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SD > SEC Filings for SD > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for SANDRIDGE ENERGY INC


8-May-2013

Quarterly Report


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

Introduction

The following discussion and analysis is intended to help the reader understand the Company's business, financial condition, results of operations, liquidity and capital resources. This discussion and analysis should be read in conjunction with the Company's unaudited condensed consolidated financial statements and the accompanying notes included in this Quarterly Report, as well as the Company's audited consolidated financial statements and the accompanying notes included in the 2012 Form 10-K. The Company's discussion and analysis includes the following subjects:
Overview;

Results by Segment;

Consolidated Results of Operations;

Liquidity and Capital Resources;

Critical Accounting Policies and Estimates; and

Valuation Allowance.

The financial information with respect to the three months ended March 31, 2013 and 2012, discussed below, is unaudited. In the opinion of management, this information contains all adjustments, which consist only of normal recurring adjustments, necessary to state fairly the unaudited condensed consolidated financial statements. The results of operations for the interim periods are not necessarily indicative of the results of operations for the full fiscal year.

Overview

SandRidge is an independent oil and natural gas company concentrating on development and production activities in the Mid-Continent and Gulf of Mexico. The Company's primary area of focus is the Mississippian formation in the Mid-Continent area of northern Oklahoma and Kansas. The Company owns and operates additional interests in the Mid-Continent, Gulf Coast, Permian Basin and West Texas Overthrust.

The Company also operates businesses and infrastructure systems that are complementary to its primary development and production activities, including gas gathering and processing facilities, an oil and gas marketing business, a saltwater disposal system, an electrical transmission system and an oil field services business, which includes a drilling rig business. These complementary businesses provide the Company with operational flexibility and an advantageous cost structure by reducing the Company's dependence on third parties for these services. The extent to which each of these supplemental businesses contributes to the Company's consolidated results of operations largely is determined by the amount of work each performs for third parties. Revenues and costs related to work performed by these businesses for the Company's own account are eliminated in consolidation and, therefore, do not directly contribute to the Company's consolidated results of operations.

First Quarter 2013 Operational Highlights

Operational highlights for the first quarter of 2013 include the following:
Drilled 123 wells, excluding salt water disposal wells, in the Mid-Continent area during the three months ended March 31, 2013. Mid-Continent properties contributed approximately 3,751 MBoe, or 42%, of the Company's total production during the three months ended March 31, 2013 compared to approximately 2,005 MBoe, or 33%, in the same period of 2012.

         Gulf of Mexico properties acquired during the second quarter of 2012
          contributed production of approximately 2,664 MBoe, or 30% of the
          Company's total production, during the three months ended March 31,
          2013.


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         Production, revenues and direct operating expenses of the properties
          located in the Permian Basin sold in February 2013, described below,
          that are included in the Company's results during the three months
          ended March 31, 2013 and 2012 were as follows:


                                               Three Months Ended March 31,
                                                    2013                  2012
Production (MBoe)                                 1,148                    2,255
Revenue (in thousands)                   $       68,027                $ 161,765
Direct operating expenses (in thousands) $       17,453                $  35,990


_______________


(1) Information for the three months ended March 31, 2013 is through February 26, 2013, the date of sale.

In addition to including activity for only a portion of the three-month period, the decrease in production, revenue and direct operating expenses for the three-month period ended March 31, 2013 compared to the same period in 2012 is a result of natural declines in production due to decreased drilling activity in the Permian Basin in advance of the sale.

