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EX-31.2 - SECTION 302 CERTIFICATION - CFO - SANDRIDGE ENERGY INCsdq39302014ex312-section30.htm
EX-31.1 - SECTION 302 CERTIFICATION - CEO - SANDRIDGE ENERGY INCsdq39302014ex311-section30.htm
EX-32.1 - SECTION 906 CERTIFICATIONS OF CEO AND CFO - SANDRIDGE ENERGY INCsdq39302014ex321-section90.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________
Form 10-Q
__________________________ 
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 001-33784
__________________________ 
SANDRIDGE ENERGY, INC.
(Exact name of registrant as specified in its charter)
__________________________
Delaware
 
20-8084793
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
123 Robert S. Kerr Avenue
Oklahoma City, Oklahoma
 
73102
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code:
(405) 429-5500
Former name, former address and former fiscal year, if changed since last report: Not applicable
__________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes þ 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
þ
 
Accelerated filer
o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o

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

The number of shares outstanding of the registrant’s common stock, par value $0.001 per share, as of the close of business on December 31, 2014, was 484,828,817.
 




References in this report to the “Company” and “SandRidge” mean SandRidge Energy, Inc., including its consolidated subsidiaries and variable interest entities of which it is the primary beneficiary.

DISCLOSURES REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (“Quarterly Report”) of the Company includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements express a belief, expectation or intention and generally are accompanied by words that convey projected future events or outcomes. These forward-looking statements may include projections and estimates concerning the Company’s capital expenditures, liquidity, capital resources and debt profile, the timing and success of specific projects, outcomes and effects of litigation, claims and disputes, elements of the Company’s business strategy, compliance with governmental regulation of the oil and natural gas industry, including environmental regulations, acquisitions and divestitures and the effects thereof on the Company’s financial condition and other statements concerning the Company’s operations and financial performance and condition. Forward-looking statements are generally accompanied by words such as “estimate,” “assume,” “target,” “project,” “predict,” “believe,” “expect,” “anticipate,” “potential,” “could,” “may,” “foresee,” “plan,” “goal,” “should,” “intend” or other words that convey the uncertainty of future events or outcomes. The Company has based these forward-looking statements on its current expectations and assumptions about future events. These statements are based on certain assumptions and analyses made by the Company in light of its experience and perception of historical trends, current conditions and expected future developments as well as other factors the Company believes are appropriate under the circumstances. The actual results or developments anticipated may not be realized or, even if substantially realized, may not have the expected consequences to or effects on the Company’s business or results. Such statements are not guarantees of future performance and actual results or developments may differ materially from those projected in such forward-looking statements. These forward-looking statements speak only as of the date hereof. The Company disclaims any obligation to update or revise these forward-looking statements unless required by law, and it cautions readers not to rely on them unduly. While the Company’s management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties relating to, among other matters, the risks and uncertainties discussed in “Risk Factors” in Item 1A of the Company’s amended Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013 (the “2013 Form 10-K/A”) filed with the Securities and Exchange Commission (the “SEC”) on January 8, 2015.



Preliminary Note

Immediately prior to filing this report, the Company filed a Form 10-K/A for the fiscal year ended December 31, 2013 and Forms 10-Q/A for the fiscal quarters ended March 31, 2014 and June 30, 2014, restating the Company’s financial statements for those periods. These filings were made to correct errors related to the accrual of the Company’s annual CO2 under delivery shortfall penalties and to make certain other adjustments with respect to the periods covered by those reports. Certain details regarding those errors and adjustments are discussed in “Note 2 - Restatement of Previously Issued Financial Statements” of this Form 10-Q.
 
Restatement

On November 4, 2014, the Company filed a Current Report on Form 8-K, stating that (i) the consolidated financial statements of the Company for the periods ended December 31, 2013 and 2012 included in the Company’s Annual Reports on Form 10-K for the periods then ended and (ii) the unaudited consolidated financial statements of the Company for the periods ended March 31, 2013, June 30, 2013, September 30, 2013, March 31, 2014, and June 30, 2014 included in the Company’s Quarterly Reports on Form 10-Q for the periods then ended should no longer be relied upon due to potential changes related to the accrual of a liability associated with the under delivery by the Company of CO2 to Occidental Petroleum Corporation’s (“Occidental”) Century Plant in Pecos County, Texas (the “Century Plant”) or elsewhere.

Historically, based on its determination of the appropriate method of accounting for the annual CO2 delivery shortfall penalty, the Company did not evaluate whether an accrual was needed within each quarterly period prior to the fourth quarter. As a result of consultation with the staff of the SEC, the Company has determined to adopt a different method of accounting for the penalty, which method considers, on a quarterly basis, whether a portion of the annual shortfall delivery penalty should be accrued at the end of each quarter. After applying this method, the Company concluded that it should restate its previously issued unaudited condensed consolidated financial statements for the quarterly and year-to-date periods ended March 31, 2013, June 30, 2013, September 30, 2013, March 31, 2014, and June 30, 2014. The effect of such corrections is to transfer a portion of the annual accrual that was previously recorded at year-end to certain of the quarter-end periods within such calendar year. No changes are being made to the annual accruals previously recorded. For the three and nine-month periods ended September 30, 2013, the correction of these errors resulted in the accrual of (i) $8.3 million and $24.3 million in CO2 under delivery shortfall penalties, respectively, which were previously included in the total 2013 annual delivery shortfall penalty of $32.7 million recorded in the fourth quarter of 2013. The correction of these errors in the unaudited condensed consolidated financial statements for the three and nine-month periods ended September 30, 2013 did not have any impact to the statement of operations or statement of cash flows for the year ended December 31, 2013 or to the balance sheet as of December 31, 2013.
    
Revision    

Additionally, as a result of consultation with the staff of the SEC, the Company has determined that construction of the Century Plant under a construction contract with Occidental should have been accounted for under the full cost method of accounting rather than the completed contract method of accounting. As of December 31, 2013, this change in accounting treatment had no impact on total assets, total liabilities, net income or retained earnings, but resulted in certain equal and offsetting adjustments within current assets or current liabilities as of December 31, 2013.

See “Note 2 - Restatement of Previously Issued Financial Statements” of this Form 10-Q for more information regarding the impact of the above-described adjustments.

Internal Control Consideration

The Company’s management has determined that the absence of an evaluation of whether an accrual for the annual CO2 delivery shortfall penalty was required within each quarterly period prior to the fourth quarter, in accordance with its prior method of accounting, was a deficiency in its internal control over financial reporting that constitutes a material weakness, as defined by SEC regulations, at September 30, 2014. For a discussion of management’s consideration of the Company’s disclosure controls and procedures and the material weakness identified, see Part I. Item 4 included in this Form 10-Q.













SANDRIDGE ENERGY, INC.
FORM 10-Q
Quarter Ended September 30, 2014

INDEX




PART I. Financial Information

ITEM 1. Financial Statements
SANDRIDGE ENERGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data) 
 
September 30,
2014
 
December 31, 2013 (Revised)
 
(Unaudited)
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
590,246

 
$
814,663

Accounts receivable, net
330,543

 
349,218

Derivative contracts
53,919

 
12,779

Prepaid expenses
6,794

 
39,253

Other current assets
23,223

 
25,910

Total current assets
1,004,725

 
1,241,823

Oil and natural gas properties, using full cost method of accounting
 
 
 
Proved
11,252,074

 
10,972,816

Unproved
300,224

 
531,606

Less: accumulated depreciation, depletion and impairment
(6,250,457
)
 
(5,762,969
)
 
5,301,841

 
5,741,453

Other property, plant and equipment, net
578,864

 
566,222

Derivative contracts
15,891

 
14,126

Other assets
77,068

 
121,171

Total assets
$
6,978,389

 
$
7,684,795


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





















4


SANDRIDGE ENERGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS - Continued
(In thousands, except per share data) 

 
September 30,
2014
 
December 31, 2013 (Revised)
 
(Unaudited)
LIABILITIES AND EQUITY
 
 
 
Current liabilities
 
 
 
Accounts payable and accrued expenses
$
652,649

 
$
812,488

Derivative contracts

 
34,267

Asset retirement obligations

 
87,063

Other current liabilities
18,549

 

Total current liabilities
671,198

 
933,818

Long-term debt
3,195,301

 
3,194,907

Derivative contracts

 
20,564

Asset retirement obligations
57,696

 
337,054

Other long-term obligations
16,418

 
22,825

Total liabilities
3,940,613

 
4,509,168

Commitments and contingencies (Note 12)

 

Equity
 
 
 
SandRidge Energy, Inc. stockholders’ equity
 
 
 
Preferred stock, $0.001 par value, 50,000 shares authorized
 
 
 
8.5% Convertible perpetual preferred stock; 2,650 shares issued and outstanding at September 30, 2014 and December 31, 2013; aggregate liquidation preference of $265,000
3

 
3

6.0% Convertible perpetual preferred stock; 2,000 shares issued and outstanding at September 30, 2014 and December 31, 2013; aggregate liquidation preference of $200,000
2

 
2

7.0% Convertible perpetual preferred stock; 3,000 shares issued and outstanding at September 30, 2014 and December 31, 2013; aggregate liquidation preference of $300,000
3

 
3

Common stock, $0.001 par value, 800,000 shares authorized; 491,262 issued and 490,224 outstanding at September 30, 2014 and 491,609 issued and 490,290 outstanding at December 31, 2013
483

 
483

Additional paid-in capital
5,292,874

 
5,298,301

Additional paid-in capital—stockholder receivable
(3,750
)
 
(3,750
)
Treasury stock, at cost
(6,823
)
 
(8,770
)
Accumulated deficit
(3,511,498
)
 
(3,460,462
)
Total SandRidge Energy, Inc. stockholders’ equity
1,771,294

 
1,825,810

Noncontrolling interest
1,266,482

 
1,349,817

Total equity
3,037,776

 
3,175,627

Total liabilities and equity
$
6,978,389

 
$
7,684,795

 
 
 
 

