Edgar Filing: Laredo Petroleum Holdings, Inc.

Laredo Petroleum Holdings 2Q13

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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

For the quarterly period ended June 30, 2013

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

For the transition period from to

Commission File Number: 001-35380

Laredo Petroleum Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)



Delaware (State or Other Jurisdiction of Incorporation or Organization)		45-3007926 (I.R.S. Employer Identification No.)



15 W. Sixth Street, Suite 1800
Tulsa, Oklahoma		74119
(Address of Principal Executive Offices)		(Zip code)

(918) 513-4570

(Registrant’s Telephone Number, Including Area Code)

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

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

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



Large accelerated filer o		Accelerated filer x

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

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

Number of shares of registrant’s common stock outstanding as of August 5, 2013: 129,503,049

TABLE OF CONTENTS



		Page
Cautionary Statement Regarding Forward-Looking Statements		iii
	Part I
Item 1.	Consolidated Financial Statements (Unaudited)	1
	Consolidated balance sheets as of June 30, 2013 and December 31, 2012	1
	Consolidated statements of operations for the three and six months ended June 30, 2013 and 2012	2
	Consolidated statement of stockholders’ equity for the six months ended June 30, 2013	3
	Consolidated statements of cash flows for the six months ended June 30, 2013 and 2012	4
	Condensed notes to the consolidated financial statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43
Item 4.	Controls and Procedures	45
	Part II
Item 1.	Legal Proceedings	46
Item 1A.	Risk Factors	46
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3.	Defaults Upon Senior Securities	48
Item 4.	Mine Safety Disclosures	48
Item 5.	Other Information	48
Item 6.	Exhibits	49
Signatures		50
Exhibit Index		51

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Various statements contained in or incorporated by reference into this Quarterly Report on Form 10-Q (this "Quarterly Report") are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended , and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements include statements, projections and estimates concerning our operations, performance, business strategy, oil and natural gas reserves, drilling program capital expenditures, liquidity and capital resources, the timing and success of specific projects, outcomes and effects of litigation, claims and disputes, derivative activities and potential financing. Forward-looking statements are generally accompanied by words such as "estimate," "project," "predict," "believe," "expect," "anticipate," "potential," "could," "may," "will," "foresee," "plan," "goal," "should," "intend," "pursue," "target," "continue," "suggest" or other words that convey the uncertainty of future events or outcomes. Forward-looking statements are not guarantees of performance. These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate under the circumstances. Among the factors that significantly impact our business and could impact our business in the future are:


•	the ongoing instability and uncertainty in the U.S. and international financial and consumer markets that is adversely affecting the liquidity available to us and our customers and is adversely affecting the demand for commodities, including oil and natural gas;


•	volatility of oil and natural gas prices;


•	the possible introduction of regulations that prohibit or restrict our ability to apply hydraulic fracturing to our oil and natural gas wells;


•	discovery, estimation, development and replacement of oil and natural gas reserves, including our expectations that estimates of our proved reserves will increase;


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


•	competition in the oil and natural gas industry;


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


•	drilling and operating risks, including risks related to hydraulic fracturing activities;


•	risks related to the geographic concentration of our assets;


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


•	the availability of sufficient pipeline and transportation facilities and gathering and processing capacity;


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


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


•	our ability to execute our strategies, including but not limited to our hedging strategies;


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


•	evolving industry standards and adverse changes in global economic, political and other conditions;


•	restrictions contained in our debt agreements, including our senior secured credit facility and the indentures governing our senior unsecured notes, as well as debt that could be incurred in the future;


•	our ability to access additional borrowing capacity under our senior secured credit facility or other means of providing liquidity; and


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

These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Forward-looking statements should, therefore, be considered in light of various factors, including those set forth under “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations”, "Part II, Item 1A. Risk Factors" and elsewhere in this Quarterly Report and under “Part I, Item 1A. Risk Factors” and “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. In light of such risks and uncertainties, we caution you not to place undue reliance on these forward-looking statements. These forward-looking statements speak only as of the date of this Quarterly Report, or if earlier, as of the date they were made. We do not intend to, and disclaim any obligation to, update or revise any forward-looking statements unless required by securities law.

iii

PART I

Item 1. Consolidated Financial Statements (Unaudited)

Laredo Petroleum Holdings, Inc.

Consolidated balance sheets

(in thousands, except share data)

(Unaudited)



	June 30, 2013			December 31, 2012
Assets
Current assets:
Cash and cash equivalents	$	43,588		$	33,224
Accounts receivable, net	89,852			83,424
Derivative financial instruments	7,073			4,644
Deferred income taxes	9,897			12,713
Restricted deposits on pending sale	44,000			—
Other current assets	4,886			3,016
Current assets held for sale	579			416
Total current assets	199,875			137,437
Property and equipment:
Oil and natural gas properties, full cost method:
Proved properties	3,350,367			2,993,266
Unproved properties not being amortized	146,505			159,946
Pipeline and gas gathering assets	29,871			23,065
Other fixed assets	31,921			23,669
	3,558,664			3,199,946
Less accumulated depreciation, depletion, amortization and impairment	1,261,518			1,130,867
Property and equipment held for sale, net of accumulated depreciation	45,698			44,812
Net property and equipment	2,342,844			2,113,891
Deferred income taxes	31,131			49,916
Derivative financial instruments	8,487			2,058
Deferred loan costs, net	27,530			29,444
Investment in equity method investee	3,174			—
Other assets, net	4,183			5,305
Noncurrent assets held for sale	389			253
Total assets	$	2,617,613		$	2,338,304
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	31,378		$	47,560
Undistributed revenue and royalties	35,015			31,988
Accrued capital expenditures	87,720			121,612
Accrued compensation and benefits	10,025			10,318
Derivative financial instruments	5,484			1,325
Accrued interest payable	26,426			26,106
Restricted deposits on pending sale	44,000			—
Other current liabilities	18,756			17,263
Current liabilities held for sale	6,112			5,896
Total current liabilities	264,916			262,068
Long-term debt	1,446,651			1,216,760
Derivative financial instruments	542			3,260
Asset retirement obligations	15,319			13,610
Other noncurrent liabilities	5,064			2,333
Noncurrent liabilities held for sale	9,416			8,550
Total liabilities	1,741,908			1,506,581
Stockholders’ equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized and zero issued at June 30, 2013 and December 31, 2012	—			—
Common stock, $0.01 par value, 450,000,000 shares authorized, and 129,416,611 and 128,298,559 issued, net of treasury, at June 30, 2013 and December 31, 2012, respectively	1,294			1,283
Additional paid-in capital	968,174			961,424
Accumulated deficit	(93,759		)	(130,980		)
Treasury stock, at cost, 7,609 common shares at June 30, 2013 and December 31, 2012	(4		)	(4		)
Total stockholders’ equity	875,705			831,723
Total liabilities and stockholders’ equity	$	2,617,613		$	2,338,304

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

Laredo Petroleum Holdings, Inc.

