XNYS:LPI Laredo Petroleum Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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TABLE OF CONTENTS

Table of Contents

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, 2012

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 o   Non-accelerated filer ý
(Do not check if a
smaller reporting company)
  Smaller reporting company o

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

        Number of shares of registrant's common stock outstanding as of August 7, 2012: 128,231,994

   


Table of Contents


TABLE OF CONTENTS

 
   
  Page  

Cautionary Statement Regarding Forward-Looking Statements

    iii  

 

Part I

       

Item 1.

 

Consolidated Financial Statements (Unaudited)

   
1
 

 

Consolidated balance sheets as of June 30, 2012 and December 31, 2011

   
1
 

 

Consolidated statements of operations for the three and six months ended June 30, 2012 and 2011

    2  

 

Consolidated statement of stockholders' equity for the six months ended June 30, 2012

    3  

 

Consolidated statements of cash flows for the six months ended June 30, 2012 and 2011

    4  

 

Condensed notes to the consolidated financial statements

    5  

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

   
37
 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

    58  

Item 4.

 

Controls and Procedures

    59  

 

Part II

       

Item 1.

 

Legal Proceedings

   
60
 

Item 1A.

 

Risk Factors

    60  

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

    60  

Item 3.

 

Defaults Upon Senior Securities

    60  

Item 4.

 

Mine Safety Disclosures

    60  

Item 5.

 

Other Information

    60  

Item 6.

 

Exhibits

    60  

Signatures

   
62
 

Exhibit Index

   
63
 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

        Various statements contained in or incorporated by reference into this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). 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," "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 crude 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;

    competition in the oil and gas industry;

    availability and costs of drilling and production equipment, labor, and oil and gas processing and other services;

    changes in domestic and global demand for oil and natural gas;

    the availability of sufficient pipeline and transportation facilities;

    uncertainties about the estimates of our oil and natural gas reserves;

    changes in the regulatory environment and changes in international, legal, political, administrative or economic conditions;

    successful results from our identified drilling locations;

    our ability to execute our strategies;

    our ability to recruit and retain the qualified personnel necessary to operate our business;

    our ability to comply with federal, state and local regulatory requirements;

    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; and

    our ability to generate sufficient cash to service our indebtedness and to generate future profits.

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        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 "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Quarterly Report on Form 10-Q, under "Item 1A. Risk Factors" and "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, 2011 and under "Part II, Item 1A. Risk Factors" in our Quarterly Report on Form 10-Q for the quarter ended March 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.

iv


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PART I

Item 1.    Consolidated Financial Statements (Unaudited)


Laredo Petroleum Holdings, Inc.

Consolidated balance sheets

(in thousands, except share data)

(Unaudited)

 
  June 30,
2012
  December 31,
2011
 

Assets

             

Current assets:

             

Cash and cash equivalents

  $ 146,485   $ 28,002  

Accounts receivable, net

    71,832     74,135  

Derivative financial instruments

    20,513     13,281  

Deferred income taxes

        5,202  

Other current assets

    5,816     2,318  
           

Total current assets

    244,646     122,938  
           

Property and equipment:

             

Oil and natural gas properties, full cost method:

             

Proved properties

    2,551,524     2,083,015  

Unproved properties not being amortized

    127,971     117,195  

Pipeline and gas gathering assets

    63,667     58,136  

Other fixed assets

    21,840     16,948  
           

    2,765,002     2,275,294  

Less accumulated depreciation, depletion, amortization and impairment

    1,008,597     896,785  
           

Net property and equipment

    1,756,405     1,378,509  
           

Deferred income taxes

    64,903     90,376  

Derivative financial instruments

    12,888     6,510  

Deferred loan costs, net

    31,666     23,457  

Other assets, net

    5,430     5,862  
           

Total assets

  $ 2,115,938   $ 1,627,652  
           

Liabilities and stockholders' equity

             

Current liabilities:

             

Accounts payable

  $ 49,311   $ 46,007  

Undistributed revenue and royalties

    31,565     26,844  

Accrued capital expenditures

    92,646     91,022  

Accrued compensation and benefits

    8,210     11,270  

Derivative financial instruments

    603     4,187  

Accrued interest payable

    26,193     20,112  

Other current liabilities

    15,498     14,919  
           

Total current liabilities

    224,026     214,361  
           

Long-term debt

    1,051,863     636,961  

Derivative financial instruments

    72     2,415  

Asset retirement obligations

    15,483     12,568  

Other noncurrent liabilities

    2,436     1,334  
           

Total liabilities

    1,293,880     867,639  
           

Stockholders' equity:

             

Preferred stock, $0.01 par value, 50,000,000 shares authorized and zero issued at June 30, 2012 and December 31, 2011

         

Common stock, $0.01 par value, 450,000,000 shares authorized, and 128,296,239 and 127,617,391 issued, net of treasury, at June 30, 2012 and December 31, 2011, respectively

    1,283     1,276  

Additional paid-in capital

    956,203     951,375  

Accumulated deficit

    (135,424 )   (192,634 )

Treasury stock, at cost, 7,609 common shares at June 30, 2012 and December 31, 2011

    (4 )   (4 )
           

Total stockholders' equity

    822,058     760,013  
           

Total liabilities and stockholders' equity

  $ 2,115,938   $ 1,627,652  
           

   

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

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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,
 
 
  2012   2011   2012   2011  

Revenues:

                         

Oil and natural gas sales

  $ 139,609   $ 130,763   $ 288,560   $ 236,532  

Natural gas transportation and treating

    1,015     964     2,412     2,306  
                   

Total revenues

    140,624     131,727     290,972     238,838  

Costs and expenses:

                         

Lease operating expenses

    15,660     10,194     30,644     18,112  

Production and ad valorem taxes

    7,318     7,897     16,237     14,999  

Natural gas transportation and treating

    391     615     691     1,167  

Drilling and production

    333     397     1,771     693  

General and administrative (including non-cash stock-based compensation of $2,588 and $557 for the three months ended June 30, 2012 and 2011, respectively, and $4,835 and $876 for the six months ended June 30, 2012 and 2011, respectively)

    14,410     10,522     31,941     19,770  

Accretion of asset retirement obligations

    292     155     556     304  

Depreciation, depletion and amortization

    60,697     43,439     112,220     75,917  

Impairment expense

        37         243  
                   

Total costs and expenses

    99,101     73,256     194,060     131,205  
                   

Operating income

    41,523     58,471     96,912     107,633  
                   

Non-operating income (expense):

                         

Realized and unrealized gain (loss):

                         

Commodity derivative financial instruments, net

    28,543     18,449     29,137     (9,585 )

Interest rate derivatives, net

        (976 )   (323 )   (1,094 )

Interest expense

    (21,674 )   (11,736 )   (36,358 )   (22,252 )

Interest and other income

    15     22     31     58  

Write-off of deferred loan costs

                (3,246 )

Loss on disposal of assets

    (8 )   (18 )   (8 )   (35 )
                   

Non-operating income (expense), net

    6,876     5,741     (7,521 )   (36,154 )
                   

Income before income taxes

    48,399     64,212     89,391     71,479  
                   

Income tax expense:

                         

Deferred

    (17,424 )   (23,140 )   (32,181 )   (25,737 )
                   

Total income tax expense

    (17,424 )   (23,140 )   (32,181 )   (25,737 )
                   

Net income

  $ 30,975   $ 41,072   $ 57,210   $ 45,742  
                   

Net income per common share:

                         

Basic

  $ 0.24         $ 0.45        

Diluted

  $ 0.24         $ 0.45        

Weighted average common shares outstanding:

                         

Basic

    126,921           126,862        

Diluted

    128,222           128,101        

   

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

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Laredo Petroleum Holdings, Inc.

Consolidated statement of stockholders' equity

(in thousands)

(Unaudited)

 
   
   
   
  Treasury Stock
(at cost)
   
   
 
 
  Common Stock    
   
   
 
 
  Additional
paid-in
capital
  Accumulated
deficit
   
 
 
  Shares   Amount   Shares   Amount   Total  

Balance, December 31, 2011

    127,617   $ 1,276   $ 951,375     8   $ (4 ) $ (192,634 ) $ 760,013  

Restricted stock awards

    777     8     (8 )                

Restricted stock forfeitures

    (98 )   (1 )   1                  

Stock-based compensation

            4,835                 4,835  

Net income

                        57,210     57,210  
                               

Balance, June 30, 2012

    128,296   $ 1,283   $ 956,203     8   $ (4 ) $ (135,424 ) $ 822,058  
                               

   

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

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Laredo Petroleum Holdings, Inc.

Consolidated statements of cash flows

(in thousands)

(Unaudited)

 
  Six months ended
June 30,
 
 
  2012   2011  

Cash flows from operating activities:

             

Net income

  $ 57,210   $ 45,742  

Adjustments to reconcile net income to net cash provided by operating activities:

             

Deferred income tax expense

    32,181     25,737  

Depreciation, depletion and amortization

    112,220     75,917  

Impairment expense

        243  

Non-cash stock-based compensation

    4,835     876  

Accretion of asset retirement obligations

    556     304  

Unrealized (gain) loss on derivative financial instruments, net

    (16,929 )   7,192  

Premiums paid for derivative financial instruments

    (2,927 )   (512 )

Amortization of premiums paid for derivative financial instruments

    319     216  

Amortization of deferred loan costs

    2,268     1,909  

Write-off of deferred loan costs

        3,246  

Amortization of October 2011 Notes premium

    (99 )    

Amortization of other assets

    10     9  

Loss on disposal of assets

    8     35  

(Increase) decrease in accounts receivable

    2,303     (12,142 )

(Increase) decrease in other current assets

    (3,075 )   (768 )

Increase (decrease) in accounts payable

    3,304     (6,513 )

Increase (decrease) in undistributed revenues and royalties

    4,721     8,019  

Increase (decrease) in accrued compensation and benefits

    (3,060 )   (3,970 )

Increase (decrease) in other accrued liabilities

    4,828     16,572  

Increase (decrease) in other noncurrent liabilities

    1,117     (54 )
           

Net cash provided by operating activities

    199,790     162,058  
           

Cash flows from investing activities:

             

Capital expenditures:

             

Oil and natural gas properties

    (473,846 )   (348,523 )

Pipeline and gas gathering assets

    (7,031 )   (6,344 )

Other fixed assets

    (4,988 )   (4,602 )

Proceeds from other fixed asset disposals

    34     20  
           

Net cash used in investing activities

    (485,831 )   (359,449 )
           

Cash flows from financing activities:

             

Borrowings on revolving credit facilities

    195,000     180,100  

Payments on revolving credit facilities

    (280,000 )   (231,300 )

Payments on term loan

        (100,000 )

Issuance of 2019 Notes

        350,000  

Issuance of 2022 Notes

    500,000      

Payments for loan costs

    (10,476 )   (10,592 )
           

Net cash provided by financing activities

    404,524     188,208  
           

Net increase (decrease) in cash and cash equivalents

    118,483     (9,183 )

Cash and cash equivalents, beginning of period

    28,002     31,235  
           

Cash and cash equivalents, end of period

  $ 146,485   $ 22,052  
           

Supplemental disclosure of cash flow information:

             

Cash paid during the period:

             

Interest, net of $505 and zero, respectively, of capitalized interest for the six months ended June 30, 2012 and 2011, respectively

  $ 27,956   $ 6,626  

   

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

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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 and Mid-Continent regions of the United States. Laredo Holdings was incorporated pursuant to the laws of the State of Delaware on August 12, 2011 for the purposes of a Corporate Reorganization (as defined below) and the initial public offering of its common stock (the "IPO") on December 20, 2011. 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.

        On July 1, 2011, Laredo Petroleum, LLC ("Laredo LLC"), a Delaware limited liability company, and Laredo completed the acquisition of Broad Oak Energy, Inc., a Delaware corporation ("Broad Oak"), for a combination of equity and cash. Prior to the acquisition, Broad Oak was owned by its management and Warburg Pincus Private Equity, L.P. ("Warburg Pincus IX"). On July 19, 2011, Broad Oak's name was changed to Laredo Petroleum—Dallas, Inc.

        On December 19, 2011, immediately prior to the IPO, Laredo LLC merged with and into Laredo Holdings, with Laredo Holdings being the surviving entity. Warburg Pincus IX and other affiliates of Warburg Pincus LLC were majority owners of Laredo LLC and are of Laredo Holdings. The preferred units and certain series of restricted units of Laredo LLC were exchanged into shares of common stock of Laredo Holdings based on the pre-offering equity value of such units (the "Corporate Reorganization"). The common stock has one vote per share and a par value of $0.01 per share.

