Edgar Filing: PDC ENERGY, INC.

PDCE 2014 9.30 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 September 30, 2014

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

For the transition period from __________ to _________

Commission File Number 000-07246

PDC ENERGY, INC.

(Exact name of registrant as specified in its charter)



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

1775 Sherman Street, Suite 3000

Denver, Colorado 80203

(Address of principal executive offices) (Zip code)

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

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

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

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



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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 35,876,283 shares of the Company's Common Stock ($0.01 par value) were outstanding as of October 17, 2014.

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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)	1
	Condensed Consolidated Statements of Operations (unaudited)	2
	Condensed Consolidated Statements of Cash Flows (unaudited)	3
	Notes to Condensed Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	40

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3.	Defaults Upon Senior Securities	40
Item 4.	Mine Safety Disclosures	40
Item 5.	Other Information	40
Item 6.	Exhibits	41

	SIGNATURES	42

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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: use of expected proceeds from the PDC Mountaineer, LLC ("PDCM") divestiture; future crude oil, natural gas and natural gas liquids (“NGLs”) production (including the components of such production); future expenses, cash flows and liquidity; our evaluation method of our customers' and derivative counterparties' credit risk is appropriate; anticipated capital projects, expenditures and opportunities; future exploration, drilling and development activities; our drilling programs; impact of the Colorado task force on oil and gas regulation and potential future ballot initiatives and legislation; availability of sufficient funding for our capital program and sources of that funding; expected 2014 capital budget allocations; acquisitions of additional acreage and other future transactions; the impact of high line pressures and the timing, availability and effect of additional mid-stream facilities going forward; the expected NYMEX differential at our two primary sales hubs; compliance with debt covenants; expected funding sources for conversion of our 3.25% convertible senior notes due 2016 and expected impact on our financial position; impact of litigation on our results of operations and financial position; effectiveness of our derivative program in providing a degree of price stability; that we do not expect to pay dividends in the foreseeable future; electronic, cyber or physical security breaches; our expected receipt of a full acceptance notice from the Internal Revenue Service ("IRS") with respect to 2013 taxes and decrease in liability for uncertain tax positions; 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 worldwide production volumes and demand, including economic conditions that might impact demand;


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


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


•	potential declines in the value of our crude oil, natural gas and NGLs properties resulting in impairments;


•	changes in estimates of proved reserves;


•	inaccuracy of reserve estimates and expected production rates;


•	potential for production decline rates from our wells being greater than expected;


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


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


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


•	timing and receipt of necessary regulatory permits;


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


•	our future cash flows, liquidity and financial condition;


•	competition within the oil and gas industry;


•	availability and cost of capital;


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


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


•	effect of crude oil and natural gas derivatives activities;


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


•	cost of pending or future litigation;


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


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


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

Further, we urge you to carefully review and consider the cautionary statements and disclosures, specifically those under the heading "Risk Factors," made in this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for the year ended December 31, 2013 ("2013 Form 10-K"), filed with the U.S. Securities and Exchange Commission ("SEC") on February 21, 2014, and our other filings with the SEC for further information on risks and uncertainties that could affect our business, financial condition, results of operations and prospects, which are incorporated by this reference as though fully set forth herein. We caution you not to place undue reliance on the forward-looking statements,

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which speak only as of the date of this report. We undertake no obligation to update any forward-looking statements in order to reflect any event or circumstance occurring after the date of this report or currently unknown facts or conditions or the occurrence of unanticipated events. All forward-looking statements are qualified in their entirety by this cautionary statement.

REFERENCES

Unless the context otherwise requires, references in this report to "PDC Energy," "PDC," "the Company," "we," "us," "our" or "ours" refer to the registrant, PDC Energy, Inc. and all subsidiaries consolidated for the purposes of its financial statements, including our proportionate share of the financial position, results of operations, cash flows and operating activities of our affiliated partnerships and PDCM, a joint venture owned, until October 14, 2014, 50% each by PDC and Lime Rock Partners, LP. See Note 1, Nature of Operations and Basis of Presentation, elsewhere in this report for a description of our consolidated subsidiaries and Note 15, Subsequent Event, to the condensed consolidated financial statements for a discussion of the sale of our interest in PDCM.

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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, 2014			December 31, 2013
Assets
Current assets:
Cash and cash equivalents	$	18,242		$	192,642
Restricted cash	46			2,211
Accounts receivable, net	102,071			88,111
Accounts receivable affiliates	3,611			6,614
Fair value of derivatives	9,147			1,521
Deferred income taxes	13,388			22,374
Assets held for sale - current	5,375			7,661
Prepaid expenses and other current assets	5,329			4,679
Total current assets	157,209			325,813
Properties and equipment, net	1,783,797			1,484,638
Assets held for sale - non-current	176,694			178,484
Fair value of derivatives	18,039			4,503
Other assets	42,770			31,765
Total Assets	$	2,178,509		$	2,025,203

Liabilities and Shareholders' Equity
Liabilities
Current liabilities:
Accounts payable	$	106,728		$	101,688
Accounts payable affiliates	—			41
Production tax liability	23,872			22,232
Fair value of derivatives	2,356			14,689
Funds held for distribution	37,413			31,040
Accrued interest payable	19,717			9,033
Liabilities held for sale - current	3,070			12,069
Other accrued expenses	53,222			22,628
Total current liabilities	246,378			213,420
Long-term debt	675,913			604,990
Deferred income taxes	124,762			118,767
Asset retirement obligation	39,564			37,638
Fair value of derivatives	2,241			2,842
Liabilities held for sale - non-current	61,543			55,915
Other liabilities	26,085			24,037
Total liabilities	1,176,486			1,057,609

