PDCE 2013 6.30 10Q
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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 June 30, 2013

or

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

For the transition period from __________ to _________

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

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

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

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

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

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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 30,456,472 shares of the Company's Common Stock ($0.01 par value) were outstanding as of July 19, 2013.

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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.
 
 
 
 
 
 
 



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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 reserves; future production (including the components of such production), expenses, cash flows and liquidity; that our evaluation method is appropriate and consistent with those used by other market participants; anticipated capital projects, expenditures and opportunities; future exploration, drilling and development activities; our Wattenberg and Utica drilling programs; availability of additional midstream facilities and services, the timing of that availability and related benefits to us; availability of sufficient funding for our 2013 capital program and sources of that funding, including our partnership repurchase obligation and potential sale of our shallow upper Devonian (non-Marcellus Shale) Appalachian basin properties; the impact of high line pressures and the expected impact of the LaSalle plant; our compliance with debt covenants; potential future transactions; the borrowing base under our credit facility; effectiveness of our derivative program in providing a degree of price stability; and our future strategies, plans and objectives.

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

Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to:
•
changes in production volumes and worldwide demand, including economic conditions that might impact demand;
•
volatility of commodity prices for crude oil, natural gas and NGLs;
•
the impact of governmental policies and/or regulations, including changes in environmental and other laws, the interpretation and enforcement related to those laws and regulations, liabilities arising thereunder and the costs to comply with those laws and regulations;
•
potential declines in the value of our crude oil and natural gas 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 of the connection of our Utica Basin wells to gathering, processing, fractionation and transportation infrastructure;
•
timing and receipt of necessary regulatory permits;
•
risks incidental to the drilling and operation of crude oil and natural gas wells;
•
our future cash flows, liquidity and financial condition;
•
competition in the oil and gas industry;
•
availability and cost of capital;
•
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 crude oil, natural gas and NGLs;
•
effect of crude oil and natural gas derivatives activities;
•
impact of environmental events, governmental and other third-party responses to such events, and our ability to insure adequately against such events;
•
cost of pending or future litigation;
•
effect that acquisitions we may pursue have on our capital expenditures;
•
purchase price or other adjustments relating to asset acquisitions or dispositions that may be unfavorable to us;
•
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, 2012 ("2012 Form 10-K"), filed with the U.S. Securities and Exchange Commission ("SEC") on February 27, 2013 and in our Current Report on Form 8-K filed on June 28, 2013, 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 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

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facts or conditions or the occurrence of unanticipated events. All forward-looking statements are qualified in their entirety by this cautionary statement.

REFERENCES

Unless the context otherwise requires, references in this report to "PDC Energy," "PDC," "the Company," "we," "us," "our" or "ours" refer to the registrant, PDC Energy, Inc. and all subsidiaries consolidated for the purposes of its financial statements, including our proportionate share of the financial position, results of operations, cash flows and operating activities of our affiliated partnerships and PDC Mountaineer, LLC's ("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" refers to our operations in the Utica Shale in Ohio and Marcellus Shale in West Virginia and Pennsylvania, including 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 elsewhere in this report for a description of our consolidated subsidiaries.

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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)
 
 
June 30, 2013
 
December 31, 2012 (1)
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
43,212

 
$
2,457

Restricted cash
 
3,949

 
3,942

Accounts receivable, net
 
73,947

 
64,880

Accounts receivable affiliates
 
14,814

 
4,842

Fair value of derivatives
 
16,287

 
52,042

Deferred income taxes
 
17,045

 
36,151

Prepaid expenses and other current assets
 
7,993

 
7,635

Total current assets
 
177,247

 
171,949

Properties and equipment, net
 
1,438,880

 
1,616,706

Assets held for sale
 
32,160

 
—

Fair value of derivatives
 
10,421

 
6,883

Other assets
 
32,727

 
31,310

Total Assets
 
$
1,691,435

 
$
1,826,848

 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
Liabilities
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
75,520

 
$
82,716

Accounts payable affiliates
 
821

 
5,296

Production tax liability
 
25,228

 
25,899

Fair value of derivatives
 
5,702

 
18,439

Funds held for distribution
 
27,730

 
34,228

Accrued interest payable
 
8,825

 
11,056

Other accrued expenses
 
23,976

 
25,715

Total current liabilities
 
167,802

 
203,349

Long-term debt
 
639,127

 
676,579

Deferred income taxes
 
118,246

 
148,427

Asset retirement obligation
 
35,367

 
61,563

Fair value of derivatives
 
4,475

 
10,137

Liabilities held for sale
 
22,370

 
—

Other liabilities
 
15,920

 
23,612

Total liabilities
 
1,003,307

 
1,123,667

 
 
 
 
 
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, 30,443,287 and 30,294,224 issued as of June 30, 2013 and December 31, 2012, respectively
 
304

 
303

Additional paid-in capital
 
392,617

 
387,494

Retained earnings
 
296,068

 
315,568

Treasury shares - at cost, 18,141 and 5,059 as of June 30, 2013 and December 31, 2012, respectively
 
(861
)
 
(184
)
Total shareholders' equity
 
688,128

 
703,181

Total Liabilities and Shareholders' Equity
 
$
1,691,435

 
$
1,826,848

__________
(1) Derived from our audited 2012 balance sheet.


See accompanying Notes to Condensed Consolidated Financial Statements
1
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PDC ENERGY, INC.
Condensed Consolidated Statements of Operations
(unaudited; in thousands, except per share data)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,

 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
 
Crude oil, natural gas and NGLs sales
 
$
77,537

 
$
51,342

 
$
156,976

 
$
118,297

Sales from natural gas marketing
 
18,079

 
8,613

 
31,749

 
19,994

Commodity price risk management gain, net
 
24,724

 
38,729

 
2,369

 
50,230

Well operations, pipeline income and other
 
965

 
1,056

 
2,037

 
2,225

Total revenues
 
121,305

 
99,740

 
193,131

 
190,746

Costs, expenses and other:
 