        In these notes, the "Company," when used in the present tense, prospectively or for historical periods since December 19, 2011, refers to Laredo Holdings, Laredo and its subsidiaries collectively, and for historical periods prior to December 19, 2011 refers to Laredo LLC, Laredo and its subsidiaries collectively, unless the context indicates otherwise.

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 Broad Oak acquisition discussed in Note A was accounted for in a manner similar to a pooling of interests. The historical financial statements present the assets and liabilities of Laredo Holdings and its subsidiaries and Broad Oak at historical carrying values and their operations as if they were consolidated for all periods presented. All material intercompany transactions and account balances have been eliminated in the consolidation of accounts. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The Company operates oil and natural gas properties as one business segment, which explores for, develops and produces oil and natural gas.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

B—Basis of presentation and significant accounting policies (Continued)

        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, 2011 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 at June 30, 2012, the results of operations for the three and six months ended June 30, 2012 and 2011 and cash flows for the six months ended June 30, 2012 and 2011. All such adjustments are of a normal recurring nature.

        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, 2011 (the "2011 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 of the Company 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, 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 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.    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.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

B—Basis of presentation and significant accounting policies (Continued)

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 and as the operator in the majority of its wells 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 over 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 as of June 30, 2012 and December 31, 2011:

(in thousands)
  June 30, 2012   December 31, 2011  

Oil and natural gas sales

  $ 38,945   $ 49,434  

Joint operations(1)

    31,104     24,190  

Other

    1,783     511  
           

Total, net

  $ 71,832   $ 74,135  
           

(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, 2012 and December 31, 2011.

4.    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.

        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).

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

B—Basis of presentation and significant accounting policies (Continued)

5.    Other current liabilities

        Other current liabilities consist of the following components as of June 30, 2012 and December 31, 2011:

(in thousands)
  June 30, 2012   December 31, 2011  

Lease operating expense payable

  $ 6,663   $ 5,297  

Prepaid drilling liability

    1,995     2,378  

Production taxes payable

    1,591     1,493  

Deferred income taxes payable

    1,506      

Current portion of asset retirement obligations

    393     506  

Other accrued liabilities

    3,350     5,245  
           

Total other current liabilities

  $ 15,498   $ 14,919  
           

6.    Property and equipment

        The following table sets forth the Company's property and equipment as of June 30, 2012 and December 31, 2011:

(in thousands)
  June 30, 2012   December 31, 2011  

Proved oil and natural gas properties

  $ 2,551,524   $ 2,083,015  

Less accumulated depletion and impairment

    993,312     884,533  
           

Proved oil and natural gas properties, net

    1,558,212     1,198,482  

Unproved properties not being amortized

   
127,971
   
117,195
 

Pipeline and gas gathering assets

   
63,667
   
58,136
 

Less accumulated depreciation

    7,900     6,394  
           

Pipeline and gas gathering assets, net

    55,767     51,742  

Other fixed assets

   
21,840
   
16,948
 

Less accumulated depreciation and amortization

    7,385     5,858  
           

Other fixed assets, net

    14,455     11,090  
           

Total property and equipment, net

  $ 1,756,405   $ 1,378,509  
           

        For the three months ended June 30, 2012 and 2011, depletion expense was $20.70 per barrel of oil equivalent ("BOE") and $20.11 per BOE, respectively. For the six months ended June 30, 2012 and 2011, depletion expense was $20.20 per BOE and $18.44 per BOE, respectively.

7.    Deferred loan costs

        Loan origination fees are stated at cost, net of amortization, which are amortized over the life of the respective debt agreements utilizing the effective interest and straight-line methods. The Company capitalized $10.5 million and $0.4 million of deferred loan costs in the three months ended June 30,

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Table of Contents


Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

B—Basis of presentation and significant accounting policies (Continued)

2012 and 2011, respectively, and $10.5 million and $10.6 million in the six months ended June 30, 2012 and 2011, respectively. The Company had total deferred loan costs of $31.7 million and $23.5 million, net of accumulated amortization of $6.7 million and $4.4 million, as of June 30, 2012 and December 31, 2011, respectively.

        During the six months ended June 30, 2011, the Company wrote off approximately $3.2 million in deferred loan costs as a result of the retirement of debt and changes in the borrowing base of the Senior Secured Credit Facility (as defined in Note C). No deferred loan costs were written off in the six months ended June 30, 2012.

        Future amortization expense of deferred loan costs at June 30, 2012 is as follows:

(in thousands)
   
 

Remaining 2012

  $ 2,534  

2013

    5,107  

2014

    5,164  

2015

    5,225  

2016

    3,969  

Thereafter

    9,667  
       

Total

  $ 31,666  
       

8.    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.

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Table of Contents


Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

B—Basis of presentation and significant accounting policies (Continued)

        The following reconciles the Company's asset retirement obligations liability as of June 30, 2012 and December 31, 2011:

(in thousands)
  Six months ended
June 30, 2012
  Year ended
December 31, 2011
 

Liability at beginning of period

  $ 13,074   $ 8,278  

Liabilities added due to acquisitions, drilling and other

    2,270     1,519  

Accretion expense

    556     616  

Liabilities settled upon plugging and abandonment

    (24 )   (340 )

Revision of estimates

        3,001  
           

Liability at end of period

  $ 15,876   $ 13,074  
           

9.    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.

10.    Compensation awards

        For stock-based compensation awards, compensation expense is recognized in "General and adminstrative" 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. See Note D for further discussion of the restricted stock awards and restricted stock option awards.

        For performance unit awards issued to management with 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 the awards at the date of grant and to re-measure the fair value at the end of each reporting period until settlement in accordance with GAAP. Due to the relatively short trading history for 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. Compensation expense for these awards amounted to $0.5 million and $1.0 million in the three and six months ended June 30, 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

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

B—Basis of presentation and significant accounting policies (Continued)

noncurrent liabilities" in the June 30, 2012 unaudited consolidated balance sheet. 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 member of management.

11.    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 asset. During the three and six months ended June 30, 2011, the Company recorded a $0.04 million and a $0.2 million write-down of materials and supplies, respectively. Other than the aforementioned write-downs, for the three and six months ended June 30, 2012 and 2011, the Company did not record any additional impairment to property and equipment used in operations or other long-lived assets.

12.    Environmental

        The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, which are often changing, 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. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. 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 at June 30, 2012 or December 31, 2011.

13.    Business combinations

        Acquisitions are accounted for under the acquisition method of accounting. Accordingly, the Company conducts assessments of net assets acquired and recognizes amounts for identifiable assets acquired and liabilities assumed at the estimated acquisition date fair values, while transaction and integration costs associated with the acquisitions are expensed as incurred.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

B—Basis of presentation and significant accounting policies (Continued)

14.    Related party transactions

        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 and is included in the unaudited consolidated statements of operations for the periods presented:

 
  Three months ended
June 30,
  Six months ended
June 30,
 
(in thousands)
  2012   2011   2012   2011  

Net oil and natural gas sales(1)

  $ 18,350   $ 18,093   $ 37,740   $ 33,533  

        The following table summarizes the amounts included in oil and natural gas sales receivable in the unaudited consolidated balance sheets for the periods presented:

(in thousands)
  June 30, 2012   December 31, 2011  

Oil and natural gas sales receivable(1)

  $ 5,504   $ 6,845  

(1)
The Company has a gas gathering and processing arrangement with affiliates of Targa Resources, Inc. ("Targa"). Warburg Pincus IX, 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.

C—Debt

1.    Interest expense

        The following amounts have been incurred and charged to interest expense for the three and six months ended June 30, 2012 and 2011:

 
  Three months ended
June 30,
  Six months ended
June 30,
 
(in thousands)
  2012   2011   2012   2011  

Cash payments for interest

  $ 1,356   $ 2,935   $ 28,461   $ 6,626  

Amortization and write-off of deferred loan costs and other adjustments

    1,240     4,105     2,321     5,155  

Change in accrued interest

    19,204     4,696     6,081     10,471  
                   

Interest costs incurred

    21,800     11,736     36,863     22,252  

Less capitalized interest

    (126 )       (505 )    
                   

Total interest expense

  $ 21,674   $ 11,736   $ 36,358   $ 22,252  
                   

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

C—Debt (Continued)

        The following table presents the weighted average interest rates and the weighted average outstanding debt balances for the three and six months ended June 30, 2012 and 2011:

 
  Three months ended June 30,   Six months ended June 30,  
 
  2012   2011   2012   2011  
(in thousands except for
percentages)
  Weighted
average
principal
  Weighted
average
interest
rate(3)
  Weighted
average
principal
  Weighted
average
interest
rate(3)
  Weighted
average
principal
  Weighted
average
interest
rate(3)
  Weighted
average
principal
  Weighted
average
interest
rate(3)
 

Senior Secured Credit Facility

  $ 270,741     0.17 % $ 43,182     0.55 % $ 190,085     0.72 % $ 68,056     0.75 %

2019 Notes

    550,000     2.37 %   350,000     2.37 %   550,000     4.73 %   350,000     4.19 %

2022 Notes

    500,000     1.29 %           500,000     1.29 %        

Term Loan(1)

                            100,000     0.31 %

Broad Oak Credit Facility(2)

            64,541     2.87 %           122,904     3.07 %

(1)
Laredo's Second Lien Term Loan Agreement was entered into on July 7, 2010 and was paid-in-full and terminated on January 20, 2011.

(2)
The Broad Oak revolving credit facility was paid-in-full and terminated on July 1, 2011.

(3)
Interest rates presented are annual rates which have been prorated to reflect the portion of the year for which they have been incurred.

2.    2022 Notes

        On April 27, 2012, Laredo completed an offering of $500 million in aggregate principal amount of 73/8% senior unsecured notes due 2022 (the "2022 Notes"). The 2022 Notes will mature on May 1, 2022 and bear an interest rate of 73/8% 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"). The net proceeds from the 2022 Notes (i) were used to pay in full $280.0 million outstanding under Laredo's revolving Amended and Restated Credit Agreement (as amended, the "Senior Secured Credit Facility"), and (ii) will be used for general working capital purposes.

        The 2022 Notes were issued under and are governed by an indenture and supplement thereto, each dated April 27, 2012 (collectively, the "2012 Indenture"), among Laredo, Wells Fargo Bank, National Association, as trustee, and the Guarantors. The 2012 Indenture contains customary terms, events of default and covenants relating to, among other things, the incurrence of debt, the payment of dividends or similar restricted payments, entering into transactions with affiliates and limitations on asset sales. Indebtedness under the 2022 Notes may be accelerated in certain circumstances upon an event of default as set forth in the 2012 Indenture.

        Laredo will have the option to redeem the 2022 Notes, in whole or in part, at any time on or after May 1, 2017, at the redemption prices (expressed as percentages of principal amount) of 103.688% for the twelve-month period beginning on May 1, 2017, 102.458% for the twelve-month period beginning

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

C—Debt (Continued)

on May 1, 2018, 101.229% for the twelve-month period beginning on May 1, 2019 and 100.000% for the twelve-month period beginning on May 1, 2020 and at any time thereafter, together with any accrued and unpaid interest to, but not including, the date of redemption. In addition, before May 1, 2017, Laredo may redeem all or any part of the 2022 Notes at a redemption price equal to the sum of the principal amount thereof, plus a make whole premium at the redemption date, plus accrued and unpaid interest, if any, to the redemption date. Furthermore, before May 1, 2015, Laredo may, at any time or from time to time, redeem up to 35% of the aggregate principal amount of the 2022 Notes with the net proceeds of a public or private equity offering at a redemption price of 107.375% of the principal amount of the 2022 Notes, plus any accrued and unpaid interest to the date of redemption, if at least 65% of the aggregate principal amount of the 2022 Notes issued under the 2012 Indenture remains outstanding immediately after such redemption and the redemption occurs within 180 days of the closing date of such equity offering. Laredo may also be required to make an offer to purchase the 2022 Notes upon a change of control triggering event. In addition, if a change of control occurs prior to May 1, 2013, Laredo may redeem all, but not less than all, of the notes at a redemption price equal to 110% of the principal amount of the 2022 Notes redeemed, plus any accrued and unpaid interest, if any, to the date of redemption.

        In connection with the issuance of the 2022 Notes, Laredo and the Guarantors entered into a registration rights agreement with the initial purchasers of the 2022 Notes on April 27, 2012, pursuant to which Laredo and the Guarantors filed with the Securities and Exchange Commission ("SEC") a registration statement that became effective with respect to an offer to exchange the 2022 Notes for substantially identical notes (other than with respect to restrictions on transfer or to any increase in annual interest rate) that are registered under the Securities Act of 1933, as amended (the "Securities Act"). The offer to exchange the 2022 Notes for substantially identical notes registered under the Securities Act commenced on July 2, 2012 and was consummated on August 1, 2012 with all notes exchanged.