Commitments and contingent liabilities

Shareholders' equity
Preferred shares - par value $0.01 per share, 50,000,000 shares authorized, none issued	—			—
Common shares - par value $0.01 per share, 150,000,000 authorized, 35,894,186 and 35,675,656 issued as of September 30, 2014 and December 31, 2013, respectively	359			357
Additional paid-in capital	686,045			674,211
Retained earnings	316,950			293,267
Treasury shares - at cost, 23,171 and 5,508 as of September 30, 2014 and December 31, 2013, respectively	(1,331		)	(241		)
Total shareholders' equity	1,002,023			967,594
Total Liabilities and Shareholders' Equity	$	2,178,509		$	2,025,203

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,
	2014			2013			2014			2013
Revenues
Crude oil, natural gas and NGLs sales	$	120,526		$	77,340		$	371,556		$	226,985
Sales from natural gas marketing	13,297			16,946			62,649			48,695
Commodity price risk management gain (loss), net	90,213			(24,138		)	12,661			(22,075		)
Well operations, pipeline income and other	520			1,667			1,650			3,681
Total revenues	224,556			71,815			448,516			257,286
Costs, expenses and other
Production costs	22,754			17,036			64,611			45,691
Cost of natural gas marketing	13,347			17,127			62,645			48,928
Exploration expense	190			1,841			773			4,647
Impairment of crude oil and natural gas properties	1,863			4,236			3,621			51,794
General and administrative expense	34,625			15,052			96,549			43,938
Depreciation, depletion and amortization	49,640			26,957			142,165			77,876
Accretion of asset retirement obligations	861			1,181			2,542			3,491
(Gain) loss on sale of properties and equipment	21			(100		)	577			(131		)
Total cost, expenses and other	123,301			83,330			373,483			276,234
Income (loss) from operations	101,255			(11,515		)	75,033			(18,948		)
Interest expense	(11,821		)	(11,957		)	(36,199		)	(37,883		)
Interest income	39			130			309			133
Income (loss) from continuing operations before income taxes	89,473			(23,342		)	39,143			(56,698		)
Provision for income taxes	(35,396		)	9,435			(15,852		)	20,789
Income (loss) from continuing operations	54,077			(13,907		)	23,291			(35,909		)
Income (loss) from discontinued operations, net of tax	(80		)	(2,093		)	392			409
Net income (loss)	$	53,997		$	(16,000	)	$	23,683		$	(35,500	)

Earnings per share:
Basic
Income (loss) from continuing operations	$	1.51		$	(0.42	)	$	0.65		$	(1.14	)
Income (loss) from discontinued operations, net of tax	—			(0.06		)	0.01			0.01
Net income (loss)	$	1.51		$	(0.48	)	$	0.66		$	(1.13	)

Diluted
Income (loss) from continuing operations	$	1.47		$	(0.42	)	$	0.63		$	(1.14	)
Income (loss) from discontinued operations, net of tax	—			(0.06		)	0.01			0.01
Net income (loss)	$	1.47		$	(0.48	)	$	0.64		$	(1.13	)

Weighted-average common shares outstanding:
Basic	35,834			33,413			35,763			31,350
Diluted	36,828			33,413			36,831			31,350

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,
	2014			2013
Cash flows from operating activities:
Net income (loss)	$	23,683		$	(35,500	)
Adjustments to net loss to reconcile to net cash from operating activities:
Net change in fair value of unsettled derivatives	(34,323		)	32,057
Depreciation, depletion and amortization	151,293			88,877
Impairment of crude oil and natural gas properties	4,054			52,436
Accretion of asset retirement obligation	2,582			3,667
Stock-based compensation	13,111			9,991
Loss on sale of properties and equipment	384			1,571
Amortization of debt discount and issuance costs	5,206			5,093
Deferred income taxes	14,981			(21,714		)
Other	(759		)	(1,017		)
Changes in assets and liabilities	21,753			(15,918		)
Net cash from operating activities	201,965			119,543
Cash flows from investing activities:
Capital expenditures	(451,081		)	(256,096		)
Proceeds from acquisition adjustments	—			7,579
Proceeds from sale of properties and equipment	1,587			178,987
Net cash from investing activities	(449,494		)	(69,530		)
Cash flows from financing activities:
Proceeds from revolving credit facility	136,750			252,500
Repayment of revolving credit facility	(61,000		)	(278,000		)
Proceeds from sale of common stock, net of issuance costs	—			275,847
Other	(2,726		)	(4,329		)
Net cash from financing activities	73,024			246,018
Net change in cash and cash equivalents	(174,505		)	296,031
Cash and cash equivalents, beginning of period	193,243			2,457
Cash and cash equivalents, end of period	$	18,738		$	298,488

Supplemental cash flow information:
Cash payments for:
Interest, net of capitalized interest	$	24,933		$	26,408
Income taxes	1,800			525
Non-cash investing activities:
Change in accounts payable related to purchases of properties and equipment	$	19,320		$	24,308
Change in asset retirement obligation, with a corresponding change to crude oil and natural gas properties, net of disposals	500			337
Change in accounts payable related to disposition of properties and equipment	—			(231		)

See accompanying Notes to Condensed Consolidated Financial Statements

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(Unaudited)

NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION

PDC Energy, Inc. is a domestic independent exploration and production company that produces, develops, acquires and explores for crude oil, natural gas and NGLs with primary operations in the Wattenberg Field in Colorado, the Utica Shale in southeastern Ohio and, until the fourth quarter of 2014, the Marcellus Shale in northern West Virginia. Our operations in the Wattenberg Field are focused on the liquid-rich horizontal Niobrara and Codell plays and our Ohio operations are focused on the liquid-rich portion of the Utica Shale play. As of September 30, 2014, we owned an interest in approximately 2,900 gross wells. We are engaged in two business segments: Oil and Gas Exploration and Production and Gas Marketing. On October 14, 2014, we sold our entire 50% ownership interest in PDCM to an unrelated third-party. See Note 12, Assets Held for Sale, Divestitures and Discontinued Operations, and Note 15, Subsequent Event, for additional information.

