Laredo Petroleum Holdings 2Q13


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
 ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2013
 or
 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: 001-35380
 Laredo Petroleum Holdings, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
 (State or Other Jurisdiction of
Incorporation or Organization)
 
45-3007926
 (I.R.S. Employer
Identification No.)
15 W. Sixth Street, Suite 1800
 
 
Tulsa, Oklahoma
 
74119
(Address of Principal Executive Offices)
 
(Zip code)
(918) 513-4570
(Registrant’s Telephone Number, Including Area Code)
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 ý  No o
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 (Section 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 ý  No o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer o
 
Accelerated filer x
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No ý 
Number of shares of registrant’s common stock outstanding as of August 5, 2013: 129,503,049




TABLE OF CONTENTS 
 
 
Page
Cautionary Statement Regarding Forward-Looking Statements
 
Part I
 
Item 1.
Consolidated Financial Statements (Unaudited)
 
Consolidated balance sheets as of June 30, 2013 and December 31, 2012
 
Consolidated statements of operations for the three and six months ended June 30, 2013 and 2012
 
Consolidated statement of stockholders’ equity for the six months ended June 30, 2013
 
Consolidated statements of cash flows for the six months ended June 30, 2013 and 2012
 
Condensed notes to the consolidated financial statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
 
Part II
 
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Signatures
Exhibit Index
 

ii


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Various statements contained in or incorporated by reference into this Quarterly Report on Form 10-Q (this "Quarterly Report") are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended , and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements include statements, projections and estimates concerning our operations, performance, business strategy, oil and natural gas reserves, drilling program capital expenditures, liquidity and capital resources, the timing and success of specific projects, outcomes and effects of litigation, claims and disputes, derivative activities and potential financing. Forward-looking statements are generally accompanied by words such as "estimate," "project," "predict," "believe," "expect," "anticipate," "potential," "could," "may," "will," "foresee," "plan," "goal," "should," "intend," "pursue," "target," "continue," "suggest" or other words that convey the uncertainty of future events or outcomes. Forward-looking statements are not guarantees of performance. These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate under the circumstances. Among the factors that significantly impact our business and could impact our business in the future are:
the ongoing instability and uncertainty in the U.S. and international financial and consumer markets that is adversely affecting the liquidity available to us and our customers and is adversely affecting the demand for commodities, including oil and natural gas;
volatility of oil and natural gas prices;
the possible introduction of regulations that prohibit or restrict our ability to apply hydraulic fracturing to our oil and natural gas wells;
discovery, estimation, development and replacement of oil and natural gas reserves, including our expectations that estimates of our proved reserves will increase;
uncertainties about the estimates of our oil and natural gas reserves;
competition in the oil and natural gas industry;
the availability and costs of drilling and production equipment, labor, and oil and natural gas processing and other services;
drilling and operating risks, including risks related to hydraulic fracturing activities;
risks related to the geographic concentration of our assets;
changes in domestic and global demand for oil and natural gas;
the availability of sufficient pipeline and transportation facilities and gathering and processing capacity;
changes in the regulatory environment or changes in international, legal, political, administrative or economic conditions;
our ability to comply with federal, state and local regulatory requirements;
our ability to execute our strategies, including but not limited to our hedging strategies;
our ability to recruit and retain the qualified personnel necessary to operate our business;
evolving industry standards and adverse changes in global economic, political and other conditions;
restrictions contained in our debt agreements, including our senior secured credit facility and the indentures governing our senior unsecured notes, as well as debt that could be incurred in the future;
our ability to access additional borrowing capacity under our senior secured credit facility or other means of providing liquidity; and
our ability to generate sufficient cash to service our indebtedness and to generate future profits.
These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Forward-looking statements should, therefore, be considered in light of various factors, including those set forth under “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations”, "Part II, Item 1A. Risk Factors" and elsewhere in this Quarterly Report and under “Part I, Item 1A. Risk Factors” and “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. In light of such risks and uncertainties, we caution you not to place undue reliance on these forward-looking statements. These forward-looking statements speak only as of the date of this Quarterly Report, or if earlier, as of the date they were made. We do not intend to, and disclaim any obligation to, update or revise any forward-looking statements unless required by securities law.

iii



PART I

Item 1.    Consolidated Financial Statements (Unaudited)

Laredo Petroleum Holdings, Inc.
Consolidated balance sheets
(in thousands, except share data)
(Unaudited)
 
 
June 30, 2013
 
December 31, 2012
Assets
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
43,588

 
$
33,224

Accounts receivable, net
 
89,852

 
83,424

Derivative financial instruments
 
7,073

 
4,644

Deferred income taxes
 
9,897

 
12,713

Restricted deposits on pending sale
 
44,000

 

Other current assets
 
4,886

 
3,016

Current assets held for sale
 
579

 
416

Total current assets
 
199,875

 
137,437

Property and equipment:
 
 
 
 

Oil and natural gas properties, full cost method:
 
 
 
 

Proved properties
 
3,350,367

 
2,993,266

Unproved properties not being amortized
 
146,505

 
159,946

Pipeline and gas gathering assets
 
29,871

 
23,065

Other fixed assets
 
31,921

 
23,669

 
 
3,558,664

 
3,199,946

Less accumulated depreciation, depletion, amortization and impairment
 
1,261,518

 
1,130,867

Property and equipment held for sale, net of accumulated depreciation
 
45,698

 
44,812

Net property and equipment
 
2,342,844

 
2,113,891

Deferred income taxes
 
31,131

 
49,916

Derivative financial instruments
 
8,487

 
2,058

Deferred loan costs, net
 
27,530

 
29,444

Investment in equity method investee
 
3,174

 

Other assets, net
 
4,183

 
5,305

Noncurrent assets held for sale
 
389

 
253

Total assets
 
$
2,617,613

 
$
2,338,304

Liabilities and stockholders’ equity
 
 
 
 

Current liabilities:
 
 
 
 

Accounts payable
 
$
31,378

 
$
47,560

Undistributed revenue and royalties
 
35,015

 
31,988

Accrued capital expenditures
 
87,720

 
121,612

Accrued compensation and benefits
 
10,025

 
10,318

Derivative financial instruments
 
5,484

 
1,325

Accrued interest payable
 
26,426

 
26,106

Restricted deposits on pending sale
 
44,000

 

Other current liabilities
 
18,756

 
17,263

Current liabilities held for sale
 
6,112

 
5,896

Total current liabilities
 
264,916

 
262,068

Long-term debt
 
1,446,651

 
1,216,760

Derivative financial instruments
 
542

 
3,260

Asset retirement obligations
 
15,319

 
13,610

Other noncurrent liabilities
 
5,064

 
2,333

Noncurrent liabilities held for sale
 
9,416

 
8,550

Total liabilities
 
1,741,908

 
1,506,581

Stockholders’ equity:
 
 

 
 

Preferred stock, $0.01 par value, 50,000,000 shares authorized and zero issued at June 30, 2013 and December 31, 2012
 

 

Common stock, $0.01 par value, 450,000,000 shares authorized, and 129,416,611 and 128,298,559 issued, net of treasury, at June 30, 2013 and December 31, 2012, respectively
 
1,294

 
1,283

Additional paid-in capital
 
968,174

 
961,424

Accumulated deficit
 
(93,759
)
 
(130,980
)
Treasury stock, at cost, 7,609 common shares at June 30, 2013 and December 31, 2012
 
(4
)
 
(4
)
Total stockholders’ equity
 
875,705

 
831,723

Total liabilities and stockholders’ equity
 
$
2,617,613

 
$
2,338,304


The accompanying notes are an integral part of these unaudited consolidated financial statements.


