Item 1B.
Unresolved Staff Comments
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.
Our contract land drilling segment is supported by several offices and yard facilities located throughout this segment’s areas of operations, including Oklahoma, Louisiana, Texas, North Dakota and Pennsylvania.
We own our office and yard in Duncan, Oklahoma and an 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.
PART II
Item 5.
Item 5.
Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
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.
On February 28, 2011, the last reported sale price of our common stock on The Nasdaq Global Select Market was $8.95 and we had approximately 34 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, 2010 with respect to shares of our common stock that may be issued under on our equity compensation plan:
Item 6.
Item 6.
Selected Financial Data.
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 2010, 2009, 2008, 2007 and 2006 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.
(1)
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, impairment, book loss on certain asset sales and other non-cash charges. 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.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation.
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 services to 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 refurbished 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 building, 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 2010. In addition, we have a 41,000 square foot machine shop in Oklahoma City, which allows us to build, 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 building and refurbishment programs.
We have a 20% 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 PEMEX and/or companies contracted with PEMEX. 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 one operating segment: contract land drilling. In June of 2009 we made the decision to suspend operations in our well servicing segment because of deteriorating market conditions resulting from the rapid decrease in oil and natural gas prices which began in the third quarter of 2008, as well as the inability of many customers to obtain financing related to their drilling and workover programs. The following is a description of this operating segment.
Through the second quarter of 2010, we explored alternatives to restructure our well servicing segment. During Q1 and Q2 2010 the market for workover services continued at depressed levels within our primary geographic well servicing market (Oklahoma). Late in Q2 2010, we determined that higher NPV projects were available within our drilling segment and chose to deploy capital in this segment rather than commit the capital required to restructure operations in the well servicing segment.
In late June 2010 we made a decision to market the assets constituting the well servicing segment for sale and redeploy the proceeds to reduce debt and to support the Company’s core drilling business. We have presented all well servicing operating results as discontinued operations in our Consolidated Statements of Operations for all periods presented.
In September 2010, substantially all of the assets of the well servicing segment were sold at auction to multiple bidders. The Company had one workover rig held for sale at December 31, 2010, with a carrying amount of $130.
In September and November 2010, we sold at auction in separate lots to multiple bidders two complete drilling rigs and components comprising six other drilling rigs (rigs 2, 9, 51, 52, 54, 70, 75 and 94), and ancillary equipment. The drilling rigs and equipment sold at auction were not being utilized currently in our business. In an unrelated transaction on September 23, 2010, we sold two drilling rigs (rigs 41 and 42) in a private sale to Windsor Permian LLC, an unaffiliated third party. On November 29, 2010, the Company sold two drilling rigs (rigs 5 and 7) and entered into a contract to sell one drilling rig (rig 6) in a private sale to Atlas Drilling, LLC, an unaffiliated third party.
In February 2011, we entered into a contract to sell two drilling rigs (rigs 56 and 62) to Windsor Permian LLC, an unaffiliated third party. The drilling rigs and related equipment sold at auction and held for sale are being sold as part of a broader strategy by management to divest of older drilling rigs and use the proceeds to pay down existing indebtedness.
Our contract land drilling segment provides contract land drilling services. As of February 28, 2011, we owned a fleet of 25 marketed land drilling rigs. We currently operate our drilling rigs in Oklahoma, Texas, Pennsylvania, West Virginia, and North Dakota. 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 25 operating drilling rigs range from 650 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 and are frequently utilized in unconventional resource plays. 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 decided 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 20 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 three months ended December 31, 2010 and 2009 and years ended December 31, 2010, 2009, and 2008, our rig utilization rates, revenue days, and average number of marketed rigs were as follows:
The increase in the number of revenue days in 2010 is due to the increase in oil and natural gas drilling activity in response to commodity prices and the availability of financing to our customers to fund their drilling programs. 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.
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 activity in the markets we serve and affect the demand for our drilling services and the revenue rates we can charge for our drilling 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 depends on.
Our business environment was 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 a result of this deterioration, there was and continues to be significant uncertainty in the capital markets and access to financing has been adversely impacted. As a result of these conditions, our customers reduced their exploration budgets which resulted in a significant decrease in demand for our services and a reduction in revenue rates and utilization. During 2010, demand for drilling activity improved as certain commodity prices strengthened in the latter half of the year. During 2010 the Company did not record any contract drilling revenue related to terminated contracts. During 2009 the Company recorded $7.9 million of contract drilling revenue related to terminated contracts. 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, 2011, the closing prices for near month delivery contracts for crude oil and natural gas as traded on the NYMEX were $96.97 per barrel and $4.04 per MMbtu, respectively. The Baker Hughes domestic land drilling rig count as of February 28, 2011 was 1,674. 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:
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 over the previous several years. Falling commodity prices and the oversupply of rigs, similar to what we began experiencing in 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. During 2010, these commodity prices strengthened and the overall demand for drilling activity increased in oil and natural gas resource plays. We expect continued increases in exploration and production spending in 2011, which we expect will result in modest increases in industry rig utilization and revenue rates in 2011, as compared to 2010. Continued fluctuations in the demand for gas and oil, among other factors including supply, could contribute to price volatility which may continue to affect demand for our services and could materially affect our future financial results.
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 occasionally 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. We had no footage contracts in progress at December 31, 2010 and 2009. 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, 2010 and 2009, our unbilled receivables totaled $428,000 and $828,000, 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 $1.7 million and $3.6 million at December 31, 2010 and 2009, 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. 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 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 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.
In the second quarter of 2010, management decided to sell the property and equipment of our well servicing segment. Management determined that the business was no longer consistent with our long-term strategic objectives. Since the well servicing property and equipment met the held for sale criteria, we were required to present its property and equipment held for sale at the lower of carrying amount or fair value less cost to sell. We evaluated well servicing’s respective assets held for sale for impairment. We engaged a third party independent appraisal company to determine the fair value of the well servicing assets. The analysis as of June 30, 2010 resulted in a $23.4 million impairment charge ($14.3 million after tax). This charge was recorded in the second quarter of 2010 and is reflected as a component of loss from discontinued operations in our Consolidated Statements of Operations.
In the third quarter of 2010, management made the decision to divest of older drilling rigs and use the proceeds to pay down existing indebtedness. Consequently, management decided to sell five drilling rigs (rigs 5, 6, 7, 51, and 54). Because the drilling rigs met the held for sale criteria, we are required to present these assets held for sale at the lower of carrying amount or fair value less anticipated cost to sell. We evaluated these assets as of September 30, 2010, for impairment. The fair value of the drilling rigs was determined using level 3 inputs. The fair value was determined by the sale price of similar assets sold by us in an auction during the third quarter and negotiated prices with interested parties. The analysis as of September 30, 2010 resulted in a $7.8 million impairment charge. We recognized an additional impairment during the fourth quarter of approximately $139,000 related to assets held for sale.
