On September 22, 2006, the Company entered into a merger agreement to be acquired by Superior. Under the terms of the agreement, for each share of the Company’s common stock, a stockholder will receive upon the closing of the transaction $14.50 in cash and 0.452 shares of Superior common stock. The total purchase price is $358.0 million based on the closing price of Superior common stock on September 22, 2006, inclusive of indebtedness of the Company. The transaction is subject to approval by the stockholders of the Company, regulatory review and customary closing conditions, and is expected to close late in the fourth quarter of 2006. On November 7, 2006, the Company mailed to its stockholders of record as of the close of business on October 31, 2006, the record date for determining stockholders of the Company eligible to vote at a special meeting, a notice of special meeting of stockholders and a proxy statement/prospectus relating to a special meeting of stockholders to be held on December 12, 2006 to vote on a proposal to adopt the merger agreement with Superior.
The majority of the Company’s revenues are generated from major and large independent natural gas and oil companies. The primary factor influencing demand for the Company’s services by those customers is their level of drilling and workover activity, which, in turn, depends primarily on the availability of drilling and workover prospects and current and anticipated future natural gas and oil commodity prices and production depletion rates.
The Company’s services are generally provided at a price based on bids submitted which in turn are based on the Company’s current pricing, equipment and crew availability and customer location and the nature of the service to be provided. These services are routinely provided to the Company’s customers and are subject to the customers’ time schedule, weather conditions, availability of the Company’s personnel and complexity of the operation. The Company’s wireline services generally take one to three days to perform while its well intervention services can take up to two weeks or longer to perform. Service revenues are recognized at the time services are performed.
The Company generally charges for its wireline services on a per-well entry basis and its well intervention services on a day-rate basis. Depending on the specific service, a per-well entry or day-rate may include one or more of these components: (1) a set-up charge, (2) an hourly service rate based on equipment and labor, (3) an equipment rental charge, (4) a consumables charge and (5) a mileage and fuel charge. The Company determines the rates charged through a competitive bid process on a job-by-job basis or, for larger customers, the Company may negotiate on an annual basis. Typically, work is performed on a “call out” basis, whereby the customer requests services on a job-specific basis, but does not guarantee work levels beyond the specific job bid.
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During the three and nine months ended September 30, 2006, approximately $30.5 million or 79.7% and $75.5 million or 77.0% of the Company’s revenues were generated from wireline services, respectively and approximately $7.7 million or 20.3% and $22.6 million or 23.0% of its revenues were generated from well intervention services, respectively. The Company’s revenues from wireline services during the three and nine months ended September 30, 2005 were approximately $17.4 million and $51.6 million, respectively. Inasmuch as the Company entered the well intervention segment of its business in December 2005 with its acquisition of Bobcat, it had no revenues from this source in the three and nine months ended September 30, 2005. During the three and nine months ended September 30, 2006, approximately 63.6% and 68.5%, respectively, of the Company’s revenues were derived from onshore activities and approximately 36.4% and 31.5%, respectively, of the Company’s revenues were derived from offshore activities. During the years ended December 31, 2005 and December 31, 2004, approximately 57.9% and 49.9%, respectively, of the Company’s revenues were derived from onshore activities and approximately 42.1% and 50.1%, respectively, of the Company’s revenues were derived from offshore activities.
Cost and Expenses
Operating Costs. The Company’s operating costs are comprised primarily of labor expenses, repair and maintenance, material and fuel and insurance. In a competitive labor market in the industry, it is possible that the Company will have to raise wage rates to attract workers and retain or expand its current work force. The Company believes it will be able to increase service rates to its customers to compensate for wage rate increases. The Company also incurs costs to employ personnel to sell and supervise its services and perform maintenance on its fleet. These costs are not directly tied to the Company’s level of business activity. Because the Company seeks to retain its experienced and well-qualified employees during cyclical downturns in its business, and is required to pay severance under employment agreements that cover a portion of its workforce, the Company expects labor expenses to increase as a percentage of revenues during future cyclical downturns. Repair and maintenance is performed by the Company’s crews, company maintenance personnel and outside service providers. The Company endeavors, where possible and subject to existing agreements, to pass on to its customers, material increases in materials and fuel costs as they are incurred by the Company. In any event, due to the timing of the Company’s marketing and bidding cycles, there is generally a delay of several weeks or months from the time that it incurs an actual price increase until the time that the Company can endeavor to pass on that increase to its customers. Insurance is generally a fixed cost regardless of utilization and relates to the number of trucks, skids, snubbing units and other equipment in the Company’s fleet, employee payroll and safety record.