1



Laredo Petroleum Holdings, Inc.
Consolidated statements of operations
(in thousands, except per share data)
(Unaudited)
 
 
Three months ended June 30,

Six months ended June 30,
 
 
2013

2012

2013

2012
Revenues:
 
 
 
 
 
 

 
 

Oil and natural gas sales
 
$
177,048


$
139,609


$
340,673


$
288,560

Natural gas transportation and treating
 
248


106


328


167

Total revenues
 
177,296


139,715


341,001


288,727

Costs and expenses:
 
 
 
 
 
 
 
 
Lease operating expenses
 
22,185


15,660


44,627


30,644

Production and ad valorem taxes
 
9,722


7,318


21,167


16,237

Natural gas transportation and treating
 
239

 
14

 
347

 
57

Drilling and production
 
597

 
269

 
1,271

 
1,486

General and administrative (including non-cash stock-based compensation of $4,463 and $2,588 for the three months ended June 30, 2013 and 2012, respectively, and $7,680 and $4,835 for the six months ended June 30, 2013 and 2012, respectively)
 
20,495

 
14,410

 
40,129

 
31,941

Accretion of asset retirement obligations
 
410

 
292

 
804

 
556

Depreciation, depletion and amortization
 
66,234


60,063


130,737


110,972

Total costs and expenses
 
119,882

 
98,026

 
239,082

 
191,893

Operating income
 
57,414

 
41,689

 
101,919

 
96,834

Non-operating income (expense):
 
 
 
 
 
 
 
 
Realized and unrealized gain (loss):
 
 
 
 
 
 
 
 
Commodity derivative financial instruments, net
 
23,975


28,543


7,121


29,137

Interest rate derivatives, net
 
(9
)



(15
)

(323
)
Loss from equity method investee
 
(49
)



(113
)


Interest expense
 
(25,943
)

(21,674
)

(51,292
)

(36,358
)
Interest and other income
 
12


15


27


31

Loss on disposal of assets
 
(59
)

(8
)

(59
)

(8
)
Non-operating income (expense), net
 
(2,073
)
 
6,876

 
(44,331
)
 
(7,521
)
Income from continuing operations before income taxes
 
55,341

 
48,565

 
57,588

 
89,313

Income tax expense:
 
 
 
 
 
 
 
 
Deferred
 
(20,047
)

(17,484
)

(21,157
)

(32,153
)
Total income tax expense
 
(20,047
)
 
(17,484
)
 
(21,157
)
 
(32,153
)
Income from continuing operations
 
35,294

 
31,081

 
36,431

 
57,160

Income (loss) from discontinued operations, net of tax
 
518


(106
)

790


50

Net income
 
$
35,812

 
$
30,975

 
$
37,221

 
$
57,210

Net income per common share:
 
 
 
 
 
 

 
 
Basic:
 
 
 
 
 
 

 


Income from continuing operations
 
$
0.28


$
0.24


$
0.29


$
0.45

Income (loss) from discontinued operations
 




0.01



Net income per share
 
$
0.28

 
$
0.24

 
$
0.30

 
$
0.45

Diluted:
 


 


 
 

 
 

Income from continuing operations
 
$
0.27


$
0.24


$
0.28

 
$
0.45

Income (loss) from discontinued operations
 




0.01

 

Net income per share
 
$
0.27

 
$
0.24

 
$
0.29

 
$
0.45

Weighted average common shares outstanding:
 
 
 
 
 
 

 
 

Basic
 
127,362


126,921


127,281

 
126,862

Diluted
 
129,384


128,222


129,119

 
128,101

 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

2



Laredo Petroleum Holdings, Inc.
Consolidated statement of stockholders’ equity
(in thousands)
(Unaudited) 
 
 
Common Stock
 
Additional
paid-in capital
 
Treasury Stock
(at cost)
 
Accumulated deficit
 
 
 
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
Total
Balance, December 31, 2012
 
128,298

 
$
1,283

 
$
961,424

 
8

 
$
(4
)
 
$
(130,980
)
 
$
831,723

Restricted stock awards
 
1,306

 
13

 
(13
)
 

 

 

 

Restricted stock forfeitures
 
(138
)
 
(2
)
 
2

 

 

 

 

Vested restricted stock exchanged for tax withholding
 

 

 

 
50

 
(919
)
 

 
(919
)
Retirement of treasury stock
 
(50
)
 

 
(919
)
 
(50
)
 
919

 

 

Stock-based compensation
 

 

 
7,680

 

 

 

 
7,680

Net income
 

 

 

 

 

 
37,221

 
37,221

Balance, June 30, 2013
 
129,416

 
$
1,294

 
$
968,174

 
8

 
$
(4
)
 
$
(93,759
)
 
$
875,705

 
The accompanying notes are an integral part of this unaudited consolidated financial statement.

3



Laredo Petroleum Holdings, Inc.
Consolidated statements of cash flows
(in thousands)
(Unaudited)
 
Six months ended June 30,
 
2013
 
2012
Cash flows from operating activities:
 

 
 

Net income
$
37,221


$
57,210

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Deferred income tax expense
21,601


32,181

Depreciation, depletion and amortization
131,364


112,220

Non-cash stock-based compensation
7,680


4,835

Accretion of asset retirement obligations
804


556

Unrealized gain on derivative financial instruments, net
(2,449
)

(16,929
)
Premiums paid for derivative financial instruments
(5,249
)

(2,927
)
Amortization of premiums paid for derivative financial instruments
282


319

Amortization of deferred loan costs
2,627


2,268

Other
74


(81
)
(Increase) decrease in accounts receivable
(6,591
)
 
2,303

(Increase) decrease in other current assets
(894
)
 
(3,075
)
Increase (decrease) in accounts payable
(16,568
)
 
3,304

Increase (decrease) in undistributed revenues and royalties
4,327

 
4,721

Increase (decrease) in accrued compensation and benefits
(293
)
 
(3,060
)
Increase (decrease) in other accrued liabilities
1,777

 
4,828

Increase (decrease) in other noncurrent liabilities
422

 
89

Increase (decrease) in fair value of performance unit awards
2,155

 
1,028

Net cash provided by operating activities
178,290

 
199,790

Cash flows from investing activities:
 
 
 
Capital expenditures:
 
 
 
Investment in equity method investee
(3,287
)


Oil and natural gas properties
(375,901
)

(473,846
)
Pipeline and gas gathering assets
(8,302
)

(7,031
)
Other fixed assets
(8,803
)

(4,988
)
Proceeds from other fixed asset disposals


34

Net cash used in investing activities
(396,293
)

(485,831
)
Cash flows from financing activities:
 
 
 
Borrowings on senior secured credit facility
230,000


195,000

Payments on senior secured credit facility


(280,000
)
Issuance of 2022 Notes


500,000

Purchase of treasury stock
(919
)


Payments for loan costs
(714
)

(10,476
)
Net cash provided by financing activities
228,367

 
404,524

Net increase in cash and cash equivalents
10,364

 
118,483

Cash and cash equivalents, beginning of period
33,224


28,002

Cash and cash equivalents, end of period
$
43,588

 
$
146,485

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest, net of $212 and $505, respectively, of capitalized interest
$
48,348

 
$
27,956

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Restricted deposits on pending sale
$
44,000

 
$

Change in accrued capital expenditures
$
(33,892
)
 
