ITEM 1A. RISK FACTORS
The following are some of the important factors that could affect our financial performance or could cause actual results to differ materially from estimates contained in our forward-looking statements. We may encounter risks in addition to those described below. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may also impair or adversely affect our business, results of operation, financial condition and prospects.
Risks Relating to Our Business
Our business depends on domestic spending by the oil and natural gas industry, and this spending and our business has been in the past, and may in the future be, adversely affected by industry and financial market conditions that are beyond our control.
We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and natural gas in the United States. Customers’ expectations for lower market prices for oil and natural gas, as well as the availability of capital for operating and capital expenditures, may cause them to curtail spending, thereby reducing demand for our services and equipment.
Index to Financial Statements Industry conditions are influenced by numerous factors over which we have no control, such as the supply of and demand for oil and natural gas, domestic and worldwide economic conditions, political instability in oil and natural gas producing countries and merger and divestiture activity among oil and gas producers. The volatility of the oil and natural gas industry and the consequent impact on exploration and production activity could adversely impact the level of drilling and workover activity by some of our customers. This reduction may cause a decline in the demand for our services or adversely affect the price of our services. In addition, reduced discovery rates of new oil and natural gas reserves in our market areas also may have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, to the extent existing production is not replaced and the number of producing wells for us to service declines.
Deterioration in the global economic environment commencing in the latter part of 2008 and continuing throughout 2009 caused the oilfield services industry to cycle into a downturn. The industry returned to higher activity levels in 2011 and remained higher in the first half of 2012, but another downturn to former levels is possible. Adverse changes in capital markets and declines in prices for oil and natural gas experienced during 2008 and 2009 caused many oil and natural gas producers to announce reductions in capital budgets for future periods. Limitations on the availability of capital, or higher costs of capital, for financing expenditures may cause oil and natural gas producers to make reductions to capital budgets in the future even if oil prices remain at current levels or natural gas prices increase from current levels. Any such cuts in spending will curtail drilling programs as well as discretionary spending on well services, which may result in a reduction in the demand for our services, the rates we can charge and our utilization. In addition, certain of our customers could become unable to pay their suppliers, including us. Any of these conditions or events could adversely affect our operating results.
If oil and natural gas prices remain volatile, or if oil prices decline or natural gas prices remain low or decline further, the demand for our services could be adversely affected.
The demand for our services is primarily determined by current and anticipated oil and natural gas prices and the related general production spending and level of drilling activity in the areas in which we have operations. Volatility or weakness in oil prices or natural gas prices (or the perception that oil prices or natural gas prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending on existing wells. This, in turn, could result in lower demand for our services and may cause lower rates and lower utilization of our well service equipment. If oil prices decline or natural gas prices continue to remain low or decline further, or if there is a reduction in drilling activities, the demand for our services and our results of operations could be materially and adversely affected.
Prices for oil and natural gas historically have been extremely volatile and are expected to continue to be volatile. The Cushing WTI Spot Oil Price averaged $79.39, $94.87 and $94.11 per barrel in 2010, 2011 and 2012, respectively, and the average wellhead price for natural gas, as recorded by the EIA, was $4.48, $3.95 and $2.59 per Mcf for 2010, 2011 and 2012, respectively. The full 2012 average wellhead price for natural gas was not available at the time this report was filed; therefore, the average price through November 2012 was used.
We may require additional capital in the future. We cannot assure you that we will be able to generate sufficient cash internally or obtain alternative sources of capital on favorable terms, if at all. If we are unable to fund capital expenditures, our business may be adversely affected.
We anticipate that we will continue to make substantial capital investments to purchase additional equipment to expand our services, refurbish our well servicing rigs and replace existing equipment. For the year ended December 31, 2012, we invested approximately $171.4 million in cash for capital expenditures, excluding acquisitions. For the year ended December 31, 2011, we invested approximately $221.8 million in cash for capital expenditures, excluding acquisitions. Historically, we have financed these investments through internally generated funds, debt and equity offerings, our capital lease program and borrowing under a senior credit facility. Please read “Liquidity and Capital Resources” for more information.
Our significant capital investments require cash that we could otherwise apply to other business needs. However, if we do not incur these expenditures while our competitors make substantial fleet investments, our
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market share may decline and our business may be adversely affected. In addition, if we are unable to generate sufficient cash internally or obtain alternative sources of capital to fund our proposed capital expenditures and acquisitions, take advantage of business opportunities or respond to competitive pressures, it could materially adversely affect our results of operations, financial condition and growth. If we raise additional funds by issuing equity securities, dilution to existing stockholders may result. Adverse changes in the capital markets could make it difficult to obtain additional capital or obtain it at attractive rates.
Competition within the well services industry may adversely affect our ability to market our services.
The well services industry is highly competitive and fragmented and includes numerous small companies capable of competing effectively in our markets on a local basis, as well as several large companies that possess substantially greater financial and other resources than we do. Our larger competitors’ greater resources could allow those competitors to compete more effectively than we can. The amount of equipment available may exceed demand, which could result in active price competition. Many contracts are awarded on a bid basis, which may further increase competition based primarily on price. In addition, adverse market conditions lower demand for well servicing equipment, which results in excess equipment and lower utilization rates. If market conditions in our oil-oriented operating areas were to deteriorate or if adverse market conditions in our natural gas-oriented operating areas persist, utilization rates may decline.
We depend on several significant customers, and a loss of one or more significant customers could adversely affect our results of operations.
Our customers consist primarily of major and independent oil and gas companies. During 2012 and 2011, our top five customers accounted for 25% and 24%, respectively, of our revenues. However, no individual customer composed greater than 10% of our revenues. The loss of any one of our largest customers or a sustained decrease in demand by any of such customers could result in a substantial loss of revenues and could have a material adverse effect on our results of operations.
We may not be able to grow successfully through future acquisitions or successfully manage future growth, and we may not be able to effectively integrate the businesses we do acquire.
Our business strategy includes growth through the acquisitions of other businesses. We may not be able to continue to identify attractive acquisition opportunities or successfully acquire identified targets. In addition, we may not be successful in integrating our current or future acquisitions into our existing operations, which may result in unforeseen operational difficulties or diminished financial performance or require a disproportionate amount of our management’s attention. Even if we are successful in integrating our current or future acquisitions into our existing operations, we may not derive the benefits, such as operational or administrative synergies, that we expected from such acquisitions, which may result in the commitment of our capital resources without the expected returns on such capital. Furthermore, competition for acquisition opportunities may escalate, increasing our cost of making further acquisitions or causing us to refrain from making additional acquisitions. We may also be limited in our ability to incur additional indebtedness in connection with or to fund future acquisitions under the Revolving Credit Facility and under the indentures governing our 7.75% Senior Notes due 2019 and 7.75% Senior Notes due 2022.
Whether we realize the anticipated benefits from an acquisition depends, in part, upon our ability to integrate the operations of the acquired business, the performance of the underlying product and service portfolio, and the performance of the management team and other personnel of the acquired operations. Accordingly, our financial results could be adversely affected from unanticipated performance issues, legacy liabilities, transaction-related charges, amortization of expenses related to intangibles, charges for impairment of long-term assets, credit guarantees, partner performance and indemnifications. While we believe that we have established appropriate and adequate procedures and processes to mitigate these risks, there is no assurance that these transactions will be successful.
Index to Financial Statements Our industry has experienced a high rate of employee turnover. Any difficulty we experience replacing or adding personnel could adversely affect our business.
We may not be able to find enough skilled labor to meet our needs, which could limit our growth. Our business activity historically decreases or increases with the prices of oil and natural gas. We may have problems finding enough skilled and unskilled laborers in the future if the demand for our services increases. If we are not able to increase our service rates sufficiently to compensate for wage rate increases, our operating results may be adversely affected.
Other factors may also inhibit our ability to find enough workers to meet our employment needs. Our services require skilled workers who can perform physically demanding work. As a result of our industry volatility and the demanding nature of the work, workers may choose to pursue employment in fields that offer a more desirable work environment at wage rates that are competitive with ours. We believe that our success is dependent upon our ability to continue to employ and retain skilled technical personnel. Our inability to employ or retain skilled technical personnel generally could have a material adverse effect on our operations.
Our success depends on key members of our management, the loss of any of whom could disrupt our business operations.
We depend to a large extent on the services of some of our executive officers. The loss of the services of Kenneth V. Huseman, our President and Chief Executive Officer, or other key personnel could disrupt our operations. Although we have entered into employment agreements with Mr. Huseman and our other executive officers that contain, among other provisions, non-compete agreements, we may not be able to enforce the non-compete provisions in the employment agreements.
Our operations are subject to inherent risks, some of which are beyond our control. These risks may be self-insured, or may not be fully covered under our insurance policies.
Our operations are subject to hazards inherent in the oil and natural gas industry, such as, but not limited to, accidents, blowouts, explosions, craterings, fires and oil spills. These conditions can cause:
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personal injury or loss of life;
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damage to or destruction of property, equipment and the environment; and
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suspension of operations.
The occurrence of a significant event or adverse claim in excess of the insurance coverage that we maintain or that is not covered by insurance could have a material adverse effect on our financial condition and results of operations. In addition, claims for loss of oil and natural gas production and damage to formations can occur in the well services industry. Litigation arising from a catastrophic occurrence at a location where our equipment and services are being used may result in our being named as a defendant in lawsuits asserting large claims.
As is customary in our industry, our service contracts generally provide that we will indemnify and hold harmless our customers from any claims arising from personal injury or death of our employees, damage to or loss of our equipment, and pollution emanating from our equipment and services. Similarly, our customers agree to indemnify and hold us harmless from any claims arising from personal injury or death of their employees, damage to or loss of their equipment, and pollution caused from their equipment or the well reservoir (including uncontained oil flow from a reservoir). Our indemnification arrangements may not protect us in every case. For example, from time to time we may enter into contracts with less favorable indemnities or perform work without a contract that protects us. In addition, our indemnification rights may not fully protect us if the customer is insolvent or becomes bankrupt, does not maintain adequate insurance or otherwise does not possess sufficient resources to indemnify us. In addition, our indemnification rights may be held unenforceable in some jurisdictions. Our inability to fully realize the benefits of our contractual indemnification protections could result in significant liabilities and could adversely affect our financial condition, results of operations and cash flows.
Index to Financial Statements We maintain insurance coverage that we believe to be customary in the industry against these hazards. However, we do not have insurance against all foreseeable risks, either because insurance is not available or because of the high premium costs. As such, not all of our property is insured. We are also self-insured up to retention limits with regard to workers’ compensation, general liability, and medical and dental coverage. We maintain accruals in our consolidated balance sheets related to self-insurance retentions by using third-party data and historical claims history. The occurrence of an event not fully insured against, or the failure of an insurer to meet its insurance obligations, could result in substantial losses. In addition, we may not be able to maintain adequate insurance in the future at rates we consider reasonable. Insurance may not be available to cover any or all of the risks to which we are subject, or, even if available, it may be inadequate, or insurance premiums or other costs could rise significantly in the future so as to make such insurance prohibitively expensive. It is likely that, in our insurance renewals, our premiums and deductibles will be higher, and certain insurance coverage either will be unavailable or considerably more expensive than it has been in the recent past. In addition, our insurance is subject to coverage limits, and some policies exclude coverage for damages resulting from environmental contamination.
Adverse weather conditions may affect our operations.
Our operations may be materially affected by severe weather conditions in areas where we operate. Severe weather, such as blizzards, extreme temperatures and hurricanes may cause evacuation of personnel, curtailment of services and suspension of operations, and loss of or damage to equipment and facilities. Damage from any adverse weather conditions could adversely affect our financial condition, results of operations and cash flows.
Weather conditions may also affect the price of crude oil and natural gas, and related demand for our services. Please read the risk factor above, “If oil and gas prices remain volatile, or if oil prices decline or natural gas prices remain low or decline further, the demand for our services could be adversely affected.”
We are subject to environmental, health and safety laws and regulations that may expose us to significant liabilities for penalties, damages or costs of remediation or compliance.
Our operations are subject to federal, regional, state and local laws and regulations relating to protection of natural resources and the environment, health and safety aspects of our operations and waste management, including the transportation and disposal of waste and other materials. These laws and regulations may impose numerous obligations on our operations, including the acquisition of permits to conduct regulated activities, the incurrence of capital expenditures to mitigate or prevent releases of materials from our facilities, the imposition of substantial liabilities for pollution resulting from our operations and the application of specific health and safety criteria addressing worker protection. Failure to comply with these laws and regulations could result in investigations restrictions or orders suspending well operations, the assessment of administrative, civil and criminal penalties, the revocation of permits and the issuance of corrective action orders, any of which could have a material adverse effect on our business, results of operations and financial condition.
There is inherent risk of environmental costs and liabilities in our business as a result of our handling of petroleum hydrocarbons and oilfield and industrial wastes, air emissions and wastewater discharges related to our operations, and historical industry operations and waste disposal practices. Our fluid services segment includes disposal operations into injection wells that pose risks of environmental liability, including leakage from the wells to surface or subsurface soils, surface water or groundwater. Some environmental laws and regulations may impose strict liability, which means that in some situations, we could be exposed to liability as a result of our conduct that was without fault or lawful at the time it occurred or as a result of the conduct of, or conditions caused by, prior operators or other third parties. Clean-up costs and other damages arising as a result of environmental laws and costs associated with changes in environmental laws and regulations could be substantial and could have a material adverse effect on our financial condition and results of operations.
Laws protecting the environment generally have become more stringent over time and are expected to continue to do so, which could lead to material increases in costs for future environmental compliance and
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remediation. The modification or interpretation of existing laws or regulations, or the adoption of new laws or regulations, could curtail exploratory or developmental drilling for oil and natural gas and could limit well servicing opportunities. We may not be able to recover some or any of our costs of compliance with these laws and regulations from insurance.
Please read “Business - Environmental Regulation and Climate Change” for more information on the environmental laws and government regulations that are applicable to us.
Climate change legislation or regulations restricting or regulating emissions of greenhouse gases could result in increased operating costs and reduced demand for our field services.
In response to findings that emissions of carbon dioxide, methane and other greenhouse gases from industrial and energy sources contribute to increases of carbon dioxide levels in the earth’s atmosphere and oceans and contribute to global warming and other environmental effects, the EPA has adopted various regulations under the federal Clean Air Act addressing emissions of greenhouse gases that may affect the oil and gas industry. On November 8, 2010, the EPA finalized rules expanding its Mandatory Greenhouse Gas Reporting Rule, originally promulgated in October 2009, to be applicable to the oil and gas industry, including certain onshore oil and natural gas production activities, which may affect certain of our or our customers’ existing or future operations and require the inventory and reporting of emissions. In addition, the EPA has taken the position that existing Clean Air Act provisions require an assessment of greenhouse gas emissions within the permitting process for certain large new or modified stationary sources under the EPA’s Prevention of Significant Deterioration and Title V permit programs beginning in 2011. Facilities triggering permit requirements may be required to reduce greenhouse gas emissions consistent with “best available control technology” standards if deemed to be cost effective. Also, on August 16, 2012, the EPA published rules that include standards to reduce methane emissions associated with oil and gas production. Such changes will affect state air permitting programs in states that administer the federal Clean Air Act under a delegation of authority, including states in which we have operations. In the recent Congress, numerous legislative measures were introduced that would have imposed restrictions or costs on greenhouse gas emissions, including from the oil and gas industry. It is uncertain whether similar measures will be introduced in, or passed by, the new Congress which convened in January 2013. In addition, the United States has been involved in international negotiations regarding greenhouse gas reductions under the United Nations Framework Convention on Climate Change. Additionally, certain U.S. states or regional coalitions of states have adopted measures regulating or limiting greenhouse gases from certain sources or have adopted policies seeking to reduce overall emissions of greenhouse gases. The adoption and implementation of any international treaty or of any federal or state legislation or regulations imposing reporting obligations on, or limiting emissions of greenhouse gases from, our equipment and operations could require us to incur costs to comply with such requirements and possibly require the reduction or limitation of emissions of greenhouse gases associated with our operations and other sources within the industrial or energy sectors. Such legislation or regulations could adversely affect demand for the production of oil and natural gas and thus reduce demand for the services we provide to oil and natural gas producers as well as increase our operating costs by requiring additional costs to operate and maintain equipment and facilities, install emissions controls, acquire allowances or pay taxes and fees relating to emissions, which could adversely affect our results of operations. Finally, it should be noted that some scientists have concluded that increasing concentrations of greenhouse gases may produce changes in climate or weather, such as increased frequency and severity of storms, floods and other climatic events, which if any such effects were to occur, could have adverse physical effects on our operations, physical assets and field services to exploration and production operators.
Federal and state legislative and regulatory initiatives related to hydraulic fracturing could result in operating restrictions or delays in the completion of oil and natural gas wells that may reduce demand for our well servicing activities and could adversely affect our financial position, results of operations and cash flows.
We provide hydraulic fracturing and fluid handling services to our customers. Hydraulic fracturing is a commonly used process that involves injection of water, sand, and certain chemicals to fracture the hydrocarbon-bearing rock formation to allow flow of hydrocarbons into the wellbore. The federal Energy Policy Act of 2005
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amended the Underground Injection Control (“UIC”) provisions of the federal Safe Drinking Water Act (“SDWA”) to exclude certain hydraulic fracturing practices from the definition of “underground injection.” The EPA has asserted regulatory authority over certain hydraulic fracturing activities involving diesel fuel and published proposed guidance relating to such practices in May 2012. In addition, repeal of the SDWA exclusion of hydraulic fracturing has been advocated by certain advocacy organizations and others in the public. Congress has considered bills to repeal the exemption for hydraulic fracturing from the SDWA, which would have the effect of allowing the EPA to promulgate new regulations and permitting requirements for hydraulic fracturing, and would require the disclosure of the chemical constituents of hydraulic fracturing fluids to a regulatory agency, which would make the information public via the internet. At the state level, Wyoming adopted rules in 2010 requiring operators to disclose chemical additives in hydraulic fracturing fluids. In addition, the Texas Railroad Commission adopted rules on December 13, 2011 that require oil and gas operators to disclose chemical ingredients and water volumes used to hydraulically fracture wells permitted after February 1, 2012, the Colorado Oil and Gas Conservation Commission adopted rules in December 2011 requiring operators to disclose chemical ingredients used in hydraulic fracturing treatments beginning on April 1, 2012 and the Oklahoma Corporation Commission finalized amendments to its oil and gas rules effective July 1, 2012 to require the disclosure of chemical ingredients and fluid volumes associated with wells hydraulically fractured after the end of 2012. Scrutiny of hydraulic fracturing activities continues in other ways, as the EPA commenced a study of the potential environmental impacts of hydraulic fracturing and issued an update on December 21, 2012, with the final results expected in 2014. As the result of a separate study in Pavillion, Wyoming, the EPA issued a report in December 2011 that suggests a link between hydraulic fracturing and groundwater contamination in the area. An independent peer-reviewed process has been instituted to review the findings. The U.S. Department of the Interior has also announced that it will consider regulations relating to the use of hydraulic fracturing techniques on public lands and disclosure of fracturing fluid constituents. On April 13, 2012, the Department of Interior, the Department of Energy and the EPA issued a memorandum outlining a multi-agency collaboration on unconventional oil and gas research in response to the White House “Blueprint for a Secure Energy Future” and the recommendations of the Secretary of Energy Advisory Board Subcommittee on Natural Gas. In addition, some states and localities have adopted, and others are considering adopting, regulations or ordinances that could restrict hydraulic fracturing in certain circumstances, that would require, with some exceptions, disclosure of constituents of hydraulic fracturing fluids, or that would impose higher taxes, fees or royalties on natural gas production. Moreover, public debate over hydraulic fracturing and shale gas production has been increasing, and has resulted in delays of well permits in some areas.