The accompanying unaudited condensed consolidated financial statements include the accounts of PDC, our wholly-owned subsidiaries, and our proportionate share of PDCM and our affiliated partnerships. As of September 30, 2014, we had four remaining affiliated partnerships that continue to conduct crude oil and natural gas producing activities. Pursuant to the proportionate consolidation method, our accompanying condensed consolidated financial statements include our pro rata share of assets, liabilities, revenues and expenses of the entities which we proportionately consolidate. All material intercompany accounts and transactions have been eliminated in consolidation.

In our opinion, the accompanying condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of our financial statements for interim periods in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the SEC. Accordingly, pursuant to such rules and regulations, certain notes and other financial information included in audited financial statements have been condensed or omitted. The information presented in this Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements and notes thereto included in our 2013 Form 10-K. Our results of operations and cash flows for the three and nine months ended September 30, 2014 are not necessarily indicative of the results to be expected for the full year or any other future period.

Certain reclassifications have been made to prior period financial statements to conform to the current year presentation. The reclassifications are mainly attributable to reporting as discontinued operations the results of operations related to PDCM's Marcellus Shale assets, which have been classified as held for sale. 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 Standards

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

In April 2014, the FASB issued changes related to the criteria for determining which disposals can be presented as discontinued operations and modified related disclosure requirements. Under the new pronouncement, a discontinued operation is defined as a component of an entity that either has been disposed of or is classified as held for sale and represents a strategic shift that has a major effect on the entity's operations and financial results. These changes are to be applied prospectively for new disposals or components of an entity classified as held for sale during interim and annual periods beginning after December 15, 2014, with early adoption permitted. On July 1, 2014, we adopted the new pronouncement and as a result have reported as discontinued operations the results of operations related to PDCM's Marcellus Shale assets, which were classified as held for sale as of September 30, 2014. See Note 12, Assets Held for Sale, Divestitures and Discontinued Operations, and Note 15, Subsequent Event, for additional information.

Recently Issued Accounting Standards

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

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

In August 2014, the FASB issued a new standard related to the disclosure of uncertainties about an entity's ability to continue as a going concern. The new standard will explicitly require management to assess an entity's ability to continue as a going concern every reporting period and to provide related footnote disclosures in certain circumstances. The new standard will be effective for all entities in the first annual period ending after December 15, 2016, with early adoption permitted. We are currently evaluating the impact these changes will have on our condensed consolidated financial statements.

NOTE 3 - FAIR VALUE OF FINANCIAL INSTRUMENTS

Derivative Financial Instruments

Determination of fair value. Our fair value measurements are estimated pursuant to a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, giving the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable data (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The lowest level input that is significant to a fair value measurement in its entirety determines the applicable level in the fair value hierarchy. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability, and may affect the valuation of the assets and liabilities and their placement within the fair value hierarchy levels. The three levels of inputs that may be used to measure fair value are defined as:

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

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

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

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

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

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



	September 30, 2014						December 31, 2013
	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Total
	(in thousands)
Assets:
Commodity-based derivative contracts	$	20,817	$	6,369	$	27,186	$	3,852		$	2,098	$	5,950
Basis protection derivative contracts	—		—		—		74			—		74
Total assets	20,817		6,369		27,186		3,926			2,098		6,024
Liabilities:
Commodity-based derivative contracts	4,079		437		4,516		16,539			987		17,526
Basis protection derivative contracts	81		—		81		5			—		5
Total liabilities	4,160		437		4,597		16,544			987		17,531
Net asset (liability)	$	16,657	$	5,932	$	22,589	$	(12,618	)	$	1,111	$	(11,507	)

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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 September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
	(in thousands)
Fair value, net asset (liability), beginning of period	$	(6,967	)	$	3,719		$	1,111		$	13,610
Changes in fair value included in statement of operations line item:
Commodity price risk management gain (loss), net	12,758			(3,242		)	3,961			(3,265		)
Sales from natural gas marketing	2			10			(24		)	16
Settlements included in statement of operations line items:
Commodity price risk management gain (loss), net	142			(66		)	882			(5,545		)
Sales from natural gas marketing	(3		)	(5		)	2			(34		)
Loss from discontinued operations, net of tax	—			—			—			(4,366		)
Fair value, net asset end of period	$	5,932		$	416		$	5,932		$	416

Net change in fair value of unsettled derivatives included in statement of operations line item:
Commodity price risk management gain (loss), net	$	11,831		$	(3,296	)	$	673		$	(5,451	)
Sales from natural gas marketing	1			(5		)	(2		)	4
Total	$	11,832		$	(3,301	)	$	671		$	(5,447	)

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

Non-Derivative Financial Assets and Liabilities

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

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

The portion of our long-term debt related to our revolving credit facility, as well as our proportionate share of PDCM's credit facility and second lien term loan, approximate fair value due to the variable nature of related interest rates. We have not elected to account for the portion of our debt related to our senior notes under the fair value option; however, as of September 30, 2014, we estimate the fair value of the portion of our long-term debt related to our 3.25% convertible senior notes due 2016 to be $158.5 million, or 137.8% of par value, and the portion related to our 7.75% senior notes due 2022 to be $536.3 million, or 107.3% 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 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 September 30, 2014, taking into account the estimated likelihood of nonperformance.

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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, 2014 with regard to our derivative assets:



Counterparty Name	Fair Value of Derivative Assets
	(in thousands)
Canadian Imperial Bank of Commerce (1)	$	7,171
JP Morgan Chase Bank, N.A (1)	5,812
Wells Fargo Bank, N.A. (1)	5,343
Bank of Nova Scotia (1)	3,470
Key Bank N.A. (1)	2,540
Other lenders in our revolving credit facility	2,844
Various (2)	6
Total	$	27,186

__________

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

(2)Represents a total of 26 counterparties.