$
1,624

Capitalized asset retirement cost
$
1,262

 
$
2,270

 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

4

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

A—Organization
Laredo Petroleum Holdings, Inc. (“Laredo Holdings”), together with its subsidiaries, is an independent energy company focused on the exploration, development and acquisition of oil and natural gas properties in the Permian Basin in West Texas and, until August 1, 2013, also the Mid-Continent regions of the United States. Laredo Holdings was incorporated pursuant to the laws of the State of Delaware on August 12, 2011. Laredo Holdings was formed for purposes of a Corporate Reorganization (defined below) and initial public offering of its common stock (the "IPO"). On December 19, 2011, Laredo Petroleum, LLC, a Delaware limited liability company, was merged with and into Laredo Holdings, with Laredo Holdings surviving the merger (the "Corporate Reorganization"). As a holding company, Laredo Holdings’ management operations are conducted through its wholly-owned subsidiary, Laredo Petroleum, Inc. (“Laredo”), a Delaware corporation, and Laredo’s subsidiaries, Laredo Petroleum Texas, LLC (“Laredo Texas”), a Texas limited liability company, Laredo Gas Services, LLC (“Laredo Gas”), a Delaware limited liability company, and Laredo Petroleum—Dallas, Inc. (“Laredo Dallas”), a Delaware corporation. In these notes, the "Company" refers to Laredo Holdings, Laredo and its subsidiaries collectively.
B—Basis of presentation and significant accounting policies
1.    Basis of presentation
The accompanying unaudited consolidated financial statements were derived from the historical accounting records of the Company and reflect the historical financial position, results of operations and cash flows for the periods described herein. The Company uses the equity method of accounting to record its net interests when the Company holds 20% to 50% of the voting rights and/or has the ability to exercise significant influence but does not control the entity. Under the equity method, the Company's proportionate share of net income (loss) is included in the unaudited consolidated statements of operations. See Note K for additional discussion of the Company's equity method investment. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). All material intercompany transactions and account balances have been eliminated in the consolidation of accounts. The Company operates oil and natural gas properties as one business segment, which explores for, develops and produces oil and natural gas.
The accompanying consolidated financial statements have not been audited by the Company’s independent registered public accounting firm, except that the consolidated balance sheet at December 31, 2012 is derived from audited consolidated financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements reflect all necessary adjustments to present fairly the Company’s financial position as of June 30, 2013, the results of operations and cash flows for the three and six months ended June 30, 2013 and 2012. The Company has reclassified certain prior period amounts in these unaudited consolidated financial statements as discontinued operations and assets classified as held for sale. See Notes B.3 and B.5 for additional discussion of these reclassifications.
Certain disclosures have been condensed or omitted from these unaudited consolidated financial statements. Accordingly, these unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Laredo Holdings’ Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 Annual Report”).
2.    Use of estimates in the preparation of interim unaudited consolidated financial statements
The preparation of the accompanying unaudited consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes these estimates are reasonable, actual results could differ from these estimates. The interim results reflected in the unaudited consolidated financial statements are not necessarily indicative of the results that may be expected for other interim periods or for the full year.
Significant estimates include, but are not limited to, estimates of the Company’s reserves of oil and natural gas, future cash flows from oil and natural gas properties, depreciation, depletion and amortization, asset retirement obligations, stock-based compensation, deferred income taxes and fair values of commodity derivatives, interest rate derivatives and commodity deferred premiums. As fair value is a market-based measurement, it is determined based on the assumptions that market participants would use. These estimates and assumptions are based on management’s best judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. Such estimates and assumptions are adjusted when facts and circumstances dictate. Illiquid credit markets and

5

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

volatile equity and energy markets have combined to increase the uncertainty inherent in such estimates and assumptions. Management believes its estimates and assumptions to be reasonable under the circumstances. As future events and their effects cannot be determined with precision, actual values and results could differ from these estimates. Any changes in estimates resulting from future changes in the economic environment will be reflected in the financial statements in future periods.
3.    Reclassifications
Certain amounts in the accompanying consolidated financial statements have been reclassified to conform to the 2013 presentation. These reclassifications had no impact to previously reported net income or losses, total stockholders' equity or cash flows.
4. Restricted deposits
Restricted deposits represent deposits received on pending sales of oil and natural gas properties. Amounts were considered restricted until the transactions closed. In May and June 2013, the Company entered into agreements to sell its oil and natural gas properties and other related assets in the Anadarko Basin and received $44.0 million in escrow deposits from the buyers. As of June 30, 2013 these deposits were included in current assets and current liabilities in the accompanying consolidated balance sheets. See Note B.5 and Note N for further discussion of the Anadarko Basin Sale (defined below).
5.    Discontinued operations
During the three months ended June 30, 2013, the Company entered into agreements to sell its oil and natural gas properties, associated pipeline assets and various other associated property and equipment in the Anadarko Granite Wash, Central Texas Panhandle and the Eastern Anadarko Basin (the "Anadarko Basin Sale") for $438.0 million, subject to closing adjustments. As of June 30, 2013, the Company had received $44.0 million in escrow deposits associated with the Anadarko Basin Sale. These deposits are included as restricted deposits in the accompanying consolidated balance sheets at June 30, 2013. The Anadarko Basin Sale closed in the third quarter of 2013. See Note N for additional information regarding the closing of the Anadarko Basin Sale. Effective at closing, the operations and cash flows of these properties were eliminated from the ongoing operations of the Company and the Company does not have continuing involvement in the operations of these properties. The oil and natural gas properties that are a component of the Anadarko Basin Sale are not presented as held for sale nor are their results of operations presented as discontinued operations pursuant to the rules governing full cost accounting for oil and gas properties. The associated pipeline assets and various other associated property and equipment qualified as held for sale as of June 30, 2013. The results of operations of the associated pipeline assets and various other associated property and equipment are presented as results of discontinued operations, net of tax in these unaudited consolidated financial statements. Accordingly, the Company has reclassified the financial results and the related notes for all prior periods presented to reflect these operations as discontinued. Unless otherwise indicated, the information in these notes relate to the Company’s continuing operations.
A summary of the assets and liabilities held for sale on the Company's consolidated balance sheets for the periods presented is detailed below:
(in thousands)
 
June 30, 2013
 
December 31, 2012
Accounts receivable, net
 
$
579

 
$
416

Deferred income taxes
 

 

Other current assets
 

 

Total current assets held for sale
 
579

 
416

Pipeline and gas gathering assets, net of accumulated depreciation
 
44,437

 
43,524

Other fixed assets, net of accumulated depreciation
 
1,261

 
1,288

Total property and equipment held for sale, net of accumulated depreciation
 
45,698


44,812

Other assets, net
 
389

 
4,480

Total noncurrent assets held for sale
 
389

 
4,480

Accounts payable
 
726

 
1,112

Undistributed revenue and royalties
 
5,377

 
4,077

Other current liabilities
 
9

 
707

Total current liabilities held for sale
 
6,112

 
5,896

Asset retirement obligations
 
7,866

 
7,510

Other noncurrent liabilities
 
1,550

 
1,040

Total noncurrent liabilities held for sale
 
$
9,416

 
$
8,550


6

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

The following represents operating results from discontinued operations for the periods presented:
 
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
 
Natural gas transportation and treating
 
$
1,478

 
$
909

 
$
3,310

 
$
2,245

Total revenues from discontinued operations
 
1,478

 
909

 
3,310

 
2,245

Cost and expenses:
 
 
 
 
 
 
 
 
Natural gas transportation and treating
 
433

 
377

 
969

 
634

Drilling and production
 
236

 
64

 
480

 
285

Depreciation, depletion and amortization
 

 
634

 
627

 
1,248

Total costs and expenses from discontinued operations
 
669

 
1,075

 
2,076

 
2,167

Income (loss) from discontinued operations before income tax
 
809

 
(166
)
 
1,234

 
78

Income tax (expense) benefit
 
(291
)
 
60

 
(444
)
 
(28
)
Income (loss) from discontinued operations
 
$
518

 
$
(106
)
 