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, 2010 and 2009, we did not capitalize any interest.
We review our equity investments 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 volatility and decline in oil and natural gas prices, a deteriorating global economic environment through 2009 and the anticipated future earnings of Challenger, we deemed it necessary to test the investment for impairment during 2008, 2009, and 2010.
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 our fair value estimates, certain key assumptions included an assumed discount rate of 14.5% and 16.5%, a control premium of 25.0% and 30.0% and a long-term growth rate of 4.0% and 4.0% for 2009 and 2008, respectively. The analysis resulted in a non-cash impairment charge of $14.4 million in 2008. The analysis resulted in a fair value of $39.8 million related to our investment in Challenger, as of September 30, 2009, which was below the carrying value of the investment and resulted in a non-cash impairment charge in the amount of $21.2 million in the statement of operations ended December 31, 2009.
In developing our fair value estimates, as of December 31, 2010, certain key assumptions included an assumed discount rate of 15.0%, a control premium of 22.1% and a long-term growth rate of 3.0%. The analysis resulted in a fair value of $40.9 million related to our investment in Challenger, which was above the carrying value of the investment and resulted in no impairment.
Recent civil and political disturbances in Libya elsewhere in North Africa, and the Middle East may affect Challenger’s operations. Ongoing political unrest may result in loss of revenue and damage to equipment. Any impact from the political turmoil and protests on Challenger’s operations could negatively impact the Company’s investment in Challenger. The current conditions may trigger additional impairment analysis during 2011 which could result in an impairment of our investment.
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, $3.3 million, and $5.8 million for 2010, 2009, and 2008, 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 (loss) of Bronco MX” and “Equity in income (loss) 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, 2010 and December 31, 2009 included accruals of approximately $3.7 million and $2.5 million, respectively, for costs under our workers’ compensation insurance. We have a deductible of $500,000 per covered accident under our workers’ compensation insurance. We maintain letters of credit in the aggregate amount of $11.5 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, 2010.
Asset Sales and Held for Sale
On September 21, 2010 through September 23, 2010, we sold at auction in separate lots to multiple bidders two complete drilling rigs and components comprising four other drilling rigs (rigs 2, 9, 52, 70, 75 and 94), and ancillary equipment. The drilling rigs and equipment sold at auction were not being utilized currently in our business. We received net proceeds of approximately $8.3 million, net of selling expenses of $817,000, for the drilling rigs and related equipment. We recorded losses of $19.9 million related to the sale of the drilling rigs and ancillary equipment. The loss was based on net book values of approximately $28.2 million for the drilling rigs and ancillary equipment. We used the entire proceeds to pay down existing indebtedness under our revolving credit facility.
In an unrelated transaction on September 23, 2010, we sold two drilling rigs (rigs 41 and 42) in a private sale to Windsor Permian LLC, an unaffiliated third party, for estimated net proceeds of $7.2 million. We recorded a $1.7 million loss on the sale of these assets based on a net book value of $8.9 million.
The decision was made by management in the third quarter to sell an additional five drilling rigs (rigs 5, 6, 7, 51, and 54). Because the drilling rigs met the held for sale criteria, we were required to present such assets, comprised of property and equipment, at the lower of carrying amount or fair value less the anticipated costs to sell. We evaluated these assets for impairment as of September 30, 2010, which resulted in recognizing a $7.8 million impairment charge which includes estimated selling expenses of approximately $125,000. At September 30, 2010, the fair value estimate was derived from the sale price of similar assets sold at auction during the third quarter and negotiated prices with interested parties. The drilling rigs and related equipment were presented as part of our land drilling segment.
On November 17, 2010, the Company sold at auction in separate lots to multiple bidders two complete drilling rigs (rigs 51 & 54) and ancillary equipment. The drilling rigs and equipment sold at auction were not being utilized currently in the Company’s business. The Company received net proceeds of approximately $1.7 million, net of selling expenses of $115,000, for the drilling rigs and related equipment. The Company recorded a loss of $2.2 million related to the sale of the drilling rigs and ancillary equipment. The loss was based on net book values of approximately $3.9 million for the drilling rigs and ancillary equipment.
On November 29, 2010, the Company sold two drilling rigs (rigs 5 and 7) in a private sale to Atlas Drilling, LLC, an unaffiliated third party, for estimated net proceeds of $2.7 million. The Company recorded a $14,000 gain on the sale of these assets based on a net book value of $2.7 million.
The Company believes the sale of rig 6 is probable within a year from the date on which we classified the drilling rig as held for sale. Because the drilling rig meets the held for sale criteria, the Company is required to present such assets, comprised of property and equipment, at the lower of carrying amount or fair value less the anticipated costs to sell. The carrying amount of the drilling rig and related equipment after impairment was $1.6 million at December 31, 2010, and is included in Non-current assets held for sale in our Consolidated Balance Sheets. The Company recognized an additional impairment during the fourth quarter of approximately $139,000 related to this rig. At December 31, 2010, the Company’s fair value estimate was derived from the negotiated prices with interested parties. The drilling rig and related equipment were included as part of our land drilling segment.
The drilling rigs and related equipment sold at auction and the drilling rig held for sale are being sold as part of a broader strategy by management to divest of older drilling rigs and use the proceeds to pay down existing indebtedness.
Well Servicing Segment
In June 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.
Through the second quarter of 2010, Bronco senior management explored alternatives to restructure the well servicing segment. During Q1 and Q2 2010 the market for workover services continued at depressed levels within the primary geographic market of our well servicing assets (Oklahoma). Late in Q2 2010, management determined that higher NPV projects were available within the core drilling segment of the business and chose to deploy capital in this segment rather than commit the capital required to restructure operations in the well servicing segment.
In late June management made a decision to market the assets constituting the well servicing segment for sale and redeploy the proceeds to reduce debt and to support the Company’s core drilling business. Since the well servicing property and equipment met the held for sale criteria, we were required to present its property and equipment held for sale at the lower of carrying amount or fair value less cost to sell. Accordingly, in the second quarter of 2010, we evaluated well servicing’s respective assets held for sale for impairment. We engaged a third party independent appraisal company to determine the fair value of the well servicing assets. The analysis as of June 30, 2010 resulted in $23.4 million impairment charge ($14.3 million after tax). This charge was recorded in the second quarter of 2010 and is reflected as a component of income (loss) from discontinued operations in our Consolidated Statements of Operations.