First Quarter 2013 Developments and Outlook

Sale of Permian Properties. On February 26, 2013, the Company sold all of its oil and natural gas properties in the Permian Basin in west Texas, excluding the assets attributable to the SandRidge Permian Trust area of mutual interest (the "Permian Properties"), for net proceeds of $2.6 billion, subject to post-closing adjustments. The Company used a portion of the sale proceeds to fund the redemption of approximately $1.1 billion aggregate principal amount of outstanding senior notes, discussed below, and intends to use the remaining proceeds to fund its capital expenditures in the Mississippian formation and for general corporate purposes. The Company recorded a non-cash loss on the sale of $399.1 million, of which $71.7 million was allocated to noncontrolling interests. Additionally, the Company settled a portion of its existing oil derivative contracts in February 2013 prior to their respective maturities to reduce volumes hedged in proportion to the anticipated reduction in daily production volumes due to the sale, which resulted in a realized loss of approximately $29.6 million. Including the impact from the sale of the Permian Properties, the Company anticipates total production during 2013 of approximately 32.7MMBoe.

Redemption of Senior Fixed Rate Notes. In March 2013, the Company redeemed the outstanding $365.5 million aggregate principal amount of its 9.875% Senior Notes due 2016 and the outstanding $750.0 million aggregate principal amount of its 8.0% Senior Notes due 2018 for total consideration of $1,061.34 per $1,000 principal amount and $1,052.77 per $1,000 principal amount, respectively. The premium paid to redeem these notes and the associated unamortized debt issuance costs resulted in a loss on extinguishment of debt of $82.0 million for the three-month period ended March 31, 2013. The redemption of these senior notes will result in a reduction in interest expense from the anticipated total for the year ending December 31, 2013, of approximately $72.8 million.

Results by Segment

The Company operates in three business segments: exploration and production, drilling and oil field services and midstream services. These segments represent the Company's three main business units, each offering different products and services. The exploration and production segment is engaged in the acquisition, development and production of oil and natural gas properties and includes the activities of the Royalty Trusts. The drilling and oil field services segment is engaged in the contract drilling of oil and natural gas wells and provides various oil field services. The midstream services segment is engaged in the purchasing, gathering, treating and selling of natural gas and the distribution of electricity to the Company's exploration and production operations in the Mississippian formation.

Management evaluates the performance of the Company's business segments based on income (loss) from operations, which is defined as segment operating revenues less operating expenses and depreciation, depletion, amortization and accretion. Results of these measurements provide important information to the Company about the activity, profitability and contributions of each of the Company's lines of business. Each of the Company's business segments for the three months ended March 31, 2013 and 2012 is discussed below.


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Exploration and Production Segment

The Company generates the majority of its consolidated revenues and cash flow from the production and sale of oil and natural gas. The Company's revenues, profitability and future growth depend substantially on prevailing prices for oil and natural gas and on the Company's ability to find and economically develop and produce oil and natural gas reserves. Prices for oil and natural gas fluctuate widely and are difficult to predict. In order to reduce the Company's exposure to these fluctuations, the Company enters into commodity derivative contracts for a portion of its anticipated future oil and natural gas production. Reducing the Company's exposure to price volatility mitigates the risk that it will not have adequate funds available for its capital expenditure programs.

The primary factors affecting the financial results of the Company's exploration and production segment are the prices the Company receives for its oil and natural gas production, the quantity of oil and natural gas it produces and changes in the fair value of its commodity derivative contracts. The average New York Mercantile Exchange ("NYMEX") prices for oil and natural gas during the three months ended March 31, 2013 and 2012 are shown in the following table:

                              Three Months Ended March 31,
                                    2013                 2012
Oil (per Bbl)           $       94.30                  $ 102.99
Natural gas (per Mcf)   $        3.47                  $   2.43


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Set forth in the table below is financial, production and pricing information for the three months ended March 31, 2013 and 2012.