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

5


SANDRIDGE ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013 (Restated)
 
2014
 
2013 (Restated)
 
(Unaudited)
Revenues
 
 
 
 
 
 
 
Oil, natural gas and NGL
$
359,613

 
$
459,211

 
$
1,104,835

 
$
1,391,510

Drilling and services
21,348

 
16,149

 
57,280

 
49,597

Midstream and marketing
11,922

 
14,624

 
44,706

 
42,854

Construction contract

 

 

 
23,253

Other
1,224

 
3,619

 
5,056

 
11,066

Total revenues
394,107

 
493,603

 
1,211,877

 
1,518,280

Expenses
 
 
 
 
 
 
 
Production
82,664

 
124,571

 
256,473

 
389,911

Production taxes
8,380

 
8,816

 
24,027

 
24,819

Cost of sales
15,992

 
13,773

 
38,942

 
45,438

Midstream and marketing
11,405

 
13,224

 
40,659

 
39,954

Construction contract

 

 

 
23,253

Depreciation and depletion—oil and natural gas
112,569

 
137,639

 
325,021

 
434,068

Depreciation and amortization—other
14,417

 
15,270

 
45,350

 
46,628

Accretion of asset retirement obligations
1,116

 
8,472

 
7,927

 
28,051

Impairment
54

 
687

 
167,966

 
16,330

General and administrative
24,584

 
37,714

 
86,115

 
172,301

Employee termination benefits
5

 
2,256

 
8,927

 
120,374

(Gain) loss on derivative contracts
(132,575
)
 
132,808

 
(4,792
)
 
70,051

(Gain) loss on sale of assets
(995
)
 
539

 
(978
)
 
398,364

Total expenses
137,616

 
495,769

 
995,637

 
1,809,542

Income (loss) from operations
256,491

 
(2,166
)
 
216,240

 
(291,262
)
Other income (expense)
 
 
 
 
 
 
 
Interest expense
(59,783
)
 
(61,385
)
 
(183,689
)
 
(208,454
)
Loss on extinguishment of debt

 

 

 
(82,005
)
Other (expense) income, net
(273
)
 
658

 
3,159

 
1,163

Total other expense
(60,056
)
 
(60,727
)
 
(180,530
)
 
(289,296
)
Income (loss) before income taxes
196,435

 
(62,893
)
 
35,710

 
(580,558
)
Income tax (benefit) expense
(1,064
)
 
2,363

 
(2,131
)
 
7,300

Net income (loss)
197,499

 
(65,256
)
 
37,841

 
(587,858
)
Less: net income attributable to noncontrolling interest
40,161

 
16,191

 
49,733

 
9,393

Net income (loss) attributable to SandRidge Energy, Inc.
157,338

 
(81,447
)
 
(11,892
)
 
(597,251
)
Preferred stock dividends
11,381

 
13,881

 
39,144

 
41,644

Income available (loss applicable) to SandRidge Energy, Inc. common stockholders
$
145,957

 
$
(95,328
)
 
$
(51,036
)
 
$
(638,895
)
Income (loss) per share
 
 
 
 
 
 
 
Basic
$
0.30

 
$
(0.20
)
 
$
(0.11
)
 
$
(1.33
)
Diluted
$
0.27

 
$
(0.20
)
 
$
(0.11
)
 
$
(1.33
)
Weighted average number of common shares outstanding
 
 
 
 
 
 
 
Basic
485,458

 
483,582

 
485,194

 
480,209

Diluted
575,911

 
483,582

 
485,194

 
480,209


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

6


SANDRIDGE ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In thousands) 
 
SandRidge Energy, Inc. Stockholders
 
 
 
 
 
Convertible Perpetual Preferred Stock
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Deficit
 
Non-controlling Interest
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
(Unaudited)
Nine Months Ended September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
7,650

 
$
8

 
490,290

 
$
483

 
$
5,294,551

 
$
(8,770
)
 
$
(3,460,462
)
 
$
1,349,817

 
$
3,175,627

Acquisition of ownership interest

 

 

 

 
(2,074
)
 

 

 
(656
)
 
(2,730
)
Sale of royalty trust units

 

 

 

 
4,091

 

 

 
18,028

 
22,119

Distributions to noncontrolling interest owners

 

 

 

 

 

 

 
(150,440
)
 
(150,440
)
Purchase of treasury stock

 

 

 

 

 
(6,281
)
 

 

 
(6,281
)
Retirement of treasury stock

 

 

 

 
(6,281
)
 
6,281

 

 

 

Stock distributions, net of purchases - retirement plans

 

 
281

 

 
(2,252
)
 
1,947

 

 

 
(305
)
Stock-based compensation

 

 

 

 
18,617

 

 

 

 
18,617

Stock-based compensation excess tax benefit

 

 

 

 
14

 

 

 

 
14

Issuance of restricted stock awards, net of cancellations

 

 
3,153

 
3

 
(3
)
 

 

 

 

Repurchase of common stock

 

 
(3,500
)
 
(3
)
 
(17,539
)
 

 

 

 
(17,542
)
Net (loss) income

 

 

 

 

 

 
(11,892
)
 
49,733

 
37,841

Convertible perpetual preferred stock dividends

 

 

 

 

 

 
(39,144
)
 

 
(39,144
)
Balance at September 30, 2014
7,650

 
$
8

 
490,224

 
$
483

 
$
5,289,124

 
$
(6,823
)
 
$
(3,511,498
)
 
$
1,266,482

 
$
3,037,776


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

7


SANDRIDGE ENERGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Nine Months Ended September 30,
 
2014
 
2013 (Restated)
 
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income (loss)
$
37,841

 
$
(587,858
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities
 
 
 
Depreciation, depletion and amortization
370,371

 
480,696

Accretion of asset retirement obligations
7,927

 
28,051

Impairment
167,966

 
16,330

Debt issuance costs amortization
7,045

 
7,730

Amortization of discount, net of premium, on long-term debt
394

 
913

Loss on extinguishment of debt

 
82,005

Deferred income tax provision

 
4,702

(Gain) loss on derivative contracts
(4,792
)
 
70,051

Cash paid on settlement of derivative contracts
(48,816
)
 
(17,943
)
(Gain) loss on sale of assets
(978
)
 
398,364

Stock-based compensation
15,853

 
79,317

Other
488

 
1,499

Changes in operating assets and liabilities
(157,615
)
 
31,150

Net cash provided by operating activities
395,684

 
595,007

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Capital expenditures for property, plant and equipment
(1,071,465
)
 
(1,163,539
)
Acquisition of assets
(16,920
)
 
(15,527
)
Proceeds from sale of assets
714,294

 
2,567,355

Net cash (used in) provided by investing activities
(374,091
)
 
1,388,289

CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Repayments of borrowings

 
(1,115,500
)
Premium on debt redemption

 
(61,997
)
Debt issuance costs

 
(91
)
Proceeds from sale of royalty trust units
22,119

 
28,985

Noncontrolling interest distributions
(150,440
)
 
(153,002
)
Acquisition of ownership interest
(2,730
)
 

Stock-based compensation excess tax benefit
14

 
(4
)
Purchase of treasury stock
(8,278
)
 
(31,270
)
Repurchase of common stock
(17,542
)
 

Dividends paid — preferred
(45,025
)
 
(45,025
)
Cash (paid) received on settlement of financing derivative contracts
(44,128
)
 
5,099

Net cash used in financing activities
(246,010
)
 
(1,372,805
)
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
(224,417
)
 
610,491

CASH AND CASH EQUIVALENTS, beginning of year
814,663

 
309,766

CASH AND CASH EQUIVALENTS, end of period
$
590,246

 
$
920,257

Supplemental Disclosure of Cash Flow Information
 
 
 
Cash paid for interest, net of amounts capitalized
$
(209,939
)
 
$
(248,233
)
Cash paid for income taxes
$
(543
)
 
$
(2,911
)
Supplemental Disclosure of Noncash Investing and Financing Activities
 
 
 
Deposit on pending sale
$

 
$
(255,000
)
Change in accrued capital expenditures
$
(49,072
)
 
$
65,087

Asset retirement costs capitalized
$
3,398

 
$
4,145


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

8


SANDRIDGE ENERGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation

Nature of Business. SandRidge Energy, Inc. is an oil and natural gas company with a principal focus on exploration and production activities in the Mid-Continent region of the United States. The Company owns and operates additional interests in west Texas. The Company also operates businesses and infrastructure systems that are complementary to its primary exploration and production activities, including gas gathering and processing facilities, marketing operations, a saltwater gathering system, an electrical transmission system and a drilling and related oil field services business.

Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its wholly owned or majority owned subsidiaries and variable interest entities (“VIEs”) for which the Company is the primary beneficiary. Noncontrolling interest represents third-party ownership interests in the Company’s subsidiaries and consolidated VIEs and is included as a component of equity in the consolidated balance sheets and consolidated statement of changes in equity. All significant intercompany accounts and transactions have been eliminated in consolidation.

Variable Interest Entities. An entity is referred to as a VIE if it possesses one of the following criteria: (i) it is thinly capitalized, (ii) the residual equity holders do not control the entity, (iii) the equity holders are shielded from the economic losses, (iv) the equity holders do not participate fully in the entity’s residual economics, or (v) the entity was established with non-substantive voting interests. The Company consolidates a VIE when it has determined it is the primary beneficiary, which requires significant judgment. The primary beneficiary of a VIE is that variable interest holder possessing a controlling financial interest through (i) its power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) its obligation to absorb losses or its right to receive benefits from the VIE that could potentially be significant to the VIE. In order to determine whether the Company owns a variable interest in a VIE and the significance of the variable interest, the Company performs a qualitative analysis of the entity’s design, organizational structure, primary decision makers and related financial agreements. In addition to the VIEs that the Company consolidates, the Company also holds a variable interest in another VIE that is not consolidated as it was determined that the Company is not the primary beneficiary. The Company monitors both consolidated and unconsolidated VIEs to determine if any events have occurred that could cause the primary beneficiary to change. See Note 4 for discussion of the Company’s significant associated VIEs.
Interim Financial Statements. The accompanying unaudited condensed consolidated financial statements as of December 31, 2013 have been derived from the audited financial statements contained in the Company’s amended Annual Report on Form 10-K/A (“2013 Form 10-K/A”) filed on January 8, 2015. The unaudited condensed consolidated financial statements have been prepared by the Company in accordance with the accounting policies stated in the audited consolidated financial statements contained in the 2013 Form 10-K/A. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted, although the Company believes that the disclosures contained herein are adequate to make the information presented not misleading. In the opinion of management, all adjustments, which consist of normal recurring adjustments, unless otherwise disclosed herein, are necessary to state fairly the accompanying unaudited condensed consolidated financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the 2013 Form 10-K/A.

