Edgar Filing: PDC ENERGY, INC.

PDCE 2012 9.30 10-Q

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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, 2012

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

For the transition period from __________ to _________

Commission File Number 000-07246

PDC ENERGY, INC.

(Exact name of registrant as specified in its charter)



Nevada	95-2636730
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1775 Sherman Street, Suite 3000

Denver, Colorado 80203

(Address of principal executive offices) (Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes T No £

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

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



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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 30,265,078 shares of the Company's Common Stock ($0.01 par value) were outstanding as of October 19, 2012.

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PDC ENERGY, INC.

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	PART I - FINANCIAL INFORMATION	Page

Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets (unaudited)	5
	Condensed Consolidated Statements of Operations (unaudited)	6
	Condensed Consolidated Statements of Cash Flows (unaudited)	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.	Controls and Procedures	44

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	44
Item 1A.	Risk Factors	44
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3.	Defaults Upon Senior Securities	45
Item 4.	Mine Safety Disclosures	45
Item 5.	Other Information	45
Item 6.	Exhibits	46

	SIGNATURES	47

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 ("Securities Act") and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act") regarding our business, financial condition, results of operations and prospects. All statements other than statements of historical facts included in, and incorporated by reference into, this report are "forward-looking statements" within the meaning of the safe harbor provisions of the United States ("U.S.") Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements herein. These statements relate to, among other things: estimated natural gas, natural gas liquids ("NGLs") and crude oil production; future production levels, adjusted EBITDA, cash flows and expenses, anticipated capital expenditures and capital projects; the availability of adequate takeaway capacity and related services and the timing of construction of future takeaway and related facilities; increased focus on the Wattenberg Field and liquid-rich areas, including the pace of development in those areas and related expenditures; our liquidity is sufficient to execute our drilling program in the Wattenberg Field and Utica Shale; that our new Piceance marketing agreement is expected to add approximately $0.40 per MMbtu to our Piceance natural gas realization; that the planned 2013 infrastructure projects include a new NGL pipeline that will provide direct access for our NGLs to Mt. Belvieu, where we anticipate improved pricing; compliance and expected continued compliance with our debt covenants and the indenture restrictions governing our senior notes and expected continued compliance; the impact of decreased commodity prices on future borrowing base redeterminations and the timing of any redeterminations; the effectiveness of our derivative policies in achieving our risk management objectives; the effectiveness of our derivative program in providing price stability despite volatility in natural gas prices; the sufficiency of our monitoring procedures for the creditworthiness of our financial institution counterparties; our expected remaining liability for uncertain tax positions; our expectation to not declare or pay dividends in the foreseeable future; the impact of outstanding legal issues and litigation; our ability to meet our partnership repurchase obligations, if applicable; our ability to benefit from crude oil and natural gas price differentials; anticipated additional Niobrara and Codell drilling locations and our future strategies, plans and objectives.

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

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


•	changes in production volumes and worldwide demand, including economic conditions that might impact demand;


•	volatility of commodity prices for natural gas, NGLs and crude oil;


•	impact of governmental policies and/or regulations, including changes in environmental and other laws, the interpretation and enforcement related to those laws and regulations, liabilities arising thereunder and the costs to comply with those laws and regulations;


•	potential declines in the values of our natural gas and crude oil 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 to be greater than expected;


•	timing and extent of our success in discovering, acquiring, developing and producing reserves;


•	our ability to acquire leases, drilling rigs, supplies and services at reasonable prices;


•	timing and receipt of necessary regulatory permits;


•	risks incidental to the drilling and operation of natural gas and crude oil wells;


•	our future cash flows, liquidity and financial position;


•	competition within the oil and gas industry;


•	availability and cost of capital to us;


•	reductions in the borrowing base under our revolving credit facility;


•	availability of sufficient pipeline, gathering and other transportation facilities and related infrastructure to process and transport our production, particularly in the Wattenberg Field, and the impact of these facilities on the prices we receive for our production;


•	our success in marketing natural gas, NGLs and crude oil;


•	effect of natural gas and crude oil derivatives activities;


•	impact of environmental events, governmental and other third-party responses to such events, and our ability to insure adequately against such events;


•	cost of pending or future litigation;


•	effect that acquisitions we may pursue have on our capital expenditures;


•	our ability to retain or attract senior management and key technical employees; and


•	success of strategic plans, expectations and objectives for future operations of the Company.

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, 2011 ("2011 Form 10-K"), filed with the United States Securities and Exchange Commission ("SEC") on March 1, 2012, and our other filings

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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 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," "PDC Energy," "the Company," "we," "us," "our," "ours," "ourselves" or other such terms refer to the registrant, PDC Energy, Inc., and all subsidiaries consolidated for the purposes of its financial statements, including our proportionate share of the financial position, results of operations, cash flows and operating activities of our affiliated partnerships and PDC Mountaineer, LLC ("PDCM"), a joint venture currently owned 50% each by PDC and Lime Rock Partners, LP, formed for the purpose of exploring and developing the Marcellus Shale formation in the Appalachian Basin. Unless the context otherwise requires, references in this report to "Appalachian Basin" include PDC's proportionate share of our affiliated partnerships' and PDCM's assets, results of operations, cash flows and operating activities. See Note 1, Nature of Operations and Basis of Presentation, to our condensed consolidated financial statements included in this report for a description of our consolidated subsidiaries.

References to "the three months ended 2012" and "the nine months ended 2012" refer to the three and nine month periods ended September 30, 2012, respectively. References to "the three months ended 2011" and "the nine months ended 2011" refer to the three and nine month periods ended September 30, 2011, respectively.

References to "quarter-over-quarter" refer to the three months ended 2012 compared to the three months ended 2011. References to "year-over-year" refer to the nine months ended 2012 compared to the nine months ended 2011.