 
 
 
 
 
 
 
Production costs
 
16,176

 
12,373

 
32,034

 
25,309

Cost of natural gas marketing
 
18,065

 
8,490

 
31,801

 
19,581

Exploration expense
 
1,437

 
2,374

 
3,126

 
4,246

Impairment of crude oil and natural gas properties
 
1,502

 
356

 
47,961

 
944

General and administrative expense
 
15,783

 
14,378

 
30,898

 
29,086

Depreciation, depletion, and amortization
 
27,800

 
23,839

 
55,749

 
51,751

Accretion of asset retirement obligations
 
1,172

 
732

 
2,320

 
1,459

Gain on sale of properties and equipment
 
(9
)
 
(2,246
)
 
(47
)
 
(2,400
)
Total cost, expenses and other
 
81,926

 
60,296

 
203,842

 
129,976

Income (loss) from operations
 
39,379

 
39,444

 
(10,711
)
 
60,770

Interest expense
 
(13,089
)
 
(10,053
)
 
(26,446
)
 
(20,497
)
Interest income
 
3

 
—

 
3

 
2

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

 
29,391

 
(37,154
)
 
40,275

Provision for income taxes
 
(9,791
)
 
(10,213
)
 
12,701

 
(14,333
)
Income (loss) from continuing operations
 
16,502

 
19,178

 
(24,453
)
 
25,942

Income (loss) from discontinued operations, net of tax
 
3,416

 
(6,907
)
 
4,953

 
2,164

Net income (loss)
 
$
19,918

 
$
12,271

 
$
(19,500
)
 
$
28,106

 
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
 
Basic
 
 
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
0.55

 
$
0.72

 
$
(0.80
)
 
$
1.03

Income (loss) from discontinued operations
 
0.11

 
(0.26
)
 
0.16

 
0.09

Net income (loss)
 
$
0.66

 
$
0.46

 
$
(0.64
)
 
$
1.12

 
 
 
 
 
 
 
 
 
Diluted
 
 
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
0.53

 
$
0.72

 
$
(0.80
)
 
$
1.03

Income (loss) from discontinued operations
 
0.11

 
(0.26
)
 
0.16

 
0.08

Net income (loss)
 
$
0.64

 
$
0.46

 
$
(0.64
)
 
$
1.11

 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
30,332

 
26,597

 
30,301

 
25,103

Diluted
 
31,014

 
26,728

 
30,301

 
25,268

 
 
 
 
 
 
 
 
 
 

See accompanying Notes to Condensed Consolidated Financial Statements
2
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PDC ENERGY, INC.
Condensed Consolidated Statements of Cash Flows
(unaudited; in thousands)
 
 
Six Months Ended June 30,
 
 
2013
 
2012
Cash flows from operating activities:
 
 
 
 
Net income (loss)
 
$
(19,500
)
 
$
28,106

Adjustments to net income (loss) to reconcile to net cash from operating activities:
 
 
 
 
Unrealized (gain) loss on derivatives, net
 
9,913

 
(24,079
)
Depreciation, depletion and amortization
 
58,007

 
74,262

Impairment of crude oil and natural gas properties
 
47,964

 
1,023

Accretion of asset retirement obligation
 
2,481

 
1,644

Stock-based compensation
 
6,951

 
3,901

Excess tax benefits from stock-based compensation
 
(930
)
 
(356
)
(Gain) loss on sale of properties and equipment
 
1,029

 
(22,331
)
Amortization of debt discount and issuance costs
 
3,419

 
3,547

Deferred income taxes
 
(11,075
)
 
12,330

Other
 
454

 
1,168

Changes in assets and liabilities
 
(56,687
)
 
(9,520
)
Net cash from operating activities
 
42,026

 
69,695

Cash flows from investing activities:
 
 
 
 
Capital expenditures
 
(139,462
)
 
(165,157
)
Acquisition of oil and gas properties
 
—

 
(309,285
)
Proceeds from acquisition adjustments
 
7,579

 
11,969

Proceeds from sale of properties and equipment
 
173,297

 
187,340

Other
 
—

 
(17,497
)
Net cash from investing activities
 
41,414

 
(292,630
)
Cash flows from financing activities:
 
 
 
 
Proceeds from revolving credit facility
 
227,750

 
483,250

Payment of revolving credit facility
 
(267,000
)
 
(425,250
)
Proceeds from sale of common stock, net of issuance costs
 
—

 
164,050

Payment of debt issuance costs
 
(1,961
)
 
(636
)
Excess tax benefits from stock-based compensation
 
930

 
356

Purchase of treasury shares
 
(2,404
)
 
(1,117
)
Net cash from financing activities
 
(42,685
)
 
220,653

Net change in cash and cash equivalents
 
40,755

 
(2,282
)
Cash and cash equivalents, beginning of period
 
2,457

 
8,238

Cash and cash equivalents, end of period
 
$
43,212

 
$
5,956

 
 
 
 
 
Supplemental cash flow information:
 
 
 
 
Cash payments (receipts) for:
 
 
 
 
Interest, net of capitalized interest
 
$
25,787

 
$
17,918

Income taxes
 
(57
)
 
1,468

Non-cash investing activities:
 
 
 
 
Change in accounts payable related to purchases of properties and equipment
 
$
(8,695
)
 
$
(12,927
)
Change in asset retirement obligation, with a corresponding change to crude oil and natural gas properties, net of disposals
 
211

 
11,934

Change in accounts payable related to disposition of properties and equipment
 
(4,680
)
 
—

Change in accounts receivable affiliates related to disposition of properties and equipment
 