$
790

 
$
50

6.    Treasury stock
The Company acquires treasury stock, which is recorded at cost, to satisfy tax withholding obligations for Laredo's employees that arise upon the lapse of restrictions on restricted stock or for other reasons. Upon acquisition, this treasury stock is retired.
7.    Accounts receivable
The Company sells oil and natural gas to various customers and participates with other parties in the drilling, completion and operation of oil and natural gas wells. Joint interest and oil and natural gas sales receivables related to these operations are generally unsecured. Accounts receivable for joint interest billings are recorded as amounts billed to customers less an allowance for doubtful accounts.
Amounts are considered past due after 30 days. The Company determines joint interest operations accounts receivable allowances based on management’s assessment of the creditworthiness of the joint interest owners. Additionally, as the operator in the majority of its wells, the Company has the ability to realize the receivables through netting of anticipated future production revenues. The Company maintains an allowance for doubtful accounts for estimated losses inherent in its accounts receivable portfolio. In establishing the required allowance, management considers historical losses, current receivables aging, and existing industry and economic data. The Company reviews its allowance for doubtful accounts quarterly. Past due balances greater than 90 days and over a specified amount are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is remote.
Accounts receivable consist of the following components for the periods presented:
(in thousands)
 
June 30, 2013
 
December 31, 2012
Oil and natural gas sales
 
$
58,536

 
$
48,418

Joint operations, net(1)
 
30,088

 
30,925

Other
 
1,228

 
4,081

Total
 
$
89,852

 
$
83,424

______________________________________________________________________________
(1)
Accounts receivable for joint operations are presented net of an allowance for doubtful accounts of approximately $0.1 million at each of June 30, 2013 and December 31, 2012.
8.    Derivative financial instruments
The Company uses derivative financial instruments to reduce exposure to fluctuations in the prices of oil and natural gas. By removing a significant portion of the price volatility associated with future production, the Company expects to mitigate, but not eliminate, the potential effects of variability in cash flows from operations due to fluctuations in commodity prices. These transactions are primarily in the form of collars, swaps, puts and basis swaps. In addition, the Company enters into derivative contracts in the form of interest rate derivatives to minimize the effects of fluctuations in interest rates.

7

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

Derivative instruments are recorded at fair value and are included on the unaudited consolidated balance sheets as assets or liabilities. The Company netted the fair value of derivative instruments by counterparty in the accompanying unaudited consolidated balance sheets where the right of offset exists. The Company determines the fair value of its derivative financial instruments utilizing pricing models for significantly similar instruments. Inputs to the pricing models include publicly available prices and forward price curves generated from a compilation of data gathered from third parties. 
The Company’s derivatives were not designated as hedges for accounting purposes for any of the periods presented. Accordingly, the changes in fair value are recognized in the unaudited consolidated statements of operations in the period of change. Realized and unrealized gains and losses on derivatives are included in cash flows from operating activities (see Note F).
9.    Property and equipment
The following table sets forth the Company’s property and equipment for the periods presented:
(in thousands)
 
June 30, 2013
 
December 31, 2012
Proved oil and natural gas properties
 
$
3,350,367

 
$
2,993,266

Less accumulated depletion and impairment
 
1,249,404

 
1,121,274

Proved oil and natural gas properties, net
 
2,100,963

 
1,871,992

 
 
 
 
 
Unproved properties not being amortized
 
146,505

 
159,946

 
 
 
 
 
Pipeline and gas gathering assets
 
29,871

 
23,065

Less accumulated depreciation
 
1,915

 
1,297

Pipeline and gas gathering assets, net
 
27,956

 
21,768

 
 
 
 
 
Other fixed assets
 
31,921

 
23,669

Less accumulated depreciation and amortization
 
10,199

 
8,296

Other fixed assets, net
 
21,722

 
15,373

 
 
 
 
 
Total property and equipment held for sale, net
 
45,698

 
44,812

 
 
 
 
 
Total property and equipment, net
 
$
2,342,844

 
$
2,113,891

For the three months ended June 30, 2013 and 2012, depletion expense was $20.08 per barrel of oil equivalent (“BOE”) and $20.70 per BOE, respectively. For the six months ended June 30, 2013 and 2012, depletion expense was $20.16 per BOE and $20.20 per BOE, respectively.
10.    Deferred loan costs
Loan origination fees, which are stated at cost, net of amortization, are amortized over the life of the respective debt agreements utilizing the effective interest and straight-line methods. The Company capitalized $0.7 million and $10.5 million of deferred loan costs in the six months ended June 30, 2013 and 2012, respectively. The Company had total deferred loan costs of $27.5 million and $29.4 million, net of accumulated amortization of $11.9 million and $9.2 million, as of June 30, 2013 and December 31, 2012, respectively.
Future amortization expense of deferred loan costs as of June 30, 2013 is as follows:
(in thousands)
 
 
Remaining 2013

$
2,718

2014

5,479

2015

5,540

2016

4,126

2017

2,724

Thereafter

6,943

Total

$
27,530


8

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

11.    Other current liabilities
Other current liabilities consist of the following components for the periods presented:
(in thousands)
 
June 30, 2013
 
December 31, 2012
Lease operating expense payable
 
$
11,116

 
$
9,766

Production taxes payable
 
2,701

 
2,121

Prepaid drilling liability
 
1,113

 
2,916

Current portion of asset retirement obligations
 
346

 
380

Other accrued liabilities
 
3,480

 
2,080

Total other current liabilities
 
$
18,756

 
$
17,263

12.    Asset retirement obligations
Asset retirement obligations associated with the retirement of tangible long-lived assets are recognized as a liability in the period in which they are incurred and become determinable. The associated asset retirement costs are part of the carrying amount of the long-lived asset. Subsequently, the asset retirement cost included in the carrying amount of the related long-lived asset is charged to expense through the depletion of the asset. Changes in the liability due to the passage of time are recognized as an increase in the carrying amount of the liability and as corresponding accretion expense. See Note G for fair value disclosures related to the Company’s asset retirement obligations.
The Company is obligated by contractual and regulatory requirements to remove certain pipeline and gas gathering assets and perform other remediation of the sites where such pipeline and gas gathering assets are located upon the retirement of those assets. However, the fair value of the asset retirement obligation cannot currently be reasonably estimated because the settlement dates are indeterminate. The Company will record an asset retirement obligation for pipeline and gas gathering assets in the periods in which settlement dates are reasonably determinable.
The following reconciles the Company’s asset retirement obligations liability for continuing and discontinued operations for the periods presented:
(in thousands)
 
Six months ended June 30, 2013
 
Year ended
December 31, 2012
Liability at beginning of period
 
$
21,505

 
$
13,074

Liabilities added due to acquisitions, drilling and other
 
1,261

 
4,233

Accretion expense
 
804

 
1,200

Liabilities settled upon plugging and abandonment
 
(66
)
 
(148
)
Revision of estimates
 

 
3,146

Liability at end of period
 
$
23,504

 
$
21,505

13.    Fair value measurements
The carrying amounts reported in the unaudited consolidated balance sheets for cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable, undistributed revenue and royalties and other accrued liabilities approximate their fair values. See Note C for fair value disclosures related to the Company’s debt obligations. The Company carries its derivative financial instruments at fair value. See Note F and Note G for details regarding the fair value of the Company’s derivative financial instruments.
14.    Compensation awards
For stock-based compensation awards, compensation expense is recognized in “General and administrative” in the Company’s unaudited consolidated statements of operations over the awards’ vesting periods based on their grant date fair value. The Company utilizes the closing stock price on the date of grant to determine the fair value of service vesting restricted stock awards and a Black-Scholes pricing model to determine the fair values of service vesting restricted stock option awards. The Company utilizes a Monte Carlo simulation prepared by an independent third party to determine the fair value of the performance unit awards. See Note D for further discussion of the restricted stock awards, restricted stock option awards and performance unit awards.