In September 2010, substantially all of the assets of the well servicing segment were sold at auction to multiple bidders. We received proceeds of $12.4 million, net of selling expenses of $638,000. The sale of the assets of the well servicing segment resulted in a loss of $8.9 million, which is reflected as a component of loss from discontinued operations in our Consolidated Statements of Operations. We used the proceeds to pay down existing indebtedness under our revolving credit facility.
Bronco MX Joint Venture
In September of 2009, CICSA purchased 60% of the outstanding membership interests of Bronco MX from us. 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.
On July 1, 2010, CICSA contributed cash of approximately $45.1 million in exchange for 735,356,219 shares of Bronco MX. The cash contributed was used to purchase five drilling rigs. As a result of the contribution, our membership interest in Bronco MX was decreased to approximately 20%. We have accounted for the share issuance as if we had sold a proportionate amount of our shares. The Company recorded a loss on the transaction in the amount of $1.3 million, which is included in our consolidated statements of operations.
Bronco MX is jointly managed, with CICSA having four representatives on its board of managers and the Company having one representative 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.
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 have affected 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:
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:
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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;
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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;
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In July 2010, subsequent to the end of our second quarter, we completed the sale of the property and equipment of our trucking assets for $11.3 million in cash, net of selling expenses in the amount of $403,000. Proceeds from this sale were used to repay existing indebtedness under our revolving credit facility with Banco Inbursa.
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In September 2010, we sold at auction in separate lots to multiple bidders substantially all of the assets of our discontinued well servicing segment, two complete drilling rigs and components comprising four other drilling rigs (rigs 2, 9, 52, 70, 75 and 94), and ancillary equipment. We recorded losses of $8.9 million and $19.9 million from the sale of the assets of our well servicing segment and drilling rigs and related equipment, respectively.
Additionally, in the third quarter of 2010 management made the decision to continue to divest of smaller legacy mechanical rigs and invest the proceeds into new generation drilling rigs and equipment. That decision resulted in the following transactions.
Results of Operations
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Contract Drilling Revenue. For the year ended December 31, 2010, we reported contract drilling revenues of approximately $124.4 million, a 21% increase from revenues of $102.9 million for 2009. The increase is primarily due to an increase in total revenue days and an increase in average dayrates. Revenue days increased 31% to 7,450 days for the year ended December 31, 2010 from 5,699 days during 2009. Average dayrates for our drilling services increased $455, or 3%, to $16,527 for the year ended December 31, 2010 from $16,072 in 2009. The increase in the number of revenue days for the year ended December 31, 2010 as compared to 2009 is attributable to the increase in our utilization rate. Utilization increased to 62% from 36% for the year ended December 31, 2010 as compared to 2009. The 72% increase in utilization was primarily due to the increase in demand for our services related to an increase in drilling activity as a result of higher oil and natural gas prices. For the year ended December 31, 2010, the Company did not record any contract drilling revenue related to terminated contracts compared to $7.9 million for 2009.
Equity in Income (Loss) of Challenger. Our equity in the loss of Challenger was $984,000 for the year ended December 31, 2010 compared to $1.9 million for the year ended December 31, 2009. The equity in loss of Challenger represents our 25% share of Challenger’s loss for 2010 and 2009. For the year ended December 31, 2010, Challenger had operating revenues of $49.3 million and operating costs of $36.7 million. For the year ended December 31, 2009, Challenger had operating revenues of $56.5 million and operating costs of $35.4 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. Due to the volatility and decline in oil and natural gas prices, a deteriorating global economic environment and the anticipated future earnings of Challenger in 2009, 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 for the year ended December 31, 2009. We performed an impairment analysis as of December 31, 2010 and based upon the results, we were not required to record additional impairments during the year ended December 31, 2010. During the first quarter of 2011, political instability and unrest occurred in Libya, which could result in additional impairments of our investment in challenger.
Equity in Income (Loss) of Bronco MX. Equity in income of Bronco MX was $22,000 for the year ended December 31, 2010. Equity in loss of Bronco MX was $588,000 for the period September 18 through December 31, 2009. The equity in income (loss) of Bronco MX represents our proportionate share of Bronco MX’s loss for 2010 and 2009. For the year ended December 31, 2010, Bronco MX had operating revenues of $34.1 million and operating costs of $33.4 million. For the period September 18 through December 31, 2009, Bronco MX had operating revenues of $7.2 million and operating costs of $9.8 million.
Contract Drilling Expense. Contract drilling expense increased $19.6 million to $90.3 million for the year ended December 31, 2010 from $70.7 million in 2009. This 28% increase is primarily due to the increase in the number of revenue days from 5,699 for the year ended December 31, 2009 to 7,450 for 2010. As a percentage of contract drilling revenue, drilling expense increased to 73% for the year ended December 31, 2010 from 69% in 2009 due primarily to revenue related to terminated contracts of $7.9 million for 2009.
Depreciation and Amortization Expense. Depreciation and amortization expense decreased $7.8 million to $28.4 million for the year ended December 31, 2010 from $36.2 million in 2009. The decrease is due to the contribution of nine drilling rigs to Bronco MX in the third quarter of 2009, the sale of our workover rig segment in the third quarter of 2010, and the sale of six complete drilling rigs and components comprising six other drilling rigs during 2010.
General and Administrative Expense. General and administrative expense increased $1.3 million, or 8%, to $17.1 million for the year ended December 31, 2010 from $15.8 million in 2009. This primarily resulted from a $2.0 million increase in accounts receivable write offs and a $309,000 increase in payroll costs. These increases were partially offset by a decrease in consulting fees of $942,000 and a decrease in professional fees of $405,000. The decreases in consulting fees and professional fees is due to expenses incurred during 2009 related to the Bronco MX transaction.
Interest Expense. Interest expense decreased $2.2 million to $4.7 million for the year ended December 31, 2010 from $6.9 million in 2009. The decrease is due to a decrease in the average outstanding balance under our credit facilities.
Income Tax Expense. We recorded an income tax benefit of $18.1 million for the year ended December 31, 2010. This compares to an income tax benefit of $27.2 million in 2009. This decrease is primarily due to a $22.7 million decrease in pre-tax loss to $52.6 million for the year ended December 31, 2010 from $75.3 million in 2009.
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 $102.9 million, a 56% decrease from revenues of $233.9 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.
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 $35.4 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. Due to the 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 during 2009. 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 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 $65.0 million to $70.7 million for the year ended December 31, 2009 from $135.7 million in 2008. This 48% 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 69% for the year ended December 31, 2009 from 60% in 2008 due primarily to fixed costs on idle drilling rigs.