Selling, General and Administrative Expenses. The Company’s selling, general and administrative expenses include administrative, marketing, employee compensation and related benefits, office and lease expenses, insurance costs and professional fees, as well as other costs and expenses not directly related to field operations. The Company’s management regularly evaluates the level of the Company’s general and administrative expenses in relation to its revenue because these expenses have a direct impact on the Company’s profitability. The Company expects to incur additional expense in future periods relating to incentive compensation paid to employees.
Interest Expense. Interest expense consists of interest associated with the Company’s revolving line of credit, term loan, convertible notes and other debt as described in the notes to the Company’s financial statements contained elsewhere in this Report. As a result of the Company’s public offering completed on April 24, 2006, the Company’s debt levels, as a consequence of the application of the net proceeds from that offering are substantially lower than their levels prior to that date. In addition, the Company’s effective borrowing rate is substantially less than that associated with convertible subordinated debt outstanding prior to April 24, 2006 which was converted to equity in connection with the public offering. Accordingly, subsequent to April 24, 2006, interest expense is substantially lower than the levels of interest expense following the Company’s acquisition of Bobcat. Interest income primarily consists of interest earned on the Company’s cash balances.
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Depreciation Expense. The Company’s depreciation expense is based on estimates, assumptions and judgments relative to capitalized costs, useful lives and salvage values of the Company’s assets. The Company generally computes depreciation using the straight-line method.
Income Taxes. At December 31, 2005, the Company had approximately $29.3 million of net operating losses (“NOLs”) available to offset future taxable income. A portion of these NOLs will be available to reduce taxable income in 2006. However, a significant portion of these NOLs are subject to IRS Section 382 limitations which restrict the Company’s ability to use them to reduce taxable income.
The Company is required to record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. At December 31, 2005 the Company has recorded a valuation allowance of $6.4 million against the gross deferred tax asset.
In assessing the realizability of deferred tax assets, management considers future reversals of existing deferred tax liabilities, projected future taxable income exclusive of temporary differences and available tax planning strategies. In 2005, the Company recorded a decrease in the valuation allowance of $8.2 million. The decrease was recorded as a $3.0 million reduction of the provision for income taxes and as a $5.2 million reduction of the deferred tax liability and goodwill associated with the acquisition of Bobcat.
Results of Operations
The following discussion includes the results of operations of Bobcat for the three and nine months ended September 30, 2006. For further information relating to the results of operations of Bobcat prior to the completion of the acquisition through September 30, 2005 and pro forma financial information reflecting the combined results of operations of the Company and Bobcat for the nine months ended September 30, 2005 and the year ended December 31, 2004, see the Company’s Amendment No. 1 to its Current Report on Form 8-K filed on February 22, 2006. See also Note 2 to the Notes to Financial Statements For the Years Ended December 31, 2005, 2004 and 2003 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 for the pro forma statements of operations of the Company and Bobcat for the years ended December 31, 2005 and 2004.
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Three and Nine Months Ended September 30, 2006 Compared to Three and Nine Months Ended September 30, 2005
Revenues
The Company’s total revenues increased by approximately $20.8 million and $46.5 million for the three and nine months ended September 30, 2006, respectively as compared to the three and nine months ended September 30, 2005. This increase in revenues was primarily the result of improved pricing and increased utilization of the Company’s services due to the increase in well maintenance and drilling activity caused by higher natural gas and oil prices and the inclusion of revenues from the well intervention segment for the three and nine month period. The Company’s wireline segment revenue increased by $13.1 million for the three months ended September 30, 2006 with the addition of two wireline units for the period. For the nine months ended September 30, 2006 the Company’s wireline segment revenues increased by $23.9 million with the addition of eight wireline units during the year ended December 31, 2005 and twelve wireline units during the nine months ended September 30, 2006. The Company’s well intervention segment revenues were $7.8 million and $22.6 million for the three and nine months ended September 30, 2006 with its acquisition of Bobcat in December 2005. Revenues from the well intervention segment declined in the third quarter to $7.8 million, or by 6%, from the second quarter of 2006 due to lower utilization of the Company’s largest and highest dayrate unit. Margins declined primarily because of the costs associated with starting the Company’s coiled tubing, nitrogen and fluid pumping group with essentially no corresponding revenues. At the end of the third quarter and in October 2006, the Company took delivery of three nitrogen units and its first coiled tubing unit. Management expects results in this segment to significantly improve in the fourth quarter of 2006 and beyond.