Significant Accounting Policies. For a description of the Company’s significant accounting policies, see Note 1 of the consolidated financial statements included in the 2013 Form 10-K/A.

Reclassifications. Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation. These reclassifications have no effect on the Company’s previously reported results of operations.

Restatement and Revision of Prior Period Financial Statements. See Note 2 “Restatement of Previously Issued Financial Statements” for a discussion of changes made during the third quarter of 2014 to the accompanying prior period unaudited condensed consolidated financial statements.

Use of Estimates. The preparation of the accompanying unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that 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.


9

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


The more significant areas requiring the use of assumptions, judgments and estimates include: oil, natural gas and natural gas liquids (“NGL”) reserves; cash flow estimates used in the valuation of guarantees; impairment tests of long-lived assets; depreciation, depletion and amortization; asset retirement obligations; assignments of fair value and allocations of purchase price in connection with business combinations; determinations of significant alterations to the full cost pool and related estimates of fair value used to allocate the full cost pool net book value to divested properties, as necessary; income taxes; valuation of derivative instruments; contingencies; and accrued revenue and related receivables. Although management believes these estimates are reasonable, actual results could differ significantly.

Recent Accounting Pronouncements Not Yet Adopted. In May 2014, the FASB issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Certain of the provisions also amend or supersede existing guidance applicable to the recognition of a gain or loss on transfers of nonfinancial assets that are not an output of an entity’s ordinary activities, including sales of property, plant and equipment and real estate. The requirements of ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period with an option of using either a full retrospective or a modified approach for adoption. The Company is currently evaluating the effect, if any, that the updated standard will have on its consolidated financial statements and related disclosures.

2. Restatement of Previously Issued Financial Statements
    
Overview

The Company has determined there were errors in the timing of its accrual of annual CO2 delivery shortfall penalties incurred under its 30-year treating agreement with Occidental Petroleum Corporation (“Occidental”) and has determined that these errors were material to previously issued unaudited condensed consolidated financial statements for the three and nine-month periods ended September 30, 2013. For the three and nine-month periods ended September 30, 2013, the correction of these errors resulted in the accrual of $8.3 million and $24.3 million in CO2 under delivery shortfall penalties, for the three and nine-month periods ended September 30, 2013, respectively, which were previously included in the total 2013 annual delivery shortfall penalty of $32.7 million recorded in the fourth quarter of 2013. As a result, these statements have been presented on a restated and amended basis herein. The correction of these errors in the financial statements for the three and nine-month periods ended September 30, 2013 did not have any impact on the statement of operations or statement of cash flows for the year ended December 31, 2013 or to the balance sheet as of December 31, 2013.

Additionally, the Company has made certain revisions to its condensed consolidated balance sheets as of December 31, 2013 in order to account for activities associated with construction of the Century Plant in Pecos County, Texas (the “Century Plant”) under the full cost method of accounting. The Company has determined that these revisions are not material to the originally issued financial statements; however, in conjunction with the Company’s need to restate its financial statements as a result of the error noted above, the Company has determined that it would be appropriate to make such revisions. The condensed consolidated balance sheet as of December 31, 2013 presented herein is consistent with the revised consolidated balance sheet included in the Company’s 2013 Form 10-K/A.



10

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



Financial Statement Presentation

In addition to the restatement of the Company’s unaudited condensed consolidated financial statements, certain information within the following notes to the unaudited condensed consolidated financial statements has been restated and/or revised to reflect the corrections presented in the tables below or to add disclosure language, as appropriate.

Note 6. Property, Plant and Equipment
Note 12. Commitment and Contingencies
Note 15. Earnings (Loss) Per Share
Note 18. Business Segment Information
Note 19. Condensed Consolidating Financial Information

Condensed Consolidated Statements of Operations. The following table presents the impact of the error corrections on the Company’s previously reported unaudited condensed consolidated statements of operations for the three and nine-month periods ended September 30, 2013 (in thousands):
 
 
Three Months Ended September 30, 2013
 
Nine Months Ended September 30, 2013
 
 
As Reported
 
As Restated
 
As Reported
 
As Restated
Production
 
$
116,317

 
$
124,571

 
$
365,629

 
$
389,911

     Total expenses
 
$
487,515

 
$
495,769

 
$
1,785,260

 
$
1,809,542

     Income (loss) from operations
 
$
6,088

 
$
(2,166
)
 
$
(266,980
)
 
$
(291,262
)
(Loss) before income taxes
 
$
(54,639
)
 
$
(62,893
)
 
$
(556,276
)
 
$
(580,558
)
Net (loss)
 
$
(57,002
)
 
$
(65,256
)
 
$
(563,576
)
 
$
(587,858
)
Net loss attributable to SandRidge Energy, Inc.
 
$
(73,193
)
 
$
(81,447
)
 
$
(572,969
)
 
$
(597,251
)
Loss applicable to SandRidge Energy, Inc. common stockholders
 
$
(87,074
)
 
$
(95,328
)
 
$
(614,613
)
 
$
(638,895
)
Loss per share
 
 
 
 
 
 
 
 
     Basic
 
$
(0.18
)
 
$
(0.20
)
 
$
(1.28
)
 
$
(1.33
)
     Diluted
 
$
(0.18
)
 
$
(0.20
)
 
$
(1.28
)
 
$
(1.33
)

Condensed Consolidated Statement of Cash Flows. The following table presents the impact of the error corrections on the Company’s previously reported unaudited condensed consolidated statement of cash flows for the nine-month period ended September 30, 2013 (in thousands):
 
 
Nine Months Ended September 30, 2013
 
 
As Reported
 
As Restated
Net loss
 
$
(563,576
)
 
$
(587,858
)
Changes in operating assets and liabilities
 
$
6,868

 
$
31,150


Condensed Consolidated Balance Sheet. The Company has determined that unreimbursed costs incurred by the Company on behalf of Occidental during construction of the Century Plant that were previously presented as costs in excess of billings and contract loss should have been presented under the full cost method of accounting as an account receivable. Accordingly, the Company has revised the condensed consolidated balance sheet as of December 31, 2013 to reflect this presentation. This revision did not have any impact to total current assets as of December 31, 2013.

11

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)



The following table presents the impact of these adjustments on the Company’s previously reported condensed consolidated balance sheet as of December 31, 2013 (in thousands):
 
 
Year Ended December 31, 2013
 
 
As Reported
 
As Revised
Current assets
 
 
 
 
     Costs in excess of billings and contract loss
 
$
4,079

 
$

     Other current assets
 
$
21,831

 
$
25,910



3. Divestitures

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’s (the “Permian Trust”) area of mutual interest, (the “Permian Properties”) for $2.6 billion. This transaction resulted in a significant alteration of the relationship between the Company’s capitalized costs and proved reserves and, accordingly, the Company recorded a $398.9 million loss on the sale for the nine-month period ended September 30, 2013. The loss is included in (gain) loss on sale of assets in the accompanying unaudited condensed consolidated statement of operations for the nine-month period ended September 30, 2013. The loss was calculated based on a comparison of proceeds received and the asset retirement obligations attributable to the Permian Properties that were assumed by the buyer to the sum of (i) an allocation of the historical net book value of the Company’s proved oil and natural gas properties attributable to the Permian Properties, (ii) the historical cost of unproved acreage sold and (iii) costs incurred by the Company to sell these properties. The allocated net book value attributable to the Permian Properties was calculated based on the relative fair value of the Permian Properties and the remaining proved oil and natural gas properties retained by the Company as of the date of sale. A portion of the loss, totaling $71.7 million, was allocated to noncontrolling interests and is reflected in net income attributable to noncontrolling interest in the accompanying unaudited condensed consolidated statement of operations for the nine-month period ended September 30, 2013.
    
The following table presents revenues and direct operating expenses of the Permian Properties included in the accompanying unaudited condensed consolidated statement of operations for the nine-month period ended September 30, 2013 (in thousands):
 
 
Nine Months Ended September 30, 2013(1)
Revenues
 
$
68,027

Direct operating expenses
 
$
17,453

__________________
(1)
Includes revenues and direct operating expenses through February 26, 2013, the date of sale.

Sale of Gulf of Mexico and Gulf Coast Properties

On February 25, 2014, the Company sold subsidiaries that owned the Company’s Gulf of Mexico and Gulf Coast oil and natural gas properties (the “Gulf Properties”) for approximately $702.6 million, net of working capital adjustments and post-closing adjustments, and the buyer’s assumption of approximately $366.0 million of related asset retirement obligations to Fieldwood Energy LLC (“Fieldwood”). This transaction did not result in a significant alteration of the relationship between the Company’s capitalized costs and proved reserves and, accordingly, the Company recorded the proceeds as a reduction of its full cost pool with no gain or loss on the sale. See Note 16 for discussion of Fieldwood’s related party affiliation with the Company.