In 2010, a committee of the U.S. House of Representatives undertook investigations into hydraulic fracturing practices involving the use of diesel fuel in hydraulic fracturing fluids, including requesting information from various field services companies including us. We responded to that request and have received no further communication from the committee with regard to that investigation. However, on January 31, 2011, Representative Henry Waxman and other members of Congress wrote to the EPA asserting that various companies, including us, had engaged in hydraulic fracturing operations requiring a permit without obtaining such a permit. We have no knowledge as to whether or how the EPA will respond to that letter.
Increased regulation and attention given to the hydraulic fracturing process could lead to greater opposition, including litigation, to oil and gas production activities using hydraulic fracturing techniques. Additional legislation or regulation could also lead to operational delays or increased operating costs in the production of oil and natural gas, including from the developing shale plays, incurred by our customers or could make it more difficult to perform hydraulic fracturing. The adoption of any federal, state or local laws or the implementation of regulations or ordinances restricting or increasing the costs of hydraulic fracturing could potentially increase our costs of operations and cause a decrease in the completion of new oil and natural gas wells and an associated decrease in demand for our well servicing activities, any or all of which could adversely affect our financial position, results of operations and cash flows.
Index to Financial Statements Potential listing of species as “endangered” under the federal Endangered Species Act could result in increased costs and new operating restrictions or delays on our oil and natural gas exploration and production customers, which could adversely reduce the amount of contract drilling services that we provide to such customers.
The federal Endangered Species Act, referred to as the “ESA,” and analogous state laws regulate a variety of activities, including oil and gas development, which could have an adverse effect on species listed as threatened or endangered under the ESA or their habitats. The designation of previously unidentified endangered or threatened species could cause oil and natural gas exploration and production operators to incur additional costs or become subject to operating delays, restrictions or bans in affected areas, which impacts could adversely reduce the amount of drilling activities in affected areas, including support services that we provide to such operators under our contract drilling services segment. Numerous species have been listed or proposed for protected status in areas in which we provide or could in the future provide field services. For instance, the Sand Dune Lizard, referred to as “Lizard,” a small lizard found in southeastern New Mexico and west Texas, an area where we provide a significant level of contract drilling services to oil and natural gas exploration and production operators, was proposed for listing as an endangered species under the ESA in December 2010 by the U.S. Fish & Wildlife Service, also referred to as the “FWS,” and on June 13, 2012, the FWS issued a statement that it had determined that the Lizard does not require listing. The Lesser Prairie-Chicken also has habitat in areas where we provide services and the FWS initiated the process to list the Lesser Prairie-Chicken as threatened in November 2012. The sage grouse and certain wildflower species, among others, are also species that have been or are being considered for protected status under the ESA and whose range can coincide with oil and natural gas production activities. The presence of protected species in areas where operators whom we provide contract drilling services conduct exploration and production operations could impair such operators’ ability to timely complete well drilling and development and, consequently, adversely affect the amount of contract drilling or other field services that we provided to such operators, which reduction of services could have a significant adverse effect on our results of operations and financial position.
Our indebtedness could restrict our operations and make us more vulnerable to adverse economic conditions.
We now have, and will continue to have, a significant amount of indebtedness. As of December 31, 2012, our total debt was $883.1 million, including the aggregate principal amount due under our 7.75% Senior Notes due 2019 of $475.0 million, the aggregate principal amount due under our 7.75% Senior Notes due 2022 of $300.0 million and capital lease obligations in the aggregate amount of $106.5 million. There were no borrowings and $22.5 million of letters of credit outstanding under our $250.0 million revolving credit facility as of December 31, 2012. For the year ended December 31, 2012, we made cash interest payments totaling $56.5 million.
Our current and future indebtedness could have important consequences. For example, it could:
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impair our ability to make investments and obtain additional financing for working capital, capital expenditures, acquisitions or other general corporate purposes;
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limit our ability to use operating cash flow in other areas of our business because we must dedicate a substantial portion of these funds to make principal and interest payments on our indebtedness;
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make us more vulnerable to a downturn in our business, our industry or the economy in general as a substantial portion of our operating cash flow will be required to make principal and interest payments on our indebtedness, making it more difficult to react to changes in our business and in industry and market conditions;
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limit our ability to obtain additional financing that may be necessary to operate or expand our business;
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put us at a competitive disadvantage to competitors that have less debt; and
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increase our vulnerability to interest rate increases to the extent that we incur variable rate indebtedness.
If we are unable to generate sufficient cash flow or are otherwise unable to obtain the funds required to make principal and interest payments on our indebtedness, or if we otherwise fail to comply with the various
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covenants in instruments governing any existing or future indebtedness, we could be in default under the terms of such instruments. In the event of a default, the holders of our indebtedness could elect to declare all the funds borrowed under those instruments to be due and payable together with accrued and unpaid interest, secured lenders could foreclose on any of our assets securing their loans and we or one or more of our subsidiaries could be forced into bankruptcy or liquidation. If our indebtedness is accelerated, or we enter into bankruptcy, we may be unable to pay all of our indebtedness in full. Any of the foregoing consequences could restrict our ability to grow our business and cause the value of our common stock to decline.
Our Revolving Credit Facility and the indentures governing our 7.75% Senior Notes due 2019 and our 7.75% Senior Notes due 2022 impose restrictions on us that may affect our ability to successfully operate our business.
Our Revolving Credit Facility and the indentures governing our 7.75% Senior Notes due 2019 and our 7.75% Senior Notes due 2022 each impose limitations on our ability to take various actions, such as:
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limitations on the incurrence of additional indebtedness;
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restrictions on mergers, sales or transfers of assets without the lenders’ consent; and
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limitations on dividends and distributions.
In addition, our Revolving Credit Facility requires us to maintain certain financial ratios and to satisfy certain financial conditions, some of which become more restrictive over time and may require us to reduce our debt or take some other action in order to comply with them. The failure to comply with any of these financial conditions, including the financial ratios or covenants, would cause a default under our Revolving Credit Facility. A default under any of our indebtedness, if not waived, could result in the acceleration of such indebtedness or other indebtedness, in which case the debt would become immediately due and payable. In addition, a default or acceleration of any of our indebtedness under our 7.75% Senior Notes due 2019, our 7.75% Senior Notes due 2022 or our Revolving Credit Facility could result in a default under or acceleration of other indebtedness with cross-default or cross-acceleration provisions. In the event of any acceleration of our indebtedness, we may not be able to pay our debt or borrow sufficient funds to refinance it, and any holders of secured indebtedness may seek to foreclose on the assets securing such indebtedness. Even if new financing is available, it may not be available on terms that are acceptable to us. These restrictions could also limit our ability to obtain future financings, make needed capital expenditures, withstand a downturn in our business or the economy in general, or otherwise conduct necessary corporate activities. We also may be prevented from taking advantage of business opportunities that arise because of the limitations imposed on us by the restrictive covenants under our Revolving Credit Facility or existing limitations on the incurrence of additional indebtedness, including in connection with acquisitions. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Revolving Credit Facility” for a discussion of our Revolving Credit Facility.
One of our directors may have a conflict of interest because he is also currently a managing partner of a private equity firm that makes investments in the energy sector. The resolution of any conflict of interest may not be in our or our stockholders’ best interests.
Steven A. Webster, the Chairman of our Board of Directors, is the Co-Managing Partner of Avista Capital Holdings, L.P., a private equity firm that makes investments in the energy sector. This relationship may create a conflict of interest because of his responsibilities to Avista and its owners. His duties as a partner in, or director or officer of, Avista or its affiliates may conflict with his duties as a director of our company regarding corporate opportunities and other matters. The resolution of any such conflict may not always be in our or our stockholders’ best interest.
Index to Financial Statements Risks Relating to Our Relationship with Credit Suisse
Affiliates of Credit Suisse will have a substantial influence on the outcome of stockholder voting and may exercise this voting power in a manner that may not be in the best interest of our other stockholders.
As of February 27, 2013, DLJ Merchant Banking Partners III, L.P. and affiliated funds (“DLJ Merchant Banking”), which are managed by affiliates of Credit Suisse AG, a Swiss Bank, beneficially owned approximately 29% of our outstanding common stock. Accordingly, Credit Suisse is in a position to have a substantial influence on the outcome of matters requiring a stockholder vote, including the election of directors, adoption of amendments to our certificate of incorporation or bylaws or approval of transactions involving a change of control. The interests of Credit Suisse may differ from those of our other stockholders, and Credit Suisse may vote its common stock in a manner that may adversely affect our other stockholders.
Risks Relating to Ownership of Our Common Stock
Our certificate of incorporation and bylaws, as well as Delaware law, contain provisions that could discourage acquisition bids or merger proposals, which may adversely affect the market price of our common stock.
Our certificate of incorporation authorizes our board of directors to issue preferred stock without stockholder approval. If our board of directors elects to issue preferred stock, it could be more difficult for a third party to acquire us. In addition, some provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire control of us, even if the change of control would be beneficial to our stockholders, including:
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a classified board of directors, so that only approximately one third of our directors are elected each year;
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limitations on the removal of directors;
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the prohibition of stockholder action by written consent;
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limitations on the ability of our stockholders to call special meetings; and
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advance notice provisions for stockholder proposals and nominations for elections to the board of directors to be acted upon at meetings of stockholders.
Delaware law prohibits us from engaging in any business combination with any “interested stockholder,” meaning generally that a stockholder who beneficially owns more than 15% of our stock cannot acquire us for a period of three years from the date this person became an interested stockholder, unless various conditions are met, such as approval of the transaction by our board of directors.
Because we have no plans to pay dividends on our common stock, investors must look solely to stock appreciation for a return on their investment in us.
We do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain all future earnings to fund the development and growth of our business. Any payment of future dividends will be at the discretion of our board of directors and will depend on, among other things, our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends and other considerations that the board of directors deems relevant. Investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize a return on their investment. Investors seeking cash dividends should not purchase our common stock.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
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ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, Basic is a party to litigation or other legal proceedings that Basic considers to be a part of the ordinary course of business. Basic is not currently involved in any legal proceedings that it considers probable or reasonably possible, individually or in the aggregate, to result in a material adverse effect on its financial condition, results of operations or liquidity.
During April 2011, Basic received notice from the Travis County District Attorney of a pending investigation of a potential felony criminal case referred by Texas Parks & Wildlife and the Texas Environmental Enforcement Task Force, to be presented to a Travis County grand jury. The potential matter related to a land farm owned by Basic located in Jefferson County, Texas. Basic and an indemnified third party received a judgment in October 2012. Although Basic was not directly held responsible for any fines or penalties, Basic paid approximately $1.4 million to an indemnified third party in connection with the judgment.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
Executive Officers of the Registrant
Our executive officers as of February 27, 2013 and their respective ages and positions are as follows:
Name
Age
Position
Kenneth V. Huseman
President, Chief Executive Officer and Director
Alan Krenek
Senior Vice President, Chief Financial Officer, Treasurer and Secretary
T.M. “Roe” Patterson
Senior Vice President and Chief Operating Officer
James F. Newman
Group Vice President - Permian Business Unit
William T. Dame
Vice President - Pressure Pumping and Wireline Services
Douglas B. Rogers
Vice President - Marketing
James E. Tyner
Vice President - Human Resources
Lanny T. Poldrack
Vice President - Safety and Operations Support
John Cody Bissett .
Vice President, Controller and Chief Accounting Officer
Set forth below is the description of the backgrounds of our executive officers.
Kenneth V. Huseman (President, Chief Executive Officer and Director) has 35 years of well servicing experience. He has been our President and Chief Executive Officer and a Director since 1999. Prior to joining Basic, he was Chief Operating Officer at Key Energy Services from 1996 to 1999. He was a Divisional Vice President at WellTech, Inc., from 1993 to 1996. From 1978 to 1993, he was employed at Pool Energy Services Co., where he managed operations throughout the United States. Mr. Huseman previously served as a director of Natural Gas Services Group, Inc. from June 2011 until February 2013. Mr. Huseman graduated with a B.B.A. degree in Accounting from Texas Tech University.
Alan Krenek (Senior Vice President, Chief Financial Officer, Treasurer and Secretary) has 25 years of related industry experience. He has been our Vice President, Chief Financial Officer and Treasurer since January 2005. He became Senior Vice President and Secretary in May 2006. Prior to joining Basic, he held various financial management positions at Landmark Graphics Corp., Noble Corporation and Pool Energy Services Company. Mr. Krenek graduated with a B.B.A. degree in Accounting from Texas A&M University and is a certified public accountant.
T. M. “Roe” Patterson (Senior Vice President and Chief Operating Officer) has 18 years of related industry experience. He has been our Senior Vice President and Chief Operating Officer since April 2011, and has been a Senior Vice President since September 2008 and the Vice President of various different groups within Basic since
Index to Financial Statements
February 2006. Prior to joining us, he was president of his own manufacturing and oilfield service company, TMP Companies, Inc., from 2000 to 2006. He was a Contracts/Sales Manager for the Permian Division of Patterson Drilling Company from 1996 to 2000. He was an Engine Sales Manager for West Texas Caterpillar from 1995 to 1996. Mr. Patterson graduated with a B.S. degree in Biology from Texas Tech University.
James F. Newman (Group Vice President - Permian Business Unit) has 28 years of related industry experience and has been our Group Vice President - Permian Business Unit since April 2011 and has been a Group Vice President since September 2008. Prior to joining Basic, he co-founded Triple N Services in 1986 and served as its President through May 2008. He initially served Basic as an Area Manager in the plugging and abandonment operations. Mr. Newman is a registered Professional Engineer and is active in the Society of Professional Engineers. Mr. Newman graduated with a B.S. in Petroleum Engineering from Colorado School of Mines.
William T. Dame (Vice President - Pressure Pumping and Wireline Services) has 32 years of related industry experience. Mr. Dame joined Basic in 2003 and has served as our Vice President - Pumping Services and Wireline Division since 2006. He previously served as our Vice President - PPW and RAFT Divisions from 2005 to 2006 and as a regional vice president from 2004 through 2005. Mr. Dame began his career in 1981 with Halliburton. From 1987 to 1997, he served as a vice president of Fleet Cementers, Inc., and from 1997 to 2003, he worked in various operational management positions at Plains Energy, Precision Drilling and New Force Energy Services. Mr. Dame attended Tarleton State University.
Douglas B. Rogers (Vice President - Marketing) has 30 years of related industry experience. He joined Basic in 2007 and serves as Vice President - Marketing after serving as Vice President - Contracts for the Drilling Division. Mr. Rogers was Vice President Rocky Mountain Division for Patterson-UTI Drilling Company from March 2003 to June 2007. He also served as Western Division Sales Manager for Ambar Lonestar Fluid Services, a division of Patterson-UTI Drilling Company, from 1998 to 2003. He began his career in 1983 with Permian Servicing Company, where he managed well servicing operations. He continued in that capacity through Permian Servicing Company’s mergers with Xpert Well Service and Pride Petroleum Service until joining Zia Drill/Nova Mud in March 1997. Mr. Rogers graduated with a B.A. degree from Eastern New Mexico University.
James E. Tyner (Vice President - Human Resources) has been a Vice President since January 2004. From 1999 to June 2003, he was the General Manager of Human Resources at CMS Panhandle Companies, where he directed delivery of HR Services. Mr. Tyner was the Director of Human Resources Administration and Payroll Services at Duke Energy’s Gas Transmission Group from 1998 to 1999. From 1981 to 1998, Mr. Tyner held various positions at Panhandle Eastern Corporation. At Panhandle, he managed all Human Resources functions and developed corporate policies and as a Certified Safety Professional, he designed and implemented programs to control workplace hazards. Mr. Tyner received a B.S. in General Science and M.S. in Microbiology from Mississippi State University.
Lanny T. Poldrack (Vice President - Safety and Operations Support) has 26 years of related industry experience. He has served as our Vice President - Safety and Operations Support in April 2011. From April 2009 to April 2011, he served as a Corporate Marketing Representative based in Houston, Texas. Prior to joining Basic, he spent 13 years at Cudd Energy Services where he held various technical sales and sales management positions for both well intervention and live well service divisions, the last 4 years of which he served as Business Development Manager for Cudd Well Control for both domestic and international operations in U.S., Canadian, Latin America, European, Middle Eastern and South East Asian markets. He began his oilfield career in West Texas as a technical field representative for Weatherford International, specializing in fishing and rental tools and hydraulic BOP systems. Mr. Poldrack graduated with an applied science degree from Odessa Junior College.
John C. Bissett (Vice President, Controller and Chief Accounting Officer) has 11 years of related industry experience. He was appointed Basic’s Vice President, Controller and Chief Accounting Officer in March 2012. Mr. Bissett previously served as Basic’s Corporate Controller from July 2008 to March 2012 and as the Director of Financial Reporting from December 2007 to July 2008. Prior to joining Basic, Mr. Bissett was the Controller of Cap Rock Energy from November 2006 through December 2007, and previously held various roles in the accounting and finance function of Sirius Computer Solutions and the audit practice of KPMG LLP. Mr. Bissett graduated with an M.B.A. and a B.B.A. in Accounting from Angelo State University and is a Certified Public Accountant.
Index to Financial Statements PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Price for Registrant’s Common Equity
Our common stock is traded on the New York Stock Exchange under the symbol “BAS.” The table below presents the high and low daily closing sales prices of the common stock, as reported by the New York Stock Exchange, for each of the quarters in the years ended December 31, 2011 and 2012, respectively:
As February 27, 2013, we had 41,760,935 shares of common stock outstanding held by approximately 271 record holders.
We have not declared or paid any cash dividends on our common stock, and we do not currently anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain all future earnings to fund the development and growth of our business. Any future determination relating to our dividend policy will be at the discretion of our board of directors and will depend on our results of operations, financial condition, capital requirements and other factors deemed relevant by our board.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information regarding options or warrants authorized for issuance under our equity compensation plans as of December 31, 2012:
(1) Consists of the Basic Energy Services, Inc. Fourth Amended and Restated 2003 Incentive Plan (as amended effective May 24, 2011).