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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, 2012			December 31, 2011 (1)
Assets
Current assets:
Cash and cash equivalents	$	2,907		$	8,238
Restricted cash	2,241			11,070
Accounts receivable, net	46,911			59,923
Accounts receivable affiliates	7,535			8,518
Fair value of derivatives	52,797			60,809
Prepaid expenses and other current assets	4,767			24,492
Total current assets	117,158			173,050
Properties and equipment, net	1,733,663			1,301,716
Assets held for sale	—			148,249
Fair value of derivatives	16,465			41,175
Accounts receivable affiliates	705			2,836
Other assets	63,913			30,979
Total Assets	$	1,931,904		$	1,698,005

Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable	$	68,174		$	76,027
Accounts payable affiliates	9,304			10,176
Production tax liability	26,762			18,949
Fair value of derivatives	22,075			27,974
Funds held for distribution	28,087			28,594
Accrued interest payable	6,949			11,243
Other accrued expenses	23,471			22,083
Total current liabilities	184,822			195,046
Long-term debt	633,908			532,157
Deferred income taxes	184,711			207,573
Asset retirement obligations	60,275			46,316
Fair value of derivatives	18,696			21,106
Accounts payable affiliates	1,459			6,134
Other liabilities	19,223			25,561
Total liabilities	1,103,094			1,033,893

Commitments and contingent liabilities

Shareholders' equity:
Preferred shares - par value $0.01 per share, 50,000,000 shares authorized, none issued	—			—
Common shares - par value $0.01 per share, 100,000,000 authorized, 30,269,648 and 23,634,958 issued as of September 30, 2012 and December 31, 2011, respectively	303			236
Additional paid-in capital	386,944			217,707
Retained earnings	441,743			446,280
Treasury shares - at cost, 5,642 and 2,938 as of September 30, 2012 and December 31, 2011, respectively	(180		)	(111		)
Total shareholders' equity	828,810			664,112
Total Liabilities and Shareholders' Equity	$	1,931,904		$	1,698,005

__________

(1) Derived from audited 2011 balance sheet.

See accompanying Notes to Condensed Consolidated Financial Statements

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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,
	2012			2011			2012			2011
Revenues:
Natural gas, NGL and crude oil sales	$	59,915		$	72,044		$	192,104		$	196,616
Sales from natural gas marketing	11,570			17,209			32,321			51,308
Commodity price risk management gain (loss), net	(31,943		)	46,706			18,287			43,361
Well operations, pipeline income and other	1,639			1,670			4,860			5,268
Total revenues	41,181			137,629			247,572			296,553
Costs, expenses and other:
Production costs	20,756			13,644			57,181			48,298
Cost of natural gas marketing	11,598			17,227			31,851			50,427
Exploration expense	1,969			1,135			6,602			4,019
Impairment of natural gas and crude oil properties	395			531			1,418			1,483
General and administrative expense	13,710			13,683			42,796			47,065
Depreciation, depletion and amortization	32,483			31,523			106,745			93,100
Accretion of asset retirement obligations	1,195			372			2,839			1,085
Gain on sale of properties and equipment	(1,508		)	(32		)	(3,908		)	(32		)
Total costs, expenses and other	80,598			78,083			245,524			245,445
Income (loss) from operations	(39,417		)	59,546			2,048			51,108
Interest income	3			36			5			47
Interest expense	(11,360		)	(9,496		)	(31,857		)	(27,625		)
Income (loss) from continuing operations before income taxes	(50,774		)	50,086			(29,804		)	23,530
Provision for income taxes	(18,131		)	19,218			(11,193		)	7,744
Income (loss) from continuing operations	(32,643		)	30,868			(18,611		)	15,786
Income from discontinued operations, net of tax	—			1,692			14,074			6,015
Net income (loss)	$	(32,643	)	$	32,560		$	(4,537	)	$	21,801

Earnings per share:
Basic
Income (loss) from continuing operations	$	(1.08	)	$	1.31		$	(0.69	)	$	0.67
Income from discontinued operations	—			0.07			0.52			0.26
Net income (loss)	$	(1.08	)	$	1.38		$	(0.17	)	$	0.93
Diluted
Income (loss) from continuing operations	$	(1.08	)	$	1.30		$	(0.69	)	$	0.67
Income from discontinued operations	—			0.07			0.52			0.25
Net income (loss)	$	(1.08	)	$	1.37		$	(0.17	)	$	0.92

Weighted-average common shares outstanding:
Basic	30,214			23,569			26,819			23,497
Diluted	30,214			23,783			26,819			23,712

See accompanying Notes to Condensed Consolidated Financial Statements

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PDC ENERGY, INC.

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)



	Nine Months Ended September 30,
	2012			2011
Cash flows from operating activities:
Net income (loss)	$	(4,537	)	$	21,801
Adjustments to net income (loss) to reconcile to net cash from operating activities:
Unrealized (gain) loss on derivatives, net	20,917			(32,608		)
Depreciation, depletion and amortization	106,745			99,347
Impairment of natural gas and crude oil properties	1,418			1,718
Exploratory dry hole costs	1,043			171
Accretion of asset retirement obligation	2,839			1,209
Gain on sale of properties and equipment	(23,828		)	(3,886		)
Deferred income taxes	(7,090		)	12,387
Stock-based compensation	6,126			7,242
Amortization of debt discount and issuance costs	5,082			5,104
Other	3,531			(1,377		)
Changes in assets and liabilities	14,929			(5,641		)
Net cash from operating activities	127,175			105,467
Cash flows from investing activities:
Capital expenditures	(271,769		)	(241,150		)
Acquisition of natural gas and crude oil properties	(309,285		)	(41,372		)
Advance to PDCM for the acquisition of properties	—			(28,594		)
Proceeds from acquisition adjustments	11,969			—
Proceeds from the sale of properties and equipment	192,040			10,140
Increase in restricted cash	(17,497		)	(19,063		)
Other	—			(133		)
Net cash from investing activities	(394,542		)	(320,172		)
Cash flows from financing activities:
Proceeds from credit facility	591,250			295,194
Payment of credit facility	(492,250		)	(113,213		)
Proceeds from sale of equity, net of issuance costs	164,496			—
Contribution by investing partner in PDCM	—			12,464
Other	(1,460		)	(1,802		)
Net cash from financing activities	262,036			192,643
Net change in cash and cash equivalents	(5,331		)	(22,062		)
Cash and cash equivalents, beginning of period	8,238			54,372
Cash and cash equivalents, end of period	$	2,907		$	32,310

Supplemental cash flow information:
Cash payments for:
Interest, net of capitalized interest	$	30,868		$	26,694
Income taxes, net of refunds	1,830			3,171
Non-cash investing activities:
Change in accounts payable related to purchases of properties and equipment	(9,514		)	14,551
Change in asset retirement obligation, with a corresponding change to natural gas and crude oil properties, net of disposals	11,871			379
See Note 12 for non-cash transactions related to our acquisitions

See accompanying Notes to Condensed Consolidated Financial Statements

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(unaudited)

NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION

PDC Energy is a domestic independent natural gas and crude oil company engaged in the exploration for and the acquisition, development, production and marketing of natural gas, NGLs and crude oil. As of September 30, 2012, we owned interests in approximately 7,200 gross wells located primarily in the Wattenberg Field, Appalachian Basin, northeast Colorado and the Piceance Basin. We are engaged in two business segments: (1) Oil and Gas Exploration and Production and (2) Gas Marketing.