In accordance with the terms of the sale, the Company agreed to guarantee on behalf of Fieldwood certain plugging and abandonment obligations associated with the Gulf Properties for a period of up to one year from the date of closing. The Company recorded a liability equal to the fair value of these guarantees, or $9.4 million, at the time the transaction closed. As of September 30, 2014, the fair value of the guarantees was approximately $10.4 million. See Note 5 for additional discussion of the determination of the guarantees’ fair value. The guarantees do not include a limit on the potential future payments for which the Company could

12

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


be obligated; however, Fieldwood has agreed to indemnify the Company for any costs it may incur as a result of the guarantees and to use its best efforts to pay any amounts sought from the Company by the Bureau of Ocean Energy Management that may arise prior to the expiration of the guarantees. Additionally, Fieldwood will maintain, for a period of up to one year from the closing date, restricted deposits totaling approximately $28.0 million held in escrow for plugging and abandonment obligations associated with the Gulf Properties. Upon expiration of the guarantees, the Company will receive payment from Fieldwood for half of such restricted deposits, or approximately $14.0 million. A receivable for this amount is included in other current assets in the accompanying unaudited condensed consolidated balance sheet at September 30, 2014.

The following table presents revenues and expenses, including direct operating expenses, depletion, accretion of asset retirement obligations and general and administrative expenses, for the Gulf Properties included in the accompanying unaudited condensed consolidated statements of operations for the three-month period ended September 30, 2013 and the nine-month periods ended September 30, 2014 and 2013 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2014(1)
 
2013
Revenues
$
153,315

 
$
90,920

 
$
498,590

Expenses
$
126,137

 
$
63,674

 
$
377,529

____________________
(1)
Includes revenues and expenses through February 25, 2014, the date of the sale.


    


13

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


4. Variable Interest Entities

The Company’s significant associated VIEs, including those for which the Company has determined it is the primary beneficiary and those for which it has determined it is not, are described below.
    
Royalty Trusts. SandRidge owns beneficial interests in three Delaware statutory trusts. SandRidge Mississippian Trust I (the “Mississippian Trust I”), the Permian Trust and SandRidge Mississippian Trust II (the “Mississippian Trust II”) (each individually, a “Royalty Trust” and collectively, the “Royalty Trusts”) completed initial public offerings of their common units in April 2011, August 2011 and April 2012, respectively. Concurrent with the closing of each offering, the Company conveyed certain royalty interests to each Royalty Trust in exchange for the net proceeds of the offering and units representing beneficial interests in the Royalty Trust. Royalty interests conveyed to the Royalty Trusts are in existing wells and wells to be drilled on oil and natural gas properties leased by the Company in defined areas of mutual interest. The following table summarizes information about each Royalty Trust as of September 30, 2014:
 
 
Mississippian Trust I
 
Permian Trust
 
Mississippian Trust II
Total outstanding common units(1)
 
28,000,000

 
39,375,000

 
37,293,750

Total outstanding subordinated units(1)
 

 
13,125,000

 
12,431,250

Liquidation date(2)
 
12/31/2030

 
3/31/2031

 
12/31/2031

____________________
(1)
The Mississippian Trust I’s previously outstanding subordinated units, all of which were held by SandRidge, converted to common units on July 1, 2014.
(2)
At the time each Royalty Trust terminates, 50% of the royalty interests conveyed to the Royalty Trust will automatically revert to the Company, and the remaining 50% will be sold, with the proceeds distributed to the Royalty Trust unitholders.

The Royalty Trusts make quarterly cash distributions to unitholders based on calculated distributable income. In order to provide support for cash distributions on the common units, the Company agreed to subordinate a portion of the units it owns in each Royalty Trust (the “subordinated units”), which constitute 25% of the total outstanding units of each Royalty Trust. The subordinated units are entitled to receive pro rata distributions from the Royalty Trusts each quarter if and to the extent there is sufficient cash to provide a cash distribution on the common units that is no less than the applicable quarterly subordination threshold. If there is not sufficient cash to fund such a distribution on all common units, the distribution made with respect to the subordinated units is reduced or eliminated for such quarter in order to make a distribution, to the extent possible, of up to the subordination threshold amount on all common units, including common units held by the Company. In exchange for agreeing to subordinate a portion of its Royalty Trust units, SandRidge is entitled to receive incentive distributions equal to 50% of the amount by which the cash available for distribution on all of the Royalty Trust units exceeds the applicable quarterly incentive threshold.

14

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


The Royalty Trusts declared and paid quarterly distributions during the three and nine-month periods ended September 30, 2014 and 2013 as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014(1)
 
2013(1)
 
2014(2)
 
2013(2)
Total distributions
 
$
56,191

 
$
81,594

 
$
184,176

 
$
226,404

Distributions to third-party unitholders
 
$
47,298

 
$
54,287

 
$
150,440

 
$
153,002

____________________
(1)
Subordination thresholds were not met for the Mississippian Trust I’s distributions for the three-month periods ended September 30, 2014 and 2013 and for the Mississippian Trust II’s distributions for the three-month period ended September 30, 2014, resulting in reduced distributions to the Company on its subordinated units for these periods.
(2)
Subordination thresholds were not met for the Mississippian Trust I’s distributions for the nine-month period ended September 30, 2014 and for the Permian Trust’s distribution for the nine-month period ended September 30, 2013, resulting in reduced distributions to the Company on its subordinated units for these periods.

See Note 20 for discussion of the Royalty Trusts’ distributions announced in October 2014.
    
Pursuant to the trust agreements governing the Royalty Trusts, SandRidge has committed to loan funds to each Royalty Trust on an unsecured basis, with terms substantially the same as would be obtained in an arm’s length transaction between SandRidge and an unaffiliated party, if at any time the Royalty Trust’s cash is not sufficient to pay ordinary course administrative expenses as they become due. Any funds loaned may not be used to satisfy indebtedness of the Royalty Trust or to make distributions. There were no amounts outstanding under the loan commitments at September 30, 2014 or December 31, 2013.

The Company and one of its wholly owned subsidiaries entered into a development agreement with each Royalty Trust that obligates the Company to drill, or cause to be drilled, a specified number of wells within respective areas of mutual interest, which are also subject to the royalty interests granted to the Mississippian Trust I, the Permian Trust and the Mississippian Trust II, by December 31, 2015, March 31, 2016 and December 31, 2016, respectively. Following the end of the fourth full calendar quarter subsequent to the Company’s satisfaction of its drilling obligation (the “subordination period”), the subordinated units of each Royalty Trust will automatically convert into common units on a one-for-one basis and the Company’s right to receive incentive distributions will terminate. On July 1, 2014, the Mississippian Trust I’s subordinated units, all of which were held by SandRidge, converted to common units. The newly-converted units remained subject to the distribution subordination thresholds through the Mississippian Trust I’s August 29, 2014 distribution. Beginning with the distribution made in November 2014, all of the Mississippian Trust I’s common units will share equally in its distribution. The Company continues to consolidate the activities of the Mississippian Trust I as its primary beneficiary subsequent to this conversion due to the Company’s original participation in the design of the Mississippian Trust I and continued (a) power to direct the activities that most significantly impact the economic performance of the Royalty Trust and (b) obligation to absorb losses and right to receive residual returns through its variable interests in the Royalty Trust, including ownership of common units, that could potentially be significant to the Mississippian Trust I.

One of the Company’s wholly owned subsidiaries also granted to each Royalty Trust a lien on the Company’s interests in the properties where the development wells will be drilled in order to secure the estimated amount of drilling costs for the Royalty Trust’s interests in the wells. As the Company fulfills its drilling obligation to each Royalty Trust, development wells that have been drilled and perforated for completion are released from the lien and the total amount that may be recovered by each Royalty Trust is proportionately reduced. As of September 30, 2014, the total maximum amount recoverable by the Permian Trust and the Mississippian Trust II under the remaining liens was approximately $31.6 million. The Company fulfilled its drilling obligation to the Mississippian Trust I in the second quarter of 2013 and the related lien was released.

Additionally, the Company and each Royalty Trust entered into an administrative services agreement, pursuant to which the Company provides certain administrative services to the Royalty Trust, including hedge management services to the Permian Trust and the Mississippian Trust II. The Company also entered into derivatives agreements with each Royalty Trust, pursuant to which the Company provides to the Royalty Trust the economic effects of certain of the Company’s derivative contracts. Substantially concurrent with the execution of the derivatives agreements with the Permian Trust and the Mississippian Trust II, the Company novated certain of the derivative contracts underlying the respective derivatives agreements to each of these Royalty Trusts. The Company novated additional derivative contracts underlying the derivatives agreements to the Permian Trust in April 2012 and to the Permian Trust and the Mississippian Trust II in March 2013. The tables below present the open oil and natural gas

15

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


commodity derivative contracts at September 30, 2014 underlying the derivatives agreements. The combined volume in the tables below reflects the total volume of the Royalty Trusts’ open oil and natural gas commodity derivative contracts.

Oil Price Swaps Underlying the Royalty Trust Derivatives Agreements
 
Notional (MBbls)
 
Weighted Average
Fixed Price
October 2014 - December 2014
415

 
$
101.01

January 2015 - December 2015
904

 
$
97.78


Natural Gas Collars Underlying the Royalty Trust Derivatives Agreements
 
Notional (MMcf)
 
Collar Range
October 2014 - December 2014
236

 
$
4.00

$
7.78

January 2015 - December 2015
1,010

 
$
4.00

$
8.55


Oil Price Swaps Underlying the Derivatives Agreements and Novated to the Royalty Trusts
 
Notional (MBbls)
 
Weighted Average
Fixed Price
October 2014 - December 2014
233

 
$
100.75

January 2015 - March 2015
141

 
$
100.90


See Note 10 for further discussion of the derivatives agreement between the Company and each Royalty Trust.

The Royalty Trusts are considered VIEs due to the lack of voting or similar decision-making rights of the Royalty Trusts’ equity holders regarding activities that have a significant effect on the economic success of the Royalty Trusts. The Company has determined it is the primary beneficiary of the Royalty Trusts as it has (a) the power to direct the activities that most significantly impact the economic performance of the Royalty Trusts through (i) its participation in the creation and structure of the Royalty Trusts, (ii) the manner in which it fulfills its drilling obligations to the Royalty Trusts and (iii) its operation of a majority of the oil and natural gas properties that are subject to the conveyed royalty interests and marketing of the associated production and (b) the obligation to absorb losses and right to receive residual returns, through its variable interests in the Royalty Trusts, including ownership of common and subordinated units, that could potentially be significant to the Royalty Trusts. As a result, the Company consolidates the activities of the Royalty Trusts into its results of operations. Amounts attributable to the common units of the Royalty Trusts owned by third parties are reflected as noncontrolling interest in the consolidated financial statements.