                                                               Three Months Ended March 31,
                                                                  2013               2012
Results (in thousands)
Revenues
Oil(1)                                                      $      390,324       $   308,352
Natural gas                                                         87,693            33,013
Other                                                                3,393             1,755
Inter-segment revenue                                                  (81 )             (77 )
Total revenues                                                     481,329           343,043
Operating expenses
Production                                                         133,442            84,067
Production taxes                                                     9,439            12,254
Depreciation and depletion-oil and natural gas                     157,526            87,066
Accretion of asset retirement obligations                            9,779             2,607
Loss on derivative contracts                                        40,897           254,646
Loss on sale of assets                                             399,065             3,358
Other operating expenses                                            32,888            22,881
Total operating expenses                                           783,036           466,879
Loss from operations                                        $     (301,707 )     $  (123,836 )

Production data
Oil (MBbls)(1)                                                       4,442             3,427
Natural gas (MMcf)                                                  27,321            15,746
Total volumes (MBoe)                                                 8,995             6,051
Average daily total volumes (MBoe/d)                                  99.9              66.5
Average prices-as reported(2)
Oil (per Bbl)(1)                                            $        87.88       $     89.99
Natural gas (per Mcf)                                       $         3.21       $      2.10
Total (per Boe)                                             $        53.14       $     56.42
Average prices-including impact of derivative contract
settlements
Oil (per Bbl)(1)                                            $        91.03       $     86.27
Natural gas (per Mcf)                                       $         3.19       $      2.35
Total (per Boe)                                             $        54.65       $     54.96


__________________
(1) Includes natural gas liquids.

(2) Prices represent actual average prices for the periods presented and do not include effects of derivative transactions.

Revenues

Exploration and production segment revenues increased $138.3 million, or 40.3%, in the three months ended March 31, 2013 from the same period in 2012, as a result of a 1,015 MBbls, or 29.6%, increase in oil production, a 11.6 Bcf, or 73.5%, increase in natural gas production and a $1.11 per Mcf, or 52.9%, increase in the average price received for natural gas production. The increase in oil and natural gas production in the three months ended March 31, 2013 compared to the same period in 2012 was due to production of approximately 2,664 MMBoe from properties located in the Gulf of Mexico that were acquired during the second quarter of 2012 combined with an increase in production from Mid-Continent properties of approximately 1,746 MBoe as a result of increased drilling throughout 2012 and the three-month period ended March 31, 2013. The increases were partially offset by a decrease in revenues from the Permian Basin due to the sale of the Permian Properties in February 2013 and natural declines in production as a result of decreased drilling activity in this area prior to the closing of the sale.


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Operating Expenses

Production expense includes the costs associated with the Company's exploration and production activities, including, but not limited to, lease operating expense and treating costs. Production expenses increased $49.4 million, or 58.7%, in the first quarter of 2013 compared to the first quarter of 2012 primarily due to increased production. Combined production increased 2,944 MBoe, or 48.7%. On a per Boe basis, production expense for 2013 increased by $0.95, or 6.8%, to $14.84 per Boe during the three months ended March 31, 2013 from $13.89 per Boe for the comparable period in 2012. The slight increase in production expense on a per Boe basis is attributable to oil production from properties located in the Gulf of Mexico that were acquired during the second quarter of 2012. The increases were partially offset by a decrease in Permian Basin production expenses due to the sale of the Permian Properties in February 2013 and natural declines in production as a result of decreased drilling activity in this area prior to the closing of the sale.

Production taxes decreased by $2.8 million, or 23.0%, in the first quarter of 2013 compared to the first quarter of 2012. Approximately 30% of the Company's oil and natural gas production for the three months ended March 31, 2013 was from production in the Gulf of Mexico which is not subject to production tax. In addition, wells drilled in the Mississippian formation in Oklahoma benefit from a tax credit incentive program that reduces the combined statutory rates applicable to the first four years of production from such wells.

Depreciation and depletion for the Company's oil and natural gas properties increased $70.5 million, or 80.9%, for the first quarter of 2013 compared to the first quarter of 2012. The increase was due to a 48.7% increase in the Company's combined production volume as well as an increase in the depreciation and depletion rate per Boe to $17.51 for the three months ended March 31, 2013 from $14.39 per Boe for the comparable period in 2012. The increase in the depreciation and depletion rate primarily resulted from the acquisition of properties located in the Gulf of Mexico during 2012.

