The drilling contracts we compete for are usually awarded on the basis of competitive bids. Our principal competitors are Nabors Industries, Inc., Patterson-UTI Energy, Inc., Unit Corp., Union Drilling, Inc., Pioneer Drilling Company and Helmerich & Payne, Inc. There are numerous smaller companies that compete in our service markets as well. We believe pricing and rig availability are the primary factors our potential customers consider in determining which drilling contractor to select. In addition, we believe the following factors are also important:
We derive all our revenues from companies in the oil and natural gas exploration and production industry, a historically cyclical industry with levels of activity that are significantly affected by the levels and volatility of oil and natural gas prices.
Global economic conditions may adversely affect our operating results.
| | | | | | | | | | | | | |
| | | Natural Gas Price | | | | | | | |
| | | per Mcf | | | Oil Price per Bbl | |
| Quarter | | High | | | Low | | | High | | | Low | |
| 2010: | | | | | | | | | | | | |
| First (through March 1, 2010) | | $ | 6.01 | | | $ | 4.68 | | | $ | 83.18 | | | $ | 71.19 | |
| 2009: | | | | | | | | | | | | | | | | |
| Fourth | | $ | 5.99 | | | $ | 4.25 | | | $ | 81.37 | | | $ | 69.57 | |
| Third | | $ | 4.88 | | | $ | 2.51 | | | $ | 74.37 | | | $ | 59.52 | |
| Second | | $ | 4.45 | | | $ | 3.25 | | | $ | 72.68 | | | $ | 45.88 | |
| First | | $ | 6.07 | | | $ | 3.63 | | | $ | 54.34 | | | $ | 33.98 | |
| 2008: | | | | | | | | | | | | | | | | |
| Fourth | | $ | 7.73 | | | $ | 5.29 | | | $ | 98.53 | | | $ | 33.87 | |
| Third | | $ | 13.58 | | | $ | 7.22 | | | $ | 145.29 | | | $ | 95.71 | |
| Second | | $ | 13.35 | | | $ | 9.32 | | | $ | 140.21 | | | $ | 100.98 | |
| First | | $ | 10.23 | | | $ | 7.62 | | | $ | 110.33 | | | $ | 86.99 | |
Our acquisition strategy exposes us to various risks, including those relating to difficulties in identifying suitable acquisition opportunities and integrating businesses, assets and personnel, as well as difficulties in obtaining financing for targeted acquisitions and the potential for increased leverage or debt service requirements.
As a component of our business strategy, we have pursued and intend to continue to pursue selected acquisitions of complementary assets and businesses. In May 2002, we purchased seven drilling rigs, associated spare parts and equipment, drill pipe, haul trucks and vehicles. In August 2003, we acquired drilling rigs and inventoried structures and components which, with refurbishment and upgrades, could be used to assemble 22 drilling rigs. In July 2005, we acquired three additional rigs and related inventory, equipment, components and a rig yard. On October 3, 2005, we acquired five operating rigs, seven inventoried rigs and rig equipment and parts. On October 14, 2005, we acquired nine operating rigs, two rigs undergoing refurbishment, two inventoried rigs and rig equipment and parts. On January 18, 2006, we acquired six operating land drilling rigs and certain other assets, including heavy haul trucks and excess rig equipment. On January 9, 2007, we acquired 31 workover rigs through our acquisition of Eagle Well. Acquisitions, including those described above, involve numerous risks, including:
| • | unanticipated costs and assumption of liabilities and exposure to unforeseen liabilities of acquired companies, including but not limited to environmental liabilities; |
| • | difficulty in integrating the operations and assets of the acquired business and the acquired personnel and distinct cultures; |
| • | our ability to properly access and maintain an effective internal control environment over an acquired company, in order to comply with public reporting requirements; |
| • | potential loss of key employees and customers of the acquired companies; |
| • | risk of entering markets in which we have limited prior experience; and |
| • | an increase in our expenses and working capital requirements. |
The process of integrating an acquired business may involve unforeseen costs and delays or other operational, technical and financial difficulties and may require a disproportionate amount of management attention and financial and other resources. Our failure to achieve consolidation savings, to incorporate the acquired businesses and assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have a material adverse effect on our financial condition and results of operations.
In addition, we may not have sufficient capital resources to complete additional acquisitions. Historically, we have funded the acquisition of rigs and the refurbishment of our rig fleet through a combination of debt and equity financing and cash flows from operations. We may incur substantial additional indebtedness to finance future acquisitions and also may issue equity, debt or convertible securities in connection with such acquisitions. Debt service requirements could represent a significant burden on our results of operations and financial condition and the issuance of additional equity or convertible securities could be dilutive to our existing stockholders. Furthermore, we may not be able to obtain additional financing on satisfactory terms. Even if we have access to the necessary capital, we may be unable to continue to identify additional suitable acquisition opportunities, negotiate acceptable terms or successfully acquire identified targets.
Increases in the supply of rigs could decrease revenue rates and utilization rates.
An increase in the supply of land drilling and workover rigs, whether through new construction or refurbishment, could decrease revenue rates and utilization rates, which would adversely affect our revenues and profitability. In addition, such adverse affect on our revenue and profitability caused by such increased competition and lower revenue rates and utilization rates could be further aggravated by any downturn in oil and natural gas prices. There has been a substantial increase in the supply of land drilling and workover rigs in the United States over the past five years which has contributed to a broad decline in revenue rates and utilization industry wide.
Our indebtedness could restrict our operations and make us more vulnerable to adverse economic conditions.
As of December 31, 2009, our total debt was approximately $56.4 million and we had the ability to incur an additional $8.5 million of debt under our revolving credit facility (net of outstanding letters of credit of $11.5 million).
Our current and future indebtedness could have important consequences, including:
| • | impairing our ability to make investments and obtain additional financing for working capital, capital expenditures, acquisitions or other general corporate purposes; |
| • | limiting our ability to use operating cash flow in other areas of our business because we must dedicate a substantial portion of these funds to make principal and interest payments on our indebtedness; |
| • | making us more vulnerable to a downturn in our business, our industry or the economy in general as a substantial portion of our operating cash flow could be required to make principal and interest payments on our indebtedness, making it more difficult to react to changes in our business and in industry and market conditions; |
| • | limiting our ability to obtain additional financing that may be necessary to operate or expand our business; |
| • | putting us at a competitive disadvantage to competitors that have less debt; and |
| • | increasing our vulnerability to rising interest rates. |
We anticipate that our cash generated by operations and our ability to borrow under the currently unused portion of our revolving credit facility should allow us to meet our routine financial obligations for the foreseeable future. However, our ability to make payments on our indebtedness, and to fund planned capital expenditures, will depend on our ability to generate cash in the future. This, to a certain extent, is subject to conditions in the oil and gas industry, general economic and financial conditions, competition in the markets where we operate, the impact of legislative and regulatory actions on how we conduct our business and other factors, all of which are beyond our control. If our business does not generate sufficient cash flow from operations to service our outstanding indebtedness, we may have to undertake alternative financing plans, such as:
| • | refinancing or restructuring our debt; |
| • | reducing or delaying acquisitions or capital investments, such as refurbishments of our rigs and related equipment; or |
| • | seeking to raise additional capital. |
However, we may be unable to implement alternative financing plans, if necessary, on commercially reasonable terms or at all, and any such alternative financing plans might be insufficient to allow us to meet our debt obligations. If we are unable to generate sufficient cash flow or are otherwise unable to obtain the funds required to make principal and interest payments on our indebtedness, or if we otherwise fail to comply with the various covenants in our revolving credit facility or other instruments governing any future indebtedness, we could be in default under the terms of our revolving credit facility or such instruments. In the event of a default, the lender under our revolving credit facility, Banco Inbursa S.A. (“Banco Inbursa”), could elect to declare all the loans made under such facility to be due and payable together with accrued and unpaid interest and terminate its commitments thereunder and we or one or more of our subsidiaries could be forced into bankruptcy or liquidation. Any of the foregoing consequences could materially and adversely affect our business, financial condition, results of operations and prospects.
Our revolving credit facility imposes restrictions on us that may affect our ability to successfully operate our business.
Our revolving credit facility limits our ability to take various actions, such as:
| • | limitations on the incurrence of additional indebtedness; |
| • | restrictions on investments, mergers or consolidations, asset dispositions, acquisitions, transactions with affiliates and other transactions without the lender’s consent; and |
| • | limitation on dividends and distributions. |
In addition, our revolving credit facility requires us to maintain certain financial ratios and to satisfy certain financial conditions, which may require us to reduce our debt or take some other action in order to comply with them. The failure to comply with any of these financial conditions, such as financial ratios or covenants, would cause an event of default under our revolving credit facility. An event of default, if not waived, could result in acceleration of the outstanding indebtedness under our revolving credit facility, in which case the debt would become immediately due and payable. If this occurs, we may not be able to pay our debt or borrow sufficient funds to refinance it. Even if new financing is available, it may not be available on terms that are acceptable to us. These restrictions could also limit our ability to obtain future financings, make needed capital expenditures, withstand a downturn in our business or the economy in general, or otherwise conduct necessary corporate activities. We also may be prevented from taking advantage of business opportunities that arise because of the limitations imposed on us by the restrictive covenants under our revolving credit facility.
Our lender may not grant additional waivers under our revolving credit facility.
In February 2010, our lender agreed to waive our compliance with the total leverage ratio covenant contained in our revolving credit facility through the quarter ended June 30, 2010, and any default or event of default that may occur as a result of our non-compliance with this covenant through the quarter ended June 30, 2010. If we are unable to comply with this covenant after the waiver period, or any other covenant or restriction contained in our revolving credit facility, there can be no assurances that our lender will grant additional waivers on commercially reasonable terms, if at all.
Carlos Slim Helú, members of his family and affiliated entities may exercise significant influence in our affairs and their interests may differ from the interests of our other stockholders.
According to a Schedule 13D/A filed with the SEC by Carlos Slim Helú, certain members of his family and affiliated entities (the “Slim Affiliates”) on March 8, 2010, collectively these individuals and entities owned approximately 15% of our common stock. Additionally, CICSA (which is also a Slim Affiliate) holds a warrant to purchase up to 5,440,770 shares of our common stock (the “Warrant”) that we originally issued in connection with our revolving credit facility. The Warrant, if exercised by CICSA, would permit the Slim Affiliates to acquire up to 19.99% of our outstanding common stock. As a consequence of the significant ownership of our common stock held by the Slim Affiliates, collectively, they may exercise significant influence over the outcome of matters involving a vote of our stockholders, including the election of our directors, a merger or other business combination or a sale of a substantial amount of our assets.
Banco Inbursa is the lender under our revolving credit facility, and is currently our largest creditor. CICSA owns 60% of the equity of Bronco MX, which is a joint venture in Mexico in which we own the other 40%. Because of the contractual and business relationships we have with the Slim Affiliates, the interests of the Slim Affiliates may differ from the interests of our other stockholders, and the revolving credit facility, the joint venture documentation relating to Bronco MX and the Warrant contain provisions that may tend to increase the influence the Slim Affiliates may exercise in our affairs.
For instance, the joint venture represents a significant investment by us that will be controlled by the Slim Affiliates, who, among other things, will be able to influence the amount and timing of any distributions of cash or property by Bronco MX to its equity holders, including us. Our revolving credit facility contains a variety of customary affirmative and negative covenants that limit our ability to engage in certain actions unless we obtain a waiver or consent from Banco Inbursa. If we are unable to satisfy our obligations to make mandatory payments of principal and/or interest under our revolving credit facility our failure to do so could lead to an event of default under the revolving credit facility, which would permit Banco Inbursa to exercise various contractual remedies under the revolving credit facility, including accelerating the maturity of our obligations and foreclosing upon our assets securing the revolving credit facility. The Warrant includes a covenant that restricts our ability to issue shares of common stock (or rights or warrants or other securities exercisable or convertible into or exchangeable for shares of common stock) at a consideration per share that is less than 95% of the market price of our common stock, subject to certain exceptions. If it became necessary for us to raise capital and we were unable to sell shares of common stock in a manner that complied with the Warrant, we would be required to obtain a waiver of this requirement or risk liability for breach of contract. If we were unable to obtain a waiver, it could have a material adverse affect on our business, financial condition and results of operation.
Our investments in Challenger and Bronco MX are illiquid and may never generate cash.
There currently is no readily available market that would facilitate the disposal of our 25% equity investment in Challenger or our 40% equity investment in Bronco MX. Furthermore, based on these minority equity positions, we may not directly receive cash proceeds resulting from the operations of Challenger or Bronco MX. We cannot assure that the investments will ever yield cash proceeds, absent a liquidating event or the increase in our equity position above a threshold that would constitute control.
Our minority equity investment in Challenger and Bronco MX limits our control of those companies.
Bronco representatives hold two of the eight total board seats on the Challenger board of directors and two of the five total board seats on the Bronco MX board of managers. We also have various rights as a shareholder of these companies, including:
Bronco is one of three shareholder groups in Challenger. Any two of the three shareholders can effectuate decisions at the board level. Due to our minority equity interest in Challenger, we cannot accomplish specific objectives or initiatives if we are unable to align our interest with at least one of the remaining shareholders. Bronco is one of two shareholder groups in Bronco MX. Due to our minority equity interest in Bronco MX, we cannot accomplish specific objectives or initiatives if we are unable to align our interests with the other shareholder.
International operations are subject to uncertain political, economic and other risks which could affect our financial results.
We currently have a 40% investment in Bronco MX, a company organized under the laws of Mexico, and a 25% investment in Challenger, an Isle of Man company with its principal operations in Libya. Risks associated with international operations and Challenger and Bronco MX’s operations include:
| • | terrorist acts, war and civil disturbances; |
| • | expropriation or nationalization of assets; |
| • | renegotiation or nullification of existing contracts; |
| • | foreign taxation, including changes in law or interpretation of existing law; |
| • | assaults on property or personnel; |
| • | changing political conditions; |
| • | foreign and domestic monetary policies; and |
| • | travel limitations or operational problems caused by public health threats. |
As we expand our operations outside of the United States, we must comply with numerous laws and regulations relating to international business operations, including the Foreign Corrupt Practices Act, or FCPA. The creation and implementation of international business practices compliance programs is costly and such programs are difficult to enforce, particularly where reliance on third parties is required.
The FCPA prohibits any U.S. individual or business from paying, offering, or authorizing payment or offering of anything of value, directly or indirectly, to any foreign official, political party or candidate for the purpose of influencing any act or decision of the foreign entity in order to assist the individual or business in obtaining or retaining business. The FCPA also obligates companies whose securities are listed in the United States to comply with certain accounting provisions requiring the company to maintain books and records that accurately and fairly reflect all transactions of the corporation, including international subsidiaries, and to devise and maintain an adequate system of internal accounting controls for international operations. The anti-bribery provisions of the FCPA are enforced primarily by the U.S. Department of Justice. The SEC is involved with enforcement of the books and records provisions of the FCPA.
The failure to comply with laws governing international business practices may result in substantial penalties, including suspension or debarment from government contracting. Violation of the FCPA can result in significant civil and criminal penalties. A failure to satisfy any of our obligations under laws governing international business practices could have a negative impact on our operations and harm our reputation. The SEC also may suspend or bar issuers from trading securities on United States exchanges for violations of the FCPA’s accounting provisions.
We operate in a highly competitive, fragmented industry in which price competition could reduce our profitability.
The fact that drilling and workover rigs are mobile and can be moved from one market to another in response to market conditions heightens the competition in the industry.
The contracts we compete for are usually awarded on the basis of competitive bids or direct negotiations with customers. We believe pricing and quality of equipment are the primary factors our potential customers consider in determining which service provider to select. In addition, we believe the following factors are also important:
| • | the type and condition of each of the competing drilling and workover rigs; |
| • | the mobility and efficiency of the rigs; |
| • | the quality of service and experience of the rig crews; |
| • | the offering of ancillary services; and |
| • | the ability to provide drilling equipment adaptable to, and personnel familiar with, new technologies and drilling techniques. |
While we must be competitive in our pricing, our competitive strategy generally emphasizes the quality of our equipment and experience of our rig crews to differentiate us from our competitors. This strategy is less effective as lower demand for services or an oversupply of rigs usually results in increased price competition and makes it more difficult for us to compete on the basis of factors other than price. In all of the markets in which we compete, an oversupply of rigs can cause greater price competition which can, in turn, reduce our profitability.
Service companies compete primarily on a regional basis, and the intensity of competition may vary significantly from region to region at any particular time. If demand for our services improves in a region where we operate, our competitors might respond by moving in suitable rigs from other regions. An influx of rigs from other regions could rapidly intensify competition and reduce profitability.
We face competition from competitors with greater resources that may make it more difficult for us to compete, which can reduce our revenue rates and utilization rates.
Some of our competitors have greater financial, technical and other resources than we do that may make it more difficult for us to compete, which can reduce our revenue rates and utilization rates. Their greater capabilities in these areas may enable them to:
| • | better withstand industry downturns; |
| • | compete more effectively on the basis of price and technology; |
| • | retain skilled rig personnel; and |
| • | build new rigs or acquire and refurbish existing rigs so as to be able to place rigs into service more quickly than us in periods of high drilling demand. |
In the event we enter into footage or turnkey contracts, we could be subject to unexpected cost overruns, which could negatively impact our profitability.
For the years ended December 31, 2009, 2008 and 2007, less than 1% of our total revenues were derived from footage contracts. Under footage contracts, we are paid a fixed amount for each foot drilled, regardless of the time required or the problems encountered in drilling the well. We typically pay more of the out-of-pocket costs associated with footage contracts as compared to daywork contracts. The risks to us on a footage contract are greater because we assume most of the risks associated with drilling operations generally assumed by the operator in a daywork contract, including the risk of blowout, loss of hole, stuck drill pipe, machinery breakdowns, abnormal drilling conditions and risks associated with subcontractors’ services, supplies, cost escalation and personnel. The occurrence of uninsured or under-insured losses or operating cost overruns on our footage jobs could have a negative impact on our profitability. Similar to our footage contracts, under turnkey contacts drilling companies assume most of the risks associated with drilling operations that the operator generally assumes under a daywork contract. Although we historically have not entered into turnkey contracts, if we were to enter into a turnkey contract or acquire such a contract in connection with future acquisitions, the occurrence of uninsured or under-insured losses or operating cost overruns on such a job could negatively impact our profitability.
Our operations involve operating hazards, which if not insured or indemnified against, could adversely affect our results of operations and financial condition.
Our operations are subject to the many hazards inherent in the contract land drilling and well servicing business, including the risks of:
| • | collapse of the borehole; |
| • | lost or stuck drill strings; and |
| • | damage or loss from natural disasters. |
Any of these hazards can result in substantial liabilities or losses to us from, among other things:
| • | suspension of operations; |
| • | damage to, or destruction of, our property and equipment and that of others; |
| • | personal injury and loss of life; |
| • | damage to producing or potentially productive oil and natural gas formations through which we drill; and |
We seek to protect ourselves from some but not all operating hazards through insurance coverage. However, some risks are either not insurable or insurance is available only at rates that we consider uneconomical. Depending on competitive conditions and other factors, we attempt to obtain contractual protection against uninsured operating risks from our customers. However, customers who provide contractual indemnification protection may not in all cases maintain adequate insurance to support their indemnification obligations. Our insurance or indemnification arrangements may not adequately protect us against liability or loss from all the hazards of our operations. The occurrence of a significant event that we have not fully insured or indemnified against or the failure of a customer to meet its indemnification obligations to us could materially and adversely affect our results of operations and financial condition. Furthermore, we may be unable to maintain adequate insurance in the future at rates we consider reasonable.
We face increased exposure to operating difficulties because we primarily focus on drilling for natural gas.
A majority of our drilling contracts are with exploration and production companies in search of natural gas. Drilling on land for natural gas generally occurs at deeper drilling depths than drilling for oil. Although deep-depth drilling exposes us to risks similar to risks encountered in shallow-depth drilling, the magnitude of the risk for deep-depth drilling is greater because of the higher costs and greater complexities involved in drilling deep wells. We generally enter into International Association of Drilling Contractors contracts that contain “daywork” indemnification language that transfers responsibility for down hole exposures such as blowout and fire to the operator, leaving us responsible only for damage to our rig and our personnel. If we do not adequately insure the risk from blowouts or if our contractual indemnification rights are insufficient or unfulfilled, our profitability and other results of operation and our financial condition could be adversely affected in the event we encounter blowouts or other significant operating difficulties while drilling at deeper depths. If our primary focus shifts from drilling for customers in search of natural gas to drilling for customers in search of oil, a portion of our rig fleet could be disadvantaged in competing for new oil drilling projects as compared to competitors that primarily use shallower drilling depth rigs when drilling in search of oil.
Our operations are subject to various laws and governmental regulations that could restrict our future operations and increase our operating costs.
Many aspects of our operations are subject to various federal, state and local laws and governmental regulations, including laws and regulations governing:
| • | remediation of contamination; |
| • | preservation of natural resources; and |
Our operations are subject to stringent federal, state and local laws and regulations governing the protection of the environment and human health and safety. Several such laws and regulations relate to the disposal of hazardous oilfield waste and restrict the types, quantities and concentrations of such regulated substances that can be released into the environment. Several such laws also require removal and remedial action and other cleanup under certain circumstances, commonly regardless of fault. Planning, implementation and maintenance of protective measures are required to prevent accidental discharges. Spills of oil, natural gas liquids, drilling fluids and other substances may subject us to penalties and cleanup requirements. Handling, storage and disposal of both hazardous and non-hazardous wastes are also subject to these regulatory requirements. In addition, our operations are often conducted in or near ecologically sensitive areas, which are subject to special protective measures and that may expose us to additional operating costs and liabilities for accidental discharges of oil, natural gas, drilling fluids, contaminated water or other substances or for noncompliance with other aspects of applicable laws and regulations. Historically, we have not been required to obtain environmental or other permits prior to drilling a well. Instead, the operator of the oil and gas property has been obligated to obtain the necessary permits at its own expense.
The federal Clean Water Act, as amended by the Oil Pollution Act, the federal Clean Air Act, the federal Resource Conservation and Recovery Act, the federal Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, the Safe Drinking Water Act, the Occupational Safety and Health Act, or OSHA, and their state counterparts and similar statutes are the primary vehicles for imposition of such requirements and for civil, criminal and administrative penalties and other sanctions for violation of their requirements. The OSHA hazard communication standard, the Environmental Protection Agency “community right-to-know” regulations under Title III of the federal Superfund Amendment and Reauthorization Act and comparable state statutes require us to organize and report information about the hazardous materials we use in our operations to employees, state and local government authorities and local citizens. In addition, CERCLA, also known as the “Superfund” law, and similar state statutes impose strict liability, without regard to fault or the legality of the original conduct, on certain classes of persons who are considered responsible for the release or threatened release of hazardous substances into the environment. These persons include the current owner or operator of a facility where a release has occurred, the owner or operator of a facility at the time a release occurred, and companies that disposed of or arranged for the disposal of hazardous substances found at a particular site. This liability may be joint and several. Such liability, which may be imposed for the conduct of others and for conditions others have caused, includes the cost of removal and remedial action as well as damages to natural resources. Few defenses exist to the liability imposed by environmental laws and regulations. It is also not uncommon for third parties to file claims for personal injury and property damage caused by substances released into the environment.
Environmental laws and regulations are complex and subject to frequent changes. Failure to comply with governmental requirements or inadequate cooperation with governmental authorities could subject a responsible party to administrative, civil or criminal action. We may also be exposed to environmental or other liabilities originating from businesses and assets that we acquired from others. We are in substantial compliance with applicable environmental laws and regulations and, to date, such compliance has not materially affected our capital expenditures, earnings or competitive position. We do not expect to incur material capital expenditures in our next fiscal year in order to comply with current or reasonably anticipated environment control requirements. However, our compliance with amended, new or more stringent requirements, stricter interpretations of existing requirements or the future discovery of regulatory noncompliance or contamination may require us to make material expenditures or subject us to liabilities that we currently do not anticipate.
We are aware of the increasing focus of local, state, national and international regulatory bodies on GHG emissions and climate change issues. We are also aware of legislation proposed by United States lawmakers to reduce GHG emissions, as well as GHG emissions regulations enacted by the U.S. Environmental Protection Agency. We will continue to monitor and assess any new policies, legislation or regulations in the areas where we operate to determine the impact of GHG emissions and climate change on our operations and take appropriate actions, where necessary. Any direct and indirect costs of meeting these requirements may adversely affect our business, results of operations and financial condition.