Consolidated statements of operations

(in thousands, except per share data)

(Unaudited)



	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Revenues:
Oil and natural gas sales	$	177,048		$	139,609		$	340,673		$	288,560
Natural gas transportation and treating	248			106			328			167
Total revenues	177,296			139,715			341,001			288,727
Costs and expenses:
Lease operating expenses	22,185			15,660			44,627			30,644
Production and ad valorem taxes	9,722			7,318			21,167			16,237
Natural gas transportation and treating	239			14			347			57
Drilling and production	597			269			1,271			1,486
General and administrative (including non-cash stock-based compensation of $4,463 and $2,588 for the three months ended June 30, 2013 and 2012, respectively, and $7,680 and $4,835 for the six months ended June 30, 2013 and 2012, respectively)	20,495			14,410			40,129			31,941
Accretion of asset retirement obligations	410			292			804			556
Depreciation, depletion and amortization	66,234			60,063			130,737			110,972
Total costs and expenses	119,882			98,026			239,082			191,893
Operating income	57,414			41,689			101,919			96,834
Non-operating income (expense):
Realized and unrealized gain (loss):
Commodity derivative financial instruments, net	23,975			28,543			7,121			29,137
Interest rate derivatives, net	(9		)	—			(15		)	(323		)
Loss from equity method investee	(49		)	—			(113		)	—
Interest expense	(25,943		)	(21,674		)	(51,292		)	(36,358		)
Interest and other income	12			15			27			31
Loss on disposal of assets	(59		)	(8		)	(59		)	(8		)
Non-operating income (expense), net	(2,073		)	6,876			(44,331		)	(7,521		)
Income from continuing operations before income taxes	55,341			48,565			57,588			89,313
Income tax expense:
Deferred	(20,047		)	(17,484		)	(21,157		)	(32,153		)
Total income tax expense	(20,047		)	(17,484		)	(21,157		)	(32,153		)
Income from continuing operations	35,294			31,081			36,431			57,160
Income (loss) from discontinued operations, net of tax	518			(106		)	790			50
Net income	$	35,812		$	30,975		$	37,221		$	57,210
Net income per common share:
Basic:
Income from continuing operations	$	0.28		$	0.24		$	0.29		$	0.45
Income (loss) from discontinued operations	—			—			0.01			—
Net income per share	$	0.28		$	0.24		$	0.30		$	0.45
Diluted:
Income from continuing operations	$	0.27		$	0.24		$	0.28		$	0.45
Income (loss) from discontinued operations	—			—			0.01			—
Net income per share	$	0.27		$	0.24		$	0.29		$	0.45
Weighted average common shares outstanding:
Basic	127,362			126,921			127,281			126,862
Diluted	129,384			128,222			129,119			128,101

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

Laredo Petroleum Holdings, Inc.

Consolidated statement of stockholders’ equity

(in thousands)

(Unaudited)



	Common Stock					Additional paid-in capital			Treasury Stock (at cost)					Accumulated deficit
	Shares		Amount			Additional paid-in capital			Shares		Amount			Accumulated deficit			Total
Balance, December 31, 2012	128,298		$	1,283		$	961,424		8		$	(4	)	$	(130,980	)	$	831,723
Restricted stock awards	1,306		13			(13		)	—		—			—			—
Restricted stock forfeitures	(138	)	(2		)	2			—		—			—			—
Vested restricted stock exchanged for tax withholding	—		—			—			50		(919		)	—			(919		)
Retirement of treasury stock	(50	)	—			(919		)	(50	)	919			—			—
Stock-based compensation	—		—			7,680			—		—			—			7,680
Net income	—		—			—			—		—			37,221			37,221
Balance, June 30, 2013	129,416		$	1,294		$	968,174		8		$	(4	)	$	(93,759	)	$	875,705

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

Laredo Petroleum Holdings, Inc.

Consolidated statements of cash flows

(in thousands)

(Unaudited)



	Six months ended June 30,
	2013			2012
Cash flows from operating activities:
Net income	$	37,221		$	57,210
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income tax expense	21,601			32,181
Depreciation, depletion and amortization	131,364			112,220
Non-cash stock-based compensation	7,680			4,835
Accretion of asset retirement obligations	804			556
Unrealized gain on derivative financial instruments, net	(2,449		)	(16,929		)
Premiums paid for derivative financial instruments	(5,249		)	(2,927		)
Amortization of premiums paid for derivative financial instruments	282			319
Amortization of deferred loan costs	2,627			2,268
Other	74			(81		)
(Increase) decrease in accounts receivable	(6,591		)	2,303
(Increase) decrease in other current assets	(894		)	(3,075		)
Increase (decrease) in accounts payable	(16,568		)	3,304
Increase (decrease) in undistributed revenues and royalties	4,327			4,721
Increase (decrease) in accrued compensation and benefits	(293		)	(3,060		)
Increase (decrease) in other accrued liabilities	1,777			4,828
Increase (decrease) in other noncurrent liabilities	422			89
Increase (decrease) in fair value of performance unit awards	2,155			1,028
Net cash provided by operating activities	178,290			199,790
Cash flows from investing activities:
Capital expenditures:
Investment in equity method investee	(3,287		)	—
Oil and natural gas properties	(375,901		)	(473,846		)
Pipeline and gas gathering assets	(8,302		)	(7,031		)
Other fixed assets	(8,803		)	(4,988		)
Proceeds from other fixed asset disposals	—			34
Net cash used in investing activities	(396,293		)	(485,831		)
Cash flows from financing activities:
Borrowings on senior secured credit facility	230,000			195,000
Payments on senior secured credit facility	—			(280,000		)
Issuance of 2022 Notes	—			500,000
Purchase of treasury stock	(919		)	—
Payments for loan costs	(714		)	(10,476		)
Net cash provided by financing activities	228,367			404,524
Net increase in cash and cash equivalents	10,364			118,483
Cash and cash equivalents, beginning of period	33,224			28,002
Cash and cash equivalents, end of period	$	43,588		$	146,485
Supplemental disclosure of cash flow information:
Cash paid for interest, net of $212 and $505, respectively, of capitalized interest	$	48,348		$	27,956
Supplemental disclosure of non-cash investing and financing activities:
Restricted deposits on pending sale	$	44,000		$	—
Change in accrued capital expenditures	$	(33,892	)	$	1,624
Capitalized asset retirement cost	$	1,262		$	2,270

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

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

A—Organization

Laredo Petroleum Holdings, Inc. (“Laredo Holdings”), together with its subsidiaries, is an independent energy company focused on the exploration, development and acquisition of oil and natural gas properties in the Permian Basin in West Texas and, until August 1, 2013, also the Mid-Continent regions of the United States. Laredo Holdings was incorporated pursuant to the laws of the State of Delaware on August 12, 2011. Laredo Holdings was formed for purposes of a Corporate Reorganization (defined below) and initial public offering of its common stock (the "IPO"). On December 19, 2011, Laredo Petroleum, LLC, a Delaware limited liability company, was merged with and into Laredo Holdings, with Laredo Holdings surviving the merger (the "Corporate Reorganization"). As a holding company, Laredo Holdings’ management operations are conducted through its wholly-owned subsidiary, Laredo Petroleum, Inc. (“Laredo”), a Delaware corporation, and Laredo’s subsidiaries, Laredo Petroleum Texas, LLC (“Laredo Texas”), a Texas limited liability company, Laredo Gas Services, LLC (“Laredo Gas”), a Delaware limited liability company, and Laredo Petroleum—Dallas, Inc. (“Laredo Dallas”), a Delaware corporation. In these notes, the "Company" refers to Laredo Holdings, Laredo and its subsidiaries collectively.