Index to Financial Statements Issuer Purchases of Equity Securities
The following table provides information relating to our repurchase of shares of common stock during the three months ended December 31, 2012 (dollars in thousands, except average price paid per share):
(1) On May 24, 2012, we announced that our Board of Directors had reauthorized the repurchase of up to approximately $35.2 million of shares of our common stock from time to time in open market or private transactions, at our discretion, as a continuation of our prior $50.0 million stock repurchase program announced in 2008 (of which $14.8 million has been previously purchased). The stock repurchase program may be suspended or discontinued at any time.
(2) These amounts include shares that were repurchased from various employees to provide such employees the cash amounts necessary to pay certain tax liabilities associated with the vesting of restricted shares owned by them. The shares were repurchased on various dates based on the closing price per share on the date of repurchase.
Index to Financial Statements Performance Graph
The following is a line graph comparing cumulative, total shareholder return from December 29, 2006 through December 31, 2012 with (i) a general market index (the Russell 2000 Index) and (ii) a group of peers selected by the Company in the same line of business or industry as the Company. The peer group is comprised of the following companies: Key Energy Services, Inc., Tetra Technologies, Inc. and Pioneer Drilling Company.
The graph assumes investments of $100 on December 29, 2006 at the closing sale price, and the reinvestment of all dividends, if any.
The graph shall not be deemed incorporated by reference by any general statement incorporating by reference this report into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.
December 29, 2006 to December 31, 2012
Value of $100 Invested at December 29, 2006, December 31, 2007, December 31, 2008,
December 31, 2009, December 31, 2010, December 30, 2011 and December 31, 2012
The foregoing graph is based on historical data and is not necessarily indicative of future performance. This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to the Regulations 14A or 14C under the Securities Exchange Act of 1934, as amended, or to the liabilities of Section 18 under such Act.
Index to Financial Statements
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected historical financial information for the periods shown. The following information should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and our financial statements included elsewhere in this report. The amounts for each historical annual period presented below were derived from our audited financial statements.
(a) Includes approximately $11,389, $7,955, $5,666, $5,152 and $4,149 of non-cash stock compensation expense for the years ended December 31, 2012, 2011, 2010, 2009 and 2008, respectively.
Index to Financial Statements
Index to Financial Statements
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Overview
We provide a wide range of well site services to oil and natural gas drilling and producing companies, including completion and remedial services, fluid services, well servicing and contract drilling services. Our results of operations reflect the impact of our acquisition strategy as a leading consolidator in the domestic land-based well services industry. Our acquisitions have increased our breadth of service offerings at the well site and expanded our market presence. In implementing this strategy, we have purchased businesses and assets in 12 separate acquisitions from January 1, 2010 to December 31, 2012 for total consideration of $351.6 million. Our hydraulic horsepower capacity for pumping services increased from 142,000 at December 31, 2010 to 291,000 at December 31, 2012. Our weighted average number of fluid service trucks increased from 791 in the first quarter of 2010 to 926 in the fourth quarter of 2012. Our weighted average number of well servicing rigs increased from 405 in the first quarter of 2010 to 429 in the fourth quarter of 2012. Our weighted average number of drilling rigs increased from nine in the first quarter of 2010 to 12 in the fourth quarter of 2012. These acquisitions make changes in revenues, expenses and income not directly comparable between periods.
Our operating revenues from each of our segments, and their relative percentages of our total revenues, consisted of the following (dollars in millions):
Our core businesses depend on our customers’ willingness to make expenditures to produce, develop and explore for oil and natural gas in the United States. Industry conditions are influenced by numerous factors, such as the supply of and demand for oil and natural gas, domestic and worldwide economic conditions, political instability in oil producing countries and merger and divestiture activity among oil and natural gas producers. The volatility of the oil and natural gas industry, and the consequent impact on exploration and production activity, could adversely impact the level of drilling and workover activity by some of our customers. This volatility also affects the demand for our services and the price of our services. In addition, the discovery rate of new oil and natural gas reserves in our market areas also may have an impact on our business, even in an environment of stronger oil and natural gas prices. For a more comprehensive discussion of our industry trends, see “General Industry Overview” included in Items 1 and 2, Business and Properties, of this Annual Report on Form 10-K.
We derive a majority of our revenues from services supporting production from existing oil and natural gas operations. Demand for these production-related services, including well servicing and fluid services, tends to remain relatively stable, even in moderate oil and natural gas price environments, as ongoing maintenance spending is required to sustain production. As oil and natural gas prices reach higher levels, demand for all of our services generally increases as our customers engage in more well servicing activities relating to existing wells to maintain or increase oil and natural gas production from those wells. Because our services are required to support drilling and workover activities, our revenues will vary based on changes in capital spending by our customers as oil and natural gas prices increase or decrease.
During 2010, oil prices remained relatively stable following the increase experienced in the second half of 2009 while natural gas prices remained depressed. Oil prices increased during the first half of 2011 primarily due to political and economic instability in several oil producing countries and remained stable through the first half
Index to Financial Statements
of 2012. Oil prices became volatile in the second half of 2012 and many of our customers did not outspend their approved budgets causing activity levels to decline and lower prices for our services. Natural gas prices since 2009 have continued to be low resulting in excess equipment being relocated from gas-based operating areas to the busier oil-based operating, areas increasing competition and reducing pricing for our services.
We expect our customers to gradually increase their 2013 spending with the U.S. land drilling rig count building throughout the year, increasing the demand for our completion services in the oil-based operating areas. We believe that natural gas fundamentals remain weak and not supporting significant natural gas drilling in 2013
We will continue to evaluate opportunities to expand our business through selective acquisitions and internal growth initiatives. Our capital investment decisions are determined by an analysis of the projected return on capital employed of each of those alternatives, which is substantially driven by the cost to acquire existing assets from a third party, the capital required to build new equipment and the point in the oil and natural gas commodity price cycle. Based on these factors, we make capital investment decisions that we believe will support our long-term growth strategy. While we believe our costs of integration for prior acquisitions have been reflected in our historical results of operations, integration of acquisitions may result in unforeseen operational difficulties or require a disproportionate amount of our management’s attention.
We believe that the most important performance measures for our business segments are as follows:
•
Completion and Remedial Services - segment profits as a percent of revenues;
•
Fluid Services - trucking hours, revenue per truck, segment profits per truck and segment profits as a percent of revenues;
•
Well Servicing - rig hours, rig utilization rate, revenue per rig hour, profits per rig hour and segment profits as a percent of revenues; and
•
Contract Drilling - rig operating days, revenue per drilling day, profits per drilling day and segment profits as a percent of revenues.
Segment profits are computed as segment operating revenues less direct operating costs. These measurements provide important information to us about the activity and profitability of our lines of business. For a detailed analysis of these indicators for our company, see “Segment Overview” below.
Recent Strategic Acquisitions and Expansions
During the period from 2010 through 2012, we grew through acquisitions and capital expenditures. During 2010, we completed four acquisitions that complemented our existing business segments, none of which were considered significant. During 2011, we completed four acquisitions, of which the Maverick Companies was considered significant. During 2012, we completed four acquisitions that complemented our existing business segments, none of which were considered significant.
We discuss the aggregate purchase prices and related financing issues below in “Liquidity and Capital Resources” and present the pro forma effects of the acquisition of the Maverick Companies in Note 3 of the notes to our historical consolidated financial statements included in this report.
Selected 2010 Acquisitions
During 2010, we made four acquisitions that complemented our existing business segments. These included, among others:
Taylor Rig, LLC
On May 3, 2010, we acquired all the assets of Taylor Rig, LLC for total consideration of $8.7 million in cash. This acquisition has been included in our well servicing segment.
Index to Financial Statements Platinum Pressure Services, Inc.
On December 16, 2010, we acquired all of the outstanding stock of Platinum Pressure Services, Inc. (“Platinum”) and Admiral Well Service, Inc., a wholly owned subsidiary of Platinum, for total cash consideration of $39.9 million. This acquisition has been included in our completion and remedial services and well servicing segments.
Selected 2011 Acquisitions
During 2011, we made four acquisitions that complemented our existing business segments. These included, among others:
The Maverick Companies
On July 8, 2011, we acquired all the equity interests of Maverick Stimulation Company, LLC, Maverick Coil Tubing Services, LLC, Maverick Thru-Tubing Services, LLC, Maverick Solutions, LLC, The Maverick Companies, LLC, MCM Holdings, LLC, and MSM Leasing LLC (collectively, the “Maverick Companies”) for total consideration of $186.3 million in cash. This acquisition has been included in our completion and remedial servicing segment.
Selected 2012 Acquisitions
During 2012, we made four acquisitions that complemented our existing business segments. These included, among others:
Surface Stac, Inc.
On May 15, 2012, we acquired substantially all of the assets of Surface Stac, Inc for total consideration of $23.2 million in cash. This acquisition has been included in our completion and remedial servicing segment.
Salt Water Disposal of North Dakota LLC
On December 19, 2012 we acquired substantially all of the assets of Salt Water Disposal of North Dakota LLC for total consideration of $43.2 million in cash. This acquisition has been included in our fluid services segment.
Segment Overview
Completion and Remedial Services
In 2012, our completion and remedial services segment represented 43% of our revenues. Revenues from our completion and remedial services segment are generally derived from a variety of services designed to stimulate oil and natural gas production or place cement slurry within the wellbores. Our completion and remedial services segment includes pumping services, rental and fishing tool operations, coiled tubing services, nitrogen services, cased-hole wireline services, snubbing and underbalanced drilling.
Our pumping services concentrate on providing single truck, lower-horsepower cementing, acidizing and fracturing services in selected markets. Our total hydraulic horsepower capacity for our pumping services was approximately 291,000 horsepower at December 31, 2012 compared to 271,000 horsepower and 142,000 horsepower at December 31, 2011 and December 31, 2010, respectively.
Our rental and fishing tool business operates 20 rental and fishing tool stores in selected markets as of December 31, 2012.
Our snubbing services operate 34 units throughout our geographic footprint as of December 31, 2012. We entered the snubbing business in 2009 with the acquisition of Team Snubbing Services, which operated in Arkansas. We further expanded our snubbing business in 2010 through the acquisition of Platinum Pressure Services, Inc., which operated in Texas, Oklahoma, Arkansas, Louisiana and Pennsylvania.
Index to Financial Statements We have operations in the wireline, coiled tubing services, nitrogen services, water treatment and the underbalanced drilling services businesses. For a description of our wireline, underbalanced drilling services, coiled tubing services, nitrogen services, water treatment, and snubbing operations, please read “Overview of Our Segments and Services - Completion and Remedial Services Segment” included in Items 1 and 2, Business and Properties, of this Annual Report on Form 10-K.
In this segment, we generally derive our revenues on a project-by-project basis in a competitive bidding process. Our bids are generally based on the amount and type of equipment and personnel required, with the materials consumed billed separately. During periods of decreased spending by oil and gas companies, we may be required to discount our rates to remain competitive, which would cause lower segment profits.
The following is an analysis of our completion and remedial services segment for each of the quarters and years in the years ended December 31, 2010, 2011 and 2012 (dollars in thousands):
We gauge the performance of our completion and remedial services segment based on the segment’s operating revenues and segment profits as a percent of revenues.
Fluid Services
In 2012, our fluid services segment represented 26% of our revenues. Revenues in our fluid services segment are earned from the sale, transportation, storage and disposal of fluids used in the drilling, production and maintenance of oil and natural gas wells. Revenues also include water treatment, well site construction and maintenance services. The fluid services segment has a base level of business consisting of transporting and disposing of salt water produced as a by-product of the production of oil and natural gas. These services are necessary for our customers and generally have a stable demand but typically produce lower relative segment profits than other parts of our fluid services segment. Fluid services for completion and workover projects typically require fresh or brine water for making drilling mud, circulating fluids or frac fluids used during a job, and all of these fluids require storage tanks and hauling and disposal. Because we can provide a full complement of fluid sales, trucking, storage and disposal required on most drilling and workover projects, the add-on services associated with drilling and workover activity enable us to generate higher segment profits. The higher segment profits are due to the relatively small incremental labor costs associated with providing these services in addition to our base fluid services operations. Revenues from our well site construction services are derived primarily from preparing
Index to Financial Statements
and maintaining access roads and well locations, installing small diameter gathering lines and pipelines, constructing foundations to support drilling rigs and providing maintenance services for oil and natural gas facilities. We typically price fluid services by the job, by the hour or by the quantities sold, disposed of or hauled.
The following is an analysis of our fluid services segment for each of the quarters and years in the years ended December 31, 2010, 2011 and 2012 (dollars in thousands):
We gauge activity levels in our fluid services segment based on trucking hours, revenue per fluid service truck, segment profits per fluid service truck and segment profits as a percent of revenues.
Well Servicing
In 2012, our well servicing segment represented 27% of our revenues. Revenue in our well servicing segment is derived from maintenance, workover, completion and plugging and abandonment services, as well as rig manufacturing operations. We provide maintenance-related services as part of the normal, periodic upkeep of producing oil and natural gas wells. Maintenance-related services represent a relatively consistent component of our business. Workover and completion services generate more revenue per hour than maintenance work due to the use of auxiliary equipment, but demand for workover and completion services fluctuates more with the overall activity level in the industry.
We typically charge our well servicing rig customers for services on an hourly basis at rates that are determined by the type of service and equipment required, market conditions in the region in which the rig operates, the ancillary equipment provided on the rig and the necessary personnel. We measure the activity level of our well servicing rigs on a weekly basis by calculating a rig utilization rate based on a 55-hour work week per rig.
We acquired our rig manufacturing business in May 2010. We manufacture workover rigs for internal purposes as well as to sell to outside companies. Our rig manufacturing operation also performs large scale refurbishments and maintenance services to used workover rigs.
Index to Financial Statements The following is an analysis of our well servicing segment for each of the quarters and years in the years ended December 31, 2010, 2011 and 2012. The revenues do not include revenues associated with rig manufacturing operations:
We gauge activity levels in our well servicing rig operations based on rig hours, rig utilization rate, revenue per rig hour, profits per rig hour and segment profits as a percent of revenues.
Contract Drilling
In 2012, our contract drilling segment represented 4% of our revenues. Revenues from our contract drilling segment are derived primarily from the drilling of new wells.
Within this segment, we typically charge our drilling rig customers at a daywork daily rate, or footage at an established rate per number of feet drilled. Depending on the type of job, we may also charge by the project. We measure the activity level of our drilling rigs on a weekly basis by calculating a rig utilization rate based on a seven-day work week per rig. In the fourth quarter of 2010, we converted three of our drilling rigs to well service rigs. We acquired six used drilling rigs during 2011 from several different companies. We acquired two drilling rigs during the first quarter of 2012, which increased our total number of drilling rigs to 12.
Index to Financial Statements The following is an analysis of our contract drilling segment for each of the quarters and years in the years ended December 31, 2010, 2011 and 2012 (dollars in thousands):
We gauge activity levels in our drilling operations based on rig operating days, revenue per drilling day, profits per drilling day and segment profits as a percent of revenues.
Operating Cost Overview
Our operating costs are comprised primarily of labor costs, including workers’ compensation and health insurance, repair and maintenance, fuel and insurance. A majority of our employees are paid on an hourly basis. We also incur costs to employ personnel to sell and supervise our services and perform maintenance on our fleet. These costs are not directly tied to our level of business activity. Compensation for our administrative personnel in local operating yards and in our corporate office is accounted for as general and administrative expenses. Repair and maintenance is performed by our crews, company maintenance personnel and outside service providers. Insurance is generally a fixed cost regardless of utilization and relates to the number of rigs, trucks and other equipment in our fleet, employee payroll and our safety record.
Critical Accounting Policies and Estimates
Our consolidated financial statements are impacted by the accounting policies used and the estimates and assumptions made by management during their preparation. A complete summary of these policies is included in Note 2 of the notes to our historical consolidated financial statements. The following is a discussion of our critical accounting policies and estimates.
Critical Accounting Policies
We have identified below accounting policies that are of particular importance in the presentation of our financial position, results of operations and cash flows and which require the application of significant judgment by management.
Index to Financial Statements Property and Equipment. Property and equipment are stated at cost, or at estimated fair value at acquisition date if acquired in a business combination. Expenditures for repairs and maintenance are charged to expense as incurred. We also review the capitalization of refurbishment of workover rigs as described in Note 2 of the notes to our historical consolidated financial statements.
Impairments. We review our assets for impairment at a minimum annually, or whenever, in management’s judgment, events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recovered over its remaining service life. Provisions for asset impairment are charged to income when the sum of the estimated future cash flows, on an undiscounted basis, is less than the asset’s carrying amount. When impairment is indicated, an impairment charge is recorded based on an estimate of future cash flows on a discounted basis.
Self-Insured Risk Accruals. We are self-insured up to retention limits with regard to workers’ compensation, general liability claims, and medical and dental coverage of our employees. We generally maintain no physical property damage coverage on our workover rig fleet, with the exception of certain of our 24-hour workover rigs and newly manufactured rigs. We have deductibles per occurrence for workers’ compensation, general liability claims, and medical and dental coverage of $1 million, $1 million, and $300,000, respectively. We have lower deductibles per occurrence for automobile liability. We maintain accruals in our consolidated balance sheets related to self-insurance retentions by using third-party actuarial data and historical claims history.
Revenue Recognition. We recognize revenues when the services are performed, collection of the relevant receivables is probable, persuasive evidence of the arrangement exists and the price is fixed and determinable. Rig manufacturing revenue is recognized by individual rig based on the completed contract method.
Income Taxes. We recognize 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 are measured using statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in the period that includes the statutory enactment date. A valuation allowance for deferred tax assets is recognized when it is more likely than not that the benefit of deferred tax assets will not be realized.
Critical Accounting Estimates
The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the balance sheet date and the amounts of revenues and expenses recognized during the reporting period. We analyze our estimates based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. However, actual results could differ from such estimates. The following is a discussion of our critical accounting estimates.
Depreciation and Amortization. In order to depreciate and amortize our property and equipment and our intangible assets with finite lives, we estimate the useful lives and salvage values of these items. Our estimates may be affected by such factors as changing market conditions, technological advances in the industry or changes in regulations governing the industry.
Impairment of Property and Equipment. Our analysis for potential impairment of property and equipment requires us to estimate undiscounted future cash flows. Actual impairment charges are recorded using an estimate of discounted future cash flows. The determination of future cash flows requires us to estimate rates and utilization in future periods and such estimates can change based on market conditions, technological advances in
Index to Financial Statements
industry or changes in regulations governing the industry. We analyze the potential impairment of property and equipment annually as of December 31 or on an interim basis if events or circumstances indicate that the fair value of the assets have decreased below the carrying value.
Impairment of Goodwill. Our goodwill is considered to have an indefinite useful economic life and is not amortized. We assess impairment of goodwill annually as of December 31 or on an interim basis if events or circumstances indicate that the fair value of the asset has decreased below its carrying value. A qualitative assessment of whether it is more likely than not that the fair value of a reporting unit is less that its carrying value is allowed but not required. If it is more likely than not that the fair value of the reporting unit is less than its carrying amount, then the two-step impairment test is performed. In the two-step test, first, the fair value of each reporting unit is compared to its carrying value to determine whether an indication of impairment exists. If impairment is indicated, then the fair value of the reporting unit’s goodwill is determined by allocating the unit’s fair value to its assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. The amount of impairment for goodwill is measured as the excess of its carrying value over its fair value. It is possible, depending upon a number of factors that are not determinable at this time or within the control of the Company, that the fair value of any reporting unit could decrease in the future and result in an impairment to goodwill.
