UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

 

 

 

Commission File Number: 001-33784

 

 

 

 

SANDRIDGE ENERGY, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

 

Registrant’s telephone number, including area code:

(405) 429-5500

 

Former name, former address and former fiscal year, if changed since last report: Not applicable

 

 

 

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     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.

 

(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 þ

 

The number of shares outstanding of the registrant’s common stock, par value $0.001 per share, as of the close of business on April 30, 2009, was 181,898,103.

 

 

SANDRIDGE ENERGY, INC.
FORM 10-Q
Quarter Ended March 31, 2009

 

INDEX

 

DISCLOSURES REGARDING FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q includes “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. Various statements contained in this report, including those that express a belief, expectation, or intention, as well as those that are not statements of historical fact, are forward-looking statements. The forward-looking statements include projections and estimates concerning 2009 capital expenditures, our liquidity and capital resources, the timing and success of specific projects, outcomes and effects of litigation, claims and disputes, and elements of our business strategy. Our forward-looking statements are generally accompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,” “anticipate,” “potential,” “could,” “may,” “foresee,” “plan,” “goal” or other words that convey the uncertainty of future events or outcomes. We have based these forward-looking statements on our current expectations and assumptions about future events. 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. However, whether actual results and developments will conform with our expectations and predictions is subject to a number of risks and uncertainties, including the risk factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008, the opportunities that may be presented to and pursued by us, competitive actions by other companies, changes in laws or regulations and other factors, many of which are beyond our control. The actual results or developments anticipated may not be realized or, even if substantially realized, they may not have the expected consequences to or effects on our company or our business or operations. The forward-looking statements contained herein are not guarantees of future performance and actual results or developments may differ materially from those projected in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements.

 

 

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

 

 

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

 

 

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

 

 

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

 

 

Nature of Business.  SandRidge Energy, Inc. and its subsidiaries (collectively, the “Company” or “SandRidge”) is an independent natural gas and crude oil company concentrating on exploration, development and production activities. The Company also owns and operates natural gas gathering and treating facilities and CO₂ treating and transportation facilities and has marketing and tertiary oil recovery operations. In addition, Lariat Services, Inc. (“Lariat”), a wholly owned subsidiary, owns and operates drilling rigs and a related oil field services business. The Company’s primary exploration, development and production areas are concentrated in West Texas. The Company also operates interests in the Mid-Continent, the Cotton Valley Trend in East Texas, the Gulf Coast and the Gulf of Mexico.

 

Interim Financial Statements.  The accompanying condensed consolidated financial statements as of December 31, 2008 have been derived from the audited financial statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008 (the “2008 Form 10-K”). The unaudited interim condensed consolidated financial statements have been prepared by the Company in accordance with the accounting policies stated in the audited consolidated financial statements contained in the 2008 Form 10-K. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted, although the Company believes that the disclosures contained herein are adequate to make the information presented not misleading. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the information in the Company’s unaudited condensed consolidated financial statements have been included. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the 2008 Form 10-K.

 

 

For a description of the Company’s accounting policies, refer to Note 1 of the consolidated financial statements included in the 2008 Form 10-K.

 

Reclassifications.  Certain reclassifications have been made in prior period financial statements to conform with current period presentation.

 

Recent Accounting Pronouncements.  Effective January 1, 2008, the Company implemented Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” for its financial assets and liabilities measured on a recurring basis. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands required disclosures about fair value measurements. See Note 3.

 

In October 2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active,” (“FSP 157-3”) which was effective upon issuance. FSP 157-3 clarifies the application of SFAS No. 157 in determining the fair value of a financial asset when the market for that financial asset is not active. As of March 31, 2009, the Company had no financial assets with a market that was not active. Accordingly, FSP 157-3 had no effect on the Company’s current financial statements.

 

Effective January 1, 2009, the Company implemented SFAS No. 157 for certain of its nonfinancial liabilities, in accordance with Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”), which delayed the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for all nonfinancial assets and liabilities except those recognized or disclosed at fair value in the financial statements on a recurring basis, at least annually. This implementation did not have a material impact on the Company’s financial position or results of operations.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Effective January 1, 2009, the Company implemented SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an Amendment of Accounting Research Bulletin No. 51,” which established accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS No. 160 also establishes disclosure requirements to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The implementation of SFAS No. 160 resulted in changes to the presentation for noncontrolling interests and did not have a material impact on the Company’s results of operations and financial condition. All historical periods presented in the condensed consolidated financial statements reflect these changes to the presentation for noncontrolling interests. See Note 15.

 

Effective January 1, 2009, the Company implemented SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” which changed disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 requires enhanced disclosure, including qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. The implementation of SFAS No. 161 did not have a material impact on the Company’s results of operations or financial condition. See Note 10.

 

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” which replaces SFAS No. 141. SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) also establishes disclosure requirements that will enable users to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is effective for business combinations with acquisition dates on or after fiscal years beginning after December 15, 2008. The Company will evaluate this standard with respect to business combinations with acquisition dates on or after January 1, 2009.