B—Basis of presentation and significant accounting policies

1. Basis of presentation

The accompanying unaudited consolidated financial statements were derived from the historical accounting records of the Company and reflect the historical financial position, results of operations and cash flows for the periods described herein. The Company uses the equity method of accounting to record its net interests when the Company holds 20% to 50% of the voting rights and/or has the ability to exercise significant influence but does not control the entity. Under the equity method, the Company's proportionate share of net income (loss) is included in the unaudited consolidated statements of operations. See Note K for additional discussion of the Company's equity method investment. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). All material intercompany transactions and account balances have been eliminated in the consolidation of accounts. The Company operates oil and natural gas properties as one business segment, which explores for, develops and produces oil and natural gas.

The accompanying consolidated financial statements have not been audited by the Company’s independent registered public accounting firm, except that the consolidated balance sheet at December 31, 2012 is derived from audited consolidated financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements reflect all necessary adjustments to present fairly the Company’s financial position as of June 30, 2013, the results of operations and cash flows for the three and six months ended June 30, 2013 and 2012. The Company has reclassified certain prior period amounts in these unaudited consolidated financial statements as discontinued operations and assets classified as held for sale. See Notes B.3 and B.5 for additional discussion of these reclassifications.

Certain disclosures have been condensed or omitted from these unaudited consolidated financial statements. Accordingly, these unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Laredo Holdings’ Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 Annual Report”).

2. Use of estimates in the preparation of interim unaudited consolidated financial statements

The preparation of the accompanying unaudited consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes these estimates are reasonable, actual results could differ from these estimates. The interim results reflected in the unaudited consolidated financial statements are not necessarily indicative of the results that may be expected for other interim periods or for the full year.

Significant estimates include, but are not limited to, estimates of the Company’s reserves of oil and natural gas, future cash flows from oil and natural gas properties, depreciation, depletion and amortization, asset retirement obligations, stock-based compensation, deferred income taxes and fair values of commodity derivatives, interest rate derivatives and commodity deferred premiums. As fair value is a market-based measurement, it is determined based on the assumptions that market participants would use. These estimates and assumptions are based on management’s best judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. Such estimates and assumptions are adjusted when facts and circumstances dictate. Illiquid credit markets and

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

volatile equity and energy markets have combined to increase the uncertainty inherent in such estimates and assumptions. Management believes its estimates and assumptions to be reasonable under the circumstances. As future events and their effects cannot be determined with precision, actual values and results could differ from these estimates. Any changes in estimates resulting from future changes in the economic environment will be reflected in the financial statements in future periods.

3. Reclassifications

Certain amounts in the accompanying consolidated financial statements have been reclassified to conform to the 2013 presentation. These reclassifications had no impact to previously reported net income or losses, total stockholders' equity or cash flows.

4. Restricted deposits

Restricted deposits represent deposits received on pending sales of oil and natural gas properties. Amounts were considered restricted until the transactions closed. In May and June 2013, the Company entered into agreements to sell its oil and natural gas properties and other related assets in the Anadarko Basin and received $44.0 million in escrow deposits from the buyers. As of June 30, 2013 these deposits were included in current assets and current liabilities in the accompanying consolidated balance sheets. See Note B.5 and Note N for further discussion of the Anadarko Basin Sale (defined below).

5. Discontinued operations

During the three months ended June 30, 2013, the Company entered into agreements to sell its oil and natural gas properties, associated pipeline assets and various other associated property and equipment in the Anadarko Granite Wash, Central Texas Panhandle and the Eastern Anadarko Basin (the "Anadarko Basin Sale") for $438.0 million, subject to closing adjustments. As of June 30, 2013, the Company had received $44.0 million in escrow deposits associated with the Anadarko Basin Sale. These deposits are included as restricted deposits in the accompanying consolidated balance sheets at June 30, 2013. The Anadarko Basin Sale closed in the third quarter of 2013. See Note N for additional information regarding the closing of the Anadarko Basin Sale. Effective at closing, the operations and cash flows of these properties were eliminated from the ongoing operations of the Company and the Company does not have continuing involvement in the operations of these properties. The oil and natural gas properties that are a component of the Anadarko Basin Sale are not presented as held for sale nor are their results of operations presented as discontinued operations pursuant to the rules governing full cost accounting for oil and gas properties. The associated pipeline assets and various other associated property and equipment qualified as held for sale as of June 30, 2013. The results of operations of the associated pipeline assets and various other associated property and equipment are presented as results of discontinued operations, net of tax in these unaudited consolidated financial statements. Accordingly, the Company has reclassified the financial results and the related notes for all prior periods presented to reflect these operations as discontinued. Unless otherwise indicated, the information in these notes relate to the Company’s continuing operations.

A summary of the assets and liabilities held for sale on the Company's consolidated balance sheets for the periods presented is detailed below:



(in thousands)	June 30, 2013		December 31, 2012
Accounts receivable, net	$	579	$	416
Deferred income taxes	—		—
Other current assets	—		—
Total current assets held for sale	579		416
Pipeline and gas gathering assets, net of accumulated depreciation	44,437		43,524
Other fixed assets, net of accumulated depreciation	1,261		1,288
Total property and equipment held for sale, net of accumulated depreciation	45,698		44,812
Other assets, net	389		4,480
Total noncurrent assets held for sale	389		4,480
Accounts payable	726		1,112
Undistributed revenue and royalties	5,377		4,077
Other current liabilities	9		707
Total current liabilities held for sale	6,112		5,896
Asset retirement obligations	7,866		7,510
Other noncurrent liabilities	1,550		1,040
Total noncurrent liabilities held for sale	$	9,416	$	8,550

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

The following represents operating results from discontinued operations for the periods presented:



	Three months ended June 30,						Six months ended June 30,
(in thousands)	2013			2012			2013			2012
Revenues:
Natural gas transportation and treating	$	1,478		$	909		$	3,310		$	2,245
Total revenues from discontinued operations	1,478			909			3,310			2,245
Cost and expenses:
Natural gas transportation and treating	433			377			969			634
Drilling and production	236			64			480			285
Depreciation, depletion and amortization	—			634			627			1,248
Total costs and expenses from discontinued operations	669			1,075			2,076			2,167
Income (loss) from discontinued operations before income tax	809			(166		)	1,234			78
Income tax (expense) benefit	(291		)	60			(444		)	(28		)
Income (loss) from discontinued operations	$	518		$	(106	)	$	790		$	50

6. Treasury stock

The Company acquires treasury stock, which is recorded at cost, to satisfy tax withholding obligations for Laredo's employees that arise upon the lapse of restrictions on restricted stock or for other reasons. Upon acquisition, this treasury stock is retired.