9,201

 
—


See accompanying Notes to Condensed Consolidated Financial Statements
3
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PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2013
(Unaudited)


NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION

PDC Energy, Inc. ("PDC," "PDC Energy," "we," "us" or "the Company") is a domestic independent crude oil, natural gas and NGL company engaged in the exploration for and the acquisition, development, production and marketing of crude oil, natural gas and NGLs. PDC is focused operationally on the liquid-rich Wattenberg Field in the DJ Basin and, in the Appalachian Basin, on the liquid-rich Utica Shale and the dry-gas Marcellus Shale. As of June 30, 2013, we owned an interest in approximately 6,200 gross wells. 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 PDC Mountaineer, LLC ("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 presentation of our financial statements for interim periods in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the SEC. Accordingly, pursuant to such rules and regulations, certain notes and other financial information included in audited financial statements have been condensed or omitted. The information presented in this Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements and notes thereto included in our 2012 Form 10-K. Our results of operations and cash flows for the three and six months ended June 30, 2013 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. The reclassifications are mainly attributable to reporting as discontinued operations the results of operations related to the sale of our Piceance Basin and Northeast Colorado ("NECO") oil and gas properties. See Note 12, Assets Held for Sale, Divestitures and Discontinued Operations, for additional information regarding the divestiture. We also reclassified accretion of asset retirement obligations out of the statement of operations line item production cost and into accretion of asset retirement obligations and reclassified prepaid well cost write-offs out of the statement of cash flows line item changes in assets and liabilities and into the line item other. These reclassifications had no impact on previously reported cash flows, net income, earnings per share or shareholders' equity.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Recently Adopted Accounting Standard

On January 1, 2013, we adopted changes issued by the Financial Accounting Standards Board regarding the disclosure of offsetting assets and liabilities. These changes require an entity to disclose both gross and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an enforceable master netting arrangement or similar agreement. The enhanced disclosures enable users of an entity’s financial statements to understand and evaluate the effect or potential effect of master netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. Our adoption of these changes had no impact on the condensed consolidated financial statements, except for additional disclosures.

Recently Issued Accounting Standard

Income Taxes. On July 18, 2013, the FASB issued an update to accounting for income taxes. The update provides clarification on the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. The update is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. We have not yet evaluated the impact of the update on our financial statements.

NOTE 3 - FAIR VALUE OF FINANCIAL INSTRUMENTS

Derivative Financial Instruments

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


4
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PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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.

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

We validate our fair value measurement through the review of counterparty statements and other supporting documentation, the determination that the source of the inputs is valid, the corroboration of the original source of inputs through access to multiple quotes, if available, or other information and monitoring changes in valuation methods and assumptions. While we use common industry practices to develop our valuation techniques, 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 crude oil and natural gas 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:

 
June 30, 2013
 
December 31, 2012
 
Significant Other
Observable
Inputs
(Level 2)
  
Significant
Unobservable
Inputs
(Level 3)
  
Total
 
Significant Other
Observable
Inputs
(Level 2)
  
Significant
Unobservable
Inputs
(Level 3)
  
Total
 
(in thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Commodity-based derivative contracts
$
21,711

 
$
4,338

 
$
26,049

 
$
42,788

   
$
15,734

   
$
58,522

Basis protection derivative contracts
642

 
17

 
659

 
387

 
16

 
403

Total assets
22,353

 
4,355

 
26,708

 
43,175

 
15,750

 
58,925

Liabilities:
 
 
 
 
 
 
 
   
 
   
 
Commodity-based derivative contracts
7,497

 
451

 
7,948

 
9,839

 
2,081

   
11,920

Basis protection derivative contracts
2,229

 
—

 
2,229

 
16,656

 
—

   
16,656

Total liabilities
9,726

 
451

 
10,177

 
26,495

 
2,081

 
28,576

Net asset
$
12,627

 
$
3,904

 
$
16,531

 
$
16,680

 
$
13,669

 
$
30,349

 
 
 
 
 
 
 
 
 
 
 
 

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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:

 
 
Three Months Ended June 30,
 
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Fair value, net asset, beginning of period
 
$
7,663

 
$
19,644

 
$
13,669

 
$
22,107

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

 
13,737

 
103

 
15,153

Sales from natural gas marketing
 
22

 
(4
)
 
6

 
39

Changes in fair value included in balance sheet line item:
 
 
 
 
 
 
 
 
Accounts payable affiliates (1)
 
—

 
(94
)
 
—

 
(146
)
Settlements included in statement of operations line items:
 
 
 
 
 
 
 
 
Commodity price risk management loss, net
 
(2,246
)
 
(4,661
)
 
(5,479
)
 
(8,458
)
Sales from natural gas marketing
 
(3
)
 
(22
)
 
(29
)
 
(95
)
Income from discontinued operations, net of tax
 
(4,366
)
 
—

 
(4,366
)
 
—

Fair value, net asset end of period
 
$
3,904

 
$
28,600

 
$
3,904

 
$
28,600

 
 
 
 
 
 
 
 
 
Changes in unrealized gains (losses) relating to assets (liabilities) still held
 
 
 
 
 
 
 
 
as of year-end, included in statement of operations line item:
 
 
 
 
 
 
 
 
Commodity price risk management gain, net
 
$
(1,717
)
 
$
10,449

 
$
(3,652
)
 
$
8,661

Sales from natural gas marketing
 
22

 
(13
)
 
10

 
1

Total
 
$
(1,695
)
 
$
10,436

 
$
(3,642
)
 
$
8,662

 
 
 
 
 
 
 
 
 
__________
(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.
    
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 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 June 30, 2013, 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 $160.5 million, or 139.6% of par value, and the portion related to our 7.75% senior notes due 2022 to be $519.7 million, or 103.9% of par value. We determined these valuations based upon measurements of trading activity and broker and/or dealer quotes, respectively, which are published market prices, and therefore are Level 2 inputs.