 

On December 31, 2008, the Securities and Exchange Commission (“SEC”) issued Release No. 33-8995, “Modernization of Oil and Gas Reporting,” which revises disclosure requirements for oil and gas companies. In addition to changing the definition and disclosure requirements for natural gas and crude oil reserves, the new rules change the requirements for determining natural gas and crude oil reserve quantities to permit the use of new technologies to determine proved reserves under certain criteria and allow companies to disclose their probable and possible reserves. The new rules also require companies to report the independence and qualifications of their reserves preparer or auditor and file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit. The new rules also require natural gas and crude oil reserves to be reported and the full cost ceiling limitation to be calculated using a twelve-month average price rather than period-end prices. The use of a twelve-month average price could have had an effect on the Company’s 2008 and 2009 depletion rates for its natural gas and crude oil properties. The new rules are effective for annual reports on Form 10-K for fiscal years ending on or after December 31, 2009, pending the contemplated alignment of certain accounting standards by the FASB with the new rules. The Company plans to implement the new requirements beginning in its Annual Report on Form 10-K for the year ended December 31, 2009. The Company is currently evaluating the impact of the new requirements on its consolidated financial statements.

 

In April 2009, the FASB issued Staff Position FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” (“FSP FAS 107-1 and APB 28-1”) which amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” and Accounting Principles Board Opinion 28, “Interim Financial Reporting,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. FSP FAS 107-1 and APB 28-1 is effective for interim reporting periods ending after June 15, 2009. This implementation is expected to have no impact on the Company’s results of operations and financial condition, but will require additional disclosures about the fair value of financial

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

instruments in the Company’s financial statements. The Company plans to implement the new requirements in its June 30, 2009 financial statements.

 

 

Effective January 1, 2008, the Company implemented SFAS No. 157 for its financial assets and liabilities measured on a recurring basis. Effective January 1, 2009, the Company implemented SFAS No. 157 for certain nonfinancial liabilities based on FSP 157-2, which delayed the effective date of SFAS No. 157 by one year for certain nonfinancial assets and liabilities, with no material impact to the Company’s financial position or results of operations as a result of this implementation. SFAS No. 157 applies to all assets and liabilities that are measured and reported on a fair value basis.

 

As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements. The statement requires fair value measurements be classified and disclosed in one of the following categories:

 

 

As required by SFAS No. 157, assets and liabilities measured at fair value are classified based on 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, which may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels. The determination of the fair values, stated below, takes into account the market for the Company’s financial assets and liabilities, the associated credit risk and other factors as required under SFAS No. 157. The Company considers active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

As required by SFAS No. 157, the Company has classified its derivative contracts into one of three levels based upon the data relied upon to determine the fair value. The fair values of the Company’s natural gas and crude oil swaps and interest rate swap are based upon quotes obtained from counterparties to the derivative contracts. The Company reviews other readily available market prices for its derivative contracts as there is an active market for these contracts; however, the Company does not have access to the specific valuation models used by the counterparties. Included in these models are discount factors that the Company must estimate in its calculation. Additionally, the Company applies a credit default risk rating factor for its counterparties in determining the fair value of its derivative contracts. Based on the inputs for the fair value measurement, the Company classified its derivative contract assets and liabilities as Level 3.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The following table summarizes the fair value of the Company’s financial assets and liabilities by SFAS No. 157 pricing levels as of March 31, 2009:

 

 

The table below sets forth a reconciliation of the Company’s financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months ended March 31, 2009 (in thousands):

 

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

Property, plant and equipment consists of the following (in thousands):

 

 

 

 

 

In January 2009, the asset lives of certain of the drilling, oil field services and midstream assets were changed to align with industry average lives for similar assets.

 

The amount of capitalized interest included in the above non natural gas and crude oil equipment balance at both March 31, 2009 and December 31, 2008 was approximately $3.8 million.

 

 

Full Cost Ceiling Limitation.  Under the full cost method of accounting, the net book value of natural gas and crude oil properties, less related deferred income taxes, may not exceed a calculated “ceiling.” The ceiling limitation is the discounted estimated after-tax future net revenue from proved natural gas and crude oil properties, excluding future cash outflows associated with settling asset retirement obligations included in the net book value of natural gas and crude oil properties, plus the cost of properties not subject to amortization. In calculating future net revenues, prices and costs used are those as of the end of the appropriate period. These prices are not changed except where different prices are fixed and determinable from applicable contracts for the remaining term of those contracts. The Company has entered into various commodity derivative contracts; however, these derivative contracts are not accounted for as cash flow hedges. Accordingly, the effect of these derivative contracts has not been considered in calculating the full cost ceiling limitation as of March 31, 2009.