7. Accounts receivable

The Company sells oil and natural gas to various customers and participates with other parties in the drilling, completion and operation of oil and natural gas wells. Joint interest and oil and natural gas sales receivables related to these operations are generally unsecured. Accounts receivable for joint interest billings are recorded as amounts billed to customers less an allowance for doubtful accounts.

Amounts are considered past due after 30 days. The Company determines joint interest operations accounts receivable allowances based on management’s assessment of the creditworthiness of the joint interest owners. Additionally, as the operator in the majority of its wells, the Company has the ability to realize the receivables through netting of anticipated future production revenues. The Company maintains an allowance for doubtful accounts for estimated losses inherent in its accounts receivable portfolio. In establishing the required allowance, management considers historical losses, current receivables aging, and existing industry and economic data. The Company reviews its allowance for doubtful accounts quarterly. Past due balances greater than 90 days and over a specified amount are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is remote.

Accounts receivable consist of the following components for the periods presented:



(in thousands)	June 30, 2013		December 31, 2012
Oil and natural gas sales	$	58,536	$	48,418
Joint operations, net⁽¹⁾	30,088		30,925
Other	1,228		4,081
Total	$	89,852	$	83,424

______________________________________________________________________________


(1)	Accounts receivable for joint operations are presented net of an allowance for doubtful accounts of approximately $0.1 million at each of June 30, 2013 and December 31, 2012.

8. Derivative financial instruments

The Company uses derivative financial instruments to reduce exposure to fluctuations in the prices of oil and natural gas. By removing a significant portion of the price volatility associated with future production, the Company expects to mitigate, but not eliminate, the potential effects of variability in cash flows from operations due to fluctuations in commodity prices. These transactions are primarily in the form of collars, swaps, puts and basis swaps. In addition, the Company enters into derivative contracts in the form of interest rate derivatives to minimize the effects of fluctuations in interest rates.

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

Derivative instruments are recorded at fair value and are included on the unaudited consolidated balance sheets as assets or liabilities. The Company netted the fair value of derivative instruments by counterparty in the accompanying unaudited consolidated balance sheets where the right of offset exists. The Company determines the fair value of its derivative financial instruments utilizing pricing models for significantly similar instruments. Inputs to the pricing models include publicly available prices and forward price curves generated from a compilation of data gathered from third parties.

The Company’s derivatives were not designated as hedges for accounting purposes for any of the periods presented. Accordingly, the changes in fair value are recognized in the unaudited consolidated statements of operations in the period of change. Realized and unrealized gains and losses on derivatives are included in cash flows from operating activities (see Note F).

9. Property and equipment

The following table sets forth the Company’s property and equipment for the periods presented:



(in thousands)	June 30, 2013		December 31, 2012
Proved oil and natural gas properties	$	3,350,367	$	2,993,266
Less accumulated depletion and impairment	1,249,404		1,121,274
Proved oil and natural gas properties, net	2,100,963		1,871,992

Unproved properties not being amortized	146,505		159,946

Pipeline and gas gathering assets	29,871		23,065
Less accumulated depreciation	1,915		1,297
Pipeline and gas gathering assets, net	27,956		21,768

Other fixed assets	31,921		23,669
Less accumulated depreciation and amortization	10,199		8,296
Other fixed assets, net	21,722		15,373

Total property and equipment held for sale, net	45,698		44,812

Total property and equipment, net	$	2,342,844	$	2,113,891

For the three months ended June 30, 2013 and 2012, depletion expense was $20.08 per barrel of oil equivalent (“BOE”) and $20.70 per BOE, respectively. For the six months ended June 30, 2013 and 2012, depletion expense was $20.16 per BOE and $20.20 per BOE, respectively.

10. Deferred loan costs

Loan origination fees, which are stated at cost, net of amortization, are amortized over the life of the respective debt agreements utilizing the effective interest and straight-line methods. The Company capitalized $0.7 million and $10.5 million of deferred loan costs in the six months ended June 30, 2013 and 2012, respectively. The Company had total deferred loan costs of $27.5 million and $29.4 million, net of accumulated amortization of $11.9 million and $9.2 million, as of June 30, 2013 and December 31, 2012, respectively.

Future amortization expense of deferred loan costs as of June 30, 2013 is as follows:



(in thousands)
Remaining 2013	$	2,718
2014	5,479
2015	5,540
2016	4,126
2017	2,724
Thereafter	6,943
Total	$	27,530

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

11. Other current liabilities

Other current liabilities consist of the following components for the periods presented:



(in thousands)	June 30, 2013		December 31, 2012
Lease operating expense payable	$	11,116	$	9,766
Production taxes payable	2,701		2,121
Prepaid drilling liability	1,113		2,916
Current portion of asset retirement obligations	346		380
Other accrued liabilities	3,480		2,080
Total other current liabilities	$	18,756	$	17,263

12. Asset retirement obligations

Asset retirement obligations associated with the retirement of tangible long-lived assets are recognized as a liability in the period in which they are incurred and become determinable. The associated asset retirement costs are part of the carrying amount of the long-lived asset. Subsequently, the asset retirement cost included in the carrying amount of the related long-lived asset is charged to expense through the depletion of the asset. Changes in the liability due to the passage of time are recognized as an increase in the carrying amount of the liability and as corresponding accretion expense. See Note G for fair value disclosures related to the Company’s asset retirement obligations.

The Company is obligated by contractual and regulatory requirements to remove certain pipeline and gas gathering assets and perform other remediation of the sites where such pipeline and gas gathering assets are located upon the retirement of those assets. However, the fair value of the asset retirement obligation cannot currently be reasonably estimated because the settlement dates are indeterminate. The Company will record an asset retirement obligation for pipeline and gas gathering assets in the periods in which settlement dates are reasonably determinable.

The following reconciles the Company’s asset retirement obligations liability for continuing and discontinued operations for the periods presented:



(in thousands)	Six months ended June 30, 2013			Year ended December 31, 2012
Liability at beginning of period	$	21,505		$	13,074
Liabilities added due to acquisitions, drilling and other	1,261			4,233
Accretion expense	804			1,200
Liabilities settled upon plugging and abandonment	(66		)	(148		)
Revision of estimates	—			3,146
Liability at end of period	$	23,504		$	21,505

13. Fair value measurements

The carrying amounts reported in the unaudited consolidated balance sheets for cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable, undistributed revenue and royalties and other accrued liabilities approximate their fair values. See Note C for fair value disclosures related to the Company’s debt obligations. The Company carries its derivative financial instruments at fair value. See Note F and Note G for details regarding the fair value of the Company’s derivative financial instruments.

14. Compensation awards

For stock-based compensation awards, compensation expense is recognized in “General and administrative” in the Company’s unaudited consolidated statements of operations over the awards’ vesting periods based on their grant date fair value. The Company utilizes the closing stock price on the date of grant to determine the fair value of service vesting restricted stock awards and a Black-Scholes pricing model to determine the fair values of service vesting restricted stock option awards. The Company utilizes a Monte Carlo simulation prepared by an independent third party to determine the fair value of the performance unit awards. See Note D for further discussion of the restricted stock awards, restricted stock option awards and performance unit awards.