The accompanying unaudited condensed consolidated financial statements include the accounts of PDC, our wholly-owned subsidiaries, and our proportionate share of PDCM and our 21 affiliated partnerships. Pursuant to the proportionate consolidation method, our accompanying condensed consolidated financial statements include our pro rata share of assets, liabilities, revenues and expenses of the entities which we proportionately consolidate. All material intercompany accounts and transactions have been eliminated in consolidation.

In our opinion, the accompanying condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary for a fair 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 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 2011 Form 10-K. Our results of operations and cash flows for the three and nine months ended 2012 are not necessarily indicative of the results to be expected for the full year or any other future period.

Certain reclassifications have been made to prior period financial statements to conform to the current year presentation, mainly related to discontinued operations. See Note 13, Divestitures and Discontinued Operations, for additional information regarding our discontinued operations. We also reclassified impairment and amortization charges recorded for unproved properties out of the statement of operations line item exploration expense and into impairment of natural gas and crude oil properties, and the accretion of asset retirement obligations out of the statement of operations line item production cost and into accretion of asset retirement obligations. The reclassifications had no impact on previously reported cash flows, net income, earnings per share or shareholders' equity.

NOTE 2 - RECENT ACCOUNTING STANDARDS

Recently Adopted Accounting Standards

Fair Value Measurement. On May 12, 2011, the Financial Accounting Standards Board ("FASB") issued changes related to fair value measurement. The changes represent the converged guidance of the FASB and the International Accounting Standards Board ("IASB") on fair value measurement. Many of the changes eliminate unnecessary wording differences between International Financial Reporting Standards and U.S. GAAP. The changes expand existing disclosure requirements for fair value measurements categorized in Level 3 by requiring a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, a description of the valuation processes in place and a narrative description of the sensitivity of the fair value to changes in unobservable inputs and the interrelationships between those inputs. In addition, the changes require the categorization by level in the fair value hierarchy of items that are not measured at fair value in the statement of financial position whose fair value must be disclosed. These changes are to be applied prospectively and are effective for public entities for interim and annual periods beginning after December 15, 2011. Adoption of these changes did not have a significant impact on our financial statements.

NOTE 3 - FAIR VALUE MEASUREMENTS AND DISCLOSURES

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.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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

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

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

We have evaluated the credit risk of the counterparties holding our derivative assets, which are primarily financial institutions who are also major lenders in our revolving credit facility, giving consideration to amounts outstanding for each counterparty and the duration of each outstanding derivative position. Based on our evaluation, we have determined that the potential impact of nonperformance of our counterparties on the fair value of our derivative instruments is not significant.

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



	September 30, 2012						December 31, 2011
	Significant other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Significant other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
	(in thousands)
Assets:
Commodity-based derivatives contracts	$	51,303	$	17,925	$	69,228	$	76,104	$	25,837	$	101,941
Basis protection derivative contracts	19		15		34		5		38		43
Total assets	51,322		17,940		69,262		76,109		25,875		101,984
Liabilities:
Commodity-based derivatives contracts	16,501		2,402		18,903		9,888		3,768		13,656
Basis protection derivative contracts	21,868		—		21,868		35,424		—		35,424
Total liabilities	38,369		2,402		40,771		45,312		3,768		49,080
Net asset	$	12,953	$	15,538	$	28,491	$	30,797	$	22,107	$	52,904

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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



	Nine Months Ended September 30,
	2012			2011
	(in thousands)

Fair value, net asset, beginning of period	$	22,107		$	10,762
Changes in fair value included in statement of operations line item:
Commodity price risk management gain (loss), net	6,098			15,285
Sales from natural gas marketing	35			51
Changes in fair value included in balance sheet line item (1):
Accounts receivable affiliates	—			49
Accounts payable affiliates	(240		)	(568		)
Settlements included in statement of operations line items:
Commodity price risk management loss, net	(12,357		)	(2,022		)
Sales from natural gas marketing	(105		)	(94		)
Fair value, net asset, end of period	$	15,538		$	23,463

Changes in unrealized gains (losses) relating to assets (liabilities) still held
as of period end, included in statement of operations line item:
Commodity price risk management gain (loss), net	$	2,577		$	9,974
Sales from natural gas marketing	(1		)	(4		)
Total	$	2,576		$	9,970

__________


(1)	Represents the change in fair value related to derivative instruments entered into by us and designated to our affiliated partnerships.

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.

See Note 4, Derivative Financial Instruments, for additional disclosure related to our derivative financial instruments.

Non-Derivative Financial Assets and Liabilities

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

The liability associated with our non-qualified deferred compensation plan for non-employee directors may be settled in cash or shares of our common stock. The carrying value of this obligation is based on the quoted market price of our common stock, which is a Level 1 input.

The portion of our long-term debt related to our revolving credit facility, as well as our proportionate share of PDCM's credit facility, approximates fair value due to the variable nature of related interest rates. We have not elected to account for the portion of our long-term debt related to our senior notes under the fair value option; however, as of September 30, 2012, we estimate the fair value of the portion of our long-term debt related to the 3.25% convertible senior notes due 2016 to be $120.9 million, or 105.1% of par value, and the portion related to our 12% senior notes due 2018 to be $219.9 million, or 108.3% of par value. We determined these valuations based upon measurements of trading activity and broker and/or dealer quotes, respectively, which are published market prices and therefore are Level 1 inputs.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 4 - DERIVATIVE FINANCIAL INSTRUMENTS

As of September 30, 2012, we had derivative instruments in place for a portion of our anticipated production through 2016 totaling 66,978 BBtu of natural gas and 4,089 MBbls of crude oil.