 

The net book value, less related deferred tax liabilities, is compared to the ceiling limitation on a quarterly and annual basis. Any excess of the net book value, less related deferred taxes, is written off as an expense. An expense recorded in one period may not be reversed in a subsequent period even though higher natural gas and crude oil prices may have increased the ceiling limitation in the subsequent period.

 

During the first quarter of 2009, the Company reduced the carrying value of its oil and gas properties by $1,304.4 million due to the full cost ceiling limitation.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

In June 2008, the Company entered into an agreement with a subsidiary of Occidental Petroleum Corporation (“Occidental”) to construct a CO₂ treating plant (the “Century Plant”) and associated compression and pipeline facilities for $800.0 million. Occidental will pay a minimum of 100% of the contract price, plus any subsequent agreed-upon revisions, to the Company through periodic cost reimbursements based upon the percentage of the project completed. Upon start-up, the Century Plant, located in Pecos County, Texas, will be owned and operated by Occidental for the purpose of separating and removing CO₂ from natural gas delivered by the Company. Pursuant to a 30-year treating agreement executed simultaneously with the construction agreement, Occidental will remove CO₂ from the Company’s delivered natural gas. The Company will retain all methane gas from the Century Plant and its other existing plants.

 

The Company accounts for construction of the Century Plant using the completed-contract method, under which contract revenues and costs are recognized when work under the contract is completed or substantially completed. In the interim, costs incurred on and billings related to contracts in process are accumulated on the balance sheet. Provisions for a contract loss are recognized when it is determined that a loss will be incurred. Costs in excess of billings (billings in excess of costs incurred) were $16.2 million and ($14.1) million and were reported as a current asset and current liability in the condensed consolidated balance sheets at March 31, 2009 and December 31, 2008, respectively. During April 2009, the Company issued and received payment for a progress billing in the amount of $42.2 million.

 

 

A reconciliation of the beginning and ending aggregate carrying amounts of the asset retirement obligation for the period from December 31, 2008 to March 31, 2009 is as follows (in thousands):

 

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

Long-term debt consists of the following (in thousands):

 

 

Senior Credit Facility.  The amount the Company can borrow under its senior secured revolving credit facility (the “senior credit facility”) is limited to a borrowing base, which was $1.1 billion at March 31, 2009. The senior credit facility matures on November 21, 2011 and is available to be drawn on and repaid without restriction so long as the Company is in compliance with its terms, including certain financial covenants.

 

The senior credit facility contains various covenants that limit the ability of the Company and certain of its subsidiaries to grant certain liens; make certain loans and investments; make distributions; redeem stock; redeem or prepay debt; merge or consolidate with or into a third party; or engage in certain asset dispositions, including a sale of all or substantially all of the Company’s assets. Additionally, the senior credit facility limits the ability of the Company and certain of its subsidiaries to incur additional indebtedness with certain exceptions, including under the senior notes.

 

The senior credit facility also contains financial covenants, including maintenance of agreed upon levels for the (i) ratio of total funded debt to EBITDAX (as defined in the senior credit facility), which may not exceed 4.5:1.0 calculated using the last four completed fiscal quarters, (ii) ratio of EBITDAX to interest expense plus current maturities of long-term debt, which must be at least 2.5:1.0 calculated using the last four completed fiscal quarters, and (iii) current ratio, which must be at least 1.0:1.0. In the current ratio calculation, as defined in the senior credit facility, any amounts available to be drawn under the senior credit facility are included in current assets, and unrealized assets and liabilities resulting from mark-to-market adjustments on the Company’s derivative contracts are disregarded. As of March 31, 2009, the Company was in compliance with all of the financial covenants under the senior credit facility.

 

The obligations under the senior credit facility are guaranteed by certain Company subsidiaries and are secured by first priority liens on all shares of capital stock of each of the Company’s material present and future subsidiaries; all intercompany debt of the Company; and substantially all of the Company’s assets, including proved natural gas and crude oil reserves representing at least 80% of the discounted present value (as defined in the senior credit facility) of proved natural gas and crude oil reserves reviewed in determining the borrowing base for the senior credit facility.

 

At the Company’s election, interest under the senior credit facility is determined by reference to the London Interbank Offered Rate (“LIBOR”) plus an applicable margin between 2.00% and 3.00% per annum, or the ‘base rate,’ which is the higher of the federal funds rate plus 0.5% or the prime rate plus, in either case, an applicable margin between 1.00% and 2.00% per annum, or the Eurodollar rate (as defined in the senior credit facility) plus 1.00% per annum. Interest is payable quarterly for prime rate loans and at the applicable maturity date for LIBOR

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

loans, except that if the interest period for a LIBOR loan is six months, interest is paid at the end of each three-month period. The average annual interest rate paid on amounts outstanding under the senior credit facility was 1.96% for the three months ended March 31, 2009. The interest rate on the senior credit facility was 2.14% at March 31, 2009.