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

15. Impairment of long-lived assets

Impairment losses are recorded on property and equipment used in operations and other long-lived assets when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. Impairment is measured based on the excess of the carrying amount over the fair value of the assets. The Company did not record any impairment to property and equipment used in operations or other long-lived assets for the three or six months ended June 30, 2013 and 2012.

16. Environmental

The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, among other things, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed in the period in which they occur. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed in the period in which they occur. Liabilities for expenditures of a non-capital nature are recorded when environmental assessment or remediation is probable and the costs can be reasonably estimated. Such liabilities are generally undiscounted unless the timing of cash payments is fixed and readily determinable. Management believes no materially significant liabilities of this nature existed as of June 30, 2013 or December 31, 2012.

17. Related party

The Company has a gas gathering and processing arrangement with affiliates of Targa Resources, Inc. (“Targa”). Warburg Pincus Private Equity IX, L.P., a majority stockholder of Laredo Holdings, and other affiliates of Warburg Pincus LLC, hold investment interests in Targa. One of Laredo Holdings’ directors is on the board of directors of affiliates of Targa.

The following table summarizes the net oil and natural gas sales (oil and natural gas sales less production taxes) received from the Company’s related party, which are included in the unaudited consolidated statements of operations for the periods presented:



	Three months ended June 30,				Six months ended June 30,
(in thousands)	2013		2012		2013		2012
Net oil and natural gas sales	$	20,178	$	18,350	$	37,788	$	37,740

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



(in thousands)	June 30, 2013		December 31, 2012
Oil and natural gas sales receivable	$	6,332	$	6,244

C—Debt

1. Interest expense

The following amounts have been incurred and charged to interest expense for the periods presented:



	Three months ended June 30,						Six months ended June 30,
(in thousands)	2013			2012			2013			2012
Cash payments for interest	$	20,816		$	1,356		$	48,560		$	28,461
Amortization of deferred loan costs and other adjustments	1,320			1,240			2,624			2,321
Change in accrued interest	3,924			19,204			320			6,081
Interest costs incurred	26,060			21,800			51,504			36,863
Less capitalized interest	(117		)	(126		)	(212		)	(505		)
Total interest expense	$	25,943		$	21,674		$	51,292		$	36,358

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

2. 2022 Notes

On April 27, 2012, Laredo completed an offering of $500.0 million in aggregate principal amount of 7 3/8% senior unsecured notes due 2022 (the “2022 Notes”). The 2022 Notes will mature on May 1, 2022 and bear an interest rate of 7 3/8% per annum, payable semi-annually, in cash in arrears on May 1 and November 1 of each year, commencing November 1, 2012. The 2022 Notes are fully and unconditionally guaranteed, jointly and severally on a senior unsecured basis by Laredo Holdings and its subsidiaries, with the exception of Laredo (collectively, the “Guarantors”).

3. 2019 Notes

On January 20, 2011, Laredo completed an offering of $350.0 million 9 1/2% senior unsecured notes due 2019 (the “January Notes”) and on October 19, 2011, Laredo completed an offering of an additional $200.0 million 9 1/2% senior unsecured notes due 2019 (the “October 2011 Notes” and together with the January Notes, the “2019 Notes”). The 2019 Notes will mature on February 15, 2019 and bear an interest rate of 9 1/2% per annum, payable semi-annually, in cash in arrears on February 15 and August 15 of each year. The 2019 Notes are fully and unconditionally guaranteed, jointly and severally on a senior unsecured basis by the Guarantors.

4. Senior secured credit facility

As of June 30, 2013, Laredo’s Third Amended and Restated Credit Agreement (as amended, the “Senior Secured Credit Facility”), which matures on July 1, 2016, had a borrowing base of $1.0 billion with $395.0 million outstanding and was subject to an interest rate of 2.25%. It contains both financial and non-financial covenants, all of which the Company was in compliance with as of June 30, 2013. Additionally, the Senior Secured Credit Facility provides for the issuance of letters of credit, limited to the lesser of total capacity or $20.0 million. At the closing of the Anadarko Basin Sale on August 1, 2013, the borrowing base on the Senior Secured Credit Facility was reduced to $825.0 million and the Company used the net proceeds from the sale to pay off its outstanding balance. On August 7, 2013, there were no amounts outstanding on the Senior Secured Credit Facility. See Note N for additional information.

5. Fair value of debt

The Company has not elected to account for its debt instruments at fair value. The following table presents the carrying amount and fair value of the Company’s debt instruments for the periods presented:



	June 30, 2013				December 31, 2012
(in thousands)	Carrying value		Fair value		Carrying value		Fair value
2019 Notes⁽¹⁾	$	551,651	$	605,000	$	551,760	$	616,000
2022 Notes	500,000		530,000		500,000		541,250
Senior Secured Credit Facility	395,000		395,296		165,000		165,098
Total value of debt	$	1,446,651	$	1,530,296	$	1,216,760	$	1,322,348

______________________________________________________________________________


(1)	The carrying value of the 2019 Notes includes the October 2011 Notes unamortized bond premium of approximately $1.7 million and $1.8 million as of June 30, 2013 and December 31, 2012, respectively.

As of June 30, 2013 and December 31, 2012, the fair value of the debt outstanding on the 2019 Notes and the 2022 Notes was determined using the June 30, 2013 and December 31, 2012 quoted market price (Level 1), respectively, and the fair value of the outstanding debt as of June 30, 2013 and December 31, 2012 on the Senior Secured Credit Facility was estimated utilizing pricing models for similar instruments (Level 2). See Note G for information about fair value hierarchy levels.

D—Employee compensation

In connection with the IPO, the Board of Directors of Laredo Holdings and its stockholders approved a Long-Term Incentive Plan (the “LTIP”), which provides for the granting of incentive awards in the form of restricted stock awards, stock options and other awards. The LTIP provides for the issuance of 10.0 million shares.

The Company recognizes the fair value of stock-based payments to employees and directors as a charge against earnings. The Company recognizes stock-based compensation expense over the requisite service period. Stock-based compensation is included in “General and administrative” in the unaudited consolidated statements of operations.

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

1. Restricted stock awards

All restricted stock awards are treated as issued and outstanding in the accompanying unaudited consolidated financial statements. If an employee terminates employment prior to the restriction lapse date, the awarded shares are forfeited and canceled and are no longer considered issued and outstanding. Restricted stock awards converted in the Corporate Reorganization vested 20% at the grant date and then vest 20% annually thereafter. The restricted stock awards granted under the LTIP to management and employees generally vest 33%, 33% and 34% per year beginning on the first anniversary date of the grant. Restricted stock awards granted to non-employee directors vest fully on the anniversary date of the grant.