The following table presents the location and fair value amounts of our derivative instruments on the balance sheets. These derivative instruments were comprised of commodity floors, collars and swaps, basis protection swaps and physical sales and purchases:



			Fair Value
Derivatives instruments not designated as hedges (1):		Balance sheet line item	September 30, 2012		December 31, 2011
			(in thousands)
Derivative assets:	Current
	Commodity contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	$	45,358	$	51,220
	Related to affiliated partnerships (2)	Fair value of derivatives	6,785		8,018
	Related to natural gas marketing	Fair value of derivatives	635		1,528
	Basis protection contracts
	Related to natural gas marketing	Fair value of derivatives	19		43
			52,797		60,809
	Non-Current
	Commodity contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	14,627		34,938
	Related to affiliated partnerships (2)	Fair value of derivatives	1,459		6,134
	Related to natural gas marketing	Fair value of derivatives	364		103
	Basis protection contracts
	Related to natural gas marketing	Fair value of derivatives	15		—
			16,465		41,175
Total derivative assets			$	69,262	$	101,984

Derivative liabilities:	Current
	Commodity contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	$	3,695	$	7,498
	Related to affiliated partnerships (3)	Fair value of derivatives	150		211
	Related to natural gas marketing	Fair value of derivatives	531		1,384
	Basis protection contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	14,803		15,762
	Related to affiliated partnerships (3)	Fair value of derivatives	2,895		3,116
	Related to natural gas marketing	Fair value of derivatives	1		3
			22,075		27,974
	Non-Current
	Commodity contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	14,189		4,357
	Related to affiliated partnerships (3)	Fair value of derivatives	26		113
	Related to natural gas marketing	Fair value of derivatives	312		93
	Basis protection contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	3,489		13,820
	Related to affiliated partnerships (3)	Fair value of derivatives	680		2,723
			18,696		21,106
Total derivative liabilities			$	40,771	$	49,080

__________


(1)	As of September 30, 2012 and December 31, 2011, none of our derivative instruments were designated as hedges.


(2)	Represents derivative positions designated to our affiliated partnerships; accordingly, our accompanying balance sheets include a corresponding payable to our affiliated partnerships representing their proportionate share of the derivative assets.


(3)	Represents derivative positions designated to our affiliated partnerships; accordingly, our accompanying balance sheets include a corresponding receivable from our affiliated partnerships representing their proportionate share of the derivative liabilities.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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




	2012									2011
Statement of Operations Line Item	Reclassification of Realized Gains (Losses) Included in Prior Periods Unrealized			Realized and Unrealized Gains (Losses) For the Current Period			Total			Reclassification of Realized Gains (Losses) Included in Prior Periods Unrealized			Realized and Unrealized Gains (Losses) For the Current Period			Total
	(in thousands)
Three Months Ended September 30,
Commodity price risk management gain, net
Realized gains (losses)	$	15,010		$	(1,915	)	$	13,095		$	2,815		$	2,132		$	4,947
Unrealized gains (losses)	(15,010		)	(30,028		)	(45,038		)	(2,815		)	44,574			41,759
Total commodity price risk management gain (loss), net	$	—		$	(31,943	)	$	(31,943	)	$	—		$	46,706		$	46,706
Sales from natural gas marketing
Realized gains	$	386		$	15		$	401		$	418		$	88		$	506
Unrealized gains (losses)	(386		)	(404		)	(790		)	(418		)	958			540
Total sales from natural gas marketing	$	—		$	(389	)	$	(389	)	$	—		$	1,046		$	1,046
Cost of natural gas marketing
Realized losses	$	(364	)	$	(20	)	$	(384	)	$	(347	)	$	(104	)	$	(451	)
Unrealized gains (losses)	364			467			831			347			(944		)	(597		)
Total cost of natural gas marketing	$	—		$	447		$	447		$	—		$	(1,048	)	$	(1,048	)

Nine Months Ended September 30,
Commodity price risk management gain, net
Realized gains	$	22,813		$	16,387		$	39,200		$	9,033		$	1,505		$	10,538
Unrealized gains (losses)	(22,813		)	1,900			(20,913		)	(9,033		)	41,856			32,823
Total commodity price risk management gain (loss), net	$	—		$	18,287		$	18,287		$	—		$	43,361		$	43,361
Sales from natural gas marketing
Realized gains	$	1,358		$	588		$	1,946		$	1,624		$	516		$	2,140
Unrealized gains (losses)	(1,358		)	(428		)	(1,786		)	(1,624		)	1,130			(494		)
Total sales from natural gas marketing	$	—		$	160		$	160		$	—		$	1,646		$	1,646
Cost of natural gas marketing
Realized losses	$	(1,195	)	$	(652	)	$	(1,847	)	$	(1,287	)	$	(525	)	$	(1,812	)
Unrealized gains (losses)	1,195			587			1,782			1,287			(1,008		)	279
Total cost of natural gas marketing	$	—		$	(65	)	$	(65	)	$	—		$	(1,533	)	$	(1,533	)

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

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents the counterparties that expose us to credit risk as of September 30, 2012, with regard to our derivative assets:



Counterparty Name	Fair Value of Derivative Assets As of September 30, 2012
	(in thousands)

JPMorgan Chase Bank, N.A. (1)	$	42,763
Wells Fargo Bank, N.A. (1)	7,831
Crèdit Agricole CIB (1)	5,206
Other lenders in our revolving credit facility	12,112
Various (2)	1,350
Total	$	69,262

__________

(1)Major lender in our revolving credit facility. See Note 7, Long-Term Debt.

(2)Represents a total of 28 counterparties.

NOTE 5 - PROPERTIES AND EQUIPMENT

The following table presents the components of properties and equipment, net of accumulated depreciation, depletion and amortization and assets held-for-sale:



	September 30, 2012			December 31, 2011
	(in thousands)
Properties and equipment, net:
Natural gas and crude oil properties
Proved	$	1,943,426		$	1,694,694
Unproved	356,235			102,466
Total natural gas and crude oil properties	2,299,661			1,797,160
Pipelines and related facilities	42,398			40,721
Transportation and other equipment	34,230			32,475
Land and buildings	14,954			14,572
Construction in progress	84,755			69,633
Gross properties and equipment	2,475,998			1,954,561
Accumulated depreciation, depletion and amortization	(742,335		)	(652,845		)
Properties and equipment, net	$	1,733,663		$	1,301,716

NOTE 6 - INCOME TAXES

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

The effective tax rates for continuing operations for the three and nine months ended 2012 were 35.7% and 37.6%, respectively, compared to 38.4% and 32.9% for the three and nine months ended 2011, respectively. The effective tax rates for the three and nine months ended 2012 approximate the statutory rate, as net permanent deductions, largely percentage depletion, were offset by nondeductible officers' compensation. The effective tax rates for the three and nine months ended 2011 differ from the statutory rate primarily due to net permanent deductions, largely percentage depletion, decreasing the tax expense on income for the three months ended 2011 and increasing the tax benefit on loss for the nine months ended September 30, 2011. There were no significant discrete items recorded during the three and nine months ended 2012 or in the three months ended 2011. In the nine months ended 2011 a discrete tax benefit of $0.6 million was recorded due to realization of uncertain tax benefits primarily because of a settlement with the IRS.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

As of September 30, 2012, we had a gross liability for unrecognized tax benefits of $0.2 million, unchanged from the amount recorded at December 31, 2011. If recognized, this liability would affect our effective tax rate. This liability is reflected in other accrued expenses on our accompanying balance sheet. We expect our remaining liability for uncertain tax positions to decrease in the next twelve months due to the expiration of statute of limitations.