 

The Company’s borrowing base is redetermined in April and October of each year. The borrowing base remained unchanged at $1.1 billion as a result of the April 2009 redetermination. The Company’s ability to develop properties and changes in commodity prices impact the borrowing base. The Company incurred additional costs related to the senior credit facility as a result of changes to the borrowing base. These costs have been deferred and are included in other assets in the accompanying condensed consolidated balance sheets. At March 31, 2009, the Company had $610.9 million outstanding and $459.6 million available to be drawn under the senior credit facility after consideration of the Company’s $24.5 million in outstanding letters of credit.

 

On October 3, 2008, Lehman Brothers Commodity Services, Inc. (“Lehman Brothers”), a lender under the Company’s senior credit facility, filed for bankruptcy. At the time that its parent, Lehman Brothers Holdings Inc., declared bankruptcy on September 15, 2008, Lehman Brothers elected not to fund its pro rata share, or 0.29%, of borrowings requested by the Company under the senior credit facility. Accordingly, the Company does not anticipate that Lehman Brothers will fund its pro rata share of any future borrowing requests. The Company does not expect this reduced availability of amounts under the senior credit facility to impact its liquidity or business operations.

 

Other Indebtedness.  The Company has financed a portion of its drilling rig fleet and related oil field services equipment through the issuance of notes secured by the equipment. At March 31, 2009, the aggregate outstanding balance of these notes was $29.2 million, with annual fixed interest rates ranging from 7.64% to 8.67%. The notes have a final maturity date of December 1, 2011 and require aggregate monthly installments of principal and interest in the amount of $1.2 million. The notes have a prepayment penalty (currently ranging from 1% to 2%) that is triggered if the Company repays the notes prior to maturity.

 

The Company’s mortgage on downtown property purchased by the Company in July 2007 to serve as its corporate headquarters is fully secured by one of the buildings and a parking garage located on the property. The mortgage bears interest at 6.08% annually and matures on November 15, 2022. Payments of principal and interest in the amount of approximately $0.5 million are due on a quarterly basis through the maturity date. During 2009, the Company expects to make payments of principal and interest on this note totaling $0.9 million and $1.1 million, respectively.

 

Senior Floating Rate Notes Due 2014 and 8.625% Senior Notes Due 2015.  In May 2008, the Company exchanged its senior term loans for senior unsecured notes with registration rights, as required under the senior term loan credit agreement, pursuant to an exchange offer exempted from registration under the Securities Act of 1933, as amended (“Securities Act”). The Company issued $350.0 million of Senior Floating Rate Notes due 2014 (“Senior Floating Rate Notes”) in exchange for the total outstanding principal amount of its senior floating rate term loan and $650.0 million of 8.625% Senior Notes due 2015 (“8.625% Senior Notes”) in exchange for the total outstanding principal amount of its 8.625% senior term loan. Terms of these senior notes are substantially identical to those of the exchanged senior term loans, except that the senior notes were issued with registration rights. These senior notes are jointly and severally, unconditionally guaranteed on an unsecured basis by all of the Company’s wholly owned subsidiaries, except certain minor subsidiaries. See Note 19.

 

In conjunction with the issuance of the senior notes, the Company agreed to file a registration statement with the SEC in connection with its offer to exchange the notes for substantially identical notes that are registered under the Securities Act. The Company filed a registration statement relating to the exchange offer during the third quarter of 2008, and all unregistered notes were exchanged for substantially identical notes registered under the Securities Act.

 

The Senior Floating Rate Notes bear interest at LIBOR plus 3.625% (5.06% at March 31, 2009), except for the period from April 1, 2008 to June 30, 2008, for which the interest rate was 6.323%. Interest is payable quarterly with

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

principal due on April 1, 2014. The average interest rate paid on amounts outstanding under the Senior Floating Rate Notes for the three months ended March 31, 2009 was 5.06% without consideration of the interest rate swap. The 8.625% Senior Notes bear interest at a fixed rate of 8.625% per annum with the principal due on April 1, 2015. Under the terms of the 8.625% Senior Notes, interest is payable semi-annually and, through the interest payment due on April 1, 2011, interest may be paid, at the Company’s option, either entirely in cash or entirely with additional fixed rate senior notes. If the Company elects to pay the interest due during any period in additional fixed rate senior notes, the interest rate will increase to 9.375% during that period. All interest payments made to date related to the 8.625% Senior Notes have been paid in cash.

 

In January 2008, the Company entered into a $350.0 million notional interest rate swap agreement to fix the variable LIBOR interest rate on the floating rate senior term loan for the period from April 1, 2008 to April 1, 2011. As a result of the exchange of the floating rate senior term loan to Senior Floating Rate Notes, the interest rate swap is now being used to fix the variable LIBOR interest rate on the Senior Floating Rate Notes at an annual rate of 6.26% through April 2011. This swap has not been designated as a hedge.

 

The Company may redeem, at specified redemption prices, some or all of the Senior Floating Rate Notes at any time, and, at specified redemption prices, some or all of the 8.625% Senior Notes on or after April 1, 2011.