Allowance for Doubtful Accounts. We estimate our allowance for doubtful accounts based on an analysis of historical collection activity and specific identification of overdue accounts. Factors that may affect this estimate include (1) changes in the financial positions of significant customers and (2) a decline in commodity prices that could affect the entire customer base.
Litigation and Self-Insured Risk Reserves. We estimate our reserves related to litigation and self-insured risk based on the facts and circumstances specific to the litigation and self-insured risk claims and our past experience with similar claims. The actual outcome of litigation and insured claims could differ significantly from estimated amounts. As discussed in “- Self-Insured Risk Accruals” above with respect to our critical accounting policies, we maintain accruals on our balance sheet to cover self-insured retentions. These accruals are based on certain assumptions developed using third-party data and historical data to project future losses. Loss estimates in the calculation of these accruals are adjusted based upon actual claim settlements and reported claims.
Fair Value of Assets Acquired and Liabilities Assumed. We estimate the fair value of assets acquired and liabilities assumed in business combinations, which involves the use of various assumptions. These estimates may be affected by such factors as changing market conditions, technological advances in the industry or changes in regulations governing the industry. The most significant assumptions, and the ones requiring the most judgment, involve the estimated fair value of property and equipment, intangible assets and the resulting amount of goodwill, if any. We test annually for impairment of the goodwill and intangible assets with indefinite useful lives recorded in business combinations. This requires us to estimate the fair values of our own assets and liabilities at the reporting unit level. Therefore, considerable judgment, similar to that described above in connection with our estimation of the fair value of an acquired company, is required to assess goodwill and certain intangible assets for impairment.
Cash Flow Estimates. Our estimates of future cash flows are based on the most recent available market and operating data for the applicable asset or reporting unit at the time the estimate is made. Our cash flow estimates are used for asset impairment analyses.
Stock-Based Compensation. We have historically compensated our directors, executives and employees through the awarding of stock options and restricted stock. We accounted for stock option and restricted stock awards in 2010, 2011 and 2012 using a grant date fair-value based method, resulting in compensation expense for stock-based awards being recorded in our consolidated statements of income. For performance based restricted stock awards, compensation expense is recognized in our financial statements based on their grant date fair value. We utilize (i) the closing stock price on the date of grant to determine the fair value of vesting restricted stock awards and (ii) a Monte Carlo simulation to criteria. The Monte Carlo simulation model utilizes multiple input
Index to Financial Statements
variables that determine the probability of satisfying the market condition stipulated in the award grant and calculates the fair value of the award. The expected volatility utilized in the model was estimated using our historical volatility and the historical volatilities of our peer companies. The risk-free interest rate was based on the U.S. treasury rate for a term commensurate with the expected life of the grant. Stock options have not been issued since 2007 but are valued on the grant date using Black-Scholes-Merton option pricing model and restricted stock issued is valued based on the fair value of our common stock at the grant date. In addition, judgment is required in estimating the amount of stock-based awards that are expected to be forfeited. Because the determination of these various assumptions is subject to significant management judgment and different assumptions could result in material differences in amounts recorded in our consolidated financial statements, management believes that accounting estimates related to the valuation of stock options are critical.
Income Taxes. The amount and availability of our loss carryforwards (and certain other tax attributes) are subject to a variety of interpretations and restrictive tests. The utilization of such carryforwards could be limited or lost upon certain changes in ownership and the passage of time. Accordingly, although we believe substantial loss carryforwards are available to us, no assurance can be given concerning the realization of such loss carryforwards, or whether or not such loss carryforwards will be available in the future.
Asset Retirement Obligations. We record the fair value of an asset retirement obligation as a liability in the period in which we incur a legal obligation associated with the retirement of tangible long-lived assets and capitalize an equal amount as a cost of the asset, depreciating it over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted at the end of each quarter to reflect the passage of time, changes in the estimated future cash flows underlying the obligation, acquisition or construction of assets, and settlement of obligations.
Results of Operations
The results of operations between periods may not be comparable, primarily due to the significant decline in the oil and natural gas industry throughout 2009 and recovery throughout 2010 and 2011, as well as the Company’s growth in asset base during 2011 and 2012.
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
Revenues. Revenues increased by 17% to $1.4 billion in 2012 from $1.2 billion in 2011. This increase was primarily due to the recovery of the oil and gas industry in 2011 and overall stabilization through most 2012, notwithstanding lower natural gas commodity prices. Our acquisitions in the second half of 2011 and during 2012 also increased our revenues, with the Maverick Companies acquisition adding incremental revenue of $68.4 in 2012 over 2011, as the Maverick Companies were acquired in the third quarter of 2011.
Completion and remedial services revenues increased by 9% to $586.1 million in 2012 as compared to $537.1 million in 2011. The increased revenues are primarily due to a full year of revenues from the Maverick Companies acquisition in the third quarter of 2011, which added approximately $68.4 million of incremental segment revenue. The incremental revenue from the Maverick Companies was offset by a decline in utilization and pricing in our stimulation services in the second half of 2012. Total hydraulic horsepower was 291,000 and 271,000 at December 31, 2012 and December 31, 2011, respectively.
Fluid services revenues increased by 6% to $352.2 million in 2012 compared to $332.0 million in 2011. Our weighted average number of fluid service trucks increased 9% to 926 in 2012 from 850 in 2011, which reflects the expansion of our truck and frac tank fleets. Revenue per fluid service truck decreased 3% to $380,000 in 2012 compared to $391,000 in 2011, due to the competitive market and pricing for our services and lower non-trucking revenues such as frac tank rentals and skim oil sales.
Well servicing revenues increased by 13% to $376.3 million in 2012 compared to $333.1 million in 2011. This increase in revenue was due to the increase in rig utilization to 73% during 2012 from 70% during 2011,
Index to Financial Statements
reflecting the continued high activity levels in oil-dominated areas. We also experienced an increase of 4% in revenue per rig hour to $397 during 2012 from $380 during 2011, due to increased revenues from plugging and abandonment units acquired during the year, which work for higher rates than workover rigs. Our average number of well servicing rigs increased to 429 during 2012 compared to 414 in 2011, primarily due to acquisitions.
Contract drilling revenues increased by 47% to $60.3 million in 2012 compared to $41.1 million in 2011. The number of rig operating days increased to 3,823 in 2012 compared to 2,889 in 2011. This increase was due to the addition of two drilling rigs during 2012.
Direct Operating Expenses. Direct operating expenses, which primarily consist of labor costs, including workers’ compensation and health insurance, and maintenance and repair costs, increased by 18% to $902.6 million in 2012 from $766.1 million in 2011. This increase was due to the higher activity levels in all of our segments.
Direct operating expenses for the completion and remedial services segment increased by 20% to $358.0 million in 2012 as compared to $297.3 million in 2011, due primarily to increased activity levels as well as a full year of the Maverick Companies acquisition. Segment profits decreased to 39% of revenues in 2012 compared to 45% in 2011, due to a decrease in pricing utilization for our services, caused by increased competition in all operating areas, with relatively flat direct costs.
Direct operating expenses for the fluid services segment increased by 12% to $236.6 million in 2012 as compared to $212.0 million in 2011, due to higher activity levels. Segment profits were 33% of revenues in 2012 and 36% of revenues in 2011, due to decreases in pricing for our trucking services and lower frac tank rental revenues.
Direct operating expenses for the well servicing segment increased by 17% to $268.2 million in 2012 as compared to $228.7 million in 2011, due primarily to the 8% increase in rig hours to 893,200 in 2012 from 829,600 in 2011. Segment profits decreased to 29% of revenues in 2012 compared to 31% in 2011, due to higher labor and other direct operating costs partially offset by improved utilization of assets.
Direct operating expenses for the contract drilling segment increased by 41% to $39.8 million in 2012 as compared to $28.2 million in 2011 due primarily to a 32% increase in rig operating days in 2012. Segment profits were 34% of revenues in 2012 compared to 31% in 2011, due primarily to increased dayrates from the larger rigs added in 2012.
General and Administrative Expenses. General and administrative expenses increased by 26% to $181.3 million in 2012 from $142.3 million in 2011, which included $11.4 million and $8.0 million of stock-based compensation expense in 2012 and 2011, respectively. The increase was primarily due to increased personnel and incentive compensation costs, including payroll taxes, the relocation of our corporate headquarters in the second half of 2012 and the full-year effect of the general and administrative expense from the Maverick Companies acquisition that was completed in July 2011. We estimate that relocation costs, including employee-related relocation costs, were approximately $7.9 million. Texas sales and use tax assessment also increased general and administrative expenses by $6.7 million.
Depreciation and Amortization Expenses. Depreciation and amortization expenses were $187.1 million in 2012, as compared to $154.3 million in 2011, reflecting the increase in the size of and investment in our asset base. We invested $84.9 million for acquisitions, $67.2 million for capital leases and an additional $171.4 million for cash capital expenditures in 2012.
Loss on Early Extinguishment of Debt. In the fourth quarter of 2012, we recorded a charge of $7.9 million for the retirement of our $225.0 million 7.75% senior notes issued in April 2006.
Index to Financial Statements Interest Expense. Interest expense increased by 16% to $62.4 million in 2012 from $53.9 million in 2011. The increased expense was due to a full year impact of interest expense for the issuance of an aggregate of $475.0 million of 7.75% senior notes in the first half of 2011 and the issuance of $300.0 million of 7.75% senior notes in the second half of 2012.
Income Tax Expense. Income tax expense was $10.9 million in 2012, as compared to a tax expense of $31.8 million in 2011. Our effective tax rate was approximately 34% in 2012 and our effective tax rate was approximately 40% in 2011. The decrease in the effective tax rate was primarily due to a $1.9 million tax refund from the state of Texas in 2012 and a charge associated with the redemption of 11.625% senior secured notes in 2011.
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Revenues. Revenues increased by 71% to $1.2 billion in 2011 from $728.2 million in 2010. This increase was primarily due to the recovery of the oil and gas industry in 2011. Our acquisitions at the end of 2010 and during 2011 also increased our revenues, with the Maverick Companies acquisition adding approximately $62.4 million of revenue since being acquired in the third quarter of 2011.
Completion and remedial services revenues increased by 105% to $537.1 million in 2011 as compared to $261.4 million in 2010. The increase in revenue between these periods was due to increased utilization and improved prices of our pressure pumping equipment, due to higher drilling and completion activity. The increased revenues also reflect the impact of the Maverick Companies acquisition in the third quarter of 2011, which added approximately $62.4 million of segment revenue. Total hydraulic horsepower was 271,000 and 142,000 at December 31, 2011 and December 31, 2010, respectively.
Fluid services revenues increased by 38% to $332.0 million in 2011 compared to $241.1 million in 2010. Our weighted average number of fluid service trucks increased 8% to 850 in 2011 from 790 in 2010, and our revenue per fluid service truck increased 28% to $391,000 in 2011 compared to $305,000 in 2010, which reflects the expansion of our truck and frac tank fleets and the increase in utilization and improved pricing for our services.
Well servicing revenues increased by 63% to $333.1 million in 2011 compared to $204.9 million in 2010. This increase in revenue was due to the increase in rig utilization to 70% during 2011 from 53% during 2010, reflecting the improvement of the industry, particularly in oil-dominated geographic areas. We also experienced an increase of 19% in revenue per rig hour to $380 during 2011 from $319 during 2010, due to increased demand. Our average number of well servicing rigs increased to 414 during 2011 compared to 405 in 2010, primarily due to the acquisition of Platinum late in the fourth quarter of 2010 and Pat’s P&A, Inc. in the third quarter of 2011.
Contract drilling revenues increased by 98% to $41.1 million in 2011 compared to $20.8 million in 2010. The number of rig operating days increased to 2,889 in 2011 compared to 2,006 in 2010. This increase was due to the addition of six drilling rigs during 2011 and increases in new well starts in the Permian Basin, the region in which all of our drilling rigs operate.
Direct Operating Expenses. Direct operating expenses, which primarily consist of labor costs, including workers’ compensation and health insurance, and maintenance and repair costs, increased by 51% to $766.1 million in 2011 from $506.9 million in 2010. This increase was due to the higher activity levels in all of our segments.
Direct operating expenses for the completion and remedial services segment increased by 90% to $297.3 million in 2011 as compared to $156.6 million in 2010, due primarily to increased activity levels as well as the Maverick Companies acquisition, which added approximately $29.8 million to the segment’s direct
Index to Financial Statements
operating expenses since it was acquired in the third quarter of 2011. Segment profits increased to 45% of revenues in 2011 compared to 40% in 2010, due to higher levels of completion and pumping services and improved pricing for our services.
Direct operating expenses for the fluid services segment increased by 19% to $212.0 million in 2011 as compared to $178.2 million in 2010, due to higher activity levels. Segment profits were 36% of revenues in 2011 and 26% of revenues in 2010, due to increases in pricing and utilization of equipment.
Direct operating expenses for the well servicing segment increased by 46% to $228.7 million in 2011 as compared to $156.9 million in 2010, due primarily to the 35% increase in rig hours to 829,600 in 2011 from 613,400 in 2010. Segment profits increased to 31% of revenues in 2011 compared to 23% in 2010, due to improved utilization of equipment and pricing of services.
Direct operating expenses for the contract drilling segment increased by 85% to $28.2 million in 2011 as compared to $15.3 million in 2010 due primarily to a 44% increase in rig operating days in 2011. Segment profits for this segment were 31% of revenues in 2011 compared to 27% in 2010, due primarily to increased dayrates and an increase in the number of drilling rigs.
General and Administrative Expenses. General and administrative expenses increased by 32% to $142.3 million in 2011 from $107.8 million in 2010, which included $8.0 million and $5.7 million of stock-based compensation expense in 2011 and 2010, respectively. The increase was primarily due to increased personnel and incentive compensation costs, including payroll taxes, the full year effect of the general and administrative expense from the Platinum acquisition that was completed in December 2010 and the six months of general and administrative expense from the Maverick Companies acquisition that was completed in July 2011.
Depreciation and Amortization Expenses. Depreciation and amortization expenses were $154.3 million in 2011, as compared to $135.0 million in 2010, reflecting the increase in the size of and investment in our asset base. We invested $218.3 million for acquisitions, $57.7 million for capital leases and an additional $221.8 million for cash capital expenditures in 2011.
Loss on Early Extinguishment of Debt. In the first quarter of 2011, we recorded a loss of $49.4 million for the retirement of our $225.0 million 11.625% senior secured notes and the retirement of our previous $30.0 million revolving credit facility entered into in September 2010.
Interest Expense. Interest expense increased by 16% to $53.9 million in 2011 from $46.5 million in 2010. The increased expense was due to the issuance of an aggregate of $475.0 million of 7.75% senior notes in the first half of 2011.
Income Tax Expense. Income tax expense was $31.8 million in 2011, as compared to a tax benefit of $24.8 million in 2010. Our effective tax rate was approximately 40% in 2011 and our effective tax rate was approximately 36% in 2010. The increase in the effective tax rate was primarily due to the change in the mix and amount of state taxes.
Liquidity and Capital Resources
Currently, our primary capital resources are net cash flows from our operations and utilization of capital leases and our $250.0 million revolving credit facility. As of December 31, 2012, we had cash and cash equivalents of $134.6 million compared to $78.5 million as of December 31, 2011. We have utilized, and expect to utilize in the future, bank and capital lease financing and sales of equity to obtain capital resources. When appropriate, we will consider public or private debt and equity offerings and non-recourse transactions to meet our liquidity needs.
Index to Financial Statements Net Cash Provided by Operating Activities
Cash flow from operating activities was $303.7 million for the year ended December 31, 2012 as compared to $279.5 million in 2011 and $49.4 million in 2010. The increase in 2012 was due primarily to the collection of accounts receivable generated in prior periods and an increase in the deferred tax liability partially offset by an increase in income tax payable due to increased profitability. The increase in cash flow in 2011 was due primarily to the increase in profitability resulting from higher revenues and margins offset by the increases in accounts receivable. In July 2011, we received aggregate federal income tax refunds of approximately $80.1 million relating to our 2009 and 2010 tax returns.
Capital Expenditures
Capital expenditures are the main component of our investing activities. Cash capital expenditures (including for acquisitions) for 2012 were $256.4 million as compared to $440.2 million in 2011, and $113.9 million in 2010. Cash capital expenditures decreased in 2012 from 2011 due to the decrease in acquisitions from $218.3 million in 2011 to $84.9 million in 2012. Cash capital expenditures increased from 2010 through 2011 due to the improvement of the utilization of our assets along with increased profitability. Through our capital lease program, we also added assets of approximately $67.2 million, $57.7 million and $23.4 million in 2012, 2011 and 2010, respectively.
In 2013, we have currently planned capital expenditures of approximately $145.0 million and capital leases of $40.0 million. We do not budget acquisitions in the normal course of business, and we regularly engage in discussions related to potential acquisitions related to the well services industry.
Corporate Office Relocation
On June 4, 2012, we announced that we were moving our corporate headquarters to Fort Worth, Texas from Midland, Texas. A transition plan was developed to provide for the move of the corporate operations, including relocation benefits for employees who were transferred, and severance and retention benefits for employees who did not continue with us after the move. As part of the relocation, severance and retention plans, we recognized $7.9 million in general and administrative expense for the year ended December 31, 2012.
Capital Resources and Financing
Our current primary capital resources are cash flow from our operations, our $250.0 million revolving credit facility, the ability to enter into capital leases and a cash balance of $134.6 million at December 31, 2012. In 2012, we financed activities in excess of cash flow from operations primarily through the use of bank debt and capital leases.
We have significant contractual obligations in the future that will require capital resources. Our primary contractual obligations are (1) our long-term debt, (2) interest on long-term debt, (3) our capital leases, (4) our operating leases, (5) our asset retirement obligations and (6) our other long-term liabilities. The following table outlines our contractual obligations as of December 31, 2012 (in thousands):
Index to Financial Statements Our long-term debt as of December 31, 2012, excluding capital leases, consisted of our $300.0 million 7.75% Senior Notes due 2022 and our $475.0 million 7.75% Senior Notes due 2019. Interest on long-term debt relates to our future contractual interest obligations on our Senior Notes. Our capital leases relate primarily to light-duty and heavy-duty vehicles and trailers. Our operating leases relate primarily to real estate.
Our ability to access additional sources of financing will be dependent on our operating cash flows and demand for our services, which could be negatively impacted due to the extreme volatility of commodity prices.
7.125% Senior Notes due 2016
In April 2006, we completed a private offering of $225.0 million aggregate principal amount of 7.125% Senior Notes due April 15, 2016 (the “2016 Notes”). The 2016 Notes were jointly and severally guaranteed by each of our restricted subsidiaries (currently all of our subsidiaries other than three immaterial subsidiaries).