Depreciation and Amortization Expense. Depreciation and amortization expense decreased $3.0 million to $36.2 million for the year ended December 31, 2009 from $39.2 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 47%, to $15.8 million for the year ended December 31, 2009 from $29.8 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 $3.3 million decrease in accounts receivable write-offs, $2.5 million decrease in stock compensation expense, a $1.4 million decrease in professional fees, a $1.0 million decrease in payroll costs, and a $564,000 decrease in yard expense. 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 $2.9 million to $6.9 million for the year ended December 31, 2009 from $4.0 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 $27.2 million for the year ended December 31, 2009. This compares to an income tax benefit of $5.3 million in 2008. This increase is primarily due to a $64.6 million increase in pre-tax loss to $75.3 million for the year ended December 31, 2009 from $10.7 million in 2008.
Liquidity and Capital Resources
Operating Activities. Net cash provided by operating activities was $38.3 million for 2010, $22.2 million for 2009, and $48.4 million in 2008. The increase of $16.1 million from 2009 to 2010 was primarily due to an increase in cash receipts from customers and lower 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 $3.0 million for 2010 and $19.0 million for 2009 compared to cash used of $75.0 million for 2008. In 2010, we received approximately $24.0 million in proceeds from the sale of assets and $911,000 from principal payments on note receivable, which were partially offset by $19.2 million used to purchase property and equipment. In 2009, we received $31.7 million from the sale of 60% of the outstanding membership interests in Bronco MX, proceeds of $635,000 from the sale of assets and principal payments on note receivable of $3.1 million, partially offset by $16.5 million used to purchase property and equipment. In 2008, approximately $5.1 million was used to obtain a 25% interest in Challenger, $76.8 million was used to purchase property and equipment, which amounts were partially offset by $4.0 million received from the sale of assets and $2.9 million received from a restricted cash account.
Financing Activities. We used cash for financing activities of $46.0 million for 2010 and $58.4 million for 2009 as compared to cash provided of $47.5 million for 2008. Our net cash used for financing activities for 2010 related to payments on our revolving credit facility with Banco Inbursa in the amount of $50.9 million, partially offset by borrowings of $5.0 million under our revolving credit facility with Banco Inbursa. 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, 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 $3.5 million in debt issuance costs.
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 with Banco Inbursa, as lender and as the issuing bank. 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.
The credit facility initially provided for revolving advances of up to $75.0 million and the borrowing base under the credit facility was initially set at $75.0 million, subject to borrowing base limitations. On February 9, 2011 we amended our credit facility which reduced the commitment to $45.0 million. The credit facility matures on September 17, 2014. 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. Commitment fees expense was $125,000 and $15,000 for the years ended December 31, 2010 and December 31, 2009, respectively.
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. We were in compliance with all covenants at December 31, 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, 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, September 18, 2009, 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. Banco Inbursa subsequently transferred the Warrant to CICSA.
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, 2010 and 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 volatilities of 50% and 45% and a risk free interest rate that ranged from 0.22% to 0.54% and 0.40% to 1.45% for 2010 and 2009, respectively. The fair value of the Warrant was $4.4 million and $2.8 million at December 31, 2010 and December 31, 2009, respectively. We recorded a change in the fair value of the Warrant on the consolidated statement of operations in the amount of $1.6 million and $1.9 million for the years ended December 31, 2010 and December 31, 2009, respectively.
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.
This 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 year ended December 31, 2009 was $447,000.
This 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.
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 conjunction with our entry into our senior secured revolving credit facility with Banco Inbursa, we issued a three-year 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, 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 to CICSA evidencing such transfer.
Capital Expenditures.
During 2010, we incurred aggregate refurbishment costs of $7.3 million related to enhancements and refurbishments of rigs for opportunities domestically and incurred $8.0 million for the purchase of top drives to upgrade our fleet.
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.
Working Capital. Our working capital was $35.7 million at December 31, 2010, compared to $25.3 million at December 31, 2009. Our current ratio, which we calculate by dividing our current assets by our current liabilites, was 3.2 at December 31, 2010 compared to 2.4 at December 31, 2009.
We believe that the liquidity shown on our balance sheet as of December 31, 2010, which includes approximately $35.7 million in working capital (including $11.9 million in cash) and availability under our then $75.0 million credit facility of $54.4 million at December 31, 2010 (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. We believe the reduction in our credit facility to $45.0 million will not materially impact our liquidity. However, additional capital may be required for future rig acquisitions. 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):
The increase in cash and cash equivalents and restricted cash at December 31, 2010 as compared to December 31, 2009 was primarily due the sale of six complete drilling rigs and components comprising six other drilling rigs and our well servicing segment and trucking operations which resulted in net proceeds of $43.6 million as well as the decrease in affiliate receivables of $8.1 million, partially offset by the payments on our revolving credit facility with Banco Inbursa, in the amount of $50.9 million. The increase in cash is also attributable to an overall increase in drilling activity for 2010. Revenue days for the year ended December 31, 2010 were 7,450 compared to 5,699 for 2009.
The increase in trade receivables and other receivables at December 31, 2010 as compared to December 31, 2009 was due to an increase in revenue days and utilization rates during 2010 compared to 2009. Utilization for the year ended December 31, 2010 was 62% compared to 36% for 2009. Revenue days for the year ended December 31, 2010 were 7,450 compared to 5,699 for 2009.
The decrease in affiliate receivables at December 31, 2010 as compared to December 31, 2009 was mainly due to $7.1 million in payments received from Bronco MX.
Contractual and Commercial Commitments
The following table summarizes our contractual obligations and commercial commitments at December 31, 2010 (in thousands):
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements.
Recent Accounting Pronouncements
In December 2010, the FASB issued an accounting standard update that addresses the disclosure of supplementary pro forma information for business combinations. This update clarifies that when public entities are required to disclose pro forma information for business combinations that occurred in the current reporting period, the pro forma information should be presented as if the business combination occurred as of the beginning of the previous fiscal year when comparative financial statements are presented. This update is effective prospectively for 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, 2010. Early adoption is permitted. The Company is currently evaluating the impact, if any, the adoption will have on our consolidated financial statements.
In January 2010, the FASB issued a new accounting standard which requires reporting entities to provide information about movements of assets among Levels 1 and 2 of the three-tier fair value hierarchy established by ASC 820, Fair Value Measurements. Also required will be a reconciliation of purchases, sales, issuance, and settlements of financial instruments valued with a Level 3 method, which is used to price the hardest to value instruments. Entities will have to provide fair value measurement disclosures for each class of financial assets and liabilities. The guidance will be effective for fiscal years beginning after December 15, 2010. We are currently evaluating the impact, if any, the adoption will have on our consolidated financial statements.