    

16

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


Each Royalty Trust’s assets can be used to settle only that Royalty Trust’s obligations and not other obligations of the Company or another Royalty Trust. The Royalty Trusts’ creditors have no contractual recourse to the general credit of the Company. Although the Royalty Trusts are included in the Company’s consolidated financial statements, the Company’s legal interest in the Royalty Trusts’ assets is limited to its ownership of the Royalty Trusts’ units. At both September 30, 2014 and December 31, 2013, $1.3 billion of noncontrolling interest in the accompanying unaudited condensed consolidated balance sheets was attributable to the Royalty Trusts. The Royalty Trusts’ assets and liabilities, after considering the effects of intercompany eliminations, included in the accompanying unaudited condensed consolidated balance sheets at September 30, 2014 and December 31, 2013 consisted of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Cash and cash equivalents(1)
$
7,584

 
$
7,912

Accounts receivable, net
17,698

 
22,540

Derivative contracts
5,991

 
4,983

Total current assets
31,273

 
35,435

Investment in royalty interests(2)
1,325,942

 
1,325,942

Less: accumulated depletion and impairment(3)
(272,346
)
 
(186,095
)
 
1,053,596

 
1,139,847

Derivative contracts

 
1,476

Total assets
$
1,084,869

 
$
1,176,758

Accounts payable and accrued expenses
$
3,049

 
$
3,393

Total liabilities
$
3,049

 
$
3,393

____________________
(1)
Includes $3.0 million held by the trustee at September 30, 2014 and December 31, 2013 as reserves for future general and administrative expenses.
(2)
Investment in royalty interests is included in oil and natural gas properties in the accompanying unaudited condensed consolidated balance sheets.
(3)
Accumulated depletion and impairment at September 30, 2014 includes full cost ceiling limitation impairment allocated to the Royalty Trusts of $42.3 million. There was no full cost ceiling limitation impairment allocated to the Royalty Trusts as of December 31, 2013.
 
During the nine-month period ended September 30, 2014, the Company sold Permian Trust common units it owned in a transaction exempt from registration pursuant to Rule 144 under the Securities Act for proceeds of approximately $22.1 million. The sale was accounted for as an equity transaction with no gain or loss recognized. The Company continues to be the primary beneficiary of the Permian Trust after consideration of this transaction and continues to consolidate the activities of the Permian Trust as well as the activities of the Mississippian Trust I and Mississippian Trust II. The Company’s beneficial interests in the Royalty Trusts at September 30, 2014 and December 31, 2013 were as follows:
 
September 30,
2014
 
December 31,
2013
Mississippian Trust I
26.9
%
 
26.9
%
Permian Trust
25.0
%
 
28.5
%
Mississippian Trust II
37.6
%
 
37.6
%

See Note 12 for discussion of the Company’s legal proceedings to which the Mississippian Trust I and Mississippian Trust II are also parties.

Grey Ranch Plant, L.P. Primarily engaged in treating and transportation of natural gas, Grey Ranch Plant, L.P. (“GRLP”) was a limited partnership that operated the Company’s Grey Ranch plant (the “Plant”) located in Pecos County, Texas. As of December 31, 2013, the Company owned a 50% interest in GRLP, which represented a variable interest. Income or loss of GRLP was allocated to the partners based on ownership percentage and any operating or cash shortfalls required contributions from the partners. GRLP was considered a VIE because certain equity holders lacked the ability to participate in decisions impacting GRLP. Agreements related to the ownership and operation of GRLP provided for GRLP to pay management fees to the Company to operate the Plant and lease payments for the Plant. Under the operating agreements, lease payments were reduced if throughput

17

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


volumes were below those expected. The Company determined that it was the primary beneficiary of GRLP as it had both (i) the power, as operator of the Plant, to direct the activities of GRLP that most significantly impact its economic performance and (ii) the obligation to absorb losses, as a result of the operating and gathering agreements, that could potentially be significant to GRLP and, therefore, consolidated the activity of GRLP in its consolidated financial statements. The 50% ownership interest not held by the Company as of December 31, 2013 is presented as noncontrolling interest in the accompanying unaudited condensed consolidated financial statements. In the first quarter of 2014, one of the Company’s wholly owned subsidiaries acquired from a third party the remaining 50% ownership interest of GRLP. Because the Company was the primary beneficiary and consolidated GRLP, the acquisition of additional ownership interest was recorded as an equity transaction with no gain or loss recognized. Additionally, as a wholly owned subsidiary of the Company, GRLP is no longer considered a VIE for reporting purposes.

Prior to the Company’s acquisition of the remaining ownership of GRLP in the first quarter of 2014, GRLP’s assets could only be used to settle its own obligations and not other obligations of the Company and GRLP’s creditors had no recourse to the general credit of the Company. At December 31, 2013, $0.7 million of noncontrolling interest in the accompanying unaudited condensed consolidated balance sheet was related to GRLP. GRLP’s assets and liabilities, after considering the effects of intercompany eliminations, included in the accompanying unaudited condensed consolidated balance sheet at December 31, 2013 consisted of the following (in thousands):
 
December 31,
2013
Cash and cash equivalents
$
132

Accounts receivable, net
16

Prepaid expenses
32

Other current assets
109

Total current assets
289

Other property, plant and equipment, net
1,163

Total assets
$
1,452

 
 
Accounts payable and accrued expenses
$
129

Total liabilities
$
129


     

18

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


Grey Ranch Plant Genpar, LLC. As of December 31, 2013, the Company owned a 50% interest in Grey Ranch Plant Genpar, LLC (“Genpar”), the managing partner and 1% owner of GRLP. The Company served as Genpar’s administrative manager. Genpar’s ownership interest in GRLP was its only asset. As managing partner of GRLP, Genpar had the sole right to manage, control and conduct the business of GRLP. However, Genpar was restricted from making certain major decisions, including the decision to remove the Company as operator of the Plant. The rights afforded the Company under the Plant operating agreement and the restrictions on Genpar limited Genpar’s ability to make decisions on behalf of GRLP. Therefore, Genpar was considered a VIE. Although both the Company and Genpar’s other equity owner shared equally in Genpar’s economic losses and benefits and also had agreements that may be considered variable interests, the Company determined it was the primary beneficiary of Genpar due to (i) its ability, as administrative manager and operator of the Plant, to direct the activities of Genpar that most significantly impacted its economic performance and (ii) its obligation or right, as operator of the Plant, to absorb the losses of or receive benefits from Genpar that could potentially have been significant to Genpar. As the primary beneficiary, the Company consolidated Genpar’s activity. However, its sole asset, the investment in GRLP, was eliminated in consolidation. Genpar had no liabilities. In the first quarter of 2014, one of the Company’s wholly owned subsidiaries acquired from a third party the remaining 50% ownership interest of Genpar. Because the Company was the primary beneficiary and consolidated Genpar, the acquisition of additional ownership interest was recorded as an equity transaction with no gain or loss recognized. Additionally, as a wholly owned subsidiary of the Company, Genpar is no longer considered a VIE for reporting purposes.    

Piñon Gathering Company, LLC. The Company has a gas gathering and operations and maintenance agreement with Piñon Gathering Company, LLC (“PGC”) through June 30, 2029. Under the gas gathering agreement, the Company is required to compensate PGC for any throughput shortfalls below a required minimum volume. By guaranteeing a minimum throughput, the Company absorbs the risk that lower than projected volumes will be gathered by the gathering system. Therefore, PGC is a VIE. Other than as required under the gas gathering and operations and maintenance agreements, the Company has not provided any support to PGC. While the Company operates the assets of PGC as directed under the operations and management agreement, the member and managers of PGC have the authority to directly control PGC and make substantive decisions regarding PGC’s activities including terminating the Company as operator without cause. Because the Company does not have the ability to control the activities of PGC that most significantly impact PGC’s economic performance, the Company is not the primary beneficiary of PGC and does not consolidate the results of PGC’s activities into its financial statements.

Amounts due from and due to PGC as of September 30, 2014 and December 31, 2013 included in the accompanying unaudited condensed consolidated balance sheets are as follows (in thousands):
 
September 30,
2014
 
December 31,
2013
Accounts receivable due from PGC
$
1,089

 
$
741

Accounts payable due to PGC
$
4,006

 
$
3,634



5. Fair Value Measurements

The Company measures and reports certain assets and liabilities on a fair value basis and has classified and disclosed its fair value measurements using the following levels of the fair value hierarchy:
Level 1
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
 
 
Level 2
Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability.
 
 
Level 3
Measurement based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable for objective sources (i.e., supported by little or no market activity).

Assets and liabilities that are measured at fair value are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, which may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels. The determination of the fair values, stated below, considers the market for the Company’s financial assets and liabilities, the associated credit risk and other factors. The Company considers active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis. The

19

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


Company has assets and liabilities classified as Level 1, Level 2 and Level 3 as of September 30, 2014 or December 31, 2013, as described below.

Level 1 Fair Value Measurements

Restricted deposits. The fair value of restricted deposits invested in mutual funds or municipal bonds is based on quoted market prices. For restricted deposits held in savings accounts, carrying value approximates fair value. Restricted deposits are included in other assets in the accompanying unaudited condensed consolidated balance sheet at December 31, 2013. There were no restricted deposits outstanding at September 30, 2014.

Investments. The fair value of investments, consisting of assets attributable to the Company’s non-qualified deferred compensation plan, is based on quoted market prices. Investments are included in other assets in the accompanying unaudited condensed consolidated balance sheets.