Concentration of Risk

Derivative Counterparties. Our derivative arrangements expose us to credit risk of nonperformance by our counterparties. We primarily use financial institutions who are also lenders under our revolving credit facility as counterparties to our derivative contracts. To date, we have had no counterparty default losses relating to our derivative arrangements. We have evaluated the credit risk of our derivative assets from our counterparties using relevant credit market default rates, giving consideration to amounts outstanding for each counterparty and the duration of each outstanding derivative position. Based on our evaluation, we have determined that the potential impact of nonperformance of our counterparties on the fair value of our derivative instruments was not significant at June 30, 2013, taking into account the estimated likelihood of nonperformance.


6
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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 June 30, 2013 with regard to our derivative assets:

Counterparty Name
 
Fair Value of
Derivative Assets
As of June 30, 2013
 
 
(in thousands)
 
 
 
JPMorgan Chase Bank, N.A. (1)
 
$
9,730

Wells Fargo Bank, N.A. (1)
 
3,671

Natixis (1)
 
2,924

Bank of Nova Scotia (1)
 
2,680

Other lenders in our revolving credit facility
 
6,754

Various (2)
 
949

Total
 
$
26,708

 
 
 
__________
(1)Major lender in our revolving credit facility. See Note 7, Long-Term Debt.
(2)Represents a total of 23 counterparties.

NOTE 4 - DERIVATIVE FINANCIAL INSTRUMENTS

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

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

We believe our derivative instruments continue to be effective in achieving the risk management objectives for which they were intended. As of June 30, 2013, we had derivative instruments, which were comprised of commodity floors, collars and swaps, basis protection swaps and physical sales and purchases, in place for a portion of our anticipated production through 2017 for a total of 47,679 BBtu of natural gas and 5,392 MBbls of crude oil.

We have elected not to designate any of our derivative instruments as hedges and therefore do not qualify for use of hedge accounting. Accordingly, changes in the fair value of our derivative instruments are recorded in the statements of operations, with the exception of changes in fair value related to those derivatives we designated to our affiliated partnerships. Changes in the fair value of derivative instruments related to our Oil and Gas Exploration and Production segment are recorded in commodity price risk management, net. Changes in the fair value of derivative instruments related to our Gas Marketing segment are recorded in sales from and cost of natural gas marketing. Changes in the fair value of the derivative instruments designated to our affiliated partnerships are recorded on the balance sheets in accounts payable affiliates and accounts receivable affiliates. As positions designated to our affiliated partnerships settle, the realized gains and losses are netted for distribution. Net realized gains are paid to the partnerships and net realized losses are deducted from the partnerships’ cash distributions from production. The affiliated partnerships bear their designated share of counterparty risk.



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

The following table presents the location and fair value amounts of our derivative instruments on the balance sheets as of June 30, 2013 and December 31, 2012:
 
 
 
 
 
Fair Value
Derivatives instruments:
 
Balance sheet line item
 
June 30, 2013
 
December 31, 2012
 
 
 
 
 
(in thousands)
Derivative assets:
Current
 
 
 
 
 
 
 
Commodity contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
$
15,099

 
$
47,016

 
Related to affiliated partnerships (1) (3)
 
Fair value of derivatives
 
—

 
4,707

 
Related to natural gas marketing
 
Fair value of derivatives
 
661

 
302

 
Basis protection contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
506

 
—

 
Related to natural gas marketing
 
Fair value of derivatives
 
21

 
17

 
 
 
 
 
16,287

 
52,042

 
Non Current
 
 
 
 
 
 
 
Commodity contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
10,197

 
6,671

 
Related to natural gas marketing
 
Fair value of derivatives
 
92

 
203

 
Basis protection contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
129

 
—

 
Related to natural gas marketing
 
Fair value of derivatives
 
3

 
9

 
 
 
 
 
10,421

 
6,883

Total derivative assets
 
 
 
 
$
26,708

 
$
58,925

 
 
 
 
 
 
 
 
Derivative liabilities:
Current
 
 
 
 
 
 
 
Commodity contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
$
2,968

 
$
1,744

 
Related to natural gas marketing
 
Fair value of derivatives
 
507

 
226

 
Basis protection contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
2,224

 
14,329

 
Related to affiliated partnerships (2) (3)
 
Fair value of derivatives
 
—

 
2,140

 
Related to natural gas marketing
 
Fair value of derivatives
 
3

 
—

 
 
 
 
 
5,702

 
18,439

 
Non Current
 
 
 
 
 
 
 
Commodity contracts
 
 
 
 
 
 
 
Related to crude oil and natural gas sales
 
Fair value of derivatives
 
4,437

 
9,969

 
Related to natural gas marketing
 
Fair value of derivatives
 
36

 
168

 
Basis protection contracts
 
 
 
 
 
 
 
Related to natural gas marketing
 
Fair value of derivatives
 
2

 
—

 
 
 
 
 
4,475

 
10,137

Total derivative liabilities
 
 
 
 
$
10,177

 
$
28,576

__________
(1)
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.
(2)
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.
(3)
In June 2013, all remaining derivative positions designated to our affiliated partnerships were liquidated prior to settlement. The net proceeds are included in the balance sheet line item accounts payable affiliates.
    