3.    2019 Notes

        On January 20, 2011, Laredo completed an offering of $350 million 91/2% Senior Notes due 2019 (the "January Notes") and on October 19, 2011, Laredo completed an offering of an additional $200 million 91/2% Senior 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 9.5% 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.

        In connection with the issuance of the 2019 Notes, Laredo and the Guarantors entered into registration rights agreements with the initial purchasers of the 2019 Notes, pursuant to which Laredo and the Guarantors filed with the SEC a registration statement that became effective with respect to an offer to exchange the 2019 Notes for substantially identical notes (other than with respect to restrictions on transfer or to any increase in annual interest rate) registered under the Securities Act. The offer to exchange the 2019 Notes for substantially identical notes registered under the Securities Act was consummated on January 13, 2012 with all notes exchanged.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

C—Debt (Continued)

4.    Senior secured credit facility

        The Senior Secured Credit Facility, which matures July 1, 2016, had a borrowing base of $785.0 million with no amounts outstanding at June 30, 2012. It contains both financial and non-financial covenants that the Company was in compliance with at June 30, 2012.

        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 June 30, 2012, Laredo had one letter of credit outstanding totaling $0.03 million under the Senior Secured Credit Facility.

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 at June 30, 2012 and December 31, 2011:

 
  June 30, 2012   December 31, 2011  
(in thousands)
  Carrying
value
  Fair
value
  Carrying
value
  Fair
value
 

2019 Notes(1)

  $ 551,863   $ 616,000   $ 551,961   $ 585,750  

2022 Notes

    500,000     521,875          

Senior Secured Credit Facility(2)

            85,000     84,893  
                   

Total value of debt

  $ 1,051,863   $ 1,137,875   $ 636,961   $ 670,643  
                   

(1)
The carrying value of the 2019 Notes includes the October 2011 Notes unamortized bond premium of approximately $1.9 million and $2.0 million as of June 30, 2012 and December 31, 2011, respectively.

(2)
No amounts were outstanding under the Senior Secured Credit Facility at June 30, 2012.

        At June 30, 2012 and December 31, 2011, the fair value of the debt outstanding on the 2019 Notes and the 2022 Notes was determined using the June 30, 2012 and December 31, 2011 quoted market price (Level 1), respectively, and the fair value of the outstanding debt at December 31, 2011 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—Stock-based compensation

        In November 2011, 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 stock options, restricted stock awards 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 payment expense over the requisite service period. Laredo Holdings' stock-based payment awards are accounted for as equity instruments.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

D—Stock-based compensation (Continued)

Stock-based compensation is included in "General and administrative" in the unaudited consolidated statements of operations.

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 cancelled 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 vest 33%, 33% and 34% per year beginning on the first anniversary date of the grant. The following table reflects the outstanding restricted stock awards for the six months ended June 30, 2012:

(in thousands, except for weighted
average grant date fair values)
  Restricted
stock
awards
  Weighted average
grant date
fair value
 

Outstanding at December 31, 2011

    911   $ 1.14  

Granted

    777   $ 23.50  

Forfeited

    (98 ) $ 14.93  

Vested

    (233 ) $ 0.44  
             

Outstanding at June 30, 2012

    1,357   $ 13.02  
             

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, 2012:

(in thousands, except for weighted average
exercise price and contractual term)
  Restricted
stock option
awards
  Weighted average
exercise price
(per option)
  Weighted average
contractual term
(years)
 

Outstanding at December 31, 2011

      $      

Granted

    603   $ 24.11     10  

Forfeited

    (54 ) $ 24.11     10  
                   

Outstanding at June 30, 2012

    549   $ 24.11     10  
                   

Vested and exercisable at end of period

                 
                   

        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. There were no restricted stock options granted during the three months ended June 30, 2012.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

D—Stock-based compensation (Continued)

        The assumptions used to estimate the fair value of restricted stock options granted on February 3, 2012 are as follows:

Risk-free interest rate(1)

    1.07 %

Expected option life(2)

    6.01  

Expected volatility(3)

    60.18 %

Fair value per option

 
$

13.36
 

(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 in accordance with GAAP.

(3)
The Company utilized a peer historical look-back, weighted with the Company's own volatility since the IPO, to develop the expected volatility.

E—Income taxes

        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.

        The Company is subject to corporate income taxes and the Texas margin tax. Income tax expense for the three and six months ended June 30, 2012 and 2011 consisted of the following:

 
  Three months ended
June 30,
  Six months ended
June 30,
 
(in thousands)
  2012   2011   2012   2011  

Current taxes

                         

Federal

  $   $   $   $  

State

                 

Deferred taxes

                         

Federal

    17,055     22,254     30,847     24,528  

State

    369     886     1,334     1,209  
                   

Income tax expense

  $ 17,424   $ 23,140   $ 32,181   $ 25,737  
                   

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Table of Contents


Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

E—Income taxes (Continued)

        Income tax expense differed from amounts computed by applying the federal income tax rate of 34% to pre-tax income from operations as a result of the following:

 
  Three months ended
June 30,
  Six months ended
June 30,
 
(in thousands)
  2012   2011   2012   2011  

Income tax expense computed by applying the statutory rate

  $ 16,456   $ 21,832   $ 30,393   $ 24,303  

State income tax, net of federal tax benefit and increase in valuation allowance

    1,395     1,478     1,900     1,189  

Income from non-taxable entity

        (6 )       (16 )

Non-deductible compensation

    275     187     655     287  

Change in valuation allowance

    1     193     2     2  

Other items

    (703 )   (544 )   (769 )   (28 )
                   

Income tax expense

  $ 17,424   $ 23,140   $ 32,181   $ 25,737  
                   

        Significant components of the Company's deferred tax assets as of June 30, 2012 and December 31, 2011 are as follows:

(in thousands)
  June 30, 2012   December 31, 2011  

Derivative financial instruments

  $ (3,526 ) $ 3,551  

Oil and natural gas properties and equipment

    (119,354 )   (87,138 )

Net operating loss carry-forward

    186,222     180,740  

Other

    705     (926 )
           

    64,047     96,227  

Valuation allowance

    (650 )   (649 )
           

Net deferred tax asset

  $ 63,397   $ 95,578  
           

        Net deferred tax assets and liabilities were classified in the unaudited consolidated balance sheets as follows as of June 30, 2012 and December 31, 2011:

(in thousands)
  June 30, 2012   December 31, 2011  

Deferred tax asset

  $ 64,903   $ 95,578  

Deferred tax liability

    1,506      
           

Net deferred tax assets

  $ 63,397   $ 95,578  
           

        The Company had federal net operating loss carry-forwards totaling approximately $527.3 million and state net operating loss carry-forwards totaling approximately $180.9 million at June 30, 2012. These carry-forwards begin expiring in 2026. The Company maintains a valuation allowance to reduce certain deferred tax assets to amounts that are more likely than not to be realized. At June 30, 2012, a $0.6 million valuation allowance was recorded against the state of Louisiana deferred tax asset and a $0.03 million valuation allowance was recorded against the Company's charitable contribution carry-forward. The Company believes the federal and state of Oklahoma net operating loss carry-forwards

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

E—Income taxes (Continued)

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 at June 30, 2012 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's income tax returns for the years 2008 through 2011 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 had operations. Additionally, the statute of limitations for examination of federal net operating loss carryovers typically does not begin to run until the year the attribute is utilized in a tax return. In evaluating its current tax positions in order to identify any material uncertain tax positions, the Company developed a policy in identifying uncertain tax positions that considers support for each tax position, industry standards, tax return disclosures and schedules, and the significance of each position. The Company had no material adjustments to its unrecognized tax benefits during the 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, 2012, the Company had 54 open derivative contracts with financial institutions, none of which were designated as hedges for accounting purposes, which extend from July 2012 to December 2015. The contracts are recorded at fair value on the balance sheet and any realized and unrealized gains and losses are recognized in current year earnings.

        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.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

F—Derivative financial instruments (Continued)

        Each basis swap transaction has an established fixed differential between the NYMEX gas futures and West Texas WAHA ("WAHA") index gas price. When the NYMEX futures settlement price less the fixed WAHA 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 WAHA 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.

        During the six months ended June 30, 2012, 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. When aggregating multiple contracts, the weighted average contract price is disclosed.

 
  Aggregate
volumes
  Swap
price
  Floor
price
  Ceiling
price
  Contract period

Oil (volumes in Bbls):

                           

Price collar

    270,000       $ 90.00   $ 126.50       April 2012 - December 2012

Price collar

    240,000       $ 90.00   $ 118.35   January 2013 - December 2013

Price collar

    198,000       $ 70.00   $ 140.00   January 2014 - December 2014

Put

    360,000       $ 75.00       January 2014 - December 2014

Price collar

    252,000       $ 75.00   $ 135.00   January 2015 - December 2015

Put

    360,000       $ 75.00       January 2015 - December 2015

Put

    180,000       $ 75.00       January 2014 - December 2014

Put

    96,000       $ 75.00       January 2015 - December 2015

Natural gas (volumes in MMBtu):

                           

Swap

    700,000   $ 2.72            April 2012 - October 2012

Price collar

    700,000       $ 3.25   $ 3.90    April 2013 - October 2013

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

F—Derivative financial instruments (Continued)

        The following table summarizes open positions as of June 30, 2012, and represents, as of such date, derivatives in place through December 31, 2015, on annual production volumes:

 
  Remaining
year
2012
  Year
2013
  Year
2014
  Year
2015
 

Oil Positions:

                         

Puts:

                         

Hedged volume (Bbls)

    336,000     1,080,000     540,000     456,000  

Weighted average price ($/Bbl)

  $ 65.79   $ 65.00   $ 75.00   $ 75.00  

Swaps:

                         

Hedged volume (Bbls)

    366,000     600,000          

Weighted average price ($/Bbl)

  $ 93.52   $ 96.32   $   $  

Collars:

                         

Hedged volume (Bbls)

    603,000     768,000     726,000     252,000  

Weighted average floor price ($/Bbl)

  $ 79.50   $ 79.38   $ 75.45   $ 75.00  

Weighted average ceiling price ($/Bbl)

  $ 118.09   $ 121.67   $ 129.09   $ 135.00  

Natural Gas Positions:

                         

Puts:

                         

Hedged volume (MMBtu)

    2,160,000     6,600,000          

Weighted average price ($/MMBtu)

  $ 5.38   $ 4.00   $   $  

Swaps:

                         

Hedged volume (MMBtu)

    1,240,000              

Weighted average price ($/MMBtu)

  $ 5.04   $   $   $  

Collars:

                         

Hedged volume (MMBtu)

    3,900,000     7,300,000     6,960,000      

Weighted average floor price ($/MMBtu)

  $ 4.12   $ 3.93   $ 4.00   $  

Weighted average ceiling price ($/MMBtu)

  $ 5.79   $ 6.75   $ 7.03   $  

Basis swaps(1):

                         

Hedged volume (MMBtu)

    1,440,000     1,200,000          

Weighted average price ($/MMBtu)

  $ 0.31   $ 0.33   $   $  

(1)
The cash settlement price of the Company's basis swaps is calculated on the difference between the Company's natural gas futures contracts that settle on the NYMEX index and the NYMEX index price at the time of settlement. At June 30, 2012, the Company had 200,000 MMBtu for the remainder of 2012 and 500,000 MMBtu for 2013 in basis swaps that did not have corresponding volumes hedged with a NYMEX index price.

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 LIBOR is lower than the fixed rate in the contract, the Company is required to pay the counterparties the difference,

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

F—Derivative financial instruments (Continued)

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 at June 30, 2012:

(in thousands except rate data)
  Year
2012
  Year
2013
  Expiration date

Notional amount

  $ 50,000   $ 50,000    

Fixed rate

    1.11 %   1.11 % September 13, 2013

Notional amount

  $ 50,000   $ 50,000    

Cap rate

    3.00 %   3.00 % September 13, 2013
             

Total

  $ 100,000   $ 100,000    
             

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, 2012   December 31, 2011  

Assets:

             

Commodity derivatives:

             

Oil derivatives

  $ 33,033   $ 16,026  

Natural gas derivatives

    28,980     34,019  

Interest rate derivatives

        11  
           

  $ 62,013   $ 50,056  
           

Liabilities:

             

Commodity derivatives:

             

Oil derivatives(1)

  $ 23,691   $ 28,044  

Natural gas derivatives(2)

    5,231     6,832  

Interest rate derivatives

    365     1,991  
           

  $ 29,287   $ 36,867  
           

(1)
The oil derivatives fair value includes a deferred premium liability of $19.7 million and $13.4 million at June 30, 2012 and December 31, 2011, respectively.

