UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended March 31, 2011
OR
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission File Number 000-51471
BRONCO DRILLING COMPANY, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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20-2902156
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(State or other jurisdiction of
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(I.R.S. Employer
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incorporation or organization)
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Identification No.)
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16217 North May Avenue
Edmond, OK 73013
(Address of principal executive offices) (Zip Code)
(405) 242-4444
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes
o
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, non-accelerated filer or a smaller reporting company. See the definitions of accelerated
filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange
Act. (check one):
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Large Accelerated Filer
o
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Accelerated Filer
þ
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Non-Accelerated Filer
o
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Smaller Reporting Company
o
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act.): Yes
o
No
þ
As of April 30, 2011, 28,800,059 shares of common stock were outstanding.
BRONCO DRILLING COMPANY, INC.
INDEX
2
Bronco Drilling Company, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share par value)
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March 31,
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December 31,
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2011
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2010
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(Unaudited)
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ASSETS
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CURRENT ASSETS
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Cash and cash equivalents
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$
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14,797
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$
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11,854
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Restricted cash
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2,700
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Receivables
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Trade and other, net of allowance for doubtful accounts of
$968 and $891 in 2011 and 2010, respectively
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22,796
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24,656
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Affiliate receivables, net of allowance of $800
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1,546
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1,508
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Unbilled receivables
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856
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428
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Income tax receivable
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5,671
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5,700
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Current deferred income taxes
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2,558
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2,765
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Current maturities of note receivable from affiliate
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1,639
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1,607
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Prepaid expenses
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1,038
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329
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Total current assets
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50,901
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51,547
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PROPERTY AND EQUIPMENT AT COST
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Drilling rigs and related equipment
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304,886
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315,085
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Transportation, office and other equipment
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16,281
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16,236
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321,167
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331,321
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Less accumulated depreciation
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104,093
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105,242
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217,074
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226,079
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OTHER ASSETS
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Investment in Challenger
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38,730
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38,730
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Investment in Bronco MX
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21,433
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20,632
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Debt issue costs and other
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4,617
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3,362
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Non-current assets held for sale and discontinued operations
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7,000
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1,680
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71,780
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64,404
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$
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339,755
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$
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342,030
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LIABILITIES AND STOCKHOLDERS EQUITY
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CURRENT LIABILITIES
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Accounts payable
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$
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8,674
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$
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7,945
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Accrued liabilities
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8,757
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7,847
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Current maturities of long-term debt
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96
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95
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Total current liabilities
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17,527
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15,887
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LONG-TERM DEBT, less current maturities
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4,150
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6,730
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WARRANT
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14,690
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4,407
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DEFERRED INCOME TAXES
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17,387
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21,664
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COMMITMENTS AND CONTINGENCIES (Note 6)
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STOCKHOLDERS EQUITY
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Common stock, $.01 par value, 100,000
shares authorized; 27,598 and 27,236 shares
issued and outstanding at March 31, 2011 and December 31, 2010
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276
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|
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277
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Additional paid-in capital
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309,874
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310,580
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Accumulated other comprehensive income
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1,811
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1,012
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Retained earnings (Accumulated deficit)
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(25,960
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)
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(18,527
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)
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|
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Total stockholders equity
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286,001
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293,342
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$
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339,755
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$
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342,030
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The accompanying notes are an integral part of these statements.
3
Bronco Drilling Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
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Three Months Ended March 31,
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2011
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2010
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(Unaudited)
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REVENUES
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Contract drilling revenues
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$
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37,006
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$
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22,295
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EXPENSES
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Contract drilling
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23,801
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18,159
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Depreciation and amortization
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5,659
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7,705
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General and administrative
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4,209
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4,217
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Loss (gain) on Bronco MX transaction
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(1,058
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)
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Impairment of drilling rigs and related equipment
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|
679
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Loss on sale of drilling rigs and related equipment
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1,175
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35,523
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29,023
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Income (loss) from continuing operations
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1,483
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(6,728
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)
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OTHER INCOME (EXPENSE)
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Interest expense
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(571
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)
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(1,456
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)
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Loss from extinguishment of debt
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(1,975
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)
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Interest income
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46
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Equity in income (loss) of Challenger
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(599
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)
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Equity in income (loss) of Bronco MX
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|
1
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(209
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)
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Other
|
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|
25
|
|
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|
48
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Change in fair value of warrant
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|
(10,283
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)
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|
272
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|
|
|
|
|
|
|
|
|
|
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(12,803
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)
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|
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(1,898
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)
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Loss from continuing operations before income taxes
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|
(11,320
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)
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(8,626
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)
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Income tax benefit
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|
(3,981
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)
|
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|
(2,621
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)
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|
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|
|
|
|
|
|
|
|
|
|
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|
Loss from continuing operations
|
|
|
(7,339
|
)
|
|
|
(6,005
|
)
|
Loss from discontinued operations, net of tax
|
|
|
(94
|
)
|
|
|
(1,414
|
)
|
|
|
|
|
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NET LOSS
|
|
$
|
(7,433
|
)
|
|
$
|
(7,419
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)
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|
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|
|
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Loss per common share-Basic
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|
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Continuing operations
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|
|
(0.27
|
)
|
|
|
(0.23
|
)
|
Discontinued operations
|
|
|
(0.00
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)
|
|
|
(0.05
|
)
|
|
|
|
|
|
|
|
Loss per common share-Basic
|
|
$
|
(0.27
|
)
|
|
$
|
(0.28
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)
|
|
|
|
|
|
|
|
|
|
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|
|
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Loss per common share-Diluted
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
|
(0.27
|
)
|
|
|
(0.23
|
)
|
Discontinued operations
|
|
|
(0.00
|
)
|
|
|
(0.05
|
)
|
|
|
|
|
|
|
|
Loss per common share-Diluted
|
|
$
|
(0.27
|
)
|
|
$
|
(0.28
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of shares outstanding-Basic
|
|
|
27,468
|
|
|
|
26,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of shares outstanding-Diluted
|
|
|
27,468
|
|
|
|
26,850
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these statements.