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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:

 
 
2013
 
2012
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 June 30,
 
 
 
 
 
 
 
 
 
 
 
 
Commodity price risk management gain, net
 
 
 
 
 
 
 
 
 
 
 
 
Realized gains
 
$
3,210

 
$
693

 
$
3,903

 
$
13,503

 
$
2,676

 
$
16,179

Unrealized gains (losses)
 
(3,210
)
 
24,031

 
20,821

 
(13,503
)
 
36,053

 
22,550

Total commodity price risk management gain, net
 
$
—

 
$
24,724

 
$
24,724

 
$
—

 
$
38,729

 
$
38,729

Sales from natural gas marketing
 
 
 
 
 
 
 
 
 
 
 
 
Realized gains (losses)
 
$
(149
)
 
$
(24
)
 
$
(173
)
 
$
749

 
$
3

 
$
752

Unrealized gains (losses)
 
149

 
1,472

 
1,621

 
(749
)
 
(322
)
 
(1,071
)
Total sales from natural gas marketing
 
$
—

 
$
1,448

 
$
1,448

 
$
—

 
$
(319
)
 
$
(319
)
Cost of natural gas marketing
 
 
 
 
 
 
 
 
 
 
 
 
Realized gains (losses)
 
$
191

 
$
34

 
$
225

 
$
(692
)
 
$
(26
)
 
$
(718
)
Unrealized gains (losses)
 
(191
)
 
(1,445
)
 
(1,636
)
 
692

 
375

 
1,067

Total cost of natural gas marketing
 
$
—

 
$
(1,411
)
 
$
(1,411
)
 
$
—

 
$
349

 
$
349

 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
 
 
 
 
 
 
 
 
Commodity price risk management gain, net
 
 
 
 
 
 
 
 
 
 
 
 
Realized gains (losses)
 
$
17,771

 
$
(5,397
)
 
$
12,374

 
$
16,046

 
$
10,060

 
$
26,106

Unrealized gains (losses)
 
(17,771
)
 
7,766

 
(10,005
)
 
(16,046
)
 
40,170

 
24,124

Total commodity price risk management gain, net
 
$
—

 
$
2,369

 
$
2,369

 
$
—

 
$
50,230

 
$
50,230

Sales from natural gas marketing
 
 
 
 
 
 
 
 
 
 
 
 
Realized gains (losses)
 
$
209

 
$
(181
)
 
$
28

 
$
1,110

 
$
435

 
$
1,545

Unrealized gains (losses)
 
(209
)
 
860

 
651

 
(1,110
)
 
114

 
(996
)
Total sales from natural gas marketing
 
$
—

 
$
679

 
$
679

 
$
—

 
$
549

 
$
549

Cost of natural gas marketing
 
 
 
 
 
 
 
 
 
 
 
 
Realized gains (losses)
 
$
(153
)
 
$
216

 
$
63

 
$
(970
)
 
$
(493
)
 
$
(1,463
)
Unrealized gains (losses)
 
153

 
(712
)
 
(559
)
 
970

 
(19
)
 
951

Total cost of natural gas marketing
 
$
—

 
$
(496
)
 
$
(496
)
 
$
—

 
$
(512
)
 
$
(512
)
 
 
 
 
 
 
 
 
 
 
 
 
 

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


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

The following table reflects the impact of netting agreements on gross derivative assets and liabilities as of June 30, 2013 and December 31, 2012:
As of June 30, 2013
 
Derivatives instruments, recorded in condensed consolidated balance sheet, gross
 
Effect of master netting agreements
 
Derivative instruments, net
 
 
 
 
 
 
 
Asset derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
26,708

 
$
(7,508
)
 
$
19,200

 
 
 
 
 
 
 
Liability derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
10,177

 
$
(7,508
)
 
$
2,669

 
 
 
 
 
 
 
As of December 31, 2012
 
Derivatives instruments, recorded in condensed consolidated balance sheet, gross
 
Effect of master netting agreements
 
Derivative instruments, net
 
 
 
 
 
 
 
Asset derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
58,925

 
$
(11,437
)
 
$
47,488

 
 
 
 
 
 
 
Liability derivatives:
 
 
 
 
 
 
Derivative instruments, at fair value
 
$
28,576

 
$
(11,437
)
 
$
17,139

 
 
 
 
 
 
 

NOTE 5 - PROPERTIES AND EQUIPMENT

The following table presents the components of properties and equipment, net of accumulated depreciation, depletion and amortization:

 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Properties and equipment, net:
 
 
 
Crude oil and natural gas properties
 
 
 
Proved
$
1,459,066

 
$
2,075,924

Unproved
316,301

 
319,327

Total crude oil and natural gas properties
1,775,367

 
2,395,251

Pipelines and related facilities
15,094

 
47,786

Equipment and other
27,893

 
34,858

Land and buildings
13,507

 
14,935

Construction in progress
90,452

 
67,217

Gross properties and equipment
1,922,313

 
2,560,047

Accumulated depreciation, depletion and amortization
(483,433
)
 
(943,341
)
Properties and equipment, net
$
1,438,880

 
$
1,616,706

 
 
 
 


10
Table of contents
PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Continuing operations:
 
 
 
 
 
 
 
Impairment of proved properties
$
—

 
$
—

 
$
45,000

 
$
—

Impairment of individually significant unproved properties
671

 
154

 
825

 
308

Amortization of individually insignificant unproved properties
831

 
202

 
2,136

 
636

Total continuing operations
1,502

 
356

 
47,961

 
944

Discontinued operations:
 
 
 
 
 
 
 
Amortization of individually insignificant unproved properties
—

 
14

 
3

 
79

Total discontinued operations
—

 
14

 
3

 
79

Total impairment of crude oil and natural gas properties
$
1,502

 
$
370

 
$
47,964

 
$
1,023

 
 
 
 
 
 
 
 

In the first quarter of 2013, we recognized an impairment charge of approximately $45 million related to all of our shallow upper Devonian (non-Marcellus Shale) Appalachian Basin producing properties located in West Virginia and Pennsylvania owned directly by us, as well as through our proportionate share of PDCM and our affiliated partnerships. The impairment charge represented the excess of the carrying value of the assets over the estimated fair value, less cost to sell. The fair value of the assets was determined based upon estimated future cash flows from unrelated third-party bids, a Level 3 input. The impairment charge was included in the statement of operations line item impairment of crude oil and natural gas properties. See Note 12, Assets Held for Sale, Divestitures and Discontinued Operations, for additional information regarding these properties.