The following table sets forth the Company’s revenues from its wireline service and well intervention service segments for the three and nine months ended September 30, 2006 and 2005. The Company entered into the well intervention service segment in December 2005 with its acquisition of Bobcat and had no revenues from this segment during the three and six months ended September 30, 2005.
| | Three Months Ended
September 30, | |
| |
| |
| | 2006 | | 2005 | |
| |
| |
| |
Wireline segment revenues | | $ | 30,494,495 | | $ | 17,421,589 | |
Well intervention segment revenues | | | 7,750,867 | | | — | |
| |
|
| |
|
| |
| | $ | 38,245,362 | | $ | 17,421,589 | |
| |
|
| |
|
| |
| | | | | | | |
| | Nine Months Ended
September 30, | |
| |
| |
| | 2006 | | 2005 | |
| |
| |
| |
Wireline segment revenues | | $ | 75,495,067 | | $ | 51,578,843 | |
Well intervention segment revenues | | | 22,564,269 | | | — | |
| |
|
| |
|
| |
| | $ | 98,059,336 | | $ | 51,578,843 | |
| |
|
| |
|
| |
The following is an analysis of the Company’s wireline segment operations for the first three quarters of 2006 and 2005 (dollars in thousands):
| | Revenue | | Operating
Income | | Average
Number of
Units | | Average
Jobs Per
Unit | |
| |
| |
| |
| |
| |
2006: | | | | | | | | | | | |
First Quarter | | $ | 20,701 | | $ | 6,513 | | 73 | | 48 | |
Second Quarter | | $ | 24,299 | | $ | 8,913 | | 77 | | 52 | |
Third Quarter | | $ | 30,494 | | $ | 12,641 | | 80 | | 49 | |
2005: | | | | | | | | | | | |
First Quarter | | $ | 14,448 | | $ | 1,597 | | 61 | | 46 | |
Second Quarter | | $ | 19,709 | | $ | 4,964 | | 65 | | 50 | |
Third Quarter | | $ | 17,422 | | $ | 3,353 | | 67 | | 51 | |
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The following is an analysis of the Company’s well intervention segment operations for the nine months ended September 30, 2006 (dollars in thousands):
| | Revenue | | Operating
Income | | Average
Number of
Units | | Utilization (1) | |
| |
| |
| |
| |
| |
2006: | | | | | | | | | | | |
First Quarter | | $ | 6,602 | | $ | 1,903 | | 15 | | 51 | |
Second Quarter | | $ | 8,211 | | $ | 2,562 | | 15 | | 47 | |
Third Quarter (2) | | $ | 7,751 | | $ | 554 | | 15 | | 46 | |
(1) | Utilization represents number of days units were on location performing services |
(2) | Includes start-up costs associated with the Company’s coiled tubing, nitrogen pumping and fluid pumping operations |
Operating Costs
The Company’s total operating costs increased by approximately $10.2 million and $21.8 million for the three and nine months ended September 30, 2006 as compared to the same periods of 2005. Operating costs were 54.1% and 54.0% of revenues for the three and nine months ended September 30, 2006, as compared to 60.5% and 60.4% of revenues for the same periods of 2005. The decrease in operating costs as a percentage of revenues was primarily the result of the higher utilization and pricing and economies of scale in the three and nine months ended September 30, 2006 compared with 2005, as well as the contribution to income from operations from the well intervention segment. The Company’s wireline segment operating costs increased by approximately $4.8 million and $9.0 million for the three and nine months ended September 30, 2006 as compared to the same periods in 2005 as a result of the increased revenues for the periods with operating costs as a percentage of revenue decreasing to 49.3% and 52.1% from 59.0% and 57.6% for the same three and nine month periods in 2005. The Company’s well intervention segment operating costs were $5.0 million and $11.9 million for the three and nine months ended September 30, 2006 with its acquisition of Bobcat in December 2005. Well intervention operating costs for the three months ended September 30, 2006 increased by $1.2 million over the prior quarter due mainly to the start up costs associated with the Company’s coiled tubing, nitrogen pumping and fluid pumping operations. Salaries and benefits increased by approximately $6.2 million and $13.5 million for the three and nine months ended September 30, 2006, as compared to the same periods in 2005. Total number of employees increased from 359 at September 30, 2005 and 480 at December 31, 2005 to 609 at September 30, 2006. The increase in salaries and benefits is primarily due to the increase in the number of employees in 2006 versus 2005.
Selling, General and Administrative Expenses
The Company’s total selling, general and administrative expenses increased by approximately $2.1 million and $5.2 million for the three and nine months ended September 30, 2006, respectively. The increases are primarily due to increases in insurance, professional fees and stock compensation expense as well as added costs from the well intervention segment. As a percentage of revenues, total selling, general and administrative expenses decreased to 11.6% from 13.5% for the three months ended September 30, 2006 and decreased to 12.2% from 13.1% for the nine months ended September 30, 2006.