(2)
The natural gas derivatives fair value includes a deferred premium liability of $3.9 million and $5.4 million at June 30, 2012 and December 31, 2011, 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

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

F—Derivative financial instruments (Continued)

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 at June 30, 2012.

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.

        The following represents the Company's reported gains and losses on derivative instruments for the three and six months ended June 30, 2012 and 2011:

 
  Three months ended
June 30,
  Six months ended
June 30,
 
(in thousands)
  2012   2011   2012   2011  

Realized gains (losses):

                         

Commodity derivatives

  $ 9,115   $ (1,584 ) $ 13,823   $ (931 )

Interest rate derivatives

    (835 )   (1,255 )   (1,938 )   (2,556 )
                   

    8,280     (2,839 )   11,885     (3,487 )

Unrealized gains (losses):

                         

Commodity derivatives

    19,428     20,033     15,314     (8,654 )

Interest rate derivatives

    835     279     1,615     1,462  
                   

    20,263     20,312     16,929     (7,192 )

Total gains (losses):

                         

Commodity derivatives

    28,543     18,449     29,137     (9,585 )

Interest rate derivatives

        (976 )   (323 )   (1,094 )
                   

  $ 28,543   $ 17,473   $ 28,814   $ (10,679 )
                   

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

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 the 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 asset or liability. Substantially all of these inputs are observable in the marketplace throughout the full term of the price risk management instrument, 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 that 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, 2012 and 2011.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

G—Fair value measurements (Continued)

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 at June 30, 2012 and December 31, 2011.

(in thousands)
  Level 1   Level 2   Level 3   Total fair
value
 

As of June 30, 2012:

                         

Commodity derivatives

  $   $ 56,643   $   $ 56,643  

Deferred premiums

            (23,552 )   (23,552 )

Interest rate derivatives

        (365 )       (365 )
                   

Total

  $   $ 56,278   $ (23,552 ) $ 32,726  
                   

 

(in thousands)
  Level 1   Level 2   Level 3   Total fair
value
 

As of December 31, 2011:

                         

Commodity derivatives

  $   $ 34,037   $   $ 34,037  

Deferred premiums

            (18,868 )   (18,868 )

Interest rate derivatives

        (1,980 )       (1,980 )
                   

Total

  $   $ 32,057   $ (18,868 ) $ 13,189  
                   

        These items are included in "Derivative financial instruments" on the unaudited consolidated balance sheets. Significant Level 2 assumptions associated with the calculation of discounted cash flows used in the "mark-to-market" analysis of commodity derivatives include the NYMEX natural gas and crude oil prices, appropriate risk adjusted discount rates and other relevant data. Significant Level 2 assumptions associated with the calculation of discounted cash flows used in the "mark-to-market" analysis of interest rate swaps include the interest rate curves, appropriate risk adjusted discount rates and other relevant data.

        The Company's deferred premiums associated with its commodity derivative contracts are categorized in Level 3, as the Company utilizes a net present value calculation to determine the valuation. They are considered to be measured on a recurring basis as the derivative contracts they derive from are measured on a recurring basis. As commodity derivative contracts containing deferred premiums are entered into, the Company discounts the associated deferred premium to its net present value at the contract trade date, using the Senior Secured Credit Facility rate at the trade date (historical input rates range from 2.06% to 3.56%) and then amortizing the change in net present value into interest expense over the period from trade until the final settlement date at the end of the contract. After this initial valuation the net present value of each deferred premium is not adjusted, therefore significant increases (decreases) in the Senior Secured Credit Facility rate would result in a significantly lower (higher) fair value measurement for each new deal containing a deferred premium entered into; however the valuation for the deals already recorded would remain unaffected. While the Company believes the sources utilized to arrive at the fair value estimates are reliable, different sources or methods could have yielded different fair value estimates; therefore on a quarterly basis, the valuation is compared to counterparty valuations and third party valuation of the deferred premiums

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

G—Fair value measurements (Continued)

for reasonableness. A summary of the changes in assets classified as Level 3 measurements for the three and six months ended June 30, 2012 and 2011 are as follows:

 
  Three months
ended June 30, 2012
  Six months
ended June 30, 2012
 
(in thousands)
  Derivative
option
contracts
  Deferred
premiums
  Derivative
option
contracts
  Deferred
premiums
 

Balance of Level 3 at beginning of period(1)

  $   $ (23,061 ) $   $ (18,868 )

Realized and unrealized gains included in earnings

                 

Amortization of deferred premiums

        (169 )       (319 )

Total purchases and settlements:

                         

Purchases

        (1,917 )       (7,292 )

Settlements

        1,595         2,927  
                   

Balance of Level 3 at end of period

  $   $ (23,552 ) $   $ (23,552 )
                   

Change in unrealized losses attributed to earnings relating to derivatives still held at end of period

  $   $   $   $  
                   

 

 
  Three months
ended June 30, 2011
  Six months
ended June 30, 2011
 
(in thousands)
  Derivative
option
contracts
  Deferred
premiums
  Derivative
option
contracts
  Deferred
premiums
 

Balance of Level 3 at beginning of period

  $ 12,856   $ (12,581 ) $ 20,026   $ (12,495 )

Realized and unrealized gains (losses) included in earnings

    521         (6,588 )    

Amortization of deferred premiums

        (109 )       (216 )

Total purchases and settlements:

                         

Purchases

    561         500      

Settlements

        20         41  
                   

Balance of Level 3 at end of period

  $ 13,938   $ (12,670 ) $ 13,938   $ (12,670 )
                   

Change in unrealized gains attributed to earnings relating to derivatives still held at end of period

  $ 10,638   $   $ 1,970   $  
                   

(1)
The Company transferred the commodity derivative option contracts out of Level 3 during the year ended December 31, 2011 due to the Company's ability to utilize transparent forward price curves and volatilities published and available through independent third party vendors. As a result, the Company transferred positions from Level 3 to Level 2 as the significant inputs used to calculate the fair value are all observable.

Fair value measurement on a nonrecurring basis

        The Company accounts for additions to its asset retirement obligation (see Note B.8) and the impairment of long-lived assets (see Note B.11), if any, at fair value on a nonrecurring basis in

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

G—Fair value measurements (Continued)

accordance with GAAP. For purposes of fair value measurement, it was determined that the impairment of long-lived assets and the additions to the asset retirement obligation are classified as Level 3 based on the use of internally developed cash flow models. No impairments of long-lived assets were recorded in the six months ended June 30, 2012.

        Inherent in the fair value calculation of asset retirement obligations are numerous assumptions and judgments including, in addition to those noted above, the ultimate settlement of these amounts, the ultimate timing of such settlement, and changes in legal, regulatory, environmental and political environments. To the extent future revisions to these assumptions impact the fair value of the existing asset retirement obligation liability, a corresponding adjustment will be made to the asset balance.

        Asset retirement obligations.    The accounting policies for asset retirement obligations are discussed in Note B.8, including a reconciliation of the Company's asset retirement obligation. The fair value of additions to the asset retirement obligation liability is measured using valuation techniques consistent with the income approach, which converts future cash flows to a single discounted amount. Significant inputs to the valuation include: (i) estimated plug and abandonment cost per well based on Company experience; (ii) estimated remaining life per well based on the reserve life per well; (iii) future inflation factors; and (iv) the Company's average credit adjusted risk free rate.

        Impairment of oil and natural gas properties.    The accounting policies for impairment of oil and natural gas properties are discussed in the audited consolidated financial statements and notes thereto included in the 2011 Annual Report. Significant inputs included in the calculation of discounted cash flows used in the impairment analysis include the Company's estimate of operating and development costs, anticipated production of proved reserves and other relevant data.

H—Credit risk

        The Company's oil and natural gas sales are to a variety of purchasers, including intrastate and interstate pipelines or their marketing affiliates and independent marketing companies. The Company's joint operations accounts receivable are from a number of oil and natural gas companies, partnerships, individuals and others who own interests in the properties operated by the Company. Management believes that any credit risk imposed by a concentration in the oil and natural gas industry is offset by the creditworthiness of the Company's customer base and industry partners. The Company routinely assesses the recoverability of all material trade and other receivables to determine collectability.

        The Company uses derivative instruments to hedge its exposure to oil and natural gas price volatility and its exposure to interest rate risk associated with the Senior Secured Credit Facility. These transactions expose the Company to potential credit risk from its counterparties. In accordance with the Company's standard practice, its derivative instruments are subject to counterparty netting under agreements governing such derivatives and therefore, the credit risk associated with its derivative counterparties is somewhat mitigated. See Note F for additional information regarding the Company's derivative instruments.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

I—Commitments and contingencies

1.    Lease commitments

        The Company leases equipment and office space under operating leases expiring on various dates through 2016. Minimum annual lease commitments at June 30, 2012 and for the calendar years following are as follows:

(in thousands)
   
 

Remaining 2012

  $ 720  

2013

    1,448  

2014

    1,102  

2015

    731  

2016

    282  
       

Total

  $ 4,283  
       

        The following table presents rent expense for the three and six months ended June 30, 2012 and 2011.

 
  Three months ended
June 30,
  Six months ended
June 30,
 
(in thousands)
  2012   2011   2012   2011  

Rent expense

  $ 295   $ 307   $ 602   $ 590  

        The Company's office space lease agreements contain scheduled escalation in lease payments during the term of the lease. In accordance with GAAP, the Company records rent expense on a straight-line basis and a deferred lease liability for the difference between the straight-line amount and the actual amounts of the lease payments.

2.    Litigation

        The Company may be involved in legal proceedings or is subject to industry rulings that could bring rise to claims in the ordinary course of business. The Company has concluded that the likelihood is remote that the ultimate resolution of any pending litigation or pending claims will be material or have a material adverse effect on the Company's business, financial position, results of operations or liquidity.

3.    Drilling contracts

        The Company has committed to several short-term drilling contracts with various third parties in order to complete its various drilling projects. The contracts contain an early termination clause that requires the Company to pay significant penalties to the third party should the Company cease drilling efforts. These penalties could significantly impact the Company's financial statements upon contract termination. These commitments are not recorded in the accompanying unaudited consolidated balance sheets. Future commitments as of June 30, 2012 are $35.8 million. Management does not anticipate canceling any drilling contracts or discontinuing drilling efforts in 2012.

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

I—Commitments and contingencies (Continued)

4.    Federal and state regulations

        Oil and natural gas exploration, production and related operations are subject to extensive federal and state laws, rules and regulations. Failure to comply with these laws, rules and regulations can result in substantial penalties. The regulatory burden on the oil and natural gas industry increases the cost of doing business and affects profitability. The Company believes that it is in compliance with currently applicable state and federal regulations and these regulations will not have a material adverse impact on the financial position or results of operations of the Company. Because these rules and regulations are frequently amended or reinterpreted, the Company is unable to predict the future cost or impact of complying with these regulations.

J—Defined contribution plans

        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 tax-deferred 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 contributions to the plans for the three and six months ended June 30, 2012 and 2011.

 
  Three months ended
June 30,
  Six months ended
June 30,
 
(in thousands)
  2012   2011   2012   2011  

Contributions

  $ 325   $ 326   $ 642   $ 855  

K—Net income per share

        Basic net income per share is computed by dividing net income by the weighted-average number of shares outstanding for the period. Diluted net income per share reflects the potential dilution of non-vested restricted stock awards. The effect of the Company's outstanding options to purchase 549,446 shares of common stock at $24.11 per share were excluded from the calculation of diluted earnings per share for the three and six months ended June 30, 2012 because the exercise price of those options was greater than the average market price during the period, and therefore the inclusion of these outstanding options would have been anti-dilutive. The following is the calculation of basic and

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

K—Net income per share (Continued)

diluted weighted average shares outstanding and net income per share for the three and six months ended June 30, 2012:

(in thousands, except for per share data)
  Three months ended
June 30, 2012
  Six months ended
June 30, 2012
 

Income (numerator):

             

Net income—basic and diluted

  $ 30,975   $ 57,210  

Weighted average shares (denominator):

             

Weighted average shares—basic

    126,921     126,862  

Non-vested restricted stock

    1,301     1,239  
           

Weighted average shares—diluted

    128,222     128,101  
           

Net income per share:

             

Basic

  $ 0.24   $ 0.45  

Diluted

  $ 0.24   $ 0.45  

L—Recently issued accounting standards

        In December 2011, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") 2011-11, Disclosures about Offsetting Assets and Liabilities, to improve reporting and transparency of offsetting (netting) assets and liabilities and the related effects on the financial statements. This ASU is effective for fiscal years and interim periods within those years beginning on or after January 1, 2013. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

M—Subsidiary guarantees

        Laredo Holdings and all of Laredo's wholly-owned subsidiaries (Laredo Gas, Laredo Texas and Laredo Dallas, collectively, the "Subsidiary Guarantors") have fully and unconditionally guaranteed the 2019 Notes, the 2022 Notes and the Senior Secured Credit Facility. In accordance with practices accepted by the SEC, Laredo has prepared condensed consolidating financial statements in order to quantify the assets, results of operations and cash flows of such subsidiaries as subsidiary guarantors. The following unaudited condensed consolidating balance sheet as of June 30, 2012 and audited condensed consolidating balance sheet as of December 31, 2011, unaudited condensed consolidating statements of operations for the three and six months ended June 30, 2012 and 2011, and unaudited condensed consolidating statements of cash flows for the six months ended June 30, 2012 and 2011, present financial information for Laredo Holdings as the parent of Laredo on a stand-alone basis (carrying any investments in subsidiaries under the equity method), financial information for Laredo on a stand-alone basis (carrying any investment in subsidiaries under the equity method), financial information for the Subsidiary Guarantors on a stand-alone basis (carrying any investment in subsidiaries under the equity method), and the consolidation and elimination entries necessary to arrive at the information for the Company on a condensed consolidated basis. All deferred income taxes are recorded on Laredo's statements of financial position, as Laredo's subsidiaries are flow-through entities for income tax purposes. Prior to the Broad Oak acquisition on July 1, 2011, both Laredo and Laredo

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

M—Subsidiary guarantees (Continued)

Dallas were separate taxable entities and deferred income taxes for the Company are recorded separately. The Subsidiary Guarantors are not restricted from making distributions to Laredo.