In December 2009, the FASB issued a new accounting standard which updates the quantitative-based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which reporting entity has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. An approach that is expected to be primarily qualitative will be more effective for identifying which reporting entity has a controlling financial interest in a variable interest entity. The amendments in this update also require additional disclosures about an reporting entity’s involvement in variable interest entities, which will enhance the information provided to users of financial statements. This new standard is effective at the start of a reporting entity’s first fiscal year beginning after January 1, 2010. The adoption of this standard did not impact our consolidated financial statements.
In October 2009, the FASB issued a new accounting standard that addresses the accounting for multiple-deliverable revenue arrangements to enable vendors to account for deliverables separately rather than as a combined unit. This new standard addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting. Existing accounting standards require a vendor to use objective and reliable evidence of fair value for the undelivered items or the residual method to separate deliverables in a multiple-deliverable arrangement. Under the new standard, it is expected that multiple-deliverable arrangements will be separated in more circumstances than under current requirements. The new standard establishes a hierarchy for determining the selling price of a deliverable for purposes of allocating revenue to multiple deliverables. The selling price used will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The new standard must be prospectively applied to all revenue arrangements entered into in fiscal years beginning on or after June 15, 2010 and became effective for us on January 1, 2011. We are currently evaluating the impact, if any, the adoption will have on our 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.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
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 $56,000 annually, based on the $9.1 million outstanding in the aggregate under our credit facility as of December 31, 2010.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
Our Financial Statements begin on page 49 of this Form 10-K, Index to Consolidated Financial Statements, and are incorporated herein by this reference.
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
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, 2010 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:
(i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of our company;
(ii)
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
(iii)
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, 2010.
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 Bronco Drilling Company, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2010, 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, 2010, based on criteria established in Internal Control - Integrated Framework issued by COSO.
We also have 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, 2010 and 2009, 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, 2010 and our report dated March 15, 2011 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
March 15, 2011
None.
PART III
Item 10.
Item 10.
Directors and Executive Officers and Corporate Governance.
The information relating to this Item 10 is incorporated by reference to either the Proxy Statement for our 2011 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, 2010.
The information relating to this Item 11
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information relating to this Item 12 is incorporated by reference to either the Proxy Statement for our 2011 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, 2010.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
The information relating to this Item 13 is incorporated by reference to either the Proxy Statement for our 2011 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, 2010.
Item 14.
Item 14.
Principal Accounting Fees and Services
The information relating to this Item 14 is incorporated by reference to either the Proxy Statement for our 2011 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, 2010.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules.
(a) The following documents are filed as part of this report:
The following exhibits are filed as part of this report or, where indicated, were previously filed and are hereby incorporated by reference.
+
Management contract, compensatory plan or arrangement
*
Filed herewith.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
BRONCO DRILLING COMPANY, INC. AND SUBSIDIARIES
Report of Independent Registered Public Accounting Firm
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, 2010 and 2009, 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, 2010. 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, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
We also have 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, 2010, 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 15, 2011 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
March 15, 2011
Bronco Drilling Company, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share par value)
The accompanying notes are an integral part of these statements.
Bronco Drilling Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
The accompanying notes are an integral part of these statements.
Bronco Drilling Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands)
The accompanying notes are an integral part of these statements.
Bronco Drilling Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
The accompanying notes are an integral part of these statements.
Bronco Drilling Company, Inc. and Subsidiaries
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 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.
Restricted Cash
At December 31, 2010, the Company had restricted cash of $2,700, at a bank in escrow related to the sale of drilling rigs.
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
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.
The asset “unbilled receivables” represents revenues we have recognized in excess of amounts billed on drilling contracts in progress or costs deferred on daywork contracts 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, 2010 and 2009, our allowance for doubtful accounts was $1,691 and $3,576, 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 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 $14,111 and $26,038 as of December 31, 2010 and 2009, respectively.
The Company capitalizes interest as a component of the cost of drilling rigs constructed for its own use. For the years ended December 31, 2010 and 2009, the Company did not capitalize any interest.
The Company evaluates for potential impairment of long-lived assets held for use 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 estimates 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. See Note 9, Asset Sales and Held for Sale, for discussion of impairment of drilling rigs and related equipment due to their classification as held for sale. Assets held for sale are recorded at the lower of carrying amount or fair value less cost to sell. See Note 10, Discontinued Operations, for discussion of well servicing segment property and equipment impairment relating to its classification as held for sale. The assumptions used in the impairment evaluation for long-lived assets and intangible assets are inherently uncertain and require management judgment.
Debt issue costs and other
Debt issue costs and other assets consist of intangibles related to acquisitions, net of amortization, 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 $78, $751, and $974 for the years ended December 31, 2010, 2009, and 2008, respectively. Total cost and accumulated amortization of intangibles at December 31, 2010 and 2009 was $2,318 and $2,318 and $3,705 and $3,403, respectively.
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 $2,669 and $2,232 at December 31, 2010 and 2009, respectively. Amortization expense related to debt issue costs was $688, $592, and $571 for the years ended December 31, 2010, 2009, and 2008, respectively, and is included in interest expense in the consolidated statements of operations. Accumulated amortization related to loan fees was $864 and $126 as of December 31, 2010 and 2009, 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, 2010, the tax years ended December 31, 2006 through December 31, 2009 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, 2010 and 2009. The following table sets forth the components of comprehensive income (loss):
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 (loss) of Challenger” and “Equity in income (loss) 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
In December 2010, the FASB issued an accounting standard update that addresses the disclosure of supplementary pro forma information for business combinations. This update clarifies that when public entities are required to disclose pro forma information for business combinations that occurred in the current reporting period, the pro forma information should be presented as if the business combination occurred as of the beginning of the previous fiscal year when comparative financial statements are presented. This update is effective prospectively for 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, 2010. Early adoption is permitted. The Company is currently evaluating the impact, if any, the adoption will have on our consolidated financial statements.
In January 2010, the FASB issued a new accounting standard which requires reporting entities to provide information about movements of assets among Levels 1 and 2 of the three-tier fair value hierarchy established by ASC 820, Fair Value Measurements. Also required will be a reconciliation of purchases, sales, issuance, and settlements of financial instruments valued with a Level 3 method, which is used to price the hardest to value instruments. Entities will have to provide fair value measurement disclosures for each class of financial assets and liabilities. The guidance will be effective for fiscal years beginning after December 15, 2010. The Company is currently evaluating the impact, if any, the adoption will have on our consolidated financial statements.