9

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

15.    Impairment of long-lived assets
Impairment losses are recorded on property and equipment used in operations and other long-lived assets when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. Impairment is measured based on the excess of the carrying amount over the fair value of the assets. The Company did not record any impairment to property and equipment used in operations or other long-lived assets for the three or six months ended June 30, 2013 and 2012.
16.    Environmental
The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, among other things, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed in the period in which they occur. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed in the period in which they occur. Liabilities for expenditures of a non-capital nature are recorded when environmental assessment or remediation is probable and the costs can be reasonably estimated. Such liabilities are generally undiscounted unless the timing of cash payments is fixed and readily determinable. Management believes no materially significant liabilities of this nature existed as of June 30, 2013 or December 31, 2012.
17.    Related party
The Company has a gas gathering and processing arrangement with affiliates of Targa Resources, Inc. (“Targa”). Warburg Pincus Private Equity IX, L.P., a majority stockholder of Laredo Holdings, and other affiliates of Warburg Pincus LLC, hold investment interests in Targa. One of Laredo Holdings’ directors is on the board of directors of affiliates of Targa.
The following table summarizes the net oil and natural gas sales (oil and natural gas sales less production taxes) received from the Company’s related party, which are included in the unaudited consolidated statements of operations for the periods presented:
 
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
 
2013
 
2012
 
2013
 
2012
Net oil and natural gas sales
 
$
20,178

 
$
18,350

 
$
37,788

 
$
37,740

The following table summarizes the related-party amounts included in oil and natural gas sales receivable in the unaudited consolidated balance sheets for the periods presented:
(in thousands)
 
June 30, 2013
 
December 31, 2012
Oil and natural gas sales receivable
 
$
6,332

 
$
6,244

C—Debt
1.    Interest expense
The following amounts have been incurred and charged to interest expense for the periods presented:
 
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
 
2013
 
2012
 
2013
 
2012
Cash payments for interest
 
$
20,816

 
$
1,356

 
$
48,560

 
$
28,461

Amortization of deferred loan costs and other adjustments
 
1,320

 
1,240

 
2,624

 
2,321

Change in accrued interest
 
3,924

 
19,204

 
320

 
6,081

Interest costs incurred
 
26,060

 
21,800

 
51,504

 
36,863

Less capitalized interest
 
(117
)
 
(126
)
 
(212
)
 
(505
)
Total interest expense
 
$
25,943

 
$
21,674

 
$
51,292

 
$
36,358


10

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

2.    2022 Notes
On April 27, 2012, Laredo completed an offering of $500.0 million in aggregate principal amount of 7 3/8% senior unsecured notes due 2022 (the “2022 Notes”). The 2022 Notes will mature on May 1, 2022 and bear an interest rate of 7 3/8% per annum, payable semi-annually, in cash in arrears on May 1 and November 1 of each year, commencing November 1, 2012. The 2022 Notes are fully and unconditionally guaranteed, jointly and severally on a senior unsecured basis by Laredo Holdings and its subsidiaries, with the exception of Laredo (collectively, the “Guarantors”).
3.    2019 Notes
On January 20, 2011, Laredo completed an offering of $350.0 million 9 1/2% senior unsecured notes due 2019 (the “January Notes”) and on October 19, 2011, Laredo completed an offering of an additional $200.0 million 9 1/2% senior unsecured notes due 2019 (the “October 2011 Notes” and together with the January Notes, the “2019 Notes”). The 2019 Notes will mature on February 15, 2019 and bear an interest rate of 9 1/2% per annum, payable semi-annually, in cash in arrears on February 15 and August 15 of each year. The 2019 Notes are fully and unconditionally guaranteed, jointly and severally on a senior unsecured basis by the Guarantors.
4.    Senior secured credit facility
As of June 30, 2013, Laredo’s Third Amended and Restated Credit Agreement (as amended, the “Senior Secured Credit Facility”), which matures on July 1, 2016, had a borrowing base of $1.0 billion with $395.0 million outstanding and was subject to an interest rate of 2.25%. It contains both financial and non-financial covenants, all of which the Company was in compliance with as of June 30, 2013. Additionally, the Senior Secured Credit Facility provides for the issuance of letters of credit, limited to the lesser of total capacity or $20.0 million. At the closing of the Anadarko Basin Sale on August 1, 2013, the borrowing base on the Senior Secured Credit Facility was reduced to $825.0 million and the Company used the net proceeds from the sale to pay off its outstanding balance. On August 7, 2013, there were no amounts outstanding on the Senior Secured Credit Facility. See Note N for additional information.
5.    Fair value of debt
The Company has not elected to account for its debt instruments at fair value. The following table presents the carrying amount and fair value of the Company’s debt instruments for the periods presented:
 
 
June 30, 2013
 
December 31, 2012
(in thousands)
 
Carrying
value
 
Fair
value
 
Carrying
value
 
Fair
value
2019 Notes(1)
 
$
551,651

 
$
605,000

 
$
551,760

 
$
616,000

2022 Notes
 
500,000

 
530,000

 
500,000

 
541,250

Senior Secured Credit Facility
 
395,000

 
395,296

 
165,000

 
165,098

Total value of debt
 
$
1,446,651

 
$
1,530,296

 
$
1,216,760

 
$
1,322,348

______________________________________________________________________________
(1)
The carrying value of the 2019 Notes includes the October 2011 Notes unamortized bond premium of approximately $1.7 million and $1.8 million as of June 30, 2013 and December 31, 2012, respectively.
As of June 30, 2013 and December 31, 2012, the fair value of the debt outstanding on the 2019 Notes and the 2022 Notes was determined using the June 30, 2013 and December 31, 2012 quoted market price (Level 1), respectively, and the fair value of the outstanding debt as of June 30, 2013 and December 31, 2012 on the Senior Secured Credit Facility was estimated utilizing pricing models for similar instruments (Level 2). See Note G for information about fair value hierarchy levels.  
D—Employee compensation
In connection with the IPO, the Board of Directors of Laredo Holdings and its stockholders approved a Long-Term Incentive Plan (the “LTIP”), which provides for the granting of incentive awards in the form of restricted stock awards, stock options and other awards. The LTIP provides for the issuance of 10.0 million shares.
The Company recognizes the fair value of stock-based payments to employees and directors as a charge against earnings. The Company recognizes stock-based compensation expense over the requisite service period. Stock-based compensation is included in “General and administrative” in the unaudited consolidated statements of operations.

11

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

1.    Restricted stock awards
All restricted stock awards are treated as issued and outstanding in the accompanying unaudited consolidated financial statements. If an employee terminates employment prior to the restriction lapse date, the awarded shares are forfeited and canceled and are no longer considered issued and outstanding. Restricted stock awards converted in the Corporate Reorganization vested 20% at the grant date and then vest 20% annually thereafter. The restricted stock awards granted under the LTIP to management and employees generally vest 33%, 33% and 34% per year beginning on the first anniversary date of the grant. Restricted stock awards granted to non-employee directors vest fully on the anniversary date of the grant.
The following table reflects the outstanding restricted stock awards for the six months ended June 30, 2013:
(in thousands, except for weighted average grant date fair values)
 
Restricted
stock
awards
 
Weighted average
grant date
fair value
Outstanding at December 31, 2012
 
1,195

 
$
15.06

Granted
 
1,306

 
$
17.44

Forfeited
 
(138
)
 
$
15.34

Vested(1)
 
(365
)
 
$
16.19

Outstanding at June 30, 2013
 
1,998

 
$
16.39

______________________________________________________________________________
(1) The vesting of certain restricted stock grants could result in state and federal income tax expense or benefits related to the difference between the market price of the common stock at the date of vesting and the date of grant. The Company recognized income tax expense of $0.1 million and $0.4 million during the three and six months ended June 30, 2013, respectively, related to restricted stock, which were recorded as adjustments to deferred income taxes. There were no comparable amounts recorded in the three or six months ended June 30, 2012.
2.    Restricted stock option awards
Restricted stock options granted under the LTIP vest and are exercisable in four equal installments on each of the first four anniversaries of the date of the grant. The following table reflects the stock option award activity for the six months ended June 30, 2013:
(in thousands, except for weighted average exercise price and contractual term)
 
Restricted
stock option
awards
 
Weighted average
exercise price
(per option)
 
Weighted average
remaining contractual term
(years)
Outstanding at December 31, 2012
 
459

 
$
24.11

 
9.1

Granted
 
1,019

 
$
17.34

 
9.6

Expired or canceled
 
(8
)
 
$
24.11

 
8.6

Forfeited
 
(87
)
 
$
20.21

 

Outstanding at June 30, 2013
 
1,383

 
$
19.37

 
9.3

Vested and exercisable at end of period
 
106

 
$
24.11

 
8.6

The Company used the Black-Scholes option pricing model to determine the fair value of restricted stock options and is recognizing the associated expense on a straight-line basis over the four-year requisite service period of the awards. Determining the fair value of equity-based awards requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise and the associated volatility.
    