We have accepted an offer for continued participation in the IRS Compliance Assurance Process program for our 2012 tax year. As of the date of this filing, we are current with our income tax filings in all applicable state jurisdictions and currently have no state income tax returns in the process of examination.

NOTE 7 - LONG-TERM DEBT

Long-term debt consisted of the following:



	September 30, 2012			December 31, 2011
	(in thousands)
Senior notes:
3.25% Convertible senior notes due 2016:
Principal amount	$	115,000		$	115,000
Unamortized discount	(14,546		)	(17,079		)
3.25% Convertible senior notes due 2016, net of discount	100,454			97,921
12% Senior notes due 2018:
Principal amount	203,000			203,000
Unamortized discount	(1,546		)	(1,764		)
12% Senior notes due 2018, net of discount	201,454			201,236
Total senior notes	301,908			299,157
Credit facilities:
Corporate	307,000			209,000
PDCM	25,000			24,000
Total credit facilities	332,000			233,000
Total long-term debt	$	633,908		$	532,157

Senior Notes

On October 3, 2012, we issued $500 million aggregate principal amount of 7.75% senior notes due October 15, 2022 (the “2022 Senior Notes”), in a private placement. See Note 16, Subsequent Events, for additional information.

3.25% Convertible Senior Notes Due 2016. In 2010, we issued $115 million of 3.25% convertible senior notes due 2016 in a private placement. The maturity date of the convertible notes is May 15, 2016. Interest is payable in cash semiannually in arrears on each May 15 and November 15. We allocated the gross proceeds of the convertible notes between the liability and equity components of the debt. The initial $94.3 million liability component was determined based upon the fair value of similar debt instruments, excluding the conversion feature, with similar terms and priced on the same day we issued our convertible notes. The original issue discount and the deferred note issuance costs are being amortized to interest expense over the term of the debt using an effective interest rate of 7.4%. Upon conversion, the convertible notes may be settled, at our election, in shares of our common stock, cash or a combination of cash and shares of our common stock. We have initially elected a net-settlement method to satisfy our conversion obligation, which allows us to settle the principal amount of the convertible notes in cash and to settle the excess conversion value in shares, as well as cash in lieu of fractional shares.

12% Senior Notes Due 2018. In 2008, we issued $203 million of 12% senior notes due 2018 (the "2018 Senior Notes") in a private placement. The maturity date of the 2018 Senior Notes is February 15, 2018. Interest is payable in cash semiannually in arrears on each February 15 and August 15. The 2018 Senior Notes were issued at a discount reflecting 98.572% of the principal amount. The indenture governing the notes contains customary restrictive covenants. The original issue discount and the deferred note issuance costs are being amortized to interest expense over the term of the debt. On October 3, 2012 we issued a notice to redeem the entire $203 million principal amount of the 2018 Senior Notes. See Note 16, Subsequent Events, for additional information.

As of September 30, 2012, we were in compliance with all covenants related to our senior notes, and expect to remain in compliance throughout the next twelve-month period.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Credit Facilities

Revolving Credit Facility. On September 21, 2012, we entered into a Sixth Amendment to the Second Amended and Restated Credit Agreement, dated as of November 5, 2010, with JPMorgan Chase Bank, N.A. as Administrative Agent and other lenders party thereto. The Sixth Amendment increased the amount of senior note indebtedness and refinancing indebtedness permitted under the revolving credit agreement, and waived any automatic reduction of the borrowing base upon the issuance of senior notes until the next scheduled semi-annual redetermination. See Note 16, Subsequent Events, for a discussion of the semi-annual redetermination that became effective on October 31, 2012. On June 29, 2012, concurrent with the acquisition of certain Wattenberg assets from affiliates of Merit Energy (the "Merit Acquisition"), we entered into a Fifth Amendment to our revolving credit facility. The Fifth Amendment increased our available borrowing base to $525 million from $425 million based on our natural gas and crude oil reserves as of December 31, 2011 and the estimated reserves as of April 1, 2012 for the acquired assets from the Merit Acquisition. The maximum allowable facility amount is $600 million. The revolving credit facility is available for working capital requirements, capital expenditures, acquisitions, general corporate purposes and to support letters of credit.

On June 25, 2012, we entered into the Fourth Amendment to our revolving credit facility. The Fourth Amendment amends certain provisions of the revolving credit facility to allow us greater flexibility in entering into hedging transactions in connection with future potential asset acquisitions. Our revolving credit facility borrowing base is subject to size redetermination semiannually based on quantification of our reserves at June 30 and December 31, and is also subject to a redetermination upon the occurrence of certain events. On May 4, 2012, we entered into the Third Amendment to our revolving credit facility and, as a result of the semi-annual redetermination by our bank group, our borrowing base was increased by $25 million to $425 million. The borrowing base of the revolving credit facility will be the loan value assigned to the proved reserves attributable to our and our subsidiaries’ natural gas and crude oil interests, excluding proved reserves attributable to PDCM and our 21 affiliated partnerships. The revolving credit facility is secured by a pledge of the stock of certain of our subsidiaries, mortgages of certain producing natural gas and crude oil properties and substantially all of our and such subsidiaries' other assets. Neither PDCM nor the various limited partnerships that we have sponsored and continue to serve as the managing general partner are guarantors of the revolving credit facility.

Our outstanding principal amount accrues interest at a varying interest rate that fluctuates with an alternate base rate (equal to the greater of JPMorgan Chase Bank, N.A.'s prime rate, the federal funds rate plus a premium and 1-month LIBOR plus a premium), or at our election, a rate equal to the rate for dollar deposits in the London interbank market 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. No principal payments are required until the credit agreement expires on November 5, 2015, 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.

We have outstanding an $18.7 million irrevocable standby letter of credit in favor of a third-party transportation service provider to provide firm transportation of the natural gas produced by us and others for whom we market production in the Appalachian Basin. This letter of credit reduced the amount of available funds under our revolving credit facility by an equal amount. We pay a fronting fee of 0.125% per annum and an additional quarterly maintenance fee equivalent to the spread over Eurodollar loans (2.5% per annum as of September 30, 2012) for the period the letter of credit remains outstanding. The letter of credit expires on July 20, 2013.

