Edgar Filing: BERRY PETROLEUM CO

09.30.2013 Form 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



T		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2013



o		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 1-9735

BERRY PETROLEUM COMPANY

(Exact name of registrant as specified in its charter)



DELAWARE (State of incorporation or organization)		77-0079387 (I.R.S. Employer Identification Number)

1999 Broadway, Suite 3700

Denver, Colorado 80202

(Address of principal executive offices, including zip code)

Registrant's telephone number, including area code: (303) 999-4400

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 Web site, 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 T	Accelerated filer £	Non-accelerated filer £ (Do not check if a smaller reporting company)	Smaller reporting company £

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

As of October 21, 2013 the registrant had 52,712,863 shares of Class A Common Stock ($0.01 par value) outstanding. The registrant also had 1,763,866 shares of Class B Stock ($0.01 par value) outstanding on October 21, 2013, all of which is held by a single holder.

Table of Contents

BERRY PETROLEUM COMPANY

INDEX TO FORM 10-Q

September 30, 2013



	Page
PART I. FINANCIAL INFORMATION	3
Item 1. Condensed Financial Statements (Unaudited)	3
Condensed Balance Sheets at September 30, 2013 and December 31, 2012	3
Condensed Statements of Operations for the three and nine months ended September 30, 2013 and 2012	4
Condensed Statements of Comprehensive Earnings for the three and nine months ended September 30, 2013 and 2012	5
Condensed Statements of Cash Flows for the nine months ended September 30, 2013 and 2012	6
Condensed Statements of Shareholders' Equity for the nine months ended September 30, 2013	7
Notes to Condensed Financial Statements	8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3. Quantitative and Qualitative Disclosures About Market Risk	39
Item 4. Controls and Procedures	42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	43
Item 1A. Risk Factors	43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3. Defaults Upon Senior Securities	43
Item 4. Removed and Reserved	43
Item 5. Other Information	43
Item 6. Exhibits	44
Signatures	45

Table of Contents

PART I. FINANCIAL INFORMATION

BERRY PETROLEUM COMPANY

Condensed Balance Sheets

(Unaudited)

(In Thousands, Except Share Information)



	September 30, 2013		December 31, 2012
ASSETS
Current assets:
Cash and cash equivalents	$	24,055	$	312
Restricted short-term investments	125		125
Accounts receivable	148,019		122,159
Deferred income taxes	1,574		703
Derivative instruments	4,960		14,661
Prepaid expenses and other	18,304		19,065
Total current assets	197,037		157,025
Oil and natural gas properties (successful efforts basis), buildings and equipment, net	3,315,247		3,128,502
Derivative instruments	17,245		10,891
Other assets	24,382		28,984
	$	3,553,911	$	3,325,402
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	103,034	$	175,893
Revenue and royalties payable	50,859		57,021
Accrued liabilities	53,969		51,151
Derivative instruments	8,561		1,111
Deferred income taxes	—		1,456
10.25% Senior notes due 2014, net of unamortized discount of $1,141	204,116		—
Total current liabilities	420,539		286,632
Long-term liabilities:
Deferred income taxes	331,734		255,471
Senior secured revolving credit facility	636,000		562,900
10.25% Senior notes due 2014, net of unamortized discount of $2,340	—		202,917
6.75% Senior notes due 2020	300,000		300,000
6.375% Senior notes due 2022	600,000		600,000
Asset retirement obligations	98,374		82,316
Derivative instruments	—		1,239
Other long-term liabilities	33,870		19,136
	1,999,978		2,023,979
Shareholders' equity:
Preferred stock, $0.01 par value, 2,000,000 shares authorized; no shares outstanding	—		—
Capital stock, $0.01 par value:
Class A Common Stock, 100,000,000 shares authorized; 52,691,955 and 52,428,423 shares issued and outstanding, respectively	527		524
Class B Stock, 3,000,000 shares authorized; 1,763,866 shares issued and outstanding (liquidation preference of $0.50 per share)	18		18
Capital in excess of par value	374,538		364,710
Retained earnings	758,311		649,539
Total shareholders' equity	1,133,394		1,014,791
	$	3,553,911	$	3,325,402

The accompanying notes are an integral part of these Condensed Financial Statements.

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BERRY PETROLEUM COMPANY

Condensed Statements of Operations

(Unaudited)

(In Thousands, Except Per Share Data)



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
REVENUES
Oil and natural gas sales	$	306,183	$	232,916	$	847,670	$	688,350
Electricity sales	10,046		9,514		27,148		21,354
Natural gas marketing	1,916		1,939		6,198		5,378
Gain on sale of assets	—		170		23		1,770
Interest and other income, net	249		286		1,098		1,678
	318,394		244,825		882,137		718,530
EXPENSES
Operating costs—oil and natural gas production	91,416		70,670		268,841		187,318
Operating costs—electricity generation	5,401		4,727		17,034		14,000
Production taxes	11,060		9,700		32,848		30,048
Depreciation, depletion & amortization—oil and natural gas production	73,011		58,887		210,934		158,869
Depreciation, depletion & amortization—electricity generation	456		461		1,283		1,382
Natural gas marketing	1,895		1,753		5,971		4,917
General and administrative	17,834		17,767		59,542		53,473
Interest	24,996		20,572		74,562		61,446
Dry hole, abandonment, impairment and exploration	1,624		2,837		3,458		7,456
Impairment of oil and natural gas properties	—		—		2,467		67
Extinguishment of debt	—		—		—		41,545
Realized and unrealized loss (gain) on derivatives, net	45,293		28,287		10,408		(56,314		)
	272,986		215,661		687,348		504,207
Earnings before income taxes	45,408		29,164		194,789		214,323
Income tax provision	17,230		11,038		72,813		81,283
Net earnings	$	28,178	$	18,126	$	121,976	$	133,040
Basic net earnings per share	$	0.51	$	0.33	$	2.20	$	2.41
Diluted net earnings per share	$	0.50	$	0.33	$	2.19	$	2.39
Dividends per share	$	0.08	$	0.08	$	0.24	$	0.24

The accompanying notes are an integral part of these Condensed Financial Statements.

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BERRY PETROLEUM COMPANY

Condensed Statements of Comprehensive Earnings

(Unaudited)

(In Thousands)



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
Net earnings	$	28,178	$	18,126	$	121,976	$	133,040
Other comprehensive earnings, net of income taxes:
Amortization of accumulated other comprehensive loss (AOCL) related to de-designated hedges, net of income tax benefits of $0, $924, $0 and $2,318, respectively	—		1,505		—		3,781
Other comprehensive earnings	$	—	$	1,505	$	—	$	3,781
Comprehensive earnings	$	28,178	$	19,631	$	121,976	$	136,821

The accompanying notes are an integral part of these Condensed Financial Statements.

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BERRY PETROLEUM COMPANY

Condensed Statements of Cash Flows

(Unaudited)

(In Thousands)



	Nine Months Ended
	September 30,
	2013			2012
Cash flows from operating activities:
Net earnings	$	121,976		$	133,040
Depreciation, depletion and amortization	212,217			160,251
Gain on sale of assets	(23		)	(1,770		)
Extinguishment of debt	—			6,842
Amortization of debt issuance costs and net discount	5,197			5,350
Impairment of oil and natural gas properties	2,467			67
Dry hole and impairment	1,441			2,515
Derivatives	9,559			(34,760		)
Stock-based compensation expense	8,491			7,589
Deferred income taxes	85,280			77,511
Other, net	5,208			(1,620		)
Allowance for bad debt	—			450
Change in book overdraft	(14,885		)	7,573
Changes in operating assets and liabilities:
Accounts receivable	(29,975		)	504
Inventories, prepaid expenses, and other current assets	456			(2,634		)
Accounts payable and revenue and royalties payable	(4,888		)	15,097
Accrued interest and other accrued liabilities	2,785			15,611
Net cash provided by operating activities	405,306			391,616
Cash flows from investing activities:
Development and exploration of oil and natural gas properties	(445,645		)	(524,036		)
Property acquisitions	(3,367		)	(75,706		)
Capitalized interest	(4,978		)	(13,977		)
Proceeds from sale of assets	11,530			17,294
Deposits on asset sales	—			(3,300		)
Net cash used in investing activities	(442,460		)	(599,725		)
Cash flows from financing activities:
Proceeds from issuance of 6.375% Senior notes due 2022	—			600,000
Repurchase of 8.25% Senior subordinated notes due 2016	—			(200,000		)
Repurchase of 10.25% Senior notes due 2014	—			(149,999		)
Long-term borrowings under credit facility	559,900			1,215,500
Repayments of long-term borrowings under credit facility	(486,800		)	(1,237,000		)
Financing obligation	(339		)	(309		)
Debt issuance costs	—			(11,424		)
Dividends paid	(13,204		)	(13,160		)
Stock options and restricted stock issued	368			3,551
Excess income tax benefit	972			756
Net cash provided by financing activities	60,897			207,915
Net increase (decrease) in cash and cash equivalents	23,743			(194		)
Cash and cash equivalents at beginning of period	312			298
Cash and cash equivalents at end of period	$	24,055		$	104
Noncash investing activities:
Accrued capital expenditures	$	40,164		$	61,044
Asset retirement obligations	13,222			16,854

The accompanying notes are an integral part of these Condensed Financial Statements.