Level 2 Fair Value Measurements

Derivative contracts. The fair values of the Company’s oil and natural gas fixed price swaps and collars are based upon inputs that are either readily available in the public market, such as oil and natural gas futures prices, volatility factors and discount rates, or can be corroborated from active markets. Fair value is determined through the use of a discounted cash flow model or option pricing model using the applicable inputs, discussed above. The Company applies a weighted average credit default risk rating factor for its counterparties or gives effect to its credit default risk rating, as applicable, in determining the fair value of these derivative contracts. Credit default risk ratings are based on current published credit default swap rates.

Level 3 Fair Value Measurements

Guarantees. As discussed in Note 3, the Company has guaranteed on Fieldwood’s behalf certain plugging and abandonment obligations associated with the Gulf Properties. The fair value of these guarantees is based on the present value of estimated future payments for plugging and abandonment obligations associated with the Gulf Properties, adjusted for the cumulative probability of Fieldwood’s default prior to expiration of the guarantee by February 25, 2015 (3.71% at September 30, 2014). The discount and probability of default rates are based upon inputs that are readily available in the public market, such as historical option adjusted spreads of the Company’s senior notes, which are publicly traded, and historical default rates of publicly traded companies with credit ratings similar to Fieldwood. The significant unobservable input used in the fair value measurement of the guarantees is the estimate of future payments for plugging and abandonment, which was developed based upon third-party quotes and current actual costs. Significant increases (decreases) in the estimate of these payments could result in a significantly higher (lower) fair value measurement. The significant unobservable input used in the fair value measurement of the Company’s financial guarantee liability at September 30, 2014 is included in the table below (in thousands).

Unobservable Input
 
 
Estimated future payments for plugging and abandonment
 
$
426,661


Derivative contracts. The fair value of the Company’s oil basis swaps outstanding during the nine-month period ended September 30, 2013 was based upon quotes obtained from counterparties to the derivative contracts. These values were reviewed internally for reasonableness through the use of a discounted cash flow model using non-exchange traded regional pricing information. Additionally, the Company applied a weighted average credit default risk rating factor for its counterparties or gave effect to its credit risk, as applicable, in determining the fair value of these derivative contracts. The significant unobservable input used in the fair value measurement of the Company’s oil basis swaps was the estimate of future oil basis differentials. Significant increases (decreases) in oil basis differentials could have resulted in a significantly higher (lower) fair value measurement. All of the oil basis swaps outstanding during 2013 contractually matured during the nine-month period ended September 30, 2013.


20

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


The following tables summarize the Company’s assets and liabilities measured at fair value on a recurring basis by the fair value hierarchy (in thousands):

September 30, 2014
 
Fair Value Measurements
 
Netting(1)
 
Assets/Liabilities at Fair Value
 
Level 1
 
Level 2
 
Level 3
 
 
Assets
 
 
 
 
 
 
 
 
 
Commodity derivative contracts
$

 
$
69,810

 
$

 
$

 
$
69,810

Investments
10,389

 

 

 

 
10,389

 
$
10,389

 
$
69,810

 
$

 
$

 
$
80,199

Liabilities
 
 
 
 
 
 
 
 
 
Guarantees
$

 
$

 
$
10,430

 
$

 
$
10,430

Commodity derivative contracts

 

 

 

 

 
$

 
$

 
$
10,430

 
$

 
$
10,430


December 31, 2013
 
Fair Value Measurements
 
Netting(1)
 
Assets/Liabilities at Fair Value
 
Level 1
 
Level 2
 
Level 3
 
 
Assets
 
 
 
 
 
 
 
 
 
Restricted deposits
$
27,955

 
$

 
$

 
$

 
$
27,955

Commodity derivative contracts

 
50,274

 

 
(23,369
)
 
26,905

Investments
13,708

 

 

 

 
13,708

 
$
41,663

 
$
50,274

 
$

 
$
(23,369
)
 
$
68,568

Liabilities
 
 
 
 
 
 
 
 
 
Commodity derivative contracts
$

 
$
78,200

 
$

 
$
(23,369
)
 
$
54,831

 
$

 
$
78,200

 
$

 
$
(23,369
)
 
$
54,831

____________________
(1)Represents the effect of netting assets and liabilities for counterparties with which the right of offset exists.

The table below sets forth a reconciliation of the Company’s Level 3 fair value measurements for guarantees during the three and nine-month periods ended September 30, 2014 (in thousands): 
Level 3 Fair Value Measurements - Guarantees
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
Beginning balance
 
$
12,028

 
$

Issuances(1)
 

 
9,446

(Gain) loss on guarantees
 
(1,598
)
 
984

Ending balance
 
$
10,430

 
$
10,430

____________________
(1)
Represents the fair value of the guarantees of certain plugging and abandonment obligations on behalf of Fieldwood as of February 25, 2014, the closing date for the sale of the Gulf Properties.

The fair value of the guarantees is determined quarterly with changes in fair value recorded as an adjustment to the full cost pool. See Note 3 for discussion of the sale of the Gulf Properties. The fair value of the guarantees as of September 30, 2014 is included in other current liabilities in the accompanying unaudited condensed consolidated balance sheet.



21

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


The table below sets forth a reconciliation of the Company’s Level 3 fair value measurements for commodity derivative contracts during the nine-month period ended September 30, 2013 (in thousands): 
Level 3 Fair Value Measurements - Commodity Derivative Contracts
 
Nine Months Ended September 30, 2013
Beginning balance
 
$
(512
)
Loss on derivative contracts
 
(133
)
Settlements paid
 
645

Ending balance
 
$


There were no outstanding Level 3 commodity derivative contracts at September 30, 2014 or 2013.

See Note 10 for further discussion of the Company’s derivative contracts.

The Company recognizes transfers between fair value hierarchy levels as of the end of the reporting period in which the event or change in circumstances causing the transfer occurred. During the three and nine-month periods ended September 30, 2014 and 2013, the Company did not have any transfers between Level 1, Level 2 or Level 3 fair value measurements.

Fair Value of Financial Instruments

The Company measures the fair value of its senior notes using pricing for the senior notes that is readily available in the public market. The Company classifies these inputs as Level 2 in the fair value hierarchy. The estimated fair values and carrying values of the Company’s senior notes at September 30, 2014 and December 31, 2013 were as follows (in thousands):
 
September 30, 2014
 
December 31, 2013
 
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
8.75% Senior Notes due 2020(1)
$
454,500

 
$
445,232

 
$
486,000

 
$
444,736

7.5% Senior Notes due 2021(2)
1,130,938

 
1,178,598

 
1,230,813

 
1,178,922

8.125% Senior Notes due 2022
735,000

 
750,000

 
795,000

 
750,000

7.5% Senior Notes due 2023(3)
781,688

 
821,471

 
837,375

 
821,249

____________________
(1)
Carrying value is net of $4,768 and $5,264 discount at September 30, 2014 and December 31, 2013, respectively.
(2)
Carrying value includes a premium, applicable to notes issued in August 2012, of $3,598 and $3,922 at September 30, 2014 and December 31, 2013, respectively.
(3)
Carrying value is net of $3,529 and $3,751 discount at September 30, 2014 and December 31, 2013, respectively.

See Note 9 for discussion of the Company’s long-term debt.


22

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


6. Property, Plant and Equipment

Property, plant and equipment consists of the following (in thousands): 
 
September 30,
2014
 
December 31,
2013
Oil and natural gas properties
 
 
 
Proved(1)
$
11,252,074

 
$
10,972,816

Unproved
300,224

 
531,606

Total oil and natural gas properties
11,552,298

 
11,504,422

Less accumulated depreciation, depletion and impairment
(6,250,457
)
 
(5,762,969
)
Net oil and natural gas properties capitalized costs
5,301,841

 
5,741,453

Land
16,300

 
18,423

Non-oil and natural gas equipment(2)
631,781

 
600,603

Buildings and structures(3)
255,469

 
233,405

Total
903,550

 
852,431

Less accumulated depreciation and amortization
(324,686
)
 
(286,209
)
Other property, plant and equipment, net
578,864

 
566,222

Total property, plant and equipment, net
$
5,880,705

 
$
6,307,675

____________________
(1)
Includes cumulative capitalized interest of approximately $33.9 million and $23.4 million at September 30, 2014 and December 31, 2013, respectively.
(2)
Includes cumulative capitalized interest of approximately $4.3 million at both September 30, 2014 and December 31, 2013.
(3)
Includes cumulative capitalized interest of approximately $15.8 million and $12.0 million at September 30, 2014 and December 31, 2013, respectively.

Accumulated depreciation, depletion and impairment on oil and natural gas properties includes cumulative full cost ceiling limitation impairment of $3.7 billion and $3.5 billion at September 30, 2014 and December 31, 2013, respectively. During the nine-month period ended September 30, 2014, the Company reduced the net carrying value of its oil and natural gas properties by $164.8 million as a result of its first quarter full cost ceiling analysis.

Century Plant Construction Costs

Included in proved oil and natural gas properties is approximately $180.0 million of costs in excess of contracted and reimbursed amounts incurred by the Company during construction of the Century Plant in Pecos County, Texas pursuant to an agreement with Occidental. Due to the high-CO2 content of the Company’s reserves in the Piñon Field and the absence of adequate processing capacity in the Piñon Field area, construction of a large-scale processing facility, such as the Century Plant, was necessary for the development of the Company’s natural gas reserves in that area. The Company entered into the construction agreement and a related treating agreement with Occidental solely to facilitate the development of its reserves in the Piñon Field and greater West Texas Overthrust area and, accordingly, has recorded these unreimbursed costs as development costs within its full cost pool. See Note 12 for discussion of the related treating agreement.