As of September 30, 2012, we had an outstanding balance of $307 million on our revolving credit facility compared to $209 million as of December 31, 2011. We pay a fee of 0.5% per annum on the unutilized commitment on the available funds under our revolving credit facility. As of September 30, 2012, the available funds under our revolving credit facility, including a reduction for the $18.7 million irrevocable standby letter of credit in effect, was $199.3 million. The weighted-average borrowing rate on our revolving credit facility, exclusive of the letter of credit, was 4.3% per annum as of September 30, 2012 compared to 3.8% as of December 31, 2011.

PDCM Credit Facility. PDCM has a credit facility dated April 30, 2010, as amended on May 11, 2012, with an aggregate revolving commitment or borrowing base of $80 million, of which our proportionate share is $40 million. The credit facility is subject to and secured by PDCM's properties, including our proportionate share of such properties. The credit facility borrowing base is subject to size redetermination semiannually based upon a valuation of PDCM's reserves at June 30 and December 31. Further, either PDCM or the lenders may request a redetermination upon the occurrence of certain events. The credit facility will be utilized by PDCM for the development of its Appalachian assets. As of September 30, 2012, our proportionate share of PDCM's outstanding credit facility balance was $25 million compared to $24 million as of December 31, 2011. PDCM pays a fee of 0.5% per annum on the unutilized commitment on the available funds under this credit facility. The weighted-average borrowing rate on PDCM's credit facility was 3.5% per annum as of September 30, 2012, compared to 5.0% as of December 31, 2011.

As of September 30, 2012, the Company was in compliance with all credit facility covenants and expects to remain in compliance throughout the next twelve-month period.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 8 - ASSET RETIREMENT OBLIGATIONS

The following table presents the changes in carrying amounts of the asset retirement obligations associated with our working interest in natural gas and crude oil properties:



	Amount
	(in thousands)

Balance at December 31, 2011	$	46,566
Obligations incurred with development activities and assumed with acquisitions	14,066
Accretion expense	2,839
Obligations discharged with disposal of properties and asset retirements	(2,196		)
Balance at September 30, 2012	61,275
Less current portion	(1,000		)
Long-term portion	$	60,275

NOTE 9 - COMMITMENTS AND CONTINGENCIES

Firm Transportation Agreements. We enter into contracts that provide firm transportation, sales and processing charges on pipeline systems through which we transport or sell natural gas. Satisfaction of the volume requirements includes volumes produced by us, volumes purchased from third parties and volumes produced by PDCM, our affiliated partnerships and other third party working interest owners. We record in our financial statements only our share of costs based upon our working interest in the wells. These contracts require us to pay these transportation and processing charges whether the required volumes are delivered or not. With the exception of contracts entered into by PDCM, the costs of any volume shortfalls are borne by PDC.

The following table presents gross volume information, including our proportionate share of PDCM, related to our long-term firm sales, processing and transportation agreements for pipeline capacity:



	For the Twelve Months Ending September 30,
Area	2013		2014		2015		2016		2017 Through Expiration		Total		Expiration Date

Volume (MMcf)
Piceance Basin	25,225		37,713		31,905		27,090		92,033		213,966		May 31, 2021
Appalachian Basin	21,216		20,359		22,855		24,186		174,575		263,191		September 30, 2025
NECO	2,554		1,916		1,825		1,825		455		8,575		December 31, 2016
Total	48,995		59,988		56,585		53,101		267,063		485,732

Dollar commitment (in thousands)	$	22,604	$	28,473	$	25,887	$	23,625	$	104,264	$	204,853

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

Alleged Class Action Filed Regarding 2010 and 2011 Partnership Purchases

On December 21, 2011 the Company and its wholly-owned merger subsidiary were served with an alleged class action on behalf of certain former partnership unit holders, related to its partnership repurchases completed by mergers in 2010 and 2011. The action was filed in U.S. District Court for the Central District of California, and is titled Schulein v. Petroleum Development Corp. The complaint primarily alleges a claim that the proxy statements issued in connection with the mergers were inadequate, and a state law breach of fiduciary duty. On February 10, 2012, the Company filed a motion to dismiss or in the alternative to stay. On June 15, 2012, the Court denied the motion. The court has approved a litigation schedule including a jury trial in May 2014. We have not recorded a liability for claims pending because we believe we have good legal defenses to the asserted claims.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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 avoid environmental contamination and mitigate the risks from environmental contamination. We conduct periodic reviews to identify changes in our environmental risk profile. Liabilities are accrued when environmental damages resulting from past events are probable and the costs can be reasonably estimated. As of September 30, 2012 and December 31, 2011, we had accrued environmental liabilities in the amount of $11.1 million and $2.5 million, respectively, included in other accrued expenses on the balance sheet. The increase primarily relates to environmental liabilities assumed following the Merit Acquisition. See Note 12, Acquisitions, for a discussion of the Merit Acquisition. We are not aware of any environmental claims existing as of September 30, 2012 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 unknown past non-compliance with environmental laws will not be discovered on our properties.

Partnership Repurchase Provision. Substantially all of our drilling programs contain a repurchase provision, whereby investing partners may request that we purchase their partnership units at any time beginning with the third anniversary of the first cash distribution. The provision provides that we are obligated to purchase an aggregate of 10% of the initial subscriptions per calendar year (at a minimum price of four times the most recent 12 months' cash distributions from production), if repurchase is requested by investors, subject to our financial ability to do so. As of September 30, 2012, the maximum annual repurchase obligation, based upon the minimum price described above, was approximately $3.5 million. We believe we have adequate liquidity to meet this obligation. For the three and nine months ended 2012, amounts paid for the repurchase of partnership units pursuant to this provision were immaterial.

Employment Agreements with Executive Officers. Each of our senior executive officers may be entitled to a severance payment and certain other benefits upon the termination of the officer's employment pursuant to the officer's employment agreement and/or the Company's executive severance compensation plan. The nature and amount of such benefits would vary based upon, among other things, whether the termination followed a change of control of the Company.

NOTE 10 - COMMON STOCK

Sale of Equity Securities

In May 2012, we completed a public offering of 6,500,000 shares of our common stock, par value $0.01 per share, at an offering price of $26.50 per share. Net proceeds of the offering were approximately $164.5 million, after deducting underwriting discounts and commissions and offering expenses, of which $65,000 is included in common shares-par value and $164.4 million is included in additional paid-in capital ("APIC") on the balance sheet. We used the net proceeds from the offering to finance a portion of the Merit Acquisition and for general corporate purposes. The offering was made pursuant to an effective shelf registration statement on Form S-3 filed with the SEC on January 23, 2012.