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BERRY PETROLEUM COMPANY

Condensed Statements of Shareholders' Equity

(Unaudited)

(In Thousands, Except Per Share Data)



	Class A		Class B		Capital in Excess of Par Value		Retained Earnings			Total Shareholders' Equity
Balances at December 31, 2012	$	524	$	18	$	364,710	$	649,539		$	1,014,791
Stock options and restricted stock issued	3		—		365		—			368
Stock based compensation expense	—		—		8,491		—			8,491
Income tax effect of stock option exercises	—		—		972		—			972
Dividends ($0.24 per share)	—		—		—		(13,204		)	(13,204		)
Net earnings	—		—		—		121,976			121,976
Balances at September 30, 2013	$	527	$	18	$	374,538	$	758,311		$	1,133,394

The accompanying notes are an integral part of these Condensed Financial Statements.

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements

(Unaudited)

1. Basis of Presentation

These Condensed Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial reporting. Pursuant to the rules and regulations of the Securities and Exchange Commission (SEC), the unaudited Condensed Financial Statements do not include all disclosures required by GAAP. For a more complete understanding of Berry Petroleum Company's (the Company) operations, financial position and accounting policies, the unaudited Condensed Financial Statements and notes thereto should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2012, previously filed with the SEC.

All adjustments, consisting of normal and recurring accruals, which are, in the opinion of management, necessary to fairly state the Company's Condensed Financial Statements have been included herein. Interim results are not necessarily indicative of expected annual results because of the impact of fluctuations in prices received for oil and natural gas, as well as other factors. In the course of preparing the Condensed Financial Statements, management makes various assumptions, judgments and estimates to determine the reported amounts of assets, liabilities, revenues and expenses, and to prepare disclosures of commitments and contingencies. Changes in these assumptions, judgments and estimates will occur as a result of the passage of time and the occurrence of future events, and, accordingly, actual results could differ from amounts previously established.

The Company's cash management process provides for the daily funding of checks as they are presented to the bank. Included in accounts payable at December 31, 2012 was $14.9 million, representing outstanding checks in excess of the bank balance (book overdraft). There were no outstanding checks in excess of the bank balance at September 30, 2013.

Recent Accounting Standards

There are no material new accounting pronouncements that have been issued but not yet adopted by the Company as of September 30, 2013.

2. Acquisitions and Divestitures

2012 Acquisitions

On September 12, 2012, the Company completed the acquisition of approximately 14,000 net acres contiguous to the Company's Brundage Canyon asset in the Uinta for an aggregate purchase price of $39.6 million, including usual and customary post-closing adjustments. Disclosures of purchase price allocation and also of pro forma revenues and net earnings for this acquisition are not material and have not been presented.

On April 13, 2012, the Company completed the acquisition of approximately 2,000 net acres and one well in the Wolfberry trend in the Permian for an aggregate purchase price of $14.9 million including usual and customary post-closing adjustments. Disclosures of purchase price allocation and also of pro forma revenues and net earnings for this acquisition are not material and have not been presented.

2012 Divestiture

On December 21, 2011, the Company entered into an agreement to sell its proved developed properties in Elko, Eureka and Nye Counties, Nevada, which closed on January 31, 2012, for total cash consideration of $15.6 million. The Company recorded a $1.6 million gain in conjunction with the sale. The gain was recorded in the Condensed Statements of Operations under the caption gain on sale of assets.

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

3. Debt

Senior Secured Revolving Credit Facility

As of September 30, 2013, the Company's credit facility, which matures on May 13, 2016, had a borrowing base of $1.4 billion, subject to lender commitments. At September 30, 2013, lender commitments under the facility were $1.2 billion. Borrowings under the credit facility bear interest at either (i) LIBOR plus a margin between 1.50% and 2.50% or (ii) the prime rate plus a margin between 0.50% and 1.50%, in each case, based on the amount utilized. The annual commitment fee on the unused portion of the credit facility ranges between 0.35% and 0.50% based on the amount utilized.

As of September 30, 2013, there were $636.0 million in outstanding borrowings under the credit facility and $26.8 million in outstanding letters of credit, leaving $537.2 million in borrowing capacity available under the credit facility. The maximum amount available under the credit facility is subject to semi-annual redeterminations of the borrowing base in April and October of each year, based on the value of the Company's proved oil and natural gas reserves, in accordance with the lenders' customary procedures and practices. The Company and the lenders each have the right to one additional redetermination each year. On October 22, 2013, the Company entered into a Sixth Amendment to its credit facility, which amended certain terms of the credit facility. See Note 12 to the Condensed Financial Statements.

Maturity of 2014 Notes

The Company's 10.25% senior notes due 2014 (2014 Notes) are scheduled to mature on June 1, 2014. As a result, all $205.3 million aggregate principal amount of the 2014 Notes is classified as a current obligation on the Company's Condensed Balance Sheet as of September 30, 2013. The Company's ability to repay or refinance the aggregate principal amount of the 2014 Notes is subject to restrictions contained in the Merger Agreement. See Note 11 to the Condensed Financial Statements. While the Company has not yet determined how it will repay or refinance the 2014 Notes, the Company may do so through multiple methods which it may pursue separately or in combination, including (i) issuing new debt or equity securities and (ii) borrowing under the Company's credit facility. Although the Company believes it will be able to complete a refinancing transaction prior to the maturity of the 2014 Notes, if the Company is unable to complete a refinancing or otherwise repay such debt, it would be in default under the indenture governing the 2014 Notes, which would also cause the Company to be in default under its credit facility and the indentures governing its other senior notes, and would result in indebtedness outstanding under those agreements to be declared immediately due and payable.

4. Income Taxes

The effective income tax rate for the three months ended September 30, 2013 and 2012 was 37.9% and 37.8%, respectively. The effective income tax rate for the nine months ended September 30, 2013 and 2012 was 37.4% and 37.9%, respectively. The Company's provision for income taxes differed from the U.S. statutory rate of 35% primarily due to state income taxes, domestic production activities deduction, percentage depletion, nondeductible employee compensation and other permanent differences.

As of September 30, 2013, the Company had a gross liability for uncertain income tax benefits of $20.1 million, $15.0 million of which, if recognized, would impact the effective income tax rate. During the second quarter of 2013, the Company recognized a benefit of $1.9 million related to closing statutes. Consistent with the Company's policy, interest and penalties on income taxes have been recorded as a component of the income tax provision. The Company estimates that it is reasonably possible that the balance of unrecognized income tax benefits as of September 30, 2013 could decrease by a maximum of $4.8 million in the next 12 months due to the expiration of statutes of limitation and audit settlements.

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

5. Earnings Per Share

Basic net earnings per share is computed using the two-class method by dividing net earnings attributable to common shareholders by the weighted average shares outstanding-basic during each period. The two-class method of computing net earnings per share is required for those entities that have participating securities. The two-class method is an earnings allocation formula that determines net earnings per share for participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. Unvested restricted shares issued under the Company's equity incentive plans prior to January 1, 2010 have the right to receive non-forfeitable dividends, participating on an equal basis with common shares, and thus are classified as participating securities. Participating securities do not have a contractual obligation to share in the Company's losses. Therefore, in periods of net loss, no portion of the loss is allocated to participating securities.