NOTE 4 - DERIVATIVE FINANCIAL INSTRUMENTS

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


•	For crude oil and natural gas sales, we enter into derivative contracts to protect against price declines in future periods. While we structure these derivatives to reduce our exposure to changes in price associated with the derivative commodity, they also limit the benefit we might otherwise have received from price increases in the physical market; and


•	For natural gas marketing, we enter into fixed-price physical purchase and sale agreements that qualify as derivative contracts. In order to offset the fixed-price physical derivatives in our natural gas marketing, we enter into financial derivative instruments that have the effect of locking in the prices we will receive or pay for the same volumes and period, offsetting the physical derivative.

We believe our derivative instruments continue to be effective in achieving the risk management objectives for which they were intended. As of September 30, 2014, we had derivative instruments, which were comprised of collars, fixed-price swaps, basis protection swaps and physical sales and purchases, in place for a portion of our anticipated production through 2017 for a total of 46,913 BBtu of natural gas and 10,502 MBbls of crude oil. The majority of our derivative contracts are entered into at no cost to us as we hedge our anticipated production at the then-prevailing commodity market prices.

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

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents the balance sheet location and fair value amounts of our derivative instruments on the condensed consolidated balance sheets as of September 30, 2014 and December 31, 2013:



			Fair Value
Derivative instruments:		Balance sheet line item	September 30, 2014		December 31, 2013
			(in thousands)
Derivative assets:	Current
	Commodity contracts
	Related to crude oil and natural gas sales	Fair value of derivatives	$	8,761	$	1,086
	Related to natural gas marketing	Fair value of derivatives	386		361
	Basis protection contracts
	Related to crude oil and natural gas sales	Fair value of derivatives	—		74
			9,147		1,521
	Non-current
	Commodity contracts
	Related to crude oil and natural gas sales	Fair value of derivatives	17,855		4,225
	Related to natural gas marketing	Fair value of derivatives	184		278
			18,039		4,503
Total derivative assets			$	27,186	$	6,024

Derivative liabilities:	Current
	Commodity contracts
	Related to crude oil and natural gas sales	Fair value of derivatives	$	1,948	$	14,437
	Related to natural gas marketing	Fair value of derivatives	334		247
	Basis protection contracts
	Related to crude oil and natural gas sales	Fair value of derivatives	74		—
	Related to natural gas marketing	Fair value of derivatives	—		5
			2,356		14,689
	Non-current
	Commodity contracts
	Related to crude oil and natural gas sales	Fair value of derivatives	2,077		2,609
	Related to natural gas marketing	Fair value of derivatives	157		233
	Basis protection contracts
	Related to crude oil and natural gas sales	Fair value of derivatives	7		—
			2,241		2,842
Total derivative liabilities			$	4,597	$	17,531

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



	Three Months Ended September 30,						Nine Months Ended September 30,
Condensed consolidated statement of operations line item	2014			2013			2014			2013
	(in thousands)
Commodity price risk management income (loss), net
Net settlements	$	(4,459	)	$	(2,051	)	$	(21,511	)	$	9,629
Net change in fair value of unsettled derivatives	94,672			(22,087		)	34,172			(31,704		)
Total commodity price risk management income (loss), net	$	90,213		$	(24,138	)	$	12,661		$	(22,075	)
Sales from natural gas marketing
Net settlements	$	210		$	240		$	(376	)	$	267
Net change in fair value of unsettled derivatives	170			(311		)	123			340
Total sales from natural gas marketing	$	380		$	(71	)	$	(253	)	$	607
Cost of natural gas marketing
Net settlements	$	(182	)	$	(188	)	$	502		$	(125	)
Net change in fair value of unsettled derivatives	(191		)	278			(199		)	(281		)
Total cost of natural gas marketing	$	(373	)	$	90		$	303		$	(406	)

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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

The following table reflects the impact of netting agreements on gross derivative assets and liabilities as of September 30, 2014 and December 31, 2013:



As of September 30, 2014	Derivative instruments, recorded in condensed consolidated balance sheet, gross		Effect of master netting agreements			Derivative instruments, net
	(in thousands)
Asset derivatives:
Derivative instruments, at fair value	$	27,186	$	(4,106	)	$	23,080

Liability derivatives:
Derivative instruments, at fair value	$	4,597	$	(4,106	)	$	491



As of December 31, 2013	Derivative instruments, recorded in condensed consolidated balance sheet, gross		Effect of master netting agreements			Derivative instruments, net
	(in thousands)
Asset derivatives:
Derivative instruments, at fair value	$	6,024	$	(4,637	)	$	1,387

Liability derivatives:
Derivative instruments, at fair value	$	17,531	$	(4,637	)	$	12,894

Derivative activity related to PDCM is included in Note 12, Assets Held for Sale, Divestitures and Discontinued Operations.

NOTE 5 - PROPERTIES AND EQUIPMENT

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



	September 30, 2014			December 31, 2013
	(in thousands)
Properties and equipment, net:
Crude oil and natural gas properties
Proved	$	1,976,930		$	1,677,271
Unproved	288,208			253,464
Total crude oil and natural gas properties	2,265,138			1,930,735
Equipment and other	30,428			28,832
Land and buildings	12,668			13,434
Construction in progress	146,324			41,180
Properties and equipment, at cost	2,454,558			2,014,181
Accumulated DD&A	(670,761		)	(529,543		)
Properties and equipment, net	$	1,783,797		$	1,484,638

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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 September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
	(in thousands)
Continuing operations:
Impairment of proved properties	$	—	$	3,750	$	—	$	48,750
Impairment of individually significant unproved properties	—		—		—		517
Amortization of individually insignificant unproved properties	1,085		486		2,843		2,527
Other	778		—		778		—
Total continuing operations	1,863		4,236		3,621		51,794
Discontinued operations:
Impairment of individually significant unproved properties	—		154		—		462
Amortization of individually insignificant unproved properties	274		82		433		180
Total discontinued operations	274		236		433		642
Total impairment of crude oil and natural gas properties	$	2,137	$	4,472	$	4,054	$	52,436

During the first quarter of 2013, we recognized an impairment charge of approximately $45.0 million related to all of our shallow Upper Devonian (non-Marcellus Shale) Appalachian Basin producing properties located in West Virginia and Pennsylvania previously owned directly by us, as well as through our proportionate share of PDCM. The impairment charge represented the excess of the carrying value of the assets over the estimated fair value, less the 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. Pursuant to a purchase and sale agreement entered into in October 2013, we determined that the carrying value of the above-mentioned properties exceeded the transaction sales price, a Level 3 input, less costs to sell. As a result, we recognized an additional impairment charge of approximately $3.8 million in the third quarter of 2013 to reduce the carrying value of the net assets to reflect the current net sales price. The impairment charge was included in the condensed consolidated statement of operations line item impairment of crude oil and natural gas properties.