In December 2009, the FASB issued a new accounting standard which updates the quantitative-based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which reporting entity has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. An approach that is expected to be primarily qualitative will be more effective for identifying which reporting entity has a controlling financial interest in a variable interest entity. The amendments in this update also require additional disclosures about an reporting entity’s involvement in variable interest entities, which will enhance the information provided to users of financial statements. This new standard is effective at the start of a reporting entity’s first fiscal year beginning after January 1, 2010. The adoption of this standard did not impact our consolidated financial statements.
In October 2009, the FASB issued a new accounting standard that addresses the accounting for multiple-deliverable revenue arrangements to enable vendors to account for deliverables separately rather than as a combined unit. This new standard addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting. Existing accounting standards require a vendor to use objective and reliable evidence of fair value for the undelivered items or the residual method to separate deliverables in a multiple-deliverable arrangement. Under the new standard, it is expected that multiple-deliverable arrangements will be separated in more circumstances than under current requirements. The new standard establishes a hierarchy for determining the selling price of a deliverable for purposes of allocating revenue to multiple deliverables. The selling price used will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The new standard must be prospectively applied to all revenue arrangements entered into in fiscal years beginning on or after June 15, 2010 and became effective for us on January 1, 2011. The Company is currently evaluating the impact, if any, the adoption will have on our 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 and cash. The Company also sold to Challenger four drilling rigs and ancillary equipment. The Company recorded equity in loss of investment of $984 and $1,914 for the years ended December 31, 2010 and 2009, 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.
The Company entered into a term note with Challenger related to the sale of four drilling rigs and ancillary equipment. 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 collaterized by the assets sold to Challenger. The note receivable from Challenger at December 31, 2010 was $1,607, all of which was classified as current. The note receivable from Challenger at December 31, 2009 was $2,517.
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 $1,508 and $2,499 at December 31, 2010 and December 31, 2009, respectively, related to these services provided.
At December 31, 2010, the book value of the Company’s ordinary share investment in Challenger was $38,730. The Company’s 25% interest of the net assets of Challenger was estimated to be $35,428. 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 $324, respectively, at December 31, 2010. 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, 2010 and 2009 was $264 and $1,026, respectively.
The Company reviews its investment in Challenger 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 in 2008, 2009 and 2010. 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 an impairment charge of $14,442 during 2008. The analysis resulted in a fair value of $39,800 related to our investment in Challenger as of September 30, 2009, which was below the carrying value of the investment and resulted in a non-cash impairment charge in the amount of $21,247.
The analysis performed at December 31, 2010, resulted in a fair value of $40,863 related to our investment in Challenger, which was above the carrying value of the investment and resulted in no impairment. The estimate of fair value required management to make many estimates and judgments, such as forecasts of future cash flows, discount rates of approximately 15.0% and long term growth rates of 3.0% which it believes were reasonable and appropriate at December 31, 2010. Changes in such assumptions can result in an estimate of fair value that could be below the carrying amount of our investment in Challenger.
Recent civil and political disturbances in Libya the elsewhere in North Africa, and the Middle East that developed during the first quarter of 2011 may affect Challenger’s operations. Ongoing political unrest may result in loss of revenue and damage to equipment. Any impact from the political turmoil in Libya and elsewhere in North Africa on Challenger’s operations could negatively impact the Company’s investment in Challenger including, the entire loss of our investment.
Summarized financial information of Challenger is presented below:
In September 2009, Carso Infraestructura y Construcción, S.A.B. de C.V., or CICSA, purchased from us 60% of the outstanding membership interests of Bronco MX. Upon closing of the transaction, the Company owned 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 general specifications of the contributed rigs are as follows:
The Company received $31,735 from CICSA in exchange for the 60% membership interest in Bronco MX, which included reimbursement for 60% of value added taxes previously paid by, or on behalf of, Bronco MX as a result of the importation to Mexico of the six drilling rigs that were contributed by the Company to Bronco MX. Upon completion of the transaction, the Company treated Bronco MX as a deconsolidated subsidiary in order to compute a loss in accordance with ASC Topic 810, Consolidation, due to the Company not retaining a controlling financial interest in Bronco MX subsequent to the sale. The Company recorded a net loss of $23,964 for the nine months ended September 30, 2009 relating to the transactions. The loss was computed based on the proceeds received from CICSA of $31,735 and the value of the Company’s 40% retained interest in Bronco MX of $21,495 less the book value of the net assets of Bronco MX, including rigs contributed to Bronco MX, of $77,194. The Company recorded a negative adjustment to the loss during the year ended December 31, 2010 of $1,487 due to post closing adjustments. Fair value of the Company’s 40% investment in Bronco MX was estimated using 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. At December 31, 2010, the book value of the Company’s ordinary share investment in Bronco MX was $20,632. The Company recorded equity in income (loss) of investment of $22 and ($588) for the year ended December 31, 2010 and for the period September 18 through December 31, 2009, respectively, related to its equity investment in Bronco MX. The Company’s investment in Bronco MX was increased by $474 as a result of a currency translation gain for the year ended December 31, 2010.
On July 1, 2010, CICSA contributed cash of approximately $45,100 in exchange for 735,356,219 shares of Bronco MX. As a result of the contribution, the Company’s membership interest in Bronco MX was decreased to approximately 20%. The Company accounted for the share issuance as if the Company had sold a proportionate amount of its shares. The Company recorded a loss on the transaction in the amount of $1,271.
Bronco MX is jointly managed, with CICSA having four representatives on its board of managers and the Company having one representative 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, the “Slim Affiliates”), these individuals and entities collectively beneficially own approximately 19.99% of our common stock. CICSA is also a Slim Affiliate.
Summarized financial information of Bronco MX is presented below:
3. Accrued liabilities
Accrued liabilities consisted of the following at December 31, 2010 and 2009:
4. Long-term Debt and Warrant
Long-term debt consists of the following:
(1)
On September 18, 2009, the Company entered into a new senior secured revolving credit facility with Banco Inbursa S.A., or 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 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 was replaced by this credit facility.
The credit facility initially provided for revolving advances of up to $75.0 million and the borrowing base under the credit facility was initially set at $75.0 million, subject to borrowing base limitations. On February 9, 2011 we amended our credit facility which reduced the commitment to $45.0 million. The credit facility matures on September 17, 2014. 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 6.05% at December 31, 2010. The Company incurred $2,232 in debt issue costs related to this credit facility.
The Company pays 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 years ended December 31, 2010 and 2009 was $125 and $15, respectively.
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. The Company was in compliance with all covenants at December 31, 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 September 18, 2009, 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. Banco Inbursa subsequently transferred the Warrant to CICSA.
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 is amortized to interest expense over the term of the revolving credit facility. 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 years ended December 31, 2010 and December 31, 2009 was $907 and $224, respectively.