Diluted earnings per share is computed using the two-class method by dividing earnings available to common shareholders by the weighted average shares outstanding-dilutive, which includes the effect of potentially dilutive securities. Under the two-class method, potentially dilutive securities consist of non-participating securities (e.g. stock options and unvested restricted stock awards issued subsequent to January 1, 2010). No potential shares of common stock are included in the computation of any diluted per share amount when a net loss exists.

The following table shows the computation of basic and diluted net earnings per share for the three and nine months ended September 30, 2013 and 2012:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands, except per share data)	2013		2012		2013		2012
Net earnings	$	28,178	$	18,126	$	121,976	$	133,040
Less: Net earnings allocable to participating securities	72		118		265		709
Net earnings available for common shareholders	$	28,106	$	18,008	$	121,711	$	132,331

Basic net earnings per share	$	0.51	$	0.33	$	2.20	$	2.41
Diluted net earnings per share	$	0.50	$	0.33	$	2.19	$	2.39

Basic weighted average shares outstanding	55,308		54,945		55,267		54,883
Add: Dilutive effects of stock options and RSUs	370		336		384		395
Dilutive weighted average shares outstanding	55,678		55,281		55,651		55,278

Not included in the diluted earnings per share calculation were 0.4 million and 0.7 million stock options and RSUs, for the three and nine months ended September 30, 2013, respectively, because their effect would have been anti-dilutive. Not included in the diluted earnings per share calculation were 0.7 million and 0.6 million stock options and RSUs, for the three and nine months ended September 30, 2012, respectively, because their effect would have been anti-dilutive.

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

6. Asset Retirement Obligations

The following table summarizes the activity for the Company's asset retirement obligations (AROs) for the nine months ended September 30, 2013 and 2012:



	Nine Months Ended
	September 30,
(in thousands)	2013			2012
Beginning balance at January 1	$	86,746		$	64,019
Liabilities incurred	7,315			5,862
Liabilities settled	(2,589		)	(2,763		)
Liabilities assumed	—			2,651
Disposition of assets	(40		)	(705		)
Accretion expense	5,465			4,201
Revisions in estimated cash flows	5,907			10,992
Ending balance at September 30	$	102,804		$	84,257

ARO reflects the estimated present value of the amount of dismantlement, removal, site reclamation and similar activities associated with the Company's oil and natural gas properties. Inherent in the fair value calculation of ARO are numerous assumptions and judgments including the ultimate settlement amounts, inflation factors, credit adjusted discount rates, timing of settlement and changes in the legal, regulatory, environmental and political environments. To the extent future revisions to these assumptions impact the fair value of the existing ARO liability, a corresponding adjustment is made to the oil and natural gas property balance.

7. Equity Incentive Compensation Plans

Stock-based compensation is measured at the grant date based on the fair value of the awards. The fair value is recognized on a straight-line basis over the requisite service period (generally the vesting period).

Total compensation cost recognized in the Condensed Statements of Operations for the grants under the Company's equity incentive compensation plans was $2.5 million and $2.0 million during the three months ended September 30, 2013 and 2012, respectively, and $8.1 million and $7.2 million during the nine months ended September 30, 2013 and 2012, respectively.

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

Stock Options

The following table summarizes stock option activity for the nine months ended September 30, 2013:



	Number of Shares		Weighted Average Exercise Price		Aggregate Intrinsic Value (in thousands)(1)		Weighted Average Remaining Contractual Term (Years)
Outstanding at January 1, 2013	1,387,592		$	33.71	$	4,681	4.08
Granted	—		—
Exercised	(22,350	)	17.23		604
Canceled/expired	—		—
Outstanding at September 30, 2013	1,365,242		$	33.98	$	13,561	3.38
Vested and expected to vest at September 30, 2013	1,364,054		$	33.96	$	13,561	3.37
Exercisable at September 30, 2013	1,259,022		$	32.53	$	13,561	2.99

__________________________________


(1)	The intrinsic value of a stock option is the amount by which the market value of the underlying stock at the end of the related period exceeds the exercise price of the option.

As of September 30, 2013, there were $1.8 million of total unrecognized compensation costs related to outstanding stock options. These costs are expected to be recognized over 2.5 years.

Restricted Stock Units

The following table summarizes restricted stock unit (RSU) activity for the nine months ended September 30, 2013:



	RSUs		Weighted Average Grant Date Fair Value		Vest Date Fair Value (in thousands)
Outstanding at January 1, 2013	981,877		$	26.72
Granted	264,033		45.27
Issued	(182,180	)	24.76		$	7,122
Canceled/expired	(21,048	)	44.81
Outstanding at September 30, 2013(1)(2)	1,042,682		$	31.97

__________________________________


(1)	The balance outstanding includes 58,036 RSUs granted to non-employee directors that are 100% vested at date of grant, but are subject to deferral elections delaying the date on which the corresponding shares are issued.


(2)	The balance outstanding includes 510,967 RSUs granted to executive officers and other officers that have vested in accordance with the RSU agreement but are subject to deferral elections delaying the date on which the corresponding shares are issued.

As of September 30, 2013, there were $17.0 million of total unrecognized compensation costs related to RSUs granted. These costs are expected to be recognized over 3.5 years.

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

7. Equity Incentive Compensation Plans (Continued)

Performance Share Program

The following table summarizes performance share award activity for the nine months ended September 30, 2013:



	Performance Share Awards(1)		Weighted Average Grant Date Fair Value		Vest Date Fair Value (in thousands)
Outstanding at January 1, 2013	222,587		$	45.79
Granted	—		—
Issued	(64,922	)	32.75		$	2,990
Canceled/expired	(34,742	)	28.32
Outstanding at September 30, 2013	122,923		$	57.61

__________________________________


(1)	For outstanding shares, reflects the maximum number of performance shares that can be issued.

As of September 30, 2013, there were $1.2 million of total unrecognized compensation costs related to performance shares granted. These costs are expected to be recognized over 1.3 years.

8. Derivative Instruments

The Company uses financial derivative instruments as part of its price risk management program to achieve a more predictable, economic cash flow from its oil production by reducing its exposure to price fluctuations. The Company has historically entered into financial commodity swap and collar contracts to fix the floor and ceiling prices received for a portion of the Company's oil and natural gas production. During the second quarter of 2012, the Company began entering into derivative contracts to fix the floor and ceiling prices paid for a portion of its natural gas consumption. The terms of the Company's derivative contracts depend on various factors, including management's view of future crude oil and natural gas prices, acquisition economics on purchased assets, future financial commitments, and other considerations. The Company periodically enters into interest rate derivative agreements to protect against changes in interest rates on its floating rate debt. The Company recognizes all gains and losses from changes in commodity derivative fair values immediately in earnings. For further discussion related to the fair value of the Company's derivatives, see Note 9 to the Condensed Financial Statements.

As of September 30, 2013, the Company had commodity derivatives associated with the following volumes:



	2013	2014	2015
Oil sales, Bbl/D	19,800	21,000	3,000
Natural gas purchases, MMBtu/D	10,000	—	—

The Company entered into the following derivative instruments during the nine months ended September 30, 2013:



Crude Oil Sales Three-Way Collars
Term	Index	Average Barrels Per Day	Sold Put / Purchased Put / Sold Call
Full year 2013 and 2014	ICE Brent	1,000	$80.00 / $100.00 / $114.05
Full year 2014	NYMEX WTI	1,000	$70.00 / $90.00 / $102.00



Crude Oil Sales (NYMEX WTI) Swaps
Term	Average Barrels Per Day	Weighted Average Price
Full year 2014	11,500	$90.14

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

8. Derivative Instruments (Continued)



Crude Oil Sales (NYMEX WTI to ICE Brent) Basis Swaps
Term	Average Barrels Per Day	Weighted Average Price
Full year 2014	10,000	$11.60
Full year 2015	8,000	$11.60



Crude Oil Sales (NYMEX WTI to Midland) Basis Swaps
Term	Average Barrels Per Day	Weighted Average Price
April 2013 - December 2013	4,000	$1.48

In March 2012, the Company terminated certain of its natural gas derivative instruments, which were associated with a total of 15,000 MMBtu/D for the remainder of 2012. The termination resulted in a net loss of $1.9 million, including cash settlements and non-cash fair value losses, and was recorded in the Condensed Statements of Operations under the caption realized and unrealized loss (gain) on derivatives, net.