4
Bronco Drilling Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME
(LOSS)
(Unaudited)
(Amounts in thousands)
|
|
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|
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Additional
|
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Other
|
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|
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|
Total
|
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|
|
Common
|
|
|
Common
|
|
|
Paid In
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
Stockholders
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Income
|
|
|
Earnings
|
|
|
Equity
|
|
Balance as of December 31, 2010
|
|
|
27,236
|
|
|
$
|
277
|
|
|
$
|
310,580
|
|
|
$
|
1,012
|
|
|
$
|
(18,527
|
)
|
|
$
|
293,342
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7,433
|
)
|
|
|
(7,433
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Comprehensive Income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
799
|
|
|
|
|
|
|
|
799
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Comprehensive Income (Loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,634
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock compensation
|
|
|
531
|
|
|
|
1
|
|
|
|
779
|
|
|
|
|
|
|
|
|
|
|
|
780
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock withheld for taxes
|
|
|
(169
|
)
|
|
|
(2
|
)
|
|
|
(1,485
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,487
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2011
|
|
|
27,598
|
|
|
$
|
276
|
|
|
$
|
309,874
|
|
|
$
|
1,811
|
|
|
$
|
(25,960
|
)
|
|
$
|
286,001
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these statements.
5
Bronco Drilling Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
Cash flows from operating activities from continuing operations:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(7,433
|
)
|
|
$
|
(7,419
|
)
|
Adjustments to reconcile net loss to net cash
provided by operating activities from continuing operations:
|
|
|
|
|
|
|
|
|
Loss from discontinued operations, net of tax
|
|
|
94
|
|
|
|
1,414
|
|
Depreciation and amortization
|
|
|
5,860
|
|
|
|
7,899
|
|
Bad debt expense
|
|
|
71
|
|
|
|
898
|
|
Loss (gain) on sale of assets
|
|
|
162
|
|
|
|
263
|
|
Write off of debt issue costs
|
|
|
1,975
|
|
|
|
|
|
Loss on sale of drilling rigs and related equipment
|
|
|
1,175
|
|
|
|
|
|
Impairment of drilling rigs and related equipment
|
|
|
679
|
|
|
|
|
|
Equity in (income) loss of Challenger
|
|
|
|
|
|
|
599
|
|
Equity in (income) loss of Bronco MX
|
|
|
(1
|
)
|
|
|
209
|
|
Change in fair value of warrant
|
|
|
10,283
|
|
|
|
(272
|
)
|
Loss on Bronco MX transaction
|
|
|
|
|
|
|
(1,058
|
)
|
Imputed interest expense
|
|
|
229
|
|
|
|
225
|
|
Stock compensation
|
|
|
780
|
|
|
|
395
|
|
Deferred income taxes
|
|
|
(3,982
|
)
|
|
|
(2,749
|
)
|
Changes in current assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables
|
|
|
1,725
|
|
|
|
(1,216
|
)
|
Affiliate receivables
|
|
|
(70
|
)
|
|
|
6,885
|
|
Unbilled receivables
|
|
|
(428
|
)
|
|
|
65
|
|
Prepaid expenses
|
|
|
(1,228
|
)
|
|
|
(429
|
)
|
Accounts payable
|
|
|
(3,648
|
)
|
|
|
(4,343
|
)
|
Accrued expenses
|
|
|
2,445
|
|
|
|
(463
|
)
|
Other
|
|
|
(1,082
|
)
|
|
|
(65
|
)
|
|
|
|
|
|
|
|
Net cash provided by operating activities from continuing operations
|
|
|
7,606
|
|
|
|
838
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities from continuing operations:
|
|
|
|
|
|
|
|
|
Proceeds from sale of assets
|
|
|
6,321
|
|
|
|
3,287
|
|
Purchase of property and equipment
|
|
|
(7,575
|
)
|
|
|
(7,830
|
)
|
|
|
|
|
|
|
|
Net cash used in investing activities from continuing operations
|
|
|
(1,254
|
)
|
|
|
(4,543
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities from continuing operations:
|
|
|
|
|
|
|
|
|
Proceeds from borrowings
|
|
|
3,000
|
|
|
|
5,000
|
|
Payments of debt
|
|
|
(9,126
|
)
|
|
|
(22
|
)
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities from continuing operations
|
|
|
(6,126
|
)
|
|
|
4,978
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents from continuing operations
|
|
|
226
|
|
|
|
1,273
|
|
|
|
|
|
|
|
|
|
|
Cash flows from discontinued operations:
|
|
|
|
|
|
|
|
|
Operating cash flows
|
|
|
17
|
|
|
|
(55
|
)
|
Investing cash flows
|
|
|
|
|
|
|
(47
|
)
|
Financing cash flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase
(decrease) in cash and cash equivalents from discontinued operations
|
|
|
17
|
|
|
|
(102