We issued the 2016 Notes pursuant to an indenture, dated as of April 12, 2006, by and among us, the guarantor parties thereto and The Bank of New York Trust Company, N.A., as trustee (the “2016 Notes Indenture”).
Interest on the 2016 Notes accrued at a rate of 7.125% per year. Interest on the 2016 Notes was payable in cash semi-annually in arrears on April 15 and October 15 of each year. The maturity date of the 2016 Notes was April 15, 2016.
On October 1, 2012, we announced a cash offer and consent solicitation with respect to any and all of the $225.0 million aggregate outstanding principal amount of the 2016 Notes. On October 16, 2012, we completed the closing of an early tender for approximately $223.3 million of the 2016 Notes and delivered to the trustee the amount required to satisfy and discharge our remaining obligations for the outstanding 2016 Notes. The tender offer expired on October 29, 2012, and all of our obligations under the 2016 Notes Indenture have be satisfied and no 2016 Notes are outstanding.
11.625% Senior Secured Notes due 2014
On July 31, 2009, we issued $225.0 million aggregate principal amount of 11.625% Senior Secured Notes due 2014 (the “Senior Secured Notes”) in a private placement. The Senior Secured Notes were jointly and severally, and unconditionally, guaranteed on a senior secured basis initially by all of our current subsidiaries other than two immaterial subsidiaries.
The Senior Secured Notes and the related guarantees were issued pursuant to an indenture dated as of July 31, 2009 (the “Senior Secured Notes Indenture”), by and among us, the guarantors party thereto and The Bank of New York Mellon Trust Company, N.A., as trustee. The obligations under the Senior Secured Notes Indenture were secured as set forth in the Senior Secured Notes Indenture and in a related Security Agreement (the “Secured Notes Security Agreement”), in favor of the trustee, by a first-priority lien (other than Permitted Collateral Liens, as defined in the Senior Secured Notes Indenture) in favor of the trustee, on the collateral described in the Secured Notes Security Agreement.
Interest on the Senior Secured Notes accrued at a rate of 11.625% per year. Interest on the Senior Secured Notes was payable semi-annually in arrears on February 1 and August 1 of each year. The maturity date of the Senior Secured Notes was August 1, 2014.
On February 1, 2011, we announced a cash tender offer and consent solicitation with respect to any and all of the $225.0 million aggregate outstanding principal amount of the Senior Secured Notes. On February 15, 2011, we completed the closing of an early tender for approximately $224.7 million of the Senior Secured Notes and delivered to the trustee the amount required to satisfy and discharge our remaining obligations for the outstanding Senior Secured Notes. The tender offer expired on March 2, 2011, and all of our obligations under the Senior Secured Notes Indenture have been satisfied and no Senior Secured Notes are outstanding.
Index to Financial Statements 7.75% Senior Notes due 2019
On February 15, 2011, we issued $275.0 million of 7.75% Senior Notes due 2019 (the “2019 Notes”). On June 13, 2011, we issued an additional $200.0 million, for an aggregate principal amount of $475.0 million of 2019 Notes. The 2019 Notes are jointly and severally, and unconditionally, guaranteed on a senior unsecured basis by all of our current subsidiaries, other than three immaterial subsidiaries. The 2019 Notes and the guarantees rank (i) equally in right of payment with any of our and the subsidiary guarantors’ existing and future senior indebtedness, including our existing 7.75% Senior Notes due 2022 and the related guarantees, and (ii) effectively junior to all existing or future liabilities of our subsidiaries that do not guarantee the 2019 Notes and to our and the subsidiary guarantors’ existing or future secured indebtedness to the extent of the value of the collateral therefore.
The 2019 Notes were offered and sold in private transactions in accordance with Rule 144A and Regulation S under the Securities Act of 1933, as amended (the “Securities Act”). Under the terms of the sale of the 2019 Notes, we were required to take appropriate steps to offer to exchange other 2019 Notes with the same terms that have been registered with the Securities and Exchange Commission for the private placement 2019 Notes. We completed the exchange offer for all of the 2019 Notes on November 15, 2011.
The purchase price for the $275.0 million of 2019 Notes issued on February 15, 2011 was 100.000% of their principal amount, and the purchase price for the $200.0 million of 2019 Notes issued on June 13, 2011 was 101.000%, plus accrued interest from February 15, 2011. We received net proceeds from the issuance of the 2019 Notes of approximately $464.6 million after premiums and offering expenses. We used a portion of the net proceeds from the February 2011 offering to fund our tender offer and consent solicitation for our Senior Secured Notes and to redeem any of the Senior Secured Notes not purchased in the tender offer. We used a portion of the net proceeds from the June 2011 offering to fund the $186.3 million purchase price for the Maverick Companies acquisition completed in July 2011 and for general corporate purposes.
The 2019 Notes were issued pursuant to an indenture dated as of February 15, 2011 (the “2019 Notes Indenture”), by and among Basic, the guarantors party thereto and Wells Fargo Bank, N.A., as trustee. Interest on the 2019 Notes accrues from and including February 15, 2011 at a rate of 7.75% per year. Interest on the 2019 Notes is payable semi-annually in arrears on February 15 and August 15 of each year. The 2019 Notes mature on February 15, 2019.
The 2019 Notes Indenture contains covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to:
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incur additional indebtedness;
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pay dividends or repurchase or redeem capital stock;
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make certain investments;
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incur liens;
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enter into certain types of transactions with affiliates;
•
limit dividends or other payments by our restricted subsidiaries to us; and
•
sell assets or consolidate or merge with or into other companies.
These and other covenants that are contained in the 2019 Notes Indenture are subject to important exceptions and qualifications set forth in the 2019 Notes Indenture. At December 31, 2012, we were in compliance with the restrictive covenants under the 2019 Notes Indenture.
We may, at our option, redeem all or part of the 2019 Notes, at any time on or after February 15, 2015, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably to par and accrued and unpaid interest to the date of redemption.
Index to Financial Statements At any time before February 15, 2014, we, at our option, may redeem up to 35% of the aggregate principal amount of the 2019 Notes issued under the 2019 Notes Indenture with the net cash proceeds of one or more qualified equity offerings at a redemption price of 107.750% of the principal amount of the 2019 Notes to be redeemed, plus accrued and unpaid interest to the date of redemption, as long as:
•
at least 65% of the aggregate principal amount of the 2019 Notes issued under the 2019 Notes Indenture remains outstanding immediately after the occurrence of such redemption; and
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such redemption occurs within 90 days of the date of the closing of any such qualified equity offering.
In addition, at any time before February 15, 2015, we may redeem some or all of the 2019 Notes at a redemption price equal to 100% of the principal amount of the 2019 Notes, plus an applicable premium and accrued and unpaid interest to the date of redemption.
Following a change of control, as defined in the 2019 Notes Indenture, we will be required to make an offer to repurchase all or a portion of the 2019 Notes at 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase.
7.75% Senior Notes due 2022
On October 16, 2012, we successfully completed the issuance and sale of $300.0 million aggregate principal amount of 7.75% Senior Notes due 2022 (the “2022 Notes”). The 2022 Notes are jointly and severally, and unconditionally, guaranteed on a senior unsecured basis initially by all of our current subsidiaries other than three immaterial subsidiaries. The 2022 Notes and the guarantees rank (i) equally in right of payment with any of our and the subsidiary guarantors’ existing and future senior indebtedness, including our existing 2019 Notes and the related guarantees, and (ii) effectively junior to all existing or future liabilities of our subsidiaries that do not guarantee the 2022 Notes and to our and the subsidiary guarantors’ existing or future secured indebtedness to the extent of the value of the collateral therefor.
The 2022 Notes and the guarantees were offered and sold in private transactions in accordance with Rule 144A and Regulation S under the Securities Act of 1933, as amended. We received net proceeds from the issuance of the 2022 Notes of approximately $293.3 million after discounts and offering expenses. We used a portion of the net proceeds from the offering to fund our pending tender offer and consent solicitation for our 2016 Notes and to redeem any of the 2016 Notes not purchased in the tender offer. The remainder of the net proceeds were used for general corporate purposes.
The 2022 Notes and the guarantees were issued pursuant to an indenture dated as of October 16, 2012 (the “2022 Notes Indenture”), by and among us, the guarantors party thereto and Wells Fargo Bank, National Association, as trustee. Interest on the 2022 Notes accrues from and including October 16, 2012 at a rate of 7.75% per year. Interest on the 2022 Notes is payable semi-annually in arrears on April 15 and October 15 of each year, commencing on April 15, 2013. The 2022 Notes mature on October 15, 2022.
The 2022 Notes Indenture contains covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to:
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incur additional indebtedness;
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pay dividends or repurchase or redeem capital stock;
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make certain investments;
•
incur liens;
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enter into certain types of transactions with affiliates;
•
limit dividends or other payments by our restricted subsidiaries to us; and
•
sell assets or consolidate or merge with or into other companies.
Index to Financial Statements These and other covenants that are contained in the 2022 Notes Indenture are subject to important exceptions and qualifications. At December 31, 2012, we were in compliance with the restrictive covenants under the 2022 Notes Indenture.
We may, at our option, redeem all or part of the 2022 Notes, at any time on or after October 15, 2017, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably to par and accrued and unpaid interest to the date of redemption.
At any time before October 15, 2015, we, at our option, may redeem up to 35% of the aggregate principal amount of the 2022 Notes issued under the 2022 Notes Indenture with the net cash proceeds of one or more qualified equity offerings at a redemption price of 107.750% of the principal amount of the 2022 Notes to be redeemed, plus accrued and unpaid interest to the date of redemption, as long as:
•
at least 65% of the aggregate principal amount of the 2022 Notes issued under the 2022 Notes Indenture remains outstanding immediately after the occurrence of such redemption; and
•
such redemption occurs within 90 days of the date of the closing of any such qualified equity offering.
In addition, at any time before October 15, 2017, we may redeem some or all of the 2022 Notes at a redemption price equal to 100% of the principal amount of the 2022 Notes, plus an applicable premium and accrued and unpaid interest to the date of redemption.
Following a change of control, as defined in the 2022 Notes Indenture, we will be required to make an offer to repurchase all or a portion of the 2022 Notes at 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase.
Revolving Credit Facility
On February 15, 2011, in connection with the initial offering of 2019 Notes, we terminated our previous $30.0 million secured revolving credit facility with Capital One, National Association, and entered into a credit agreement (the “Credit Agreement”) providing for a new $165.0 million Revolving Credit Facility with Merrill Lynch, Pierce, Fenner & Smith Incorporated and Capital One, National Association, as joint lead arrangers and joint book managers, the lenders party thereto and Bank of America, N.A., as administrative agent. The Credit Agreement includes an accordion feature whereby the total credit available to us can be increased by up to $100.0 million under certain circumstances, subject to additional lender commitments. The obligations under the Credit Agreement are guaranteed on a joint and several basis by each of our current subsidiaries, other than three immaterial subsidiaries, and are secured by substantially all of our and our subsidiary guarantors’ assets as collateral under a related Security Agreement (the “Security Agreement”). As of December 31, 2012, the non-guarantor subsidiaries held no assets and performed no operations. On July 15, 2011, we exercised the accordion feature and amended the Credit Agreement to increase our total credit available from $165.0 million to $225.0 million. On April 5, 2012, we amended the Credit Agreement to increase the aggregate amount of commitments thereunder to $250.0 million. On October 1, 2012, we further amended the Credit Agreement to permit the transactions contemplated by the offering of 2022 Notes and tender offer and redemption of 2016 Notes.
Borrowings under the Credit Agreement mature on January 15, 2016, and we have the ability at any time to prepay the Credit Agreement without premium or penalty. At our option, advances under the Credit Agreement may be comprised of (i) alternate base rate loans, at a variable base interest rate plus a margin ranging from 1.50% to 2.25% based on our leverage ratio or (ii) Eurodollar loans, at a variable base interest rate plus a margin ranging from 2.50% to 3.25% based on our leverage ratio. We will pay a commitment fee equal to 0.50% on the daily unused amount of the commitments under the Credit Agreement.
Index to Financial Statements The Credit Agreement contains various covenants that, subject to agreed upon exceptions, limit our ability and the ability of certain of our subsidiaries to:
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incur indebtedness;
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grant liens;
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enter into sale and leaseback transactions;
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make loans, capital expenditures, acquisitions and investments;
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change the nature of business;
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acquire or sell assets or consolidate or merge with or into other companies;
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declare or pay dividends;
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enter into transactions with affiliates;
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enter into burdensome agreements;
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prepay, redeem or modify or terminate other indebtedness;
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change accounting policies and reporting practices; and
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amend organizational documents.
The Credit Agreement also contains covenants that, among other things, limit the amount of capital contributions we may make and require us to maintain specified ratios or conditions as follows:
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a minimum consolidated interest coverage ratio of not less than 2.50 to 1.00;
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a maximum consolidated leverage ratio not to exceed 4.00 to 1.00; and
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a maximum consolidated senior secured leverage ratio of 2.00 to 1.00.
If an event of default occurs under the Credit Agreement, then the lenders may (i) terminate their commitments under the Credit Agreement, (ii) declare any outstanding loans under the Credit Agreement to be immediately due and payable after applicable grace periods and (iii) foreclose on the collateral secured by the Security Agreement.
We had no borrowings and $22.5 million of letters of credit outstanding under the Credit Agreement as of December 31, 2012, giving us $227.5 million of available borrowing capacity. At December 31, 2012, we were in compliance with our covenants under the Credit Agreement.
Other Debt
We have a variety of other capital leases and notes payable outstanding that is generally customary in our business. None of these debt instruments is material individually. Our leases with Banc of America Leasing & Capital, LLC requires us to maintain a minimum debt service coverage ratio of 1.05 to 1.00. As of December 31, 2012, we had total capital leases of approximately $106.5 million.
Losses on Extinguishment of Debt
In October 2012, upon the retirement of the 2016 Notes, we wrote off unamortized debt issuance costs of approximately $1.8 million. Basic also paid a premium of $6.1 million to the holders of the 2016 Notes for the early termination of the notes. In February 2011, upon the retirement of the 11.625% Senior Secured Notes and the termination of our previous $30.0 million revolving credit facility, we wrote off unamortized debt issuance costs of approximately $3.9 million and unamortized discount of $9.2 million. We also paid a premium of $36.2 million to the holders of the 11.625% Senior Secured Notes for the early termination of the notes.
Index to Financial Statements Preferred Stock
At December 31, 2012 and December 31, 2011, we had 5,000,000 shares of $.01 par value preferred stock authorized, of which none was designated, issued or outstanding.
Other Matters
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Net Operating Losses
As of December 31, 2012, we had approximately $47.0 million of NOL carryforwards.
Recent Accounting Pronouncements
In September 2011, the FASB issued ASU No. 2011-08, “Intangibles - Goodwill and Other” (“ASU 2011-08”). ASU 2011-08 allows a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the two-step impairment test for that reporting unit would be performed. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and early adoption is permitted. Basic adopted this accounting standard update early, and although it has changed the process Basic uses to determine if goodwill is impaired, it has not had a material impact on Basic’s consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet” (“ASU 2011-11”). The standard amends and expands disclosure requirements about balance sheet offsetting and related arrangements. ASU 2011-11 becomes effective for Basic on January 1, 2013. Basic does not anticipate any impact to its results of operations, financial position or liquidity when the guidance becomes effective.
In July 2012, the FASB issued ASU No. 2012-02, “Intangibles - Goodwill and Other: Testing Indefinite-Lived Intangible Assets for Impairment” (“ASU 2012-02”). ASU 2012-02 allows a qualitative assessment of whether it is more likely than not that the indefinite-lived intangible asset’s fair value is less than its carrying amount before applying the quantitative impairment test. If it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, then the impairment test for that indefinite-lived intangible asset would be performed. ASU 2012-02 is effective for annual and interim impairment tests performed for indefinite-lived intangible assets for fiscal years beginning after September 15, 2012 and early adoption is permitted. Basic plans on adopting this accounting standard update early, and although it will change the process Basic uses to determine if indefinite-lived intangible assets are impaired, it is not expected to have a material impact on Basic’s consolidated financial statements.
Impact of Inflation on Operations
Management is of the opinion that inflation has not had a significant impact on our business.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2012, we had no borrowings outstanding under any agreements with market risk sensitive instruments, and were not party to any other material market risk sensitive instruments.
Index to Financial Statements
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Basic Energy Services, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Index to Financial Statements MANAGEMENT’S REPORT ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Basic Energy Services, Inc. (“Basic” or the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting for the Company. As defined by the Securities and Exchange Commission (Rule 13a-15(f) under the Exchange Act of 1934, as amended), internal control over financial reporting is a process designed by, or under the supervision of Basic’s principal executive and principal financial officers and effected by its Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.
The Company’s internal control over financial reporting is supported by written policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the Company’s transactions and dispositions of the Company’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorization of the Company’s management and directors; 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 consolidated 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 connection with the preparation of the Company’s annual consolidated financial statements, management has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of those controls.
Based on this assessment, management has concluded that as of December 31, 2012, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
The Company acquired Salt Water Disposal of North Dakota LLC, Surface Stac Inc., SPA Victoria LP and Mayo Marrs Casing & Pulling Inc. (collectively, the “Acquisitions”) during 2012, and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, the Acquisitions’ internal control over financial reporting associated with total assets of $85.0 million and total revenues of $20.5 million included in the consolidated financial statements of Basic Energy Services, Inc. and subsidiaries as of and for the year ended December 31, 2012.
KPMG LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this report, has issued an attestation report on the effectiveness of internal control over financial reporting.
/s/ Kenneth V. Huseman
/s/ Alan Krenek
Kenneth V. Huseman
Alan Krenek
Chief Executive Officer
Chief Financial Officer
Index to Financial Statements Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Basic Energy Services, Inc.:
We have audited Basic Energy Services, Inc.’s (“the Company”) internal control over financial reporting as of December 31, 2012, 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 Report of Internal Controls 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, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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, Basic Energy Services, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
The Company acquired Saltwater Disposal of North Dakota, LLC, Surface Stac Inc., SPA Victoria LP and Mayo Marrs Casing & Pulling, Inc. (collectively the “Acquisitions”) during 2012, and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, the Acquisitions’ internal control over financial reporting associated with total assets of $85.0 million and total revenues of $20.5 million included in the consolidated financial statements of Basic Energy Services, Inc. and subsidiaries as of and for the year ended December 31, 2012. Our audit of the internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of the Acquisitions.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Basic Energy Services, Inc. and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2012, and our report dated February 27, 2013 expressed an unqualified opinion on those consolidated financial statements.
KPMG LLP
Dallas, Texas
February 27, 2013
Index to Financial Statements Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Basic Energy Services, Inc.:
We have audited the accompanying consolidated balance sheets of Basic Energy Services, Inc. and subsidiaries (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2012. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedules. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules 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 Basic Energy Services, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Basic Energy Services, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2013 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
KPMG LLP
Dallas, Texas
February 27, 2013
Index to Financial Statements Basic Energy Services, Inc.