NOTE 6 - INCOME TAXES

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

The effective tax rate for continuing operations for the three and nine months ended September 30, 2014 was a 39.6% and 40.5%, respectively, provision on income compared to a 40.4% provision on income and 36.7% benefit on loss for the three and nine months ended September 30, 2013, respectively. The effective tax rates for the three and nine months ended September 30, 2014 include discrete tax expense of $0.6 million. This discrete tax expense arose based upon the final 2013 tax return expense exceeding the previous year’s tax provision amount. The effective rate for the three and nine months ended September 30, 2014 would have been 38.8% and 38.9%, respectively, without the inclusion of discrete items. This effective rate is based upon a full year forecasted tax provision on income and is greater than the statutory rate primarily due to nondeductible officers' compensation, partially offset by percentage depletion and domestic production deductions. There were no significant discrete items recorded during the three and nine months ended September 30, 2013. The effective tax rate for the three months ended September 30, 2013 differs from the statutory rate primarily due to net permanent additions, largely nondeductible officers' compensation, partially offset by percentage depletion deduction. For the nine months ended September 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.

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

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

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 7 - LONG-TERM DEBT

Long-term debt consists of the following:



	September 30, 2014			December 31, 2013
	(in thousands)
Senior notes:
3.25% Convertible senior notes due 2016:
Principal amount	$	115,000		$	115,000
Unamortized discount	(7,087		)	(10,010		)
3.25% Convertible senior notes due 2016, net of discount	107,913			104,990
7.75% Senior notes due 2022	500,000			500,000
Total senior notes	607,913			604,990
Revolving credit facility	68,000			—
Long-term debt	675,913			604,990

PDCM credit facility	44,750			37,000
PDCM second lien term loan	15,000			15,000
PDCM long-term debt (included in liabilities held for sale - non-current)	59,750			52,000

Total debt	$	735,663		$	656,990

Senior Notes

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

Upon conversion, the Convertible Notes may be settled, at our election, in shares of our common stock, cash or a combination of cash and shares of our common stock. We have initially elected a net-settlement method to satisfy our conversion obligation, which allows us to settle the principal amount of the Convertible Notes in cash and to settle the excess conversion value in shares, as well as cash in lieu of fractional shares. The Convertible Notes were not convertible at the option of holders as of September 30, 2014. Notwithstanding the inability to convert, the “if-converted” value of the Convertible Notes as of September 30, 2014 exceeded the principal amount by approximately $21.4 million.

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

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

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Credit Facility

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. The borrowing base is based on, among other things, the loan value assigned to the proved reserves attributable to our and our subsidiaries' crude oil and natural gas interests, excluding proved reserves attributable to PDCM and our affiliated partnerships. The borrowing base is subject to a semi-annual size redetermination based upon quantification of our reserves at June 30 and December 31, and is also subject to a redetermination upon the occurrence of certain events. On September 26, 2014, the semi-annual redetermination of our revolving credit facility's borrowing base was completed, resulting in an increase in the borrowing base from $450 million to $700 million. We have elected to maintain the aggregate commitment at $450 million. The revolving credit facility is secured by a pledge of the stock of certain of our subsidiaries, mortgages of certain producing crude oil and natural gas properties and substantially all of our and such subsidiaries' other assets. Neither PDCM nor our affiliated partnerships are guarantors of our obligations under the revolving credit facility.

We had an outstanding balance of $68.0 million on our revolving credit facility as of September 30, 2014 compared to no outstanding balance as of December 31, 2013. The weighted-average borrowing rate on our revolving credit facility, exclusive of the letter of credit noted below, was 4.1% per annum as of September 30, 2014.

As of September 30, 2014, Riley Natural Gas, a wholly-owned subsidiary of PDC, had an irrevocable standby letter of credit of approximately $11.7 million in favor of a third-party transportation service provider to secure firm transportation of the natural gas produced by third-party producers for whom we market production in the Appalachian Basin. The letter of credit expires in September 2015. The letter of credit reduces the amount of available funds under our revolving credit facility by an equal amount. As of September 30, 2014, the available funds under our revolving credit facility, including the reduction for the $11.7 million letter of credit, was $370.3 million. In addition to our currently elected commitment of $450 million, we have an additional $250 million of borrowing base availability under the revolving credit facility.

The revolving credit facility contains covenants customary for agreements of this type, with the most restrictive being certain financial tests on a quarterly basis. The financial tests, as defined per the revolving credit facility, include requirements to: (a) maintain a minimum current ratio of 1.00 to 1.00 and (b) not exceed a maximum leverage ratio of 4.25 to 1.00. As of September 30, 2014, we were in compliance with all the revolving credit facility covenants and expect to remain in compliance throughout the next 12-month period.

PDCM

On October 14, 2014, we closed the sale of our entire 50% ownership interest in PDCM to an unrelated third-party. The transaction included the repayment of the PDCM credit facility and Second Lien Credit Agreement ("Term Loan Agreement") by the buyer. See Note 15, Subsequent Event, for additional information.