The Company routinely enters into derivative contracts with a variety of counterparties, typically resulting in individual derivative instruments with both fair value asset and liability positions. The Company nets the fair values of derivative instruments executed with the same counterparty pursuant to ISDA master agreements, which mitigate the credit risk of the Company's derivative instruments by providing for net settlement over the term of the contract and in the event of default or termination of the contract. The tables below summarize the fair value of derivative assets and liabilities and the effect of netting on the Condensed Balance Sheets:



(in millions)		September 30, 2013
Description	Balance Sheet Classification	Gross Amounts of Recognized Assets or Liabilities		Gross Amounts Offset in the Condensed Balance Sheets			Net Amounts of Assets or Liabilities Presented in the Condensed Balance Sheets
Assets
Commodity derivative instruments	Current	$	21.8	$	(16.8	)	$	5.0
Commodity derivative instruments	Long-term	19.6		(2.4		)	17.2
Total assets		$	41.4	$	(19.2	)	$	22.2

Liabilities
Commodity derivative instruments	Current	$	25.4	$	(16.8	)	$	8.6
Commodity derivative instruments	Long-term	2.4		(2.4		)	—
Total liabilities		$	27.8	$	(19.2	)	$	8.6

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

8. Derivative Instruments (Continued)



(in millions)		December 31, 2012
Description	Balance Sheet Classification	Gross Amounts of Recognized Assets or Liabilities		Gross Amounts Offset in the Condensed Balance Sheets			Net Amounts of Assets or Liabilities Presented in the Condensed Balance Sheets
Assets
Commodity derivative instruments	Current	$	16.4	$	(1.7	)	$	14.7
Commodity derivative instruments	Long-term	10.9		—			10.9
Total assets		$	27.3	$	(1.7	)	$	25.6

Liabilities
Commodity derivative instruments	Current	$	2.8	$	(1.7	)	$	1.1
Commodity derivative instruments	Long-term	1.2		—			1.2
Total liabilities		$	4.0	$	(1.7	)	$	2.3

The table below summarizes the location and the amount of derivative instrument losses (gains) before income taxes reported in the Condensed Statements of Operations for the periods indicated:



		Three Months Ended					Nine Months Ended
(in millions)	Location of Loss (Gain) Recognized in Earnings	September 30,					September 30,
Description of Loss (Gain)	Location of Loss (Gain) Recognized in Earnings	2013		2012			2013		2012
Commodity
Loss reclassified from AOCL into earnings (amortization of frozen amounts)	Oil and natural gas sales	$	—	$	2.7		$	—	$	7.9
Loss (gain) recognized in earnings (cash settlements and mark-to-market movements)	Realized and unrealized loss (gain) on derivatives, net	45.3		28.3			10.4		(56.3		)
Interest rate
Gain reclassified from AOCL into earnings (amortization of frozen amounts)	Interest	$	—	$	(0.3	)	$	—	$	(1.8	)

Credit Risk

The Company does not require collateral or other security from counterparties to support derivative instruments. However, the agreements with those counterparties typically contain netting provisions such that if a default occurs, the non-defaulting party can offset the amount payable to the defaulting party under the derivative contract with the amount due from the defaulting party. As a result of the netting provisions, the Company's maximum amount of loss due to credit risk is limited to the net amounts due to and from the counterparties under the derivative contracts. The maximum amount of loss due to credit risk that the Company would have incurred if all counterparties to its derivative contracts failed to perform at September 30, 2013 was $16.0 million.

As of September 30, 2013, the counterparties to the Company's commodity derivative contracts consist of nine financial institutions. The Company's counterparties or their affiliates are also lenders under the Company's credit facility. As a result, the counterparties to the Company's derivative agreements share in the collateral supporting the Company's credit facility. The Company is not generally required to post additional collateral under derivative agreements.

Certain of the Company's derivative agreements contain cross default provisions that require acceleration of amounts due under such agreements if the Company were to default on its obligations under its material debt agreements. In addition, if the Company were to default on certain of its material debt agreements, including its derivative agreements, the Company would be

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

8. Derivative Instruments (Continued)

in default under the credit facility. As of September 30, 2013, the Company was in a net liability position with one of the counterparties to the Company's derivative instruments, totaling $2.3 million. As of September 30, 2013, the Company's largest two counterparties accounted for 62% of the value of its total net derivative positions.

9. Fair Value Measurements

The authoritative guidance for fair value measurements establishes a three-tier fair value hierarchy, which prioritizes the inputs used to measure fair value. These tiers include: Level 1, defined as unadjusted quoted prices in active markets for identical assets or liabilities; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for use when little or no market data exists, therefore requiring an entity to develop its own assumptions.

A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the classification of assets and liabilities within the fair value hierarchy. The Company recognizes transfers between levels at the end of the reporting period for which the transfer has occurred.

The fair value of all derivative instruments is estimated with industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. The fair value of all derivative instruments is estimated using a combined income and market valuation methodology based upon forward commodity price and volatility curves. The curves are obtained from independent pricing services, and the Company has made no adjustments to the obtained prices. The independent pricing services publish observable market information from multiple brokers and exchanges. All valuations were compared against counterparty valuations to verify the reasonableness of prices. The Company also considers counterparty credit risk and its own credit risk in its determination of all estimated fair values. The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the types of derivative contracts it holds.

Assets (Liabilities) Measured at Fair Value on a Recurring Basis

The following table presents information about the Company's financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair values:



(in millions)	Total		Level 1		Level 2		Level 3
Commodity derivative asset, net
September 30, 2013	$	13.6	$	—	$	13.6	$	—
December 31, 2012	$	23.2	$	—	$	23.2	$	—

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BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

9. Fair Value Measurements (Continued)

Fair Market Value of Financial Instruments

The Company uses various assumptions and methods in estimating the fair values of its financial instruments. The following table presents fair value information about the Company's financial instruments:



September 30, 2013	Carrying Amount		Estimated Fair Value
(in millions)			Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	24	$	24	$	—	$	—	$	24
Senior secured revolving credit facility(1)	636		—		636		—		636
10.25% Senior notes due 2014(2)	205		217		—		—		217
6.75% Senior notes due 2020	300		308		—		—		308
6.375% Senior notes due 2022	600		605		—		—		605

__________________________________

(1)

The Company's credit facility can be repaid at any time without penalty. Interest is generally fixed for 30-day increments at the prime rate or LIBOR plus a stipulated margin for the amount utilized and at a stipulated percentage as a commitment fee for the portion not utilized. The carrying amount of the credit facility approximated fair value due to the short-term maturities of the borrowings and because the borrowings bear interest at variable market rates.


(2)	Carrying amount does not include unamortized discount of $1.1 million.



December 31, 2012	Carrying Amount		Estimated Fair Value
(in millions)			Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	—	$	—	$	—	$	—	$	—
Senior secured revolving credit facility(1)	563		—		563		—		563
10.25% Senior notes due 2014(2)	205		229		—		—		229
6.75% Senior notes due 2020	300		323		—		—		323
6.375% Senior notes due 2022	600		627		—		—		627

_________________________________

(1)


(2)	Carrying amount does not include unamortized discount of $2.3 million.

10. Commitments and Contingencies

E. Texas Gathering System

In July 2009, the Company closed on the financing of its E. Texas natural gas gathering system for $18.4 million in cash. The Company entered into concurrent long-term natural gas gathering agreements for the E. Texas production which contained an embedded lease. Accordingly, the $16.7 million net book value of the property is being depreciated over the remaining useful life of the asset and the cash received of $18.4 million was recorded as a financing obligation. A portion of the payments under the agreements is recorded as gathering expense and is presented in the Condensed Financial Statements under the caption operating costs—oil and natural gas production. In addition, a portion of the payments is recorded as interest expense, and the balance of the payments is recorded as a reduction to the financing obligation. There are no minimum payments required under these agreements. For the three months ended September 30, 2013 and 2012, the Company incurred net costs of $0.5 million and $0.6 million, respectively, under the agreements. For the nine months ended September 30, 2013 and 2012, the Company incurred net costs of $1.5 million and $2.0 million, respectively, under the agreements.

BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

Carry and Earning Agreement

In January 2011, the Company entered into an amendment relating to certain contractual obligations to a third-party co-owner of certain Piceance assets in Colorado. The amendment waives the $0.2 million penalty for each well not spud by February 2011 and requires the Company to reassign to such co-owner, by January 31, 2020, all of the interest acquired by the Company from the co-owner in each 160-acre tract in which the Company has not drilled and completed a well that is producing or capable of producing from a designated formation, or deeper formation, on January 1, 2020. The amendment also requires the Company to pay the first $9.0 million of costs incurred in connection with the construction of either an extension of the existing access road or a new access road, including the third party's 50% share. Pursuant to the terms of a further amendment effective June 2013, if by September 30, 2014, the Company does not expend $9.0 million on the construction of either the extension of the road or a new road, the Company is obligated to pay the third party 50% of the difference between $12.0 million and the actual amount expended on road construction as of such date. This deadline is subject to further extension to no later than December 31, 2014 under the terms of the amendment. Due to the need to obtain regulatory approvals, among other reasons, the Company has not yet commenced construction of either an extension of the existing access road or a new access road and may be unable to do so by the extended deadline, thus triggering the payment obligation to the third party.

Legal Matters

Department of the Interior Notice of Proposed Debarment. On June 14, 2012, the Company received a Notice of Proposed Debarment issued by the United States Department of the Interior (DOI). Pursuant to the notice, the DOI's Office of the Inspector General proposed to debar the Company from participation in certain federal contracts and assistance activities, including oil and natural gas leases, for a period of three years. The basis for the proposed debarment relates to the Company's purported noncompliance with Bureau of Land Management (BLM) regulations relating to the operation of certain equipment, and the submission of related site facility diagrams, in its Uinta operations. In 2011, the Company entered into a settlement agreement with the BLM and paid a $2.1 million civil penalty relating to the matter. The Company has contested the proposed debarment and believes the matter is without merit; nevertheless, in June 2013, the Company entered into an agreement with the DOI to resolve the matter administratively through an independent compliance review. The Company believes the compliance review will be completed during the fourth quarter of 2013.

Other. The Company is involved in various other lawsuits, claims and inquiries, most of which are routine to the nature of its business. In the opinion of management, the resolution of these matters will not have a material effect on its financial position, results of operations or operating cash flows.

Environmental Matters

The Company has no material accrued environmental liabilities for its sites, including sites in which governmental agencies have designated the Company as a potentially responsible party, because it is not probable that a loss will be incurred and the minimum cost and/or amount of loss cannot be reasonably estimated. However, due to some of the uncertainties associated with environmental assessment and remediation activities, future expense to remediate the currently identified sites, and sites identified in the future, if any, could be incurred. Management believes, based upon current site assessments, that the ultimate resolution of any matters will not result in material costs incurred.

11. LinnCo, LLC Merger

On February 20, 2013, the Company, Linn Energy, LLC (Linn), LinnCo, LLC (LinnCo), Linn Acquisition Company, LLC, a direct wholly owned subsidiary of LinnCo (LinnCo Merger Sub), Bacchus HoldCo, Inc., a direct wholly owned subsidiary of the Company (HoldCo), and Bacchus Merger Sub, Inc., a direct wholly owned subsidiary of HoldCo (Bacchus Merger Sub), entered into a definitive Agreement and Plan of Merger (the Merger Agreement), pursuant to which LinnCo agreed to acquire the Company in an all-stock transaction in which the Company's stockholders would receive 1.25 shares representing limited liability company interests in LinnCo (LinnCo Shares) for each share of the Company's common stock.

BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

11. LinnCo, LLC Merger (Continued)

The transaction will occur through multiple steps. First, the Company will engage in a holding company merger (the HoldCo Merger) involving HoldCo and Bacchus Merger Sub. In the HoldCo Merger, Bacchus Merger Sub will merge with and into the Company, with the Company surviving as a wholly owned subsidiary of HoldCo, and each issued and outstanding share of the Company's Class A common stock and Class B common stock will convert into the right to receive one equivalent share of Class A common stock and one equivalent share of Class B common stock, respectively, of HoldCo.

Second, promptly after the HoldCo Merger, the Company will be converted into a limited liability company. Third, promptly following such conversion, HoldCo will be merged with and into LinnCo Merger Sub, with LinnCo Merger Sub surviving as the surviving company (the LinnCo Merger). In the LinnCo Merger, each share of Holdco's Class A common stock and each share of Holdco's Class B common stock will be converted into 1.25 LinnCo Shares.

Finally, promptly following the LinnCo Merger, LinnCo will contribute all of the outstanding equity interests in LinnCo Merger Sub (and therefore also its indirect ownership interest in the Company) to Linn (the Contribution) in exchange for the issuance to LinnCo (the Issuance) of newly issued Linn common units. The number of Linn common units to be issued to LinnCo in the Issuance will be equal to the greater of (i) the aggregate number of LinnCo Shares issued in the LinnCo Merger and (ii) the number of Linn common units required to cause LinnCo to own no less than one-third of all of the outstanding Linn common units following the Contribution. In addition, for three years following the closing, Linn will pay to LinnCo additional cash distributions in the amount of $6 million per year.

The closing of the transactions is subject to customary closing conditions, including approval of the Merger Agreement and the transactions contemplated thereby by the stockholders of the Company and the holders of the shares or units of LinnCo and Linn, respectively, receipt of certain opinions by the parties with respect to the tax-free nature of the transactions, and other customary conditions. The closing will not occur on or prior to October 31, 2013 (the End Date), and any of the Company, Linn, or LinnCo may unilaterally terminate the Merger Agreement after the End Date. There can be no assurances as to whether the parties will agree to extend the End Date or that the parties will refrain from exercising their rights to terminate the Merger Agreement.

On March 21, 2013, a purported stockholder class action captioned Nancy P. Assad Trust v. Berry Petroleum Co., et al. was filed in the District Court for the City and County of Denver, Colorado, No. 13-CV-31365. The action names as defendants the Company, the members of its board of directors, HoldCo, Bacchus Merger Sub, LinnCo, LINN and LinnCo Merger Sub. On April 5, 2013, an amended complaint was filed, which alleges that the individual defendants breached their fiduciary duties in connection with the transactions by engaging in an unfair sales process that resulted in an unfair price for the Company, by failing to disclose all material information regarding the transactions, and that the entity defendants aided and abetted those breaches of fiduciary duty. The amended complaint seeks a declaration that the transactions are unlawful and unenforceable, an order directing the individual defendants to comply with their fiduciary duties, an injunction against consummation of the transactions, or, in the event they are completed, rescission of the transactions, an award of fees and costs, including attorneys’ and experts’ fees and expenses, and other relief. On May 21, 2013, the Colorado District Court stayed and administratively closed the Nancy P. Assad Trust action in favor of the Hall action described below that is pending in the Delaware Court of Chancery. On July 19, 2013, the plaintiffs in the Nancy P. Assad Trust action voluntarily dismissed the case without prejudice.

On April 12, 2013, a purported stockholder class action captioned David Hall v. Berry Petroleum Co., et al. was filed in the Delaware Court of Chancery, C.A. No. 8476-VCG. The complaint names as defendants the Company, the members of its board of directors, HoldCo, Bacchus Merger Sub, LinnCo, LINN and LinnCo Merger Sub. The complaint alleges that the individual defendants breached their fiduciary duties in connection with the transactions by engaging in an unfair sales process that resulted in an unfair price for the Company, by failing to disclose all material information regarding the transactions, and that the entity defendants aided and abetted those breaches of fiduciary duty. The complaint seeks a declaration that the transactions are unlawful and unenforceable, an order directing the individual defendants to comply with their fiduciary duties, an injunction against consummation of the transactions, or, in the event they are completed, rescission of the transactions, an award of fees and costs, including attorneys’ and experts’ fees and expenses, and other relief. The Company is unable to estimate a possible loss, or range of possible losses, if any, at this time. The Company believes the claims relating to the merger are without merit, and intends to defend such actions vigorously.