Accretion on asset retirement obligations increased $7.2 million for the first quarter of 2013 compared to the first quarter of 2012 as a result of the increase in future plugging and abandonment obligations associated with the oil and natural gas properties located in the Gulf of Mexico that were acquired during the second quarter of 2012.

Loss on sale of assets increased $395.7 million for the first quarter of 2013 compared to the first quarter of 2012 primarily as a result of the $399.1 million loss on the sale of the Permian Properties in February 2013.

The following table summarizes the cash settlements and valuation gain and loss on the Company's commodity derivative contracts, which are included in loss from operations for the exploration and production segment for the three months ended March 31, 2013 and 2012 (in thousands):

                                                                  Three Months Ended March 31,
                                                                    2013                2012
Realized (gain) loss
Realized loss on early settlements                            $      29,623       $             -
Realized loss on amended contracts                                        -               117,108
Realized (gain) loss on settlements at contractual maturity         (13,538 )               8,348
Total realized loss                                                  16,085               125,456
Unrealized loss                                                      24,812               129,190
Loss on commodity derivative contracts                        $      40,897       $       254,646

The Company's derivative contracts are not designated as accounting hedges and, as a result, realized and unrealized gains or losses on commodity derivative contracts are recorded as a component of operating expenses. Internally, management views the settlement of such derivative contracts as adjustments to the price received for oil and natural gas production to determine "effective prices." Early settlements are not considered in the calculation of effective prices. In conjunction with the sale of the Permian Properties, the Company settled a portion of its existing oil derivative contracts prior to their contractual maturities, resulting in a realized loss of $29.6 million. The realized gain on settlements at contractual maturity for the three months ended March 31, 2013 was due primarily to lower oil prices at the time of settlement compared to the contract price for the Company's oil price swaps. The realized loss for the three-month period ended March 31, 2012 was primarily due to higher oil prices at the time of settlement compared to the contract price for the Company's oil price swaps. Non-cash realized losses of $117.1 million resulting from the amendment of certain 2012 derivative contracts to contracts maturing in 2014 and 2015 were included in the net realized loss for the three-month period ended March 31, 2012.


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Unrealized gain or loss on derivative contracts represents the change in fair value of open derivative contracts during the period. The unrealized loss on the Company's commodity contracts recorded during the three months ended March 31, 2013 and 2012 was attributable to an increase in average oil prices at the end of the period compared to the average oil prices at the beginning of the period, or the contract price for contracts entered into during the period.

See "Consolidated Results of Operations" below for a discussion of other operating expenses.

Drilling and Oil Field Services Segment

The financial results of the Company's drilling and oil field services segment depend primarily on demand and prices that can be charged for its services. On a consolidated basis, drilling and oil field service revenues earned and expenses incurred in performing services for third parties, including third-party working interests in wells the Company operates, are included in drilling and services revenues and expenses. Drilling and oil field service revenues earned and expenses incurred in performing services for the Company's own account are eliminated in consolidation. The primary factors affecting the results of the Company's drilling and oil field services segment are the rates received on rigs drilling for third parties, the number of days drilling for third parties and the amount of oil field services provided to third parties.

Set forth in the table below is financial and drilling rig information regarding the drilling and oil field services segment for the three months ended March 31, 2013 and 2012.

                                                                Three Months Ended March 31,
                                                                   2013               2012
Results (in thousands)
Revenues                                                     $      49,737       $      98,332
Inter-segment revenue                                              (32,367 )           (69,023 )
Total revenues                                                      17,370              29,309
Operating expenses                                                  26,335              25,830
(Loss) income from operations                                $      (8,965 )     $       3,479

Drilling rig statistics
Average number of operational rigs owned during the period            30.0                30.0
Average number of rigs working for third parties                       3.5                 9.4
Number of days drilling for third parties                              319                 867
Average drilling revenue per day per rig drilling for
third parties(1)                                             $      15,051       $      15,747

Rig status - end of period
Working for SandRidge                                                   15                  20
Working for third parties                                                3                  10
Idle(2)                                                                  9                   -
Total operational                                                       27                  30
Non-operational                                                          4                   1
Total rigs                                                              31                  31


____________________


(1) Represents revenues from rigs working for third parties, excluding stand-by revenue, divided by the total number of days such drilling rigs were used by third parties during the period, excluding revenues for related rental equipment.