Consolidated Balance Sheets
(in thousands, except share data)
See accompanying notes to consolidated financial statements.
Index to Financial Statements Basic Energy Services, Inc.
Consolidated Statements of Operations and Comprehensive Income (Loss)
(Dollars in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
Index to Financial Statements Basic Energy Services, Inc.
Consolidated Statements of Stockholders’ Equity
(in thousands, except share data)
See accompanying notes to consolidated financial statements.
Index to Financial Statements Basic Energy Services, Inc.
Consolidated Statements of Cash Flows
(in thousands)
See accompanying notes to consolidated financial statements.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements
December 31, 2012, 2011, and 2010
1. Nature of Operations
Basic Energy Services, Inc. (“Basic” or the “Company”) provides a wide range of well site services to oil and natural gas drilling and producing companies, including completion and remedial services, fluid services and wellsite construction services, well servicing and contract drilling. These services are primarily provided by Basic’s fleet of equipment. Basic’s operations are concentrated in major United States onshore oil and natural gas producing regions located in Texas, New Mexico, Oklahoma, Kansas, Arkansas, Louisiana, Pennsylvania, West Virginia, Wyoming, North Dakota, Colorado, Utah and Montana.
Basic’s reportable business segments are Completion and Remedial Services, Fluid Services, Well Servicing, and Contract Drilling. These segments were selected based on changes in management’s resource allocation and performance assessment in making decisions regarding the Company.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Basic and its wholly-owned subsidiaries. Basic has no variable interest in any other organization, entity, partnership, or contract. All intercompany transactions and balances have been eliminated.
Estimates, Risks and Uncertainties
Preparation of the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Management uses historical and other pertinent information to determine these estimates. Actual results could differ from those estimates. Areas where critical accounting estimates are made by management include:
•
Depreciation and amortization of property and equipment and intangible assets
•
Impairment of property and equipment, goodwill and intangible assets
•
Allowance for doubtful accounts
•
Litigation and self-insured risk reserves
•
Fair value of assets acquired and liabilities assumed
•
Stock-based compensation
•
Income taxes
•
Asset retirement obligation
Revenue Recognition
Completion and Remedial Services - Basic recognizes revenue when services are performed, collection of the relevant receivables is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. Basic prices completion and remedial services by the hour, day, or project depending on the type of service performed. When Basic provides multiple services to a customer, revenue is allocated to the services performed based on the fair values of the services.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
Fluid Services - Fluid services consist primarily of the sale, transportation, storage and disposal of fluids used in drilling, production and maintenance of oil and natural gas wells. Basic recognizes revenue when services are performed, collection of the relevant receivables is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. Basic prices fluid services by the job, by the hour or by the quantities sold, disposed of or hauled.
Well Servicing - Well servicing consists primarily of maintenance services, workover services, completion services and plugging and abandonment services and rig manufacturing and servicing. Basic recognizes revenue when services are performed, collection of the relevant receivables is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. Basic prices well servicing by the hour or by the day of service performed. Rig manufacturing revenue is recognized when the rig is accepted by the customer, based on the completed contract method by individual rig.
Contract Drilling - Basic recognizes revenue when services are performed, collection of the relevant receivables is probable, persuasive evidence of an arrangement exists and the price is fixed or determinable. Basic prices these jobs by “daywork” contracts, in which an agreed upon rate per day is charged to the customer, or “footage” contracts, in which an agreed upon rate per the number of feet drilled is charged to the customer.
Taxes assessed on sales transactions are presented on a net basis and are not included in revenue.
Cash and Cash Equivalents and Restricted Cash
Basic considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents. Basic maintains its excess cash in various financial institutions, where deposits may exceed federally insured amounts at times.
Fair Value of Financial Instruments
The following is a summary of the carrying amounts and estimated fair values of our financial instruments as of December 31, 2012 and 2011. Fair value is defined as the amount 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.
Cash and cash equivalents, restricted cash, trade accounts receivable, accounts receivable-related parties, accounts payable and accrued expenses: These carrying amounts approximate fair value because of the short maturity of these instruments.
Mutual Funds: The fair value of our mutual funds is based on matrix pricing at December 31, 2012. Matrix pricing is a mathematical technique widely used in the industry to value debt securities without exclusively on quoted prices for specific securities but rater by relying on the securities’ relationship to other benchmark quoted securities.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
7.125% Senior Notes, 7.75% Senior Notes due 2019, and 7.75% Senior Notes due 2022: The fair value of our long-term notes is based upon the quoted market prices at December 31, 2012 and December 31, 2011.
Inventories
For rental and fishing tools, inventories consisting mainly of grapples, controls, and drill bits are stated at the lower of cost or market, with cost being determined on the average cost method. Other inventories, consisting mainly of manufacturing raw materials, rig components, repair parts, drilling and completion materials and gravel, are held for use in the operations of Basic and are stated at the lower of cost or market, with cost being determined on the first-in, first-out (“FIFO”) method.
Property and Equipment
Property and equipment are stated at cost or at estimated fair value at acquisition date if acquired in a business combination. Expenditures for repairs and maintenance are charged to expense as incurred and additions and improvements that significantly extend the lives of the assets are capitalized. Upon sale or other retirement of depreciable property, the cost and accumulated depreciation and amortization are removed from the related accounts and any gain or loss is reflected in operations. All property and equipment are depreciated or amortized (to the extent of estimated salvage values) on the straight-line method and the estimated useful lives of the assets are as follows:
The components of a well servicing rig generally require replacement or refurbishment during the well servicing rig’s life and are depreciated over their estimated useful lives, which ranges from 3 to 15 years. The costs of the original components of a purchased or acquired well servicing rig are not maintained separately from the base rig.
Impairments
Long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment at a minimum annually, or whenever, in management’s judgment events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of such assets to estimated undiscounted future cash flows expected to be generated by the assets. Expected future cash flows and carrying values are aggregated at their lowest identifiable level, which is at the business segment level. If the
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
carrying amount of such assets exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of such assets exceeds the fair value of the assets. Assets to be disposed of would be separately presented in the consolidated balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities, if material, of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the consolidated balance sheet. These assets are normally sold within a short period of time through a third party auctioneer.
Deferred Debt Costs
Basic capitalizes certain costs in connection with obtaining its borrowings, such as lender’s fees and related attorney’s fees. These costs are being amortized to interest expense using the effective interest method.
Deferred debt costs were approximately $22.6 million net of accumulated amortization of $4.1 million, and $20.8 million net of accumulated amortization of $4.6 million at December 31, 2012 and December 31, 2011, respectively. Amortization of deferred debt costs totaled approximately $2.8 million, $2.3 million and $1.6 million for the years ended December 31, 2012, 2011 and 2010, respectively.
Basic recorded a charge of $1.8 million during the fourth quarter of 2012 related to the write-off of debt costs associated with its 2016 Notes. On October 16, 2012, Basic completed the closing of an early tender for approximately $223.3 million of the 2016 Notes and delivered to the trustee amounts required to satisfy and discharge remaining obligations for the outstanding notes. Additionally, on October 16, 2012, Basic incurred $7.0 million of deferred debt costs associated with the issuance of 7.75% Senior Notes due 2022.
Basic recorded a charge of $3.9 million during the first quarter of 2011 related to the write-off of debt costs associated with its 11.625% Senior Secured Notes and $30.0 million revolving credit facility. On February 15, 2011, Basic terminated the revolving credit facility and completed the closing of an early tender for approximately $224.7 million of the Senior Secured Notes and delivered to the trustee amounts required to satisfy and discharge remaining obligations for the outstanding notes. Basic also incurred $3.2 million of deferred debt costs associated with the revolving credit facility entered into on February 15, 2011. Additionally, on June 13, 2011, Basic incurred $12.4 million of deferred debt costs associated with the issuance of additional 7.75% Senior Notes due 2019.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets not subject to amortization are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. A qualitative assessment is allowed to determine if goodwill is potentially impaired. The qualitative assessment determines whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount. If it is more likely that not that the fair value of the reporting unit is less than the carrying amount, then the two step impairment test is performed. First, the fair value of each reporting unit is compared to its carrying value to determine whether an indication of impairment exists. If impairment is indicated, then the fair value of the reporting unit’s goodwill is determined by allocating the unit’s fair value to its assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. The amount of impairment for goodwill is measured as the excess of its carrying value over its fair value. Basic completes its assessment of goodwill impairment as of December 31 each year. No impairment was recorded for the years ended December 31, 2012, 2011 and 2010.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
The changes in the carrying amount of goodwill for the year ended December 31, 2012, are as follows (in thousands):
Basic had trade names of $1.9 million as of December 31, 2012 and 2011. Trade names have an indefinite life and are tested for impairment annually.
Basic’s intangible assets subject to amortization consist of customer relationships, non-compete agreements and rig engineering plans. The gross carrying amount of customer relationships subject to amortization was $90.1 million and $78.2 million as of December 31, 2012 and 2011, respectively. The gross carrying amount of non-compete agreements subject to amortization totaled approximately $8.0 million and $7.6 million at December 31, 2012 and 2011, respectively. The gross carrying amount of other intangible assets subject to amortization was $1.1 million as of December 31, 2012 and 2011, respectively. Accumulated amortization related to these intangible assets totaled approximately $18.4 million and $14.1 million at December 31, 2012 and 2011, respectively. Amortization expense for the years ended December 31, 2012, 2011 and 2010 was approximately $6.9 million, $5.5 million, and $3.4 million, respectively. Amortization expense for the next five succeeding years is estimated to be approximately $7.7 million, $7.6 million, $7.5 million, $7.0 million, and $6.5 million in 2013, 2014, 2015, 2016, and 2017, respectively. Other intangibles net of accumulated amortization allocated to reporting units as of December 31, 2012 were $60.7 million, $3.3 million, $14.5 million and $4.2 million for completion and remedial services, fluid services, well servicing, and contract drilling, respectively.
Customer relationships are amortized over a 15-year life, non-compete agreements are amortized over a five-year life, and rig engineering plans are amortized over 15-year life.
Basic has identified its reporting units to be completion and remedial services, fluid services, well servicing and contract drilling.
Stock-Based Compensation
Basic has historically compensated our directors, executives and employees through the awarding of stock options and restricted stock. Basic accounted for stock option and restricted stock awards in 2010, 2011, and
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
2012 using a grant date fair-value based method, resulting in compensation expense for stock-based awards being recorded in our consolidated statements of income. For performance based restricted stock awards, compensation expense is recognized in the Company’s financial statements based on their grant date fair value. Basic utilizes (i) the closing stock price on the date of grant to determine the fair value of vesting restricted stock awards and (ii) a Monte Carlo simulation to determine the fair value of restricted stock awards with a combination of market and service vesting criteria. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market condition stipulated in the award grant and calculates the fair value of the award. The expected volatility utilized in the model was estimated using our historical volatility and the historical volatilities of our peer companies. The risk-free interest rate was based on the U.S. treasury rate for a term commensurate with the expected life of the grant. Stock options issued are valued on the grant date using Black-Scholes-Merton option pricing model and restricted stock issued is valued based on the fair value of Basic’s common stock at the grant date. In addition, judgment is required in estimating the amount of stock-based awards that are expected to be forfeited. Because the determination of these various assumptions is subject to significant management judgment and different assumptions could result in material differences in amounts recorded in Basic’s consolidated financial statements, management believes that accounting estimates related to the valuation of stock options are critical.
Income Taxes
Deferred tax assets and liabilities are recognized 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 are measured using statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in the period that includes the statutory enactment date. A valuation allowance for deferred tax assets is recognized when it is more likely than not that the benefit of deferred tax assets will not be realized.
Accounts Receivable
Basic estimates its allowance for losses on accounts receivable based on historic collections and expectations for future collections. These losses historically have been within management’s expectations. Basic regularly reviews accounts for collectability. After all collection efforts are exhausted, if the balance is still determined to be uncollectable, the balance is written off. Expense related to the write off of uncollected accounts is recorded in general and administrative expense.
Concentrations of Credit Risk
Financial instruments, which potentially subject Basic to concentration of credit risk, consist primarily of temporary cash investments and trade receivables. Basic restricts investment of temporary cash investments to financial institutions with high credit standing. Basic’s customer base consists primarily of multi-national and independent oil and natural gas producers. It performs ongoing credit evaluations of its customers but generally does not require collateral on its trade receivables. Credit risk is considered by management to be limited due to the large number of customers comprising its customer base. Basic maintains an allowance for potential credit losses on its trade receivables, and such losses have been within management’s expectations.
Basic did not have any one customer which represented 10% or more of consolidated revenue for 2012, 2011, or 2010.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
Asset Retirement Obligations
Basic is required to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets and capitalize an equal amount as a cost of the asset depreciating it over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted at the end of each quarter to reflect the passage of time, changes in the estimated future cash flows underlying the obligation, acquisition or construction of assets, and settlements of obligations.
Environmental
Basic is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require Basic to remove or mitigate the adverse environmental effects of disposal or release of petroleum, chemical and other substances at various sites. Environmental expenditures are expensed or capitalized depending on the future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a non-capital nature are recorded when environmental assessment and/or remediation is probable and the costs can be reasonably estimated.
Litigation and Self-Insured Risk Reserves
Basic estimates its reserves related to litigation and self-insured risks based on the facts and circumstances specific to the litigation and self-insured claims and its past experience with similar claims. Basic maintains accruals in the consolidated balance sheets to cover self-insurance retentions (See Note 7).
Comprehensive Income (Loss)
All items that are required to be recognized under accounting rules as components of comprehensive income (loss) are to be reported in a financial statement that is displayed with the same prominence as other financial statements. Gains and losses on cash flow hedging derivatives, to the extent effective, are included in other comprehensive income (loss). For the three-year period ended December 31, 2012, Basic did not have any items of other comprehensive income (loss).
Reclassifications
Certain reclassifications of prior year financial statement amounts have been made to conform to current year presentations.
Recent Accounting Pronouncements
In September 2011, the FASB issued ASU No. 2011-08, “Intangibles - Goodwill and Other” (“ASU 2011-08”). ASU 2011-08 allows a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the two-step impairment test for that reporting unit would be performed. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and early adoption is permitted. Basic early adopted this accounting standard update and although it has changed the process Basic uses to determine if goodwill is impaired, it has not had a material impact on Basic’s consolidated financial statements.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet” (“ASU 2011-11”). The standard amends and expands disclosure requirements about balance sheet offsetting and related arrangements. ASU 2011-11 becomes effective for Basic on January 1, 2013. Basic does not anticipate any impact to its results of operations, financial position or liquidity when the guidance becomes effective.
In July 2012, the FASB issued ASU No. 2012-02, “Intangibles - Goodwill and Other: Testing Indefinite-Lived Intangible Assets for Impairment” (“ASU 2012-02”). ASU 2012-02 allows a qualitative assessment of whether it is more likely than not that the indefinite-lived intangible asset’s fair value is less than its carrying amount before applying the quantitative impairment test. If it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, then the impairment test for that indefinite-lived intangible asset would be performed. ASU 2012-02 is effective for annual and interim impairment tests performed for indefinite-lived intangible assets for fiscal years beginning after September 15, 2012 and early adoption is permitted. Basic early adopted this accounting standard update and although it has changed the process Basic uses to determine if indefinite-lived intangible assets are impaired, it has not had a material impact on Basic’s consolidated financial statements.
3. Acquisitions
In 2012, 2011 and 2010, Basic acquired either substantially all of the assets or all of the outstanding capital stock of each of the following businesses, each of which were accounted for using the purchase method of accounting. The following table summarizes the final values at the date of acquisition, except for the acquisitions completed in 2011 whose values are provisional (in thousands):
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
The operations of each of the acquisitions listed above are included in Basic’s statement of operations as of each respective closing date. The acquisition of the Maverick Companies in July 2011 has been deemed significant and is discussed below in further detail. The pro forma effect of the remainder of the acquisitions completed in 2010, 2011 or 2012 are not material, either individually or when aggregated, to the reported results of operations.
The Maverick Companies
On July 8, 2011, Basic acquired all of the equity interests of Maverick Stimulation Company, LLC, Maverick Coil Tubing Services, LLC, Maverick Thru-Tubing, LLC, Maverick Solutions, LLC, The Maverick Companies, LLC, MCM Holdings, LLC, and MSM Leasing LLC (collectively the “Maverick Companies”). The results of the Maverick Companies’ operations have been included in the financial statements since that date. The amount of revenue included in the consolidated income statement in 2012 and 2011 was $130.8 million and $62.4 million, respectively. The aggregate purchase price was approximately $186.3 million in cash. This acquisition allowed us to expand our stimulation, coiled tubing, and thru tubing business in Colorado, New Mexico, Utah, and Oklahoma. This acquisition also allowed us to enter the water treatment business. The Maverick Companies operate in Basic’s completion and remedial segment. The following table summarizes the fair value of the assets acquired and liabilities assumed at the date of acquisition for the Maverick Companies (in thousands):
(1) Other intangible assets consists of customer relationship of $25.3 million, amortizable over 15 years, non-compete agreements of $3.6 million, amortizable over five years, intellectual property of $380,000, amortizable over 15 years, and trade name of $170,000 with an indefinite life.
(2) Goodwill is primarily attributable to operational and cost synergies expected to be realized from the acquisition by integrating Maverick’s equipment and assembled workforce. All of the goodwill is expected to be deductible for tax purposes.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
4. Property and Equipment
Property and equipment consists of the following (in thousands):
Basic is obligated under various capital leases for certain vehicles and equipment that expire at various dates during the next five years. The gross amount of property and equipment and related accumulated amortization recorded under capital leases and included above consists of the following (in thousands):
Amortization of assets held under capital leases of approximately $28.5 million, $22.0 million and $21.2 million for the years ended December 31, 2012, 2011 and 2010, respectively, is included in depreciation and amortization expense in the consolidated statements of operations.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
5. Long-Term Debt
Long-term debt consists of the following (in thousands):
7.125% Senior Notes due 2016
In April 2006, we completed a private offering of $225.0 million aggregate principal amount of 7.125% Senior Notes due April 15, 2016 (the “2016 Notes”). The 2016 Notes were jointly and severally guaranteed by each of our restricted subsidiaries (currently all of our subsidiaries other than three immaterial subsidiaries). We issued the 2016 Notes pursuant to an indenture, dated as of April 12, 2006, by and among us, the guarantor parties thereto and The Bank of New York Trust Company, N.A., as trustee (the “2016 Notes Indenture”). Interest on the 2016 Notes accrued at a rate of 7.125% per year. Interest on the 2016 Notes was payable in cash semi-annually in arrears on April 15 and October 15 of each year. The maturity date of the 2016 Notes was April 15, 2016.
On October 1, 2012, we announced a cash offer and consent solicitation with respect to any and all of the $225.0 million aggregate outstanding principal amount of the 2016 Notes. On October 16, 2012, we completed the closing of an early tender for approximately $223.3 million of the 2016 Notes and delivered to the trustee the amount required to satisfy and discharge our remaining obligations for the outstanding 2016 Notes. The tender offer expired on October 29, 2012, and all of our obligations under the 2016 Notes Indenture have be satisfied and no 2016 Notes are outstanding.