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Depreciation and Amortization
Depreciation and amortization increased by approximately $2.0 million and $4.9 million for the three and nine months ended September 30, 2006. The increase was primarily due to the Bobcat acquisition and the amortization of intangible assets acquired in the Bobcat acquisition.
Interest Expense
Interest expense increased by approximately $35,000 and $1.2 million for the three and nine months ended September 30, 2006, as compared to the same periods in 2005. The increase in interest expense for the nine month period is primarily attributable to the increase in the Company’s senior debt outstanding as a result of the Bobcat acquisition in December 2005 which was substantially repaid in April 2006 as well as an increase in interest rates for the periods and for new property additions and deposits in 2006.
Other Income
Other income increased by approximately $140,000 and $395,000 for the three and nine months ended September 30, 2006, as compared to the same periods in 2005 due to the expensing of certain non-recurring transaction related costs in the three months ended September 30, 2005.
Income Taxes
The provision for income taxes was approximately $3.3 million and $7.6 million for the three and nine months ended September 30, 2006 and approximately $49,000 and $135,000 for the three and nine months ended September 30, 2005. The Company has utilized substantially all of its remaining unrestricted NOLs to reduce the amount of current cash taxes payable. No change in the valuation allowance occurred during the period ended September 30, 2006. For the period ended September 30, 2005, the Company recorded a decrease in the valuation allowance which resulted in a reduction in the provision for income taxes.
Texas House Bill 3 (“HB3”), which was signed into law in May 2006, provides a comprehensive change in the method of business taxation in Texas. HB3 eliminates the taxable capital and earned surplus components of the existing Texas franchise tax and replaces these components with a taxable margin tax. This change is effective for tax reports filed on or after January 1, 2008 (which are based upon 2007 business activity) and results in no impact on the Company’s current Texas income tax position.
The Company is required to include, in income, the impact of HB3 on its deferred state income taxes during the period which includes the date of enactment. Based on the available information regarding the proposed implementation of this new tax, the Company has determined that no change in deferred state income taxes is needed.
Net Income
Net income for the three and nine months ended September 30, 2006 was approximately $5.6 million and $12.9 million, respectively, compared with net income of approximately $2.2 million and $6.6 million, respectively, for the same periods of 2005. The improved results for the three and nine months ended September 30, 2006 over the same periods in 2005 was primarily the result of an increase in revenues reflecting an increase in demand for the Company’s services which resulted in improved pricing and utilization of the Company’s wireline and well intervention services.
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Liquidity and Capital Resources
The Company’s primary liquidity needs are to fund capital expenditures, such as expanding its wireline and well intervention services, geographic expansion, manufacturing and upgrading trucks, skids and snubbing units, the addition of complementary service lines and funding general working capital needs. In addition, the Company could need capital to fund strategic business acquisitions. The Company’s primary sources of funds have historically been cash flow from operations, proceeds from borrowings under bank credit facilities and the issuance of debt. With completion of the Company’s public offering in April 2006, the Company anticipates that it will rely on cash generated from operations, borrowings under its credit facility and possible debt and equity offerings to satisfy its liquidity needs. The Company believes that with the current and anticipated operating environment of the natural gas and oil industry, it will be able to meet its liquidity requirements for the remainder of 2006 and through September 2007. In addition to funding operating expenses, cash requirements for 2006 and through September 2007 are expected to be comprised mainly of amortization payments on indebtedness and funding capital improvements. The Company’s planned growth initiatives are expected to require capital expenditures of in excess of $100.0 million through approximately December 31, 2008. The Company’s ability to fund planned capital expenditures and to make acquisitions will depend upon its future operating performance, and more broadly, on the availability of debt and potentially equity financing, which will be affected by prevailing economic conditions in the Company’s industry, and general financial, business and other factors, some of which are beyond the Company’s control.
At September 30, 2006, the Company’s outstanding indebtedness included primarily senior secured indebtedness aggregating approximately $46.3 million and other indebtedness of approximately $1.7 million.
Cash provided by the Company’s operating activities was approximately $22.0 million (including a use of cash of $3.0 million for financing of the Company’s insurance premiums and $1.6 million for a change of control payment) for the nine months ended September 30, 2006 as compared to cash provided of approximately $13.1 million for the same period in 2005. The increase in cash provided by operating activities was due mainly as a result in the increase in demand for the Company’s services. During the nine months ended September 30, 2006, investing activities used cash of approximately $41.6 million for the acquisition of property, plant and equipment (including $11.7 million in deposits on future deliveries of coiled tubing, nitrogen pumping and fluid pumping units) as compared to $5.9 million for the same period in 2005. During the nine months ended September 30, 2006, financing activities used cash of approximately $36.7 million for principal payments on debt offset by net proceeds from the public offering and stock repurchases, exercise of options, bank and other borrowings and net draws on working capital revolving loans of approximately $58.1 million. During the nine months ended September 30, 2005, financing activities used cash of approximately $3.8 million for principal payments on debt offset by proceeds from bank and other borrowings and net draws on working capital revolving loans of approximately $573,000.