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,
	2012			2011			2012			2011 (1)
	(in thousands)

Stock-based compensation expense	$	2,225		$	1,693		$	6,126		$	7,242
Income tax benefit	(847		)	(643		)	(2,333		)	(2,751		)
Net expense	$	1,378		$	1,050		$	3,793		$	4,491

__________

(1) Includes a total of $2.5 million, pretax, related to a separation agreement with our former chief executive officer.

Stock Appreciation Rights ("SARs")

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

In January 2012, the Compensation Committee of our Board of Directors (the "Committee") awarded 68,361 SARs to our executive officers. The fair value of each SAR award was estimated on the date of grant using a Black-Scholes pricing model using the following assumptions:

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued



	Nine Months Ended September 30,
	2012			2011

Expected term	6 years			6 years
Risk-free interest rate	1.1		%	2.5		%
Expected volatility	64.3		%	60.2		%
Weighted-average grant date fair value per share	$	17.61		$	25.22

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. The expected volatility was based on our historical volatility. We do not expect to declare or pay dividends in the foreseeable future.

The following table presents the changes in our SARs:



	Nine Months Ended September 30,
	2012						2011
	Number of SARs	Weighted -Average Exercise Price		Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in thousands)		Number of SARs		Weighted -Average Exercise Price		Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in thousands)

Outstanding beginning of year, January 1,	50,471	$	31.61	8.6	$	341	57,282		$	24.44	9.3	$	—
Granted	68,361	30.19		9.3	—		31,552		43.95		9.7	—
Exercised	—	—		—	—		(2,814	)	24.44		—	—
Forfeited	—	—		—	—		(35,549	)	31.57		—	—
Outstanding at September 30,	118,832	30.80		8.7	328		50,471		31.61		8.9	—
Vested and expected to vest at September 30,	113,426	30.77		8.7	319		46,488		31.45		8.9	—
Exercisable at September 30,	27,458	28.84		7.8	153		10,636		24.44		8.6	—

The total compensation cost related to SARs granted and not yet recognized in our statement of operations as of September 30, 2012 was $1.2 million. The cost is expected to be recognized over a weighted-average period of 2 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 or four years. The time-based shares vest ratably on each annual anniversary following the grant date that a participant is continuously employed.

In January 2012, the Committee awarded a total of 79,889 time-based restricted shares to executive officers that vest ratably over a three-year period ending on January 16, 2015.

The following table presents the changes in nonvested time-based awards for the nine months ended 2012:



	Shares		Weighted-Average Grant-Date Fair Value per Share

Nonvested at December 31, 2011	527,801		$	29.29
Granted	334,451		26.48
Vested	(150,264	)	30.04
Forfeited	(16,566	)	26.81
Nonvested at September 30, 2012	695,422		27.88

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued



	As of / Nine Months Ended September 30,
	2012		2011
	(in thousands, except per share data)

Total intrinsic value of time-based awards vested	$	4,818	$	8,615
Total intrinsic value of time-based awards nonvested	21,996		10,215
Market price per common share as of September 30,	31.63		19.39
Weighted-average grant date fair value per share	26.48		34.14

The total compensation cost related to nonvested time-based awards expected to vest and not yet recognized in our statements of operations as of September 30, 2012 was $13.7 million. This cost is expected to be recognized over a weighted-average period of 2.4 years.

Market-Based Awards. The fair value of the market-based restricted shares is amortized ratably over the requisite service period, primarily three years. Generally, the market-based shares vest if the participant is continuously employed throughout the performance period and the market-based performance measure is achieved, with a maximum vesting period of five years. All compensation cost related to the market-based awards will be recognized if the requisite service period is fulfilled, even if the market condition is not achieved.

In January 2012, the Committee awarded a total of 30,541 market-based restricted shares to our executive officers. In addition to continuous employment, the vesting of these shares is contingent on the Company's total shareholder return ("TSR"), which is essentially the Company’s stock price change including any dividends, as compared to the TSR of a set group of 15 peer companies. The shares are measured over a three-year period ending on December 31, 2014, and can result in a payout between 0% and 200% of the total shares awarded. The weighted-average grant date fair value per market-based share for these awards granted was computed using the Monte Carlo pricing model using the following assumptions:



	Nine Months Ended September 30,
	2012			2011

Expected term	3 years			3 years
Risk-free interest rate	0.3		%	1.1		%
Expected volatility	65.3		%	74.2		%
Weighted-average grant date fair value per share	$	36.54		$	58.53

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. We do not expect to pay or declare dividends in the foreseeable future.

The following table presents the change in nonvested market-based awards for the nine months ended 2012:



	Shares	Weighted-Average Grant-Date Fair Value per Share

Nonvested at December 31, 2011	43,081	$	42.05
Granted	30,541	36.54
Nonvested at September 30, 2012	73,622	41.87

The total compensation cost related to nonvested market-based awards expected to vest and not yet recognized in our statement of operations as of September 30, 2012 was $1 million. This cost is expected to be recognized over a weighted-average period of 2.1 years.

Treasury Share Purchases

In accordance with our stock-based compensation plans, employees and directors may surrender shares of common stock to pay tax withholding obligations upon the vesting or exercise of stock-based awards. The shares acquired may be retired or reissued to service awards under our 2010 Long-Term Equity Compensation Plan (the "2010 Plan"). For shares that are retired, we first charge any excess of cost over the par value to APIC to the extent we have amounts in APIC, with any remaining excess cost charged to retained earnings. For shares reissued to service awards under the 2010 Plan, shares are recorded at cost and, upon reissuance, we reduce the carrying value of shares acquired and held pursuant to the 2010 Plan by the weighted-average cost per share with an offsetting charge to APIC. During the nine months ended September 30, 2012, we acquired 33,971 shares pursuant to our stock-based compensation plans for payment of tax liabilities,

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

of which 11,796 shares were retired and the remaining 19,930 shares were reissued pursuant to our 2010 Plan.

NOTE 11 - EARNINGS PER SHARE

The following is a reconciliation of weighted-average diluted shares outstanding:



	Three Months Ended September 30,		Nine Months Ended September 30,
	2012	2011	2012	2011
	(in thousands)

Weighted-average common shares outstanding - basic	30,214	23,569	26,819	23,497
Dilutive effect of share-based compensation:
Restricted stock	—	162	—	167
SARs	—	49	—	45
Non-employee director deferred compensation	—	3	—	3
Weighted-average common and common share equivalents outstanding - diluted	30,214	23,783	26,819	23,712

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



	Three Months Ended September 30,		Nine Months Ended September 30,
	2012	2011	2012	2011
	(in thousands)
Weighted-average common share equivalents excluded from diluted earnings
per share due to their anti-dilutive effect:
Restricted stock	777	198	688	173
Stock options	7	9	7	10
SARs	119	29	115	23
Non-employee director deferred compensation	3	—	3	—
Total anti-dilutive common share equivalents	906	236	813	206

In November 2010, we issued 115,000 convertible senior notes, $1,000 principal amount per note, that give the holders the right to convert the aggregate principal amount into 2.7 million common shares at a conversion price of $42.40 per share. The convertible notes could have a dilutive impact on our earnings per share if the average market share price exceeds the $42.40 conversion price. The average market share price did not exceed the conversion price during the three and nine months ended 2012 or 2011.