In addition, our business depends on the demand for land drilling services from the oil and natural gas industry and, therefore, is affected by tax, environmental and other laws relating to the oil and natural gas industry generally, by changes in those laws and by changes in related administrative regulations. It is possible that these laws and regulations may in the future add significantly to our operating costs or those of our customers or otherwise directly or indirectly affect our operations.
We rely on a few key employees whose absence or loss could disrupt our operations resulting in a loss of revenues.
Many key responsibilities within our business have been assigned to a small number of employees. The loss of their services could disrupt our operations resulting in a loss of revenues. Although we have employment agreements with a small number of our employees, as a practical matter such employment agreements will not assure the retention of those employees. In addition, we do not maintain “key person” life insurance policies on any of our employees. As a result, we are not insured against any losses resulting from the death of our key employees.
We may be unable to attract and retain qualified, skilled employees necessary to operate our business.
Our success depends in large part on our ability to attract and retain skilled and qualified personnel. Our inability to hire, train and retain a sufficient number of qualified employees could impair our ability to manage and maintain our business. We require skilled employees who can perform physically demanding work. Shortages of qualified personnel can occur in our industry. As a result of the volatility of the oil and natural gas industry and the demanding nature of the work, potential employees may choose to pursue employment in fields that offer a more desirable work environment at wage rates that are competitive with ours. If we should suffer any material loss of personnel to competitors or be unable to employ additional or replacement personnel with the requisite level of training and experience to adequately operate our equipment, our operations could be materially and adversely affected. With a reduced pool of workers, it is possible that we will have to raise wage rates to attract workers from other fields and to retain our current employees. If we are not able to increase our service rates to our customers to compensate for wage-rate increases, our profitability and other results of operations may be adversely affected.
Shortages in equipment and supplies could limit our operations and jeopardize our relations with customers.
The materials and supplies we use in our operations include fuels to operate our drilling equipment, drilling mud, drill pipe, drill collars, drill bits and cement. Shortages in drilling equipment and supplies could limit our drilling operations and jeopardize our relations with customers. We do not rely on a single source of supply for any of these items. From time to time there have been shortages of drilling equipment and supplies during periods of high demand which we believe could reoccur. Shortages could result in increased prices for drilling equipment or supplies that we may be unable to pass on to customers. In addition, during periods of shortages, the delivery times for equipment and supplies can be substantially longer. Any significant delays in our obtaining drilling equipment or supplies could limit our operations and jeopardize our relations with customers. In addition, shortages of drilling equipment or supplies could delay and adversely affect our ability to obtain new contracts for our drilling rigs, which could negatively impact our revenues and profitability.
If the price of our common stock fluctuates significantly, your investment could lose value.
Prior to our initial public offering in August 2005, there had been no public market for our common stock. Although our common stock is now quoted on The Nasdaq Global Select Market, we cannot assure you that an active public market will continue to exist for our common stock or that our common stock will continue to trade in the public market at or above current prices. If an active public market for our common stock does not continue, the trading price and liquidity of our common stock will be materially and adversely affected. If there is a thin trading market or “float” for our stock, the market price for our common stock may fluctuate significantly more than the stock market as a whole. Without a large float, our common stock is less liquid than the stock of companies with broader public ownership and, as a result, the trading price of our common stock may be more volatile. In addition, in the absence of an active public trading market, investors may be unable to liquidate their investment in us. In addition, the stock market is subject to significant price and volume fluctuations, and the price of our common stock could fluctuate widely in response to several factors, including:
| • | our quarterly operating results; |
| • | changes in our earnings estimates; |
| • | additions or departures of key personnel; |
| • | changes in the business, earnings estimates or market perceptions of our competitors; |
| • | changes in general market or economic conditions; and |
| • | announcements of legislative or regulatory change. |
The stock market has experienced extreme price and volume fluctuations in recent years that have significantly affected the quoted prices of the securities of many companies, including companies in our industry. The changes often appear to occur without regard to specific operating performance. The price of our common stock could fluctuate based upon factors that have little or nothing to do with our company and these fluctuations could materially reduce our stock price.
The market price of our common stock could decline following sales of substantial amounts of our common stock in the public markets.
If a large number of shares of our common stock is sold in the open market, the trading price of our common stock could decrease. As of December 31, 2009, we had an aggregate of 66,050,899 shares of our common stock authorized but unissued and not reserved for specific purposes. In general, we may issue all of these shares without any approval by our stockholders. We may issue shares of our common stock, or securities convertible into shares of our common stock, to, among other things, finance the cost of acquisitions, refinance existing indebtedness, finance capital expenditures and capacity expansion, and/or generate proceeds for general corporate purposes or working capital.
We may issue preferred stock whose terms could adversely affect the voting power or value of our common stock.
Our certificate of incorporation authorizes us to issue, without the approval of our stockholders, one or more classes or series of preferred stock having such designations, preferences, limitations and relative rights, including preferences over our common stock respecting dividends and distributions, as our board of directors may determine. The terms of one or more classes or series of preferred stock could adversely impact the voting power or value of our common stock. For example, we might grant holders of preferred stock the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we might assign to holders of preferred stock could affect the residual value of the common stock.
Provisions in our organizational documents could delay or prevent a change in control of our company, even if that change would be beneficial to our stockholders.
The existence of some provisions in our organizational documents could delay or prevent a change in control of our company, even if that change would be beneficial to our stockholders. Our certificate of incorporation and bylaws contain provisions that may make acquiring control of our company difficult, including:
| • | provisions regulating the ability of our stockholders to nominate directors for election or to bring matters for action at annual meetings of our stockholders; |
| • | announcements of legislative or regulatory change. |
| • | the authorization given to our board of directors to issue and set the terms of preferred stock; and |
| • | limitations on the ability of our stockholders from removing our directors without cause. |
We do not intend to pay cash dividends on our common stock in the foreseeable future, and therefore only appreciation of the price of our common stock, which may not occur, will provide a return to our stockholders.
We currently anticipate that we will retain all future earnings, if any, to finance the growth and development of our business. We do not intend to pay cash dividends in the foreseeable future. Any payment of cash dividends will depend upon our financial condition, capital requirements, earnings and other factors deemed relevant by our board of directors. In addition, the terms of our credit facilities prohibit us from paying dividends and making other distributions. As a result, only appreciation of the price of our common stock, which may not occur, will provide a return to our stockholders.
None.
Our corporate headquarters is located at 16217 North May Avenue, Edmond, Oklahoma in an office building we purchased on January 2, 2007. The approximately 18,100 square foot building was purchased for a total purchase price of $3.0 million, less an amount equal to one-half of the principal reduction on the seller’s loan secured by the property between the effective date of the purchase agreement and the closing. We paid $1.4 million in cash and assumed existing debt of approximately $1.6 million.
Contract Land Drilling Segment – Our contract land drilling segment is supported by several offices and yard facilities located throughout this segment’s areas of operations, including Oklahoma, Louisiana, Colorado, North Dakota and Pennsylvania.
Well Servicing Segment – Our well servicing segment is supported by several offices and yard facilities located throughout this segment’s areas of operations, including Oklahoma, Texas, Kansas and New Mexico.
We own our office and yard in Duncan, Oklahoma and our office and yard in Scenery Hill, Pennsylvania. We lease the remainder of our facilities, and do not believe that any one of the leased facilities is individually material to our operations. We believe that our existing facilities are suitable and adequate to meet our needs.
Various claims and lawsuits, incidental to the ordinary course of business, are pending against the Company. In the opinion of management, all matters are adequately covered by insurance or, if not covered, are not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
| Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
Our common stock has been quoted under the symbol “BRNC” on The Nasdaq Global Select Market since January 1, 2009, and on The Nasdaq Global Market from August 16, 2005 to December 31, 2008. The following table sets forth for the indicated periods the high and low sale prices of our common stock as quoted on those markets.
| Year Ending December 31, 2008: | | High | | | Low | |
| First Quarter | | $ | 16.25 | | | $ | 11.21 | |
| Second Quarter | | $ | 18.69 | | | $ | 16.04 | |
| Third Quarter | | $ | 18.60 | | | $ | 9.80 | |
| Fourth Quarter | | $ | 10.32 | | | $ | 3.63 | |
| | | | | | | | | |
| Year Ending December 31, 2009: | | | | | | | | |
| First Quarter | | $ | 6.68 | | | $ | 3.65 | |
| Second Quarter | | $ | 6.68 | | | $ | 4.09 | |
| Third Quarter | | $ | 7.54 | | | $ | 3.34 | |
| Fourth Quarter | | $ | 8.64 | | | $ | 4.60 | |
| | | | | | | | | |
| Year ending December 31, 2010: | | | | | | | | |
| First Quarter (through February 28,2010) | | $ | 6.52 | | | $ | 4.60 | |
| | | | | | | | | |
On February 26, 2010, the last reported sale price of our common stock on The Nasdaq Global Select Market was $4.84 and we had approximately 37 holders of record of our common stock.
Dividend Policy
We have never declared or paid dividends on our common stock, and we currently anticipate that we will retain all future earnings, if any, to finance the growth and development of our business. We do not intend to pay cash dividends in the foreseeable future. Any payment of cash dividends will depend upon our financial condition, capital requirements, earnings and other factors deemed relevant by our board of directors. In addition, the terms of our credit facility prohibit us from paying dividends and making other distributions.
Equity Compensation Plan Information
The following table provides information as of December 31, 2009 with respect to shares of our common stock that may be issued under on our equity compensation plan:
| | | | | | | |
| | | | | | | Number of securities |
| | | | | | | remaining available for |
| | | Number of securities to be | | Weighted-average | | future issuance under equity |
| | | issued upon exercise of | | exercise price per share | | compensation plans |
| | | outstanding options, | | of outstanding options, | | (excluding securities |
| Plan category | | warrants and rights | | warrants and rights | | reflected in column (a)) |
| | | (a) | | (b) | | (c) |
| Equity compensation plans approved | | | | | | |
| by security holders | | - | | $ - | | 1,290,871 |
| | | | | | | |
| Equity compensation plans not approved | | | | | | |
| by security holders | | - | | - | | - |
| | | | | | | |
| Total | | - | | $ - | | 1,290,871 |
| | | | | | | |
(1) As of December 31, 2009, we had no options to purchase shares of our common stock outstanding. As of December 31, 2009, we had issued 549,559 shares of our restricted stock under the 2006 Plan. The securities remaining available for future issuance reflect securities that may be issued under the 2006 Plan, as no more shares remain available for the grant of awards under the 2005 Plan.
The following table sets forth our selected historical financial data as of and for each of the years indicated. We derived the selected historical financial data as of and for each of the years ended 2009, 2008, 2007, 2006 and 2005 from our historical audited consolidated financial statements. You should review this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and consolidated historical financial statements and related notes included elsewhere in this Form 10-K.
| | Years Ended December 31, | |
| | (in thousands, except per share amounts) | |
| | 2009 | | 2008 | | | 2007 | | | 2006 | | 2005 | |
| Consolidated Statements of Operations Information: | | | | | | | | | | | | | | | | | | | | |
| Contract drilling revenues | | $ | 106,738 | | | $ | 247,829 | | | $ | 276,088 | | | $ | 285,828 | | | $ | 77,885 | |
| Well service | | | 3,799 | | | | 33,284 | | | | 22,864 | | | | - | | | | - | |
| | | | 110,537 | | | | 281,113 | | | | 298,952 | | | | 285,828 | | | | 77,885 | |
| Costs and expenses: | | | | | | | | | | | | | | | | | | | | |
| Contract drilling | | | 75,996 | | | | 148,866 | | | | 153,797 | | | | 139,607 | | | | 44,695 | |
| Well service | | | 4,267 | | | | 24,478 | | | | 14,299 | | | | - | | | | - | |
| Depreciation and amortization | | | 45,674 | | | | 50,388 | | | | 44,241 | | | | 30,335 | | | | 9,143 | |
| General and administrative | | | 19,777 | �� | | | 33,771 | | | | 22,690 | | | | 15,709 | | | | 9,395 | |
| Impairment of goodwill | | | - | | | | 24,328 | | | | - | | | | - | | | | - | |
| Gain on Challenger transactions | | | - | | | | (3,138) | | | | - | | | | - | | | | - | |
| Loss on Bronco MX transaction | | | 23,705 | | | | - | | | | - | | | | - | | | | - | |
| Total operating costs and expenses | | | 169,419 | | | | 278,693 | | | | 235,027 | | | | 185,651 | | | | 63,233 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income (loss) from operations | | | (58,882) | | | | 2,420 | | | | 63,925 | | | | 100,177 | | | | 14,652 | |
| | | | | | | | | | | | | | | | | | | | | |
| Other income (expense): | | | | | | | | | | | | | | | | | | | | |
| Interest expense | | | (7,038) | | | | (4,171) | | | | (4,762) | | | | (1,736) | | | | (1,415) | |
| Loss from early extinguishment of debt | | | (2,859) | | | | (155) | | | | - | | | | (1,000) | | | | (2,062) | |
| Interest income | | | 274 | | | | 1,058 | | | | 1,239 | | | | 164 | | | | 432 | |
| Equity in income (loss) of Challenger | | | (1,914) | | | | 2,186 | | | | - | | | | - | | | | - | |
| Equity in income (loss) of Bronco MX | | | (588) | | | | - | | | | �� - | | | | - | | | | - | |
| Impairment of investment in Challenger | | | (21,247) | | | | (14,442) | | | | - | | | | - | | | | - | |
| Other income (expense) | | | (284) | | | | (300) | | | | 294 | | | | 284 | | | | 53 | |
| Change in fair value of warrant | | | 1,850 | | | | - | | | | - | | | | - | | | | - | |
| Total other income (expense) | | | (31,806) | | | | (15,824) | | | | (3,229) | | | | (2,288) | | | | (2,992) | |
| | | | | | | | | | | | | | | | | | | | | |
| Income (loss) before income taxes | | | (90,688) | | | | (13,404) | | | | 60,696 | | | | 97,889 | | | | 11,660 | |
| Income tax expense (benefit) | | | (33,109) | | | | (5,161) | | | | 23,104 | | | | 38,056 | | | | 6,529 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | (57,579) | | | $ | (8,243) | | | $ | 37,592 | | | $ | 59,833 | | | $ | 5,131 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income (loss) per common share-Basic | | $ | (2.16) | | | $ | (0.31) | | | $ | 1.45 | | | $ | 2.43 | | | $ | 0.32 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income (loss) per common share-Diluted | | $ | (2.16) | | | $ | (0.31) | | | $ | 1.44 | | | $ | 2.43 | | | $ | 0.31 | |
| | | | | | | | | | | | | | | | | | | | | |
| Weighted average number of shares outstanding-Basic | | | 26,651 | | | | 26,293 | | | | 25,996 | | | | 24,585 | | | | 16,259 | |
| | | | | | | | | | | | | | | | | | | | | |
| Weighted average number of shares outstanding-Diluted | | | 26,651 | | | | 26,293 | | | | 26,101 | | | | 24,623 | | | | 16,306 | |
| | | | | | | | | | | | | | | | | | | | | |
| Pro Forma C Corporation Data (Unaudited): (1) | | | | | | | | | | | | | | | | | | | | |
| Historical income | | | | | | | | | | | | | | | | | | | | |
| before income taxes | | | | | | | | | | | | | | | | | | $ | 11,660 | |
| Pro forma provision for income | | | | | | | | | | | | | | | | | | | | |
| taxes | | | | | | | | | | | | | | | | | | | 4,396 | |
| | | | | | | | | | | | | | | | | | | | | |
| Pro forma income | | | | | | | | | | | | | | | | | | $ | 7,264 | |
| | | | | | | | | | | | | | | | | | | | | |
| Pro forma income per common share basic and diluted | | | | | | | | | | | | | | | | | | $ | 0.45 | |
| | | | | | | | | | | | | | | | | | | | | |
| Weighted average pro forma shares outstanding-Basic | | | | | | | | | | | | | | | | | | | 16,259 | |
| Weighted average pro forma shares outstanding-Diluted | | | | | | | | | | | | | | | | | | | 16,306 | |
| | | | | | | | | | | | | | | | | | | | | |
| Other Financial Data (Unaudited): | | | | | | | | | | | | | | | | | | | | |
| Calculation of Adjusted EBITDA (2): | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | (57,579) | | | $ | (8,243) | | | $ | 37,592 | | | $ | 59,833 | | | $ | 5,131 | |
| Interest expense | | | 7,038 | | | | 4,171 | | | | 4,762 | | | | 1,736 | | | | 1,415 | |
| Income tax expense (benefit) | | | (33,109) | | | | (5,161) | | | | 23,104 | | | | 38,056 | | | | 6,529 | |
| Depreciation and amortization | | | 45,674 | | | | 50,388 | | | | 44,241 | | | | 30,335 | | | | 9,143 | |
| Impairment of goodwill | | | - | | | | 24,328 | | | | - | | | | - | | | | - | |
| Impairment of investment in Challenger | | | 21,247 | | | | 14,442 | | | | - | | | | - | | | | - | |
| Adjusted EBITDA (2) | | | (16,729) | | | | 79,925 | | | | 109,699 | | | | 129,960 | | | | 22,218 | |
| | | | | | | | | | | | | | | | | | | | | |
| Consolidated Cash Flow Information: | | | | | | | | | | | | | | | | | | | | |
| Net cash provided by (used in): | | | | | | | | | | | | | | | | | | | | |
| Operating activities | | | 28,048 | | | | 59,100 | | | | 82,607 | | | | 93,053 | | | | 3,318 | |
| Investing activities | | | 18,194 | | | | (82,795) | | | | (79,984) | | | | (143,199) | | | | (190,326) | |
| Financing activities | | | (63,421) | | | | 44,650 | | | | (7,510) | | | | 43,715 | | | | 202,908 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | As of December 31, | |
| | 2009 | | 2008 | | | 2007 | | | 2006 | | 2005 | |
| Consolidated Balance Sheet Information: | | | | | | | | | | | | | | | | | | | | |
| Total current assets | | $ | 43,077 | | | $ | 107,821 | | | $ | 72,019 | | | $ | 73,372 | | | $ | 53,953 | |
| Total assets | | | 445,583 | | | | 612,354 | | | | 568,605 | | | | 482,488 | | | | 330,520 | |
| Total debt | | | 51,903 | | | | 117,547 | | | | 68,118 | | | | 64,727 | | | | 51,825 | |
| Total liabilities | | | 105,312 | | | | 218,343 | | | | 172,176 | | | | 142,503 | | | | 91,184 | |
| Total stockholders'/members' equity | | | 340,271 | | | | 394,011 | | | | 396,429 | | | | 339,985 | | | | 239,336 | |
| (1) | Prior to the completion of our initial public offering in August 2005, we merged with Bronco Drilling Company, L.L.C., our predecessor company. Bronco Drilling Company, L.L.C. was a limited liability company treated as a partnership for federal income tax purposes. As a result, essentially all of its taxable earnings and losses were passed through to its members, and it did not pay federal income taxes at the entity level. Historical income taxes consist mainly of deferred income taxes on a taxable subsidiary, Elk Hill. Since we are a C corporation, for comparative purposes we have included a pro forma provision (benefit) for income taxes assuming we had been taxed as a C corporation in all periods prior to the merger. |
| (2) | Adjusted EBITDA is a non-GAAP financial measure equal to net income (loss), the most directly comparable Generally Accepted Accounting Principles, or GAAP, financial measure, plus interest expense, income tax expense, depreciation, amortization and impairment. We have presented Adjusted EBITDA because we use Adjusted EBITDA as an integral part of our internal reporting to measure our performance and to evaluate the performance of our senior management. We consider Adjusted EBITDA to be an important indicator of the operational strength of our business. Adjusted EBITDA eliminates the uneven effect of considerable amounts of non-cash depreciation and amortization. Limitations of this measure, however, are that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our business or changes in our working capital needs or the significant interest expense and cash requirements necessary to service our debt. Management evaluates the costs of tangible and intangible assets through other financial measures, such as capital expenditures, investment spending and return on capital. Therefore, we believe that Adjusted EBITDA provides useful information to our investors regarding our performance and overall results of operations. Adjusted EBITDA is not intended to be a performance measure that should be regarded as an alternative to, or more meaningful than, either net income as an indicator of operating performance or to cash flows from operating activities as a measure of liquidity. In addition, Adjusted EBITDA is not intended to represent funds available for dividends, reinvestment or other discretionary uses, and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. The Adjusted EBITDA measure presented in this Form 10-K may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements. |
The following discussion and analysis should be read in conjunction with the “Selected Historical Financial Data” and the consolidated financial statements and related notes included elsewhere in this Form 10-K. This discussion contains forward-looking statements reflecting our current expectations and estimates and assumptions concerning events and financial trends that may affect our future operating results or financial position. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the sections entitled “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” appearing elsewhere in this Form 10-K.
Overview
We provide contract land drilling and workover services to independent oil and gas exploration and production companies throughout the United States. We commenced operations in 2001 with the purchase of one stacked 650-horsepower drilling rig that we reburbished and deployed. We subsequently made selective acquisitions of both operational and inventoried drilling rigs, as well as ancillary equipment. Our management team has significant experience not only with acquiring rigs, but also with refurbishing and deploying inventoried rigs. We have successfully refurbished and brought into operation 25 inventoried drilling rigs during the period from November 2003 through December 2009. In addition, we have a 41,000 square foot machine shop in Oklahoma City, which allows us to refurbish and repair our rigs and equipment in-house. This facility, which complements our two drilling rig refurbishment yards, significantly reduces our reliance on outside machine shops and the attendant risk of third-party delays in our rig refurbishment program. As of February 28, 2010, we also owned a fleet of 60 trucks used to transport our rigs.
We have a 40% equity investment in Bronco MX, a company organized under the laws of Mexico. Bronco MX provides contract land drilling services and leases land drilling rigs to oil and natural gas companies in Mexico. We also have a 25% equity investment in Challenger Limited, or Challenger, a company organized under the laws of the Isle of Man. Challenger is an international provider of contract land drilling and workover services to oil and natural gas companies with its principal operations in Libya.
Operating Segments
We currently conduct our operations through two operating segments: contract land drilling and well servicing. The following is a description of these two operating segments. Financial information about our operating segments is included in Note 9, Business Segments and Concentrations, of the Notes to Consolidated Financial Statements, included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Contract Land Drilling – Our contract land drilling segment provides contract land drilling services. As of February 28, 2010, we owned a fleet of 37 marketed land drilling rigs. We currently operate our drilling rigs in Oklahoma, Texas, Pennsylvania, West Virginia, North Dakota, Utah and Louisiana. A majority of the wells we drill for our customers are drilled in unconventional basins also known as resource plays. These plays are generally characterized by complex geologic formations that often require higher horsepower, premium rigs and experienced crews to reach targeted depths. Our current fleet of 37 marketed drilling rigs range from 950 to 2,000 horsepower. Accordingly, such rigs can, or in the case of inventoried rigs upon refurbishment, will be able to, reach the depths required and have the capability of drilling horizontal and directional wells, which are increasing as a percentage of total wells drilled in North America. We believe our premium rig fleet, inventory and experienced crews position us to benefit from the natural gas drilling activity in our core operating areas.
We obtain our contracts for drilling oil and natural gas wells either through competitive bidding or through direct negotiations with customers. We typically enter into drilling contracts that provide for compensation on a daywork basis. Occasionally, we enter into drilling contracts that provide for compensation on a footage basis. We have not historically entered into turnkey contracts; however, we may decide to enter into such contracts in the future. It is also possible that we may acquire such contracts in connection with future acquisitions. Contract terms we offer generally depend on the complexity and risk of operations, the on-site drilling conditions, the type of equipment used and the anticipated duration of the work to be performed. Although, we currently have 13 of our drilling rigs operating under term contracts, our contracts generally provide for the drilling of a single well and typically permit the customer to terminate on short notice.
A significant performance measurement that we use to evaluate this segment is operating rig utilization. We compute operating drilling rig utilization rates by dividing revenue days by total available days during a period. Total available days are the number of calendar days during the period that we have owned the operating rig. Revenue days for each operating rig are days when the rig is earning revenues under a contract, i.e. when the rig begins moving to the drilling location until the rig is released from the contract. On daywork contracts, during the mobilization period we typically receive a fixed amount of revenue based on the mobilization rate stated in the contract. We begin earning our contracted daywork rate and mobilization revenue when we begin drilling the well. Occasionally, in periods of increased demand, we will receive a percentage of the contracted dayrate during the mobilization period. We account for these revenues as mobilization fees.