NOTE 6 - INCOME TAXES

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

The effective tax rates for continuing operations for the three and six months ended June 30, 2013 was a 37.2% expense on income and 34.2% benefit on loss, respectively, compared to a 34.7% and 35.6% expense on income for the three and six months ended June 30, 2012, respectively. The effective tax rates for the three and six months ended June 30, 2013 differ from the statutory rate primarily due to net permanent additions, largely nondeductible officers' compensation, partially offset by percentage depletion deduction. For the six months ended June 30, 2013, the nondeductible item for officers' compensation exceeded our deduction for percentage depletion, thereby reducing our tax benefit rate. Additionally, state statutory limits on the utilization of our net operating losses resulted in a reduced state tax benefit. The effective tax rates for the three and six months ended June 30, 2012 differ from the statutory rate primarily due to net permanent deductions, largely percentage depletion partially offset by nondeductible officer's compensation. There were no significant discrete items recorded during the three and six months ended June 30, 2013 or 2012.

As of June 30, 2013, we had a gross liability for unrecognized tax benefits of $0.2 million, unchanged from the amount recorded at December 31, 2012. If recognized, this liability would affect our effective tax rate. This liability is reflected in other accrued expenses on our accompanying balance sheets. We expect our remaining liability for uncertain tax positions to decrease in the next twelve months due to the expiration of statute of limitations.

As of the date of this filing, we are current with our income tax filings in all applicable state jurisdictions. We have received notice from the State of Colorado that our state income tax returns for the tax years 2008 through 2011 have been selected for audit.


11
Table of contents
PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 7 - LONG-TERM DEBT

Long-term debt consists of the following:

 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Senior notes:
 
 
 
3.25% Convertible senior notes due 2016:
 
 
 
Principal amount
$
115,000

 
$
115,000

Unamortized discount
(11,873
)
 
(13,671
)
3.25% Convertible senior notes due 2016, net of discount
103,127

 
101,329

7.75% Senior notes due 2022
500,000

 
500,000

Total senior notes
603,127

 
601,329

Credit facilities:
 
 
 
Corporate
—

 
49,000

PDCM
36,000

 
26,250

Total credit facilities
36,000

 
75,250

Total long-term debt
$
639,127

 
$
676,579


 
 
 
    
Senior Notes

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

Upon conversion, the convertible senior 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.

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

As of June 30, 2013, we were in compliance with all covenants related to the 2016 Convertible Senior Notes and the 2022 Senior Notes, and expect to remain in compliance throughout the next twelve-month period.

In connection with the issuance of the 2022 Senior Notes, we entered into a registration rights agreement with the initial purchasers in which we agreed to file a registration statement with the SEC related to an offer to exchange the notes for other freely tradable notes and to use commercially reasonable efforts to cause the exchange offer to be completed on or prior to September 28, 2013. The registration statement was declared effective July 9, 2013.
    
Credit Facilities

Revolving Credit Facility. In May 2013, we entered into a Third Amended and Restated Credit Agreement with JPMorgan Chase Bank, N.A. as administrative agent and other lenders party thereto. This agreement amends and restates the credit agreement dated November 2010 and expires in May 2018. The revolving credit facility is available for working capital requirements, capital expenditures, acquisitions, general corporate purposes and to support letters of credit. The revolving credit facility provides for a maximum of $1 billion in allowable borrowing capacity, subject to the borrowing base. As of June 30, 2013, the borrowing base on the revolving credit facility was $450 million. The borrowing base of the revolving credit facility is based on, among other things, the loan value assigned to the proved reserves attributable to our and our subsidiaries' crude oil and natural gas interests, excluding proved reserves attributable to PDCM and our 21 affiliated partnerships. Our revolving credit facility borrowing base is subject to a semi-annual size redetermination based upon quantification of our reserves at June 30 and December 31, and is also subject to a redetermination upon the occurrence of certain events. The revolving credit facility is secured by a pledge of the stock of certain of our subsidiaries, mortgages of certain producing crude oil and natural gas properties and substantially all of our and such subsidiaries' other assets. Neither PDCM nor the various limited partnerships that we have sponsored, and continue to serve as the managing general partner,

12
Table of contents
PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

are guarantors of the revolving credit facility. As of June 30, 2013, we had no outstanding draws on our revolving credit facility compared to $49 million at a weighted-average interest rate of 2.3% as of December 31, 2012.

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 in May 2018, or in the event that the borrowing base would fall below the outstanding balance.

The revolving credit facility contains covenants customary for agreements of this type, with the most restrictive being certain financial tests and requirements to maintain certain financial ratios on a quarterly basis. The financial tests and ratios, as defined per the revolving credit facility, include requirements to maintain a minimum current ratio of 1.00 to 1.00 and to not exceed a maximum leverage ratio of 4.25 to 1.00.
  
As of June 30, 2013 we had an $18.7 million irrevocable standby letter of credit outstanding in favor of a third-party transportation service provider to secure firm transportation of the natural gas produced by us and others for whom we market production in West Virginia. The letter of credit reduces 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 (1.5% per annum as of June 30, 2013) for the period in which the letter of credit remains outstanding. The letter of credit expires on July 20, 2014. We expect to renew the letter of credit prior to its expiration.

We pay a fee of 0.375% per annum on the unutilized commitment on the available funds under our revolving credit facility. As of June 30, 2013, the available funds under our revolving credit facility, including a reduction for the $18.7 million irrevocable standby letter of credit in effect, was $431.3 million.

