on the above matters. We continued to conduct meetings with these agencies in working toward a resolution of the matters. On September 28, 2017, the parties jointly filed for an extension of time for PDC to reply to the complaint. The extension was requested because the parties reached an agreement to resolve the case subject to final approval by the appropriate persons within the federal government and state government, as well as outcome of the period of public comment on the proposed decree.

A consent decree was signed by all parties on October 31, 2017 and is subject to a 30-day comment period in which it will be publicly published in the Federal Register. The consent decree provides that we will implement changes to our design, operation, and maintenance of most of our field-wide storage tank systems to enhance our emission management in the DJ Basin.  Agreed upon and planned efforts include, but are not limited to, vapor control system modifications and verification, increased inspection and monitoring, and installation of tank pressure monitors. We voluntarily included in the consent decree approximately 40 additional facilities associated with our pending acquisition of additional assets in the basin.  The three primary elements of the consent decree are: (i) fine/supplemental environmental projects ($1.5 million cash fine, plus $1 million in supplemental environmental projects); (ii) injunctive relief with an estimated cost of approximately $18 million, primarily representing capital enhancements to our operations; and (iii) mitigation with an estimated cost of $1.7 million.  Certain expenditures for the injunctive relief are believed to have been incurred in 2016 and 2017, with the remainder expected to be incurred over the next few years. We do not believe that the expenditures resulting from the settlement will have a material adverse effect on our consolidated financial statements. Although we believe the consent decree will be approved by the court following the comment period, this cannot be guaranteed. 

NOTE 17 - COMMON STOCK

Sale of Equity Securities

During December 2016, we issued 9.4 million shares of our common stock as partial consideration for 100 percent of the common stock of Arris Petroleum and for the acquisition of certain Delaware Basin properties. Pursuant to the terms of previously disclosed lock-up agreements, the resale of these shares was restricted. The lock-up period ended on June 4, 2017. We have registered the 9.4 million shares of our common stock for resale under the Securities Act of 1933.

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 September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Stock-based compensation expense
 
$
4,761

 
$
4,079

 
$
14,587

 
$
15,205

Income tax benefit
 
(1,781
)
 
(1,552
)
 
(5,457
)
 
(5,786
)
Net stock-based compensation expense
 
$
2,980

 
$
2,527

 
$
9,130

 
$
9,419

 
 
 
 
 
 
 
 
 

Stock Appreciation Rights

The stock appreciation right ("SARs") vest ratably over a three-year period and may be exercised at any point after vesting through ten 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.


23

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


The Compensation Committee of our Board of Directors awarded SARs to our executive officers during the nine months ended September 30, 2017 and 2016. The fair value of each SAR award was estimated on the date of grant using a Black-Scholes pricing model using the following assumptions:

 
Nine Months Ended September 30,
 
2017
 
2016
 
 
 
 
Expected term of award (in years)
6

 
6

Risk-free interest rate
2.0
%
 
1.8
%
Expected volatility
53.3
%
 
54.5
%
Weighted-average grant date fair value per share
$
38.58

 
$
26.96


The expected term 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 for the nine months ended September 30, 2017:

 
Number of
SARs
 
Weighted-Average
Exercise
Price
 
Average Remaining Contractual
Term (in years)
 
Aggregate Intrinsic
Value
(in thousands)
Outstanding at December 31, 2016
244,078

 
$
41.36

 
6.9

 
$
7,620

Awarded
54,142

 
74.57

 

 

Outstanding at September 30, 2017
298,220

 
47.39

 
6.7

 
2,043

Exercisable at September 30, 2017
186,248

 
39.38

 
5.6

 
1,867


Total compensation cost related to non-vested SARs granted and not yet recognized in our condensed consolidated statement of operations as of September 30, 2017 was $2.3 million. The cost is expected to be recognized over a weighted-average period of 1.9 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 generally vest ratably on each anniversary following the grant date provided that a participant is continuously employed.

The following table presents the changes in non-vested time-based awards to all employees, including executive officers, for the nine months ended September 30, 2017:
 
Shares
 
Weighted-Average
Grant Date
Fair Value per Share
 
 
 
 
Non-vested at December 31, 2016
479,642

 
$
56.09

Granted
260,019

 
66.00

Vested
(206,242
)
 
56.44

Forfeited
(7,990
)
 
64.32

Non-vested at September 30, 2017
525,429

 
60.73

 
 
 
 


24

PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(unaudited)


The following table presents the weighted-average grant date fair value per share and related information as of/for the periods presented:
 
As of/Nine Months Ended September 30,

 
2017
 
2016
 
(in thousands, except per share data)
 
 
 
 
Total intrinsic value of time-based awards vested
$
13,266

 
$
14,675

Total intrinsic value of time-based awards non-vested
25,762

 
35,079

Market price per common share as of September 30,
49.03

 
67.06

Weighted-average grant date fair value per share
66.00

 
57.12


Total compensation cost related to non-vested time-based awards and not yet recognized in our condensed consolidated statements of operations as of September 30, 2017 was $22.0 million. This cost is expected to be recognized over a weighted-average period of 1.9 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 three 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.
    
The Compensation Committee of our Board of Directors awarded a total of 28,069 market-based restricted shares to our executive officers during the nine months ended September 30, 2017. In addition to continuous employment, the vesting of these shares is contingent on our total stockholder return ("TSR"), which is essentially our stock price change including any dividends as compared to the TSR of a group of peer companies. The shares are measured over a three-year period ending on December 31, 2019, and can result in a payout between 0 percent and 200 percent of the total shares awarded. The weighted-average grant date fair value per market-based share for these awards was computed using the Monte Carlo pricing model using the following assumptions:
 
Nine Months Ended September 30,
 
2017
 
2016
 
 
 
 
Expected term of award (in years)
3

 
3

Risk-free interest rate
1.4
%
 
1.2
%
Expected volatility
51.4
%
 
52.3
%
Weighted-average grant date fair value per share
$
94.02

 
$
72.54


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 the nine months ended September 30, 2017:
 
 
Shares
 
Weighted-Average
Grant Date
Fair Value per Share
 
 
 
 
 
Non-vested at December 31, 2016
 
48,420

 
$
64.97

Granted
 
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