Condensed consolidating balance sheet
June 30, 2012
(unaudited)

(in thousands)
  Laredo
Holdings
  Laredo   Subsidiary
Guarantors
  Intercompany
eliminations
  Consolidated
company
 

Accounts receivable

  $   $ 54,616   $ 17,216   $   $ 71,832  

Other current assets

        172,615     199         172,814  

Total oil and natural gas properties, net

        999,604     686,579         1,686,183  

Total pipeline and gas gathering assets, net

            55,767         55,767  

Total other fixed assets, net

        11,686     2,769         14,455  

Investment in subsidiaries

    942,804     619,841         (1,562,645 )    

Total other long-term assets

        114,887             114,887  
                       

Total assets

  $ 942,804   $ 1,973,249   $ 762,530   $ (1,562,645 ) $ 2,115,938  
                       

Accounts payable

  $ 1   $ 29,730   $ 19,580   $   $ 49,311  

Other current liabilities

        126,691     48,024         174,715  

Other long-term liabilities

        9,443     8,548         17,991  

Long-term debt

        1,051,863             1,051,863  

Stockholders' equity

    942,803     755,522     686,378     (1,562,645 )   822,058  
                       

Total liabilities and stockholders' equity

  $ 942,804   $ 1,973,249   $ 762,530   $ (1,562,645 ) $ 2,115,938  
                       

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

M—Subsidiary guarantees (Continued)


Condensed consolidating balance sheet
December 31, 2011
(audited)

(in thousands)
  Laredo
Holdings
  Laredo   Subsidiary
Guarantors
  Intercompany
eliminations
  Consolidated
company
 

Accounts receivable

  $   $ 53,006   $ 21,129   $   $ 74,135  

Other current assets

    54,921     20,599     204     (26,921 )   48,803  

Total oil and natural gas properties, net

        780,152     535,525         1,315,677  

Total pipeline and gas gathering assets, net

            51,742         51,742  

Total other fixed assets, net

        10,321     769         11,090  

Investment in subsidiaries

    888,043     554,901         (1,442,944 )    

Total other long-term assets

        126,205             126,205  
                       

Total assets

  $ 942,964   $ 1,545,184   $ 609,369   $ (1,469,865 ) $ 1,627,652  
                       

Accounts payable

  $ 1   $ 58,729   $ 14,198   $ (26,921 ) $ 46,007  

Other current liabilities

        130,990     37,364         168,354  

Other long-term liabilities

        8,779     7,538         16,317  

Long-term debt

        636,961             636,961  

Stockholders' equity

    942,963     709,725     550,269     (1,442,944 )   760,013  
                       

Total liabilities and stockholders' equity

  $ 942,964   $ 1,545,184   $ 609,369   $ (1,469,865 ) $ 1,627,652  
                       


Condensed consolidating statement of operations
For the three months ended June 30, 2012
(unaudited)

(in thousands)
  Laredo
Holdings
  Laredo   Subsidiary
Guarantors
  Intercompany
eliminations
  Consolidated
company
 

Total operating revenues

  $   $ 76,692   $ 66,570   $ (2,638 ) $ 140,624  

Total operating costs and expenses

    140     64,951     36,648     (2,638 )   99,101  
                       

Income (loss) from operations

    (140 )   11,741     29,922         41,523  

Interest income (expense), net

        (21,659 )           (21,659 )

Other, net

        28,543     (8 )       28,535  
                       

Income (loss) from operations before income tax

    (140 )   18,625     29,914         48,399  

Income tax expense

        (17,424 )           (17,424 )
                       

Net income (loss)

  $ (140 ) $ 1,201   $ 29,914   $   $ 30,975  
                       

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

M—Subsidiary guarantees (Continued)


Condensed consolidating statement of operations
For the three months ended June 30, 2011
(unaudited)

(in thousands)
  Laredo
Holdings
  Laredo   Subsidiary
Guarantors
  Intercompany
eliminations
  Consolidated
company
 

Total operating revenues

  $   $ 59,958   $ 73,489   $ (1,720 ) $ 131,727  

Total operating costs and expenses

        40,320     34,656     (1,720 )   73,256  
                       

Income from operations

        19,638     38,833         58,471  

Interest income (expense), net

    19     (9,203 )   (2,530 )       (11,714 )

Other, net

        3,113     14,342         17,455  
                       

Income from operations before income tax

    19     13,548     50,645         64,212  

Income tax expense

        (5,323 )   (17,817 )       (23,140 )
                       

Net income

  $ 19   $ 8,225   $ 32,828   $   $ 41,072  
                       


Condensed consolidating statement of operations
For the six months ended June 30, 2012
(unaudited)

(in thousands)
  Laredo
Holdings
  Laredo   Subsidiary
Guarantors
  Intercompany
eliminations
  Consolidated
company
 

Total operating revenues

  $   $ 152,458   $ 143,403   $ (4,889 ) $ 290,972  

Total operating costs and expenses

    159     126,564     72,226     (4,889 )   194,060  
                       

Income (loss) from operations

    (159 )   25,894     71,177         96,912  

Interest income (expense), net

        (36,327 )           (36,327 )

Other, net

        28,814     (8 )       28,806  
                       

Income (loss) from operations before income tax

    (159 )   18,381     71,169         89,391  

Income tax expense

        (32,181 )           (32,181 )
                       

Net income (loss)

  $ (159 ) $ (13,800 ) $ 71,169   $   $ 57,210  
                       

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

M—Subsidiary guarantees (Continued)


Condensed consolidating statement of operations
For the six months ended June 30, 2011
(unaudited)

(in thousands)
  Laredo
Holdings
  Laredo   Subsidiary
Guarantors
  Intercompany
eliminations
  Consolidated
company
 

Total operating revenues

  $   $ 102,482   $ 139,650   $ (3,294 ) $ 238,838  

Total operating costs and expenses

    7     71,859     62,633     (3,294 )   131,205  
                       

Income (loss) from operations

    (7 )   30,623     77,017         107,633  

Interest income (expense), net

    55     (17,152 )   (5,097 )       (22,194 )

Other, net

        (5,696 )   (8,264 )       (13,960 )
                       

Income from operations before income tax

    48     7,775     63,656         71,479  

Income tax expense

        (4,336 )   (21,401 )       (25,737 )
                       

Net income

  $ 48   $ 3,439   $ 42,255   $   $ 45,742  
                       


Condensed consolidating statement of cash flows
For the six months ended June 30, 2012
(unaudited)

(in thousands)
  Laredo
Holdings
  Laredo   Subsidiary
Guarantors
  Intercompany
eliminations
  Consolidated
company
 

Net cash flows provided by (used in) operating activities

  $ (160 ) $ 49,843   $ 123,186   $ 26,921   $ 199,790  

Net cash flows provided by used in investing activities

    (54,761 )   (307,882 )   (123,188 )       (485,831 )

Net cash flows provided by financing activities

        404,524             404,524  
                       

Net increase (decrease) in cash and cash equivalents

    (54,921 )   146,485     (2 )   26,921     118,483  

Cash and cash equivalents at beginning of period

    54,921         2     (26,921 )   28,002  
                       

Cash and cash equivalents at end of period

  $   $ 146,485   $   $   $ 146,485  
                       

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

M—Subsidiary guarantees (Continued)

Condensed consolidating statement of cash flows
For the six months ended June 30, 2011
(unaudited)

(in thousands)
  Laredo
Holdings
  Laredo   Subsidiary
Guarantors
  Intercompany
eliminations
  Consolidated
company
 

Net cash flows provided by operating activities

  $ 47   $ 65,580   $ 102,583   $ (6,152 ) $ 162,058  

Net cash flows used in investing activities

    (7,318 )   (203,452 )   (148,679 )       (359,449 )

Net cash flows provided by financing activities

        137,872     50,336         188,208  
                       

Net increase (decrease) in cash and cash equivalents

    (7,271 )       4,240     (6,152 )   (9,183 )

Cash and cash equivalents at beginning of period

    38,652         6,489     (13,906 )   31,235  
                       

Cash and cash equivalents at end of period

  $ 31,381   $   $ 10,729   $ (20,058 ) $ 22,052  
                       

N—Subsequent events

1.    Acquisition

        On July 12, 2012, the Company completed the acquisition of additional working interest in certain oil and natural gas properties located in Glasscock County, TX for a contract price of $20.5 million from a private company, subject to certain purchase price adjustments. The initial accounting for the business combination is not complete pending detailed analyses of the facts and circumstances that existed as of the acquisition date.

2.    New derivative contracts

        Subsequent to June 30, 2012, the Company entered into additional commodity contracts, with approximately $4.2 million in deferred premiums associated. The following table summarizes information about these new commodity derivative contracts. When aggregating multiple contracts, the weighted average contract price is disclosed.

 
  Aggregate
volumes
  Floor
price
  Ceiling
price
  Contract period  

Natural gas (volumes in MMBtu):

                         

Price collar

    8,760,000   $ 3.00   $ 5.00     January 2013 - December 2013  

Price collar

    11,160,000   $ 3.00   $ 5.50     January 2014 - December 2014  

Price collar

    15,480,000   $ 3.00   $ 6.00     January 2015 - December 2015  

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Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements (Continued)

(Unaudited)

O—Supplementary information

Costs incurred in oil and natural gas property acquisition, exploration and development activities(1)

        Costs incurred in the acquisition and development of oil and natural gas assets are presented below for the three and six months ended June 30, 2012 and 2011:

 
  Three months ended
June 30,
  Six months ended
June 30,
 
(in thousands)
  2012   2011   2012   2011  

Property acquisition costs:

                         

Proved

  $   $   $   $  

Unproved

                 

Exploration

    22,219     12,973     51,686     21,868  

Development costs

    232,508     160,747     427,599     312,390  
                   

Total costs incurred

  $ 254,727   $ 173,720   $ 479,285   $ 334,258  
                   

(1)
The costs incurred for oil and natural gas development activities include $1.4 million and $0.2 million in asset retirement obligations for the three months ended June 30, 2012 and 2011, respectively, and $2.3 million and $0.5 million for the six months ended June 30, 2012 and 2011, respectively.

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

        The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited consolidated financial statements and condensed notes thereto included elsewhere in this Quarterly Report on Form 10-Q as well as our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011 (the "2011 Annual Report"). The following discussion contains "forward-looking statements" that reflect our future plans, estimates, beliefs and expected performance. We caution that assumptions, expectations, projections, intentions or beliefs about future events may, and often do, vary from actual results and the differences can be material. Please see "Cautionary Statement Regarding Forward-Looking Statements."

        Except for purposes of the unaudited consolidated financial statements and condensed notes thereto included elsewhere in this Quarterly Report on Form 10-Q, references in this Quarterly Report on Form 10-Q to "Laredo," "we," "us," "our" or similar terms refer to Laredo Petroleum, LLC together with its subsidiaries for periods prior to the Corporate Reorganization, and to Laredo Petroleum Holdings, Inc. together with its subsidiaries for periods after the Corporate Reorganization, unless the context otherwise indicates or requires. For more information regarding the Corporate Reorganization and IPO, see Note A to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Overview

        We are an independent energy company focused on the exploration, development and acquisition of oil and natural gas properties in the Permian and Mid-Continent regions of the United States. Laredo was founded in October 2006 to explore, develop and operate oil and natural gas properties and has grown rapidly through its drilling program and by making strategic acquisitions and joint ventures. On July 1, 2011, we completed the acquisition of Broad Oak Energy, Inc. ("Broad Oak"), whereby Broad Oak became a wholly-owned subsidiary of Laredo Petroleum, Inc., and its name was changed to Laredo Petroleum—Dallas, Inc. This acquisition was considered a combination of entities under common control and the historical and financial operating data presented herein are shown on a consolidated basis. In December 2011, we completed the Corporate Reorganization and IPO.