11.625% Senior Secured Notes due 2014
On July 31, 2009, we issued $225.0 million aggregate principal amount of 11.625% Senior Secured Notes due 2014 (the “Senior Secured Notes”) in a private placement. The Senior Secured Notes were jointly and severally, and unconditionally, guaranteed on a senior secured basis initially by all of our current subsidiaries other than two immaterial subsidiaries. The Senior Secured Notes and the related guarantees were issued pursuant to an indenture dated as of July 31, 2009 (the “Senior Secured Notes Indenture”), by and among us, the guarantors party thereto and The Bank of New York Mellon Trust Company, N.A., as trustee. The obligations under the Senior Secured Notes Indenture were secured as set forth in the Senior Secured Notes Indenture and in a related Security Agreement (the “Secured Notes Security Agreement”), in favor of the trustee, by a first-priority lien (other than Permitted Collateral Liens, as defined in the Senior Secured Notes Indenture) in favor of the trustee, on the collateral described in the Secured Notes Security Agreement. Interest on the Senior Secured Notes accrued at a rate of 11.625% per year. Interest on the Senior Secured Notes was payable semi-annually in arrears on February 1 and August 1 of each year. The maturity date of the Senior Secured Notes was August 1, 2014.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
On February 1, 2011, we announced a cash tender offer and consent solicitation with respect to any and all of the $225.0 million aggregate outstanding principal amount of the Senior Secured Notes. On February 15, 2011, we completed the closing of an early tender for approximately $224.7 million of the Senior Secured Notes and delivered to the trustee the amount required to satisfy and discharge our remaining obligations for the outstanding Senior Secured Notes. The tender offer expired on March 2, 2011, and all of our obligations under the Senior Secured Notes Indenture have been satisfied and no Senior Secured Notes are outstanding.
7.75% Senior Notes due 2019
On February 15, 2011, we issued $275.0 million of 7.75% Senior Notes due 2019 (the “2019 Notes”). On June 13, 2011, we issued an additional $200.0 million, for an aggregate principal amount of $475.0 million of 2019 Notes. The 2019 Notes are jointly and severally, and unconditionally, guaranteed on a senior unsecured basis by all of our current subsidiaries, other than three immaterial subsidiaries. The 2019 Notes and the guarantees rank (i) equally in right of payment with any of our and the subsidiary guarantors’ existing and future senior indebtedness, including our existing 7.75% Senior Notes due 2022 and the related guarantees, and (ii) effectively junior to all existing or future liabilities of our subsidiaries that do not guarantee the 2019 Notes and to our and the subsidiary guarantors’ existing or future secured indebtedness to the extent of the value of the collateral therefore.
The 2019 Notes were offered and sold in private transactions in accordance with Rule 144A and Regulation S under the Securities Act of 1933, as amended (the “Securities Act”). Under the terms of the sale of the 2019 Notes, we were required to take appropriate steps to offer to exchange other 2019 Notes with the same terms that have been registered with the Securities and Exchange Commission for the private placement 2019 Notes. We completed the exchange offer for all of the 2019 Notes on November 15, 2011.
The purchase price for the $275.0 million of 2019 Notes issued on February 15, 2011 was 100.000% of their principal amount, and the purchase price for the $200.0 million of 2019 Notes issued on June 13, 2011 was 101.000%, plus accrued interest from February 15, 2011. We received net proceeds from the issuance of the 2019 Notes of approximately $464.6 million after premiums and offering expenses. We used a portion of the net proceeds from the February 2011 offering to fund our tender offer and consent solicitation for our Senior Secured Notes and to redeem any of the Senior Secured Notes not purchased in the tender offer. We used a portion of the net proceeds from the June 2011 offering to fund the $186.3 million purchase price for the Maverick Companies acquisition completed in July 2011 and for general corporate purposes.
The 2019 Notes were issued pursuant to an indenture dated as of February 15, 2011 (the “2019 Notes Indenture”), by and among Basic, the guarantors party thereto and Wells Fargo Bank, N.A., as trustee. Interest on the 2019 Notes accrues from and including February 15, 2011 at a rate of 7.75% per year. Interest on the 2019 Notes is payable semi-annually in arrears on February 15 and August 15 of each year. The 2019 Notes mature on February 15, 2019.
The 2019 Notes Indenture contains covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to:
•
incur additional indebtedness;
•
pay dividends or repurchase or redeem capital stock;
•
make certain investments;
•
incur liens;
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
•
enter into certain types of transactions with affiliates;
•
limit dividends or other payments by our restricted subsidiaries to us; and
•
sell assets or consolidate or merge with or into other companies.
These and other covenants that are contained in the 2019 Notes Indenture are subject to important exceptions and qualifications set forth in the 2019 Notes Indenture. At December 31, 2012, we were in compliance with the restrictive covenants under the 2019 Notes Indenture.
We may, at our option, redeem all or part of the 2019 Notes, at any time on or after February 15, 2015, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably to par and accrued and unpaid interest to the date of redemption.
At any time before February 15, 2014, we, at our option, may redeem up to 35% of the aggregate principal amount of the 2019 Notes issued under the 2019 Notes Indenture with the net cash proceeds of one or more qualified equity offerings at a redemption price of 107.750% of the principal amount of the 2019 Notes to be redeemed, plus accrued and unpaid interest to the date of redemption, as long as:
•
at least 65% of the aggregate principal amount of the 2019 Notes issued under the 2019 Notes Indenture remains outstanding immediately after the occurrence of such redemption; and
•
such redemption occurs within 90 days of the date of the closing of any such qualified equity offering.
In addition, at any time before February 15, 2015, we may redeem some or all of the 2019 Notes at a redemption price equal to 100% of the principal amount of the 2019 Notes, plus an applicable premium and accrued and unpaid interest to the date of redemption.
Following a change of control, as defined in the 2019 Notes Indenture, we will be required to make an offer to repurchase all or a portion of the 2019 Notes at 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase.
7.75% Senior Notes due 2022
On October 16, 2012, we successfully completed the issuance and sale of $300.0 million aggregate principal amount of 7.75% Senior Notes due 2022 (the “2022 Notes”). The 2022 Notes are jointly and severally, and unconditionally, guaranteed on a senior unsecured basis initially by all of our current subsidiaries other than three immaterial subsidiaries. The 2022 Notes and the guarantees rank (i) equally in right of payment with any of our and the subsidiary guarantors’ existing and future senior indebtedness, including our existing 2019 Notes and the related guarantees, and (ii) effectively junior to all existing or future liabilities of our subsidiaries that do not guarantee the 2022 Notes and to our and the subsidiary guarantors’ existing or future secured indebtedness to the extent of the value of the collateral therefor.
The 2022 Notes and the guarantees were offered and sold in private transactions in accordance with Rule 144A and Regulation S under the Securities Act of 1933, as amended. We received net proceeds from the issuance of the 2022 Notes of approximately $293.3 million after discounts and offering expenses. We used a portion of the net proceeds from the offering to fund our pending tender offer and consent solicitation for our 2016 Notes and to redeem any of the 2016 Notes not purchased in the tender offer. The remainder of the net proceeds were used for general corporate purposes.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
The 2022 Notes and the guarantees were issued pursuant to an indenture dated as of October 16, 2012 (the “2022 Notes Indenture”), by and among us, the guarantors party thereto and Wells Fargo Bank, National Association, as trustee. Interest on the 2022 Notes accrues from and including October 16, 2012 at a rate of 7.75% per year. Interest on the 2022 Notes is payable semi-annually in arrears on April 15 and October 15 of each year, commencing on April 15, 2013. The 2022 Notes mature on October 15, 2022.
The 2022 Notes Indenture contains covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to:
•
incur additional indebtedness;
•
pay dividends or repurchase or redeem capital stock;
•
make certain investments;
•
incur liens;
•
enter into certain types of transactions with affiliates;
•
limit dividends or other payments by our restricted subsidiaries to us; and
•
sell assets or consolidate or merge with or into other companies.
These and other covenants that are contained in the 2022 Notes Indenture are subject to important exceptions and qualifications. At December 31, 2012, we were in compliance with the restrictive covenants under the 2022 Notes Indenture.
We may, at our option, redeem all or part of the 2022 Notes, at any time on or after October 15, 2017, at a redemption price equal to 100% of the principal amount thereof, plus a premium declining ratably to par and accrued and unpaid interest to the date of redemption.
At any time before October 15, 2015, we, at our option, may redeem up to 35% of the aggregate principal amount of the 2022 Notes issued under the 2022 Notes Indenture with the net cash proceeds of one or more qualified equity offerings at a redemption price of 107.750% of the principal amount of the 2022 Notes to be redeemed, plus accrued and unpaid interest to the date of redemption, as long as:
•
at least 65% of the aggregate principal amount of the 2022 Notes issued under the 2022 Notes Indenture remains outstanding immediately after the occurrence of such redemption; and
•
such redemption occurs within 90 days of the date of the closing of any such qualified equity offering.
In addition, at any time before October 15, 2017, we may redeem some or all of the 2022 Notes at a redemption price equal to 100% of the principal amount of the 2022 Notes, plus an applicable premium and accrued and unpaid interest to the date of redemption.
Following a change of control, as defined in the 2022 Notes Indenture, we will be required to make an offer to repurchase all or a portion of the 2022 Notes at 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase.
Revolving Credit Facility
On February 15, 2011, in connection with the initial offering of 2019 Notes, we terminated our previous $30.0 million secured revolving credit facility with Capital One, National Association, and entered into a credit agreement (the “Credit Agreement”) providing for a new $165.0 million Revolving Credit Facility with Merrill
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
Lynch, Pierce, Fenner & Smith Incorporated and Capital One, National Association, as joint lead arrangers and joint book managers, the lenders party thereto and Bank of America, N.A., as administrative agent. The Credit Agreement includes an accordion feature whereby the total credit available to us can be increased by up to $100.0 million under certain circumstances, subject to additional lender commitments. The obligations under the Credit Agreement are guaranteed on a joint and several basis by each of our current subsidiaries, other than three immaterial subsidiaries, and are secured by substantially all of our and our subsidiary guarantors’ assets as collateral under a related Security Agreement (the “Security Agreement”). As of December 31, 2012, the non-guarantor subsidiaries held no assets and performed no operations. On July 15, 2011, we exercised the accordion feature and amended the Credit Agreement to increase our total credit available from $165.0 million to $225.0 million. On April 5, 2012, we amended the Credit Agreement to increase the aggregate amount of commitments thereunder to $250.0 million. On October 1, 2012, we further amended the Credit Agreement to permit the transactions contemplated by the offering of 2022 Notes and tender offer and redemption of 2016 Notes.
Borrowings under the Credit Agreement mature on January 15, 2016, and we have the ability at any time to prepay the Credit Agreement without premium or penalty. At our option, advances under the Credit Agreement may be comprised of (i) alternate base rate loans, at a variable base interest rate plus a margin ranging from 1.50% to 2.25% based on our leverage ratio or (ii) Eurodollar loans, at a variable base interest rate plus a margin ranging from 2.50% to 3.25% based on our leverage ratio. We will pay a commitment fee equal to 0.50% on the daily unused amount of the commitments under the Credit Agreement.
The Credit Agreement contains various covenants that, subject to agreed upon exceptions, limit our ability and the ability of certain of our subsidiaries to:
•
incur indebtedness;
•
grant liens;
•
enter into sale and leaseback transactions;
•
make loans, capital expenditures, acquisitions and investments;
•
change the nature of business;
•
acquire or sell assets or consolidate or merge with or into other companies;
•
declare or pay dividends;
•
enter into transactions with affiliates;
•
enter into burdensome agreements;
•
prepay, redeem or modify or terminate other indebtedness;
•
change accounting policies and reporting practices; and
•
amend organizational documents.
The Credit Agreement also contains covenants that, among other things, limit the amount of capital contributions we may make and require us to maintain specified ratios or conditions as follows:
•
a minimum consolidated interest coverage ratio of not less than 2.50 to 1.00;
•
a maximum consolidated leverage ratio not to exceed 4.00 to 1.00; and
•
a maximum consolidated senior secured leverage ratio of 2.00 to 1.00.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
If an event of default occurs under the Credit Agreement, then the lenders may (i) terminate their commitments under the Credit Agreement, (ii) declare any outstanding loans under the Credit Agreement to be immediately due and payable after applicable grace periods and (iii) foreclose on the collateral secured by the Security Agreement.
We had no borrowings and $22.5 million of letters of credit outstanding under the Credit Agreement as of December 31, 2012, giving us $227.5 million of available borrowing capacity. At December 31, 2012, we were in compliance with our covenants under the Credit Agreement.
Other Debt
Basic has a variety of other capital leases and notes payable outstanding that are generally customary in its business. None of these debt instruments are individually material. Basic’s leases with Banc of America Leasing & Capital, LLC require us to maintain a minimum debt service coverage ratio of 1.05 to 1.00. At December 31, 2012, Basic was in compliance with this covenant.
As of December 31, 2012 the aggregate maturities of debt, including capital leases, for the next five years and thereafter are as follows (in thousands):
Basic’s interest expense consisted of the following (in thousands):
Losses on Extinguishment of Debt
In October 2012, upon the retirement of the 2016 Notes, Basic wrote off unamortized debt issuance costs of approximately $1.8 million. Basic also paid a premium of $6.1 million to the holders of the 2016 Notes for the early termination of the notes. In February 2011, upon the retirement of the 11.625% Senior Secured Notes and
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
the termination of Basic’s $30.0 million revolving credit facility, Basic wrote off unamortized debt issuance costs of approximately $3.9 million and unamortized discount of $9.2 million. Basic also paid a premium of $36.2 million to the holders of the 11.625% Senior Secured Notes for the early termination of the notes.
6. Income Taxes
Income tax expense (benefit) consists of the following (in thousands):
Basic paid federal income taxes of $601,000 during 2012. Basic paid no federal income taxes during 2011 or 2010.
Reconciliation between the amount determined by applying the federal statutory rate of 35% to income from continuing operations with the provision for income taxes is as follows (in thousands):
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows (in thousands):
Basic provides a valuation allowance when it is more likely than not that some portion of the deferred tax assets will not be realized. There was no valuation allowance necessary as of December 31, 2012 or 2011.
Interest is recorded in interest expense and penalties are recorded in income tax expense. We had no interest or penalties related to an uncertain tax positions during 2012. Basic files federal income tax returns and state income tax returns in Texas and other state tax jurisdictions. In general, the Company’s federal tax returns for fiscal years after 2005 currently remain subject to examination by appropriate taxing authorities. The Company’s 2011 federal income tax return is under examination at this time.
As of December 31, 2012, Basic had approximately $47.0 million of net operating loss carryforwards (“NOL”) for income tax purposes, which begin to expire in 2030.
7. Commitments and Contingencies
Environmental
Basic is subject to various federal, state and local environmental laws and regulations that establish standards and requirements for protection of the environment. Basic cannot predict the future impact of such standards and requirements which are subject to change and can have retroactive effectiveness. Basic continues to monitor the status of these laws and regulations. Management believes that the likelihood of new environmental regulations resulting in a material adverse impact to Basic’s financial position, liquidity, capital resources or future results of operations is unlikely.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
Currently, Basic has not been fined, cited or notified of any environmental violations that would have a material adverse effect upon its financial position, liquidity or capital resources other than the situation noted below. However, management does recognize that by the very nature of its business, material costs could be incurred in the near term to maintain compliance. The amount of such future expenditures is not determinable due to several factors, including the unknown magnitude of possible regulation or liabilities, the unknown timing and extent of the corrective actions which may be required, the determination of Basic’s liability in proportion to other responsible parties and the extent to which such expenditures are recoverable from insurance or indemnification.
During April 2011, Basic received notice from the Travis County District Attorney of a pending investigation of a case referred by Texas Parks & Wildlife and the Texas Environmental Enforcement Task Force. The potential matter related to a land farm owned by Basic located in Jefferson County, Texas. The matter was tried in Travis County, Texas, and Basic and an indemnified third party received a judgment in October 2012. Although Basic was not directly held responsible for any fines or penalties, Basic paid approximately $1.4 million to an indemnified third party in connection with the judgment.
Litigation
From time to time, Basic is a party to litigation or other legal proceedings that Basic considers to be a part of the ordinary course of business. Basic is not currently involved in any legal proceedings that it considers probable or reasonably possible, individually or in the aggregate, to result in a material adverse effect on its financial condition, results of operations or liquidity.
State Tax Audit
In 2011, Basic was notified by the Texas State Comptroller’s office that a sales and use tax audit for the period from 2006 through 2010 would be conducted. A preliminary report has been issued for this audit, and Basic will appeal the preliminary report through the redetermination process. Based on Basic’s analysis, the potential liability associated with this audit ranges from $5.9 million to $7.3 million. An accrual for the estimated liability of $5.9 million was recorded in 2012 in Basic’s financial statements as general and administrative expense. This range could potentially change in future periods after further review and discussions.
Operating Leases
Basic leases certain property and equipment under non-cancelable operating leases. The term of the operating leases generally range from 12 to 60 months with varying payment dates throughout each month.
As of December 31, 2011, the future minimum lease payments under non-cancelable operating leases are as follows (in thousands):
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
Rent expense approximated $18.5 million, $17.2 million and $12.8 million for 2012, 2011 and 2010, respectively.
Basic leases rights for the use of various brine and fresh water wells and disposal wells ranging in terms from month-to-month up to 99 years. The above table reflects the future minimum lease payments if the lease contains a periodic rental. However, the majority of these leases require payments based on a royalty percentage or a volume usage.
Employment Agreements
Under the employment agreement with Mr. Huseman, Chief Executive Officer and President of Basic, effective through December 31, 2013, Mr. Huseman is currently entitled to an annual salary of $700,000. Under this employment agreement, Mr. Huseman is eligible from time to time to receive grants of stock options and other long-term equity incentive compensation under our Amended and Restated 2003 Incentive Plan. In addition, upon a qualified termination of employment, Mr. Huseman would be entitled to three times his annual base salary plus his current annual incentive target bonus for the full year in which the termination of employment occurred. If employment is terminated for certain reasons within the six months preceding or the twelve months following the change of control of the Company, Mr. Huseman would be entitled to a lump sum severance payment equal to three times the sum of his annual base salary plus the higher of (i) his current incentive target bonus for the full year in which the termination of employment occurred or (ii) the highest annual incentive bonus received by him for any of the last three fiscal years.
Basic has entered into employment agreements with various other executive officers through December 31, 2013. Under these agreements, if the officer’s employment is terminated for certain reasons, he would be entitled to a lump sum severance payment equal to either 0.75 times to 1.5 times the sum of his annual base salary plus his current annual incentive target bonus for the full year in which the termination occurred. If employment is terminated for certain reasons within the six months preceding or the twelve months following the chance of control of the Company, he would be entitled to a lump sum severance payment equal to either 1.0 or 2.0 times the sum of his annual base salary plus the higher of (i) his current incentive target bonus for the full year in which the termination of employment occurred or (ii) the highest annual incentive bonus received by him for any of the last three fiscal years.