(2) The Company's rigs are primarily intended to drill for its own account; as such, the number of idle rigs does not significantly impact the consolidated results of operations.


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Drilling and oil field services segment revenues decreased $11.9 million to $17.4 million in the three-month period ended March 31, 2013 from the same period in 2012, due to a decrease in the number of rigs working for third parties and a decrease in supplies sold to and oil field services work performed for wells that had been operated by the Company in the Permian Basin prior to their sale. Decreases in drilling and oil field expenses due to the decrease in work performed in the Permian Basin were more than offset by costs associated with maintenance performed on rigs that were stacked as a result of the sale of the Permian Properties, resulting in an overall increase in drilling and oil field services segment expenses of $0.5 million during the three months ended March 31, 2013 compared to the same period in 2012. The decrease in revenue and slight increase in expenses resulted in a loss from operations of $9.0 million in the three-month period ended March 31, 2013 compared to income from operations of $3.5 million in the 2012 period.

Midstream Services Segment

Midstream services segment revenues consist mostly of revenue from gas marketing, which is a very low-margin business, and revenues from the distribution of electricity to the Company's exploration and production operations in the Mississippian formation. On a consolidated basis, midstream and marketing revenues include natural gas sold on behalf of third parties and the fees the Company charges to gather, compress and treat this natural gas. Gas marketing operating costs represent payments made to third parties for the proceeds from the sale of natural gas owned by such parties, net of any applicable margin and actual costs the Company charges to gather, compress and treat the natural gas. In general, natural gas purchased and sold by the Company's midstream services segment is priced at a published daily or monthly index price. Midstream gas services are primarily undertaken to realize incremental margins on natural gas purchased at the wellhead and to provide value-added services to customers. The Company has constructed an electrical transmission system in the Mid-Continent area to distribute electricity for use in the Mississippian formation at a lower cost than electricity provided by on-site generation. On a consolidated basis, revenues from the electrical transmission system represent the sale of electricity to third-party working interest owners in Company operated wells in the Mississippian formation. Electrical transmission system operating expenses represent the cost to purchase the electricity and other operating costs of the infrastructure. The primary factors affecting the results of the Company's midstream services segment are the quantity of natural gas the Company gathers, treats and markets and the prices it pays and receives for natural gas as well as the rates charged and volumes distributed by the electrical transmission system.

Set forth in the table below is financial information regarding the midstream services segment for the three months ended March 31, 2013 and 2012.

                            Three Months Ended March 31,
                               2013               2012
Results (in thousands)
Revenues                 $      36,834       $      26,162
Inter-segment revenue          (24,696 )           (18,295 )
Total revenues                  12,138               7,867
Operating expenses              14,597              10,594
Loss from operations     $      (2,459 )     $      (2,727 )

Gas Marketed
Volumes (MMcf)                   2,048               2,397
Price                    $        3.35       $        2.29

Midstream services segment total revenues and operating expenses for the three-month period ended March 31, 2013 increased $4.3 million and $4.0 million, respectively, from the same period in 2012. The increases in revenue and operating expenses were due to an increase of $1.06 per Mcf in the average price received for natural gas purchased and marketed in west Texas and an increase in revenue from and expenses related to electrical transmission services provided by the Company's expanded electrical infrastructure in the Mid-Continent to third-party working interest owners. These increases were slightly offset by a 349 MMcf decrease in third-party volumes processed and marketed as a result of decreased natural gas production in west Texas.


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