As of June 30, 2013, we were in compliance with all the revolving credit facility covenants and expect to remain in compliance throughout the next twelve-month period.

PDCM Credit Facility. PDCM has a credit facility dated April 2010, as amended in May 2013, with an aggregate revolving commitment or borrowing base of $80 million, of which our proportionate share is $40 million. The maximum allowable facility amount is $400 million. At PDCM's discretion, interest accrues at either an alternative base rate ("ABR") or an adjusted LIBOR. The ABR is the greater of Wells Fargo's prime rate, the federal funds effective rate plus 0.5% or the adjusted LIBOR for a three month interest period plus 1%. ABR and adjusted LIBOR borrowings are assessed an additional margin based upon the outstanding balance as a percentage of the available balance. ABR borrowings are assessed an additional margin of 1.25% to 2.0%. Adjusted LIBOR borrowings are assessed an additional margin spread of 2.25% to 3.0%. No principal payments are required until the credit agreement expires in April 2017, or in the event that the borrowing base falls below the outstanding balance. The credit facility is subject to and secured by PDCM's properties, including our proportionate share of such properties. The credit facility borrowing base is subject to size redetermination semi-annually based upon a valuation of PDCM's reserves at June 30 and December 31. Either PDCM or the lenders may request a redetermination upon the occurrence of certain events. The credit facility will be utilized by PDCM for the exploration and development of its Marcellus Shale assets.

The credit facility contains covenants customary for agreements of this type, with the most restrictive being certain financial tests and financial ratios that must be met on a quarterly basis. The financial tests and ratios, as defined by the credit facility, include requirements to maintain a minimum current ratio of 1.0 to 1.0, not to exceed a debt to EBITDAX ratio of 5.0 to 1.0 (declining to 4.25 to 1.0 on July 1, 2013 and to 4.0 to 1.0 on July 1, 2014) and to maintain a minimum interest coverage ratio of 2.5 to 1.0. As of June 30, 2013, our proportionate share of PDCM's outstanding credit facility balance was $36.0 million compared to $26.3 million as of December 31, 2012. PDCM is required to pay a commitment fee of 0.5% per annum on the unutilized portion of the credit facility. The weighted-average borrowing rate on PDCM's credit facility was 3.6% per annum as of June 30, 2013, compared to 3.5% as of December 31, 2012.

 As of June 30, 2013, PDCM was not in compliance with the minimum current ratio covenant under the PDCM credit facility. In July 2013, PDCM received a waiver from Wells Fargo regarding the covenant violation. PDCM expects to maintain compliance with all PDCM credit facility covenants throughout the next twelve-month period.

In July 2013, PDCM entered into a Second Lien Credit Agreement. See Note 15, Subsequent Events, for additional information.


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Table of contents
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 crude oil and natural gas properties:
 
Amount
 
(in thousands)
 
 
Balance at December 31, 2012
$
62,563

Obligations incurred with development activities
211

Accretion expense
2,481

Revisions in estimated cash flows
963

Obligations discharged with disposal of properties and asset retirements
(7,481
)
Balance at June 30, 2013
58,737

Liabilities held for sale (1)
(22,370
)
Less current portion
(1,000
)
Long-term portion
$
35,367

 
 
______________
(1)
Represents asset retirement obligations related to our assets held for sale. See Note 12, Assets Held for Sale, Divestitures and Discontinued Operations, for additional information regarding the planned sale of these properties.

NOTE 9 - COMMITMENTS AND CONTINGENCIES

Firm Transportation Agreements. We enter into contracts that provide firm transportation, sales and processing services on pipeline systems through which we transport or sell natural gas. Volumes produced by us, PDCM, our affiliated partnerships and other third-party working interest owners can be used to satisfy volume requirements, as can volumes purchased from third parties. 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 transportation, sales and processing agreements for pipeline capacity:
 
 
For the Twelve Months Ending June 30,
 
 
 
 
Area
 
2014
 
2015
 
2016
 
2017
 
2018 and
Through
Expiration
 
Total
 
Expiration
Date
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Volume (MMcf)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
West Virginia
 
20,644

 
22,855

 
24,369

 
24,862

 
155,869

 
248,599

 
September 20, 2025
Utica Shale
 
1,935

 
2,737

 
2,737

 
2,738

 
16,658

 
26,805

 
July 22, 2023
Total
 
22,579

 
25,592

 
27,106

 
27,600

 
172,527

 
275,404

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dollar commitment
(in thousands)
 
$
9,320

 
$
10,054

 
$
10,361

 
$
10,455

 
$
50,258

 
$
90,448

 
 

In March 2013, we entered into long-term agreements with a subsidiary of MarkWest Energy Partners, LP to provide midstream services, including gas gathering, processing, fractionation and marketing, to support our Utica Shale operations in Guernsey County in Southeast Ohio. The primary term of the agreements commenced in July 2013 when our natural gas began to flow into the gathering system. The gas processing agreement includes minimum volume commitments as shown in the table above, with certain fees assessed for any shortfall.

In June 2013, we closed a transaction pursuant to which our Piceance Basin and NECO firm gathering commitments were assumed by the buyer of certain of our oil and natural gas properties. See Note 12, Assets Held for Sale, Divestitures, and Discontinued Operations, for additional information regarding the sale of our non-core Colorado assets.

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


14
Table of contents
PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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 that the disclosures in the proxy statements issued in connection with the mergers were inadequate, and a state law breach of fiduciary duty. On June 15, 2012, the Court denied the Company's motion to dismiss and 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 and because the plaintiffs have not specified damages and it is not possible for management to reasonably estimate what, if any, monetary damages could result from this claim.