Self-Insured Risk Accruals
Basic is self-insured up to retention limits as it relates to workers’ compensation, general liability claims, and medical and dental coverage of its employees. Basic generally maintains no physical property damage coverage on its workover rig fleet, with the exception of certain of its 24-hour workover rigs and newly manufactured rigs. Basic has deductibles per occurrence for workers’ compensation, general liability claims, and medical and dental coverage of $1.0 million, $1.0 million and $300,000, respectively. Basic has lower deductibles per occurrence for automobile liability. Basic maintains accruals in the accompanying consolidated balance sheets related to self-insurance retentions by using third-party data and claims history. In 2012 and 2011, Basic classified the workers’ compensation self-insured risk reserve between short-term and long-term, with $5.9 million and $5.0 million being allocated to short-term and $6.9 million and $5.5 million being allocated to long-term, respectively.
At December 31, 2012 and December 31, 2011, self-insured risk accruals totaled approximately $22.9 million, net of $205,000 receivable for medical and dental coverage, and $19.7 million, net of $1,000 receivable for medical and dental coverage, respectively.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
8. Stockholders’ Equity
Common Stock
At December 31, 2012 and 2011, Basic had 80,000,000 shares of Basic’s common stock, par value $.01 per share, authorized.
In March 2009, the Compensation Committee of Basic’s Board of Directors approved grants of performance-based stock awards to certain members of management. In March 2010, it was determined that 79,500 shares, or 30% of the target number of shares, were earned based on Basic’s achievement of certain earnings per share growth and return on capital employed performance over the performance period from January 1, 2007 through December 31, 2009, as compared to other members of a defined peer group. These shares remain subject to vesting over a three-year period, with the first shares vesting on March 15, 2011.
In March 2010, Basic granted various employees 588,600 unvested shares of common stock which vest over a five-year period.
In March 2010, the Compensation Committee of Basic’s Board of Directors approved grants of performance-based stock awards to certain members of management. In February 2011, it was determined that 285,281 shares, or 150% of the target number of shares, were earned based on Basic’s achievement of total stockholder return over the performance period from January 1, 2010 through December 31, 2010, as compared to other members of a defined peer group. These shares remain subject to vesting over a three-year period, with the first shares vesting on March 15, 2012.
In March 2011, Basic granted various employees 510,399 restricted shares of common stock that vest over a three-year period.
In March 2011, the Compensation Committee of Basic’s Board of Directors approved grants of performance-based stock awards to certain members of management. In January 2012, it was determined that 161,785 shares, or 111% of the target number of shares, were earned based on Basic’s achievement of total stockholder return over the performance period from January 1, 2011 through December 31, 2011, as compared to other members of a defined peer group. These restricted shares remain subject to vesting over a three-year period, with the first shares vesting on March 15, 2013.
In March 2012, Basic granted various employees 646,438 restricted shares of common stock that vest over a three-year period and 179,000 shares that vest over a four-year period. The Compensation Committee of Basic’s Board of Directors approved grants of performance-based stock awards to certain members of management. In January 2013, it was determined that 42,513 shares, or 25% of the target number of shares, were earned based on Basic’s achievement of total stockholder return over the performance period from January 1, 2012 through December 31, 2012, as compared to other members of a defined peer group. These restricted shares remain subject to vesting over a three-year period, with the first shares vesting on March 15, 2014.
During the year ended 2012, Basic issued 133,200 shares of common stock from treasury stock for the exercise of stock options and 0 shares of newly-issued common stock for the exercise of stock options.
Treasury Stock
In May 2012, Basic announced that its Board of Directors reinstated the share repurchase program initially adopted in 2008 and suspended in 2009. The program allows the repurchase of up to $50.0 million of Basic’s shares of common stock from time to time in open market or private transactions, at Basic’s discretion. The
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
number of shares purchased and the timing of purchases is based on several factors, including the price of the common stock, general market conditions, available cash and alternative investment opportunities. During 2012, Basic repurchased 1,558,394 shares for a total price of approximately $14.9 million (an average of approximately $9.54 per share), inclusive of commissions and fees. As of December 31, 2012, Basic may purchase up to an additional $20.3 million of Basic’s shares of common stock under this program.
Basic also acquired treasury shares through net share settlements for payment of payroll taxes upon the vesting of restricted stock. Basic repurchased a total of 357,714 and 79,730 shares through net share settlements during 2012 and 2011, respectively.
Preferred Stock
At December 31, 2012 and 2011, Basic had 5,000,000 shares of preferred stock, par value $.01 per share, authorized, of which none was designated, issued or outstanding.
9. Stockholders’ Agreement
On December 20, 2010, Basic entered into the Third Amended and Restated Stockholders’ Agreement (the “Stockholders’ Agreement”) effective as of December 20, 2010 by and among Basic and certain affiliates of DLJ Merchant Banking party thereto (such affiliates, the “DLJ Parties”), which amended and restated the Second Amended and Restated Stockholders’ Agreement dated as of April 2, 2004, which terminated with respect to all other parties in accordance with its terms on December 21, 2010.
The Stockholders’ Agreement provides for certain informational and consultation rights, along with confidentiality obligations, and registration rights for the DLJ Parties. As long as (i) any DLJ Party remains an Affiliate (as defined in the Stockholders’ Agreement) of Basic or (ii) the DLJ Parties, collectively, beneficially hold at least ten percent of the outstanding shares of Basic’s common stock, the DLJ Parties can require Basic to register shares of common stock on up to three occasions, provided that the proposed offering proceeds for the offering equal or exceed $10 million (or $5 million if Basic is able to register such securities on Form S-3). In addition such demand registration rights, the Stockholders’ Agreement provides the DLJ Parties with piggyback registration rights with respect to any proposed offering of equity securities pursuant to a registration statement filed by Basic (other than a registration statement on Form S-4 or Form S-8). Basic is also obligated under the Stockholders’ Agreement to perform certain other actions in connection with a demand registration or piggyback registration request by any of the DLJ Parties.
The Stockholders’ Agreement terminates upon the earliest of (i) the dissolution, liquidation or winding-up of Basic, (ii) the date all of the DLJ Parties cease to be affiliates of Basic and the DLJ Parties, collectively, beneficially hold less than ten percent of the outstanding shares of common stock of Basic, or (iii) December 21, 2015.
10. Incentive Plan
In May 2003, Basic’s board of directors and stockholders approved the Basic 2003 Incentive Plan (as amended effective May 26, 2009) (the “Plan”), which provides for granting of incentive awards in the form of stock options, restricted stock, performance awards, bonus shares, phantom shares, cash awards and other stock-based awards to officers, employees, directors and consultants of Basic. The Plan assumed the awards of the plans of Basic’s predecessors that were awarded and remained outstanding prior to adoption of the Plan. The Plan provides for the issuance of 8,350,000 shares. Of these shares, approximately 1,968,625 shares are available
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
for grant as of December 31, 2012. The Plan is administered by the Plan committee, and in the absence of a Plan committee, by the Board of Directors, which determines the awards and the associated terms of the awards and interprets its provisions and adopts policies for implementing the Plan. The number of shares authorized under the Plan and the number of shares subject to an award under the Plan will be adjusted for stock splits, stock dividends, recapitalizations, mergers and other changes affecting the capital stock of Basic.
There were no options granted during 2012, 2011 or 2010.
During the years ended December 31, 2012, 2011 and 2010, compensation expense related to share-based arrangements including both restricted stock awards and stock option awards was approximately $11.4 million, $8.0 million and $5.7 million, respectively. For compensation expense recognized during the years ended December 31, 2012, 2011 and 2010, Basic recognized a tax benefit of approximately $3.9 million, $3.2 million and $2.1 million, respectively.
As of December 31, 2012, there was $18.8 million of total unrecognized compensation related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 1.9 years. The total fair value of share-based awards vested during the years ended December 31, 2012, 2011 and 2010 was approximately $13.0 million, $9.1 million and $3.9 million, respectively. The actual tax benefit realized for the tax deduction from vested share-based awards was $619,000 for the year ended December 31, 2010. During 2012 and 2011 there was no tax benefit due to the NOL. If there was no NOL the tax benefits would have been $1.5 million and $1.4 million, respectively.
Stock Option Awards
The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option-pricing model. Options granted under the Plan expire ten years from the date they are granted, and generally vest over a three-to-five year service period.
The following table reflects the summary of stock options outstanding at December 31, 2012 and the changes during the twelve months then ended:
The total intrinsic value of share options exercised during the years ended December 31, 2012, 2011 and 2010 was approximately $1.0 million, $12.4 million and $393,000, respectively.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
Cash received from option exercises under the Plan was approximately $798,000, $4.5 million and $322,000 for the years ended December 31, 2012, 2011 and 2010, respectively. The actual tax benefit realized for the tax deductions from options exercised was $142,000 for the year ended December 31, 2010. During 2012 and 2011 there was no tax benefit due to the NOL. If there was no NOL the tax benefit would have been $174,000 and $3.7 million, respectively.
The Company has a history of issuing treasury and newly-issued shares to satisfy share option exercises.
Restricted Stock Awards
On March 8, 2012, the Compensation Committee of Basic’s Board of Directors approved grants of performance-based stock awards to certain members of management. The performance-based awards are tied to Basic’s achievement of total stockholder return over the performance period from January 1, 2012 through December 31, 2012, as compared to other members of a defined peer group. The number of shares to be issued will range from 0% to 150% of the 190,126 target number of shares depending on the performance noted above. Any shares earned at the end of the performance period will then remain subject to vesting over a three-year period, with the first shares vesting March 15, 2014. As of December 31, 2012, Basic calculated that 25% of the target number of performance-based awards will be earned. A summary of the status of Basic’s non-vested share grants at December 31, 2012 and changes during the year ended December 31, 2012 is presented in the following table:
11. Related Party Transactions
Basic had receivables from employees of approximately $52,000 and $65,000 as of December 31, 2012 and December 31, 2011, respectively. During 2006, Basic entered into a lease agreement with Darle Vuelta Cattle Co., LLC, an affiliate of the Chief Executive Officer, for approximately $69,000 per year. The term of the lease is five years and will continue on a year-to-year basis unless terminated by either party. In December 2010, Basic entered into a lease agreement with Darle Vuelta Cattle Co., LLC for the right to operate a salt water disposal well, brine well and fresh water well. The term of the leases is two years and will continue until the salt water disposal well and brine well are plugged and no fresh water is being sold. The lease payments are the greater of (i) the sum of $0.10 per barrel of disposed oil and gas waste and $0.05 per barrel of brine or fresh water sold or (ii) $5,000 per month. In October 2011, Basic purchased approximately 17 acres of land for approximately $209,000 from Darle Vuelta Cattle Co., LLC. In April 2012, Basic purchased approximately 22 acres of land for approximately $215,000 from Darle Vuelta Cattle Co., LLC.
Basic entered into a joint venture agreement with a family member of an executive officer to form an entity in 2010. Basic holds 80 percent of the equity in the joint venture, and accounts the entity as an equity investment. In 2012, Basic funded approximately $4.5 million for this joint venture. The entity had only research and development activities in 2012.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
12. Profit Sharing Plan
Basic has a 401(k) profit sharing plan that covers substantially all employees. Employees may contribute up to their base salary not to exceed the annual Federal maximum allowed for such plans. Basic makes a matching contribution proportional to each employee’s contribution. Employee contributions are fully vested at all times. Employer matching contributions vest incrementally, with full vesting occurring after five years of service. Employer contributions to the 401(k) plan approximated $3.5 million, $2.6 million, and $80,000 in 2012, 2011 and 2010, respectively.
13. Deferred Compensation Plan
In April 2005, Basic established a deferred compensation plan for certain employees. Participants may defer up to 50% of their salary and 100% of any cash bonuses. Basic makes matching contributions of 100% of the first 3% of the participants’ deferred pay and 50% of the next 2% of the participants’ deferred pay to a maximum match of $10,000 per year. Employer matching contributions and earnings thereon are subject to a five-year vesting schedule with full vesting occurring after five years of service. Employer contributions to the deferred compensation plan net of earnings approximated an expense of $687,000 in 2012, an expense of $128,000 in 2011 and an expense of $337,000 in 2010, respectively.
14. Earnings Per Share
Basic earnings per common share are determined by dividing net earnings applicable to common stock by the weighted average number of common shares actually outstanding during the year. Diluted earnings per common share is based on the increased number of shares that would be outstanding assuming conversion of dilutive outstanding securities using the “as if converted” method. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share data):
There were no antidilutive shares at December 31, 2012 and 2011. The number of antidilutive shares at December 31, 2010 was 1.7 million.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
15. Business Segment Information
Basic’s reportable business segments are Completion and Remedial Services, Fluid Services, Well Servicing, and Contract Drilling. These segments have been selected based on changes in management’s resource allocation and performance assessment in making decisions regarding the Company. The following is a description of the segments:
Completion and Remedial Services: This segment utilizes a fleet of pressure pumping units, air compressor packages specially configured for underbalanced drilling operations, coiled tubing services, nitrogen services, cased-hole wireline units, an array of specialized rental equipment and fishing tools, thru-tubing and snubbing units. The largest portion of this business consists of pressure pumping services focused on cementing, acidizing and fracturing services in niche markets.
Fluid Services: This segment utilizes a fleet of trucks and related assets, including specialized tank trucks, storage tanks, water wells, disposal facilities, water treatment and related equipment. Basic employs these assets to provide, transport, store and dispose of a variety of fluids. These services are required in most workover, completion and remedial projects as well as part of daily producing well operations. Also included in this segment are our construction services which provide services for the construction and maintenance of oil and natural gas production infrastructures.
Well Servicing: This segment encompasses a full range of services performed with a mobile well servicing rig, including the installation and removal of downhole equipment and elimination of obstructions in the well bore to facilitate the flow of oil and natural gas. These services are performed to establish, maintain and improve production throughout the productive life of an oil and natural gas well and to plug and abandon a well at the end of its productive life. Basic’s well servicing equipment and capabilities also facilitate most other services performed on a well. This segment also includes the manufacture and servicing of mobile well servicing rigs.
Contract Drilling: This segment utilizes shallow and medium depth rigs and associated equipment for drilling wells to a specified depth for customers on a contract basis.
Basic’s management evaluates the performance of its operating segments based on operating revenues and segment profits. Corporate expenses include general corporate expenses associated with managing all reportable operating segments. Corporate assets consist principally of working capital and debt financing costs.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
The following table sets forth certain financial information with respect to Basic’s reportable segments (in thousands):
The following table reconciles the segment profits reported above to the operating income as reported in the consolidated statements of operations (in thousands):
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Notes to Consolidated Financial Statements - (Continued)
16. Accrued Expenses
The accrued expenses are as follows (in thousands):
17. Supplemental Schedule of Cash Flow Information
The following table reflects non-cash financing and investing activity during:
Basic paid $2.4 million and $990,000 in income taxes during the years ended December 31, 2012 and 2011, respectively. Basic paid no income taxes during the year ended December 31, 2010.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
18. Quarterly Financial Data (Unaudited)
The following table summarizes results for each of the four quarters in the years ended December 31, 2012 and 2011 (in thousands, except earnings per share data):
(a) The sum of individual quarterly net income per share may not agree to the total for the year due to each period’s computation being based on the weighted average number of common shares outstanding during each period.
19. Fair Value Measurements
Fair value is the price that would be received to sell an asset or the amount paid to transfer a liability in an orderly transaction between market participants (an exit price) at the measurement date. Fair value is a market based measurement considered from the perspective of a market participant. The Company uses market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation. These inputs can be readily observable, market corroborated,
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
or unobservable. If observable prices or inputs are not available, unobservable prices or inputs are used to estimate the current fair value, often using an internal valuation model. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the item being valued. The Company primarily applies a market approach for recurring fair value measurements using the best available information while utilizing valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.
There is a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The Company classifies fair value balances based on the observability of those inputs. The three levels of the fair value hierarchy are as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 - Inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable. These inputs are either directly observable in the marketplace or indirectly observable through corroboration with market data for substantially the full contractual term of the asset or liability being measured.
Level 3 - Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
In valuing certain assets and liabilities, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. For disclosure purposes, assets and liabilities are classified in their entirety in the fair value hierarchy level based on the lowest level of input that is significant to the overall fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the placement within the fair value hierarchy levels.
Index to Financial Statements BASIC ENERGY SERVICES, INC.
Notes to Consolidated Financial Statements - (Continued)
A description of the valuation methodologies used for assets measured at fair value on a recurring basis, as well as the general classification of such assets pursuant to the fair value hierarchy, is set forth below.
Mutual funds are valued at fair value on a recurring basis. The fair values of mutual funds are determined by obtaining quoted prices on nationally recognized securities exchange (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 Inputs). The Mutual funds are included on the face of the balance sheet under other assets. Assets and liabilities are measured at fair value on a recurring basis and summarized below:
20. Subsequent Events
On February 19, 2013, Basic acquired substantially all of the operating assets of Atlas Equipment Company for approximately $22.0 million. On February 22, 2013, Basic acquired substantially all of the operating assets of Petroleum Water Solutions, LLC for approximately $3.3 million.
Index to Financial Statements Schedule II - Valuation and Qualifying Accounts
(a) Charges relate to provisions for doubtful accounts
(b) Reflects the impact of acquisitions
(c) Deductions relate to the write-off of accounts receivable deemed uncollectible
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ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Based on their evaluation as of the end of the fiscal year ended December 31, 2012, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and effective to ensure that information required to be disclosed in such reports is accumulated and communicated to our management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
During the most recent fiscal quarter, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Design and Evaluation of Internal Control over Financial Reporting
Management’s Report on Internal Control over Financial Reporting and the Report of the Independent Registered Public Accounting Firm are set forth in Part II, Item 8 of this report and are incorporated herein by reference.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
Pursuant to paragraph 3 of General Instruction G to Form 10-K, the information required by Item 10, to the extent not set forth in “Executive Officers of the Registrant” in Part I above, and Items 11 through 14 of Part III of this Report is incorporated by reference from our definitive proxy statement involving the election of directors and the approval of independent auditors, which is to be filed pursuant to Regulation 14A within 120 days after the end of our fiscal year ended December 31, 2012.
Index to Financial Statements PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements, Schedules and Exhibits
(1) Financial Statements - Basic Energy Services, Inc. and Subsidiaries:
The Financial Statements listed in the Index to Consolidated Financial Statements are filed as part of this report on Form 10-K (see Part II, Item 8, Financial Statements and Supplementary Data).
(2) Financial Statement Schedules
With the exception of Schedule II - Valuation and Qualifying Accounts, all other consolidated financial statement schedules have been omitted because they are not required, are not applicable, or the required information has been included elsewhere within this Form 10-K.
(3) Exhibits
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* Incorporated by reference
 Management contract or compensatory plan or arrangement
Index to Financial Statements SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: February 27, 2013
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Index to Financial Statements EXHIBIT INDEX
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* Incorporated by reference
 Management contract or compensatory plan or arrangement