12

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

The assumptions used to estimate the fair value of restricted stock options granted on February 15, 2013 are as follows:
Risk-free interest rate(1)
1.19
%
Expected option life(2)
6.3 years

Expected volatility(3)
58.89
%
Fair value per option
$
9.67

______________________________________________________________________________
(1)
U.S. Treasury yields as of the grant date were utilized for the risk-free interest rate assumption, matching the treasury yield terms to the expected life of the option.
(2)
As the Company has no historical exercise history, expected option life assumptions were developed using the simplified method.
(3)
The Company utilized a peer historical look-back, which was weighted with the Company’s own volatility since the IPO, in order to develop the expected volatility.
3.    Performance unit awards
The performance unit awards issued to management are subject to a combination of market and service vesting criteria. A Monte Carlo simulation prepared by an independent third party is utilized in order to determine the fair value of these awards at the date of grant and to re-measure the fair value at the end of each reporting period until settlement. Due to the relatively short trading history of the Company’s stock, the volatility criteria utilized in the Monte Carlo simulation is based on the volatilities of a group of peer companies that have been determined to be most representative of the Company’s expected volatility. These awards are accounted for as liability awards as they will be settled in cash at the end of the requisite service period based on the achievement of certain performance criteria. The liability and related compensation expense for each period for these awards is recognized by dividing the fair value of the total liability by the requisite service period and recording the pro rata share for the period for which service has already been provided. As there are inherent uncertainties related to the factors and the Company’s judgment in applying them to the fair value determinations, there is risk that the recorded performance unit compensation may not accurately reflect the amount ultimately earned by the members of management.
Compensation expense for these awards amounted to $2.1 million and $0.5 million in the three months ended June 30, 2013 and 2012, respectively, and $2.2 million and $1.0 million in the six months ended June 30, 2013 and 2012, respectively, and is recognized in “General and administrative” in the Company’s unaudited consolidated statements of operations, and the corresponding liability is included in “Other noncurrent liabilities” in the June 30, 2013 and December 31, 2012 unaudited consolidated balance sheets.
4.    Defined contribution plan
The Company sponsors a 401(k) defined contribution plan for the benefit of substantially all employees at the date of hire. The plan allows eligible employees to make pre-tax and after-tax contributions up to 100% of their annual compensation, not to exceed annual limits established by the federal government. The Company makes matching contributions of up to 6% of an employee’s compensation and may make additional discretionary contributions for eligible employees. Employees are 100% vested in the employer contributions upon receipt.
The following table presents total employer contributions to the plans for the periods presented:
 
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
 
2013
 
2012
 
2013
 
2012
Contributions
 
$
422

 
$
325

 
$
881

 
$
642

E—Income taxes
The Company uses an asset and liability approach for financial accounting and for reporting income tax. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

13

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

The Company is subject to corporate income taxes and the Texas margin tax. Income tax expense attributable to income from continuing operations for the periods presented consisted of the following:
 
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)

2013

2012

2013

2012
Current taxes:

 


 


 


 

Federal

$

 
$

 
$

 
$

State


 

 

 

Deferred taxes:

 


 

 
 

 
 

Federal

(19,212
)

(17,114
)

(20,290
)

(30,819
)
State

(835
)

(370
)

(867
)

(1,334
)
Income tax expense

$
(20,047
)

$
(17,484
)

$
(21,157
)

$
(32,153
)
The following presents the comprehensive provision for income taxes for the periods presented:
 

Three months ended June 30,

Six months ended June 30,
(in thousands)

2013

2012

2013

2012
Comprehensive provision for income taxes allocable to:

 


 







Continuing operations

$
(20,047
)

$
(17,484
)

$
(21,157
)

$
(32,153
)
Discontinued operations

(291
)

60


(444
)

(28
)
Comprehensive provision for income taxes

$
(20,338
)

$
(17,424
)

$
(21,601
)

$
(32,181
)
Income tax expense attributable to income from continuing operations before income taxes differed from amounts computed by applying the applicable federal income tax rate of 34% to pre-tax earnings as a result of the following:
 

Three months ended June 30,

Six months ended June 30,
(in thousands)

2013

2012

2013

2012
Income tax expense computed by applying the statutory rate

$
(18,816
)
 
$
(16,512
)
 
$
(19,580
)
 
$
(30,366
)
State income tax, net of federal tax benefit and increase in valuation allowance

(551
)
 
(1,400
)
 
(572
)
 
(1,897
)
Non-deductible stock-based compensation

(164
)
 
(275
)
 
(339
)
 
(655
)
Stock-based compensation tax deficiency

(120
)
 

 
(411
)
 

Change in deferred tax valuation allowance

(20
)
 
(1
)
 
(29
)
 
(2
)
Other items

(376
)
 
704

 
(226
)
 
767

Income tax expense

$
(20,047
)
 
$
(17,484
)
 
$
(21,157
)
 
$
(32,153
)
 
Significant components of the Company’s deferred tax assets for the periods presented are as follows:
(in thousands)
 
June 30, 2013
 
December 31, 2012
Derivative financial instruments
 
$
4,403

 
$
7,108

Oil and natural gas properties and equipment
 
(226,192
)
 
(175,823
)
Net operating loss carry-forward
 
252,173

 
222,017

Accrued bonus
 
2,722

 
3,502

Stock-based compensation
 
3,957

 
2,928

Other
 
4,061

 
2,963

Gross deferred tax asset
 
41,124

 
62,695

Valuation allowance
 
(96
)
 
(66
)
Net deferred tax asset
 
$
41,028

 
$
62,629


14

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

Net deferred tax assets and liabilities were classified in the unaudited consolidated balance sheets as follows for the periods presented:
(in thousands)
 
June 30, 2013
 
December 31, 2012
Deferred tax asset
 
$
41,028

 
$
62,629

Deferred tax liability
 

 