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 recorded when environmental damages resulting from past events are probable and the costs can be reasonably estimated. As of June 30, 2013 and December 31, 2012, we had accrued environmental liabilities in the amount of $4.9 million and $8.4 million, respectively, included in other accrued expenses on the balance sheets. We are not aware of any environmental claims existing as of June 30, 2013 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 where 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 June 30, 2013, the maximum annual repurchase obligation, based upon the minimum price described above, was approximately $4.1 million. We believe we have adequate liquidity to meet this potential obligation. For the quarter ended June 30, 2013, 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

Stock-Based Compensation Plans

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

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
 
 
(in thousands)
 
 
 
 
 
 
 
 
 
Stock-based compensation expense
 
$
4,349

 
$
1,955

 
$
6,951

 
$
3,901

Income tax benefit
 
(1,661
)
 
(744
)
 
(2,655
)
 
(1,486
)
Net stock-based compensation expense
 
$
2,688

 
$
1,211

 
$
4,296

 
$
2,415

 
 
 
 
 
 
 
 
 

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.


15
Table of contents
PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

In January 2013, the Compensation Committee awarded 87,078 SARs to our executive officers. The fair value of each SAR award was estimated on the date of grant using a Black-Scholes pricing model using the following assumptions:

 
Six Months Ended June 30,
 
2013
 
2012
 
 
 
 
Expected term of award
6 years

 
6 years

Risk-free interest rate
1.0
%
 
1.1
%
Expected volatility
65.5
%
 
64.3
%
Weighted-average grant date fair value per share
$
21.96

 
$
17.61


The expected life of the award was estimated using historical stock option exercise behavior data. The risk-free interest rate was based on the U.S. Treasury yields approximating the expected life of the award in effect at the time of grant. Expected volatilities were based on our historical volatility. We do not expect to pay or declare dividends in the foreseeable future.
    
The following table presents the changes in our SARs:
 
Six Months Ended June 30,
 
2013
 
2012
 
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,
118,832

 
$
30.80

 
8.4

 
$
486

 
50,471

 
$
31.61

 
8.6

 
$
341

Awarded
87,078

 
37.18

 
—

 
—

 
68,361

 
30.19

 
—

 
—

Outstanding at June 30,
205,910

 
33.50

 
8.6

 
3,703

 
118,832

 
30.80

 
8.9

 
3

Vested and expected to vest at June 30,
196,421

 
33.40

 
8.6

 
3,552

 
112,285

 
30.76

 
8.9

 
3

Exercisable at June 30,
67,069

 
29.99

 
7.6

 
1,441

 
27,458

 
28.84

 
8.0

 
2


Total compensation cost related to SARs granted, net of estimated forfeitures, and not yet recognized in our statement of operations as of June 30, 2013 was $2.2 million. The cost is expected to be recognized over a weighted-average period of 2.2 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 if the participant is continuously employed.

In January 2013, the Compensation Committee awarded a total of 103,050 time-based restricted shares to our executive officers that vest ratably over a three-year period ending on January 16, 2016.

The following table presents the changes in non-vested time-based awards for the six months ended June 30, 2013:
 
Shares
 
Weighted-Average
Grant-Date
Fair Value
 
 
 
 
Non-vested at December 31, 2012
646,490

 
$
27.93

Granted
281,879

 
44.24

Vested
(189,939
)
 
28.69

Forfeited
(18,102
)
 
29.54

Non-vested at June 30, 2013
720,328

 
34.08

 
 
 
 


16
Table of contents
PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

 
As of/Year Ended June 30,
 
2013
 
2012
 
(in thousands, except per share data)
 
 
 
 
Total intrinsic value of time-based awards vested
$
8,544

 
$
4,315

Total intrinsic value of time-based awards non-vested
37,082

 
12,602

Market price per common share as of June 30,
51.48

 
24.52

Weighted-average grant date fair value per share
44.24

 
29.58


Total compensation cost related to non-vested time-based awards, net of estimated forfeitures, and not yet recognized in our statements of operations as of June 30, 2013 was $18.4 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. 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 between three to 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 2013, the Compensation Committee awarded a total of 41,570 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 16 peer companies. The shares are measured over a three-year period ending on December 31, 2015 and can result in a payout between 0% and 200% of the total shares awarded. The weighted-average grant date fair value per market-based share for these awards granted was computed using the Monte Carlo pricing model using the following assumptions:
 
 
Six Months Ended June 30,
 
 
2013
 
2012
 
 
 
 
 
Expected term of award
 
3 years

 
3 years

Risk-free interest rate
 
0.4
%
 
0.3
%
Expected volatility
 
56.6
%
 
65.3
%
Weighted-average grant date fair value per share
 
$
49.04

 
$
36.54


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. We do not expect to pay or declare dividends in the foreseeable future.
    
The following table presents the change in non-vested market-based awards during six months ended June 30, 2013:
 
 
Shares
 
Weighted-Average
Grant-Date
Fair Value per Share
 
 
 
 
 
Non-vested at December 31, 2012
 
40,696

 
$
39.22

Granted
 
41,570

 
49.04

Non-vested at June 30, 2013
 
82,266

 
44.18

 
 
 
 
 

 
As of/Year Ended June 30,
 
2013
 
2012
 
(in thousands, except per share data)
 
 
 
 
Total intrinsic value of market-based awards non-vested
$
4,235

 
$
1,805

Market price per common share as of June 30,
51.48

 
24.52

Weighted-average grant date fair value per share
49.04

 
36.54


Total compensation cost related to non-vested market-based awards, net of estimated forfeitures, and not yet recognized in our statement of operations as of June 30, 2013 was $2.3 million. This cost is expected to be recognized over a weighted-average period of 2.2 years.


17
Table of contents
PDC ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 11 - EARNINGS PER SHARE

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

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