BERRY PETROLEUM COMPANY

Notes to Condensed Financial Statements (Continued)

(Unaudited)

12. Subsequent Event

Credit Facility Amendment

On October 22, 2013, as part of the semi-annual borrowing base redetermination process, the Company entered into the Sixth Amendment to its Second Amended and Restated Credit Agreement by and among the Company, Wells Fargo Bank, N.A., as administrative agent, and the lenders party thereto (the Sixth Amendment). Among other things, the Sixth Amendment eliminates the requirement that the maturity date for borrowings under the Company's credit facility would be accelerated to February 28, 2014 if the Company's 2014 Notes have not been refinanced by such date. In addition, the Sixth Amendment eliminates the leverage and pro forma liquidity tests that the Company would otherwise be required to meet under the credit facility in order to refinance the 2014 Notes. The amendment did not result in any changes to the Company's borrowing base or lender commitments under the credit facility.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is management's discussion and analysis of certain significant factors that have affected aspects of our financial position and the results of operations during the periods included in the accompanying Condensed Financial Statements. The following discussion and analysis should be read in conjunction with the discussion under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited Financial Statements for the year ended December 31, 2012, included in our Annual Report on Form 10-K and the Condensed Financial Statements included elsewhere herein.

Our revenue, profitability and future growth rate depend on many factors beyond our control, such as economic, political and regulatory developments and competition from other sources of energy. Oil and natural gas prices have been volatile and may fluctuate widely in the future. The following charts highlight the quarterly average NYMEX price trends for crude oil and natural gas since the first quarter of 2010:

Lower oil and natural gas prices may not only decrease our revenues, but may also reduce the amount of oil and natural gas that we can produce economically and therefore potentially lower our oil and natural gas reserves. A substantial or extended decline in oil or natural gas prices may result in impairments of our proved oil and natural gas properties and may materially and adversely affect our future business, financial condition, results of operations, operating cash flows, liquidity or ability to finance planned capital expenditures. Lower oil and natural gas prices may also reduce the amount of our borrowing base under our credit agreement, which is determined at the discretion of the lenders and is based on the collateral value of our proved reserves that have been mortgaged to the lenders. Alternatively, higher oil prices may result in significant non-cash fair value losses being incurred on our oil derivatives, which could cause us to experience net losses when prices rise.

Steam costs are a significant variable component of our operating costs and fluctuate based on the amount of steam we inject and the price of natural gas used to generate steam. We benefit from lower natural gas prices as a consumer of natural gas in our California operations. In the Permian, Uinta, E. Texas and Piceance, we benefit from higher natural gas pricing as a producer of natural gas. In addition, production rates, labor and equipment costs, maintenance expenses and production taxes influence our operating costs. Our results of operations may fluctuate from period to period based on such factors.

LinnCo, LLC Merger

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Following the execution of the Merger Agreement, the Company entered into certain derivative transactions with respect to our production. See Item 3. Quantitative and Qualitative Disclosures About Market Risk for additional information.

On April 12, 2013, a purported stockholder class action captioned David Hall v. Berry Petroleum Co., et al. was filed in the Delaware Court of Chancery, C.A. No. 8476-VCG. The complaint names as defendants the Company, the members of its board of directors, HoldCo, Bacchus Merger Sub, LinnCo, LINN and LinnCo Merger Sub. The complaint alleges that the individual defendants breached their fiduciary duties in connection with the transactions by engaging in an unfair sales process that resulted in an unfair price for the Company, by failing to disclose all material information regarding the transactions, and that the entity defendants aided and abetted those breaches of fiduciary duty. The complaint seeks a declaration that the transactions are unlawful and unenforceable, an order directing the individual defendants to comply with their fiduciary duties, an injunction against consummation of the transactions, or, in the event they are completed, rescission of the transactions, an award of fees and costs, including attorneys’ and experts’ fees and expenses, and other relief. The Company is unable to estimate a possible loss, or range of possible loss, if any, at this time. The Company believes the claims relating to the merger are without merit, and intends to defend such actions vigorously.

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Notable Third Quarter 2013 Items


•	Generated discretionary cash flow of $172.9 million from production of 41,413 BOE/D, of which 80% was oil⁽¹⁾


•	Generated an operating margin of $51.45 per BOE⁽¹⁾


•	Increased total production and oil production by 5% from the second quarter of 2013


•	Increased total production by 14% and oil production by 20% from the third quarter of 2012


•	Diatomite production averaged 5,260 BOE/D, an 11% increase from the second quarter of 2013


•	Production from our North Midway-Sunset—New Steam Floods (NMWSS—NSF) properties, which include McKittrick, averaged 3,290 BOE/D, a 24% increase from the second quarter of 2013


•	Uinta production averaged 8,055 BOE/D, a 10% increase from the second quarter of 2013


•	Drilled 35 Diatomite wells, 32 Uinta wells, 11 Permian wells and 18 South Midway-Sunset—Steam Floods (SMWSS—Steam Floods) wells

Notable Items and Expectations for the Fourth Quarter and Full Year 2013


•	Expect to drill approximately 35 Diatomite wells, 19 NMWSS—NSF steam injection wells, 36 Uinta wells and ten Permian wells during the fourth quarter of 2013


•	Expect full-year 2013 development capital of approximately $600 million


•	Expect full-year 2013 production of between 40,500 and 40,800 BOE/D, comprised of approximately 80% oil

________________


(1)	Discretionary cash flow and operating margin are considered non-GAAP measures and reference should be made to "Reconciliation of Non-GAAP Measures" for further explanation as well as reconciliations to the most directly comparable GAAP measures.

Results of Operations.

In the third quarter of 2013, we reported net earnings of $28.2 million, or $0.50 per diluted share, and net cash provided by operating activities of $173.3 million. Net earnings in the third quarter of 2013 included a loss on derivatives of $24.6 million, net of income taxes, resulting from non-cash changes in fair values. For the first nine months of 2013, we reported net earnings of $122.0 million, or $2.19 per diluted share, and net cash provided by operating activities of $405.3 million. Net earnings for the first nine months of 2013 included a loss on derivatives of $6.0 million resulting from non-cash changes in fair values, lease write offs of $1.5 million and professional fees of $1.6 million associated with the pending LinnCo merger, in each case net of income taxes.

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Operating Data.

The following table sets forth selected operating data for the three months ended:



	September 30, 2013			%	September 30, 2012			%	June 30, 2013			%
Heavy oil production (BOE/D)	20,824			50	18,149			50	19,775			50
Light oil production (BOE/D)	12,173			30	9,344			26	11,681			30
Total oil production (BOE/D)	32,997			80	27,493			76	31,456			80
Natural gas production (Mcf/D)	50,494			20	52,758			24	48,436			20
Total (BOE/D)(1)	41,413			100	36,286			100	39,529			100
Oil and natural gas, per BOE:
Average realized sales price	$	79.83			$	70.22			$	74.91
Average sales price including cash derivative settlements	$	78.34			$	71.45			$	75.58
Oil, per BOE:
Average WTI price	$	105.81			$	92.20			$	94.17
Price sensitive royalties(2)	(2.59		)		(3.12		)		(2.64		)
Location differential and other(3)	(8.75		)		(0.68		)		(4.00		)
Oil derivatives non-cash amortization(4)	—				(1.10		)		—
Oil revenue	$	94.47			$	87.30			$	87.53
Add: Oil derivatives non-cash amortization(4)	—				1.10				—
Oil derivative cash settlements(5)	(1.88		)		0.64				0.70
Average realized oil price	$	92.59			$	89.04			$	88.23
Natural gas price:
Average Henry Hub price per MMBtu	$	3.58			$	2.80			$	4.10
Conversion to Mcf	0.25				0.19				0.28
Natural gas derivatives non-cash amortization(4)	—				0.02				—
Location differential and other	(0.18		)		(0.13		)		(0.29		)
Natural gas revenue per Mcf	$	3.65			$	2.88			$	4.09
Add: Natural gas derivatives non-cash amortization(4)	—				(0.02		)		—
Natural gas derivative cash settlements(5)	0.02				(0.04		)		0.09
Average realized natural gas price per Mcf	$	3.67			$	2.82			$	4.18

__________________________________


(1)	Oil equivalents are determined using the ratio of six Mcf of natural gas to one barrel of oil.