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The Company and certain of the former holders of the equity securities purchased by the Company out of the proceeds Company’s public offering are currently involved in an arbitration proceeding regarding the allocation of fees and expenses related to the offering and deducted by the Company in arriving at the amounts payable to the former holders. There is a binding agreement to arbitrate, with a hearing anticipated in the first quarter of 2007. The Company believes that any additional amount determined to be payable to such persons would not be material to its financial condition.
Senior Secured Credit Agreement
On December 16, 2005, the Company entered into the Senior Secured Credit Agreement with GECC, providing for a term loan and revolving and capital expenditure credit facilities in an aggregate amount of $50.0 million. The Senior Secured Credit Agreement includes:
| • | a revolving credit facility of up to $30.0 million ($14.5 million available at September 30, 2006), but not exceeding a borrowing base of 85% of the book value of eligible accounts receivable, less any reserves GECC may establish from time to time, |
| • | a term loan of $30.0 million, and |
| • | a one-year capital expenditure loan facility of up to $25.0 million ($20.0 available at September 30, 2006), but not exceeding the lesser of 80% of the hard costs of eligible capital equipment and 75% of the forced liquidation value of eligible capital equipment, subject to adjustment by GECC. |
GECC’s agreement to make revolving loans expires on December 16, 2008 and its agreement to make capital expenditure loans expires on June 16, 2007, unless earlier terminated under the terms of the Senior Secured Credit Agreement. Based on the Leverage Ratio, the annual interest rate on borrowings under the revolving loan facility range from 0.50% to 1.5% above the index rate, and the annual interest rate on borrowings under the term loan and capital expenditure loan facilities range from 2.00% to 3.0% above the index rate. The index rate is a floating rate equal to the higher of (i) the rate publicly quoted from time to time by the Wall Street Journal as the prime rate, or (ii) the average of the rates on overnight Federal funds transactions among members of the Federal Reserve System plus 0.5%. Subject to the absence of an event of default and fulfillment of certain other conditions, the Company can elect to borrow or convert any loan and pay the annual interest at the LIBOR rate plus applicable margins, based on the Leverage Ratio, ranging from 1.5% to 2.5% on the revolving loan and ranging from 3.0% to 4.0% on the term loan and capital expenditure loan. At September 30, 2006 the interest rates were 9.3%, 8.9% and 8.9% for the revolving loan, term loan and capital expenditure loan, respectively.
Advances under the Senior Secured Credit Agreement are collateralized by a senior lien against substantially all of the Company’s assets.
Borrowings under the revolving loan are able to be repaid and re-borrowed from time to time for working capital and general corporate needs, subject to the Company’s continuing compliance with the terms of the agreement. Any amounts outstanding under the revolving loan are due and payable on December 16, 2008. The term loan is to be repaid in 12 consecutive quarterly installments of $1.1 million commencing January 1, 2006 with a final installment of $16.8 million due and payable on January 1, 2009. The capital expenditure loan is to be repaid in eight quarterly installments commencing January 1, 2007 and continuing thereafter with the first two installments to be equal to $250,000 and the last six installments to be equal to the sum of $250,000 plus 1/20th of the principal amount of the capital expenditure loan funded on or after August 14, 2006. A final ninth installment is due and payable on December 16, 2008 and is to be in the amount of the entire remaining balance of the capital expenditure loan.
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The following table sets forth information as of September 30, 2006 with respect to the Company’s repayment obligations relating to its long term debt:
| | Total | | Prior to
December 31,
2006 | | January 1,
2007 to
December 31,
2008 | | January 1,
2009 to
December 31,
2011 | | January 1,
2012
and
thereafter | |
| |
| |
| |
| |
| |
| |
Long Term Debt | | $ | 48,019,754 | | $ | 21,757,765 | | $ | 14,446,512 | | $ | 10,908,749 | | $ | 906,728 | |
| | | | | | | | | | | | | | | | |
Borrowings under the Senior Secured Credit Agreement are subject to certain mandatory pre-payments including, among other requirements, pre-payment out of a portion of the net proceeds of any sale of stock by the Company in a public offering. The Company must apply the net proceeds from any sale of its stock, other than on exercise of existing warrants and conversion rights, occurring before December 31, 2006 to the prepayment of loans. If the Company issues any shares of common stock, other than as described above, or any debt at any time, the Company is required to prepay the loans outstanding under the Senior Secured Credit Agreement in an amount equal to all such proceeds, net of underwriting discounts and commissions and other reasonable costs. The Company is also required to prepay annually, commencing with the fiscal year ending December 31, 2006, loans and other outstanding obligations under the Senior Secured Credit Agreement in an amount equal to 75% of the Company’s excess cash flow, as defined, for the immediately preceding fiscal year. At September 30, 2006, no excess cash flow payment is due.