For the years ended December 31, 2009, 2008, and 2007, our drilling rig utilization rates, revenue days and average number of operating drilling rigs were as follows:
| | | Year Ended December 31, |
| | | 2009 | | 2008 | | 2007 | |
| Average number of operating drilling rigs | | 44 | | 44 | | 51 | |
| Revenue days | | 5,699 | | 12,712 | | 14,245 | |
| Utilization Rates | | 36% | | 79% | | 76% | |
| | | | | | | | |
The decrease in the number of revenue days in 2009 is primarily attributable to the sharp decrease in oil and natural gas prices beginning in the third quarter of 2008 through 2009 as well as the inability of most customers to obtain financing related to their drilling programs. Additionally, the average number of rigs decreased in the third quarter due to the contribution of 9 rigs to Bronco MX. The decrease in the number of revenue days in 2008 is attributable to the decrease in the average number of operating rigs due to the rigs contributed and sold to Challenger. We devote substantial resources to maintaining, upgrading and expanding our rig fleet. We substantially completed the refurbishment of three drilling rigs in 2007.
Well Servicing – Our well servicing segment is capable of providing a broad range of services to oil and natural gas exploration and prodution companies, including well maintenance, well workover, new well completion and plugging and abandonment. We are able to provide maintenance-related services as part of the normal, periodic upkeep of producing oil and gas wells. Workover and completion services typically generate more revenue per hour than maintenance work due to the use of auxiliary equipment, but demand for workover and completion services tend to be cyclical and highly correlated to the overall activity level in the industry.
The Company earns well servicing revenue based on purchase orders, contracts or other persuasive evidence of an arrangement with the customer, such as a master service agreement, that include fixed or determinable prices. We generally charge our customers an hourly rate for these services, which varies based on a number of considerations including market conditions in each region, the type of rig and ancillary equipment required, and the necessary personnel.
Our well servicing rig fleet has increased from a weighted average number of 24 rigs in the first quarter of 2007 to 61 in the fourth quarter of 2009 due to newbuild purchases. We gauge activity levels in our well servicing rig operations based on rig utilization rate. We compute operating workover rig utilization rates by dividing revenue hours by total available hours during a period. Total available hours are the number of hours during the period that we have owned the operating workover rig based on a 50-hour work week per rig.For the years ended December 31, 2009, 2008 and 2007, our workover rig utilization rates, revenue hours and average number of operating workover rigs were as follows:
| | | Year Ended December 31, |
| | | 2009 | | 2008 | | 2007 | |
| Average number of operating workover rigs | | 52 | | 52 | | 33 | |
| Revenue hours | | 11,386 | | 91,591 | | 63,746 | |
| Utilization Rates | | 17% | | 68% | | 78% | |
In June of 2009 management made the decision to temporarily suspend operations in the well servicing division. Market conditions had sharply deteriorated due to the rapid decrease in oil and natural gas prices which began in the third quarter of 2008 as well as the inability of most customers to obtain financing related to their drilling and workover programs.
Due to the industry slowdown and subsequent suspension of operations revenue hours were down 88% for 2009 as compared to 2008. Revenue hours by quarter in 2009 were as follows: Q1 8,012, Q2 3,374, Q3 0 and Q4 0.
Market Conditions in Our Industry
The United States contract land drilling and well servicing industry is highly cyclical. Volatility in oil and natural gas prices can produce wide swings in the levels of overall drilling and well servicing activity in the markets we serve and affect the demand for our drilling and workover services and the revenue rates we can charge for our drilling and workover rigs. The availability of financing sources, past trends in oil and natural gas prices and the outlook for future oil and natural gas prices strongly influence the capital expenditure budgets of exploration and production companies.
Our business environment has been adversely affected by the decline in oil and natural gas prices and the deteriorating global economic environment beginning in the third quarter of 2008. As part of this deterioration, there has been significant uncertainty in the capital markets and access to financing has been reduced. As a result of these conditions, our customers have curtailed their exploration budgets, which has resulted in a significant decrease in demand for our services, a reduction in revenue rates and utilization. During 2009 and 2008, the Company recorded $7.9 million and $3.6 million of contract drilling revenue related to terminated contracts, respectively. Due to the current economic environment, certain customers may not be able to pay suppliers, including us, if they are not able to access capital to fund their business operations.
On February 28, 2010, the closing prices for near month delivery contracts for crude oil and natural gas as traded on the NYMEX were $79.66 per barrel and $4.81per MMbtu, respectively. The Baker Hughes domestic land drilling rig count as of February 28, 2010 was1,313. Baker Hughes is a large oil field services firm that has issued the rotary rig counts as a service to the petroleum industry since 1944.
The following table depicts the prices for near month delivery contracts for crude oil and natural gas as traded on the NYMEX, as well as the most recent Baker Hughes domestic land rig count, on the dates indicated:
| | | At December 31, | |
| | | 2009 | | | 2008 | | | 2007 | |
| Crude oil (Bbl) | | $ | 79.36 | | | $ | 44.60 | | | $ | 95.98 | |
| Natural gas (Mmbtu) | | $ | 5.57 | | | $ | 5.62 | | | $ | 7.48 | |
| U.S. Land Rig Count | | | 1,150 | | | | 1,653 | | | | 1,719 | |
Increased expenditures for exploration and production activities generally lead to increased demand for our services. Until mid-2008, rising oil and natural gas prices and the corresponding increase in onshore oil and natural gas exploration and production spending led to expanded drilling and well service activity as reflected by the increases in the U.S. land rig counts and U.S. workover rig counts over the previous several years. Falling commodity prices and the oversupply of rigs, similar to what we have experienced since the beginning of the third quarter of 2008, generally leads to lower demand for our services.
The decline in oil and natural gas prices and the deteriorating global economic environment resulted in reductions in our rig utilization and revenue rates in 2009. Our near-term strategy is to maintain a strong balance sheet and ample liquidity. Management has initiated certain cost reduction measures including workforce and wage rate reductions, optimization of purchasing processes and the rationalization of real estate, overhead and operating divisions. These actions should reduce operating expenses during the current downturn in the industry. Budgeted capital expenditures for 2010 represent a reduction from average historical levels and consists of routine capital expenditures necessary to maintain our equipment in safe and efficient working order and discretionary capital expenditures for new equipment or upgrades of existing equipment in order to make our rigs marketable to customers in areas identified as strategically important by management. Management benchmarks each discretionary capital project against internal required rates of return on capital and/or strategic objectives.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting policies that are described in the notes to our consolidated financial statements. The preparation of the consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our judgments and estimates in determining our financial condition and operating results. Estimates are based upon information available as of the date of the financial statements and, accordingly, actual results could differ from these estimates, sometimes materially. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and operating results and require management’s most subjective judgments. The most critical accounting policies and estimates are described below.
Revenue and Cost Recognition—Our contract land drilling segment earns revenues by drilling oil and natural gas wells for our customers typically under daywork contracts, which usually provide for the drilling of a single well. We occasionnaly enter into footage contracts, which also usually provide for the drilling of a single well. We recognize revenues on daywork contracts for the days completed based on the dayrate each contract specifies. Mobilization revenues and costs are deferred and recognized over the drilling days of the related drilling contract. Individual contracts are usually completed in less than 120 days. We follow the percentage-of-completion method of accounting for footage contract drilling arrangements. Under this method, drilling revenues and costs related to a well in progress are recognized proportionately over the time it takes to drill the well. Percentage of completion is determined based upon the amount of expenses incurred through the measurement date as compared to total estimated expenses to be incurred drilling the well. Mobilization costs are not included in costs incurred for percentage-of-completion calculations. Mobilization costs on footage contracts and daywork contracts are deferred and recognized over the days of actual drilling. Under the percentage-of-completion method, management estimates are relied upon in the determination of the total estimated expenses to be incurred drilling the well. When estimates of revenues and expenses indicate a loss on a contract, the total estimated loss is accrued.
Our management has determined that it is appropriate to use the percentage-of-completion method to recognize revenue on our footage contracts, which is the predominant practice in the industry. Although our footage contracts do not have express terms that provide us with rights to receive payment for the work that we perform prior to drilling wells to the agreed upon depth, we use this method because, as provided in applicable accounting literature, we believe we achieve a continuous sale for our work-in-progress and we believe, under applicable state law, we ultimately could recover the fair value of our work-in-progress even in the event we were unable to drill to the agreed upon depth in breach of the applicable contract. However, ultimate recovery of that value, in the event we were unable to drill to the agreed upon depth in breach of the contract, would be subject to negotiations with the customer and the possibility of litigation.
We are entitled to receive payment under footage contracts when we deliver to our customer a well completed to the depth specified in the contract, unless the customer authorizes us to drill to a shallower depth. Since inception, we have completed all our footage contracts. Although our initial cost estimates for footage contracts do not include cost estimates for risks such as stuck drill pipe or loss of circulation, we believe that our experienced management team, our knowledge of geologic formations in our areas of operations, the condition of our drilling equipment and our experienced crews enable us to make reasonably dependable cost estimates and complete contracts according to our drilling plan. While we do bear the risk of loss for cost overruns and other events that are not specifically provided for in our initial cost estimates, our pricing of footage contracts takes such risks into consideration. When we encounter, during the course of our drilling operations, conditions unforeseen in the preparation of our original cost estimate, we immediately adjust our cost estimate for the additional costs to complete the contracts. If we anticipate a loss on a contract in progress at the end of a reporting period due to a change in our cost estimate, we immediately accrue the entire amount of the estimated loss, including all costs that are included in our revised estimated cost to complete that contract, in our consolidated statement of operations for that reporting period. During 2007, we did not experience a loss on the footage jobs we completed. We had no footage contracts in progress at December 31, 2009 and 2008. When we enter into footage contracts, we are more likely to encounter losses on them in years in which revenue rates are lower for all types of contracts.
Revenues and costs during a reporting period could be affected by jobs in progress at the end of a reporting period that have not been completed before our financial statements for that period are released. At December 31, 2009 and 2008, our unbilled receivables totaled $828,000 and $2.9 million, respectively, all of which relates to the revenue recognized but not yet billed or costs deferred on daywork contracts in progress.
We accrue estimated contract costs on footage contracts for each day of work completed based on our estimate of the total costs to complete the contract divided by our estimate of the number of days to complete the contract. Contract costs include labor, materials, supplies, repairs and maintenance and operating overhead allocations. In addition, the occurrence of uninsured or under-insured losses or operating cost overruns on our footage contracts could have a material adverse effect on our financial position and results of operations. Therefore, our actual results could differ significantly if our cost estimates are later revised from our original estimates for contracts in progress at the end of a reporting period that were not completed prior to the release of our financial statements.
Accounts Receivable—We evaluate the creditworthiness of our customers based on their financial information, if available, information obtained from major industry suppliers, current prices of oil and natural gas and any past experience we have with the customer. Consequently, an adverse change in those factors could affect our estimate of our allowance for doubtful accounts. In some instances, we require new customers to establish escrow accounts or make prepayments. We typically invoice our customers at 30-day intervals during the performance of daywork contracts and upon completion of the daywork contract. Footage contracts are invoiced upon completion of the contract. Our typical contract provides for payment of invoices in 30 days. We generally do not extend payment terms beyond 30 days. We are currently involved in legal actions to collect various overdue accounts receivable. Our allowance for doubtful accounts was $3.6 million and $3.8 million at December 31, 2009 and 2008, respectively. Any allowance established is subject to judgment and estimates made by management. We determine our allowance by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss history, our customer’s current ability to pay its obligation to us and the condition of the general economy and the industry as a whole. We write off specific accounts receivable when they become uncollectible and payments subsequently received on such receivables reduce the allowance for doubtful accounts.
If a customer defaults on its payment obligation to us under one of our typical contracts, we would need to rely on applicable law to enforce our lien rights, because our contracts do not expressly grant to us a security interest in the work we have completed under the contract and we have no ownership rights in the work-in-progress or completed drilling work, except any rights arising under applicable law. If we were unable to drill to the agreed on depth in breach of a footage contract, we might also need to rely on equitable remedies to recover the fair value of our work-in-progress under a footage contract.
Asset Impairment and Depreciation— We evaluate for potential impairment of long-lived assets and intangible assets subject to amortization when indicators of impairment are present, as defined in ASC Topic 360, Accounting for the Impairment or Disposal of Long-Lived Assets. Circumstances that could indicate a potential impairment include significant adverse changes in industry trends, economic climate, legal factors, and an adverse action or assessment by a regulator. More specifically, significant adverse changes in industry trends include significant declines in revenue rates, utilization rates, oil and natural gas market prices and industry rig counts for drilling rigs and workover rigs. In performing an impairment evaluation, we estimate the future undiscounted net cash flows from the use and eventual disposition of long-lived assets and intangible assets grouped at the lowest level that cash flows can be identified. If the sum of the estimated future undiscounted net cash flows is less than the carrying amount of the long-lived assets and intangible assets for these asset grouping levels, then we would recognize an impairment charge. The amount of an impairment charge would be measured as the difference between the carrying amount and the fair value of these assets. We did not record an impairment charge on any long-lived assets for our contract land drilling or well servicing segments for the year ended December 31, 2009. The assumptions used in the impairment evaluation for long-lived assets and intangible assets are inherently uncertain and require management judgment.
Goodwill impairment testing is performed at the level of our reporting units under the provisions of ASC Topic 350, Goodwill and Other Intangible Assets. Our reporting units have been determined to be the same as our operating segments, contract land drilling and well servicing. In our testing of possible impairment of goodwill, we compare the fair value of the reporting units with their carrying value. If the fair value exceeds the carrying value, no impairment is indicated. If the carrying value exceeds the fair value, we measure any impairment of goodwill in that reporting unit by allocating the fair value to the identifiable assets and liabilities of the reporting unit based on their respective fair values. Any excess un-allocated fair value would equal the implied fair value of goodwill, and if that amount is below the carrying value of goodwill, an impairment charge is recognized.
In completing the first step of the goodwill impairment analysis during the fourth quarter of 2008, management used a five-year projection of discounted cash flows, plus a terminal value determined using a constant growth method to estimate the fair value of reporting units. In developing these fair value estimates, certain key assumptions included an assumed discount rate of 11.0% and 14.0% for our contract land drilling and well servicing segments, respectively, and an assumed long-term growth rate of 2.0% for both reporting units.
Based on the results of the first step of the goodwill impairment test, impairment was indicated in both reporting units. Management performed the second step of the analysis of its drilling and well servicing reporting units, allocating the estimated fair value to the indentifiable tangible and intangible assets and liabilities of these reporting units based on their respective values. This allocation indicated no residual value for goodwill, and accordingly we recorded an impairment charge of $24.3 million in our December 31, 2008 statement of operations. This impairment charge did not have an impact on our liquidity or debt covenants; however, it was a reflection of the overall downturn in our industry and decline in our projected cash flows. The Company has no goodwill after this impairment.
Our determination of the estimated useful lives of our depreciable assets, directly affects our determination of depreciation expense and deferred taxes. A decrease in the useful life of our drilling equipment would increase depreciation expense and reduce deferred taxes. We provide for depreciation of our drilling rigs, transportation and other equipment on a straight-line method over useful lives that we have estimated and that range from three to fifteen years after the rig was placed into service. We record the same depreciation expense whether an operating rig is idle or working. Depreciation is not recorded on an inventoried rig until placed in service. Our estimates of the useful lives of our drilling, transportation and other equipment are based on our experience in the drilling industry with similar equipment.
We capitalize interest cost as a component of drilling and workover rigs refurbished for our own use. During the years ended December 31, 2009 and 2008, we capitalized approximately $0 and $1.3 million, respectively.
We reviewed our investment in Challenger at September 30, 2009 for impairment based on the guidance of ASC Topic 323, Investments-Equity Method and Joint Venture, which states that a loss in value of an investment which is other than a temporary decline should be recognized. Evidence of a loss in value might include the absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. A current fair value of an investment that is less than its carrying amount may indicate a loss in value of the investment. Due to the recent volatility and decline in oil and natural gas prices, a deteriorating global economic environment and the anticipated future earnings of Challenger, we deemed it necessary to test the investment for impairment.
Fair value of the investment was estimated using a combination of income, or discounted cash flows approach and the market approach, which utilizes comparable companies’ data. In developing these fair value estimates, certain key assumptions included an assumed discount rate of 14.5%, a control premium of 25.0% and a long-term growth rate of 4.0%. The analysis resulted in a fair value of $39.8 million related to our investment in Challenger, which was below the carrying value of the investment and resulted in a non-cash impairment charge in the amount of $21.2 million.
Stock Based Compensation--- We have adopted ASC Topic 718, Stock Compensation, upon granting our first stock options on August 16, 2005. ASC Topic 718 requires a public entity to measure the costs of employee services received in exchange for an award of equity or liability instruments based on the grant-date fair value of the award. That cost will be recognized over the periods during which an employee is required to provide service in exchange for the award. Stock compensation expense was $3.3 million, $5.8 million and $3.7 million for 2009, 2008 and 2007, respectively.
Deferred Income Taxes—We provide deferred income taxes for the basis difference in our property and equipment, stock compensation expense and other items between financial reporting and tax reporting purposes. For property and equipment, basis differences arise from differences in depreciation periods and methods and the value of assets acquired in a business acquisition where we acquire the stock in an entity rather than just its assets. For financial reporting purposes, we depreciate the various components of our drilling rigs and refurbishments over fifteen years, while federal income tax rules require that we depreciate drilling rigs and refurbishments over five years. Therefore, in the first five years of our ownership of a drilling rig, our tax depreciation exceeds our financial reporting depreciation, resulting in our providing deferred taxes on this depreciation difference. After five years, financial reporting depreciation exceeds tax depreciation, and the deferred tax liability begins to reverse. Deferred tax assets are reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Equity Method Investments—Investee companies that are not consolidated, but over which we exercise significant influence, are accounted for under the equity method of accounting. Whether or not we exercise significant influence with respect to an Investee depends on an evaluation of several factors including, among others, representation on the Investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the Investee company. Under the equity method of accounting, an Investee company’s accounts are not reflected within our Consolidated Balance Sheets and Statements of Operations; however, our share of the earnings or losses of the Investee company is reflected in the captions “Equity in income of Bronco MX” and “Equity in income of Challenger” in the Consolidated Statements of Operations. Our carrying value in an equity method Investee company is reflected in the captions “Investment in Bronco MX” and “Investment in Challenger” in our Consolidated Balance Sheets.
Other Accounting Estimates—Our other accrued expenses as of December 31, 2009 and December 31, 2008 included accruals of approximately $2.5 million and $4.3 million, respectively, for costs under our workers’ compensation insurance. We have a deductible of $1.0 million per covered accident under our workers’ compensation insurance. We maintain letters of credit in the aggregate amount of $11.6 million for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which may become payable under the terms of the underlying insurance contracts. The letters of credit are typically renewed annually. No amounts have been drawn under the letters of credit. We accrue for these costs as claims are incurred based on cost estimates established for each claim by the insurance companies providing the administrative services for processing the claims, including an estimate for incurred but not reported claims, estimates for claims paid directly by us, our estimate of the administrative costs associated with these claims and our historical experience with these types of claims. We also have a self-insurance program for major medical, hospitalization and dental coverage for employees and their dependents. We recognize both reported and incurred but not reported costs related to the self-insurance portion of our health insurance. Since the accrual is based on estimates of expenses for claims, the ultimate amount paid may differ from accrued amounts.
Year in Review Highlights
The following are recent highlights that have impacted our results of operations for the year ended December 31, 2009.
Well Servicing Segment
In June of 2009 management made the decision to temporarily suspend operations in the well servicing segment. As previously discussed, market conditions had sharply deteriorated. The dramatic decline in activity was evident as revenue hours decreased 87% from a peak of 25,533 hours in the third quarter of 2008 to 3,374 hours in the second quarter of 2009. This represents a utilization rate of 75% and 10% for the respective quarters. The decrease in activity was coupled with similar erosions in pricing and margin. As such, the segment was unable to generate adequate rates of return on capital in the near future. Because the core drilling business is very capital intensive and was at the same time experiencing a similar slowdown, management felt it prudent to temporarily suspend operations in the well service segment. We intend to strategically refocus this business segment and deploy assets in the future with a more efficient operational and cost structure. Currently, Bronco senior management is rebuilding the management team within Bronco Energy Services. Several candidates have been identified to lead this division going forward. The plan for potential redeployment includes new geographic markets, a greater focus on completion services as well as the exploration of potential expansion into international markets where we feel we have a competitive advantage.
Bronco MX Joint Venture
On September 18, 2009, the Company and Saddleback Properties LLC, a wholly-owned subsidiary of the Company, entered into a Membership Interest Purchase Agreement (the “Purchase Agreement”) with CICSA, pursuant to which CICSA purchased 60% of the outstanding membership interests of Bronco MX. The Company owns the remaining 40% of the outstanding membership interests of Bronco MX. Immediately prior to the sale of the membership interests in Bronco MX to CICSA, the Company contributed six drilling rigs (Nos. 4, 43, 53, 58, 60 and 72), and the future net profit from rig leases relating to three additional drilling rigs (Nos. 55, 76 and 78), which the Company contributed to Bronco MX upon the expiration of the leases relating to such rigs.
The Company received $31.7 million from CICSA in exchange for the 60% membership interest in Bronco MX. CICSA also reimbursed the Company for 60% of the value added taxes previously paid by, or on behalf of, Bronco MX as a result of the importation of six drilling rigs that were contributed by the Company to Bronco MX to Mexico. The description of the Purchase Agreement set forth herein is a summary, is not complete and is qualified in its entirety by reference to the full text of such agreement, which was filed as exhibit 2.1 to the Company’s Current Report on Form 8-K with the SEC on September 23, 2009.
Bronco MX is jointly managed, with CICSA having three representatives on its board of managers and the Company having two representatives on its board of managers. The Company and CICSA, and their respective affiliates, agreed to conduct all future land drilling and workover rig services, rental, construction, refurbishment, transportation, trucking and mobilization in Mexico and Latin America exclusively through Bronco MX, subject to Bronco MX’s ability to perform.
Senior Secured Revolving Credit Facility with Banco Inbursa
On September 18, 2009, the Company entered into a new senior secured revolving credit facility with Banco Inbursa, as lender and as the issuing bank. The Company utilized (i) borrowings under this credit facility, (ii) proceeds from the sale of the membership interests of Bronco MX and (iii) cash-on-hand to repay all amounts outstanding under the Company’s prior revolving credit agreement with Fortis Bank SA/NV, New York Branch, which has been replaced by this credit facility.
The credit facility provides for revolving advances of up to $75.0 million and matures on September 17, 2014. The borrowing base under the credit facility has been initially set at $75.0 million, subject to borrowing base limitations. Outstanding borrowings under the credit facility bear interest at the Eurodollar rate plus 5.80% per annum, subject to adjustment under certain circumstances.
The Company will pay a quarterly commitment fee of 0.5% per annum on the unused portion of the credit facility and a fee of 1.50% for each letter of credit issued under the facility. In addition, an upfront fee equal to 1.50% of the aggregate commitments under the credit facility was paid by the Company at closing. The Company’s domestic subsidiaries guaranteed the loans and other obligations under the credit facility. The obligations under the credit facility and the related guarantees are secured by a first priority security interest in substantially all of the assets of the Company and its domestic subsidiaries, including the equity interests of the Company’s direct and indirect subsidiaries.
The credit facility contains customary representations and warranties and various affirmative and negative covenants, including, but not limited to, covenants that restrict the Company’s ability to make capital expenditures, incur indebtedness, incur liens, dispose of property, repay debt, pay dividends, repurchase shares and make certain acquisitions, and a financial covenant requiring that the Company maintain a ratio of consolidated debt to consolidated earnings before interest, taxes, depreciation and amortization for any four consecutive fiscal quarters of not more than 3.5 to 1.0. On February 9, 2010, we received a waiver from Banco Inbursa for the ratio of consolidated debt to consolidated earnings before interest, taxes, depreciation and amortization through the second quarter of 2010. A violation of these covenants or any other covenant in the credit facility could result in a default under the credit facility which would permit the lender to restrict the Company’s ability to access the credit facility and require the immediate repayment of any outstanding advances under the credit facility.
Warrant Issuance
In conjunction with its entry into the credit facility, the Company entered into a Warrant Agreement with Banco Inbursa and, pursuant thereto, issued a three-year warrant (the "Warrant") to Banco Inbursa evidencing the right to purchase up to 5,440,770 shares of the Company’s common stock, $0.01 par value per share (the "Common Stock") subject to the terms and conditions set forth in the Warrant, including the limitations on exercise set forth below, at an exercise price of $6.50 per share of Common Stock from the date of issuance of the Warrant (the "Issue Date") through the first anniversary of the Issue Date, $7.00 per share following the first anniversary of the Issue Date through the second anniversary of the Issue Date, and $7.50 per share following the second anniversary of the Issue Date through the third anniversary of the Issue Date. The Warrant may be exercised by the payment of the exercise price in cash or through a cashless exercise whereby the Company withholds shares issuable under the Warrant having a value equal to the aggregate exercise price.