Drilling Carry Commitments

The Company has agreements with two co-working interest parties, which contain carry commitments to fund a portion of its future drilling, completing and equipping costs within areas of mutual interest. The Company recorded approximately $205.6 million for Repsol E&P USA, Inc.’s (“Repsol”) carry during the nine-month period ended September 30, 2014, and a combined $334.2 million for both Atinum MidCon I, LLC’s (“Atinum”) and Repsol’s drilling carries during the nine-month periods ended September 30, 2013, which reduced the Company’s capital expenditures for the respective periods. Atinum fully funded its carry commitment in the third quarter of 2013, and the carry commitment from Repsol was fully utilized during the third quarter of 2014.


23

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


Under the agreement with Repsol, the carry commitment could have been reduced if a certain number of wells were not drilled within the area of mutual interest during a twelve-month period and the Company failed to drill such wells following a proposal by Repsol to drill the wells.  During 2013, the Company temporarily reduced its rate of drilling activity. As a result, the Company drilled less than the targeted number of wells for such twelve-month period, which resulted in Repsol having a right to propose additional wells. In the second quarter of 2014, the Company and Repsol amended their agreement to eliminate Repsol’s right to propose such additional wells in exchange for a commitment by the Company to drill 484 net wells in the area of mutual interest between January 1, 2014 and May 31, 2015, subject to delays due to factors beyond the Company’s control. If the Company does not drill the committed number of wells within such time period, it will be required to carry Repsol’s drilling, completing and equipping costs for subsequent wells drilled in the area of mutual interest, up to a maximum of $75.0 million in carry costs.  As of September 30, 2014, the Company has drilled 241 net wells under this arrangement and currently anticipates satisfying its drilling commitment within the required time period. The Company has no other drilling obligation to Repsol.
    

7. Other Assets

Other assets consist of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Debt issuance costs, net of amortization
$
54,878

 
$
61,923

Investments
10,389

 
13,708

Deferred tax asset
7,985

 

Restricted deposits(1)

 
27,955

Notes receivable on asset retirement obligations(1)

 
11,640

Other
3,816

 
5,945

Total other assets
$
77,068

 
$
121,171

____________________
(1)
Assets at December 31, 2013 were included in the sale of the Gulf Properties in February 2014, as discussed in Note 3.

8. Construction Contract

In the second quarter of 2013, the Company substantially completed the construction of a series of electrical transmission expansion and upgrade projects in northern Oklahoma for a third party. The Company constructed these projects for a contract price of $23.3 million, which included agreed upon change orders. Upon substantial completion of the contract, the Company recognized construction contract revenue and costs equal to the revised contract price of $23.3 million, which are included in the accompanying unaudited condensed consolidated statements of operations for the nine-month period ended September 30, 2013.

9. Long-Term Debt

Long-term debt consists of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Senior credit facility
$

 
$

Senior notes
 
 
 
 8.75% Senior Notes due 2020, net of $4,768 and $5,264 discount, respectively
445,232

 
444,736

 7.5% Senior Notes due 2021, including premium of $3,598 and $3,922, respectively
1,178,598

 
1,178,922

 8.125% Senior Notes due 2022
750,000

 
750,000

 7.5% Senior Notes due 2023, net of $3,529 and $3,751 discount, respectively
821,471

 
821,249

Total debt
3,195,301

 
3,194,907

Less: current maturities of long-term debt

 

Long-term debt
$
3,195,301

 
$
3,194,907



24

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


Senior Credit Facility

The senior secured revolving credit facility (the “senior credit facility”), which was amended and restated on October 22, 2014, is available to be drawn on subject to limitations based on its terms and certain financial covenants, as described below. As of September 30, 2014, the senior credit facility contained financial covenants, including maintenance of agreed upon levels for the (i) ratio of total funded net debt to EBITDA, which may not exceed 4.5:1.0 at each quarter end, calculated using the last four completed fiscal quarters and (ii) ratio of current assets to current liabilities, which must be at least 1.0:1.0 at each quarter end. If no amounts are drawn under the senior credit facility when calculating the ratio of total funded net debt to EBITDA, the Company’s debt is reduced by its cash balance in excess of $10.0 million. In the current ratio calculation, any amounts available to be drawn under the senior credit facility are included in current assets, and unrealized assets and liabilities resulting from mark-to-market adjustments on the Company’s derivative contracts are disregarded. The senior credit facility matures in October 2019.

The senior credit facility also contains various covenants that limit the ability of the Company and certain of its subsidiaries to: grant certain liens; make certain loans and investments; make distributions; redeem stock; redeem or prepay debt; merge or consolidate with or into a third party; or engage in certain asset dispositions, including a sale of all or substantially all of the Company’s assets. Additionally, the senior credit facility limits the ability of the Company and certain of its subsidiaries to incur additional indebtedness with certain exceptions. As of and during the three and nine-month periods ended September 30, 2014, the Company was in compliance with all applicable financial covenants under the senior credit facility.

The obligations under the senior credit facility are guaranteed by certain Company subsidiaries and are secured by first priority liens on all shares of capital stock of certain of the Company’s material present and future subsidiaries, certain intercompany debt of the Company, and substantially all of the Company’s assets, including proved oil, natural gas and NGL reserves representing at least 80.0% of the discounted present value (as defined in the senior credit facility) of proved oil, natural gas and NGL reserves considered by the lenders in determining the borrowing base for the senior credit facility.
    
At the Company’s election, interest under the senior credit facility is determined by reference to (a) the London Interbank Offered Rate (“LIBOR”) plus an applicable margin between 1.50% and 2.50% per annum or (b) the “base rate,” which is the highest of (i) the federal funds rate plus 0.5%, (ii) the prime rate published by Bank of America or (iii) the one-month Eurodollar rate (as defined in the senior credit facility) plus 1.00% per annum, plus, in each case under scenario (b), an applicable margin between 0.50% and 1.50% per annum. Interest is payable quarterly for base rate loans and at the end of the applicable interest period for LIBOR loans, except that if the interest period for a LIBOR loan is six months or longer, interest is paid at the end of each three-month period. Quarterly, the Company pays commitment fees assessed at annual rates ranging from 0.375% to 0.5% on any available portion of the senior credit facility.

Borrowings under the senior credit facility may not exceed the lower of the borrowing base or the committed amount. In October 2014, in connection with the amendment and restatement of the senior credit facility, the Company’s borrowing base was increased to $1.2 billion (previously $775.0 million). Under the amended and restated agreement, the availability of the borrowing base initially will be limited to a facility amount of $900.0 million.  Upon delivery by the Company of a written request and the payment of additional up-front fees to the lenders, the facility amount may be increased up to the full borrowing base. The next redetermination is expected to take place in April 2015. With respect to each redetermination, the administrative agent and the lenders under the senior credit facility consider several factors, including the Company’s proved reserves and projected cash requirements, and make assumptions regarding, among other things, oil and natural gas prices and production. Because the value of the Company’s proved reserves is a key factor in determining the amount of the borrowing base, changing commodity prices and the Company’s success in developing reserves may affect the borrowing base. The Company at times incurs additional costs related to the senior credit facility as a result of amendments to the credit agreement and changes to the borrowing base.

At September 30, 2014, the Company had no amount outstanding under the senior credit facility and $10.4 million in outstanding letters of credit, which reduce the availability under the senior credit facility on a dollar-for-dollar basis.


25

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


On November 14, 2014, the Company and its lenders amended the credit agreement to waive certain defaults that may have arisen as a result of the application of any new accounting treatment to the under delivery penalty described in Note 2 and extend the period for delivering the unaudited condensed consolidated financial statements for the period ended September 30, 2014.

Senior Notes

The Company’s unsecured senior fixed rate notes (“Senior Notes”) bear interest at a fixed rate per annum, payable semi-annually, with the principal due upon maturity. Certain of the Senior Notes were issued at a discount or a premium. The discount or premium is amortized to interest expense over the term of the respective series of Senior Notes. The Senior Notes are redeemable, in whole or in part, prior to their maturity at specified redemption prices and are jointly and severally guaranteed unconditionally, in full, on an unsecured basis by certain of the Company’s wholly owned subsidiaries. See Note 19 for condensed financial information of the subsidiary guarantors.

Debt issuance costs of $70.2 million incurred in connection with the offerings and subsequent registered exchange offers of the Senior Notes outstanding at September 30, 2014 are included in other assets in the accompanying unaudited condensed consolidated balance sheets and are being amortized to interest expense over the term of the respective series of Senior Notes.

2013 Activity. In March 2013, the Company redeemed the outstanding $365.5 million aggregate principal amount of its 9.875% Senior Notes due 2016 and $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 expense incurred to write off the remaining associated unamortized debt issuance costs, totaling $82.0 million, were recorded as a loss on extinguishment of debt in the accompanying unaudited condensed consolidated statement of operations for the nine-month period ended September 30, 2013.    

Indentures. Each of the indentures governing the Company’s Senior Notes contains covenants that restrict the Company’s ability to take a variety of actions, including limitations on the incurrence of indebtedness, payment of dividends, investments, asset sales, certain asset purchases, transactions with related parties and consolidations or mergers. As of and during the three and nine-month periods ended September 30, 2014, the Company was in compliance with all of the covenants contained in the indentures governing its outstanding Senior Notes.


26

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


10. Derivatives

The Company has not designated any of its derivative contracts as hedges for accounting purposes. The Company records all derivative contracts at fair value. Changes in derivative contract fair values are recognized in earnings. Cash settlements and valuation gains and losses are included in loss on derivative contracts for commodity derivative contracts and in interest expense for interest rate swaps in the consolidated statements of operations. Commodity derivative contracts are settled on a monthly or quarterly basis. Derivative assets and liabilities arising from the Company’s derivative contracts with the same counterparty that provide for net settlement are reported on a net basis in the consolidated balance sheets.

Commodity Derivatives. The Company is exposed to commodity price risk, which impacts the predictability of its cash flows from the sale of oil and natural gas. The Company seeks to manage this risk through the use of commodity derivative contracts. These derivative contracts allow the Company to limit its exposure to commodity price volatility on a portion of its forecasted oil and natural gas sales. None of the Company’s derivative contracts may be terminated prior to contractual maturity solely as a result of a downgrade in the credit rating of a party to the contract. At September 30, 2014, the Company’s commodity derivative contracts consisted of fixed price swaps and collars, which are described below:
Fixed price swaps
The Company receives a fixed price for the contract and pays a floating market price to the counterparty over a specified period for a contracted volume.
 