Under the Senior Secured Credit Agreement, the Company is obligated to maintain compliance with a number of affirmative and negative covenants, including, among others, a prohibition on merging with, acquiring all or substantially all the assets or stock of, or otherwise combining with or acquiring, another person, incurring any indebtedness other than specified permitted indebtedness, and making any restricted payments, including payment of dividends, stock or warrant redemptions, repaying subordinated notes, except as otherwise permitted under the Senior Secured Credit Agreement. The financial covenants:
| • | limit the maximum amount of capital expenditures the Company is permitted to make as follows (such amounts exclude amounts financed entirely with proceeds of its capital expenditure loan facility): |
Period | | Maximum Capital
Expenditure Per Period | |
| |
| |
Year ended December 31, 2006 | | $ | 45.0 million | |
Year ended December 31, 2007 | | $ | 50.0 million | |
Each year ended December 31 thereafter | | $ | 40.0 million | |
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| • | Require the Company to have at the end of each fiscal quarter and for the 12-month period then ended, a ratio of (a) EBITDA minus capital expenditures paid in cash during such period, excluding capital expenditures financed under the Senior Secured Credit Agreement, minus income taxes paid in cash during such period to (b) fixed charges including, with certain exceptions, the total of principal and interest payments during such period, of not less than 1.5:1.0. For the purpose of calculating the ratio for the fiscal quarters ending March 31, 2006, June 30, 2006 and September 30, 2006, EBITDA and fixed charges are to be measured for the period commencing on January 1, 2006 and ending on the last day of such fiscal quarter. |
| • | Require the Company to have, at the end of each fiscal month, a ratio of funded debt to EBITDA as of the last day of such fiscal month and for the 12-month period then ended of not more than the following: |
| • | 2.25:1.00 for the fiscal months ending on January 31, 2006 through March 31, 2006; |
| • | 2.25:1.00 for the fiscal months ending on April 30, 2006 through June 30, 2006; |
| • | 2.00:1.00 for the fiscal months ending on July 31, 2006 through March 31, 2007; and |
| • | 1.75:1.00 for each fiscal month ending thereafter. |
| • | Require the Company to have, at the end of each fiscal month, EBITDA for the 12-month period then ended of not less than the following: |
| • | $33,000,000 for the fiscal months ending on January 31, 2006 through March 31, 2006; |
| • | $33,000,000 for the fiscal months ending on April 30, 2006 through June 30, 2006; |
| • | $34,000,000 for the fiscal months ending on July 31, 2006 through December 31, 2006; and |
| • | $35,000,000 for each fiscal month ending thereafter. |
Events of default under the Senior Secured Credit Agreement include, among others and subject to certain limitations,
| • | the failure to make any payment of principal, interest, or fees when due and payable or to pay or reimburse GECC for any expense reimbursable under the Senior Secured Credit Agreement within ten days of demand for payment, |
| • | the failure to perform the covenants under the Senior Secured Credit Agreement relating to use of proceeds, maintenance of a cash management system, maintenance of insurance, delivery of certificates of title for equipment, delivery of certain post-closing documents, and maintenance of compliance with the Senior Secured Credit Agreement’s negative covenants, |
| • | the failure to deliver to the lenders monthly un-audited, quarterly un-audited and annual audited financial statements, an annual operating plan, and other reports, certificates and information as required by the Senior Secured Credit Agreement, |
| • | the failure to perform any other provision of the Senior Secured Credit Agreement (other than those set forth above) which nonperformance remains un-remedied for 20 days or more, |
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| • | a default or breach under any other agreement or instrument to which the Company is a party beyond any grace period that involves the failure to pay in excess of $250,000 or causes or permits to cause indebtedness in excess of $250,000 to become due prior to its stated maturity, |
| • | any information in a borrowing base certificate or any representation or warranty or certificate or in any written statement report, or financial statement delivered to GECC being untrue or incorrect in any material respect, |
| • | a change of control, as defined, of the Company, |
| • | the occurrence of an event having a material adverse effect, as defined, |
| • | the initiation of insolvency, bankruptcy or liquidation proceedings, |
| • | any final judgment for the payment of money in excess of $250,000 is outstanding against the Company and is not within thirty days discharged, stayed or bonded pending appeal, |
| • | any material provision of or lien under any document relating to the Senior Secured Credit Agreement ceases to be valid, |
| • | the attachment, seizure or levy upon of the Company’s assets which continues for 30 days or more, and |
| • | William Jenkins ceases to serve as the Company’s chief executive officer, unless otherwise agreed by GECC. |
Upon the occurrence of a default, which is defined as any event that with the passage of time or notice or both would, unless waived or cured, become an event of default, the lenders may discontinue making revolving loans and capital expenditure loans to the Company and increase the interest rate on all loans. Upon the occurrence of an event of default, the lenders may terminate the Senior Secured Credit Agreement, declare all indebtedness outstanding under the Senior Secured Credit Agreement due and payable, and exercise any of their rights under the Senior Secured Credit Agreement which includes the ability to foreclose on the Company’s assets. In the event of a bankruptcy or liquidation proceeding, all borrowings under the Senior Secured Credit Agreement are immediately due and payable.