The exercise price per share and the number of shares of Common Stock for which the Warrant may be exercised are subject to adjustment in the event of any split, subdivision, reclassification, combination or similar transactions affecting the Common Stock. Additionally, in the event that the Warrant is sold and the proceeds per share received by the holder are less than the positive difference of the current market price per share of the Common Stock less the exercise price then in effect, the Company will be required to pay the seller of the Warrant a make-whole payment equal to such difference. However, the obligations of the Company in respect of the make-whole payment only inure to the benefit of Banco Inbursa and other members of the Investor Group (as defined in the Warrant), and not other holders of the Warrant.
The Warrant contains limitations on the number of shares of Common Stock that may be acquired by the holder of the Warrant upon any exercise of the Warrant. Pursuant to the terms of the Warrant, the holder of the Warrant may not exercise the Warrant for a number of shares of Common Stock which will exceed 19.99% of the shares of the Common Stock that are issued and outstanding on the Issue Date (subject to adjustment for stock splits, combinations and similar events). In addition, the number of shares that may be acquired by the holder of the Warrant and its Affiliates (as defined in the Warrant) and any other Person (as defined in the Warrant) whose ownership of Common Stock would be aggregated with the ownership of the holder of the Warrant for purposes of Section 13(d) of the Securities Exchange Act of 1934, as amended, does not exceed 19.99% of the total number of shares of Common Stock that are outstanding immediately after giving effect to such exercise of the Warrant.
In conjunction with the issuance of the Warrant, the Company entered into a Registration Rights Agreement for the benefit of Banco Inbursa and its permitted assignees and transferees. The Registration Rights Agreement provides for up to three demand registration rights and unlimited piggyback registration rights covering the Warrant, the shares of Common Stock for which the Warrant is exercisable and all other shares of Common Stock held by Banco Inbursa and its permitted assignees and transferees. The Registration Rights Agreement provides that the Company shall pay all fees and expenses incident to the performance of its obligations under the Registration Rights Agreement, including the payment of all filing, registration and qualification fees, printers’ and accounting fees, and expenses and disbursements of counsel and contains other customary terms, provisions and covenants for agreements of this type, including, without limitation, provisions requiring the Company to provide indemnification arising out of or relating to any untrue or alleged untrue statement of a material fact, or relating to any omission or alleged omission of a material fact required to be stated therein to make the statements therein not misleading, contained in a registration statement, prospectus, free writing prospectus or certain other documents.
The descriptions of the Credit Facility set forth herein is a summary, is not complete and is qualified in its entirety by reference to the full text of such agreements, which was filed as exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on September 23, 2009.
Global Financial Markets
Events, both within the United States and the world, have brought about significant and immediate changes in the global financial markets which in turn are affecting the United States economy, our industry and us. In the United States, these events and others have had a significant impact on the prices for oil and natural gas as reflected in the following table:
| | | Natural Gas Price | | | | | | | |
| | | per Mcf | | | Oil Price per Bbl | |
| Quarter | | High | | | Low | | | High | | | Low | |
| 2010: | | | | | | | | | | | | |
| First (through March 1, 2010) | | $ | 6.01 | | | $ | 4.68 | | | $ | 83.18 | | | $ | 71.19 | |
| 2009: | | | | | | | | | | | | | | | | |
| Fourth | | $ | 5.99 | | | $ | 4.25 | | | $ | 81.37 | | | $ | 69.57 | |
| Third | | $ | 4.88 | | | $ | 2.51 | | | $ | 74.37 | | | $ | 59.52 | |
| Second | | $ | 4.45 | | | $ | 3.25 | | | $ | 72.68 | | | $ | 45.88 | |
| First | | $ | 6.07 | | | $ | 3.63 | | | $ | 54.34 | | | $ | 33.98 | |
| 2008: | | | | | | | | | | | | | | | | |
| Fourth | | $ | 7.73 | | | $ | 5.29 | | | $ | 98.53 | | | $ | 33.87 | |
| Third | | $ | 13.58 | | | $ | 7.22 | | | $ | 145.29 | | | $ | 95.71 | |
| Second | | $ | 13.35 | | | $ | 9.32 | | | $ | 140.21 | | | $ | 100.98 | |
| First | | $ | 10.23 | | | $ | 7.62 | | | $ | 110.33 | | | $ | 86.99 | |
As noted in the table, oil and natural gas prices declined significantly in late calendar 2008 and there was a deteriorating national and global economic environment. During 2009, the economic recession, including the decline in oil and natural gas prices and deterioration in the credit markets, had a significant effect on customer spending and drilling activity. When drilling activity and spending decline for any sustained period of time our dayrates and utilization rates also tend to decline. In addition, lower commodity prices for any sustained period of time could impact the liquidity condition of some of our customers, which, in turn, might limit their ability to meet their financial obligations to us.
The impact on our business and financial results as a consequence of the volatility in oil and natural gas prices and the global economic crisis is uncertain in the long term, but in the short term, it has had a number of consequences for us, including the following:
| • | In December 2008, we incurred goodwill impairment of our contract land drilling and well servicing segments of $24.3 million due to the fair value of the segments being less than their carrying value; |
| • | In June 2009, we temporarily suspended operations in our well servicing segment; |
| • | In September 2009, we incurred an impairment charge to our investment in Challenger of $21.2 million due to the fair value of the investment being less than its carrying value; |
| • | Due to declining commodity prices of oil and natural gas, several of our customers have significantly reduced their drilling budgets for 2010, resulting in a significant reduction in the average utilization of our drilling and workover rig fleet. Our average utilization was approximately 36% for 2009 and 79% for 2008. |
Results of Operations
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Contract Drilling Revenue. For the year ended December 31, 2009, we reported contract drilling revenues of approximately $106.7 million, a 57% decrease from revenues of $247.8 million for 2008. The decrease is primarily due to a decrease in total revenue days and a decrease in average dayrates. Revenue days decreased 55% to 5,699 days for the year ended December 31, 2009 from 12,712 days during 2008. Average dayrates for our drilling services decreased $1,565, or 9%, to $16,072 for the year ended December 31, 2009 from $17,637 in 2008. The decrease in the number of revenue days for the year ended December 31, 2009 as compared to 2008 is attributable to the decrease in our utilization rate. Utilization decreased to 36% from 79% for the year ended December 31, 2009 as compared to 2008. The 54% decrease in utilization was primarily due to decrease in demand for our services related to a decline in drilling activity as a result of lower oil and natural gas prices and a more competitive market resulting from an increase in the supply of drilling rigs. For the year ended December 31, 2009, the Company recorded $7.9 million of contract drilling revenue related to terminated contracts compared to $3.6 million for 2008.
Well Service Revenue. For the year ended December 31, 2009, we reported well service revenues of approximately $3.8 million, an 89% decrease from revenues of $33.3 million for 2008. The decrease is primarily due to a decrease in total revenue hours and a decrease in the average hourly rate. Revenue hours decreased 88% to 11,386 for the year ended December 31, 2009 from 91,591 during 2008. The average hourly rate decreased $29, or 8%, to $334 for the year ended December 31, 2009 from $363 during 2008. We temporarily suspended operations of our workover segment in June of 2009.
Equity in Income (Loss) of Challenger. Our equity in the loss of Challenger was $1.9 million for the year ended December 31, 2009 compared to Equity in income of $2.2 million for the year ended December 31, 2008. The equity in income (loss) of Challenger represents our 25% share of Challenger’s income (loss) for 2009 and 2008. For the year ended December 31, 2009, Challenger had operating revenues of $56.5 million and operating costs of $47.6 million. For the year ended December 31, 2008, Challenger had operating revenues of $71.8 million and operating costs of $38.5 million. We reviewed our investment in Challenger at September 30, 2009 for impairment based on the guidance of ASC Topic 323, Investments-Equity Method and Joint Venture, which states that a loss in value of an investment which is other than temporary decline should be recognized. Evidence of a loss in value might include the absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. A current fair value of an investment that is less than its carrying amount may indicate a loss in value of the investment. Due to the recent volatility and decline in oil and natural gas prices, a deteriorating global economic environment and the anticipated future earnings of Challenger, we deemed it necessary to test the investment for impairment. Fair value of the investment was estimated using a combination of income, or discounted cash flows approach, and the market approach, which utilizes comparable companies’ data. The analysis resulted in a fair value of $39.8 million for our investment in Challenger, which was below the carrying value of the investment and resulted in a non-cash impairment charge in the amount of $21.2 million.
Equity in Income (Loss) of Bronco MX. Equity in loss of Bronco MX was $588 for the period September 18 through December 31, 2009. The equity in loss of Bronco MX represents our 40% share of Bronco MX’s loss for 2009. For the period September 18, 2009 through December 31, 2009, Bronco MX had operating revenues of $7.2 million and operating costs of $9.2 million.
Contract Drilling Expense. Contract drilling expense decreased $72.9 million to $76.0 million for the year ended December 31, 2009 from $148.9 million in 2008. This 49% decrease is primarily due to the decrease in the number of revenue days from 12,712 for the year ended December 31, 2008 to 5,699 for 2009. As a percentage of contract drilling revenue, drilling expense increased to 71% for the year ended December 31, 2009 from 60% in 2008 due primarily to fixed costs on idle drilling rigs.
Well Service Expense. For the year ended December 31, 2009, we reported well service expense of approximately $4.3 million, an 82% decrease from expense of $24.5 million for 2008. The decrease is primarily due to a decrease in total revenue hours. Revenue hours decreased 88% to 11,386 for the year ended December 31, 2009 from 91,591 during 2008. As a percentage of well service revenue, expenses increased to 112% for the year ended December 31, 2009 from 74% in 2008. We temporarily suspended operations of our workover segment in June of 2009.
Depreciation and Amortization Expense. Depreciation and amortization expense decreased $4.7 million to $45.7 million for the year ended December 31, 2009 from $50.4 million in 2008. The decrease is due to the contribution of nine drilling rigs to Bronco MX in the third quarter of 2009.
General and Administrative Expense. General and administrative expense decreased $14.0 million, or 41%, to $19.8 million for the year ended December 31, 2009 from $33.8 million in 2008. This primarily resulted from a $4.5 million termination fee paid in 2008 related to our terminated merger with Allis-Chalmers Energy, Inc. The remainder of the decrease is due to a $2.5 million decrease in stock compensation expense, a $1.8 million decrease in payroll costs, a $1.6 million decrease in accounts receivable write-offs, a $1.3 million decrease in yard expense, and a $997,000 decrease in professional fees. The decrease in stock compensation expense is primarily due to stock grants with higher grant date fair values becoming fully amortized. The other decreases are due to the overall decrease in activity for the company in the current year.
Interest Expense. Interest expense increased $2.8 million to $7.0 million for the year ended December 31, 2009 from $4.2 million in 2008. The increase is due to a decrease in the capitalization of interest expense related to our rig refurbishment program and an increase in the average outstanding balance under our credit facilities. We did not capitalize any interest in 2009 compared to $1.3 million of interest for the year ended December 31, 2008.
Income Tax Expense. We recorded an income tax benefit of $33.1 million for the year ended December 31, 2009. This compares to an income tax benefit of $5.2 million in 2008. This increase is primarily due to a $77.3 million increase in pre-tax loss to $90.7 million for the year ended December 31, 2009 from $13.4 million in 2008.
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Contract Drilling Revenue. For the year ended December 31, 2008, we reported contract drilling revenues of approximately $247.8 million, a 10% decrease from revenues of $276.1 million for 2007. The decrease is primarily due to decreases in total revenue days, average operating rigs, and average dayrates for the year ended December 31, 2008 as compared to 2007. Revenue days decreased 11% to 12,712 days for the year ended December 31, 2008 from 14,245 days during 2007. Our average number of operating drilling rigs decreased to 44 from 51, or 14%, for the year ended December 31, 2008, as compared to 2007. Average dayrates for our drilling services decreased $239, or 1%, to $17,637 for the year ended December 31, 2008 from $17,876 in 2007. The decrease in the number of revenue days for the year ended December 31, 2008 as compared to 2007 is attributable to the decrease in the size of our drilling fleet due to the contribution and sale of 10 rigs to Challenger during 2008. During the fourth quarter of 2008, the Company recorded $3.6 million of contract drilling revenue related to terminated contracts.
Well Service Revenue. For the year ended December 31, 2008, we reported well service revenues of approximately $33.3 million, a 46% increase from revenues of $22.9 million for 2007. This increase is primarily due to an increase in revenue hours and average revenue per hour for the year ended December 31, 2008 as compared to 2007. Revenue hours increased 44% to 91,591 hours for the year ended December 31, 2008 from 63,746 for 2007. Our average revenue per hour increased 1% to $363 from $359, for the year ended December 31, 2008 as compared to 2007. The increase in revenue hours and the size of our operating workover rig fleet is due to additional workover rigs purchased during 2008 and 2007.
Equity in Income of Challenger. Equity in income of Challenger was $2.2 million for the year ended December 31, 2008. The equity in income of Challenger represents our 25% share of Challenger’s income for 2008. For the year ended December 31, 2008, Challenger had operating revenues of $71.8 million and operating costs of $38.5 million.
Contract Drilling Expense. Contract drilling expense decreased $4.9 million to $148.9 million for the year ended December 31, 2008 from $153.8 million in 2007. This 3% decrease is primarily due to the decrease in the average number of operating drilling rigs in our fleet to 44 for the year ended December 31, 2008 as compared to 51 in 2007. As a percentage of contract drilling revenue, drilling expense increased to 60% for the year ended December 31, 2008 from 56% in 2007 due primarily to a wage increase for field personnel and general increase in the cost of supplies and materials.
Well Service Expense. Well service expense increased $10.2 million to $24.5 million for the year ended December 31, 2008 from $14.3 million for the same period in 2007. This 71% increase is primarily due to the increase in revenue hours and the average hourly operating expense for the year ended December 31, 2008 as compared to the same period in 2007.
Depreciation and Amortization Expense. Depreciation and amortization expense increased $6.2 million to $50.4 million for the year ended December 31, 2008 from $44.2 million in 2007. This increase is primarily due to the 1% increase in fixed assets and an entry to credit depreciation expense in the third quarter of 2007 for $2.1 million related to a change in the depreciable life of certain rig components that moved between working rigs and the yard.
General and Administrative Expense. General and administrative expense increased $11.1 million, or 50%, to $33.8 million for the year ended December 31, 2008 from $22.7 million in 2007. This increase is primarily attributed to the termination fee of $4.5 million paid to Allis-Chalmers Energy, Inc. upon termination of the proposed merger. Professional fees increased $1.4 million and consulting fees expense increased $749,000 primarily due to the terminated merger. The remaining increase is due to an increase in administrative salaries of $2.2 million and stock compensation expense of $2.1 million. The increases in administrative salaries and stock compensation expense are partially due to the grant of additional shares of restricted stock in 2008 and due to the termination of our employment agreement with Larry Bartlett, our former Senior Vice President of Rig Operations, during the third quarter of 2008.
Impairments. In connection with our annual goodwill impairment assessment performed as of December 31, 2008, we performed an impairment test of our contract drilling and well servicing reporting units under the provisions of ASC Topic 350, Goodwill and Other Intangible Assets. Based on the results of the first step on the impairment test, impairment was indicated in both reporting units. Management performed the second step of the analysis of our drilling and well servicing reporting units, allocating the estimated fair value to the identifiable tangible and intangible assets and liabilities of these reporting units based on their respective values. This allocation indicated no residual value for goodwill, and accordingly we recorded an impairment charge of $24.3 million in our December 31, 2008 statement of operations. This impairment charge is not expected to have an impact on our liquidity or debt covenants; however, it is a reflection of the overall downturn in our industry and decline in our projected cash flows.
We reviewed our investment in Challenger at December 31, 2008 for impairment based on the guidance of ASC Topic 323, Investments-Equity Method and Joint Venture, which states that a loss in value of an investment which is other than a temporary decline should be recognized. Fair value of the investment was estimated using a combination of income, or discounted cash flows approach and the market approach, which utilizes comparable companies’ data. The analysis resulted in a fair value of $62.9 million related to our investment in Challenger, which was below the carrying value of the investment and resulted in a non-cash impairment charge in the amount of $14.4 million.
Interest Expense. Interest expense decreased $591,000 to $4.2 million for the year ended December 31, 2008 from $4.8 million in 2007. The decrease is due to the waiver of interest in the amount of $1.0 million related to our use tax liability recorded in 2007 and a decrease in the average interest rate on our revolving credit facility partially offset by a higher outstanding balance on our revolving credit facility and a decrease in the capitalization of interest expense related to our rig refurbishment program. We capitalized $1.3 million of interest for the year ended December 31, 2008 as compared to $1.7 million for the same period in 2007 as part of our rig refurbishment program.
Income Tax Expense. We recorded an income tax benefit of $5.2 million for the year ended December 31, 2008. This compares to an income tax expense of $23.1 million in 2007. This decrease is primarily due to a $74.1 million decrease in pre-tax income to a pre-tax loss of $13.4 million for the year ended December 31, 2008 from pre-tax income of $60.7 million in 2007.
Liquidity and Capital Resources
Operating Activities. Net cash provided by operating activities was $28.1 million for 2009, $59.1 million in 2008 and $82.6 million in 2007. The decrease of $31.0 million from 2008 to 2009 and $23.5 million from 2007 to 2008 was primarily due to a decrease in cash receipts from customers and higher cash payments to employees and suppliers.
Investing Activities. We use a significant portion of our cash flows from operations and financing activities for acquisitions and for the refurbishment of our rigs. Net cash provided by investing activities was $18.2 million for 2009 compared to cash used of $82.8 million for 2008 and $80.0 million for 2007. In 2009, we received $31.7 million from the sale of 60% of the outstanding membership interests in Bronco MX, proceeds of $953,000 from the sale of assets and principal payments on note receivable of $3.1 million, partially offset by $17.6 million used to purchase property and equipment. In 2008, approximately $5.1 million was used to obtain a 25% interest in Challenger, $87.3 million was used to purchase property and equipment, which amounts were partially offset by $6.6 million received from the sale of assets and $2.9 million received from a restricted cash account. In 2007, approximately $2.4 million was used for an acquisition made during 2007 and $82.8 million was used to purchase property and equipment, which amounts were partially offset by $5.1 million received from the sale of assets.
Financing Activities. We used cash for financing activities of $63.4 million for 2009 as compared to cash provided of $44.7 million for 2008 and $7.5 million used in financing activities for 2007. Our net cash used for financing activities for 2009 related to us repaying in full our revolving credit facility with Fortis Bank SA/NV on September 18, 2009 in the amount of $111.1 million, $5.1 million paid to various lenders and debt issue costs of $2.2 million, partially offset by borrowings of $55.0 million under our revolving credit facility with Banco Inbursa. Our net cash provided by financing for 2008 related to borrowings of $51.1 million under our credit facility with Fortis, partially offset by $2.9 million paid to other finance companies and $3.5 million in debt issuance costs. Our net cash used for financing activities for 2007 related to principal payments on borrowings of $17.0 million to Fortis, $5.5 million to Bank of Beaver City and $2.0 million to other finance companies, partially offset by borrowings of $17.0 million under our credit agreement with Fortis.
Sources of Liquidity. Our primary sources of liquidity are cash from operations and borrowings under our credit facilities and equity financing.
Debt Financing. On September 18, 2009, we entered into a new senior secured revolving credit facility (the “Credit Facility”) with Banco Inbursa, as lender and as the issuing bank (“Banco Inbursa”). We utilized (i) borrowings under the Credit Facility, (ii) proceeds from the sale of the membership interests of Bronco MX, and (iii) cash-on-hand to repay all amounts outstanding under our prior revolving credit agreement with Fortis Bank SA/NV, which has been replaced by the Credit Facility.
The Credit Facility provides for revolving advances of up to $75.0 million and matures on September 17, 2014. The borrowing base under the Credit Facility has been initially set at $75.0 million, subject to borrowing base limitations. Outstanding borrowings under the Credit Facility bear interest at the Eurodollar rate plus 5.80% per annum, subject to adjustment under certain circumstances.
We will pay a quarterly commitment fee of 0.5% per annum on the unused portion of the Credit Facility and a fee of 1.50% for each letter of credit issued under the facility. In addition, an upfront fee equal to 1.50% of the aggregate commitments under the Credit Facility was paid by us at closing. Our domestic subsidiaries have guaranteed the loans and other obligations under the Credit Facility. The obligations under the Credit Facility and the related guarantees are secured by a first priority security interest in substantially all of our assets and our domestic subsidiaries, including the equity interests of our direct and indirect subsidiaries.
The Credit Facility contains customary representations and warranties and various affirmative and negative covenants, including, but not limited to, covenants that restrict our ability to make capital expenditures, incur indebtedness, incur liens, dispose of property, repay debt, pay dividends, repurchase shares and make certain acquisitions, and a financial covenant requiring that we maintain a ratio of consolidated debt to consolidated earnings before interest, taxes, depreciation and amortization for any four consecutive fiscal quarters of not more than 3.5 to 1.0. On February 9, 2010, the Company received a waiver from Banco Inbursa for the ratio of consolidated debt to consolidated earnings before interest, taxes, depreciation and amortization through the second quarter of 2010. A violation of these covenants or any other covenant in the Credit Facility could result in a default under the Credit Facility which would permit the lender to restrict our ability to access the Credit Facility and require the immediate repayment of any outstanding advances under the Credit Facility. The Credit Facility also provides for mandatory prepayments in certain circumstances.
In conjunction with our entry into the Credit Facility, we entered into a Warrant Agreement, pursuant to which we, issued a three-year warrant (the “Warrant”) to Banco Inbursa evidencing the right to purchase up to 5,440,770 shares of our common stock, $0.01 par value per share (the “Common Stock”), subject to the terms and conditions set forth in the Warrant, including the limitations on exercise set forth below, at an exercise price of $6.50 per share of Common Stock from the date of issuance of the Warrant (the "Issue Date") through the first anniversary of the Issue Date, $7.00 per share following the first anniversary of the Issue Date through the second anniversary of the Issue Date, and $7.50 per share following the second anniversary of the Issue Date through the third anniversary of the Issue Date. The Warrant may be exercised by the payment of the exercise price in cash or through a cashless exercise whereby we withhold shares issuable under the Warrant having a value equal to the aggregate exercise price.
The exercise price per share and the number of shares of Common Stock for which the Warrant may be exercised are subject to adjustment in the event of any split, subdivision, reclassification, combination or similar transactions affecting the Common Stock. Additionally, in the event that the Warrant is sold and the proceeds per share received by the holder are less than the positive difference of the current market price per share of the Common Stock less the exercise price then in effect, we will be required to pay the seller of the Warrant a make-whole payment equal to such difference. However, our obligations in respect of the make-whole payment only inure to the benefit of Banco Inbursa and other members of the Investor Group (as defined in the Warrant), and not other holders of the Warrant.
The Warrant contains limitations on the number of shares of Common Stock that may be acquired by the holder of the Warrant upon any exercise of the Warrant. Pursuant to the terms of the Warrant, the holder of the Warrant may not exercise the Warrant for a number of shares of Common Stock which will exceed 19.99% of the shares of the Common Stock that are issued and outstanding on the Issue Date (subject to adjustment for stock splits, combinations and similar events). In addition, the number of shares that may be acquired by the holder of the Warrant and its Affiliates (as defined in the Warrant) and any other Person (as defined in the Warrant) whose ownership of Common Stock would be aggregated with the ownership of the holder of the Warrant for purposes of Section 13(d) of the Securities Exchange Act of 1934, as amended, does not exceed 19.99% of the total number of shares of Common Stock that are outstanding immediately after giving effect to such exercise of the Warrant.
In accordance with accounting standards, the proceeds from the revolving credit facility were allocated to the credit facility and Warrant based on their respective fair values. Based on this allocation, $50.3 million and $4.7 million of the net proceeds were allocated to the credit facility and Warrant, respectively. The Warrant has been classified as a liability on the consolidated balance sheet due to our obligation to pay the seller of the Warrant a make-whole payment, in cash, under certain circumstances. The fair value of the Warrant was determined using a pricing model based on a version of the Black Scholes model, which is adjusted to account for the dilution resulting from the additional shares issued for the Warrant. The valuation was determined by computing the value of the Warrant if exercised in Year 1 – 3 with the values weighted by the probability that the Warrant would actually be exercised in that year. Some of the assumptions used in the model were a volatility of 45% and a risk free interest rate that ranged from 0.41% to 1.57%.
The resulting discount to the revolving credit facility will be amortized to interest expense over the term of the revolving credit facility such that, in the absence of any conversions, the carrying value of the revolving credit facility at maturity would be equal to $55.0 million. Accordingly, we will recognize annual interest expense on the debt at an effective interest rate of Eurodollar rate plus 6.25%.