In accordance with accounting standards, the Company revalued the Warrant as of December 31, 2010 and 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 volatilities of 50% and 45% and a risk free interest rate that ranged from 0.22% to 0.54% and 0.40% to 1.45% for 2010 and 2009, respectively. The fair value of the Warrant was $4,407 and $2,829 at December 31, 2010 and December 31, 2009, respectively. The Company recorded a gain (loss) on the change in the fair value of the Warrant on the consolidated statement of operations in the amount of $(1,578) and $1,850 for the years ended December 31, 2010 and December 31, 2009, respectively.
Long-term debt maturing each year subsequent to December 31, 2010 is as follows:
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, 2010, 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, 2010, the tax years ended December 31, 2006 through December 31, 2009 are open for examination by U.S. taxing authorities.
Income tax expense (benefit) consists of the following:
Deferred income tax assets and liabilities are as follows:
In assessing its ability to realize deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred tax liabilities and projected future taxable income in making this assessment. The Company believes it is more likely than not that it will realize the benefits of these deductible differences.
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:
6. Workers’ Compensation and Health Insurance
The Company is insured under a large deductible workers’ compensation insurance policy. The policy generally provides for a $500 deductible per covered accident. The Company maintains letters of credit in the aggregate amount of $11,460 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, 2010 and 2009 included approximately $3,695 and $2,458, 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, 2010 and 2009 included approximately $735 and $784, respectively, for our estimate of incurred but not reported costs related to the self-insurance portion of our health insurance.
7. Transactions with Affiliates
During 2009, the Company had 6 operating leases with affiliated entities. As of January 9, 2010, these entities are no longer affiliated entities. Related rent expense was approximately $520 for the year ended December 31, 2009.
The Company had receivables from affiliates of $1,508 and $9,620 at December 31, 2010 and 2009, respectively.
Additional information about our transactions with affiliates is included in Note 2, Equity Method Investments.
8. Commitments and Contingencies
The Company leases 14 service locations under noncancelable operating leases that have various expirations from 2011 to 2015. Related rent expense was $986, $1,194, and $1,064 for the years ended December 31, 2010, 2009, and 2008, respectively.
Aggregate future minimum lease payments under the noncancelable operating leases for years subsequent to December 31, 2010 are as follows:
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. Asset Sales and Held for Sale
On September 21, 2010 through September 23, 2010, the Company sold at auction in separate lots to multiple bidders two complete drilling rigs and components comprising four other drilling rigs (rigs 2, 9, 52, 70, 75 and 94), and ancillary equipment. The drilling rigs and equipment sold at auction were not being utilized currently in the Company’s business. The Company received net proceeds of approximately $8,286, net of selling expenses of $817, for the drilling rigs and related equipment. The Company recorded losses of $19,892 related to the sale of the drilling rigs and ancillary equipment. The loss was based on net book values of approximately $28,178 for the drilling rigs and ancillary equipment. The Company used the entire proceeds to pay down existing indebtedness under its revolving credit facility.
In an unrelated transaction on September 23, 2010, the Company sold two drilling rigs (rigs 41 and 42) in a private sale to Windsor Permian LLC, an unaffiliated third party, for net proceeds of $7,173. The Company recorded a $1,685 loss on the sale of these assets based on a net book value of $8,858.
The decision was made by management in the third quarter to sell an additional five drilling rigs (rigs 5, 6, 7, 51, and 54). Because the drilling rigs meet the held for sale criteria, the Company is required to present such assets, comprised of property and equipment, at the lower of carrying amount or fair value less the anticipated costs to sell. The Company evaluated these assets for impairment as of September 30, 2010 and December 31, 2010, for the year ended 2010, which resulted in recognizing a $7,900 impairment charge. Rig 6 is the only drilling rig unsold at December 31, 2010 with a carrying value of $1,550, which is the anticipated sale price, and is included in Non-current assets held for sale in our Consolidated Balance Sheets. At December 31, 2010, the Company’s fair value estimate was derived from negotiated prices with interested parties. The drilling rigs and related equipment were included as part of our land drilling segment.
On November 17, 2010, the Company sold at auction in separate lots to multiple bidders two complete drilling rigs (rigs 51 & 54) and ancillary equipment. The drilling rigs and equipment sold at auction were not being utilized currently in the Company’s business. The Company received net proceeds of approximately $1,666, net of selling expenses of $115, for the drilling rigs and related equipment. The Company recorded losses of $2,169 related to the sale of the drilling rigs and ancillary equipment. The loss was based on net book values of approximately $3,835 for the drilling rigs and ancillary equipment.
On November 29, 2010, the Company sold two drilling rigs (rigs 5 and 7) and entered into a contract to sell one drilling rig (rig 6) in a private sale to Atlas Drilling, LLC, an unaffiliated third party, for estimated net proceeds of $2,700. The Company recorded a $14 gain on the sale of these assets based on a net book value of $2,686.
The drilling rigs and related equipment sold at auction and the drilling rig held for sale are being sold as part of a broader strategy by management to divest of older drilling rigs and use the proceeds to pay down existing indebtedness.
10. Discontinued Operations
Well Servicing
In the second quarter of 2010, management determined that our well servicing business segment was no longer consistent with the Company’s long-term strategic objectives and that the Company should seek to market this business for sale. During Q1 and Q2 2010 the market for workover services continued at depressed levels within the primary geographic market of our well servicing assets (Oklahoma). Management determined that higher return projects were available within the core drilling segment of the business and chose to deploy capital in this segment rather than commit the capital required to restructure operations in the well servicing segment. In late June management made a decision to market the assets constituting the well servicing segment for sale and redeploy the proceeds to reduce debt and to support the Company’s core drilling business. As of June 30, 2010, the well servicing property and equipment was classified as held for sale in our Consolidated Balance Sheets and well servicing operating results as discontinued operations in our Consolidated Statements of Operations. Well servicing was previously presented as its own reportable segment.
Because the well servicing assets met the held for sale criteria, the Company was required to present such assets, comprised of property and equipment, at the lower of carrying amount or fair value less the anticipated cost to sell. In connection with its June 30, 2010 quarterly report, the Company evaluated well servicing’s respective assets held for sale for impairment. The Company’s analysis as of June 30, 2010 resulted in recognizing a $23,376 impairment charge ($14,329 after tax). This second quarter charge is reflected as a component of loss from discontinued operations in the Company’s Consolidated Statements of Operations for the year ended.