Reference is made to the Senior Secured Credit Agreement filed as an exhibit to the Company’s Current Report on Form 8-K for December 16, 2005 and amendments thereto filed as exhibits to the Company’s Current Report on Form 8-K for April 18, 2006 for a complete statement of the terms and conditions.
At September 30, 2006, the Company is in compliance with all covenants under its Senior Secured Credit Agreement.
Second Lien Credit Agreement
On December 16, 2005, the Company entered into the Second Lien Credit Agreement with GECC, providing for a term loan of $25.0 million. The annual interest rate on borrowings under the term loan was 6.0% above the index rate, as defined above. The loan under the Second Lien Credit Agreement was collateralized by a junior lien against substantially all of the Company’s assets, subordinate to the lien under the Senior Secured Credit Agreement. Initial borrowings under the Second Lien Credit Agreement advanced on December 16, 2005 of $25.0 million were used to pay a portion of the Bobcat acquisition purchase price. This loan was repaid on April 25, 2006 out of the net proceeds from the Company’s underwritten public offering of common stock.
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Significant Accounting Policies
The Company’s Discussion and Analysis of Financial Condition and Results of Operations is based upon its financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the allowance for bad debts, inventory, long-lived assets, intangibles and goodwill. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company’s significant accounting policies are described in Note 4 of the Notes to Financial Statements in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004) “Share-Based Payment” (SFAS 123(R)), as more fully described in Note 2 to the financial statements.
Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995
With the exception of historical matters, the matters discussed in this Report are “forward-looking statements” as defined under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve risks and uncertainties. The Company intends that the forward-looking statements herein be covered by the safe-harbor provisions for forward-looking statements contained in the Securities Exchange Act of 1934, as amended, and this statement is included for the purpose of complying with these safe-harbor provisions.
Forward-looking statements include, but are not limited to, the matters described under Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 3. Qualitative and Quantitative Disclosures About Market Risk. Such forward-looking statements relate to the completion by the Company of its merger with Superior, the Company’s ability to generate improved revenues and maintain profitability and cash flow, which in turn are based on the stability and level of prices for natural gas and oil, predictions and expectations as to the fluctuations in the levels of natural gas and oil prices, pricing in the natural gas and oil services industry and the willingness of customers to commit for natural gas and oil well services, the Company’s ability to implement its intended business plans, which include, among other things, the implementation of its previously announced growth initiatives and business strategy and goals, the Company’s ability to raise additional debt or equity capital to meet its requirements and to implement its intended growth initiatives and to obtain additional financing to fund that growth when required, the Company’s ability to maintain compliance with the covenants of its credit agreement and obtain waivers of violations that occur and consents to amendments as required, the Company’s ability to compete in the premium natural gas and oil services market, the Company’s ability to re-deploy its equipment among regional operations as required, the Company’s ability to provide services using state of the art tooling and its ability to successfully integrate and operate the well intervention operations acquired from Bobcat.