In accordance with accounting standards, we revalued the Warrant as of December 31, 2009 and recorded the change in the fair value of the Warrant on the consolidated statement of operations. The fair value of the Warrant was determined using a pricing model based on a version of the Black Scholes model, which is adjusted to account for the dilution resulting from the additional shares issued for the Warrant. The valuation was determined by computing the value of the Warrant if exercised in Year 1 – 3 with the values weighted by the probability that the warrant would actually be exercised in that year. Some of the assumptions used in the model were a volatility of 45% and a risk free interest rate that ranged from 0.40% to 1.45%. The fair value of the Warrant was $2.8 million at December 31, 2009. We recorded a change in the fair value of the Warrant on the consolidated statement of operations in the amount of $1.9 million for the year ended December 31, 2009.
In conjunction with the issuance of the Warrant, we entered into a Registration Rights Agreement for the benefit of Banco Inbursa and its permitted assignees and transferees. The Registration Rights Agreement provides for up to three demand registration rights and unlimited piggyback registration rights covering the Warrant, the shares of Common Stock for which the Warrant is exercisable and all other shares of Common Stock held by Banco Inbursa and its permitted assignees and transferees. The Registration Rights Agreement provides that we shall pay all fees and expenses incident to the performance of our obligations under the Registration Rights Agreement, including the payment of all filing, registration and qualification fees, printers’ and accounting fees, and expenses and disbursements of counsel and contains other customary terms, provisions and covenants for agreements of this type, including, without limitation, provisions requiring us to provide indemnification arising out of or relating to any untrue or alleged untrue statement of a material fact, or relating to any omission or alleged omission of a material fact required to be stated therein to make the statements therein not misleading, contained in a registration statement, prospectus, free writing prospectus or certain other documents.
The description of the Credit Facility, set forth herein is a summary, is not complete and is qualified in its entirety by reference to the full text of such agreements, which were filed as exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on September 23, 2009.
On January 13, 2006, we entered into our prior $150.0 million revolving credit facility with Fortis Capital Corp., as administrative agent, lead arranger and sole book runner, and a syndicate of lenders. On September 29, 2008, we amended and restated this revolving credit facility. This $150.0 million amended and restated credit facility was with Fortis Bank SA/NV, New York Branch, as administrative agent, joint lead arranger and sole bookrunner, and a syndicate of lenders, which included The Royal Bank of Scotland plc, The CIT Group/Business Credit, Inc., The Prudential Insurance Company of America, Legacy Bank, Natixis and Caterpillar Financial Services Corporation. Loans under the revolving credit facility bore interest at LIBOR plus a 4.0% margin or, at our option, the prime rate plus a 3.0% margin. We incurred $3.5 million in debt issue costs related to the amended and restated credit facility.
The revolving credit facility provided for a quarterly commitment fee of 0.5% per annum of the unused portion of the revolving credit facility, and fees for each letter of credit issued under the facility. Commitment fees expense for the years ended December 31, 2009 and 2008 were $447,000 and $406,000, respectively.
The revolving credit facility was repaid in full on September 18, 2009. We incurred a loss from early extinguishment of debt of approximately $2.9 million.
At December 31, 2008 we were party to term installment loans for an aggregate principal amount of approximately $4.5 million. These term loans are payable in 96 monthly installments, mature in 2013 and 2015 and have a weighted average annual interest rate of 6.93%. The proceeds from these term loans were used to purchase cranes. These loans were paid in full in March of 2009.
We are party to a term loan agreement with Ameritas Life Insurance Corp. for an aggregate principal amount of approximately $1.6 million related to the acquisition of a building. This term loan is payable in 166 monthly installments, matures in 2021 and has an interest rate of 6%.
Issuances of Equity.
In connection with our acquisition of Eagle Well Service, Inc. in January 2007, we issued 1,070,390 shares of our common stock. See “—Capital Expenditures” below. In conjunction with our entry into our senior secured revolving credit facility with Banco Inbursa, we issued a three-year warrant (the “Warrant”) to Banco Inbursa evidencing the right to purchase up to 5,440,770 shares of our common stock, $0.01 par value per share (the “Common Stock”), subject to the terms and conditions set forth in the Warrant. Banco Inbursa subsequently transferred the Warrant to CICSA. Pursuant to the terms of the Warrant, we cancelled the Warrant issued to Banco Inbursa and issued a warrant containing the same terms and provisions to CICSA evidencing such transfer.
Capital Expenditures.
During 2009, we incurred aggregate refurbishment costs of $13.4 million related to enhancements and refurbishments of rigs related to international expansion in Mexico and new opportunities domestically and incurred $2.7 million for the purchase of top drives to upgrade our rig fleet. We also incurred $859,000 in costs related to the refurbishment of workover rigs.
During 2008, we incurred aggregate refurbishment costs of $54.4 million related to newbuilds, enhancements and refurbishments of rigs related to international expansion in Libya and Mexico and new plays domestically. We also incurred $5.1 million in costs related to the purchase and refurbishment of workover rigs.
During 2007 we substantially completed the refurbishment of three rigs, ranging from 1,200 to 1,500 horsepower. We incurred aggregate refurbishment costs of $23.5 million, ranging from $7.0 million to $8.5 million per rig, which were funded with borrowings under our revolving credit facility with Fortis Capital Corp. and cash flow from operations.
On January 2, 2007, we purchased an approximately 18,100 square foot building located in Edmond, Oklahoma for cash of $1.4 million and the assumption of existing debt of approximately $1.6 million, less one-half of the principal reduction on the sellers’ loan secured by the property between the effective date and closing. Prior to closing on the building we subleased a total of 9,050 square feet of the building from its current tenants for a monthly rental of $8,341.
On January 9, 2007, we completed the acquisition of 31workover rigs, 24 of which were operating, from Eagle Well and related subsidiaries for $2.6 million in cash, 1,070,390 shares of our common stock and the assumption of debt of $6.5 million, liabilities of $678,000 and additional deferred income taxes of $7.2 million. We subsequently deployed the remaining rigs periodically during the first nine months of 2007.
Working Capital. Our working capital was $25.3 million at December 31, 2009, compared to $71.6 million at December 31, 2008. Our current ratio, which we calculate by dividing our current assets by our current liabilites, was 2.4 at December 31, 2009 compared to 3.0 at December 31, 2008.
We believe that the liquidity shown on our balance sheet as of December 31, 2009, which includes approximately $25.3 million in working capital (including $9.5 million in cash) and availability under our $75.0 million credit facility of $8.5 million at December 31, 2009 (net of outstanding letters of credit of $11.5 million), together with cash expected to be generated from operations, provides us with sufficient ability to fund our operations for at least the next twelve months. However, additional capital may be required for future rig requirements. While we would expect to fund such acquisitions with additional borrowings and the issuance of debt and equity securities, we cannot assure you that such funding will be available or, if available, that it will be on terms acceptable to us. The changes in the components of our working capital were as follows (amounts in thousands):
| | | December 31, | | | | |
| | | 2009 | | | 2008 | | | Change | |
| Cash and cash equivalents | | $ | 9,497 | | | $ | 26,676 | | | $ | (17,179 | ) |
| Trade and other receivables | | | 15,306 | | | | 62,430 | | | | (47,124 | ) |
| Affiliate receivables | | | 9,620 | | | | 3,387 | | | | 6,233 | |
| Unbilled receivables | | | 828 | | | | 2,940 | | | | (2,112 | ) |
| Income tax receivable | | | 3,800 | | | | 2,072 | | | | 1,728 | |
| Current deferred income taxes | | | 1,360 | | | | 2,844 | | | | (1,484 | ) |
| Current maturities of note receivable | | | 2,000 | | | | 6,900 | | | | (4,900 | ) |
| Prepaid expenses | | | 666 | | | | 572 | | | | 94 | |
| Current assets | | | 43,077 | | | | 107,821 | | | | (64,744 | ) |
| | | | | | | | | | | | | |
| Current debt | | | 89 | | | | 1,464 | | | | (1,375 | ) |
| Accounts Payable | | | 9,756 | | | | 18,473 | | | | (8,717 | ) |
| Accrued liabilities and deferred revenues | | | 7,952 | | | | 16,249 | | | | (8,297 | ) |
| Current liabilities | | | 17,797 | | | | 36,186 | | | | (18,389 | ) |
| | | | | | | | | | | | | |
| Working capital | | $ | 25,280 | | | $ | 71,635 | | | $ | (46,355 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
The decrease in cash and cash equivalents was primarily due to the repayment of our revolving credit facility with Fortis Bank SA/NV, in the amount of $111.1 million, capital expenditures during 2009 in the amount of $17.6 million, $5.1 million paid to various lenders, an increase in affiliate receivables of $6.2 million and a decrease in accounts payable of $8.7 million, partially offset by the reduction in trade and other receivables of $47.1 million, the receipt of $31.7 million in proceeds from CICSA related to the sale of a 60% membership interest in Bronco MX and a $55.0 million draw on our new revolving credit facility with Banco Inbursa.
The decrease in trade receivables and other receivables as well as accounts payable at December 31, 2009 as compared to December 31, 2008 was due to a continued reduction in revenue days and utilization rates during 2009 compared to 2008. Utilization for the year ended December 31, 2009 was 36% compared to 79% for 2008.
The decrease in accrued liabilities was due to a $2.5 million decrease in accrued salaries and related, a decrease in deferred revenue of approximately $2.8 million due to the reduction in the deferral of mobilization revenue, a $1.3 million reduction in accrued interest and a $1.8 million reduction in our workers compensation accrual. The decrease in our deferral of mobilization revenue is due to the reduction in revenue days and utilization rates for the year ended 2009 compared to the year ended 2008.
Contractual and Commercial Commitments
The following table summarizes our contractual obligations and commercial commitments at December 31, 2009 (in thousands):
| | | Payments Due by Period | |
| | | | | | | | | | | | | | | | |
| Contractual Obligations | | Total | | | Less than 1 | | | 1-3 years | | | 4-5 years | | | More than 5 | |
| | | | | | year | | | | | | | | | years | |
| Short and long-term debt | | | 51,903 | | | $ | 89 | | | $ | 301 | | | $ | 50,778 | | | $ | 735 | |
| Interest on long-term debt | | | 16,218 | | | | 3,407 | | | | 10,185 | | | | 2,506 | | | | 120 | |
| Operating lease obligations | | | 2,895 | | | | 913 | | | | 1,681 | | | | 301 | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 71,016 | | | $ | 4,409 | | | $ | 12,167 | | | $ | 53,585 | | | $ | 855 | |
| | | | | | | | | | | | | | | | | | | | | |
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements.
Recent Accounting Pronouncements
The FASB Accounting Standards Codification. FASB Accounting Standards Codification (ASC) became effective for this quarterly report. ASC Topic 105, Generally Accepted Accounting Principles establishes the ASC as the single source of authoritative U.S. generally accepted accounting principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. The ASC supersedes all existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the ASC will become nonauthoritative. Following ASC Topic 105, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, the FASB will issue Accounting Standards Updates, which will serve only to: (a) update the ASC, (b) provide background information about the guidance; and (c) provide the basis for conclusions on the change(s) in the ASC. The adoption of this standard has changed how we reference various elements of U.S. GAAP in our financial statement disclosures, but has no impact on our financial position, results of operation or cash flows.
In September 2006, the FASB issued an accounting standard that defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. The initial application of this standard was limited to financial assets and liabilities and became effective on January 1, 2008. On January 1, 2009 we adopted this standard on a prospective basis for non-financial assets and liabilities not measured at fair value on a recurring basis. The application of this standard to our non-financial assets and liabilities is primarily limited to assets acquired and liabilities assumed in a business combination, asset retirement obligations and asset impairments, including goodwill and long lived assets and has not had a material impact on our financial position, results of operations or cash flows.
In December 2007, the FASB issued a new accounting standard that calls for significant changes from then current practice in accounting for business combinations. The standard establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The standard also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The standard applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this standard did not have an immediate impact on our financial position, results of operations or cash flows.
In December 2007, the FASB issued a new accounting standard which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The standard requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of this standard shall be applied prospectively. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The provisions of this standard were applied to the Company’s accounting for the sale of 60% of the membership interests in Bronco MX. See Note 2, Equity Method Investments, regarding the $23,705 loss on the Bronco MX transaction.
In June 2008, the FASB issued a new accounting standard which provides that unvested share-based payment awards that contain nonforfeitable rights to dividends are participating securities and shall be included in the computation of earnings per share pursuant to the two class method. This standard is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. The adoption of this standard did not have a material impact on our consolidated financial statements s.
In April 2009, the FASB issued a staff position which increases the frequency of fair value disclosures for financial instruments from annual only to quarterly reporting periods. The provisions of this staff position are effective for financial statements issued for interim and annual periods ending after June 15, 2009 and became effective for us in the quarter ended June 30, 2009. The adoption of this staff position did not have a material impact on our consolidated financial statements.
We are subject to market risk exposure related to changes in interest rates on our outstanding floating rate debt. Borrowings under our revolving credit facility bear interest at a floating rate equal to LIBOR plus a margin of 5.80%. An increase or decrease of 1% in the interest rate would have a corresponding decrease or increase in our net income (loss) of approximately $337,000 annually, based on the $55.0 million outstanding in the aggregate under our credit facility as of December 31, 2009.
Our Financial Statements begin on page 32 of this Form 10-K, Index to Consolidated Financial Statements, and are incorporated herein by this reference.
None.
Evaluation of Disclosure Control and Procedures.
As of the end of the period covered by this Annual Report on Form 10−K, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a−15(e) or 15d−15(e) under the Securities Exchange Act of 1934, as amended). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2009 our disclosure controls and procedures are effective.
Disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms; and include controls and procedures designed to ensure that information is accumulated and communicated to our management, and made known to our Chief Executive Officer and Chief Financial Officer, particularly during the period when this Annual Report on Form 10−K was prepared, as appropriate to allow timely decision regarding the required disclosure.
Management's Report on Internal Control over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a−15(f) and 15d−15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes those policies and procedures that:
| | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of our company; |
| | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and our Board of Directors; and |
| | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted its evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Although there are inherent limitations in the effectiveness of any system of internal controls over financial reporting, based on our evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2009.
The independent registered public accounting firm that audited the Company's financial statements, Grant Thornton LLP, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting. This report appears below.
Changes in Internal Controls over Financial Reporting.
There were no changes in internal control over financial reporting during the fourth quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting
Report of Independent Registered Public Accounting Firm
Board of Directors
Bronco Drilling Company, Inc.
We have audited the internal control over financial reporting of Bronco Drilling Company, Inc. and Subsidiaries (the "Company") as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’equity and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 2009 and our report dated March 12, 2010 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
March 12, 2010
On November 13, 2009, our annual meeting of stockholders was held in Duncan, Oklahoma. A total of 24,147,646 of our shares of common stock were present or represented by proxy at the annual meeting. This represented more than 88% of our shares outstanding on the record date. At the meeting, our stockholders voted on the election of five persons to serve as our directors. Each of the five nominees, D. Frank Harrison, Dr. Gary C. Hill, David W. House, David L. Houston and William R. Snipes, was elected as a director to serve until our next annual meeting of stockholders and until his successor is duly elected and qualified. The results of the tabulation of the votes cast at our annual meeting are as follows:
Proposal – Election of Directors Name | | For (#) | | Withheld (#) |
D. Frank Harrison | | 23,777,495 | | 370,151 |
| Dr. Gary C. Hill | | 20,794,227 | | 3,353,419 |
| David W. House | �� | 20,803,676 | | 3,343,970 |
| David L. Houston | | 23,622,936 | | 524,710 |
| William R. Snipes | | 21,057,047 | | 3,090,599 |
The information relating to this Item 10 is incorporated by reference to either the Proxy Statement for our 2010 Annual Meeting of Stockholders or an amendment to this Form 10-K, which will be filed with the SEC no later than 120 days after December 31, 2009.
The information relating to this Item 11 is incorporated by reference to either the Proxy Statement for our 2010 Annual Meeting of Stockholders or an amendment to this Form 10-K, which will be filed with the SEC no later than 120 days after December 31, 2009.
The information relating to this Item 12 is incorporated by reference to either the Proxy Statement for our 2010 Annual Meeting of Stockholders or an amendment to this Form 10-K, which will be filed with the SEC no later than 120 days after December 31, 2009.
The information relating to this Item 13 is incorporated by reference to either the Proxy Statement for our 2010 Annual Meeting of Stockholders, or an amendment to this Form 10-K, which will be filed with the SEC no later than 120 days after December 31, 2009.
The information relating to this Item 14 is incorporated by reference to either the Proxy Statement for our 2010 Annual Meeting of Stockholders, or an amendment to this Form 10-K, which will be filed with the SEC no later than 120 days after December 31, 2009.
(a) The following documents are filed as part of this report:
See Index to Consolidated Financial Statements on page 30 of this Form 10-K.
| | 2. | Financial Statement Schedules |
Schedule II
The following exhibits are filed as part of this report or, where indicated, were previously filed and are hereby incorporated by reference.
60;
| 2.1 | Merger Agreement, dated as of August 11, 2005, by and among Bronco Drilling Holdings, L.L.C, Bronco Drilling Company, L.L.C. and Bronco Drilling Company, Inc. (incorporated by reference to Exhibit 2.1 to the Registration Statement on Form S-1, File No. 333-128861, filed by the Company with the SEC on October 6, 2005). |
| | 2.2 | Agreement and Plan of Merger by and among the Company, BDC Acquisition Company, Eagle Well Service, Inc. (“Eagle”), and the stockholders of Eagle dated as of January 9, 2007 (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, File No. 000-51571, filed by the Company with the SEC on January 16, 2007). |
| 2.3 | First Amendment, dated as of June 1, 2008, to Agreement and Plan of Merger by and among Allis-Chalmers Energy, Inc., Bronco Drilling Company, Inc. and Elway Merger Sub, Inc. (incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K, File No. 000-51471, filed by the Company with the SEC on June 2, 2008). |
| 2.4 | Agreement and Plan of Merger by and among the Company, BDC Acquisition Company, Eagle Well Service, Inc. (“Eagle”), and the stockholders of Eagle dated as of January 9, 2007 (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, File No. 000-51571, filed by the Company with the SEC on January 16, 2007). |
| 2.5 | Membership Interest Purchase Agreement, dated September 18, 2009, by and among Bronco Drilling Company, Inc., Saddleback Properties LLC and Carso Infraestructura y Construccion, S.A.B. de C.V. (incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K, File No. 000-51471, filed by the Company with the SEC on September 23, 2009). |
| 3.1 | Amended and Restated Certificate of Incorporation of the Company, dated August 11, 2005 (incorporated by reference to Exhibit 2.1 to the Registration Statement on Form S-1, File No. 333-128861, filed by the Company with the SEC on October 6, 2005). |
| 3.2 | Bylaws of the Company (incorporated by reference to Exhibit 3.2 to Amendment No. 1 to the Registration Statement on Form S-1, File No. 333-125405, filed by the Company with the SEC on July 14, 2005). |
| 4.1 | Form of Common Stock certificate (incorporated by reference to Exhibit 4.1 to Amendment No. 2 to the Registration Statement on Form S-1, File No. 333-125405, filed by the Company with the SEC on August 2, 2005). |
| 10.1 | Credit Agreement, dated September 18, 2009, by and among Bronco Drilling Company, Inc., certain subsidiaries of Bronco Drilling Company, Inc., as guarantors, and Banco Inbursa S.A., Institución de Banca Múltiple, Grupo Financiero Inbursa, as lender and as the issuing bank (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K, File No. 000-51471, filed by the Company with the SEC on September 23, 2009). |
| 10.2 | Warrant Agreement, dated September 18, 2009, by and among Bronco Drilling Company, Inc. and Banco Inbursa S.A., Institución de Banca Múltiple, Grupo Financiero Inbursa (incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K, File No. 000-51471, filed by the Company with the SEC on September 23, 2009). |
| 10.3 | Warrant No. W-1, dated September 18, 2009, by and among Bronco Drilling Company, Inc. and Banco Inbursa S.A., Institución de Banca Múltiple, Grupo Financiero Inbursa (incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K, File No. 000-51471, filed by the Company with the SEC on September 23, 2009). |
| 10.4 | Registration Rights Agreement, dated September 18, 2009, by and among Bronco Drilling Company, Inc., Banco Inbursa S.A., Institución de Banca Múltiple, Grupo Financiero Inbursa (incorporated by reference to Exhibit 10.4 to the Current Report on Form 8-K, File No. 000-51471, filed by the Company with the SEC on September 23, 2009). |
| | Amended and Restated Employment Agreement, dated January 6, 2010, by and between the Company and Matthew S. Porter. |
| | Warrant No. W-2, dated September 18, 2009, by and among Bronco Drilling Company, Inc. and Carso Infraestructura y Construcción, S.A.B. de C.V. |
| | Waiver Letter, dated February 9, 2010, by and between Bronco Drilling Company, Inc. and Banco Inbursa S.A., Institución de Banca Múltiple, Grupo Financiero Inbursa (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K, File No. 000-51471, filed by the Company with the SEC on February 16, 2010) |
| | Bronco Drilling Company, Inc. 2008 Stock Incentive Plan (incorporated by reference to Appendix B to the Company’s Proxy Statement, filed by the Company with the SEC on April 28, 2008). |
| | Form of Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, File No. 000-51571, filed by the Company with the SEC on June 15, 2008). |
| | Form of Stock Option Agreement (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K, File No. 000-51571, filed by the Company with the SEC on June 15, 2008). |
| | List of the Company’s Subsidiaries. |
| | Consent of Grant Thornton LLP |
| | Power of Attorney (included on signature page). |
| | Certification of Chief Executive Officer of Bronco Drilling Company, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended. |
| | Certification of Chief Financial Officer of Bronco Drilling Company, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended |
| | Certification of Chief Executive Officer of Bronco Drilling Company, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code. |
| | Certification of Chief Financial Officer of Bronco Drilling Company, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code. |
| | + Management contract, compensatory plan or arrangement |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
BRONCO DRILLING COMPANY, INC. AND SUBSIDIARIES
| | |
| | Page |
| Bronco Drilling Company, Inc. and Subsidiaries | |
| 31 |
| 32 |
| 33 |
| 34 |
| 35 |
| 36 |
Board of Directors
Bronco Drilling Company, Inc.