The following table reflects the outstanding restricted stock awards for the six months ended June 30, 2013:



(in thousands, except for weighted average grant date fair values)	Restricted stock awards		Weighted average grant date fair value
Outstanding at December 31, 2012	1,195		$	15.06
Granted	1,306		$	17.44
Forfeited	(138	)	$	15.34
Vested⁽¹⁾	(365	)	$	16.19
Outstanding at June 30, 2013	1,998		$	16.39

______________________________________________________________________________

(1) The vesting of certain restricted stock grants could result in state and federal income tax expense or benefits related to the difference between the market price of the common stock at the date of vesting and the date of grant. The Company recognized income tax expense of $0.1 million and $0.4 million during the three and six months ended June 30, 2013, respectively, related to restricted stock, which were recorded as adjustments to deferred income taxes. There were no comparable amounts recorded in the three or six months ended June 30, 2012.

2. Restricted stock option awards

Restricted stock options granted under the LTIP vest and are exercisable in four equal installments on each of the first four anniversaries of the date of the grant. The following table reflects the stock option award activity for the six months ended June 30, 2013:



(in thousands, except for weighted average exercise price and contractual term)	Restricted stock option awards		Weighted average exercise price (per option)		Weighted average remaining contractual term (years)
Outstanding at December 31, 2012	459		$	24.11	9.1
Granted	1,019		$	17.34	9.6
Expired or canceled	(8	)	$	24.11	8.6
Forfeited	(87	)	$	20.21	—
Outstanding at June 30, 2013	1,383		$	19.37	9.3
Vested and exercisable at end of period	106		$	24.11	8.6

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

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

The assumptions used to estimate the fair value of restricted stock options granted on February 15, 2013 are as follows:



Risk-free interest rate⁽¹⁾	1.19		%
Expected option life⁽²⁾	6.3 years
Expected volatility⁽³⁾	58.89		%
Fair value per option	$	9.67

______________________________________________________________________________


(1)	U.S. Treasury yields as of the grant date were utilized for the risk-free interest rate assumption, matching the treasury yield terms to the expected life of the option.


(2)	As the Company has no historical exercise history, expected option life assumptions were developed using the simplified method.


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

3. Performance unit awards

The performance unit awards issued to management are subject to a combination of market and service vesting criteria. A Monte Carlo simulation prepared by an independent third party is utilized in order to determine the fair value of these awards at the date of grant and to re-measure the fair value at the end of each reporting period until settlement. Due to the relatively short trading history of the Company’s stock, the volatility criteria utilized in the Monte Carlo simulation is based on the volatilities of a group of peer companies that have been determined to be most representative of the Company’s expected volatility. These awards are accounted for as liability awards as they will be settled in cash at the end of the requisite service period based on the achievement of certain performance criteria. The liability and related compensation expense for each period for these awards is recognized by dividing the fair value of the total liability by the requisite service period and recording the pro rata share for the period for which service has already been provided. As there are inherent uncertainties related to the factors and the Company’s judgment in applying them to the fair value determinations, there is risk that the recorded performance unit compensation may not accurately reflect the amount ultimately earned by the members of management.

Compensation expense for these awards amounted to $2.1 million and $0.5 million in the three months ended June 30, 2013 and 2012, respectively, and $2.2 million and $1.0 million in the six months ended June 30, 2013 and 2012, respectively, and is recognized in “General and administrative” in the Company’s unaudited consolidated statements of operations, and the corresponding liability is included in “Other noncurrent liabilities” in the June 30, 2013 and December 31, 2012 unaudited consolidated balance sheets.

4. Defined contribution plan

The Company sponsors a 401(k) defined contribution plan for the benefit of substantially all employees at the date of hire. The plan allows eligible employees to make pre-tax and after-tax contributions up to 100% of their annual compensation, not to exceed annual limits established by the federal government. The Company makes matching contributions of up to 6% of an employee’s compensation and may make additional discretionary contributions for eligible employees. Employees are 100% vested in the employer contributions upon receipt.

The following table presents total employer contributions to the plans for the periods presented:



	Three months ended June 30,				Six months ended June 30,
(in thousands)	2013		2012		2013		2012
Contributions	$	422	$	325	$	881	$	642

E—Income taxes

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

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

The Company is subject to corporate income taxes and the Texas margin tax. Income tax expense attributable to income from continuing operations for the periods presented consisted of the following:



	Three months ended June 30,						Six months ended June 30,
(in thousands)	2013			2012			2013			2012
Current taxes:
Federal	$	—		$	—		$	—		$	—
State	—			—			—			—
Deferred taxes:
Federal	(19,212		)	(17,114		)	(20,290		)	(30,819		)
State	(835		)	(370		)	(867		)	(1,334		)
Income tax expense	$	(20,047	)	$	(17,484	)	$	(21,157	)	$	(32,153	)

The following presents the comprehensive provision for income taxes for the periods presented:



	Three months ended June 30,						Six months ended June 30,
(in thousands)	2013			2012			2013			2012
Comprehensive provision for income taxes allocable to:
Continuing operations	$	(20,047	)	$	(17,484	)	$	(21,157	)	$	(32,153	)
Discontinued operations	(291		)	60			(444		)	(28		)
Comprehensive provision for income taxes	$	(20,338	)	$	(17,424	)	$	(21,601	)	$	(32,181	)

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



	Three months ended June 30,						Six months ended June 30,
(in thousands)	2013			2012			2013			2012
Income tax expense computed by applying the statutory rate	$	(18,816	)	$	(16,512	)	$	(19,580	)	$	(30,366	)
State income tax, net of federal tax benefit and increase in valuation allowance	(551		)	(1,400		)	(572		)	(1,897		)
Non-deductible stock-based compensation	(164		)	(275		)	(339		)	(655		)
Stock-based compensation tax deficiency	(120		)	—			(411		)	—
Change in deferred tax valuation allowance	(20		)	(1		)	(29		)	(2		)
Other items	(376		)	704			(226		)	767
Income tax expense	$	(20,047	)	$	(17,484	)	$	(21,157	)	$	(32,153	)

Significant components of the Company’s deferred tax assets for the periods presented are as follows:



(in thousands)	June 30, 2013			December 31, 2012
Derivative financial instruments	$	4,403		$	7,108
Oil and natural gas properties and equipment	(226,192		)	(175,823		)
Net operating loss carry-forward	252,173			222,017
Accrued bonus	2,722			3,502
Stock-based compensation	3,957			2,928
Other	4,061			2,963
Gross deferred tax asset	41,124			62,695
Valuation allowance	(96		)	(66		)
Net deferred tax asset	$	41,028		$	62,629

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

Net deferred tax assets and liabilities were classified in the unaudited consolidated balance sheets as follows for the periods presented:



(in thousands)	June 30, 2013		December 31, 2012
Deferred tax asset	$	41,028	$	62,629
Deferred tax liability	—		—
Net deferred tax assets	$	41,028	$	62,629

The Company had federal net operating loss carry-forwards totaling approximately $716.4 million and state of Oklahoma net operating loss carry-forwards totaling approximately $230.1 million as of June 30, 2013. These carry-forwards begin expiring in 2026. As of June 30, 2013, the Company believes the federal and state of Oklahoma net operating loss carry-forwards are fully realizable. The Company considered all available evidence, both positive and negative, in determining whether, based on the weight of that evidence, a valuation allowance was needed. Such consideration included estimated future projected earnings based on existing reserves and projected future cash flows from its oil and natural gas reserves (including the timing of those cash flows), the reversal of deferred tax liabilities recorded as of June 30, 2013 and the Company’s ability to capitalize intangible drilling costs, rather than expensing these costs, in order to prevent an operating loss carry-forward from expiring unused.