 

The Company incurred $26.1 million of debt issuance costs in connection with the senior term loans. As the senior term loans were exchanged for unsecured senior notes with substantially identical terms, the remaining unamortized debt issuance costs on the senior term loans will be amortized over the terms of the Senior Floating Rate Notes and the 8.625% Senior Notes. These costs are included in other assets in the consolidated balance sheets.

 

8.0% Senior Notes Due 2018.  In May 2008, the Company issued $750.0 million of unsecured 8.0% Senior Notes due 2018 (“8.0% Senior Notes”). The notes bear interest at a fixed rate of 8.0% per annum, payable semi-annually, with the principal due on June 1, 2018. The notes are redeemable, in whole or in part, prior to their maturity at specified redemption prices. The 8.0% Senior Notes are jointly and severally, unconditionally guaranteed on an unsecured basis by all of the Company’s wholly owned subsidiaries, except certain minor subsidiaries. See Note 19. The notes became freely tradable on November 17, 2008, 180 days after their issuance, pursuant to Rule 144 under the Securities Act.

 

The Company incurred $16.0 million of debt issuance costs in connection with the offering of the 8.0% Senior Notes. These costs are included in other assets in the consolidated balance sheet and amortized over the term of the notes.

 

The indentures governing all of the senior notes contain financial covenants similar to those of the senior credit facility and include limitations on the incurrence of indebtedness, payment of dividends, asset sales, certain asset purchases, transactions with related parties and consolidation or merger agreements. As of March 31, 2009, the Company was in compliance with all of the covenants contained in the indentures governing the senior notes.

 

For the three months ended March 31, 2009 and 2008, interest payments, net of amounts capitalized, were approximately $10.0 million and $25.4 million, respectively.

 

 

The Company has recorded a long-term obligation for amounts to be paid under a settlement agreement with Conoco, Inc. entered into in January 2007. The Company agreed to pay approximately $25.0 million plus interest, payable in $5.0 million increments on April 1, 2007, July 1, 2008, July 1, 2009, July 1, 2010 and July 1, 2011. The payment to be made on July 1, 2009 has been included in accounts payable-trade in the consolidated balance sheets at March 31, 2009 and December 31, 2008. The non-current unpaid settlement amount of $10.0 million has been included in other long-term obligations in the consolidated balance sheets at March 31, 2009 and December 31, 2008.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

The Company is exposed to commodity price risk which impacts the predictability of its cash flows related to the sale of natural gas and crude oil. The primary risk managed by the Company’s use of commodity derivative contracts is commodity price risk. These derivative contracts allow the Company to limit its exposure to a portion of its projected natural gas and crude oil sales. None of the Company’s derivative contracts contain credit risk related contingent features. At March 31, 2009 and December 31, 2008, the Company’s commodity derivative contracts consisted of fixed price swaps and basis swaps, which are included in the derivative descriptions below:

 

 

In January 2008, the Company entered into a $350.0 million notional interest rate swap agreement to fix the variable LIBOR interest rate on its floating rate senior term loan at 6.26% per annum for the period April 1, 2008 to April 1, 2011 to manage the interest rate risk on a portion of its floating rate debt. Due to the exchange of the floating rate senior term loan for Senior Floating Rate Notes, the interest rate swap is now being used to fix the variable LIBOR interest rate on the Senior Floating Rate Notes at 6.26% per annum through April 2011. This swap has not been designated as a hedge.

 

The Company’s derivative contracts have not been designated as hedges. The Company records all derivative contracts at fair value. Changes in derivative contract fair values are recognized in earnings. Cash settlements and valuation gains and losses are included in (gain) loss on derivative contracts in the consolidated statements of operations. All swaps are settled on a monthly basis.

 

The balance sheet classification of the assets and liabilities related to derivative contracts is summarized below at March 31, 2009 and December 31, 2008 (in thousands):

 

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The following table summarizes the effect of the Company’s derivative contracts on the condensed consolidated statements of operations for the three-month periods ended March 31, 2009 and 2008 (in thousands):

 

 

A counterparty to one of the Company’s derivative contracts, Lehman Brothers, declared bankruptcy on October 3, 2008. Due to Lehman Brothers’ bankruptcy and the declaration of bankruptcy by its parent, Lehman Brothers Holdings Inc., on September 15, 2008, the Company has not assigned any value to this derivative contract as of March 31, 2009.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

At March 31, 2009, the Company’s open natural gas and crude oil commodity derivative contracts consisted of the following:

 

Natural Gas

 

 

 

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

Crude Oil

 

 

The following table summarizes the cash settlements and valuation gains and losses on the commodity derivative contracts for the three months ended March 31 (in thousands):

 

 

An unrealized loss of $0.3 million and realized losses of $1.0 million related to the interest rate swap were included in interest expense in the condensed consolidated statement of operations for the three months ended March 31, 2009. An unrealized gain of $0.8 million was included in the condensed consolidated statement of operations for the three months ended March 31, 2008.