        Our financial and operating performance for the three months ended June 30, 2012 included the following:

    Oil and natural gas sales of approximately $139.6 million, compared to approximately $130.8 million for the three months ended June 30, 2011;

    Average daily production of 31,385 BOE/D, compared to 23,081 BOE/D for the three months ended June 30, 2011; and

    Adjusted EBITDA (a non-GAAP financial measure) of $113.9 million compared to $100.9 million for the three months ended June 30, 2011.

        Our financial and operating performance for the six months ended June 30, 2012 included the following:

    Oil and natural gas sales of approximately $288.6 million, compared to approximately $236.5 million for the six months ended June 30, 2011;

    Average daily production of 29,690 BOE/D, compared to 22,070 BOE/D for the six months ended June 30, 2011; and

    Adjusted EBITDA (a non-GAAP financial measure) of $227.8 million compared to $183.8 million for the six months ended June 30, 2011.

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Core areas of operations

        Our activities are primarily focused in the Wolfberry and deeper horizons of the Permian Basin in West Texas and the Anadarko Granite Wash in the Texas Panhandle and Western Oklahoma. The oil and liquids-rich Permian Basin and the liquids-rich Anadarko Granite Wash are characterized by multiple target horizons, extensive production histories, long-lived reserves, high drilling success rates and significant initial production rates. As of June 30, 2012, we had an interest in 1,291 gross producing wells.

        Additionally, as of June 30, 2012, we have accumulated 404,276 net acres. Through December 31, 2011, we had identified over 6,000 gross potential drilling locations on our existing acreage. We intend to continue to explore and develop this large acreage position to increase our cash flow, production and reserves through continued vertical and horizontal drilling programs.

Pricing

        Our results of operations are heavily influenced by commodity prices. Prices for oil and natural gas can fluctuate widely in response to relatively minor changes in the global and regional supply of and demand for oil and natural gas, market uncertainty, economic conditions and a variety of additional factors. Since the inception of our oil and natural gas activities, commodity prices have experienced significant fluctuations, and additional changes in commodity prices may significantly affect the economic viability of drilling projects, as well as the economic valuation and economic recovery of oil and natural gas reserves.

        The unweighted arithmetic average first-day-of-the-month index prices for the prior 12 months ended June 30, 2012 and June 30, 2011 used to value our reserves were $92.17 per Bbl for oil and $3.01 per MMBtu for natural gas, and $86.60 per Bbl for oil and $4.00 per MMBtu for natural gas, respectively. The prices used to estimate proved reserves for all periods did not give effect to derivative transactions, were held constant throughout the life of the properties and have been adjusted for quality, transportation fees, geographical differentials, marketing bonuses or deductions and other factors affecting the price received at the wellhead. Our reserves are reported in two streams: crude oil and liquids-rich natural gas. The economic value of the natural gas liquids in our natural gas is included in the wellhead natural gas price.

        We have entered into a number of commodity derivatives, which have allowed us to offset a portion of the changes caused by price fluctuations on our oil and natural gas production as discussed in "—Hedging" below.

Sources of our revenue

        Our revenues are derived from the sale of oil and natural gas within the continental United States and do not include the effects of derivatives. For the three months ended June 30, 2012, our revenues are comprised of sales of approximately 71% oil, 28% natural gas and 1% for transportation and treating. For the six months ended June 30, 2012, our revenues are comprised of sales of approximately 70% oil, 29% natural gas and 1% for transportation and treating. Our revenues may vary significantly from period to period as a result of changes in volumes of production sold or changes in commodity prices.

Hedging

        Due to the inherent volatility in oil and natural gas prices, we use commodity derivative instruments, such as collars, swaps, puts and basis swaps to hedge price risk associated with a significant portion of our anticipated oil and natural gas production. By removing a majority of the price volatility associated with future production, we expect to reduce, but not eliminate, the potential effects of

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variability in cash flow from operations due to fluctuations in commodity prices. We have not elected hedge accounting on these derivatives and, therefore, the unrealized gains and losses on open positions are reflected currently in earnings. At each period end, we estimate the fair value of our commodity derivatives using an independent third party valuation and recognize an unrealized gain or loss. During the three and six months ended June 30, 2012, we recognized unrealized gains on our commodity derivatives of $19.4 million and $15.3 million, respectively, and during the three and six months ended June 30, 2011, we recognized an unrealized gain of $20.0 million and an unrealized loss of $8.7 million on our commodity derivatives, respectively, based on market price fluctuations compared to prices in our commodity derivative contracts.

        Subsequent to June 30, 2012, we entered into 15 additional derivative contracts to hedge the price risk associated with approximately 8,760,000 MMBtu, 11,160,000 MMBtu and 15,480,000 MMBtu of our natural gas production for the twelve months ending December 31, 2013, 2014 and 2015, respectively. These derivative contracts have associated deferred premiums totaling approximately $4.2 million. See Note N to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information regarding these derivative contracts.

        Our hedged positions as of June 30, 2012 are as follows:

 
  Remaining
year 2012
  Year
2013
  Year
2014
  Year
2015
  Total  

Oil(1)

                               

Total volume hedged with ceiling price (Bbls)

    969,000     1,368,000     726,000     252,000     3,315,000  

Weighted average ceiling price ($/Bbl)

  $ 108.81   $ 110.55   $ 129.09   $ 135.00   $ 115.96  

Total volume hedged with floor price (Bbls)

   
1,305,000
   
2,448,000
   
1,266,000
   
708,000
   
5,727,000
 

Weighted average floor price ($/Bbl)

  $ 79.90   $ 77.19   $ 75.26   $ 75.00   $ 77.11  

Natural Gas(2)

                               

Total volume hedged with ceiling price (MMBtu)

    5,140,000     7,300,000     6,960,000         19,400,000  

Weighted average ceiling price(3) ($/MMBtu)

  $ 5.54   $ 6.72   $ 7.03   $   $ 6.51  

Total volume hedged with floor price (MMBtu)

   
7,300,000
   
13,900,000
   
6,960,000
   
   
28,160,000
 

Weighted average floor price(3) ($/MMBtu)

  $ 4.59   $ 3.95   $ 4.00   $   $ 4.13  

Natural Gas basis swaps (MMbtu)

                               

Total volume hedged(4) (MMBtu)

    1,440,000     1,200,000             2,640,000  

Weighted average price ($/MMBtu)

  $ 0.31   $ 0.33   $   $   $ 0.32  

(1)
The oil derivatives are settled based on the month's average daily NYMEX price of West Texas Intermediate Light Sweet Crude Oil.

(2)
The natural gas derivatives are settled based on NYMEX natural gas futures, the Northern Natural Gas Co. demarcation price or the Panhandle Eastern Pipe Line spot price of natural gas for the calculation period. The basis swap derivatives are settled based on the differential between the NYMEX natural gas futures and the West Texas WAHA index gas price.

(3)
The cash settlement price of our basis swaps is calculated on the difference between our natural gas futures contracts that settle on the NYMEX index and the NYMEX index price at the time of

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    settlement. At June 30, 2012, we had 200,000 MMBtu for the remainder of 2012 and 500,000 MMBtu for 2013 in basis swaps that did not have corresponding volumes hedged with a NYMEX index price. As such, the weighted average price of the basis differential attributable to these volumes has not been included in the weighted average ceiling and floor prices presented above as these basis contracts are not expected to settle based on our June 30, 2012 hedge positions.

(4)
Total volume hedged for natural gas basis swaps includes 200,000 MMBtu for the remainder of 2012 and 500,000 MMBtu for 2013 in basis swaps that did not have corresponding volumes hedged with a NYMEX index price at June 30, 2012.

Results of operations

        The following table sets forth information regarding production, average sales prices and average costs per BOE for the three and six months ended June 30, 2012 and 2011:

 
  Three months ended
June 30,
  Six months ended
June 30,
 
 
  2012   2011   2012   2011  

Production data:

                         

Oil and condensate (MBbl)

    1,164     808     2,231     1,517  

Natural gas (MMcf)

    10,152     7,754     19,034     14,866  

Oil equivalents (MBOE)(1)(2)

    2,856     2,100     5,404     3,995  

Average daily production (BOE/d)

    31,385     23,081     29,690     22,070  

% Oil and condensate

    41 %   38 %   41 %   38 %

Average sales prices:

                         

Oil and condensate, realized(3) ($/Bbl)

  $ 85.45   $ 98.53   $ 91.23   $ 94.57  

Natural gas, realized(3) ($/Mcf)

  $ 3.95   $ 6.60   $ 4.47   $ 6.26  

Oil equivalents, realized ($/BOE)

  $ 48.88   $ 62.27   $ 53.40   $ 59.21  

Oil and condensate, hedged(4) ($/Bbl)

 
$

85.45
 
$

93.43
 
$

90.20
 
$

90.31
 

Natural gas, hedged(4) ($/Mcf)

  $ 4.85   $ 6.93   $ 5.31   $ 6.63  

Oil equivalents, hedged ($/BOE)

  $ 52.07   $ 61.53   $ 55.95   $ 58.97  

Average costs per BOE:

                         

Lease operating expenses

  $ 5.48   $ 4.85   $ 5.67   $ 4.53  

Production and ad valorem taxes

    2.56     3.76     3.00     3.75  

General and administrative(5)

    5.05     5.01     5.91     4.95  

DD&A

    21.25     20.69     20.77     19.00  
                   

Total

  $ 34.34   $ 34.31   $ 35.35   $ 32.23  
                   

(1)
MBbl equivalents ("MBOE") are calculated using a conversion rate of six MMcf per one MBbl.

(2)
The volumes presented are based on actual results and are not calculated using the rounded numbers presented in the table above.

(3)
Realized crude oil and natural gas prices are the actual prices realized at the wellhead after all adjustments for NGL content, quality, transportation fees, geographical differentials, marketing bonuses or deductions and other factors affecting the price at the wellhead.

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(4)
Hedged prices reflect the after effect of our commodity hedging transactions on our average sales prices. Our calculation of such after effects include realized gains and losses on cash settlements for commodity derivatives, which do not qualify for hedge accounting. See Note F.4 to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information regarding our realized gains and losses on commodity derivatives.

(5)
General and administrative includes non-cash stock-based compensation of $2.6 million and $0.6 million for the three months ended June 30, 2012 and 2011, respectively, and $4.8 million and $0.9 million for the six months ended June 30, 2012 and 2011, respectively. Excluding stock-based compensation from the above metric results in general and administrative per BOE of $4.14 and $4.75 for the three months ended June 30, 2012 and 2011, respectively, and $5.02 and $4.73 for the six months ended June 30, 2012 and 2011, respectively.

Three months ended June 30, 2012 as compared to the three months ended June 30, 2011

        The following table sets forth selected operating data for the three months ended June 30, 2012 compared to the three months ended June 30, 2011:

 
  Three months ended
June 30,
 
(in thousands)
  2012   2011  

Revenues

             

Oil

  $ 99,462   $ 79,600  

Natural gas

    40,147     51,163  

Natural gas transportation and treating

    1,015     964  
           

Total revenues

    140,624     131,727  

Costs and expenses

             

Lease operating expenses

    15,660     10,194  

Production and ad valorem taxes

    7,318     7,897  

Natural gas transportation and treating

    391     615  

Drilling and production

    333     397  

General and administrative (including non-cash stock-based compensation of $2,588 and $557 for the three months ended June 30, 2012 and 2011, respectively)

    14,410     10,522  

Accretion of asset retirement obligations

    292     155  

Depreciation, depletion and amortization

    60,697     43,439  

Impairment expense

        37  
           

Total costs and expenses

    99,101     73,256  

Non-operating income (expense):

             

Realized and unrealized gain (loss):

             

Commodity derivative financial instruments, net

    28,543     18,449  

Interest rate derivatives, net

        (976 )

Interest expense

    (21,674 )   (11,736 )

Interest and other income

    15     22  

Loss on disposal of assets

    (8 )   (18 )
           

Non-operating income, net

    6,876     5,741  

Income tax expense

    (17,424 )   (23,140 )
           

Net income

  $ 30,975   $ 41,072  
           

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        Oil and natural gas revenues.    Our oil and natural gas revenues increased by approximately $8.8 million, or 7%, to $139.6 million during the three months ended June 30, 2012 as compared to the three months ended June 30, 2011. Our revenues are a function of oil and natural gas production volumes sold and average sales prices received for those volumes. Average daily production sold increased by 8,304 BOE/D, or 36%, during the three months ended June 30, 2012 as compared to the same period in 2011. The total increase in revenue of approximately $8.8 million for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 is attributable to higher oil and natural gas production volumes, which were offset by declining market prices for oil and natural gas for the three months ended June 30, 2012. Production increased by 356 MBbls for oil and 2,398 MMcf for natural gas for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011. The net dollar effect of the decrease in prices of approximately $42.1 million (calculated as the change in period-to-period average prices times current quarter production volumes for oil and natural gas) and the net dollar effect of the increase in production of approximately $50.9 million (calculated as the increase in period-to-period volumes for oil and natural gas times the prior period average prices) are shown below.