The Company maintains a valuation allowance to reduce certain deferred tax assets to amounts that are more likely than not to be realized. As of June 30, 2013, a full valuation allowance of $0.1 million was recorded against the deferred tax asset related to the Company’s charitable contribution carry-forward of $0.3 million.

In evaluating its current tax positions in order to identify any material uncertain tax positions, the Company developed a policy for identifying uncertain tax positions that considers support for each position, industry standard, tax return disclosure and schedule, and the significance of each position. The Company had no material adjustments to its unrecognized tax benefits during the three or six months ended June 30, 2013.

The Company and its subsidiaries file a federal corporate income tax return on a consolidated basis. The Company's income tax returns for the years 2009 through 2012 remain open and subject to examination by federal tax authorities and/or the tax authorities in Oklahoma, Texas and Louisiana which are the jurisdictions where the Company has or has had operations. Additionally, the statute of limitations for examination of federal net operating loss carry-overs typically does not begin to run until the year the attribute is utilized in a tax return.

The effective tax rate for the Company's continuing operations for the six months ended June 30, 2013, was 37% as compared to 36% for the corresponding period ended June 30, 2012. GAAP requires the application of the estimated annual effective rate in determining the interim period tax provision unless a rate cannot be reliably estimated, such as when a small change in pre-tax income or loss creates significant variations in the customary relationship between income tax expense or benefit and pre-tax income or loss in interim periods. In such a situation, the interim period tax provision should be based on actual year-to-date results. The estimated annual effective rate used to record the Company's tax provisions, before considering discrete items, for each of the six months ended June 30, 2013 and 2012 was 36%.

The impact of significant discrete items is separately recognized in the quarter in which they occur. During the six months ended June 30, 2013, certain shares related to restricted stock awards vested at times when the Company's stock price was lower than the fair value of those shares at the time of grant. As a result, the income tax deduction related to such shares is less than the expense previously recognized for book purposes. In accordance with GAAP, such shortfalls reduce additional paid-in capital to the extent windfall tax benefits have been previously recognized. However, the Company has not previously recognized any windfall tax benefits. Therefore, the tax impact of these shortfalls totaling $0.1 million and $0.4 million for the three and six months ended June 30, 2013, respectively, is included in income tax expense attributable to continuing operations for these periods. There is no comparative amount for the three or six months ended June 30, 2012.

F—Derivative financial instruments

1. Commodity derivatives

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

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

realized and unrealized gains and losses are recognized in current period earnings. See Note N for information regarding the Company's commodity derivative contracts entered into subsequent to June 30, 2013.

Each collar transaction has an established price floor and ceiling. When the settlement price is below the price floor established by these collars, the Company receives an amount from its counterparty equal to the difference between the settlement price and the price floor multiplied by the hedged contract volume. When the settlement price is above the price ceiling established by these collars, the Company pays its counterparty an amount equal to the difference between the settlement price and the price ceiling multiplied by the hedged contract volume.

Each swap transaction has an established fixed price. When the settlement price is above the fixed price, the Company pays its counterparty an amount equal to the difference between the settlement price and the fixed price multiplied by the hedged contract volume. When the settlement price is below the fixed price, the counterparty pays the Company an amount equal to the difference between the settlement price and the fixed price multiplied by the hedged contract volume.

Each put transaction has an established floor price. The Company pays the counterparty a premium in order to enter into the put transaction. When the settlement price is below the floor price, the counterparty pays the Company an amount equal to the difference between the settlement price and the fixed price multiplied by the hedged contract volume. When the settlement price is above the floor price, the put option expires.

Each natural gas basis swap transaction has an established fixed basis differential between the New York Mercantile Exchange ("NYMEX") gas futures and West Texas WAHA ("WAHA") index gas price. When the NYMEX futures settlement price less the fixed basis differential is greater than the actual WAHA price, the difference multiplied by the hedged contract volume is paid to the Company by the counterparty. When the difference between the NYMEX futures settlement price less the fixed basis differential is less than the actual WAHA price, the Company pays the counterparty an amount equal to the difference multiplied by the hedged contract volume.

Each oil basis swap transaction has an established fixed basis differential between the West Texas Intermediate Midland Argus ("Midland") index crude oil price and the West Texas Intermediate Argus ("WTI") index crude oil price. When the WTI price less the fixed basis differential is greater than the actual Midland price, the difference multiplied by the hedged contract volume is paid to the Company by the counterparty. When the WTI price less the fixed basis differential is less than the actual Midland price, the difference multiplied by the hedged contract volume is paid by the Company to the counterparty.

During the six months ended June 30, 2013, the Company entered into additional commodity contracts to hedge a portion of its estimated future production. The following table summarizes information about these additional commodity derivative contracts. Subsequent to June 30, 2013, certain commodity contracts were transferred to a buyer in connection with the Anadarko Basin Sale. See Note N for additional information.



	Aggregate volumes	Swap price		Floor price		Ceiling price		Contract period
Oil (volumes in Bbl):
Swap	1,377,000	$	98.10	$	—	$	—	March 2013 - December 2013
Basis swap	4,026,000	$	1.00	$	—	$	—	March 2013 - December 2014
Swap	912,500	$	93.65	$	—	$	—	January 2014 - December 2014
Swap	365,000	$	93.68	$	—	$	—	January 2014 - December 2014
Price collar	1,277,500	$	—	$	80.00	$	98.50	January 2015 - December 2015
Price collar	1,281,000	$	—	$	80.00	$	93.00	January 2016 - December 2016
Natural gas (volumes in MMBtu):
Price collar	2,900,000	$	—	$	3.00	$	4.00	March 2013 - December 2013
Swap	3,338,400	$	4.31	$	—	$	—	June 2013 - December 2013
Swap	3,978,500	$	4.36	$	—	$	—	January 2014 - December 2014

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

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



	Remaining Year 2013		Year 2014		Year 2015		Year 2016
Oil Positions:
Puts:
Hedged volume (Bbl)	540,000		540,000		456,000		—
Weighted average price ($/Bbl)	$	65.00	$	75.00	$	75.00	$	—
Swaps:
Hedged volume (Bbl)	1,128,000		1,277,500		—		—
Weighted average price ($/Bbl)	$	97.63	$	93.66	$	—	$	—
Collars:
Hedged volume (Bbl)	384,000		726,000		1,529,500		1,281,000
Weighted average floor price ($/Bbl)	$	79.38	$	75.45	$	79.18	$	80.00
Weighted average ceiling price ($/Bbl)	$	121.67	$	129.09	$	104.51	$	93.00
Basis swaps:
Hedged volume (Bbl)	1,472,000		2,252,000		—		—
Weighted average price ($/Bbl)	$	1.40	$	1.04	$	—	$	—
Natural Gas Positions:
Puts:
Hedged volume (MMBtu)	3,300,000		—		—		—
Weighted average price ($/MMBtu)	$	4.00	$	—	$	—	$	—
Swaps:
Hedged volume (MMBtu)	2,870,400		3,978,500		—		—
Weighted average price ($/MMBtu)	$	4.31	$	4.36	$	—	$	—
Collars:
Hedged volume (MMBtu)	9,820,000		18,120,000		15,480,000		—
Weighted average floor price ($/MMBtu)	$	3.35	$	3.38	$	3.00	$	—
Weighted average ceiling price ($/MMBtu)	$	5.47	$	6.09	$	6.00	$	—
Basis swaps:
Hedged volume (MMBtu)	600,000		—		—		—
Weighted average price ($/MMBtu)	$	0.33	$	—	$	—	$	—