 

Refer to Note 3 for additional discussion on the fair value measurement of the Company’s derivative contracts.

 

 

In accordance with GAAP, the Company estimates for each interim reporting period the effective tax rate expected for the full fiscal year and uses that estimated rate in providing income taxes on a current year-to-date basis.

 

The provisions (benefits) for income taxes consisted of the following components for the three-month periods ended March 31 (in thousands):

 

 

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 reporting. Deferred tax assets are reduced by a valuation allowance if a determination is made that it is more likely than not that some or all

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

of the deferred assets will not be realized based on the weight of all available evidence. For the year ended December 31, 2008, the Company determined it was appropriate to record a full valuation allowance against its net deferred tax asset. For the period ended March 31, 2009, the Company recorded a $408.3 million increase to the previously established valuation allowance. The increase is primarily a result of not recording a tax benefit for the current period loss before income taxes of $1,156.0 million.

 

Internal Revenue Code (“IRC”) Section 382 addresses company ownership changes and specifically limits the utilization of certain tax attributes on an annual basis following an ownership change. The Company has experienced several owner shifts, within the meaning of IRC Section 382, since the time of its last ownership change, which occurred in June 2008. Further owner shifts occurring during the three-year period beginning as of June 2008 may result in another ownership change. In the event another ownership change occurs, the application of IRC Section 382 may limit the amount of tax attributes, including the 2009 projected net operating loss, that the Company can utilize on an annual basis. The Company will continue to closely monitor its ownership activity.

 

No reserves for uncertain income tax positions have been recorded pursuant to FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”). Tax years 1994 to present remain open for the majority of taxing authorities due to net operation loss utilization. The Company’s accounting policy is to recognize interest and penalties, if any, related to unrecognized tax benefits as income tax expense. The Company does not have an accrued liability for interest and penalties at March 31, 2009.

 

For the three months ended March 31, 2009 and March 31, 2008, net income tax (refunds) payments were approximately ($0.5) million and $0.2 million, respectively.

 

 

Basic earnings per share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed using the weighted average shares outstanding during the period, but also include the dilutive effect of awards of restricted stock. The following table summarizes the calculation of weighted average common shares outstanding used in the computation of diluted earnings per share for the three-month periods ended March 31 (in thousands):

 

 

For the three-month periods ended March 31, 2009 and 2008, restricted stock awards covering 4.2 million shares and 2.2 million shares, respectively, were excluded from the computation of net loss per share because their effect would have been antidilutive.

 

In computing diluted earnings per share, the Company evaluated the if-converted method with respect to its outstanding 8.5% convertible perpetual preferred stock for the three-month period ended March 31, 2009 and with respect to its outstanding redeemable convertible preferred stock for the three-month period ended March 31, 2008. Under this method, the Company assumes the conversion of the preferred stock to common stock and determines if this is more dilutive than including the preferred stock dividends (paid and unpaid) in the computation of income available to common stockholders. The Company determined the if-converted method is not more dilutive for the three-month periods ended March 31, 2009 and 2008.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

The Company is a defendant in lawsuits from time to time in the normal course of business. In management’s opinion, the Company is not currently involved in any legal proceedings which, individually or in the aggregate, could have a material effect on the financial condition, operations or cash flows of the Company.

 

 

In November 2006, the Company sold 2,136,667 shares of redeemable convertible preferred stock to finance a portion of its acquisition of NEG Oil & Gas, LLC. Each holder of redeemable convertible preferred stock was entitled to quarterly cash dividends at the annual rate of 7.75% of the accreted value, or $210 per share, of their redeemable convertible preferred stock. Each share of redeemable convertible preferred stock was initially convertible into ten shares, and ultimately convertible into 10.2 shares, of common stock at the option of the holder, subject to certain anti-dilution adjustments. A summary of dividends declared and paid on the redeemable convertible preferred stock is as follows (in thousands, except per share data):

 

 

 

 

On March 30, 2007, certain holders of the Company’s common units (consisting of shares of common stock and a warrant to purchase redeemable convertible preferred stock upon the surrender of common stock) exercised warrants to purchase redeemable convertible preferred stock. The holders converted 526,316 shares of common stock into 47,619 shares of redeemable convertible preferred stock.

 

During March 2008, holders of 339,823 shares of the Company’s redeemable convertible preferred stock elected to convert those shares into 3,465,593 shares of the Company’s common stock. This conversion resulted in an increase to additional paid-in capital of $71.3 million, which represents the difference between the par value of the common stock issued and the carrying value of the redeemable convertible shares converted. The Company also recorded a charge to retained earnings for $1.1 million in accelerated accretion expense related to the converted redeemable convertible preferred shares.