PDCM Credit Facility. As of September 30, 2014, PDCM had a credit facility dated April 2010, as amended in February 2014, with a borrowing base of $105 million, of which our proportionate share was approximately $53 million. As of September 30, 2014, our proportionate share of PDCM's outstanding credit facility balance was $44.8 million, included in liabilities held for sale - non-current on the condensed consolidated balance sheets, compared to $37.0 million as of December 31, 2013. The weighted-average borrowing rate on PDCM's credit facility was 3.5% per annum as of September 30, 2014, compared to 3.7% as of December 31, 2013.

PDCM Second Lien Term Loan. In July 2013, PDCM entered into a Term Loan Agreement with Wells Fargo Energy Capital as administrative agent and a syndicate of other lenders party thereto. As of September 30, 2014, amounts borrowed and outstanding on the Term Loan Agreement were $30.0 million, of which our proportionate share was $15 million. This amount is included in liabilities held for sale - non-current on the condensed consolidated balance sheets. The weighted-average interest rate on the term loan was 8.5% per annum as of both September 30, 2014 and December 31, 2013.

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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 crude oil and natural gas properties:



	Amount
	(in thousands)

Balance at beginning of period, January 1, 2014	$	41,030
Obligations incurred with development activities	501
Accretion expense	2,582
Revisions in estimated cash flows	(134		)
Obligations discharged with divestitures of properties and asset retirements	(2,984		)
Balance end of period, September 30, 2014	40,995
Less: Liabilities held for sale (1)	(273		)
Less: Current portion	(1,158		)
Long-term portion	$	39,564

______________

(1) Represents asset retirement obligations related to our assets held for sale. See Note 12, Assets Held for Sale, Divestitures and Discontinued Operations, and Note 15, Subsequent Event, for additional information regarding the sale of our interest in PDCM.

NOTE 9 - COMMITMENTS AND CONTINGENCIES

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

The following table presents gross volume information, including our proportionate share of PDCM, related to our long-term firm transportation, sales and processing agreements for pipeline capacity as of September 30, 2014:



	For the Twelve Months Ending September 30,
Area	2015		2016		2017		2018		2019 and Through Expiration		Total		Expiration Date

Natural gas (MMcf)
Appalachian Basin	18,993		20,368		20,987		20,987		109,638		190,973		January 31, 2026
Utica Shale	2,737		2,745		2,737		2,737		13,239		24,195		July 22, 2023
Total	21,730		23,113		23,724		23,724		122,877		215,168

Crude oil (MBbls)
Wattenberg Field	1,210		2,420		2,414		2,414		3,616		12,074		March 31, 2020

Dollar commitment (in thousands)	$	14,101	$	20,678	$	20,654	$	19,508	$	52,129	$	127,070

In September 2014, we entered into a long-term agreement with White Cliffs Pipeline, LLC, to ship crude oil from southern Weld County, Colorado, to Cushing, Oklahoma. The primary term of the agreement is five years commencing on the first delivery of crude oil to the pipeline system. We currently expect crude oil delivery to the pipeline system to begin in April 2015. The agreement includes minimum volume commitments as shown in the table above, with certain fees assessed for any shortfall.

On October 14, 2014, we closed the sale of our entire 50% ownership interest in PDCM to an unrelated third-party. The transaction includes the buyer's assumption of approximately 134,875 MMcf and $30.4 million of our Appalachian Basin firm transportation obligation. See Note 15, Subsequent Event, for additional information.

Litigation. The Company is involved in various legal proceedings that it considers normal to its business. The Company reviews the status of these proceedings on an ongoing basis and, from time to time, may settle or otherwise resolve these matters on terms and conditions that management believes are in the best interests of the Company. There is no assurance that settlements can be reached on acceptable terms

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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.

Class Action Regarding 2010 and 2011 Partnership Purchases

In December 2011, the Company and its wholly-owned merger subsidiary were served with an alleged class action on behalf of unit holders of 12 former limited partnerships, related to its repurchase of the 12 partnerships, which were formed beginning in late 2002 through 2005. The mergers were completed in 2010 and 2011. The action was filed in U.S. District Court for the Central District of California and is titled Schulein v. Petroleum Development Corp. The complaint primarily alleges that the disclosures in the proxy statements issued in connection with the mergers were inadequate, and a state law breach of fiduciary duty. In January 2014, the plaintiffs were certified as a class by the court.

In October 2014, the Company and plaintiffs’ counsel reached an oral settlement agreement, subject to the contingencies noted below. Under this agreement the plaintiffs would receive a cash payment of $37.5 million, of which PDC would pay $31.5 million and insurers would pay $6 million directly to the plaintiffs. This all-cash settlement agreement is a different structure than the initial agreement in principle, which was structured as part up-front cash and part interests in future wells. The proposed all-cash settlement remains subject to the satisfaction of various conditions, including but not limited to the following: execution of a written settlement agreement; preliminary approval by the court; payments to plaintiffs by the Company’s insurance carriers; and final court approval following notice to members of the class. As a result, the Company accrued an additional $7.4 million of expense during the quarter ended September 30, 2014, which is included in general and administrative expense in the condensed consolidated statement of operations. As of September 30, 2014, the Company has accrued a total liability of $31.5 million related to this litigation, which is our best estimate of the amount required to settle the case. The liability is included in other accrued expenses in the condensed consolidated balance sheet.

Under this settlement agreement, the class action would be dismissed with prejudice and all claims would be released. If the matter proceeds to trial, the plaintiffs have indicated that they will seek damages of approximately $175 million, plus pre-judgment interest. In such event, we continue to believe we would have good defenses to both the asserted claims and plaintiffs’ damage calculations.