 
  Change in
prices(1)
  Production
volumes for the
three months ended
6/30/2012(2)
  Total net
dollar effect
of change
(in thousands)
 

Effect of changes in price:

                   

Oil

  $ (13.08 )   1,164   $ (15,225 )

Natural gas

  $ (2.65 )   10,152   $ (26,903 )
                   

Total revenues due to change in price

              $ (42,128 )

 

 
  Change in
production
volumes(2)
  Prices at
6/30/2011(1)
  Total net
dollar effect
of change
(in thousands)
 

Effect of changes in volumes:

                   

Oil

    356   $ 98.53   $ 35,077  

Natural gas

    2,398   $ 6.60   $ 15,827  
                   

Total revenues due to change in volumes

              $ 50,904  

Rounding differences

             
$

70
 
                   

Total change in revenues

              $ 8,846  
                   

(1)
Prices shown are realized, unhedged $/Bbl for oil and are realized, unhedged $/Mcf for natural gas.

(2)
Production volumes are presented in MBbls for oil and in MMcf for natural gas.

        Lease operating expenses.    Lease operating expenses, which include workover expenses, increased to $15.7 million for the three months ended June 30, 2012 from $10.2 million for the three months ended June 30, 2011, an increase of approximately 54%. The increase was primarily due to an increase in drilling activity, which resulted in additional producing wells during the second quarter of 2012 compared to the second quarter of 2011. The increase in well count also led to increases in routine repairs and maintenance. On a per-BOE basis, lease operating expenses increased in total to $5.48 per BOE for the three months ended June 30, 2012 from $4.85 per BOE for the three months ended June 30, 2011.

        Production and ad valorem taxes.    Production and ad valorem taxes decreased to approximately $7.3 million for the three months ended June 30, 2012 from $7.9 million for the three months ended

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June 30, 2011, a decrease of $0.6 million. This decrease was primarily due to the decrease in market prices for oil and natural gas, which was offset by a significant increase in production for the second quarter of 2012 as compared to the same period in 2011. The average realized prices excluding derivatives for the three months ended June 30, 2012 were $85.45 per Bbl for oil and $3.95 per Mcf for natural gas as compared to $98.53 per Bbl for oil and $6.60 per Mcf for natural gas for the three months ended June 30, 2011.

        General and administrative ("G&A").    G&A expense increased to approximately $14.4 million for the three months ended June 30, 2012 from $10.5 million for the same period in 2011, an increase of $3.9 million, or 37%. Increases in salaries, benefits and bonuses accounted for approximately $2.1 million of the increase due to an increase in the number of employees as we continue to grow our business. Professional fees decreased by approximately $0.9 million due largely to fees incurred for the Broad Oak acquisition during the second quarter of 2011.

        Additionally, stock-based compensation increased by approximately $2.0 million to $2.6 million for the three months ended June 30, 2012 as compared to the same period in 2011 due to the issuance of 776,711 restricted stock awards and 602,948 non-qualified stock options during 2012. The fair value of the restricted stock awards issued during the first and second quarters of 2012 was calculated based on the value of our stock price on the date of grant in accordance with the applicable generally accepted accounting principles in the United States of America ("GAAP") and is being recognized on a straight-line basis over the three year requisite service period of the awards. The fair value of our non-qualified restricted stock options was determined using a Black-Scholes valuation model in accordance with applicable GAAP accounting and is being recognized on a straight-line basis over the four year requisite service period of the awards. The issuance of our cash-settled performance unit liability awards in February 2012, which are revalued at the end of each reporting period using a Monte Carlo simulation, accounted for approximately $0.5 million of the total change for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011.

        On a per-BOE basis, G&A expense increased to $5.05 per BOE during the three months ended June 30, 2012 from $5.01 per BOE for the three months ended June 30, 2011. Excluding non-cash, stock-based compensation, G&A expense per BOE was $4.14 and $4.75 for the three months ended June 30, 2012 and 2011, respectively.

        See Notes B and D to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information regarding our stock and performance based compensation.

        Depreciation, depletion and amortization ("DD&A").    DD&A increased to approximately $60.7 million for the three months ended June 30, 2012 from $43.4 million for the same period in 2011, an increase of $17.3 million, or 40%. The following table provides components of our DD&A expense for the three months ended June 30, 2012 and 2011.

 
  Three months ended
June 30,
 
(in thousands except for per BOE data)
  2012   2011  

Depletion of proved oil and natural gas properties

  $ 59,111   $ 42,239  

Depreciation of pipeline assets

    772     595  

Depreciation of other property and equipment

    814     605  
           

Total DD&A

  $ 60,697   $ 43,439  
           

Depletion of proved oil and natural gas properties per BOE

  $ 20.70   $ 20.11  

DD&A per BOE

  $ 21.25   $ 20.69  

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        The increase in depletion of proved oil and natural gas properties of $16.9 million and the increase in the depletion rate of $0.59 per BOE resulted primarily from (i) increased net book value on new reserves added, (ii) higher total production levels, and (iii) increased capitalized costs for new wells completed in 2012.

        Impairment expense.    Impairment expense decreased to zero for the three months ended June 30, 2012 from $0.04 million for the three months ended June 30, 2011. Impairment expense incurred in the first three months of 2011 was to reflect our materials and supplies inventory at the lower of cost or market value calculated as of June 30, 2011. It was determined at June 30, 2012 that a lower of cost or market adjustment was not needed for materials and supplies.

        We evaluate the impairment of our oil and natural gas properties on a quarterly basis according to the full cost method prescribed by the SEC. If the carrying amount exceeds the calculated full cost ceiling, we reduce the carrying amount of the oil and natural gas properties to the calculated full cost ceiling amount, which is determined to be the estimated fair value. At June 30, 2012 and 2011, it was determined that our oil and natural gas properties were not impaired.

        Commodity derivative financial instruments.    Due to the inherent volatility in oil and natural gas prices, we use commodity derivative instruments, including puts, swaps, collars and basis swaps to hedge price risk associated with a significant portion of our anticipated oil and natural gas production. At each period end, we estimate the fair value of our commodity derivatives using a valuation prepared by an independent third party and recognize an unrealized gain or loss. We have not elected hedge accounting on these derivatives, and therefore, the unrealized gains and losses on open positions are reflected in current earnings. For the three months ended June 30, 2012 and 2011, our commodity derivatives resulted in a realized gain of $9.1 million and a realized loss of $1.6 million, respectively. For the three months ended June 30, 2012 and 2011, our commodity derivatives resulted in unrealized gains of $19.4 million and $20.0 million, respectively. At June 30, 2012, we had 18 commodity derivatives contracts with associated deferred premiums totaling approximately $27.5 million. The estimated fair value of our total deferred premiums was approximately $23.6 million at June 30, 2012. The fair market value of these premiums is deducted from our unrealized gain or loss at each period end.

        Interest expense and realized and unrealized gains and losses on interest rate swaps.    Interest expense increased to approximately $21.7 million for the three months ended June 30, 2012 from $11.7 million for the three months ended June 30, 2011, largely due to the issuance of (i) $200.0 million in 91/2% senior unsecured notes due 2019 in October of 2011 in addition to the previously outstanding $350.0 million 91/2% senior unsecured notes due in 2019 (collectively, the "2019 senior unsecured notes"), and (ii) $500.0 million in 73/8% senior unsecured notes due 2022 ("2022 senior unsecured notes") in April of 2012 as shown in the table below.

 
  Three months ended June 30, 2012   Three months ended June 30, 2011  
(in thousands except for percentages)
  Weighted average
principal
  Weighted average
interest rate(2)
  Weighted average
principal
  Weighted average
interest rate(2)
 

Senior secured credit facility

  $ 270,741     0.17 % $ 43,182     0.55 %

2019 senior unsecured notes

    550,000     2.37 %   350,000     2.37 %

2022 senior unsecured notes

    500,000     1.29 %        

Broad Oak credit facility(1)

            64,541     2.87 %

(1)
The Broad Oak credit facility was paid-in-full and terminated on July 1, 2011 in connection with the Broad Oak acquisition.

(2)
Interest rates presented are annual rates which have been prorated to reflect the portion of the year for which they have been incurred.

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        We have entered into certain variable-to-fixed interest rate swaps that hedge our exposure to interest rate variations on our variable interest rate debt. At June 30, 2012, we had interest rate swaps outstanding for a notional amount of $100.0 million with fixed pay rates ranging from 1.11% to 3.00% and terms expiring through September 2013. At June 30, 2011, we had interest rate swaps outstanding for a notional amount of $260.0 million with fixed pay rates ranging from 1.11% to 3.41% and terms expiring through September 2013. We realized losses on interest rate swaps of $0.8 million and $1.3 million for the three months ended June 30, 2012 and 2011, respectively. Additionally, we recorded unrealized gains on interest rate swaps of $0.8 million and $0.3 million for the three months ended June 30, 2012 and 2011, respectively. At June 30, 2012, the estimated fair value of our interest rate swaps was in a net liability position of $0.4 million compared to $2.0 million at December 31, 2011.

        Income tax expense.    We recorded a deferred income tax expense of $17.4 million for the three months ended June 30, 2012, compared to a deferred income tax expense of $23.1 million for the three months ended June 30, 2011. The estimated annual effective tax rate was 36% for each of the three months ended June 30, 2012 and 2011. Our effective tax rate is based on our estimated annual permanent tax differences and estimated annual pre-tax book income. Our estimates involve assumptions we believe to be reasonable at the time of the estimation.

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Six months ended June 30, 2012 as compared to the six months ended June 30, 2011

        The following table sets forth selected operating data for the six months ended June 30, 2012 compared to the six months ended June 30, 2011:

 
  Six months ended
June 30,
 
(in thousands)
  2012   2011  

Revenues

             

Oil

  $ 203,529   $ 143,464  

Natural gas

    85,031     93,068  

Natural gas transportation and treating

    2,412     2,306  
           

Total revenues

    290,972     238,838  

Costs and expenses

             

Lease operating expenses

    30,644     18,112  

Production and ad valorem taxes

    16,237     14,999  

Natural gas transportation and treating

    691     1,167  

Drilling and production

    1,771     693  

General and administrative (including non-cash stock-based compensation of $4,835 and $876 for the six months ended June 30, 2012 and 2011, respectively)

    31,941     19,770  

Accretion of asset retirement obligations

    556     304  

Depreciation, depletion and amortization

    112,220     75,917  

Impairment expense

        243  
           

Total costs and expenses

    194,060     131,205  

Non-operating income (expense):

             

Realized and unrealized gain (loss):

             

Commodity derivative financial instruments, net

    29,137     (9,585 )

Interest rate derivatives, net

    (323 )   (1,094 )

Interest expense

    (36,358 )   (22,252 )

Interest and other income

    31     58  

Write-off of deferred loan costs

        (3,246 )

Loss on disposal of assets

    (8 )   (35 )
           

Non-operating expense, net

    (7,521 )   (36,154 )

Income tax expense

    (32,181 )   (25,737 )
           

Net income

  $ 57,210   $ 45,742  
           

        Oil and natural gas revenues.    Our oil and natural gas revenues increased by approximately $52.0 million, or 22%, to $288.6 million during the six months ended June 30, 2012 as compared to the six months ended June 30, 2011. Our revenues are a function of oil and natural gas production volumes sold and average sales prices received for those volumes. Average daily production sold increased by 7,620 BOE/D during the six months ended June 30, 2012 as compared to the same period in 2011. The total increase in revenue of approximately $52.0 million is largely attributable to higher oil and natural gas production volumes for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011. Production increased by 714 MBbls for oil and 4,168 MMcf for natural gas for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011. The net dollar effect of the decrease in prices of approximately $41.5 million (calculated as the change in period-to-period average prices times current year-to-date production volumes for oil and natural gas) and the net dollar effect of the increase in production of approximately $93.6 million (calculated as the increase in

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period-to-period volumes for oil and natural gas times the prior period average prices) are shown below.