 

Approximately $8.1 million in paid and unpaid dividends on the redeemable convertible preferred stock has been included in the Company’s earnings per share calculations for the three-month period ended March 31, 2008 as presented in the condensed consolidated statements of operations.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

Preferred Stock.  The following table presents information regarding the Company’s preferred stock (in thousands):

 

 

In January 2009, the Company completed a private placement of 2,650,000 shares of 8.5% convertible perpetual preferred stock to qualified institutional buyers eligible under Rule 144A of the Securities Act. The offering included 400,000 shares of convertible perpetual preferred stock issued upon the full exercise of the initial purchaser’s option to cover over-allotments. Net proceeds from the offering were approximately $243.3 million after deducting offering expenses of approximately $8.6 million. The Company used the net proceeds from the offering to repay outstanding borrowings under the senior credit facility and for general corporate purposes.

 

Each share of 8.5% convertible perpetual preferred stock has a liquidation preference of $100 per share and is convertible at the holder’s option at any time initially into approximately 12.4805 shares of the Company’s common stock, subject to adjustments upon the occurrence of certain events. Each holder of the convertible perpetual preferred stock is entitled to an annual dividend of $8.50 to be paid semi-annually in cash, common stock or a combination thereof at the Company’s election with the first dividend payment due in February 2010. The convertible perpetual preferred stock is not redeemable by the Company at any time. After February 20, 2014, the Company may cause all outstanding shares of the convertible perpetual preferred stock to automatically convert into common stock at the then-prevailing conversion rate if certain conditions are met.

 

Common Stock.  The following table presents information regarding the Company’s common stock (in thousands):

 

 

During March 2008, the Company issued 3,465,593 shares of common stock upon the conversion of 339,823 shares of its redeemable convertible preferred stock. See additional discussion in Note 14.

 

Treasury Stock.  The Company makes required tax payments on behalf of employees when their restricted stock awards vest and then withholds a number of vested shares of common stock having a value on the date of vesting equal to the tax obligation. As a result of such transactions, the Company withheld approximately 70,000 shares at a total value of $0.5 million and approximately 38,000 shares at a total value of $1.3 million during the three-month periods ended March 31, 2009 and 2008, respectively. These shares were accounted for as treasury stock.

 

In February 2008, the Company transferred 184,484 shares of its treasury stock into an account established for the benefit of the Company’s 401(k) Plan. The transfer was made in order to satisfy the Company’s $5.0 million accrued payable to match employee contributions made to the plan during 2007. The historical cost of the shares transferred totaled approximately $2.4 million and resulted in an increase to the Company’s additional paid-in capital of approximately $2.6 million.

 

Restricted Stock.  The Company issues restricted common stock awards under incentive compensation plans that vest over specified periods of time, subject to certain conditions. Awards issued prior to 2006 had vesting periods of one, four or seven years. All awards issued during and after 2006 have four year vesting periods. Shares of

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

restricted common stock are subject to restriction on transfer. Unvested restricted stock awards are included in the Company’s outstanding shares of common stock.

 

For the three-month periods ended March 31, 2009 and 2008, the Company recognized stock-based compensation expense, net of $1.2 million and $0 capitalized, respectively, related to restricted common stock of $5.2 million and $3.2 million, respectively. Stock-based compensation expense is reflected in general and administrative expenses in the condensed consolidated statements of operations.

 

Noncontrolling Interest.  On January 1, 2009, the Company implemented SFAS No. 160, which established accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. As required by SFAS No. 160, the noncontrolling interest in one of the Company’s subsidiaries represents an ownership interest in the consolidated entity and is included as a component of equity in the condensed consolidated balance sheets and condensed consolidated statement of changes in equity.

 

 

The Company has transactions with certain stockholders and other related parties in the ordinary course of business. These transactions primarily consist of purchases of drilling equipment and sales of oil field service supplies. Following is a summary of significant transactions with related parties for the three-month periods ended March 31, 2009 and 2008 (in thousands):

 

 

The Company leases office space in Oklahoma City from a member of its Board of Directors. The Company believes that the payments made under this lease are at fair market rates. Rent expense related to the lease totaled $0.3 million and $0.4 million for the three-month periods ended March 31, 2009 and 2008, respectively. The lease expires in August 2009.

 

Larclay, L.P.  Until April 15, 2009, Lariat and its partner Clayton Williams Energy, Inc. (“CWEI”) each owned a 50% interest in Larclay L.P. (“Larclay”), a limited partnership. Larclay currently owns twelve rigs, one of which has not yet been assembled. Larclay financed the acquisition cost of its twelve rigs with a loan from a third party, secured by the purchased rigs, and a loan from CWEI. In addition, CWEI has guaranteed a portion of the third party debt. Until April 15, 2009, Lariat operated the rigs owned by the partnership.