We have audited the accompanying consolidated balance sheets of Bronco Drilling Company, Inc. and Subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’equity and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bronco Drilling Company, Inc. and Subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 12, 2010 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
March 12, 2010
| |
| |
| (Amounts in thousands, except share par value) | |
| | | | | | | |
| | | December 31, | |
| | | 2009 | | | 2008 | |
| ASSETS | | | | | | |
| | | | | | | |
| CURRENT ASSETS | | | | | | |
| Cash and cash equivalents | | $ | 9,497 | | | $ | 26,676 | |
| Receivables | | | | | | | | |
| Trade and other, net of allowance for doubtful accounts of | | | | | | | | |
| $3,576 and $3,830 in 2009 and 2008, respectively | | | 15,306 | | | | 62,430 | |
| Affiliate receivables | | | 9,620 | | | | 3,387 | |
| Unbilled receivables | | | 828 | | | | 2,940 | |
| Income tax receivable | | | 3,800 | | | | 2,072 | |
| Current deferred income taxes | | | 1,360 | | | | 2,844 | |
| Current maturities of note receivable from affiliate | | | 2,000 | | | | 6,900 | |
| Prepaid expenses | | | 666 | | | | 572 | |
| | | | | | | | | |
| Total current assets | | | 43,077 | | | | 107,821 | |
| | | | | | | | | |
| PROPERTY AND EQUIPMENT - AT COST | | | | | | | | |
| Drilling rigs and related equipment | | | 440,760 | | | | 512,158 | |
| Transportation, office and other equipment | | | 42,354 | | | | 43,912 | |
| | | | 483,114 | | | | 556,070 | |
| Less accumulated depreciation | | | 145,918 | | | | 123,915 | |
| | | | 337,196 | | | | 432,155 | |
| | | | | | | | | |
| OTHER ASSETS | | | | | | | | |
| Note receivable from affiliate, less current maturities | | | 517 | | | | 3,451 | |
| Investment in Challenger | | | 39,714 | | | | 62,875 | |
| Investment in Bronco MX | | | 21,407 | | | | - | |
| Intangibles, net, and other | | | 3,672 | | | | 6,052 | |
| | | | 65,310 | | | | 72,378 | |
| | | | | | | | | |
| | | $ | 445,583 | | | $ | 612,354 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| | | | | | | | | |
| CURRENT LIABILITIES | | | | | | | | |
| Accounts payable | | $ | 9,756 | | | $ | 18,473 | |
| Accrued liabilities | | | 7,952 | | | | 16,249 | |
| Current maturities of long-term debt | | | 89 | | | | 1,464 | |
| | | | | | | | | |
| Total current liabilities | | | 17,797 | | | | 36,186 | |
| | | | | | | | | |
| LONG-TERM DEBT, less current maturities and discount | | | 51,814 | | | | 116,083 | |
| | | | | | | | | |
| WARRANT | | | 2,829 | | | | - | |
| | | | | | | | | |
| DEFERRED INCOME TAXES | | | 32,872 | | | | 66,074 | |
| | | | | | | | | |
| COMMITMENTS AND CONTINGENCIES (Note 8) | | | | | | | | |
| | | | | | | | | |
| STOCKHOLDERS' EQUITY | | | | | | | | |
| Common stock, $.01 par value, 100,000 | | | | | | | | |
| shares authorized; 26,713 and 26,346 shares | | | | | | | | |
| issued and outstanding at December 31, 2009 and 2008 | | | 270 | | | | 267 | |
| | | | | | | | | |
| Additional paid-in capital | | | 307,313 | | | | 304,015 | |
| | | | | | | | | |
| Accumulated other comprehensive income | | | 538 | | | | - | |
| | | | | | | | | |
| Retained earnings | | | 32,150 | | | | 89,729 | |
| Total stockholders' equity | | | 340,271 | | | | 394,011 | |
| | | | | | | | | |
| | | $ | 445,583 | | | $ | 612,354 | |
| | | | | | | | | |
| The accompanying notes are an integral part of these statements. | |
| | | | | | | | | |
| | | | | | | | | |
| |
| CONSOLIDATED STATEMENTS OF OPERATIONS | |
| (Amounts in thousands, except per share amounts) | |
| | | | | | | | | | |
| | | Years Ended December 31, | |
| | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | |
| REVENUES | | | | | | | | | |
| Contract drilling revenues, including 0%, 2% and 1% | | | | | | | | | |
| to related parties | | $ | 106,738 | | | $ | 247,829 | | | $ | 276,088 | |
| Well service, including 0%, 2% and 0% | | | | | | | | | | | | |
| to related parties | | | 3,799 | | | | 33,284 | | | | 22,864 | |
| | | | 110,537 | | | | 281,113 | | | | 298,952 | |
| EXPENSES | | | | | | | | | | | | |
| Contract drilling | | | 75,996 | | | | 148,866 | | | | 153,797 | |
| Well service | | | 4,267 | | | | 24,478 | | | | 14,299 | |
| Depreciation and amortization | | | 45,674 | | | | 50,388 | | | | 44,241 | |
| General and administrative | | | 19,777 | | | | 33,771 | | | | 22,690 | |
| Impairment of goodwill | | | - | | | | 24,328 | | | | - | |
| Gain on Challenger transactions | | | - | | | | (3,138 | ) | | | - | |
| Loss on Bronco MX transaction | | | 23,705 | | | | - | | | | - | |
| | | | 169,419 | | | | 278,693 | | | | 235,027 | |
| | | | | | | | | | | | | |
| Income (loss) from operations | | | (58,882 | ) | | | 2,420 | | | | 63,925 | |
| | | | | | | | | | | | | |
| OTHER INCOME (EXPENSE) | | | | | | | | | | | | |
| Interest expense | | | (7,038 | ) | | | (4,171 | ) | | | (4,762 | ) |
| Loss from early extinguishment of debt | | | (2,859 | ) | | | (155 | ) | | | - | |
| Interest income | | | 274 | | | | 1,058 | | | | 1,239 | |
| Equity in income (loss) of Challenger | | | (1,914 | ) | | | 2,186 | | | | - | |
| Equity in income (loss) of Bronco MX | | | (588 | ) | | | - | | | | - | |
| Impairment of investment in Challenger | | | (21,247 | ) | | | (14,442 | ) | | | - | |
| Other | | | (284 | ) | | | (300 | ) | | | 294 | |
| Change in fair value of warrant | | | 1,850 | | | | - | | | | - | |
| | | | (31,806 | ) | | | (15,824 | ) | | | (3,229 | ) |
| Income (loss) before income taxes | | | (90,688 | ) | | | (13,404 | ) | | | 60,696 | |
| Income tax expense (benefit) | | | (33,109 | ) | | | (5,161 | ) | | | 23,104 | |
| | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | (57,579 | ) | | $ | (8,243 | ) | | $ | 37,592 | |
| | | | | | | | | | | | | |
| Income (loss) per common share-Basic | | $ | (2.16 | ) | | $ | (0.31 | ) | | $ | 1.45 | |
| | | | | | | | | | | | | |
| Income (loss) per common share-Diluted | | $ | (2.16 | ) | | $ | (0.31 | ) | | $ | 1.44 | |
| | | | | | | | | | | | | |
| Weighted average number of shares outstanding-Basic | | | 26,651 | | | | 26,293 | | | | 25,996 | |
| | | | | | | | | | | | | |
| Weighted average number of shares outstanding-Diluted | | | 26,651 | | | | 26,293 | | | | 26,101 | |
| | | | | | | | | | | | | |
| The accompanying notes are an integral part of these statements. | |
| |
| CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) | |
| (Amounts in thousands) | |
| | | | | | | | | | | | Accumulated | | | | | | | |
| | | | | | | | | Additional | | | Other | | | | | | Total | |
| | | Common | | | Common | | | Paid In | | | Comprehensive | | | Retained | | | Stockholders' | |
| | | Shares | | | Amount | | | Capital | | | Income | | | Earnings | | | Equity | |
| Balance as of December 31, 2006 | | | 24,938 | | | | 250 | | | | 279,355 | | | | - | | | | 60,380 | | | | 339,985 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock issued in acquisition | | | 1,070 | | | | 10 | | | | 15,114 | | | | - | | | | - | | | | 15,124 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | - | | | | - | | | | 37,592 | | | | 37,592 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock compensation | | | 23 | | | | 2 | | | | 3,726 | | | | - | | | | - | | | | 3,728 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance as of December 31, 2007 | | | 26,031 | | | | 262 | | | | 298,195 | | | | - | | | | 97,972 | | | | 396,429 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | - | | | | (8,243 | ) | | | (8,243 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock compensation | | | 315 | | | | 5 | | | | 5,820 | | | | - | | | | - | | | | 5,825 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance as of December 31, 2008 | | | 26,346 | | | | 267 | | | | 304,015 | | | | - | | | | 89,729 | | | | 394,011 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | - | | | | - | | | | - | | | | - | | | | (57,579 | ) | | | (57,579 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Other Comprehensive Income: | | | | | | | | | | | | | | | | | | | | | | | | |
| Foreign currency translation adjustment | | | - | | | | - | | | | - | | | | 538 | | | | - | | | | 538 | |
| Total Comprehensive Income (Loss) | | | | | | | | | | | | | | | | | | | | | | | (57,041 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock compensation | | | 367 | | | | 3 | | | | 3,298 | | | | - | | | | - | | | | 3,301 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance as of December 31, 2009 | | | 26,713 | | | $ | 270 | | | $ | 307,313 | | | $ | 538 | | | $ | 32,150 | | | $ | 340,271 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| The accompanying notes are an integral part of these statements. | |
| |
| CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| (Amounts in thousands) | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | Years Ended December 31, | |
| | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | |
| Net income (loss) | | $ | (57,579 | ) | | $ | (8,243 | ) | | $ | 37,592 | |
| Adjustments to reconcile net income (loss) to net cash | | | | | | | | | | | | |
| provided by operating activities: | | | | | | | | | | | | |
| Depreciation and amortization | | | 46,436 | | | | 51,044 | | | | 44,826 | |
| Bad debt expense | | | 2,134 | | | | 3,745 | | | | 4,370 | |
| Loss (gain) on sale of assets | | | 412 | | | | 426 | | | | (1,589 | ) |
| Gain on Challenger transactions | | | - | | | | (3,138 | ) | | | - | |
| Equity in loss (income) of Challenger | | | 1,914 | | | | (2,186 | ) | | | - | |
| Equity in loss (income) of Bronco MX | | | 588 | | | | - | | | | - | |
| Change in fair value of warrant | | | (1,850 | ) | | | - | | | | - | |
| Loss on Bronco MX transaction | | | 23,705 | | | | - | | | | - | |
| Write off of debt issue costs | | | 2,859 | | | | 155 | | | | - | |
| Imputed interest expense | | | 224 | | | | - | | | | - | |
| Stock compensation | | | 3,301 | | | | 5,825 | | | | 3,728 | |
| Impairment of goodwill | | | - | | | | 24,328 | | | | - | |
| Impairment of investment in Challenger | | | 21,247 | | | | 14,442 | | | | - | |
| Provision for deferred income taxes | | | (31,717 | ) | | | (4,122 | ) | | | 17,648 | |
| Changes in current assets and liabilities, net of assets and liabilities of business acquired: | | | | | | | | | | | | |
| Receivables | | | 43,517 | | | | (9,274 | ) | | | (3,920 | ) |
| Affiliate receivables | | | (6,233 | ) | | | - | | | | - | |
| Unbilled receivables | | | 2,112 | | | | (813 | ) | | | (139 | ) |
| Prepaid expenses | | | (94 | ) | | | 131 | | | | (176 | ) |
| Other assets | | | 241 | | | | 720 | | | | (417 | ) |
| Accounts payable | | | (13,142 | ) | | | (9,673 | ) | | | (15,831 | ) |
| Accrued expenses | | | (8,297 | ) | | | (3,030 | ) | | | 1,430 | |
| Income taxes receivable | | | (1,730 | ) | | | (1,237 | ) | | | (4,915 | ) |
| | | | | | | | | | | | | |
| Net cash provided by operating activities | | | 28,048 | | | | 59,100 | | | | 82,607 | |
| | | | | | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | | | | | |
| Restricted cash account | | | - | | | | 2,899 | | | | 145 | |
| Business acquisitions, net of cash acquired | | | - | | | | (5,063 | ) | | | (2,431 | ) |
| Principal payments received on note receivable | | | 3,065 | | | | - | | | | - | |
| Proceeds from sale of assets | | | 32,688 | | | | 6,643 | | | | 5,084 | |
| Purchase of property and equipment | | | (17,559 | ) | | | (87,274 | ) | | | (82,782 | ) |
| | | | | | | | | | | | | |
| Net cash provided by (used in) investing activities | | | 18,194 | | | | (82,795 | ) | | | (79,984 | ) |
| | | | | | | | | | | | | |
| Cash flows from financing activities: | | | | | | | | | | | | |
| Proceeds from borrowings and warrant | | | 55,000 | | | | 51,100 | | | | 17,000 | |
| Payments of debt | | | (116,189 | ) | | | (2,949 | ) | | | (24,510 | ) |
| Debt issue costs | | | (2,232 | ) | | | (3,501 | ) | | | - | |
| | | | | | | | | | | | | |
| Net cash provided by (used in) financing activities | | | (63,421 | ) | | | 44,650 | | | | (7,510 | ) |
| | | | | | | | | | | | | |
| Net increase (decrease) in cash and cash equivalents | | | (17,179 | ) | | | 20,955 | | | | (4,887 | ) |
| | | | | | | | | | | | | |
| Beginning cash and cash equivalents | | | 26,676 | | | | 5,721 | | | | 10,608 | |
| | | | | | | | | | | | | |
| Ending cash and cash equivalents | | $ | 9,497 | | | $ | 26,676 | | | $ | 5,721 | |
| | | | | | | | | | | | | |
| Supplmentary disclosure of cash flow information | | | | | | | | | | | | |
| Interest paid, net of amount capitalized | | $ | 11,549 | | | $ | 2,704 | | | $ | 3,250 | |
| Income taxes paid | | | 337 | | | | 198 | | | | 10,373 | |
| Supplementary disclosure of non-cash investing and financing: | | | | | | | | | | | | |
| Liabilities assumed in acquisition | | $ | - | | | $ | - | | | $ | 7,867 | |
| Common stock issued for acquisition | | | - | | | | - | | | | 15,124 | |
| Debt assumed in acquisition | | | - | | | | - | | | | 6,527 | |
| Note issued for acquisition of property and equipment | | | - | | | | 1,277 | | | | 4,386 | |
| Assets exchanged/sold for equity interest and note receivable | | | - | | | | 72,503 | | | | - | |
| Common stock received for payment of receivable | | | - | | | | 1,900 | | | | - | |
| Purchase of property and equipment in accounts payable | | | 4,425 | | | | 11,430 | | | | - | |
| Reduction of receivable for property and equipment | | | 5,040 | | | | - | | | | - | |
| Reduction of debt for warrants issued | | | 4,679 | | | | - | | | | - | |
| Assets contributed to Bronco MX | | | 77,194 | | | | - | | | | - | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| The accompanying notes are an integral part of these statements. | | | | | |
| | | | | | | | | | | | | |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ Amounts in thousands, except per share amounts)
1. Organization and Summary of Significant Accounting Policies
Business and Principles of Consolidation
Bronco Drilling Company, Inc. (the “Company”) provides contract land drilling and workover services to oil and natural gas exploration and production companies. The accompanying consolidated financial statements include the Company’s accounts and the accounts of its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
The Company has prepared the consolidated financial statements and related notes in accordance with accounting principles generally accepted in the United States of America. In preparing the financial statements, the Company made various estimates and assumptions that affect the amounts of assets and liabilities the Company reports as of the dates of the balance sheets and amounts the Company reports for the periods shown in the consolidated statements of operations, stockholders’ equity and cash flows. The Company’s actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the Company’s recognition of revenues and accrued expenses, estimate of the allowance for doubtful accounts, estimate of asset impairments, estimate of deferred taxes and determination of depreciation and amortization expense.
A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with a maturity of three months or less when acquired and money market mutual funds to be cash equivalents.
The Company maintains its cash and cash equivalents in accounts and instruments that may not be federally insured beyond certain limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risks on cash and cash equivalents.
Foreign Currency
The U.S. dollar is the functional currency for the Company’s consolidated operations. However, the Company has an equity investment in a Mexican entity whose functional currency is the peso. The assets and liabilities of the Mexican investment are translated into U.S. dollars based on the current exchange rate in effect at the balance sheet dates. Mexican income and expenses are translated at average rates for the periods presented. Translation adjustments have no effect on net income and are included in accumulated other comprehensive income in stockholders’ equity.
Revenue Recognition
Contract Land Drilling Segment - The Company earns contract drilling revenue under daywork and footage contracts.
Revenues on daywork contracts are recognized based on the days completed at the dayrate each contract specifies. Mobilization revenues and costs for daywork contracts are deferred and recognized over the days of actual drilling.
The Company follows the percentage-of-completion method of accounting for footage contract drilling arrangements. Under this method, drilling revenues and costs related to a well in progress are recognized proportionately over the time it takes to drill the well. Percentage-of-completion is determined based upon the amount of expenses incurred through the measurement date as compared to total estimated expenses to be incurred drilling the well. Mobilization costs are not included in costs incurred for percentage-of-completion calculations. Mobilization costs on footage contracts are deferred and recognized over the days of actual drilling. Under the percentage-of-completion method, management estimates are relied upon in the determination of the total estimated expenses to be incurred drilling the well. When estimates of revenues and expenses indicate a loss on a contract, the total estimated loss is accrued.
Revenue arising from claims for amounts billed in excess of the contract price or for amounts not included in the original contract are recognized when billed less any allowance for uncollectibility. Revenue from such claims is only recognized if it is probable that the claim will result in additional revenue, the costs for the additional services have been incurred, management believes there is a legal basis for the claim and the amount can be reliably estimated. Revenue from such claims are recorded only to the extent that contract costs relating to the claim have been incurred. Historically we have not billed any customers for amounts not included in the original contract.
Well Servicing Segment – The Company earns well servicing revenue based on purchase orders, contracts or other persuasive evidence of an arrangement with the customer, such as a master service agreement, that include fixed or determinable prices. The well servicing revenues are recognized when the services have been rendered and collectability is reasonably assured.
The asset “unbilled receivables” represents revenues we have recognized in excess of amounts billed on drilling contracts and well servicing in progress.
Accounts Receivable
The Company records trade accounts receivable at the amount invoiced to customers. Substantially all of the Company’s accounts receivable are due from companies in the oil and gas industry. Credit is extended based on evaluation of a customer’s financial condition and, generally, collateral is not required. Accounts receivable are due within 30 days and are stated at amounts due from customers, net of an allowance for doubtful accounts when the Company believes collection is doubtful. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company and the condition of the general economy and the industry as a whole. The Company writes off specific accounts receivable when they become uncollectible and payments subsequently received on such receivables reduce the allowance for doubtful accounts. At December 31, 2009 and 2008, our allowance for doubtful accounts was $3,576 and $3,830, respectively.
Prepaid Expenses
Prepaid expenses include items such as insurance and fees. The Company routinely expenses these items in the normal course of business over the periods these expenses benefit.
Property and Equipment
Property and equipment, including renewals and betterments, are capitalized and stated at cost, while maintenance and repairs are expensed currently. Assets are depreciated on a straight-line basis. The depreciable lives of drilling and workover rigs and related equipment are three to 15 years. The depreciable life of other equipment is three years. Depreciation is not commenced until acquired rigs are placed in service. Once placed in service, depreciation continues when rigs are being repaired, refurbished or between periods of deployment. Assets not placed in service and not being depreciated were $26,038 and $34,293 as of December 31, 2009 and 2008, respectively. Due to immateriality, gains and losses on dispositions, with the exception of the Challenger and Bronco MX transactions are included in contract drilling and well service revenues.
The Company capitalizes interest as a component of the cost of drilling and workover rigs constructed for its own use. For the years ended December 31, 2009 and 2008, the Company capitalized $0 and $1,256, respectively, of interest costs incurred during the construction periods of certain drilling and workover rigs.
The Company evaluates for potential impairment of long-lived assets and intangible assets subject to amortization when indicators of impairment are present, as defined in ASC Topic 360, Accounting for the Impairment or Disposal of Long-Lived Assets. Circumstances that could indicate a potential impairment include significant adverse changes in industry trends, economic climate, legal factors, and an adverse action or assessment by a regulator. More specifically, significant adverse changes in industry trends include significant declines in revenue rates, utilization rates, oil and natural gas market prices and industry rig counts for drilling rigs and workover rigs. In performing an impairment evaluation, the Company estimated the future undiscounted net cash flows from the use and eventual disposition of long-lived assets and intangible assets grouped at the lowest level that cash flows can be identified. If the sum of the estimated future undiscounted net cash flows is less than the carrying amount of the long-lived assets and intangible assets for these asset grouping levels, then the Company would recognize an impairment charge. The amount of an impairment charge would be measured as the difference between the carrying amount and the fair value of these assets. The Company did not record an impairment charge on any long-lived assets for our contract land drilling or well servicing segments for the year ended December 31, 2009. The assumptions used in the impairment evaluation for long-lived assets and intangible assets are inherently uncertain and require management judgment.
Goodwill
The Company evaluates the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value below its carrying amount. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, the Company compares its fair value to its carrying amount, including goodwill. Fair value is estimated using a combination of income, or discounted cash flows approach and the market approach, which utilizes comparable companies’ data. If the carrying amount exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of goodwill, the fair value of the Company is allocated to all of its other assets and liabilities based on their fair values. The excess of the fair value of the Company over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value.
Goodwill impairment testing is performed at the level of the Company’s reporting units under the provisions of ASC Topic 350, Goodwill and Other Intangible Assets. The Company’s reporting units have been determined to be the same as our operating segments, contract land drilling and well servicing. In the Company’s testing of possible impairment of goodwill, we compared the fair value of the reporting units with their carrying value. If the fair value exceeds the carrying value, no impairment is indicated. If the carrying value exceeds the fair value, we measure any impairment of goodwill in that reporting unit by allocating the fair value to the identifiable assets and liabilities of the reporting unit based on their respective fair values. Any excess un-allocated fair value would equal the implied fair value of goodwill, and if that amount is below the carrying value of goodwill, an impairment charge is recognized.
In completing the first step of the goodwill impairment analysis during the fourth quarter of 2008, management used a five-year projection of discounted cash flows, plus a terminal value determined using a constant growth method to estimate the fair value of reporting units. In developing these fair value estimates, certain key assumptions included an assumed discount rate of 11.0% and 14.0% for our contract land drilling and well servicing segments, respectively, and an assumed long-term growth rate of 2.0% for both reporting units.
Based on the results of the first step of the goodwill impairment test, impairment was indicated in both reporting units. Management performed the second step of the analysis of its drilling and well servicing reporting units, allocating the estimated fair value to the indentifiable tangible and intangible assets and liabilities of these reporting units based on their respective values. This allocation indicated no residual value for goodwill, and accordingly we recorded an impairment charge of $24,328 million in our December 31, 2008 statement of operations. This impairment charge did not have an impact on the Company’s liquidity or debt covenants; however, it was a reflection of the overall downturn in our industry and decline in the Company’s projected cash flows.
Intangibles, Net and Other
Intangibles, restricted cash and other assets consist of intangibles related to acquisitions, net of amortization, cash deposits related to the deductibles on the Company’s workers compensation insurance policies and debt issue costs, net of amortization. The Company follows Statement ASC Topic 323, “Intangibles – Goodwill and Other” to account for amortizable intangibles. Intangible assets that are acquired either individually or with a group of other assets are recognized based on its fair value and amortized over its useful life. The Company’s amortizable intangibles consist entirely of customer lists and relationships obtained through acquisitions. Customer lists and relationships are amortized over their estimated benefit period of four years. Depreciation and amortization expense includes amortization of intangibles of $751, $974, and $919 for the years ended December 31, 2009, 2008, and 2007, respectively. Total cost and accumulated amortization of intangibles at December 31, 2009 and 2008 was $3,705 and $3,403 and $3,705 and $2,652, respectively.
The Company evaluates for potential impairment of long-lived assets and intangible assets subject to amortization when indicators of impairment are present, as defined in ASC Topic 360, Property, Plant and Equipment. In light of adverse market conditions affecting the Company, including a substantial decrease in the operating levels of its business segments, a significant decline in oil and natural gas commodity prices, management deemed it necessary to assess the recoverability of long-lived assets and intangibles within its contract land drilling and well servicing segments.
Management performed its impairment assessment under the provisions of ASC Topic 360 using the undiscounted cash flows for each segment. Based on the results of these impairment tests, the carrying amounts of intangible assets were determined to be recoverable.
Estimated amortization expense for each year subsequent to December 31, 2009 is as follows:
| 2010………………….. | $ 249 |
| 2011………………….. | 53 |
| 2012………………….. | - |
| 2013………………….. | - |
| 2014………………….. | - |
Legal fees and other debt issue costs incurred in obtaining financing are amortized over the term of the debt using a method which approximates the effective interest method. Gross debt issue costs were $2,232 and $3,501 at December 31, 2009 and 2008, respectively. Amortization expense related to debt issue costs was $592, $571, and $564 for years ended December 31, 2009, 2008, and 2007, respectively, and is included in interest expense in the consolidated statements of operations. Accumulated amortization related to loan fees was $126 and $175 as of December 31, 2009 and 2008, respectively. On September 18, 2009 and September 29, 2008 the Company refinanced its revolving debt facility and incurred $2,232 and $3,501 of debt issuance costs, respectively. The Company wrote-off debt issue costs of $2,859, which is included in loss from early extinguishment of debt on the consolidated statement of operations for the year ended December 31, 2009.
Income Taxes
Pursuant to Statement ASC Topic 740, Income Taxes, the Company follows the asset and liability method of accounting for income taxes, under which the Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities were measured using enacted tax rates expected to apply to taxable income in the years in which the Company expects to recover or settle those temporary differences. A statutory Federal tax rate of 35% and effective state tax rate of 3.7% (net of Federal income tax effects) were used for the enacted tax rates for all periods.
As changes in tax laws or rates are enacted, deferred income tax assets and liabilities are adjusted through the provision for income taxes. Deferred tax assets are reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The classification of current and noncurrent deferred tax assets and liabilities is based primarily on the classification of the assets and liabilities generating the difference.
The Company applies the provisions of ASC Topic 740 which addresses the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company recognizes interest and/or penalties related to income tax matters as income tax expense. As of December 31, 2009, the tax years ended December 31, 2005 through December 31, 2008 are open for examination by U.S. taxing authorities.