Partnership Liquidation Lawsuit

In October 2014, PDC entered into a preliminary settlement agreement pursuant to which PDC will pay approximately $8.8 million in resolution of an adversary proceeding filed in June 2014 titled Eastern 1996D Limited Partnership, et al. v. PDC Energy, Inc. Adv. Pro. No. 14-03080 (the “Adversary Proceeding”) related to bankruptcy Case No. 13-34773-HDH-11, currently pending in the United States Bankruptcy Court for the Northern District of Texas (the “Bankruptcy Court”). The bankruptcy case relates to 12 limited partnerships formed from1996 to 2002, for which PDC is the managing general partner. These partnerships filed bankruptcy in September 2013 to pursue an orderly liquidation of their assets and distribute the resulting proceeds to limited partners and the managing general partner. The Adversary Proceeding primarily alleges claims for breach of fiduciary duty and breach of contract against PDC as managing general partner of the partnerships. On October 28, 2014, the Bankruptcy Court approved the proposed disclosure statement in support of the debtors’ joint liquidating plan and the manner of solicitation of votes on such plan. The plan incorporates and seeks approval of the above proposed settlement. The plan is expected to be mailed to the limited partners in November 2014, and the Bankruptcy Court is expected to hold a hearing in December 2014 regarding final approval of the plan and settlement agreement. During the quarter ended September 30, 2014, we recorded a litigation charge of $8.8 million related to this matter, included in general and administrative expense in the condensed consolidated statements of operations, of which an accrued liability of $7 million and a $1.8 million reduction in related-party accounts receivable are included in other accrued expenses and accounts receivable affiliates, respectively, at September 30, 2014 in the condensed consolidated balance sheet.

Environmental. Due to the nature of the natural gas and oil industry, we are exposed to environmental risks. We have various policies and procedures designed to mitigate the risks of environmental contamination and related liabilities. We conduct periodic reviews to identify changes in our environmental risk profile. Liabilities are recorded when environmental damages resulting from past events are probable and the costs can be reasonably estimated. As of September 30, 2014 and December 31, 2013, we had accrued environmental liabilities in the amount of $1.9 million and $5.4 million, respectively, included in other accrued expenses on the condensed consolidated balance sheets. We are not aware of any environmental claims existing as of September 30, 2014 which have not been provided for or would otherwise be expected to have a material impact on our financial statements. However, there can be no assurance that current regulatory requirements will not change or unknown past non-compliance with environmental laws will not be discovered on our properties.

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

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

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

transition and entered into a consulting agreement with our current Chief Executive Officer pursuant to which he will provide consulting services to the Company in 2015. Under the agreement, the current Chief Executive Officer ceased to be a participant in our executive severance plan.

NOTE 10 - COMMON STOCK

Stock-Based Compensation Plans

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



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
	(in thousands)

Stock-based compensation expense	$	4,232		$	3,040		$	13,111		$	9,991
Income tax benefit	(1,482		)	(1,161		)	(4,856		)	(3,816		)
Net stock-based compensation expense	$	2,750		$	1,879		$	8,255		$	6,175

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



	Nine Months Ended September 30,
	2014			2013

Expected term of award	6 years			6 years
Risk-free interest rate	2.1		%	1.0		%
Expected volatility	65.6		%	65.5		%
Weighted-average grant date fair value per share	$	29.96		$	21.96

The expected life of the award was estimated using historical stock option exercise behavior data. The risk-free interest rate was based on the U.S. Treasury yields approximating the expected life of the award in effect at the time of grant. Expected volatilities were based on our historical volatility. We do not expect to pay or declare dividends in the foreseeable future.

The following table presents the changes in our SARs:



	Nine Months Ended September 30,
	2014						2013
	Number of SARs	Weighted-Average Exercise Price		Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in thousands)		Number of SARs	Weighted-Average Exercise Price		Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in thousands)
Outstanding beginning of year, January 1,	190,763	$	33.77				118,832	$	30.80
Awarded	88,248	49.57					87,078	37.18
Outstanding at September 30,	279,011	38.77		8.0	$	3,215	205,910	33.50		8.4	$	5,363
Vested and expected to vest at September 30,	270,589	38.56		8.0	3,173		198,163	33.41		8.4	5,178
Exercisable at September 30,	109,920	32.71		7.1	1,933		67,069	29.99		7.3	1,982

Total compensation cost related to SARs granted, net of estimated forfeitures, and not yet recognized in our condensed consolidated statement of operations as of September 30, 2014 was $3.0 million. The cost is expected to be recognized over a weighted-average period of 1.9 years.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Restricted Stock Awards

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

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

The following table presents the changes in non-vested time-based awards to all employees, including executive officers, for the nine months ended September 30, 2014:



	Shares		Weighted-Average Grant-Date Fair Value

Non-vested at December 31, 2013	651,781		$	36.36
Granted	284,705		56.64
Vested	(269,725	)	34.13
Forfeited	(30,536	)	41.67
Non-vested at September 30, 2014	636,225		46.13

The following table presents the weighted-average grant date fair value per share and related information as of/for the periods presented:



	As of/for the Nine Months Ended September 30,
	2014		2013
	(in thousands, except per share data)

Total intrinsic value of time-based awards vested	$	15,840	$	12,562
Total intrinsic value of time-based awards non-vested	31,996		38,774
Market price per common share as of September 30,	50.29		59.54
Weighted-average grant date fair value per share	56.64		44.56

Total compensation cost related to non-vested time-based awards, net of estimated forfeitures, and not yet recognized in our condensed consolidated statements of operations as of September 30, 2014 was $20.8 million. This cost is expected to be recognized over a weighted-average period of 2.0 years.