NOTE 12 - ACQUISITIONS

Merit Acquisition. On June 29, 2012, we completed the acquisition of certain Wattenberg Field oil and natural gas properties, leasehold mineral interests and related assets located in Weld, Adams and Boulder Counties, Colorado from affiliates of Merit Energy, an unrelated third-party. The aggregate purchase price of these properties was approximately $326.8 million based upon a transaction effective date of April 1, 2012, subject to certain post-closing adjustments. We financed the purchase with cash from the May 2012 offering of our common stock and a draw on our revolving credit facility. At closing, $17.5 million was deposited into an escrow account for curative title work related to leases and other matters in accordance with the purchase and sale agreement, and is included in other assets on the balance sheet. If the seller is able to cure the defects, this amount will be paid to the seller and recorded as a purchase price adjustment increasing properties and equipment.

This acquisition was accounted for under the acquisition method of accounting. 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. The initial accounting for the business combination is based on preliminary data and is not complete. Adjustments to provisional amounts, or recognition of additional assets acquired or liabilities assumed, may occur as more detailed analyses are completed and additional information is obtained about the facts and circumstances that existed as of the acquisition date.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following presents the preliminary values assigned to the net assets acquired as of the acquisition date:



	(in thousands)

Total acquisition cost	$	326,782

Recognized amounts of identifiable assets acquired and liabilities assumed:
Assets acquired:
Natural gas and crude oil properties - proved	$	126,101
Natural gas and crude oil properties - unproved	208,098
Other assets	23,589
Total assets acquired	357,788
Liabilities assumed:
Asset retirement obligations	13,870
Other accrued expenses	10,100
Other liabilities	7,036
Total liabilities assumed	31,006
Total identifiable net assets acquired	$	326,782

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 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 oil and natural gas properties include estimates of reserves, future operating and development costs, future commodity prices, estimated future cash flows and a market-based weighted-average cost of capital rate. These inputs require significant judgments and estimates by management at the time of the valuation and are the most sensitive and subject to change.

Pro Forma Information. The results of operations for the Merit Acquisition has been included in our consolidated financial statements since the June 29, 2012 closing date. The following unaudited pro forma financial information presents a summary of the condensed consolidated results of operations for the three months and nine months ended September 30, 2011 and nine months ended September 30, 2012, assuming the Merit Acquisition had been completed as of January 1, 2011, including adjustments to reflect the values assigned to the net assets acquired. The pro forma financial information is not necessarily indicative of the results of operations that would have been achieved if the Merit Acquisition had been effective as of these dates, or of future results. Pro forma information for the Seneca-Upshur Acquisition is not presented as the pro forma results would not be materially different from the information presented below.



	Three Months Ended September 30,		Nine Months Ended September 30,
	2011		2012		2011
	(in thousands, except per share amounts)

Total revenues	$	148,136	$	261,927	$	329,656
Total costs, expenses and other	79,763		248,509		253,508
Net income	41,387		6,833		46,841

Earnings per share:
Basic	$	1.76	$	0.25	$	1.99
Diluted	$	1.74	$	0.25	$	1.98

Seneca-Upshur. Following PDCM's October 2011 acquisition of Seneca-Upshur, several title defects were discovered that were not cured by the seller within the time specified by the purchase and sale agreement. Accordingly, to date PDCM received title defect payments of approximately $24.3 million, of which $12.2 million represents our share. These payments were recorded as a purchase price adjustment reducing unproved natural gas and crude oil properties. The refund for these title defects reduced the purchase price from $162.9 million down to $138.6 million, with our portion being $69.3 million. The final payment to PDCM for title defects is subject to additional adjustments.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 13 - DIVESTITURES AND DISCONTINUED OPERATIONS

Permian Basin. During the fourth quarter of 2011, we completed the sale of our non-core Permian assets to unrelated third parties for a total of $13.2 million. Additionally, on December 20, 2011, we executed a purchase and sale agreement with COG Operating LLC (“COG”), a wholly owned subsidiary of Concho Resources Inc., an unrelated third-party, for the sale of our core Permian Basin assets for a sale price of $173.9 million, subject to customary terms and adjustments, including adjustments based on title and environmental due diligence to be conducted by COG. The effective date of the transaction was November 1, 2011. Following the sale to COG, we do not have significant continuing involvement in the operations of, or cash flows from, these assets; accordingly, the Permian assets were reclassified as held for sale as of December 31, 2011, and the results of operations related to those assets have been separately reported as discontinued operations in the condensed consolidated statement of operations for all periods presented. On February 28, 2012, the divestiture closed. Upon final settlement, total proceeds received were $189.2 million after closing adjustments, resulting in a pretax gain on sale of $19.9 million.

North Dakota. In December 2010, we executed a letter of intent with an unrelated third-party for the sale of our North Dakota assets. In February 2011, we executed a purchase and sale agreement and subsequently closed with the same unrelated party. Proceeds from the sale were $9.5 million, net of non-affiliated investor partners' share of $3.8 million, resulting in a pretax gain on sale of $3.9 million. Following the sale to the unrelated party, we do not have significant continuing involvement in the operations of, or cash flows from, these assets; accordingly, the results of operations related to the North Dakota assets have been reported as discontinued operations in the condensed consolidated statement of operations for the nine months ended 2011.

Selected financial information related to divested and discontinued operations. The table below presents selected operational information related to discontinued operations. While the reclassification of revenues and expenses related to discontinued operations for the prior period had no impact on previously reported net earnings, the statement of operations table below presents the revenues and expenses that were reclassified from the specified statement of operations line items to discontinued operations. The nine months ended 2011, in addition to the discontinued operations data of our Permian assets, includes operations data related to the February 2011 divestiture of our North Dakota assets.



	Three Months Ended September 30,		Nine Months Ended September 30,
Statement of Operations - Discontinued Operations	2011		2012		2011
	(dollars in thousands)
Revenues
Natural gas, NGL and crude oil sales	$	7,330	$	4,456	$	19,299