Comprehensive Income (Loss)
Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income. Other comprehensive income includes the translation adjustments of the financial statements of Bronco MX at December 31, 2009. The following table sets forth the components of comprehensive income (loss):
| | | Years ended | |
| | | December 31, | |
| | | 2009 | | | 2008 | | | 2007 | |
| Net income (loss) | | $ | (57,579 | ) | | $ | (8,243 | ) | | $ | 37,592 | |
| Other comprehensive income - translation adjustment | | | 538 | | | | - | | | | - | |
| Comprehensive income (loss) | | $ | (57,041 | ) | | $ | (8,243 | ) | | $ | 37,592 | |
| | | | | | | | | | | | | |
Net income (Loss) Per Common Share
The Company computes and presents net income (loss) per common share in accordance with ASC Topic 260, Earnings per Share. This standard requires dual presentation of basic and diluted net income (loss) per share on the face of the Company’s statement of operations. Basic net income (loss) per common share is computed by dividing net income or loss attributable to common stock by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per common share reflects the potential dilution that could occur if options or other contracts to issue common stock were exercised or converted into common stock.
Stock-based Compensation
The Company has adopted ASC Topic 718, Stock Compensation upon granting its first stock options on August 16, 2005. ASC Topic 718 requires a public entity to measure the costs of employee services received in exchange for an award of equity or liability instruments based on the grant-date fair value of the award. That cost will be recognized over the periods during which an employee is required to provide service in exchange for the award.
Equity Method Investments
Investee companies that are not consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting. Whether or not the Company exercises significant influence with respect to an Investee depends on an evaluation of several factors including, among others, representation on the Investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the Investee company. Under the equity method of accounting, an Investee company’s accounts are not reflected within the Company’s Consolidated Balance Sheets and Statements of Operations; however, the Company’s share of the earnings or losses of the Investee company is reflected in the caption “Equity in income of Challenger” and “Equity in income of Bronco MX” in the Consolidated Statements of Operations. The Company’s carrying value in an equity method Investee company is reflected in the caption “Investment in Challenger” and “Investment in Bronco MX” in the Company’s Consolidated Balance Sheets.
Recent Accounting Pronouncements
The FASB Accounting Standards Codification. FASB Accounting Standards Codification (ASC) became effective for this quarterly report. ASC Topic 105, Generally Accepted Accounting Principles establishes the ASC as the single source of authoritative U.S. generally accepted accounting principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. The ASC supersedes all existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the ASC will become nonauthoritative. Following ASC Topic 105, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, the FASB will issue Accounting Standards Updates, which will serve only to: (a) update the ASC; (b) provide background information about the guidance; and (c) provide the basis for conclusions on the change(s) in the ASC. The adoption of this standard has changed how we reference various elements of U.S. GAAP in the Company’s financial statement disclosures, but has no impact on the Company’s financial position, results of operation or cash flows.
In September 2006, the FASB issued an accounting standard that defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. The initial application of this standard was limited to financial assets and liabilities and became effective on January 1, 2008 for the Company. On January 1, 2009 the Company adopted this standard on a prospective basis for non-financial assets and liabilities not measured at fair value on a recurring basis. The application of this standard to the Company’s non-financial assets and liabilities is primarily limited to assets acquired and liabilities assumed in a business combination, asset retirement obligations and asset impairments, including goodwill and long lived assets and has not had a material impact on the Company’s consolidated financial statements.
In December 2007, the FASB issued a new accounting standard that calls for significant changes from then current practice in accounting for business combinations. The standard establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The standard also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The standard applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this standard did not have an immediate impact on the Company’s consolidated financial statements.
In December 2007, the FASB issued a new accounting standard which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The standard requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of this standard shall be applied prospectively. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The provisions of this standard were applied to the Company’s accounting for its sale of 60% of its membership interests in Bronco MX. See Note 2 Equity Method Investments, regarding the $23,705 loss on the Bronco MX transaction.
In June 2008, the FASB issued a new accounting standard which provides that unvested share-based payment awards that contain nonforfeitable rights to dividends are participating securities and shall be included in the computation of earnings per share pursuant to the two class method. This standard is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued a staff position which increases the frequency of fair value disclosures for financial instruments from annual only to quarterly reporting periods. The provisions of this staff position are effective for financial statements issued for interim and annual periods ending after June 15, 2009 and became effective for the Company in the quarter ended June 30, 2009. The adoption of this staff position did not have a material impact on the Company’s consolidated financial statements.
In June 2009, the FASB issued a new accounting standard that amends the accounting and disclosure requirements for the consolidation of variable interest entities. This new standard removes the previously existing exception from applying consolidation guidance to qualifying special-purpose entities and requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. Before this new standard, generally accepted accounting principles required reconsideration of whether an enterprise is the primary beneficiary of a variable interest entity only when specific events occurred. This new standard is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. This new standard became effective for us on January 1, 2010. The adoption of this standard did not impact our consolidated financial statements.
Reclassifications
Certain amounts in the financial statements for the prior years have been reclassified to conform to the current year’s presentation.
2. Equity Method Investments
On January 4, 2008, we acquired a 25% equity interest in Challenger Limited, in exchange for six drilling rigs valued at $72,937 and $5,063 in cash. The Company’s 25% interest at December 31, 2009 was based on 64,957,265 shares outstanding. The Company recorded equity in income (loss) of investment of $(1,914) and $2,186 for the years ended December 31, 2009 and 2008, respectively, related to its equity investment in Challenger. Challenger is an international provider of contract land drilling and workover services to oil and natural gas companies with its principal operations in Libya. Five of the contributed drilling rigs were from our existing marketed fleet and one was a newly constructed rig. The general specifications of the contributed rigs are as follows:
| | | | | | |
| | | | Approximate | | |
| | | | Drilling | | |
| Rig | | Design | Depth (ft) | Type | Horsepower |
| 3 | | Cabot 900 | 10,000 | Mechanical | 950 |
| 18 | | Gardner Denver 1500E | 25,000 | Electric | 2,000 |
| 19 | | Mid Continent U-1220 EB | 25,000 | Electric | 2,000 |
| 38 | | National 1320 | 25,000 | Electric | 2,000 |
| 93 | | National T-32 | 8,000 | Mechanical | 500 |
| 96 | | Ideco H-35 | 8,000 | Mechanical | 400 |
| | | | | | |
The Company also sold to Challenger four drilling rigs and ancillary equipment. The sales price of $12,990 consisted of $1,950 in cash, installment receivable of $1,500 and a term note of $9,540. During the second quarter of 2009, the Company and Challenger agreed to reduce the installment receivable and term note by approximately $5,040 and the Company assumed ownership of two drilling rigs that were originally sold to Challenger. The term note bears interest at 8.5%. Interest and principal payments of $529 on the note are due quarterly until maturity at February 2, 2011. The note receivable is collateralized by the assets sold to Challenger. The note receivable from Challenger at December 31, 2009 was $2,517, of which $2,000 was classified as current and $517 was classified as long-term.
The Company recorded a net gain of $3,138 for the year ended December 31, 2008 relating to the exchange and sale of rigs and equipment to Challenger. The transactions were completed on January 4, 2008. Prior to these transactions, Challenger owned a fleet of 23 rigs.
On February 20, 2008, the Company entered into a Management Services Agreement and Master Services Agreement with Challenger. The Company agreed to make available to Challenger certain employees of the Company for the purpose of providing land drilling services, certain business consulting services and managerial support to Challenger. The Company invoices Challenger monthly for the services provided. The Company had accounts receivable from Challenger of $2,499 and $3,387 at December 31, 2009 and December 31, 2008, respectively, related to these services provided.
At December 31, 2009, the book value of the Company’s ordinary share investment in Challenger was $39,714. The Company’s 25% interest of the net assets of Challenger was estimated to be $36,149. The basis difference between the Company’s ordinary equity investment in Challenger and the Company’s 25% interest of the net assets of Challenger primarily consists of certain property, plant and equipment and accumulated depreciation in the amount of $3,626 and $61 respectively, at December 31, 2009. These amounts are being amortized against the Company’s 25% interest of Challenger’s net income over the estimated useful lives of 15 years for the property, plant and equipment. Amortization recorded during years ended December 31, 2009 and 2008 was $1,026 and $322, respectively, which is included in the equity in income (loss) of Challenger on the consolidated statements of operations.
The Company reviewed its investment in Challenger at September 30, 2009 for impairment based on the guidance of ASC Topic 323, Investments-Equity Method and Joint Venture, which states that a loss in value of an investment which is other than a temporary decline should be recognized. Evidence of a loss in value might include the absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. A current fair value of an investment that is less than its carrying amount may indicate a loss in value of the investment. Due to the recent volatility and decline in oil and natural gas prices, a deteriorating global economic environment and the anticipated future earnings of Challenger, the Company deemed it necessary to test the investment for impairment. Fair value of the investment was estimated using a combination of income, or discounted cash flows approach, and the market approach, which utilizes comparable companies’ data. The analysis resulted in a fair value of $39,800 related to our investment in Challenger, which was below the carrying value of the investment and resulted in a non-cash impairment charge in the amount of $21,247.
On February 16, 2009, Challenger entered into a financing agreement with Natixis SA. The Company’s 25% interest in Challenger was pledged as collateral as part of this agreement.
Summarized financial information of Challenger is presented below:
| | | December 31, | |
| | | 2009 | | | 2008 | |
| Condensed statement of operations: | | | | | | |
| Revenues | | $ | 56,509 | | | $ | 71,840 | |
| Gross margin | | $ | 21,076 | | | $ | 33,372 | |
| Net Income (loss) | | $ | (3,552 | ) | | $ | 10,076 | |
| | | | | | | | | |
| Condensed balance sheet: | | | | | | | | |
| Current assets | | $ | 59,971 | | | $ | 50,837 | |
| Noncurrent assets | | | 130,667 | | | | 141,558 | |
| Total assets | | $ | 190,638 | | | $ | 192,395 | |
| | | | | | | | | |
| Current liabilities | | $ | 25,511 | | | $ | 26,944 | |
| Noncurrent liabilities | | | 20,531 | | | | 17,304 | |
| Equity | | | 144,596 | | | | 148,147 | |
| Total liabilities and equity | | $ | 190,638 | | | $ | 192,395 | |
| | | | | | | | | |
On September 18, 2009, the Company and Saddleback Properties LLC, a wholly-owned subsidiary of the Company, entered into a Membership Interest Purchase Agreement with Carso Infraestructura y Construccion, S.A.B. de C.V., or CICSA, pursuant to which CICSA purchased 60% of the outstanding membership interests of Bronco MX. The Company owns the remaining 40% of the outstanding membership interests of Bronco MX. Immediately prior to the sale of the membership interests in Bronco MX to CICSA, the Company contributed six drilling rigs (Nos. 4, 43, 53, 58, 60 and 72), and the future net profit from rig leases relating to three additional drilling rigs (Nos. 55, 76 and 78), which the Company has contributed to Bronco MX upon the expiration of the leases relating to such rigs. The general specifications of the contributed rigs are as follows:
| Rig | | Design | Approximate Drilling Depth (ft) | Type | Horsepower |
| 43 | | Gardner Denver 800 | 15,000 | Mechanical | 1,000 |
| 4 | | Skytop Brewster N46 | 14,000 | Mechanical | 950 |
| 53 | | Skytop Brewster N42 | 12,000 | Mechanical | 850 |
| 55 | | Oilwell 660 | 12,000 | Mechanical | 1,000 |
| 58 | | National N55 | 12,000 | Mechanical | 800 |
| 60 | | Skytop Brewster N46 | 14,000 | Mechanical | 850 |
| 72 | | Skytop Brewster N42 | 10,000 | Mechanical | 750 |
| 76 | | National N55 | 12,000 | Mechanical | 700 |
| 78 | | Seaco 1200 | 12,000 | Mechanical | 1,200 |
| | | | | | |
Bronco MX is jointly managed, with CICSA having three representatives on its board of managers and the Company having two representatives on its board of managers. The Company and CICSA, and their respective affiliates, have agreed to conduct all future land drilling and workover rig services, rental, construction, refurbishment, transportation, trucking and mobilization in Mexico and Latin America exclusively through Bronco MX, subject to Bronco MX’s ability to perform.
According to a Schedule 13D/A filed with the SEC on March 8, 2010 by Carlos Slim Helú, certain members of his family and affiliated entities, collectively these individuals and entities owned approximately 19.99% of our common stock. CICSA is also a Slim affiliate.
Summarized financial information of Bronco MX is presented below:
| | | December 31, | |
| | | 2009 | |
| Condensed statement of operations: | | | |
| Revenues | | $ | 7,171 | |
| Gross margin | | $ | (2,582 | ) |
| Net Income (loss) | | $ | (1,472 | ) |
| | | | | |
| Condensed balance sheet: | | | | |
| Current assets | | $ | 8,931 | |
| Noncurrent assets | | | 57,746 | |
| Total assets | | $ | 66,677 | |
| | | | | |
| Current liabilities | | $ | 13,162 | |
| Noncurrent liabilities | | | - | |
| Equity | | | 53,515 | |
| Total liabilities and equity | | $ | 66,677 | |
| | | | | |
3. Accrued liabilities
Accrued liabilities consisted of the following at December 31, 2009 and 2008:
| | | 2009 | | | 2008 | |
| Salaries, wages, payroll taxes and benefits | | $ | 623 | | | $ | 3,122 | |
| Workers' compensation liability | | | 2,458 | | | | 4,288 | |
| Sales, use and other taxes | | | 2,211 | | | | 1,566 | |
| Health insurance | | | 784 | | | | 1,773 | |
| Deferred revenue | | | 1,251 | | | | 4,048 | |
| General liability insurance | | | 500 | | | | - | |
| Accrued interest | | | 125 | | | | 1,452 | |
| | | $ | 7,952 | | | $ | 16,249 | |
| | | | | | | | | |
4. Long-term Debt and Warrant
Long-term debt consists of the following:
| | | | | | | |
| | | December 31, | | | December 31, | |
| | | 2009 | | | 2008 | |
| | | | | | | |
| Notes payable to De Lage Landen Financial Services, collateralized by cranes, | | | | | | |
| payable in ninety-six monthly principal and interest installments of $61 | | | | | | |
| Interest on the notes ranges from 6.74% - 7.07%, repaid in March, 2009. (1) | | $ | - | | | $ | 3,234 | |
| | | | | | | | | |
| Revolving credit facility with Fortis Capital Corp., collateralized by the Company's assets, | | | | | | | | |
| and matures on September 29, 2013. Loans under the revolving credit facility | | | | | | | | |
| bore interest at variable rates as defined in the credit agreement, repaid September, 2009. (2) | | | - | | | | 111,100 | |
| | | | | | | | | |
| Revolving credit facility with Banco Inbursa S.A., collateralized by the Company's assets, | | | | | | | | |
| and matures on September 17, 2014. Loans under the revolving credit facility | | | | | | | | |
| bear interest at variable rates as defined in the credit agreement. (3) | | | 50,545 | | | | - | |
| | | | | | | | | |
Note payable to Ameritas Life Insurance Corp., collateralized by a building, payable in principal and interest installments of $14, interest on the note is 6.0%, maturity date of January 1, 2021. (4) | | | 1,358 | | | | 1,442 | |
| | | | | | | | | |
Notes payable to General Motors Acceptance Corporation, collateralized by trucks, payable in monthly principal and interest installments of $65, repaid in March, 2009. (5) | | | - | | | | 1,623 | |
| | | | | | | | | |
Note payable to John Deere Construction & Forestry Company, collaterized by forklifts, payable in thirty-six monthly installments of $11, repaid in March, 2009 (6) | | | - | | | | 124 | |
| | | | | | | | | |
| Note payable to Ford Motor Credit, collateralized by a truck, payable in principal and interest | | | | | | | | |
| installments of $1. Interest on the note is 2.9%, repaid in March, 2009. (7) | | | - | | | | 24 | |
| | | | | | | | | |
| | | | 51,903 | | | | 117,547 | |
| Less current installments | | | 89 | | | | 1,464 | |
| | | $ | 51,814 | | | $ | 116,083 | |
| (1) | On December 7, 2005, January 4, 2006, and June 12, 2006, the Company entered into Term Loan and Security Agreements with De Lage Landen Financial Services, Inc. The loans provide for term installments in an aggregate amount not to exceed $4,512. The proceeds of the term loans were used to purchase four cranes. The term loans were repaid in full on March 30, 2009. |
| (2) | On January 13, 2006, the Company entered into a $150,000 revolving credit facility with Fortis Capital Corp., as administrative agent, lead arranger and sole book runner, and a syndicate of lenders. On September 29, 2008, the Company amended and restated this revolving credit facility. This $150,000 amended and restated credit facility was with Fortis Bank SA/NV, New York Branch, as administrative agent, joint lead arranger and sole bookrunner, and a syndicate of lenders, which included The Royal Bank of Scotland plc, The CIT Group/Business Credit, Inc., The Prudential Insurance Company of America, Legacy Bank, Natixis and Caterpillar Financial Services Corporation. Loans under the revolving credit facility bore interest at LIBOR plus a 4.0% margin or, at our option, the prime rate plus a 3.0% margin. The Company incurred $3,501 in debt issue costs related to the amended and restated credit facility. The revolving credit facility also provided for a quarterly commitment fee of 0.5% per annum of the unused portion of the revolving credit facility, and fees for each letter of credit issued under the facility. Commitment fees expense for the years ended December 31, 2009 and 2008 were $447 and $405, respectively. The revolving credit facility was repaid in full on September 18, 2009. The Company incurred a loss from early extinguishment of debt of approximately $2,859. |
| (3) | On September 18, 2009, the Company entered into a new senior secured revolving credit facility with Banco Inbursa, as lender and as the issuing bank. The Company utilized (i) borrowings under the credit facility, (ii) proceeds from the sale of the membership interest of Bronco MX and (iii) cash-on-hand to repay all amounts outstanding under the Company's prior revolving credit agreement with Fortis Bank SA/NV, New York Branch which has been replaced by this credit facility. |
| | The credit facility provides for revolving advances of up to $75,000 and matures on September 17, 2014. The borrowing base under the credit facility has been initially set at $75,000, subject to borrowing base limitations. Our availability under the credit facility is reduced by outstanding letters of credit which were approximately $11.5 million at December 31, 2009. Outstanding borrowings under the credit facility bear interest at the Eurodollar rate plus 5.80% per annum, subject to adjustment under certain circumstances. The effective interest rate was 6.50% at December 31, 2009. The Company incurred $2,232 in debt issue costs related to this credit facility. |
| | The Company will pay a quarterly commitment fee of 0.5% per annum on the unused portion of the credit facility and a fee of 1.50% for each letter of credit issued under the facility. In addition, an upfront fee equal to 1.50% of the aggregate commitments under the credit facility was paid by the Company at closing. The Company’s domestic subsidiaries have guaranteed the loans and other obligations under the credit facility. The obligations under the credit facility and the related guarantees are secured by a first priority security interest in substantially all of the assets of the Company and its domestic subsidiaries, including the equity interests of the Company’s direct and indirect subsidiaries. Commitment fees expense for the year ended December 31, 2009 was $15. |
| | The credit facility contains customary representations and warranties and various affirmative and negative covenants, including, but not limited to, covenants that restrict the Company’s ability to make capital expenditures, incur indebtedness, incur liens, dispose of property, repay debt, pay dividends, repurchase shares and make certain acquisitions, and a financial covenant requiring that the Company maintain a ratio of consolidated debt to consolidated earnings before interest, taxes, depreciation and amortization as defined in the credit agreement for any four consecutive fiscal quarters of not more than 3.5 to 1.0. On February 9, 2010, the Company received a waiver from Banco Inbursa for the ratio of consolidated debt to consolidated earnings before interest, taxes, depreciation and amortization through the second quarter of 2010. A violation of these covenants or any other covenant in the credit facility could result in a default under the credit facility which would permit the lender to restrict the Company’s ability to access the credit facility and require the immediate repayment of any outstanding advances under the credit facility. |
| | In conjunction with its entry into the credit facility, the Company entered into a Warrant Agreement with Banco Inbursa and, pursuant thereto, issued a three-year warrant (the “Warrant”) to Banco Inbursa evidencing the right to purchase up to 5,440,770 shares of the Company’s common stock, $0.01 par value per share (the “Common Stock”) subject to the terms and conditions set forth in the Warrant, including the limitations on exercise set forth below, at an exercise price of $6.50 per share of Common Stock from the date of issuance of the Warrant (the “Issue Date”) through the first anniversary of the Issue Date, $7.00 per share following the first anniversary of the Issue Date through the second anniversary of the Issue Date, and $7.50 per share following the second anniversary of the Issue Date through the third anniversary of the Issue Date. The Warrant may be exercised by the payment of the exercise price in cash or through a cashless exercise whereby the Company withholds shares issuable under the Warrant having a value equal to the aggregate exercise price. |
| | The exercise price per share and the number of shares of Common Stock for which the Warrant may be exercised are subject to adjustment in the event of any split, subdivision, reclassification, combination or similar transactions affecting the Common Stock. Additionally, in the event that the Warrant is sold and the proceeds per share received by the holder are less than the positive difference of the current market price per share of the Common Stock less the exercise price then in effect, the Company will be required to pay the seller of the Warrant a make-whole payment equal to such difference. However, the obligations of the Company in respect of the make-whole payment only inure to the benefit of Banco Inbursa and other members of the Investor Group (as defined in the Warrant), and not other holders of the Warrant. |
| | The Warrant contains limitations on the number of shares of Common Stock that may be acquired by the holder of the Warrant upon any exercise of the Warrant. Pursuant to the terms of the Warrant, the holder of the Warrant may not exercise the Warrant for a number of shares of Common Stock which will exceed 19.99% of the shares of the Common Stock that are issued and outstanding on the Issue Date (subject to adjustment for stock splits, combinations and similar events). In addition, the number of shares that may be acquired by the holder of the Warrant and its Affiliates (as defined in the Warrant) and any other Person (as defined in the Warrant) whose ownership of Common Stock would be aggregated with the ownership of the holder of the Warrant for purposes of Section 13(d) of the Securities Exchange Act of 1934, as amended, does not exceed 19.99% of the total number of shares of Common Stock that are outstanding immediately after giving effect to such exercise of the Warrant. |
| | In accordance with accounting standards, the proceeds from the revolving credit facility were allocated to the credit facility and Warrant based on their respective fair values. Based on this allocation, $50,321 and $4,679 of the net proceeds were allocated to the credit facility and Warrant, respectively. The Warrant has been classified as a liability on the consolidated balance sheet due to the Company’s obligation to pay the seller of the Warrant a make-whole payment, in cash, under certain circumstances. The fair value of the Warrant was determined using a pricing model based on a version of the Black Scholes model, which is adjusted to account for the dilution resulting from the additional shares issued for the Warrant. The valuation was determined by computing the value of the Warrant if exercised in Year 1 – 3 with the values weighted by the probability that the warrant would actually be exercised in that year. Some of the assumptions used in the model were a volatility of 45% and a risk free interest rate that ranged from 0.41% to 1.57%. |
| | The resulting discount to the revolving credit facility will be amortized to interest expense over the term of the revolving credit facility such that, in the absence of any conversions, the carrying value of the revolving credit facility at maturity would be equal to $55,000. Accordingly, the Company will recognize annual interest expense on the debt at an effective interest rate of Eurodollar rate plus 6.25%. Imputed interest expense recognized for the year ended December 31, 2009 was $224. |
| | In accordance with accounting standards, the Company revalued the Warrant as of December 31, 2009 and recorded the change in the fair value of the Warrant on the consolidated statement of operations. The fair value of the Warrant was determined using a pricing model based on a version of the Black Scholes model, which is adjusted to account for the dilution resulting from the additional shares issued for the Warrant. The valuation was determined by computing the value of the Warrant if exercised in Year 1 – 3 with the values weighted by the probability that the Warrant would actually be exercised in that year. Some of the assumptions used in the model were a volatility of 45% and a risk free interest rate that ranged from 0.40% to 1.45%. The fair value of the warrant was $2,829 at December 31, 2009. The Company recorded a change in the fair value of the Warrant on the consolidated statement of operations in the amount of $1,850 for the year ended December 31, 2009. |
| | In conjunction with the issuance of the Warrant, the Company entered into a Registration Rights Agreement for the benefit of Banco Inbursa and its permitted assignees and transferees. The Registration Rights Agreement provides for up to three demand registration rights and unlimited piggyback registration rights covering the Warrant, the shares of Common Stock for which the Warrant is exercisable and all other shares of Common Stock held by Banco Inbursa and its permitted assignees and transferees. The Registration Rights Agreement provides that the Company shall pay all fees and expenses incident to the performance of its obligations under the Registration Rights Agreement, including the payment of all filing, registration and qualification fees, printers’ and accounting fees, and expenses and disbursements of counsel and contains other customary terms, provisions and covenants for agreements of this type, including, without limitation, provisions requiring the Company to provide indemnification arising out of or relating to any untrue or alleged untrue statement of a material fact, or relating to any omission or alleged omission of a material fact required to be stated therein to make the statements therein not misleading, contained in a registration statement, prospectus, free writing prospectus or certain other documents. |
| | Banco Inbursa subsequently transferred the Warrant to CICSA. Pursuant to the terms of the Warrant, we cancelled the Warrant issued to Banco Inbursa and issued a warrant containing the same terms and provisions to CICSA evidencing such transfer. |
| (4) | On January 2, 2007, the Company assumed a term loan agreement with Ameritas Life Insurance Corp. related to the acquisition of a building. The loan provides for term installments in an aggregate not to exceed $1,590. |
| (5) | On various dates during 2007 and 2008, the Company entered into term loan agreements with General Motors Acceptance Corporation. The loans provide for term installments in an aggregate not to exceed $2,282. The proceeds of the term loans were used to purchase 57 trucks. The term loans were repaid in full on March 16, 2009. |
| (6) | On November 21, 2006, the Company entered into term loan agreements with John Deere Credit. The loans provide for term installments in an aggregate not to exceed $403. The proceeds of the term loans were used to purchase two forklifts. The term loans were repaid in full on March 19, 2009. |
| (7) | On November 9, 2007, the Company entered into a term loan agreement with Ford Credit. The loan provides for a term installment in an aggregate not to exceed $36. The proceeds of the term loan were used to purchase a truck. The term loan was repaid in full on March 24, 2009. |
Long-term debt maturing each year subsequent to December 31, 2009 is as follows:
| | | | |
| 2010 | | $ | 89 | |
| 2011 | | | 94 | |
| 2012 | | | 100 | |
| 2013 | | | 107 | |
| 2014 | | | 50,658 | |
| 2015 and thereafter | | | 855 | |
| | | $ | 51,903 | |
5. Income Taxes
The Company adopted ASC Topic 740 on January 1, 2007. ASC Topic 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. As of December 31, 2009, the Company had no unrecognized tax benefits. The Company is continuing its practice of recognizing interest and/or penalties related to income tax matters as income tax expense. As of December 31, 2009, the tax years ended December 31, 2005 through December 31, 2008 are open for examination by U.S. taxing authorities.