 
Collars
Two-way collars contain a fixed floor price (put) and a fixed ceiling price (call). If the market price exceeds the call strike price or falls below the put strike price, the Company receives the fixed price and pays the market price. If the market price is between the call and the put strike price, no payments are due from either party.
 
Three-way collars have two fixed floor prices (a purchased put and a sold put) and a fixed ceiling price (call). The purchased put establishes a minimum price unless the market price falls below the sold put, at which point the minimum price would be New York Mercantile Exchange (“NYMEX”) plus the difference between the purchased put and the sold put strike price. The call establishes a maximum price (ceiling) the Company will receive for the volumes under the contract. If the market price is between the ceiling price and purchased put, no payments are due from either party.
        
Interest Rate Swaps. The Company is exposed to interest rate risk on its long-term fixed rate debt and will be exposed to variable interest rates if it draws on its senior credit facility. Fixed rate debt, where the interest rate is fixed over the life of the instrument, exposes the Company to (i) changes in market interest rates reflected in the fair value of the debt and (ii) the risk that the Company may need to refinance maturing debt with new debt at a higher rate. Variable rate debt, where the interest rate fluctuates, exposes the Company to short-term changes in market interest rates as the Company’s interest obligations on these instruments are periodically redetermined based on prevailing market interest rates, primarily LIBOR and the federal funds rate.

Prior to its maturity on April 1, 2013, the Company had a $350.0 million notional interest rate swap agreement which effectively fixed the variable interest rate on the Senior Floating Rate Notes due 2014 (“Senior Floating Rate Notes”) at an annual rate of 6.69% for periods prior to their repurchase and redemption in the third quarter of 2012. The interest rate swap was not designated as a hedge.

Derivatives Agreements with Royalty Trusts. The Company is party to derivatives agreements with the Mississippian Trust I, Permian Trust and Mississippian Trust II, respectively, that provide each Royalty Trust with the economic effect of certain oil and natural gas derivative contracts entered into by the Company with third parties. The underlying commodity derivative contracts cover volumes of oil and natural gas production through December 31, 2015, March 31, 2015 and December 31, 2014 for the Mississippian Trust I, Permian Trust and Mississippian Trust II, respectively. Under these arrangements, the Company pays the Royalty Trusts amounts it receives from its counterparties in accordance with the underlying contracts, and the Royalty Trusts pay the Company any amounts that the Company is required to pay its counterparties under such contracts.

In accordance with the terms of the respective derivatives agreements, the Company has novated certain of the derivative contracts underlying the derivatives agreements to each of the Permian Trust and the Mississippian Trust II. As a party to these contracts, the Permian Trust and the Mississippian Trust II receive payment directly from the counterparty and pay any amounts owed directly to the counterparty. To secure its obligations under the respective derivative contracts novated to it, each of the Permian Trust and the Mississippian Trust II granted the counterparties liens on the royalty interests held by each respective Royalty Trust. Under the derivatives agreements, as additional development wells are drilled for the benefit of the Permian Trust and the

27

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


Mississippian Trust II, the Company has the right, under certain circumstances, to assign or novate additional derivative contracts to the Permian Trust and the Mississippian Trust II.

All contracts underlying the derivatives agreements with the Royalty Trusts, including those novated to the Permian Trust and the Mississippian Trust II, have been included in the Company’s consolidated derivative disclosures. See Note 4 for the Royalty Trusts’ open derivative contracts.

Fair Value of Derivatives. The following table presents the fair value of the Company’s derivative contracts as of September 30, 2014 and December 31, 2013 on a gross basis without regard to same-counterparty netting (in thousands):
Type of Contract
 
Balance Sheet Classification
 
September 30,
2014
 
December 31,
2013
Derivative assets
 
 
 
 
 
 
Oil price swaps
 
Derivative contracts-current
 
$
29,676

 
$
15,887

Natural gas price swaps
 
Derivative contracts-current
 
8,178

 
1,598

Oil collars - three way
 
Derivative contracts-current
 
15,768

 
706

Natural gas collars
 
Derivative contracts-current
 
297

 
177

Oil price swaps
 
Derivative contracts-noncurrent
 
7,405

 
19,376

Natural gas price swaps
 
Derivative contracts-noncurrent
 
311

 

     Oil collars - three way
 
Derivative contracts-noncurrent
 
8,072

 
12,189

Natural gas collars
 
Derivative contracts-noncurrent
 
103

 
341

Derivative liabilities
 
 
 
 
 
 
Oil price swaps
 
Derivative contracts-current
 

 
(38,396
)
Natural gas price swaps
 
Derivative contracts-current
 

 
(1,460
)
Oil price swaps
 
Derivative contracts-noncurrent
 

 
(38,344
)
Total net derivative contracts
 
$
69,810

 
$
(27,926
)

See Note 5 for additional discussion of the fair value measurement of the Company’s derivative contracts.

28

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


Master Netting Agreements and the Right of Offset. The Company has master netting agreements with all of its derivative counterparties and has presented its derivative assets and liabilities with the same counterparty on a net basis in the consolidated balance sheets. As a result of the netting provisions, the Company's maximum amount of loss under derivative transactions due to credit risk is limited to the net amounts due from its counterparties. As of September 30, 2014, the counterparties to the Company’s open derivative contracts consisted of 9 financial institutions, all of which are also lenders under the Company’s senior credit facility. The Company is not required to post additional collateral under its derivative contracts as the majority of the counterparties to the Company’s derivative contracts share in the collateral supporting the Company’s senior credit facility. To secure their obligations under the derivative contracts novated by the Company, the Permian Trust and the Mississippian Trust II have each given the counterparties to such contracts a lien on its royalty interests. The following tables summarize (i) the Company's derivative contracts on a gross basis, (ii) the effects of netting assets and liabilities for which the right of offset exists based on master netting arrangements and (iii) for the Company’s net derivative liability positions, the applicable portion of shared collateral under the senior credit facility (for SandRidge's derivative contracts) and under liens granted on royalty interests (for the Permian Trust’s and the Mississippian Trust II’s novated derivative contracts) (in thousands):

September 30, 2014
 
 
Gross Amounts
 
Gross Amounts Offset
 
Amounts Net of Offset
 
Financial Collateral
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
Derivative contracts - current
 
$
53,919

 
$

 
$
53,919

 
$

 
$
53,919

Derivative contracts - noncurrent
 
15,891

 

 
15,891

 

 
15,891

Total
 
$
69,810

 
$

 
$
69,810

 
$

 
$
69,810

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Derivative contracts - current
 
$

 
$

 
$

 
$

 
$

Derivative contracts - noncurrent
 

 

 

 

 

Total
 
$

 
$

 
$

 
$

 
$


December 31, 2013
 
 
Gross Amounts
 
Gross Amounts Offset
 
Amounts Net of Offset
 
Financial Collateral
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
Derivative contracts - current
 
$
18,368

 
$
(5,589
)
 
$
12,779

 
$

 
$
12,779

Derivative contracts - noncurrent
 
31,906

 
(17,780
)
 
14,126

 

 
14,126

Total
 
$
50,274

 
$
(23,369
)
 
$
26,905

 
$

 
$
26,905

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Derivative contracts - current
 
$
39,856

 
$
(5,589
)
 
$
34,267

 
$
(34,267
)
 
$

Derivative contracts - noncurrent
 
38,344

 
(17,780
)
 
20,564

 
(20,564
)
 

Total
 
$
78,200

 
$
(23,369
)
 
$
54,831

 
$
(54,831
)
 
$


The Company recorded a (gain) loss on commodity derivative contracts of $(132.6) million and $132.8 million for the three-month periods ended September 30, 2014 and 2013, respectively, as reflected in the accompanying unaudited condensed consolidated statements of operations, which includes net cash (receipts) payments upon settlement of $(3.4) million and $12.5 million, respectively. The Company recorded a (gain) loss on commodity derivative contracts of $(4.8) million and $70.1 million for the nine-month periods ended September 30, 2014, and 2013, respectively, which includes net cash payments upon settlement of $92.9 million and $12.8 million, respectively. Included in these net cash payments are $69.6 million and $29.3 million of cash payments related to settlements of commodity derivative contracts with contractual maturities after the period in which they were settled (“early settlements”) primarily as a result of the sale of the Gulf Properties in February 2014 and the Permian Properties in February 2013, respectively.

29

SANDRIDGE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Unaudited)


At September 30, 2014, the Company’s open commodity derivative contracts consisted of the following:

Oil Price Swaps 
 
Notional (MBbls)
 
Weighted Average
Fixed Price
October 2014 - December 2014
1,115

 
$
98.78

January 2015 - December 2015
5,588

 
$
92.44

January 2016 - December 2016
1,464

 
$
88.36


Natural Gas Price Swaps 
 
Notional (MMcf)
 
Weighted Average
Fixed Price
October 2014 - December 2014
11,040

 
$
4.31

January 2015 - December 2015
15,400

 
$
4.51


Oil Collars - Three-way
 
Notional (MBbls)
 
Sold Put
Purchased Put
Sold Call
October 2014 - December 2014
2,070

 
$70.00
$90.20
$100.00
January 2015 - December 2015
4,576

 
$76.56
$90.28
$103.48
January 2016 - December 2016
2,556

 
$83.13
$90.00
$100.85

Natural Gas Collars
 
Notional (MMcf)
 
Collar Range
October 2014 - December 2014
236

 
$4.00
$7.78
January 2015 - December 2015
1,010

 
$4.00
$8.55

11. Asset Retirement Obligations

A reconciliation of the beginning and ending aggregate carrying amounts of the asset retirement obligations for the period from December 31, 2013 to September 30, 2014 is as follows (in thousands):

Asset retirement obligations at December 31, 2013
$
424,117

Liability incurred upon acquiring and drilling wells