In September 2010, substantially all of the assets of the well servicing segment were sold at auction to multiple bidders. The Company received proceeds of $12,362, net of selling expenses of $638. The sale of the assets of the well servicing segment resulted in a loss of $8,915, which is reflected as a component of loss from discontinued operations in the Company’s Consolidated Statements of Operations. The Company used the proceeds to pay down existing indebtedness under its revolving credit facility. The Company has one workover rig held for sale at December 31, 2010, with a carrying amount of $130. The Company recorded an impairment charge of $318 related to this workover rig during the third quarter.
The results of operations for the years ended December 31, 2010, 2009 and 2008 are below:
At June 30, 2010, the Company’s fair value estimate was derived from an appraisal performed specific to the property and equipment of the Company’s well servicing segment. Refer to Note 12, Fair Value Measurements, for further discussion.
Trucking Assets
In July 2010, the Company completed the sale of all of the Company’s trucking assets, property and equipment, for $11,299 in cash, net of selling expenses of $403. As drilling activity decreased in 2008 and 2009 the utilization of these trucking assets fell sharply. The ongoing operating losses in our trucking division required resources to be directed away from the core drilling business. As such, management made the decision in the second quarter 2010 to sell these assets as their operations were not considered core. Proceeds from this sale were used to prepay existing indebtedness under our revolving credit facility with Banco Inbursa in July 2010. Based on the proceeds received and net book value of the property and equipment in the amount of $337, the Company recognized a gain of $10,962 in the third quarter of 2010. Operating results and the gain on sale of such assets are included as a component of discontinued operations in our Consolidated Statements of Operations for all periods presented. The trucking assets and operating activities were previously presented as part of our land drilling reportable segment. The results of operations for the years ended December 31, 2010, 2009 and 2008 are below:
11. 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:
The weighted average number of diluted shares excludes 87,850, 89,108, and 82,962 shares for the years ended December 31, 2010, 2009 and 2008, respectively, subject to restricted stock awards due to their antidilutive effects.
12. 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, 2010 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 50% and a risk free interest rate that ranged from 0.22% to 0.54%. The fair value of the Warrant was $4,407 at December 31, 2010. The Company recorded a change in the fair value of the Warrant on the consolidated statement of operations in the amount of $(1,578) and $1,850 for the years ended December 31, 2010 and 2009, respectively.
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.
In the second quarter of 2010, management determined that our well servicing business segment was no longer consistent with the Company’s long-term strategic objectives and that the Company should seek to market this business for sale. Because the well servicing property and equipment met the held for sale criteria, the Company was required to present its assets held for sale at the lower of carrying amount or fair value less the anticipated cost to sell. The Company evaluated well servicing’s respective assets held for sale for impairment. The fair value of the well servicing assets was determined using level 3 inputs. The Company engaged a third party independent appraisal company to determine the fair value of the well servicing assets. The appraised value was based on an on-site inspection of the assets and market research and analysis of applicable data. The Company’s analysis as of June 30, 2010 resulted in a $23,376 impairment charge ($14,329 after tax). This charge was recorded in the second quarter of 2010 and is reflected as a component of income (loss) from discontinued operations in the Company’s Consolidated Statements of Operations.
In the third quarter of 2010, management made the decision to divest of older drilling rigs and use the proceeds to pay down existing indebtedness. Consequently, management decided to sell five drilling rigs (rigs 5, 6, 7, 51, and 54). Because the drilling rigs meet the held for sale criteria, the Company is required to present these assets held for sale at the lower of carrying amount or fair value less anticipated cost to sell. The Company evaluated these assets as of September 30, 2010, for impairment. The fair value of the drilling rigs was determined using level 3 inputs. The fair value was determined by the sale price of similar assets sold by the Company in an auction during the third quarter and negotiated prices with interested parties. The analysis as of September 30, 2010 resulted in $7,761 impairment charge. The Company recorded an additional impairment during the fourth quarter of $139.
The Company reviewed its investment in Challenger at December 31, 2010 for impairment due to the recent volatility in oil and natural gas prices, the global economic environment and the anticipated future earnings of Challenger. 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 $40,863 related to our investment in Challenger, which was above the carrying value of the investment and resulted in no impairment. The estimate of fair value required management to make many estimates and judgements, such as forecasts of future cash flows, discount rates of 15.0% and long term growth rates of 3.0% which it believes were reasonable and appropriate at December 31, 2010. Changes in such assumptions can result in an estimate of fair value that could be below the carrying amount of our investments in Challenger.
13. 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. Effective December 10, 2010, the Company’s board of directors and a majority of our shareholders approved an amendment to the 2006 Plan to increase the shares available for issuance thereunder by 2,500,000 shares. 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 5,000,000 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 2,549,878 at December 31, 2010. 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, 2010, 2009 and 2008 related to shares of restricted stock was $3,274, $3,301, and $5,825, respectively. Restricted stock activity for the years ended December 31, 2010, 2009 and 2008 was as follows:
There was $3,863,209 of total unrecognized compensation cost related to nonvested restricted stock awards to be recognized over a weighted-average period of 1.18 years as of December 31, 2010.
14. 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.
15. 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, 2010, 2009 and 2008 were $548, $628, and $1,093, respectively.
16. Quarterly Results of Operations (unaudited)
The following table summarizes quarterly financial data for our years ended December 31, 2010 and 2009;
Bronco Drilling Company Inc.
Quarterly Results
Year Ended December 31, 2010
(Amounts in thousands except per share amounts)
(Unaudited)
17. Valuation and Qualifying Accounts
The Company’s valuation and qualifying accounts for the years ended December 31, 2010, 2009 and 2008 are as follows:
18. Subsequent Events
On February 9, 2011, the Company entered into an amendment to its revolving credit facility (the “Amended Credit Facility”) with Banco Inbursa S.A., Institucion de Banca Multiple, Grupo Financiero Inbursa. The Amended Credit Facililty reduced the commitment of the lender from $75,000 to $45,000 and reduced the number of drilling rigs pledged as collateral thereunder.
On February 25, 2011, the Company entered into a purchase and sale agreement to sell two drilling rigs (rigs 56 and 62) to Windsor Drilling LLC. The Company expects to record a loss on the sale of the drilling rigs of approximately $1,703 based on estimated proceeds of $11,500 and a net book value of $13,203.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Bronco Drilling Company, Inc. has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
Power of Attorney
Each of the persons whose signature appears below hereby constitutes and appoints D. Frank Harrison, Matthew S. Porter and Mark Dubberstein, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, from such person and in each person’s name, place and stead, in any and all capacities, to sign the Form 10-K filed herewith and any and all amendments to said Form 10-K, with all exhibits thereto and all documents in connection therewith, with the SEC, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done as fully to all said attorneys-in-fact and agents, or any of them, may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of Bronco Drilling Company, Inc. and in the capacities and on the dates indicated.