2. Interest rate derivatives

The Company is exposed to market risk for changes in interest rates related to its Senior Secured Credit Facility. Interest rate derivative agreements are used to manage a portion of the exposure related to changing interest rates by converting floating-rate debt to fixed-rate debt. If the London Interbank Offered Rate ("LIBOR") is lower than the fixed rate in the contract, the Company is required to pay the counterparties the difference, and conversely, the counterparties are required to pay the Company if LIBOR is higher than the fixed rate in the contract. The Company did not designate the interest rate derivatives as cash flow hedges; therefore, the changes in fair value of these instruments are recorded in current earnings.

The following presents the settlement terms of the interest rate derivatives as of June 30, 2013:



(in thousands except rate data)	Year 2013			Expiration date
Notional amount	$	50,000
Fixed rate	1.11		%	September 13, 2013
Notional amount	$	50,000
Cap rate	3.00		%	September 13, 2013
Total	$	100,000

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

3. Balance sheet presentation

The Company’s oil and natural gas commodity derivatives and interest rate derivatives are presented on a net basis in “Derivative financial instruments” in the unaudited consolidated balance sheets.

The following summarizes the fair value of derivatives outstanding on a gross basis as of:



(in thousands)	June 30, 2013		December 31, 2012
Assets:
Commodity derivatives:
Oil derivatives	$	33,368	$	16,219
Natural gas derivatives	13,859		17,896
Total assets	$	47,227	$	34,115

Liabilities:
Commodity derivatives:
Oil derivatives⁽¹⁾	$	31,048	$	21,308
Natural gas derivatives⁽²⁾	6,559		10,413
Interest rate derivatives	86		277
Total liabilities	$	37,693	$	31,998

Net derivative position	$	9,534	$	2,117

______________________________________________________________________________

(1) The oil derivatives fair value includes a deferred premium liability of $14.9 million and $18.3 million as of June 30, 2013 and December 31, 2012, respectively.

(2) The natural gas derivatives fair value includes a deferred premium liability of $4.8 million and $6.4 million as of June 30, 2013 and December 31, 2012, respectively.

By using derivative instruments to economically hedge exposures to changes in commodity prices and interest rates, the Company exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk. The Company’s counterparties are participants in the Senior Secured Credit Facility which is secured by the Company’s oil and natural gas reserves; therefore, the Company is not required to post any collateral. The Company does not require collateral from its counterparties. The Company minimizes the credit risk in derivative instruments by: (i) limiting its exposure to any single counterparty; (ii) entering into derivative instruments only with counterparties that are also lenders in the Senior Secured Credit Facility and meet the Company’s minimum credit quality standard, or have a guarantee from an affiliate that meets the Company’s minimum credit quality standard; and (iii) monitoring the creditworthiness of the Company’s counterparties on an ongoing basis. In accordance with the Company’s standard practice, its commodity and interest rate derivatives are subject to counterparty netting under agreements governing such derivatives and, therefore, the risk of such loss is somewhat mitigated as of June 30, 2013. Market risk is the exposure to changes in the market price of oil and natural gas, which are subject to fluctuations resulting from changes in supply and demand.

4. Gain (loss) on derivatives

Gains and losses on derivatives are reported on the unaudited consolidated statements of operations in the respective “Realized and unrealized gain (loss)” amounts. Realized gains (losses) represent amounts related to the settlement of derivative instruments, and for commodity derivatives, are aligned with the underlying production. Unrealized gains (losses) represent the change in fair value of the derivative instruments and are non-cash items.

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

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



	Three months ended June 30,						Six months ended June 30,
(in thousands)	2013			2012			2013			2012
Realized gains (losses):
Commodity derivatives	$	1,086		$	9,115		$	4,863		$	13,823
Interest rate derivatives	(105		)	(835		)	(206		)	(1,938		)
	981			8,280			4,657			11,885
Unrealized gains:
Commodity derivatives	22,889			19,428			2,258			15,314
Interest rate derivatives	96			835			191			1,615
	22,985			20,263			2,449			16,929
Total gains (losses):
Commodity derivatives	23,975			28,543			7,121			29,137
Interest rate derivatives	(9		)	—			(15		)	(323		)
	$	23,966		$	28,543		$	7,106		$	28,814

G—Fair value measurements

The Company accounts for its oil and natural gas commodity and interest rate derivatives at fair value. The fair value of derivative financial instruments is determined utilizing pricing models for similar instruments. The models use a variety of techniques to arrive at fair value, including quotes and pricing analysis. Inputs to the pricing models include publicly available prices and forward curves generated from a compilation of data gathered from third parties.

The Company has categorized its assets and liabilities measured at fair value, based on the priority of inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).

Assets and liabilities recorded at fair value on the unaudited consolidated balance sheets are categorized based on inputs to the valuation techniques as follows:



Level 1—	Assets and liabilities recorded at fair value for which values are based on unadjusted quoted prices for identical assets or liabilities in an active market that management has the ability to access. Active markets are considered to be those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2—	Assets and liabilities recorded at fair value for which values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the assets or liabilities. Substantially all of these inputs are observable in the marketplace throughout the full term of the price risk management instrument and can be derived from observable data or supported by observable levels at which transactions are executed in the marketplace.

Level 3—	Assets and liabilities recorded at fair value for which values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Unobservable inputs are not corroborated by market data. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.

When the inputs used to measure fair value fall within different levels of the hierarchy in a liquid environment, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company conducts a review of fair value hierarchy classifications on an annual basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Transfers between fair value hierarchy levels are recognized and reported in the period in which the transfer occurred. No transfers between fair value hierarchy levels occurred during the three and six months ended June 30, 2013 or 2012.

Laredo Petroleum Holdings, Inc.

Condensed notes to the consolidated financial statements

(Unaudited)

1. Fair value measurement on a recurring basis

The following presents the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis for the periods presented:



(in thousands)	Level 1		Level 2			Level 3			Total fair value
As of June 30, 2013:
Commodity derivatives	$	—	$	29,362		$	—		$	29,362
Deferred premiums	—		—			(19,742		)	(19,742		)
Interest rate derivatives	—		(86		)	—			(86		)
Total	$	—	$	29,276		$	(19,742	)	$	9,534



(in thousands)	Level 1		Level 2		Level 3		Total fair value
As of December 31, 2012:
Commodity derivatives	$	—	$	27,103	$	—	$	27,103
Deferred premiums	—		—		(24,709