 
  Change in
prices(1)
  Production
volumes for the six
months ended
6/30/2012(2)
  Total net
dollar effect
of change
(in thousands)
 

Effect of changes in price:

                   

Oil

  $ (3.34 )   2,231   $ (7,452 )

Natural gas

  $ (1.79 )   19,034   $ (34,071 )
                   

Total revenues due to change in price

              $ (41,523 )

 

 
  Change in
production
volumes(2)
  Prices at
6/30/2011(1)
  Total net
dollar effect
of change
(in thousands)
 

Effect of changes in volumes:

                   

Oil

    714   $ 94.57   $ 67,523  

Natural gas

    4,168   $ 6.26   $ 26,092  
                   

Total revenues due to change in volumes

              $ 93,615  

Rounding differences

              $ (64 )
                   

Total change in revenues

              $ 52,028  
                   

(1)
Prices shown are realized, unhedged $/Bbl for oil and are realized, unhedged $/Mcf for natural gas.

(2)
Production volumes are presented in MBbls for oil and in MMcf for natural gas.

        Lease operating expenses.    Lease operating expenses, which include workover expenses, increased to $30.6 million for the six months ended June 30, 2012 from $18.1 million for the six months ended June 30, 2011, an increase of approximately 69%. The increase was primarily due to an increase in drilling activity, which resulted in additional producing wells during the first six months of 2012 compared to the same period in 2011. The increase in well count also led to increases in routine repairs and maintenance. Additionally, a portion of the increase is due to approximately $1.1 million in additional workover expenses incurred during the first six months of 2012 as compared to the same period in 2011 resulting largely from costs incurred for the workover of one well. This workover is not indicative of costs typically incurred for workovers and was fully completed in the first quarter of 2012.

        On a per-BOE basis, lease operating expenses increased in total to $5.67 per BOE for the six months ended June 30, 2012 from $4.53 per BOE for the six months ended June 30, 2011. Excluding the one-time workover expense noted above, lease operating expense per BOE at June 30, 2012 was $5.44 per BOE.

        Production and ad valorem taxes.    Production and ad valorem taxes increased to approximately $16.2 million for the six months ended June 30, 2012 from $15.0 million for the six months ended June 30, 2011, an increase of $1.2 million. This increase was primarily due to the significant increase in production of approximately 1,409 MBOE, or 35%, for the first six months of 2012 as compared to the same period in 2011.

        Drilling and production.    Drilling and production costs increased to approximately $1.8 million for the six months ended June 30, 2012 from $0.7 million for the six months ended June 30, 2011 as a result of increased maintenance costs related to the increase in drilling during the first six months of 2012 as compared to the same period in 2011.

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        General and administrative ("G&A").    G&A expense increased to approximately $31.9 million for the six months ended June 30, 2012 from $19.8 million for the six months ended June 30, 2011, an increase of $12.1 million, or 61%. Increases in salaries, benefits and bonuses accounted for approximately $6.3 million of the increase due to the payment of performance bonuses totaling $2.0 million in February 2012 as well as an increase in the number of employees as we continue to grow our business.

        Additionally, stock-based compensation increased by approximately $4.0 million to $4.8 million for the first six months of 2012 as compared to the same period in 2011 due to the issuance of 776,711 restricted stock awards and 602,948 non-qualified stock options during 2012. The fair value of the restricted stock awards issued during the first and second quarters of 2012 was calculated based on the value of our stock price on the date of grant in accordance with GAAP and is being recognized on a straight-line basis over the three year requisite service period of the awards. The fair value of our non-qualified restricted stock options was determined using a Black-Scholes valuation model in accordance with applicable GAAP accounting and is being recognized on a straight-line basis over the four year requisite service period of the awards. The issuance of our cash-settled performance unit liability awards in February 2012, which are revalued at the end of each reporting period using a Monte Carlo simulation, accounted for approximately $1.0 million of the total change for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011.

        On a per-BOE basis, G&A expense increased to $5.91 per BOE during the six months ended June 30, 2012 from $4.95 per BOE for the six months ended June 30, 2011. Excluding non-cash, stock-based compensation, G&A expense per BOE was $5.02 and $4.73 for the six months ended June 30, 2012 and 2011, respectively.

        See Notes B and D to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information regarding our stock and performance based compensation.

        Depreciation, depletion and amortization ("DD&A").    DD&A increased to approximately $112.2 million for the six months ended June 30, 2012 from $75.9 million for the six months ended June 30, 2011, an increase of $36.3 million, or 48%. The following table provides components of our DD&A expense for the six months ended June 30, 2012 and 2011.

 
  Six months ended
June 30,
 
(in thousands except for per BOE data)
  2012   2011  

Depletion of proved oil and natural gas properties

  $ 109,178   $ 73,670  

Depreciation of pipeline assets

    1,505     1,151  

Depreciation of other property and equipment

    1,537     1,096  
           

Total DD&A

  $ 112,220   $ 75,917  
           

Depletion of proved oil and natural gas properties per BOE

  $ 20.20   $ 18.44  

DD&A per BOE

  $ 20.77   $ 19.00  

        The increase in depletion of proved oil and natural gas properties of $35.5 million and the increase in the depletion rate of $1.76 per BOE resulted primarily from (i) increased net book value on new reserves added, (ii) higher total production levels and (iii) increased capitalized costs for new wells completed in 2012.

        Impairment expense.    Impairment expense decreased to zero for the six months ended June 30, 2012 from $0.2 million for the six months ended June 30, 2011. Impairment expense incurred in the first six months of 2011 was to reflect our materials and supplies inventory at the lower of cost or

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market value calculated as of June 30, 2011. It was determined at June 30, 2012 that a lower of cost or market value adjustment was not needed for materials and supplies.

        We evaluate the impairment of our oil and natural gas properties on a quarterly basis according to the full cost method prescribed by the SEC. If the carrying amount exceeds the calculated full cost ceiling, we reduce the carrying amount of the oil and natural gas properties to the calculated full cost ceiling amount, which is determined to be the estimated fair value. At June 30, 2012 and 2011, it was determined that our oil and natural gas properties were not impaired.

        Commodity derivative financial instruments.    Due to the inherent volatility in oil and natural gas prices, we use commodity derivative instruments, including puts, swaps, collars and basis swaps to hedge price risk associated with a significant portion of our anticipated oil and natural gas production. At each period end, we estimate the fair value of our commodity derivatives using a valuation prepared by an independent third party and recognize an unrealized gain or loss. We have not elected hedge accounting on these derivatives, and therefore, the unrealized gains and losses on open positions are reflected in current earnings. For the six months ended June 30, 2012 and 2011, our commodity derivatives resulted in a realized gain of $13.8 million and a realized loss of $0.9 million, respectively. For the six months ended June 30, 2012 and 2011, our commodity derivatives resulted in an unrealized gain of $15.3 million and an unrealized loss of $8.7 million, respectively. At June 30, 2012, we had 18 commodity derivatives contracts with associated deferred premiums totaling approximately $27.5 million. The estimated fair value of our total deferred premiums was approximately $23.6 million at June 30, 2012. The fair market value of these premiums is deducted from our unrealized gain or loss at each period end.

        Interest expense and realized and unrealized gains and losses on interest rate swaps.    Interest expense increased to approximately $36.4 million for the six months ended June 30, 2012 from $22.3 million for the six months ended June 30, 2011, largely due to the issuance of our 2019 senior unsecured notes in January and October of 2011 as well as the issuance of our 2022 senior unsecured notes in April of 2012 as shown in the table below.

 
  Six months ended June 30, 2012   Six months ended June 30, 2011  
(in thousands except for percentages)
  Weighted average
principal
  Weighted average
interest rate(3)
  Weighted average
principal
  Weighted average
interest rate(3)
 

Senior secured credit facility

  $ 190,085     0.72 % $ 68,056     0.75 %

2019 senior unsecured notes

    550,000     4.73 %   350,000     4.19 %

2022 senior unsecured notes

    500,000     1.29 %        

Term loan(1)

            100,000     0.31 %

Broad Oak credit facility(2)

            122,904     3.07 %

(1)
The term loan was entered into on July 7, 2010 and was paid-in-full and terminated on January 20, 2011.

(2)
The Broad Oak credit facility was paid-in-full and terminated on July 1, 2011 in connection with the Broad Oak acquisition.

(3)
Interest rates presented are annual rates which have been prorated to reflect the portion of the year for which they have been incurred.

        We have entered into certain variable-to-fixed interest rate swaps that hedge our exposure to interest rate variations on our variable interest rate debt. At June 30, 2012, we had interest rate swaps outstanding for a notional amount of $100.0 million with fixed pay rates ranging from 1.11% to 3.00% and terms expiring through September 2013. At June 30, 2011, we had interest rate swaps outstanding for a notional amount of $260.0 million with fixed pay rates ranging from 1.11% to 3.41% and terms expiring through September 2013. We realized losses on interest rate swaps of $1.9 million and

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$2.6 million for the six months ended June 30, 2012 and 2011, respectively. Additionally, we recorded unrealized gains on interest rate swaps of $1.6 million and $1.5 million for the six months ended June 30, 2012 and June 30, 2011, respectively. At June 30, 2012, the estimated fair value of our interest rate swaps was in a net liability position of $0.4 million compared to $2.0 million at December 31, 2011.

        Income tax expense.    We recorded a deferred income tax expense of $32.2 million for the six months ended June 30, 2012, compared to a deferred income tax expense of $25.7 million for the six months ended June 30, 2011. The estimated annual effective tax rate was 36% for each of the six months ended June 30, 2012 and 2011. Our effective tax rate is based on our estimated annual permanent tax differences and estimated annual pre-tax book income. Our estimates involve assumptions we believe to be reasonable at the time of the estimation.

Liquidity and capital resources

        Since our IPO, our primary sources of liquidity have been cash flows from operations, borrowings under our senior secured credit facility and proceeds from our senior unsecured notes. Our primary use of capital has been for the exploration, development and acquisition of oil and natural gas properties. As we pursue reserves and production growth, we continually consider which capital resources, including equity and debt financings, are available to meet our future financial obligations, planned capital expenditure activities and liquidity requirements. Our future ability to grow proved reserves and production will be highly dependent on the capital resources available to us, which resources we cannot assure you will be available to us or their terms. We believe that we have sufficient liquidity available to us from cash flows from operations and under our senior secured credit facility as well as the remaining proceeds from the April 2012 offering of the 2022 senior unsecured notes for our planned exploration and development activities. In addition, our hedge positions currently provide relative certainty on a majority of our cash flows from operations through 2012 even with the general decline in the prices of natural gas.

        At June 30, 2012, we had no debt outstanding and approximately $0.03 million of outstanding letters of credit under our senior secured credit facility. Additionally, we had $1.05 billion of outstanding senior unsecured notes, excluding the remaining premium of $1.9 million received on the October 2011 offering of our 2019 senior unsecured notes. We had approximately $785.0 million available for borrowings under our senior secured credit facility and $146.5 million in cash on hand for total available liquidity of approximately $931.5 million at June 30, 2012. We believe such availability as well as cash flows from operations provide us with the ability to implement our planned exploration and development activities.

        As of August 7, 2012, we had no outstanding debt under our senior secured credit facility, approximately $785.0 million available for borrowings and approximately $47.8 million in cash on hand.

        We expect that, in the future, our commodity derivative positions will help us stabilize a portion of our expected cash flows from operations despite potential declines in the price of oil and natural gas. Please see "Item 3. Quantitative and Qualitative Disclosures About Market Risk" below.

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Cash flows

        Our cash flows for the six months ended June 30, 2012 and 2011 are as follows:

 
  Six months ended
June 30,
 
(in thousands)
  2012   2011  

Net cash provided by operating activities

  $ 199,790   $ 162,058  

Net cash used in investing activities

    (485,831 )   (359,449 )

Net cash provided by financing activities

    404,524     188,208  
           

Net increase (decrease) in cash

  $ 118,483   $ (9,183 )
           

Cash flows provided by operating activities

        Net cash provided by operating activities was $199.8 million and $162.1 million for the six months ended June 30, 2012 and 2011, respectively. The increase of $37.7 million was largely due to increases in revenue due to increased production.

        Our operating cash flows are sensitive to a number of variables, the most significant of which are production levels and the volatility of oil and natural gas prices. Regional and worldwide economic activity, weather, infrastructure, capacity to reach markets, costs of operations and other variable factors significantly impact the prices of these commodities. These factors are not within our control and are difficult to predict. For additional information on the impact of changing prices on our financial position, see "Item 3. Quantitative and Qualitative Disclosures About Market Risk."