Net deferred tax assets
 
$
41,028

 
$
62,629

The Company had federal net operating loss carry-forwards totaling approximately $716.4 million and state of Oklahoma net operating loss carry-forwards totaling approximately $230.1 million as of June 30, 2013. These carry-forwards begin expiring in 2026. As of June 30, 2013, the Company believes the federal and state of Oklahoma net operating loss carry-forwards are fully realizable. The Company considered all available evidence, both positive and negative, in determining whether, based on the weight of that evidence, a valuation allowance was needed. Such consideration included estimated future projected earnings based on existing reserves and projected future cash flows from its oil and natural gas reserves (including the timing of those cash flows), the reversal of deferred tax liabilities recorded as of June 30, 2013 and the Company’s ability to capitalize intangible drilling costs, rather than expensing these costs, in order to prevent an operating loss carry-forward from expiring unused.
The Company maintains a valuation allowance to reduce certain deferred tax assets to amounts that are more likely than not to be realized. As of June 30, 2013, a full valuation allowance of $0.1 million was recorded against the deferred tax asset related to the Company’s charitable contribution carry-forward of $0.3 million.
In evaluating its current tax positions in order to identify any material uncertain tax positions, the Company developed a policy for identifying uncertain tax positions that considers support for each position, industry standard, tax return disclosure and schedule, and the significance of each position. The Company had no material adjustments to its unrecognized tax benefits during the three or six months ended June 30, 2013.
The Company and its subsidiaries file a federal corporate income tax return on a consolidated basis. The Company's income tax returns for the years 2009 through 2012 remain open and subject to examination by federal tax authorities and/or the tax authorities in Oklahoma, Texas and Louisiana which are the jurisdictions where the Company has or has had operations. Additionally, the statute of limitations for examination of federal net operating loss carry-overs typically does not begin to run until the year the attribute is utilized in a tax return.
The effective tax rate for the Company's continuing operations for the six months ended June 30, 2013, was 37% as compared to 36% for the corresponding period ended June 30, 2012. GAAP requires the application of the estimated annual effective rate in determining the interim period tax provision unless a rate cannot be reliably estimated, such as when a small change in pre-tax income or loss creates significant variations in the customary relationship between income tax expense or benefit and pre-tax income or loss in interim periods. In such a situation, the interim period tax provision should be based on actual year-to-date results. The estimated annual effective rate used to record the Company's tax provisions, before considering discrete items, for each of the six months ended June 30, 2013 and 2012 was 36%.
The impact of significant discrete items is separately recognized in the quarter in which they occur. During the six months ended June 30, 2013, certain shares related to restricted stock awards vested at times when the Company's stock price was lower than the fair value of those shares at the time of grant. As a result, the income tax deduction related to such shares is less than the expense previously recognized for book purposes. In accordance with GAAP, such shortfalls reduce additional paid-in capital to the extent windfall tax benefits have been previously recognized. However, the Company has not previously recognized any windfall tax benefits. Therefore, the tax impact of these shortfalls totaling $0.1 million and $0.4 million for the three and six months ended June 30, 2013, respectively, is included in income tax expense attributable to continuing operations for these periods. There is no comparative amount for the three or six months ended June 30, 2012.
F—Derivative financial instruments

1.    Commodity derivatives

The Company engages in derivative transactions such as collars, swaps, puts and basis swaps to hedge price risks due to unfavorable changes in oil and natural gas prices related to its oil and natural gas production. As of June 30, 2013, the Company had 49 open derivative contracts with financial institutions which extend from July 2013 to December 2016, none of which were designated as hedges for accounting purposes. The contracts are recorded at fair value on the balance sheet and any

15

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

realized and unrealized gains and losses are recognized in current period earnings. See Note N for information regarding the Company's commodity derivative contracts entered into subsequent to June 30, 2013.
Each collar transaction has an established price floor and ceiling. When the settlement price is below the price floor established by these collars, the Company receives an amount from its counterparty equal to the difference between the settlement price and the price floor multiplied by the hedged contract volume. When the settlement price is above the price ceiling established by these collars, the Company pays its counterparty an amount equal to the difference between the settlement price and the price ceiling multiplied by the hedged contract volume.
Each swap transaction has an established fixed price. When the settlement price is above the fixed price, the Company pays its counterparty an amount equal to the difference between the settlement price and the fixed price multiplied by the hedged contract volume. When the settlement price is below the fixed price, the counterparty pays the Company an amount equal to the difference between the settlement price and the fixed price multiplied by the hedged contract volume.
Each put transaction has an established floor price. The Company pays the counterparty a premium in order to enter into the put transaction. When the settlement price is below the floor price, the counterparty pays the Company an amount equal to the difference between the settlement price and the fixed price multiplied by the hedged contract volume. When the settlement price is above the floor price, the put option expires.
Each natural gas basis swap transaction has an established fixed basis differential between the New York Mercantile Exchange ("NYMEX") gas futures and West Texas WAHA ("WAHA") index gas price. When the NYMEX futures settlement price less the fixed basis differential is greater than the actual WAHA price, the difference multiplied by the hedged contract volume is paid to the Company by the counterparty. When the difference between the NYMEX futures settlement price less the fixed basis differential is less than the actual WAHA price, the Company pays the counterparty an amount equal to the difference multiplied by the hedged contract volume.
Each oil basis swap transaction has an established fixed basis differential between the West Texas Intermediate Midland Argus ("Midland") index crude oil price and the West Texas Intermediate Argus ("WTI") index crude oil price. When the WTI price less the fixed basis differential is greater than the actual Midland price, the difference multiplied by the hedged contract volume is paid to the Company by the counterparty. When the WTI price less the fixed basis differential is less than the actual Midland price, the difference multiplied by the hedged contract volume is paid by the Company to the counterparty.
During the six months ended June 30, 2013, the Company entered into additional commodity contracts to hedge a portion of its estimated future production. The following table summarizes information about these additional commodity derivative contracts. Subsequent to June 30, 2013, certain commodity contracts were transferred to a buyer in connection with the Anadarko Basin Sale. See Note N for additional information.
 
 
Aggregate
volumes
 
Swap
price
 
Floor
price
 
Ceiling
price
 
Contract period
Oil (volumes in Bbl):
 
 
 
 
 
 
 
 
 
 
Swap
 
1,377,000

 
$
98.10

 
$

 
$

 
  March 2013 - December 2013
Basis swap
 
4,026,000

 
$
1.00

 
$

 
$

 
  March 2013 - December 2014
Swap
 
912,500

 
$
93.65

 
$

 
$

 
January 2014 - December 2014
Swap
 
365,000

 
$
93.68

 
$

 
$

 
January 2014 - December 2014
Price collar
 
1,277,500

 
$

 
$
80.00

 
$
98.50

 
January 2015 - December 2015
Price collar
 
1,281,000

 
$

 
$
80.00

 
$
93.00

 
January 2016 - December 2016
Natural gas (volumes in MMBtu):
 
 
 
 
 
 
 
 
Price collar
 
2,900,000

 
$

 
$
3.00

 
$
4.00

 
  March 2013 - December 2013
Swap
 
3,338,400

 
$
4.31

 
$

 
$

 
     June 2013 - December 2013
Swap
 
3,978,500

 
$
4.36

 
$

 
$

 
January 2014 - December 2014


16

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

The following table summarizes open positions as of June 30, 2013, and represents, as of such date, derivatives in place through December 2016, on annual production volumes:
 
 
Remaining Year
2013
 
Year
2014
 
Year
2015
 
Year
2016
Oil Positions:
 
 

 
 

 
 

 
 
Puts:
 
 

 
 

 
 

 
 
Hedged volume (Bbl)
 
540,000

 
540,000

 
456,000

 

Weighted average price ($/Bbl)
 
$
65.00

 
$
75.00

 
$
75.00

 
$

Swaps:
 
 

 
 

 
 

 
 
Hedged volume (Bbl)
 
1,128,000

 
1,277,500

 

 

Weighted average price ($/Bbl)
 
$
97.63

 
$
93.66

 
$

 
$

Collars:
 
 

 
 

 
 

 
 
Hedged volume (Bbl)
 
384,000

 
726,000

 
1,529,500

 
1,281,000

Weighted average floor price ($/Bbl)
 
$
79.38

 
$
75.45

 
$
79.18

 
$
80.00

Weighted average ceiling price ($/Bbl)
 
$
121.67

 
$
129.09

 
$
104.51

 
$
93.00

Basis swaps:
 
 
 
 
 
 
 
 
Hedged volume (Bbl)
 
1,472,000

 
2,252,000

 

 

Weighted average price ($/Bbl)
 
$
1.40

 
$
1.04

 
$

 
$

Natural Gas Positions:
 
 

 
 

 
 

 
 
Puts:
 
 

 
 

 
 

 
 
Hedged volume (MMBtu)
 
3,300,000

 

 

 

Weighted average price ($/MMBtu)
 
$
4.00

 
$

 
$

 
$

Swaps:
 
 

 
 

 
 

 
 