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

In January 2014, the Compensation Committee awarded a total of 42,151 market-based restricted shares to our executive officers. In addition to continuous employment, the vesting of these shares is contingent on the Company's total shareholder return ("TSR"), which is essentially the Company’s stock price change including any dividends, as compared to the TSR of a set group of 15 peer companies. The shares are measured over a three-year period ending on December 31, 2016 and can result in a payout between 0% and 200% of the total shares awarded. The weighted-average grant date fair value per market-based share for these awards granted was computed using the Monte Carlo pricing model using the following assumptions:



	Nine Months Ended September 30,
	2014			2013

Expected term of award	3 years			3 years
Risk-free interest rate	0.8		%	0.4		%
Expected volatility	55.2		%	56.6		%
Weighted-average grant date fair value per share	$	56.87		$	49.04

The expected term of the awards was based on the requisite service period. The risk-free interest rate was based on the U.S. Treasury yields in effect at the time of grant and extrapolated to approximate the life of the award. The expected volatility was based on our historical volatility.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents the change in non-vested market-based awards during nine months ended September 30, 2014:



	Shares	Weighted-Average Grant-Date Fair Value per Share

Non-vested at December 31, 2013	72,111	$	43.75
Granted	42,151	56.87
Non-vested at September 30, 2014	114,262	48.59

The following table presents the weighted-average grant date fair value per share and related information as of/for the periods presented:



	As of/for the Nine Months Ended September 30,
	2014		2013
	(in thousands, except per share data)

Total intrinsic value of market-based awards non-vested	$	5,746	$	4,898
Market price per common share as of September 30,	50.29		59.54
Weighted-average grant date fair value per share	56.87		49.04

Total compensation cost related to non-vested market-based awards, net of estimated forfeitures, and not yet recognized in our condensed consolidated statement of operations as of September 30, 2014 was $2.7 million. This cost is expected to be recognized over a weighted-average period of 1.9 years.

NOTE 11 - EARNINGS PER SHARE

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

The following table presents a reconciliation of the weighted-average diluted shares outstanding for the three and nine months ended September 30, 2014:



	Three Months Ended September 30,		Nine Months Ended September 30,
	2014	2013	2014	2013
	(in thousands)

Weighted-average common shares outstanding - basic	35,834	33,413	35,763	31,350
Dilutive effect of:
Restricted stock	259	—	287	—
SARs	56	—	45	—
Stock options	1	—	1	—
Non-employee director deferred compensation	6	—	5	—
Convertible notes	672	—	730	—
Weighted-average common shares and equivalents outstanding - diluted	36,828	33,413	36,831	31,350

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

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

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



	Three Months Ended September 30,		Nine Months Ended September 30,
	2014	2013	2014	2013
	(in thousands)

Weighted-average common share equivalents excluded from diluted earnings
per share due to their anti-dilutive effect:
Restricted stock	4	805	—	857
SARs	11	83	30	65
Stock options	—	7	—	7
Non-employee director deferred compensation	—	4	—	4
Convertible notes	—	671	—	387
Total anti-dilutive common share equivalents	15	1,570	30	1,320

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

NOTE 12 - ASSETS HELD FOR SALE, DIVESTITURES AND DISCONTINUED OPERATIONS

Appalachian Basin. In December 2013, we divested our shallow Upper Devonian (non-Marcellus Shale) Appalachian Basin crude oil and natural gas properties previously owned directly by us, as well as through our proportionate share of PDCM, for aggregate consideration of approximately $20.6 million, of which our share of the proceeds was approximately $5.1 million. We received our proportionate share of cash proceeds and a note receivable. Concurrent with the closing of the transaction, our $6.7 million irrevocable standby letter of credit and an agreement for firm transportation services was released and novated to the buyer.

In July 2014, we signed a definitive agreement pursuant to which we agreed to sell our entire 50% ownership interest in PDCM to an unrelated third-party for aggregate consideration of approximately $250 million, subject to certain purchase price adjustments. The transaction includes the buyer's assumption of our share of the firm transportation obligations related to the assets owned by PDCM as well as our share of certain of PDCM's natural gas hedging positions for the years 2014 through 2017 and the repayment of outstanding PDCM debt. Our proportionate share of PDCM's assets and liabilities have been classified as held for sale in the condensed consolidated balance sheets for all periods presented. In addition, because the divestiture represents a strategic shift that will have a major effect on our operations, our proportionate share of PDCM's Marcellus Shale results of operations have been separately reported as discontinued operations in the condensed consolidated statement of operations for all periods presented. In October 2014, this divestiture closed for total consideration, after our share of PDCM's debt repayment and other working capital adjustments, of approximately $190 million, comprised of approximately $150 million in cash and a promissory note due in 2020 of approximately $40 million, subject to customary post-closing adjustments. See Note 15, Subsequent Event, for additional information regarding the closing of this divestiture.

Piceance Basin and NECO. In June 2013, we divested our Piceance Basin, NECO and certain other non-core Colorado oil and gas properties, leasehold mineral interests and related assets for total consideration of approximately $177.6 million, with an additional $17.0 million paid to our non-affiliated investor partners in our affiliated partnerships. Following the sale, we do not have significant continuing involvement in the operations of, or cash flows from, the Piceance Basin and NECO oil and gas properties. Accordingly, the results of operations related to these assets have been separately reported as discontinued operations in the condensed consolidated statement of operations for the nine months ended September 30, 2013.

Selected Financial Information Related to Divested and Discontinued Operations. The tables below set forth selected financial information related to net assets held for sale and operating results related to discontinued operations. Net assets held for sale represent the assets that were expected to be sold, net of liabilities that were expected to be assumed by the purchaser.

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PDC ENERGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents condensed consolidated balance sheet data related to net assets held for sale:



Condensed consolidated balance sheet	As of September 30, 2014		As of December 31, 2013
	(in thousands)
Assets
Current assets
Cash and cash equivalents	$	496	$	601
Other current assets	4,879		7,060
Assets held for sale - current	5,375		7,661

Non-current assets
Properties and equipment, net	169,672		171,592
Other assets	7,022		6,892
Assets held for sale - non-current	176,694		178,484

Liabilities
Liabilities held for sale - current	3,070		12,069

Non-current liabilities
Long-term debt	59,750		52,000
Asset retirement obligation	273		2,234
Other liabilities	1,520		1,681
Liabilities held for sale - non-current	61,543		55,915