 

Under the partnership agreement, if Larclay had an operating shortfall, Lariat and CWEI were obligated to provide loans to the partnership. In April 2008, Lariat and CWEI each made loans of $2.5 million to Larclay under promissory notes. The notes yielded interest at a floating rate based on a LIBOR average plus 3.25% as provided in the Larclay partnership agreement. In June 2008, Larclay executed a $15.0 million revolving promissory note with each of Lariat and CWEI. Amounts drawn under each revolving promissory note bear interest at a floating rate based on a LIBOR average plus 3.25% as provided in the Larclay partnership agreement. Lariat advanced $5.0 million to Larclay under the revolving promissory note during the year ended December 31, 2008. Total advances outstanding to Larclay were $7.5 million ($2.5 million promissory note and $5.0 million drawn on revolving promissory note) at December 31, 2008. Due to economic conditions and cash shortfalls within Larclay, the Company impaired both the notes receivable and its investment in Larclay as of December 31, 2008. No additional advances were made by the Company to Larclay during the three-month period ended March 31, 2009.

 

On April 15, 2009, Lariat completed an assignment to CWEI of Lariat’s 50% equity interest in Larclay pursuant to the terms of an Assignment and Assumption Agreement (the “Agreement”) entered into between Lariat

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

and CWEI on March 13, 2009. As a result of the transactions contemplated by the Agreement, CWEI owns 100% of Larclay. Pursuant to the Agreement, Lariat assigned all of its right, title and interest in and to Larclay to CWEI effective as of April 15, 2009, and CWEI assumed all of the obligations and liabilities of Lariat relating to Larclay from and after April 15, 2009, including Lariat’s obligations as operator of the Larclay drilling rigs. Under the terms of the Agreement, Lariat assigned to CWEI all of its right, title and interest in the subordinated loans previously advanced by Lariat to Larclay. Pursuant to the Agreement, Lariat and CWEI agreed to indemnify each other for certain losses, and to waive certain claims, whether known or unknown, Lariat and CWEI may have against each other arising from their interests in Larclay. As a result of the Company’s impairment of both the notes receivable from and investment in Larclay at December 31, 2008, there were no additional losses on Larclay during the three-months ended March 31, 2009 or as a result of the Agreement with CWEI.

 

The following table summarizes the Company’s other transactions with Larclay (in thousands):

 

 

 

 

In April 2009, the Company completed a registered underwritten offering of 14,480,000 shares of its common stock, including 2,280,000 shares of common stock acquired by the underwriters from the Company to cover over-allotments. Net proceeds to the Company from the offering were approximately $108.0 million after deducting offering expenses of approximately $2.0 million and were used to repay a portion of the amount outstanding under the senior credit facility and for general corporate purposes.

 

In April 2009, the Company’s borrowing base under its senior credit facility was redetermined and remained unchanged at $1.1 billion.

 

In May 2009, the Company signed an agreement to sell the rights to its East Texas leasehold below the Cotton Valley formation for $60.0 million. The transaction is subject to customary adjustments and closing conditions and is expected to close during the second quarter of 2009.

 

 

The Company has three business segments: exploration and production, drilling and oil field services and midstream gas services. These segments represent the Company’s three main business units, each offering different products and services. The exploration and production segment is engaged in the acquisition, development and production of natural gas and crude oil properties. The drilling and oil field services segment is engaged in the land contract drilling of natural gas and crude oil wells. The midstream gas services segment is engaged in the purchasing, gathering, processing, treating and selling of natural gas. The all other column includes items not related to the Company’s reportable segments including the Company’s CO₂ gathering and sales operations and corporate operations.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Management evaluates the performance of the Company’s business segments based on operating income, which is defined as segment operating revenues less operating expenses and depreciation, depletion and amortization. Summarized financial information concerning the Company’s segments is shown in the following table (in thousands):

 

 

 

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

 

The Company is providing condensed consolidating financial information for its subsidiaries that are guarantors of its public debt. Subsidiary guarantors are wholly owned and have, jointly and severally, unconditionally guaranteed on an unsecured basis the Company’s 8.625% Senior Notes due 2015, Senior Floating Rate Notes due 2014 and 8.0% Senior Notes due 2018. The subsidiary guarantees (i) rank equally in right of payment with all of the existing and future senior debt of the subsidiary guarantors; (ii) rank senior to all of the existing and future subordinated debt of the subsidiary guarantors; (iii) are effectively subordinated in right of payment to any existing or future secured obligations of the subsidiary guarantors to the extent of the value of the assets securing such obligations; and (iv) are structurally subordinated to all debt and other obligations of the subsidiaries of the guarantors who are not themselves guarantors.

 

The Company has not presented separate financial and narrative information for each of the subsidiary guarantors because it believes that such financial and narrative information would not provide any additional information that would be material in evaluating the sufficiency of the guarantees.

 

The following condensed consolidating financial information represents the financial information of SandRidge Energy, Inc. and its wholly owned subsidiary guarantors, prepared on the equity basis of accounting. The non-guarantor subsidiaries are minor and, therefore, not presented separately. The information is presented in accordance with the requirements of Rule 3-10 under the SEC’s Regulation S-X. The financial information may not necessarily be indicative of the financial position, results of operations, or cash flows had the subsidiary guarantors operated as independent entities.

 

SandRidge Energy, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Condensed Consolidating Balance Sheet