Hedged volume (MMBtu)
 
2,870,400

 
3,978,500

 

 

Weighted average price ($/MMBtu)
 
$
4.31

 
$
4.36

 
$

 
$

Collars:
 
 

 
 

 
 

 
 
Hedged volume (MMBtu)
 
9,820,000

 
18,120,000

 
15,480,000

 

Weighted average floor price ($/MMBtu)
 
$
3.35

 
$
3.38

 
$
3.00

 
$

Weighted average ceiling price ($/MMBtu)
 
$
5.47

 
$
6.09

 
$
6.00

 
$

Basis swaps:
 
 

 
 

 
 

 
 
Hedged volume (MMBtu)
 
600,000

 

 

 

Weighted average price ($/MMBtu)
 
$
0.33

 
$

 
$

 
$

2.    Interest rate derivatives
The Company is exposed to market risk for changes in interest rates related to its Senior Secured Credit Facility. Interest rate derivative agreements are used to manage a portion of the exposure related to changing interest rates by converting floating-rate debt to fixed-rate debt. If the London Interbank Offered Rate ("LIBOR") is lower than the fixed rate in the contract, the Company is required to pay the counterparties the difference, and conversely, the counterparties are required to pay the Company if LIBOR is higher than the fixed rate in the contract. The Company did not designate the interest rate derivatives as cash flow hedges; therefore, the changes in fair value of these instruments are recorded in current earnings.    
The following presents the settlement terms of the interest rate derivatives as of June 30, 2013:
(in thousands except rate data)
 
Year
2013
 
Expiration date
Notional amount
 
$
50,000

 
 
Fixed rate
 
1.11
%
 
September 13, 2013
Notional amount
 
$
50,000

 
 
Cap rate
 
3.00
%
 
September 13, 2013
  Total
 
$
100,000

 
 
 

17

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

3.    Balance sheet presentation
The Company’s oil and natural gas commodity derivatives and interest rate derivatives are presented on a net basis in “Derivative financial instruments” in the unaudited consolidated balance sheets.
The following summarizes the fair value of derivatives outstanding on a gross basis as of:
(in thousands)
 
June 30, 2013
 
December 31, 2012
Assets:
 
 

 
 

Commodity derivatives:
 
 

 
 

Oil derivatives
 
$
33,368

 
$
16,219

Natural gas derivatives
 
13,859

 
17,896

Total assets
 
$
47,227

 
$
34,115

 
 
 
 
 
Liabilities:
 
 
 
 
Commodity derivatives:
 
 
 
 
Oil derivatives(1)
 
$
31,048

 
$
21,308

Natural gas derivatives(2)
 
6,559

 
10,413

Interest rate derivatives
 
86

 
277

 Total liabilities
 
$
37,693

 
$
31,998

 
 
 
 
 
Net derivative position
 
$
9,534

 
$
2,117

______________________________________________________________________________
(1) The oil derivatives fair value includes a deferred premium liability of $14.9 million and $18.3 million as of June 30, 2013 and December 31, 2012, respectively.
(2) The natural gas derivatives fair value includes a deferred premium liability of $4.8 million and $6.4 million as of June 30, 2013 and December 31, 2012, respectively.
By using derivative instruments to economically hedge exposures to changes in commodity prices and interest rates, the Company exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk. The Company’s counterparties are participants in the Senior Secured Credit Facility which is secured by the Company’s oil and natural gas reserves; therefore, the Company is not required to post any collateral. The Company does not require collateral from its counterparties. The Company minimizes the credit risk in derivative instruments by: (i) limiting its exposure to any single counterparty; (ii) entering into derivative instruments only with counterparties that are also lenders in the Senior Secured Credit Facility and meet the Company’s minimum credit quality standard, or have a guarantee from an affiliate that meets the Company’s minimum credit quality standard; and (iii) monitoring the creditworthiness of the Company’s counterparties on an ongoing basis. In accordance with the Company’s standard practice, its commodity and interest rate derivatives are subject to counterparty netting under agreements governing such derivatives and, therefore, the risk of such loss is somewhat mitigated as of June 30, 2013. Market risk is the exposure to changes in the market price of oil and natural gas, which are subject to fluctuations resulting from changes in supply and demand.
4.    Gain (loss) on derivatives
Gains and losses on derivatives are reported on the unaudited consolidated statements of operations in the respective “Realized and unrealized gain (loss)” amounts. Realized gains (losses) represent amounts related to the settlement of derivative instruments, and for commodity derivatives, are aligned with the underlying production. Unrealized gains (losses) represent the change in fair value of the derivative instruments and are non-cash items.

18

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

The following represents the Company’s reported gains and losses on derivative instruments for the periods presented:
 

Three months ended June 30,
 
Six months ended June 30,
(in thousands)

2013

2012
 
2013
 
2012
Realized gains (losses):

 




 
 

 
 

Commodity derivatives

$
1,086


$
9,115

 
$
4,863

 
$
13,823

Interest rate derivatives

(105
)

(835
)
 
(206
)
 
(1,938
)
 

981


8,280

 
4,657

 
11,885

Unrealized gains:

 

 
 
 
 
 
Commodity derivatives

22,889


19,428

 
2,258

 
15,314

Interest rate derivatives

96


835

 
191

 
1,615

 

22,985


20,263

 
2,449

 
16,929

Total gains (losses):




 
 
 
 
 
Commodity derivatives

23,975


28,543

 
7,121

 
29,137

Interest rate derivatives

(9
)


 
(15
)
 
(323
)
 

$
23,966


$
28,543

 
$
7,106

 
$
28,814

 
G—Fair value measurements
The Company accounts for its oil and natural gas commodity and interest rate derivatives at fair value. The fair value of derivative financial instruments is determined utilizing pricing models for similar instruments. The models use a variety of techniques to arrive at fair value, including quotes and pricing analysis. Inputs to the pricing models include publicly available prices and forward curves generated from a compilation of data gathered from third parties.
The Company has categorized its assets and liabilities measured at fair value, based on the priority of inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).
Assets and liabilities recorded at fair value on the unaudited consolidated balance sheets are categorized based on inputs to the valuation techniques as follows: 
Level 1—
Assets and liabilities recorded at fair value for which values are based on unadjusted quoted prices for identical assets or liabilities in an active market that management has the ability to access. Active markets are considered to be those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
 
 
Level 2—
Assets and liabilities recorded at fair value for which values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the assets or liabilities. Substantially all of these inputs are observable in the marketplace throughout the full term of the price risk management instrument and can be derived from observable data or supported by observable levels at which transactions are executed in the marketplace.
 
 
Level 3—
Assets and liabilities recorded at fair value for which values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Unobservable inputs are not corroborated by market data. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.
When the inputs used to measure fair value fall within different levels of the hierarchy in a liquid environment, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company conducts a review of fair value hierarchy classifications on an annual basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Transfers between fair value hierarchy levels are recognized and reported in the period in which the transfer occurred. No transfers between fair value hierarchy levels occurred during the three and six months ended June 30, 2013 or 2012.

19

Laredo Petroleum Holdings, Inc.
Condensed notes to the consolidated financial statements
(Unaudited)

1.                      Fair value measurement on a recurring basis
The following presents the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis for the periods presented:
(in thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total fair
value
As of June 30, 2013:
 
 

 
 

 
 

 
 

Commodity derivatives
 
$

 
$
29,362

 
$

 
$
29,362

Deferred premiums
 

 

 
(19,742
)
 
(19,742
)
Interest rate derivatives
 

 
(86
)
 

 
(86
)
Total
 
$

 
$
29,276

 
$
(19,742
)
 
$
9,534

(in thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total fair
value
As of December 31, 2012:
 
 
 
 
 
 
 
 
Commodity derivatives
 
$

 
$
27,103

 
$

 
$
27,103

Deferred premiums
 

 

 
(24,709