(2)

Our Formax property in SMWSS—Steam Floods is subject to a price-sensitive royalty burden. The royalty is 53% of the amount of the heavy oil posted price above the 2013 base price of $17.78 per barrel as long as we maintain a minimum steam injection level. We met the steam injection level in the third quarter of 2013 and expect to meet the requirement going forward. The base price escalates at 2% annually and will be $18.14 in 2014.


(3)	In California, the per barrel oil posting differential at September 30, 2013 was ($3.99), ranged from $1.58 to ($3.99) during the third quarter of 2013 and averaged ($2.38) during the third quarter of 2013. In Utah, the per barrel oil posting differential during the third quarter of 2013 was ($16.50).


(4)	Non-cash amortization of accumulated other comprehensive loss (AOCL) resulting from discontinuing hedge accounting effective January 1, 2010. Recorded in the Condensed Statements of Operations under the caption oil and natural gas sales. At December 31, 2012, the entire balance of AOCL had been reclassified into earnings.


(5)	Cash settlements on derivatives are recorded in the Condensed Statements of Operations under the caption realized and unrealized loss (gain) on derivatives, net.

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The following table sets forth selected operating data for the nine months ended:



	September 30, 2013			%	September 30, 2012			%
Heavy oil production (BOE/D)	20,060			50	17,519			50
Light oil production (BOE/D)	11,816			29	8,781			24
Total oil production (BOE/D)	31,876			79	26,300			74
Natural gas production (Mcf/D)	50,018			21	54,372			26
Total (BOE/D)(1)	40,212			100	35,362			100
Oil and natural gas, per BOE:
Average realized sales price	$	76.73			$	71.18
Average sales price including cash derivative settlements	$	76.66			$	72.08
Oil, per BOE:
Average WTI price	$	98.20			$	96.16
Price sensitive royalties(2)	(2.68		)		(3.62		)
Location differential and other(3)	(4.69		)		(1.00		)
Oil derivatives non-cash amortization(4)	—				(1.12		)
Oil revenue	$	90.83			$	90.42
Add: Oil derivatives non-cash amortization(4)	—				1.12
Oil derivative cash settlements(5)	(0.14		)		(0.50		)
Average realized oil price	$	90.69			$	91.04
Natural gas price:
Average Henry Hub price per MMBtu	$	3.67			$	2.58
Conversion to Mcf	0.26				0.17
Natural gas derivatives non-cash amortization(4)	—				0.01
Location differential and other	(0.20		)		(0.18		)
Natural gas revenue per Mcf	$	3.73			$	2.58
Add: Natural gas derivatives non-cash amortization(4)	—				(0.01		)
Natural gas derivative cash settlements(5)	0.03				0.29
Average realized natural gas price per Mcf	$	3.76			$	2.86

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(1)	Oil equivalents are determined using the ratio of six Mcf of natural gas to one barrel of oil.

(2)

(3)

In California, the per barrel oil posting differential at September 30, 2013 was ($3.99), ranged from $11.02 to ($3.99) during the first nine months of 2013 and averaged $4.16 during the first nine months of 2013. In Utah, the per barrel oil posting differential at September 30, 2013 was ($16.50), ranged from ($14.50) to ($16.50) during the first nine months of 2013 and averaged ($16.23) during the first nine months of 2013.


(4)	Non-cash amortization of AOCL resulting from discontinuing hedge accounting effective January 1, 2010. Recorded in the Condensed Statements of Operations under the caption oil and natural gas sales. At December 31, 2012, the entire balance of AOCL had been reclassified into earnings.


(5)	Cash settlements on derivatives are recorded in the Condensed Statements of Operations under the caption realized and unrealized loss (gain) on derivatives, net.

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The following table sets forth results of operations (in thousands except per share data) for the three month periods ended:



	September 30, 2013		September 30, 2012		3Q12 to 3Q13 Change		June 30, 2013		2Q13 to 3Q13 Change
Oil sales	$	289,217	$	218,952	32	%	$	256,682	13	%
Natural gas sales	16,966		13,964		21	%	18,033		(6	)%
Total oil and natural gas sales	$	306,183	$	232,916	31	%	$	274,715	11	%
Electricity sales	10,046		9,514		6	%	9,513		6	%
Natural gas marketing	1,916		1,939		(1	)%	2,255		(15	)%
Gain on sale of assets	—		170		(100	)%	—		—	%
Interest and other income, net	249		286		(13	)%	374		(33	)%
Total revenues and other income	$	318,394	$	244,825	30	%	$	286,857	11	%
Net earnings	$	28,178	$	18,126	55	%	$	61,364	(54	)%
Diluted earnings per share	$	0.50	$	0.33	52	%	$	1.10	(55	)%

The following table sets forth results of operations (in thousands except per share data) for the nine month periods ended:



	September 30, 2013		September 30, 2012		% Change
Oil sales	$	796,676	$	649,922	23	%
Natural gas sales	50,994		38,428		33	%
Total oil and natural gas sales	$	847,670	$	688,350	23	%
Electricity sales	27,148		21,354		27	%
Natural gas marketing	6,198		5,378		15	%
Gain on sale of assets	23		1,770		(99	)%
Interest and other income, net	1,098		1,678		(35	)%
Total revenues and other income	$	882,137	$	718,530	23	%
Net earnings	$	121,976	$	133,040	(8	)%
Diluted earnings per share	$	2.19	$	2.39	(8	)%

Oil and Natural Gas Sales.

Oil and natural gas sales increased $73.3 million, or 31%, to $306.2 million in the third quarter of 2013 compared to the same period in 2012. The increase was primarily due to an increase in oil sales volumes between periods. Our oil sales volumes increased 22% in the third quarter of 2013 compared to the same period in 2012, while our natural gas sales volumes decreased 4%. The oil sales volume increase was primarily due to increased oil production from all of our oil properties with the exception of SMWSS—Steam Floods, which declined marginally as expected. Diatomite oil production in the third quarter of 2013 increased 1,760 BOE/D, or 50%, Uinta oil production increased 1,555 BOE/D, or 44%, NMWSS—NSF oil production increased 1,365 BOE/D, or 71%, and Permian oil production increased 1,345 BOE/D, or 24%, in each case compared to the same period in 2012. The decrease in natural gas sales volumes was primarily due to expected production declines from our E. Texas and Piceance properties, partially offset by increased natural gas production from our other natural gas producing properties. In addition to increased oil production, a 14% increase in the average realized sales price, largely due to an 8% increase in realized oil prices and a 27% increase in realized natural gas prices, contributed to the increase in oil and natural gas sales in the third quarter of 2013 from the third quarter of 2012.

Oil and natural gas sales increased $31.5 million, or 11%, to $306.2 million in the third quarter of 2013 compared to the second quarter of 2013. The increase was primarily due to a 7% increase in the average realized sales price between periods, largely due to an 8% increase in the average realized oil price. In addition, our oil sales volumes increased 4% between periods primarily due to increased oil production from all of our oil properties with the exception of SMWSS—Steam Floods, which declined marginally as expected. NMWSS—NSF oil production in the third quarter of 2013 increased 640 BOE/D, or 24%, Diatomite oil production increased 530 BOE/D, or 11%, Permian oil production increased 360 BOE/D, or 5%, and Uinta oil

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production increased 165 BOE/D, or 3%, in each case compared to the second quarter of 2013. The decrease in natural gas sales volumes was primarily due to expected field decline in E. Texas and the Piceance.