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Important factors that may affect the Company’s ability to meet these objectives or requirements include:
| • | adverse developments in general economic conditions; |
| • | changes in capital markets; |
| • | adverse developments in the natural gas and oil industry; |
| • | developments in international relations; |
| • | the commencement or expansion of hostilities by the United States or other governments; |
| • | events of terrorism; and |
| • | declines and fluctuations in the prices for natural gas and oil; |
Material declines in the prices for natural gas and oil can be expected to adversely affect the Company’s revenues. The Company cautions readers that various risk factors described in this Quarterly Report could cause the Company’s operating results and financial condition to differ materially from those expressed in any forward-looking statements it makes and could adversely affect the Company’s financial condition and the Company’s ability to pursue its business strategy and plans. Risk factors that could affect the Company’s revenues, profitability and future business operations, among others, are set forth under Item 1A – Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Item 3. Qualitative and Quantitative Disclosures About Market Risk
From time to time, the Company holds financial instruments comprised of debt securities and time deposits. All such instruments are classified as securities available for sale. At December 31, 2005 and September 30, 2006, the Company had no securities available for sale. The Company does not invest in portfolio equity securities, or commodities, or use financial derivatives for trading or hedging purposes. The Company’s debt security portfolio represents funds held temporarily pending use in its business and operations. The Company manages these funds accordingly. The Company seeks reasonable assuredness of the safety of principal and market liquidity by investing in rated fixed income securities while, at the same time, seeking to achieve a favorable rate of return. The Company’s market risk exposure consists of exposure to changes in interest rates and to the risks of changes in the credit quality of issuers. The Company typically invests in investment grade securities with a term of three years or less. The Company believes that any exposure to interest rate risk is not material.
Under the Company’s Senior Secured Credit Agreement and its Second Lien Credit Agreement with General Electric Capital Corporation entered into on December 16, 2005, the Company is subject to market risk exposure related to changes in the prime interest rate. Assuming the Company’s level of borrowings from GECC at December 31, 2005 remained unchanged throughout 2006, if a 100 basis point increase in interest rates under the Restated Credit Agreement from rates in existence at December 31, 2005 prevailed throughout the year 2006, it would increase the Company’s 2006 interest expense by approximately $416,000.
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On April 24, 2006, the Company repaid its Second Lien Credit Agreement in full and reduced its outstanding indebtedness under its Senior Secured Credit Agreement by approximately $4.0 million.
Item 4. Controls and Procedures
Under the supervision and with the participation of the Company’s management, including William Jenkins, its President and Chief Executive Officer, and Ronald Whitter, its Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report, and, based on their evaluation, Mr. Jenkins and Mr. Whitter have concluded that these controls and procedures are effective. There were no changes in the Company’s internal controls over financial reporting that occurred during the three months ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
Disclosure controls and procedures are the Company’s controls and other procedures that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act are recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including Mr. Jenkins and Mr. Whitter, as appropriate to allow timely decisions regarding required disclosure.
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PART II – OTHER INFORMATION
The following may be deemed to be a material change in the risk factors set forth under Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005:
Failure to complete the merger with Superior could negatively impact the stock price and the future business and financial results of the Company.
Although the Company has agreed that its board of directors will, subject to fiduciary exceptions, recommend that its stockholders approve and adopt the merger agreement with Superior dated September 22, 2006, there is no assurance that the merger agreement and the merger will be approved, and there is no assurance that the other conditions to the completion of the merger will be satisfied. If the merger is not completed, the Company will be subject to several risks, including the following:
| • | The Company may be required to pay Superior $11.5 million, if the merger agreement is terminated under certain circumstances; |
| • | The current market price of the Company’s common stock may reflect a market assumption that the merger will occur, and a failure to complete the merger could result in a negative perception by the stock market of the Company generally and a resulting decline in the market price of the Company’s common stock; |
| • | Certain costs relating to the merger (such as legal, accounting and financial advisory fees) are payable by the Company whether or not the merger is completed; |
| • | There may be substantial disruption to the business of the Company and a distraction of its management and employees from day-to-day operations, because matters related to the merger may require substantial commitments of time and resources, which could otherwise have been devoted to other opportunities that could have been beneficial to the Company; |
| • | The Company’s business could be adversely affected if it is unable to retain key employees or attract qualified replacements; and |
| • | The Company would continue to face the risks that it currently faces as an independent company, as further described in the periodic reports and other documents the Company has filed with the Securities and Exchange Commission. |
If the merger is not completed, these risks may materialize and may have a material adverse effect on the Company’s business, financial results, financial condition and stock price.
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31.1 | Certification of President and Chief Executive Officer Pursuant to Rule 13a-14(a) |
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31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) |
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32.1 | Certification of President and Chief Executive Officer Pursuant to Section 1350 (furnished, not filed) |
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32.2 | Certification of Chief Financial Officer Pursuant to Section 1350 (furnished, not filed) |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | WARRIOR ENERGY SERVICES CORPORATION |
| | | (Registrant) |
Date: November 9, 2006 | | |
/S/ William L. Jenkins
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| | | | William L. Jenkins
President and Chief Executive Officer |
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/S/ Ronald Whitter
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| | | | Ronald Whitter
Chief Financial Officer |
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