Income tax expense (benefit) consists of the following:
| | | Years Ended December 31, | |
| | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | |
| Current: | | | | | | | | | |
| State | | $ | 28 | | | $ | (165 | ) | | $ | 541 | |
| Federal | | | (1,420 | ) | | | (874 | ) | | | 4,915 | |
| Deferred: | | | | | | | | | | | | |
| State | | | (2,229 | ) | | | (415 | ) | | | 1,878 | |
| Federal | | | (29,488 | ) | | | (3,707 | ) | | | 15,770 | |
| Income tax expense (benefit) | | $ | (33,109 | ) | | $ | (5,161 | ) | | $ | 23,104 | |
| | | | | | | | | | | | | |
Deferred income tax assets and liabilities are as follows:
| | | Years Ended December 31, | |
| | | 2009 | | | 2008 | |
| Deferred tax assets: | | | | | | |
| | | | | | | |
| Stock option expense | | $ | 2,607 | | | $ | 3,170 | |
| Alternative minimum tax credit carryforward | | | 2,225 | | | | 2,225 | |
| Net operating loss carryforwards | | | 37,905 | | | | 3,441 | |
| Accounts receivable allowance | | | 1,383 | | | | 1,481 | |
| Tax credits | | | - | | | | 875 | |
| Employee benefits and insurance accruals | | | 303 | | | | 488 | |
| Other | | | 1,093 | | | | 484 | |
| Total deferred tax assets | | | 45,516 | | | | 12,164 | |
| | | | | | | | | |
| Deferred tax liabilities: | | | | | | | | |
| | | | | | | | | |
| Property and equipment, principally due | | | | | | | | |
| to differences in depreciation and impairments | | | 76,964 | | | | 75,330 | |
| Other | | | 64 | | | | 64 | |
| Total deferred tax liabilities | | | 77,028 | | | | 75,394 | |
| Net deferred tax liabilities | | $ | 31,512 | | | $ | 63,230 | |
| | | | | | | | | |
The provision for income taxes on continuing operations differs from the amounts computed by applying the federal income tax rate of 35% to net income. The differences are summarized as follows:
| | | Years Ended December 31, | |
| | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | |
| Expected tax expense (benefit) | | $ | (31,741 | ) | | $ | (4,692 | ) | | $ | 21,244 | |
| State income taxes (benefit) | | | (2,201 | ) | | | (345 | ) | | | 2,246 | |
| Nondeductible officer compensation | | | 121 | | | | 330 | | | | 98 | |
| Nondeductible meals and entertainment | | | 19 | | | | 68 | | | | 45 | |
| Stock compensation FAS123R adjustment | | | 783 | | | | - | | | | - | |
| Domestic production activities | | | - | | | | - | | | | (83 | ) |
| Goodwill impairment | | | - | | | | 1,125 | | | | - | |
| Foreign tax credit | | | (660 | ) | | | (832 | ) | | | - | |
| Prior year estimate adjustment | | | 356 | | | | (295 | ) | | | - | |
| Other | | | 214 | | | | (520 | ) | | | (446 | ) |
| | | $ | (33,109 | ) | | $ | (5,161 | ) | | $ | 23,104 | |
| | | | | | | | | | | | | |
6. Workers’ Compensation and Health Insurance
The Company is insured under a large deductible workers’ compensation insurance policy. The policy generally provides for a $1,000 deductible per covered accident. The Company maintains letters of credit in the aggregate amount of $11,560 for the benefit of various insurance companies as collateral for retrospective premiums and retained losses which may become payable under the terms of the underlying insurance contracts. The letters of credit are typically renewed annually. No amounts have been drawn under the letters of credit. Accrued expenses at December 31, 2009 and 2008 included approximately $2,458 and $4,288, respectively, for estimated incurred but not reported costs and premium accruals related to our workers’ compensation insurance.
On November 1, 2005, the Company initiated a self-insurance program for major medical, hospitalization and dental coverage for employees and their dependents, which is partially funded by payroll deductions. The Company provided for both reported and incurred but not reported medical costs in the accompanying consolidated balance sheets. We have a maximum liability of $125 per employee/dependent per year. Amounts in excess of the stated maximum are covered under a separate policy provided by an insurance company. Accrued expenses at December 31, 2009 and 2008 included approximately $784 and $1,773, respectively, for our estimate of incurred but not reported costs related to the self-insurance portion of our health insurance.
7. Transactions with Affiliates
The Company has 6 operating leases with affiliated entities. Related rent expense was approximately $520 and $572 for the years ended December 31, 2009 and 2008.
The Company provided contract drilling services totaling $0, $4,571, and $2,617 to affiliated entities for the years ended December 31, 2009, 2008, and 2007. The Company provided workover services to affiliated entities totaling $0 and $765 for the years ended December 31, 2009 and 2008, respectively. The Company had receivables from affiliates of $9,620 and $3,387 at December 31, 2009 and 2008, respectively. Additional information about our transactions with affiliates is included in Note 2, Equity Method Investments.
8. Commitments and Contingencies
The Company leases fifteen service locations under noncancelable operating leases that have various expirations from 2010 to 2015. Related rent expense was $1,194, $1,064, and $790 for the years ended December 31, 2009, 2008, and 2007, respectively.
Aggregate future minimum lease payments under the noncancelable operating leases for years subsequent to December 31, 2009 are as follows:
| | | |
| 2010 | | $ | 913 |
| 2011 | | | 757 |
| 2012 | | | 535 |
| 2013 | | | 389 |
| 2014 | | | 226 |
| 2015 and thereafter | | | 75 |
| | | $ | 2,895 |
| | | | |
Various claims and lawsuits, incidental to the ordinary course of business, are pending against the Company. In the opinion of management, all matters are adequately covered by insurance or, if not covered, are not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
9. Business Segments and Concentrations
The Company’s reportable business segments are contract land drilling and well servicing. The contract land drilling segment utilizes a fleet of land drilling rigs to provide contract drilling services to oil and natural gas exploration and production companies. During 2009 our rigs operated in Oklahoma, Texas, Colorado, Montana, Utah, North Dakota, Louisiana, Wyoming, Pennsylvania, West Virginia and Mexico. The well servicing segment encompasses a full range of services performed with mobile well servicing rigs, including the installation and removal of downhole equipment and elimination of obstructions in the well bore to facilitate the flow of oil and gas. During 2009 our workover rigs operated in Oklahoma, Texas, Kansas, Colorado, Louisiana, Arkansas, Wyoming, and New Mexico. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company’s reportable segments are strategic business units that offer different products and services.
The following table sets forth certain financial information with respect to the Company’s reportable segments:
| | | | | | | | | | |
| | | Contract land drilling | | | Well servicing | | | Total | |
| Year ended December 31, 2009 | | | | | | | | | |
| Operating revenues | | $ | 106,738 | | | $ | 3,799 | | | $ | 110,537 | |
| Direct operating costs | | | (75,996 | ) | | | (4,267 | ) | | | (80,263 | ) |
| Segment profits | | $ | 30,742 | | | $ | (468 | ) | | $ | 30,274 | |
| Depreciation and amortization | | $ | 39,054 | | | $ | 6,620 | | | $ | 45,674 | |
| Capital expenditures | | $ | 16,532 | | | $ | 1,027 | | | $ | 17,559 | |
| Identifiable assets | | $ | 395,891 | | | $ | 49,692 | | | $ | 445,583 | |
| | | | | | | | | | | | | |
| Year ended December 31, 2008 | | | | | | | | | | | | |
| Operating revenues | | $ | 247,829 | | | $ | 33,284 | | | $ | 281,113 | |
| Direct operating costs | | | (148,866 | ) | | | (24,478 | ) | | | (173,344 | ) |
| Impairments of goodwill | | $ | (21,115 | ) | | $ | (3,213 | ) | | $ | (24,328 | ) |
| Segment profits | | $ | 77,848 | | | $ | 5,593 | | | $ | 83,441 | |
| Depreciation and amortization | | $ | 44,419 | | | $ | 5,969 | | | $ | 50,388 | |
| Capital expenditures | | $ | 79,136 | | | $ | 8,138 | | | $ | 87,274 | |
| Identifiable assets | | $ | 551,575 | | | $ | 60,779 | | | $ | 612,354 | |
| | | | | | | | | | | | | |
The following table reconciles the segment profits above to the operating income as reported in the consolidated statements of operations:
| | | Year Ended | |
| | | December 31, 2009 | | | December 31, 2008 | |
| Segment profits | | $ | 30,274 | | | $ | 83,441 | |
| General and administrative expenses | | | (19,777 | ) | | | (33,771 | ) |
| Depreciation and amortization | | | (45,674 | ) | | | (50,388 | ) |
| Gain on Challenger transactions | | | - | | | | 3,138 | |
| Loss on Mexico transactions | | | (23,705 | ) | | | - | |
| Operating income (loss) | | $ | (58,882 | ) | | $ | 2,420 | |
| | | | | | | | | |
For the year ended December 31, 2009, revenue from one customer was approximately 12% of total revenue, for 2008 revenue from one customer was approximately 11% of total revenue, and for 2007 revenue from one customer was approximately 11% of total revenue. At December 31, 2009, seven customers accounted for approximately 16%, 10%, 10%, 6%, 6%, 5%, and 5% of accounts receivable. At December 31, 2008, six customers accounted for approximately 8%, 7%, 5%, 5%, 5%, and 5% of accounts receivable.
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of demand deposits, temporary cash investments and trade receivables.
The Company believes it has placed its deposits and temporary cash investments with high credit-quality financial institutions. At December 31, 2009 and 2008, the Company’s demand deposits and temporary cash investments consisted of the following (in thousands):
| | | | | | | |
| | | 2009 | | | 2008 | |
| Deposits in FDIC-insured institutions under insurance limits | | $ | 1,084 | | | $ | 905 | |
| Deposits in FDIC-insured institutions over insurance limits | | | 9,576 | | | | 30,082 | |
| Deposits in foreign banks | | | 47 | | | | 281 | |
| | | | 10,707 | | | | 31,268 | |
| Less outstanding checks and other reconciling items | | | (1,210 | ) | | | (4,592 | ) |
| Cash and cash equivalents | | $ | 9,497 | | | $ | 26,676 | |
10. Net Income (Loss) Per Common Share
The following table presents a reconciliation of the numerators and denominators of the basic and diluted earnings per share (“EPS”) and diluted EPS comparisons as required by ASC Topic 260:
| | | Year Ended | |
| | | December 31, | |
| | | 2009 | | | 2008 | | | 2007 | |
| Basic: | | | | | | | | | |
| Net income (loss) | | $ | (57,579 | ) | | $ | (8,243 | ) | | $ | 37,592 | |
| | | | | | | | | | | | | |
| Weighted average shares (thousands) | | | 26,651 | | | | 26,293 | | | | 25,996 | |
| | | | | | | | | | | | | |
| Income (loss) per share | | $ | (2.16 | ) | | $ | (0.31 | ) | | $ | 1.45 | |
| | | | | | | | | | | | | |
| Diluted: | | | | | | | | | | | | |
| Net income (loss) | | $ | (57,579 | ) | | $ | (8,243 | ) | | $ | 37,592 | |
| | | | | | | | | | | | | |
| Weighted average shares: | | | | | | | | | | | | |
| Outstanding (thousands) | | | 26,651 | | | | 26,293 | | | | 25,996 | |
| Restricted Stock and Options (thousands) | | | - | | | | - | | | | 105 | |
| | | | 26,651 | | | | 26,293 | | | | 26,101 | |
| | | | | | | | | | | | | |
| Income (loss) per share | | $ | (2.16 | ) | | $ | (0.31 | ) | | $ | 1.44 | |
| | | | | | | | | | | | | |
11. Fair Value Measurements
Fair Value Measurements
As defined in ASC 820, Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (referred to as an "exit price"). Authoritative guidance on fair value measurements and disclosures clarifies that a fair value measurement for a liability should reflect the entity's non-performance risk. In addition, a fair value hierarchy is established that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are:
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. This category includes quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3: Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources.
Fair Value on Recurring Basis
The Company issued a Warrant in conjunction with its revolving credit facility with Banco Inbursa. In accordance with accounting standards, the Company revalued the Warrant as of December 31, 2009 and recorded the change in the fair value of the Warrant on the consolidated statement of operations. The fair value of the Warrant was determined using level 3 inputs. The Company used a pricing model based on a version of the Black Scholes model, which is adjusted to account for the dilution resulting from the additional shares issued for the Warrant. The valuation was determined by computing the value of the Warrant if exercised in Year 1 – 3 with the values weighted by the probability that the Warrant would actually be exercised in that year. Some of the assumptions used in the model were a volatility of 45% and a risk free interest rate that ranged from 0.36% to 1.38%. The fair value of the Warrant was $2,829 at December 31, 2009. The Company recorded a change in the fair value of the Warrant on the consolidated statement of operations in the amount of $1,850 for the year ended December 31, 2009.
Fair Value on Non-Recurring Basis
On January 1, 2009, the Company adopted the provisions of ASC 820 for nonfinancial assets and liabilities measured at fair value on a non-recurring basis. Certain assets and liabilities are reported at fair value on a nonrecurring basis in the Company’s consolidated balance sheets. The Company reviews its long-lived assets to be held and used, including property plant and equipment and its investments in Challenger and Bronco MX, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable.
Due to the recent volatility and decline in oil and natural gas prices, a deteriorating global economic environment and the anticipated future earnings of Challenger, the Company deemed it necessary to test the investment for impairment. Fair value of the investment was estimated using level three inputs based on a combination of income, or discounted cash flows approach, and the market approach, which utilizes comparable companies’ data. The analysis resulted in a fair value of $39,800 related to our investment in Challenger as stated in other assets on the Company’s consolidated balance sheet, which was below the carrying value of the investment and resulted in a non-cash impairment charge in the amount of $21,247.
The fair value of the Company’s 40% investment in Bronco MX as of September 18, 2009, was estimated using level three inputs based upon a combination of income, or discounted cash flows approach, the market approach, which utilizes pricing of third-party transactions of comparable businesses or assets and the cost approach which considers replacement cost as the primary indicator of value. The analysis resulted in a fair value of $21,495 related to the Company’s 40% retained interest in Bronco MX as stated in other assets on the Company’s consolidated balance sheet.
12. Restricted Stock
The Company’s board of directors and a majority of our stockholders approved our 2006 Stock Incentive Plan, which the Company refers to as the 2006 Plan, effective April 20, 2006. The purpose of the 2006 Plan is to provide a means by which eligible recipients of awards may be given an opportunity to benefit from increases in value of our common stock through the granting of one or more of the following awards: (1) incentive stock options, (2) nonstatutory stock options, (3) restricted awards, (4) performance awards and (5) stock appreciation rights.
The purpose of the plan is to enable the Company, and any of its affiliates, to attract and retain the services of the types of employees, consultants and directors who will contribute to our long range success and to provide incentives that are linked directly to increases in share value that will inure to the benefit of our stockholders.
Eligible award recipients are employees, consultants and directors of the Company and its affiliates. Incentive stock options may be granted only to our employees. Awards other than incentive stock options may be granted to employees, consultants and directors. The shares that may be issued pursuant to awards consist of our authorized but unissued common stock, and the maximum aggregate amount of such common stock that may be issued upon exercise of all awards under the plan, including incentive stock options, may not exceed 2,500,000 shares, subject to adjustment to reflect certain corporate transactions or changes in our capital structure.
Under all restricted stock awards to date, nonvested shares are subject to forfeiture for failure to fulfill service conditions. Restricted stock awards consist of our common stock that vest over a two year period. Total shares available for future stock option grants and restricted stock grants to employees and directors under existing plans were 1,290,871. Restricted stock awards are valued at the grant date market value of the underlying common stock and are being amortized to operations over the respective vesting period. Compensation expense for the years ended December 31, 2009, 2008 and 2007 related to shares of restricted stock was $3,301, $5,825 and $2,699, respectively. On April 20, 2007, the Company filed a tender Offer Statement on Schedule TO relating to the Company's offer to eligible directors, officers, employees and consultants to exchange certain outstanding options to purchase shares of the Company's common stock for restricted stock awards consisting of the right to receive restricted stock. The offer expired on May 21, 2007. Pursuant to the offer, the Company accepted for cancellation eligible options to purchase 729,000 shares of the Company's common stock tendered by directors, officers, employees and consultants eligible to participate in the offer. Compensation expense for the year ended December 31, 2007 related to stock options was $1,029. Restricted stock activity for the years ended December 31, 2009, 2008 and 2007 was as follows:
| | | | | | Weighted Average | |
| | | | | | Grant Date | |
| | | Shares | | | Fair Value | |
| Outstanding at December 31, 2006 | | | 66,667 | | | $ | 20.25 | |
| Granted | | | 125,000 | | | | 15.47 | |
| Converted | | | 384,500 | | | | 16.58 | |
| Vested | | | (22,222 | ) | | | 20.25 | |
| Forfeited/expired | | | (500 | ) | | | 16.69 | |
| | | | | | | | | |
| Outstanding at December 31, 2007 | | | 553,445 | | | $ | 16.64 | |
| Granted | | | 232,874 | | | | 13.98 | |
| Vested | | | (321,889 | ) | | | 16.36 | |
| Forfeited/expired | | | (750 | ) | | | 16.69 | |
| | | | | | | | | |
| Outstanding at December 31, 2008 | | | 463,680 | | | $ | 15.22 | |
| Granted | | | 415,955 | | | | 5.28 | |
| Vested | | | (375,037 | ) | | | 13.86 | |
| | | | | | | | | |
| Outstanding at December 31, 2009 | | | 504,598 | | | $ | 7.67 | |
| | | | | | | | | |
13. Fair Value of Financial Instruments
Cash and cash equivalents, trade receivables and payables and short-term debt:
The carrying amounts of our cash and cash equivalents, trade receivables, payables and short-term debt approximate their fair values due to the short-term nature of these instruments.
Long-term debt
The carrying amount of our long-term debt approximates its fair value, as supported by the recent issuance of the debt and because the rates and terms currently available to us approximate the rates and terms of the existing debt.
14. Employee Benefit Plans
The Company implemented a 401(k) retirement plan for its eligible employees during 2008. Under the plan, the Company matches 100% of employees’ contributions up to 5% of eligible compensation. Employee and employer contributions vest immediately. The Company’s contributions for the years ended December 31, 2009, 2008 and 2007 were $628, $1,093 and $1,030, respectively.
15. Quarterly Results of Operations (unaudited)
The following table summarizes quarterly financial data for our years ended December 31, 2009 and 2008;
| Bronco Drilling Company Inc. | |
| Quarterly Results | |
| Year Ended December 31, 2009 | |
| (Amounts in thousands except per share amounts) | |
| (Unaudited) | |
| | | | | | | | | | | | | |
| | | First | | | Second | | | Third | | | Fourth | |
| | | Quarter | | | Quarter | | | Quarter (1) | | | Quarter | |
| 2009 | | | | | | | | | | | | |
| Revenues | | $ | 50,605 | | | $ | 27,518 | | | $ | 16,233 | | | $ | 16,181 | |
| Income (loss) from operations | | | 732 | | | | (8,865 | ) | | | (39,248 | ) | | | (11,501 | ) |
| Income tax expense (benefit) | | | (11 | ) | | | (4,108 | ) | | | (25,115 | ) | | | (3,875 | ) |
| Net income (loss) | | | (1,709 | ) | | | (7,158 | ) | | | (42,654 | ) | | | (6,058 | ) |
| Income (loss) per share: | | | | | | | | | | | | | | | | |
| Basic | | | (0.06 | ) | | | (0.27 | ) | | | (1.60 | ) | | | (0.23 | ) |
| Diluted | | | (0.06 | ) | | | (0.27 | ) | | | (1.60 | ) | | | (0.23 | ) |
| | | | | | | | | | | | | | | | | |
| | | First | | | Second | | | Third | | | Fourth | |
| | | Quarter | | | Quarter | | | Quarter (2) | | | Quarter (3) | |
| 2008 | | | | | | | | | | | | | | | | |
| Revenues | | $ | 67,003 | | | $ | 68,307 | | | $ | 72,920 | | | $ | 76,021 | |
| Income (loss) from operations | | | 11,206 | | | | 7,642 | | | | (609 | ) | | | (15,819 | ) |
| Income tax expense (benefit) | | | 4,552 | | | | 2,655 | | | | (60 | ) | | | (12,308 | ) |
| Net income (loss) | | | 8,148 | | | | 4,339 | | | | (917 | ) | | | (19,813 | ) |
| Income (loss) per share: | | | | | | | | | | | | | | | | |
| Basic | | | 0.31 | | | | 0.17 | | | | (0.03 | ) | | | (0.75 | ) |
| Diluted | | | 0.31 | | | | 0.16 | | | | (0.03 | ) | | | (0.75 | ) |
| | | | | | | | | | | | | | | | | |
| | | | (1) Includes $21, 247 of impairment to our Challenger Investment and $23,964 loss on Bronco MX transaction |
| | | | |
| | | | (2) Includes $6,000 of failed merger costs. |
| | | | |
| | | | (3) Includes $24,328 and $14,442 of impairments of goodwill and Challenger investment. |
16. Valuation and Qualifying Accounts
The Company’s valuation and qualifying accounts for the years ended December 31, 2009, 2008 and 2007 are as follows:
| | | Valuation and Qualifying Accounts | |
| | | Balance | | | Charged | | | | | | | |
| | | at | | | to Costs | | | Deductions | | | Balance | |
| | | Beginning | | | and | | | from | | | at | |
| | | of Year | | | Expenses | | | Accounts | | | Year End | |
| | | | | | | | | | | | | |
| Year ended December 31, 2007 | | | | | | | | | | | | |
| Allowance for doubtful receivables | | $ | 400 | | | $ | 4,370 | | | $ | (2,936 | ) | | $ | 1,834 | |
| | | | | | | | | | | | | | | | | |
| Year ended December 31, 2008 | | | | | | | | | | | | | | | | |
| Allowance for doubtful receivables | | $ | 1,834 | | | $ | 3,745 | | | $ | (1,749 | ) | | $ | 3,830 | |
| | | | | | | | | | | | | | | | | |
| Year ended December 31, 2009 | | | | | | | | | | | | | | | | |
| Allowance for doubtful receivables | | $ | 3,830 | | | $ | 2,134 | | | $ | (2,388 | ) | | $ | 3,576 | |
| | | | | | | | | | | | | | | | | |