Oil and natural gas sales increased $159.3 million, or 23%, to $847.7 million in the nine months ended September 30, 2013 compared to the same period in 2012. The increase was primarily due to a 22% increase in the oil sales volume between periods, while our natural gas sales volumes decreased 8%. The oil sales volume increase was primarily due to increased oil production from all of our oil properties with the exception of SMWSS—Steam Floods, which declined marginally as expected. Diatomite oil production in the nine months ended September 30, 2013 increased 1,655 BOE/D, or 54%, Uinta oil production increased 1,580 BOE/D, or 48%, Permian oil production increased 1,535 BOE/D, or 29%, and NMWSS—NSF oil production increased 1,040 BOE/D, or 60%, in each case compared to the same period in 2012. The decrease in natural gas sales volumes was primarily due to expected production declines from our E. Texas and Piceance properties, partially offset by increased natural gas production from our other properties. In addition to increased oil production, an 8% increase in the average sales price, primarily due to a 45% increase in realized natural gas prices contributed to the increase in oil and natural gas sales in the nine months ended September 30, 2013 from the same period in 2012.

Electricity Sales.

The following table sets forth selected results of operations for the periods ended:



	Three Months Ended						Nine Months Ended
	September 30, 2013		September 30, 2012		June 30, 2013		September 30, 2013		September 30, 2012
Electricity
Electricity sales (in thousands)	$	10,046	$	9,514	$	9,513	$	27,148	$	21,354
Operating costs—electricity generation (in thousands)	$	5,401	$	4,727	$	6,337	$	17,034	$	14,000
Electric power produced (MWh/D)	1,793		2,146		1,957		1,922		2,099
Electric power sold (MWh/D)	1,720		1,939		1,772		1,781		1,919
Average sales price per MWh	$	63.30	$	53.34	$	58.98	$	55.52	$	40.62
Fuel gas cost per MMBtu (including transportation)	$	3.60	$	2.97	$	3.95	$	3.70	$	2.68
Estimated natural gas volumes consumed to produce electricity (MMBtu/D)(1)	13,192		15,417		14,612		14,181		15,187

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(1)	Estimate is based on the historical allocation of fuel costs to electricity.

Electricity sales in the third quarter of 2013 increased 6% compared to the third quarter of 2012 primarily due to a 19% increase in the average sales price of electricity, partially offset by an 11% decrease in electric power sold. Electricity operating costs in the third quarter of 2013 increased 14% compared to the third quarter of 2012 largely due to a 21% increase in fuel gas cost, partially offset by a 16% decrease in electric power produced primarily due to with the shut down of one of our three cogeneration facilities for unscheduled maintenance in August and September 2013.

Electricity sales in the third quarter of 2013 increased 6% compared to the second quarter of 2013, primarily due to a 7% increase in the average sales price of electricity partially offset by a 3% decrease in electric power sold. Electricity operating costs in the third quarter of 2013 decreased 15% compared to the second quarter of 2013 due to a 9% decrease in fuel gas cost and an 8% decrease in electric power produced, primarily due to the shut down of one of our three cogeneration facilities for unscheduled maintenance in August and September 2013.

Electricity sales in the nine months ended September 30, 2013 increased 27% compared to the nine months ended September 30, 2012 primarily due to a 37% increase in the average sales price of electricity, partially offset by a 7% decrease in electric power sold. Electricity operating costs in the nine months ended September 30, 2013 increased 22% compared to the nine months ended September 30, 2012 primarily due to a 38% increase in fuel gas cost, partially offset by an 8% decrease in electric power produced.

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Electricity Sales Contracts. We sell electricity produced by our cogeneration facilities under long-term contracts approved by the California Public Utilities Commission (CPUC) to two California investor owned utilities (IOUs): Southern California Edison Company (Edison) and Pacific Gas and Electric Company (PG&E). Under these power purchase agreements (PPAs), we are paid an energy payment that reflects the utility's Short Run Avoided Cost (SRAC) of energy plus a capacity payment that reflects a recovery of capital expenditures that would otherwise have been made by the utility. Beginning in 2015, the energy prices we will be paid under the contracts for our Cogen 18 and Cogen 38 facilities will be based on market prices for electricity in California.

Our legacy PPAs for our Cogen 42 facilities expired in May 2012, at which time a transition PPA with Edison became effective. The transition PPA will terminate on July 1, 2014, upon the effectiveness of a seven-year contract for our Cogen 42 facilities pursuant to a competitive solicitation (the RFO PPA).

Our legacy PPA for our Cogen 38 facility expired in March 2012, at which time a transition PPA with PG&E became effective. We intend to participate in future competitive solicitations for the sale of energy and capacity from our Cogen 38 facility, although there is no assurance we will be successful in entering into a new RFO PPA for this facility. Our transition PPA with PG&E will remain in effect until June 2015.

Our legacy PPA with PG&E for our Cogen 18 facility terminated on September 30, 2012 and was replaced with a new Public Utilities Regulatory Policy Act of 1978, as amended (PURPA) PPA with PG&E, effective October 1, 2012, for a term of seven years. Because the rated capacity of our Cogen 18 facility is less than 20 MW, it continues to be eligible for PPAs pursuant to PURPA.

Under the PURPA PPA for our Cogen 18 facility and the transition PPAs for our Cogen 38 and Cogen 42 facilities, we will be paid the CPUC-determined SRAC energy price and a combination of firm and "as-available" capacity payments. Under the RFO PPA for our Cogen 42 facility, we will be paid a negotiated energy and capacity price stipulated in the contract.

The following table summarizes our cogeneration facilities and related contract information as of September 30, 2013:



Facility	Type of Contract	Purchaser	Contract Expiration
Cogen 42	Transition	Edison	Jul 2014(1)
Cogen 18	PURPA	PG&E	Sept 2019
Cogen 38	Transition	PG&E	Jun 2015(2)

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(1)	A new seven-year RFO PPA with Edison will be effective on July 1, 2014.


(2)	We anticipate the current contract will be replaced by a long-term contract with a term of up to seven years pursuant to a future competitive solicitation.

Natural Gas Marketing.

We have long-term firm transportation contracts on the Rockies Express, Wyoming Interstate Company, and Ruby pipelines, each with a total average capacity of 35,000 MMBtu/D. Demand charges for our capacity are reflected in operating costs—oil and natural gas production in our Condensed Statements of Operations. Our current production is insufficient to fully utilize this capacity. To optimize our remaining capacity, we purchase third-party natural gas at the market rate in our producing areas and utilize FERC-approved asset management agreements. Sales and purchases of third-party natural gas are recorded under natural gas marketing in the revenues and expenses sections of the Condensed Statements of Operations, respectively. The pre-tax net earnings of natural gas marketing operations for the three months ended September 30, 2013 and 2012 were $0.0 million and $0.2 million, respectively. The pre-tax net earnings of natural gas marketing operations for the nine months ended September 30, 2013 and 2012 was $0.2 million and $0.5 million, respectively.

Gain on Sale of Assets.

In the third quarter of 2012, we recorded a $0.2 million gain in conjunction with the sale of our three drilling rigs, which had previously been impaired and recorded at fair value less cost to sell. In the first quarter of 2012, we recorded a $1.6 million gain in conjunction with the sale of our Nevada Assets. These gains were recorded in the Condensed Statements of Operations under the caption gain on sale of assets.

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Oil and Natural Gas Operating and Other Expenses.

The following table sets forth our operating expenses for the three months ended:



	Amount Per BOE						Amount (in thousands)
	September 30, 2013		September 30, 2012		June 30, 2013		September 30, 2013		September 30, 2012		June 30, 2013
Operating costs—oil and natural gas production(1)	$	23.99	$	21.17	$	25.37	$	91,416	$	70,670	$	91,277
Production taxes	2.90		2.91		3.06		11,060		9,700		11,004
DD&A—oil and natural gas production	19.16		17.64		19.42		73,011		58,887		69,839
General and administrative	4.68		5.32		5.40		17,834		17,767		19,430
Interest expense	6.56		6.16		6.92		24,996		20,572		24,879
Total	$	57.29	$	53.20	$	60.17	$	218,317	$	177,596	$	216,429

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(1)	Operating costs—oil and natural gas production includes firm transportation costs of $8.7 million and $7.4 million for the three months ended September 30, 2013 and 2012, respectively, and $8.3 million for the three months ended June 30, 2013.


•	Operating costs—oil and natural gas production in the third quarter of