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase in cash and cash equivalents
|
|
|
243
|
|
|
|
1,171
|
|
|
|
|
|
|
|
|
|
|
Beginning cash and cash equivalents
|
|
|
14,554
|
|
|
|
9,497
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending cash and cash equivalents
|
|
$
|
14,797
|
|
|
$
|
10,668
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplementary disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
Interest paid, net of amount capitalized
|
|
$
|
526
|
|
|
$
|
1,255
|
|
Income taxes paid
|
|
|
3
|
|
|
|
128
|
|
Supplementary disclosure of non-cash investing and financing:
|
|
|
|
|
|
|
|
|
Purchase of property and equipment in accounts payable
|
|
|
2,865
|
|
|
|
1,110
|
|
The accompanying notes are an integral part of these statements.
6
Bronco Drilling Company, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
($ Amounts in thousands, except per share amounts)
Unless the context requires otherwise, a reference in this quarterly report to Bronco, the
Company, we, us, and our are to Bronco Drilling Company, Inc., a Delaware corporation, and
its consolidated subsidiaries.
1. Organization and Summary of Significant Accounting Policies
Business and Principles of Consolidation
Bronco Drilling Company, Inc. (the Company) provides contract land drilling services to oil
and natural gas exploration and production companies. The accompanying consolidated financial
statements include the Companys accounts and the accounts of its wholly owned subsidiaries. All
intercompany accounts and transactions have been eliminated in consolidation.
The Company has prepared the accompanying unaudited consolidated financial statements and
related notes in accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions of Form 10-Q and Regulation
S-X. In preparing the financial statements, the Company made various estimates and assumptions that
affect the amounts of assets and liabilities the Company reports as of the dates of the balance
sheets and amounts the Company reports for the periods shown in the consolidated statements of
operations, stockholders equity and cash flows. The Companys actual results could differ
significantly from those estimates. Material estimates that are particularly susceptible to
significant changes in the near term relate to the Companys recognition of revenues and accrued
expenses, estimate of the allowance for doubtful accounts, estimate of asset impairments, estimate
of deferred taxes and determination of depreciation and amortization expense.
In managements opinion, the accompanying unaudited consolidated financial statements contain
all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial
position of the Company as of March 31, 2011, the related results of operations for the three
months ended March 31, 2011 and 2010 and the cash flows for the three months ended March 31, 2011
and 2010. The information included in this Quarterly Report on Form 10-Q should be read in
conjunction with the Companys Annual Report on Form 10-K for the year ended December 31, 2010.
The results of operations for the three months ended March 31, 2011 are not necessarily an
indication of the results expected for the full year.
A summary of the significant accounting policies consistently applied in the preparation of
the accompanying consolidated financial statements follows.
Property and Equipment
Property and equipment, including renewals and betterments, are capitalized and stated at
cost, while maintenance and repairs are expensed currently. Assets are depreciated on a
straight-line basis. The depreciable lives of drilling rigs and related equipment are three to 15
years. The depreciable life of other equipment is three years. Depreciation is not commenced until
acquired rigs are placed in service. Once placed in service, depreciation continues when rigs are
being repaired, refurbished or between periods of deployment. Assets not placed in service and not
being depreciated were $20,813 and $14,111 as of March 31, 2011 and December 31, 2010,
respectively.
The Company capitalizes interest as a component of the cost of drilling rigs constructed for
its own use. For the three months ended March 31, 2011 the Company capitalized $40 of interest
expense. The Company did not capitalize any interest for the three months ended March 31, 2010.
The Company evaluates for potential impairment of long-lived assets and intangible assets
subject to amortization when indicators of impairment are present, as defined in ASC Topic 360,
Accounting for the Impairment or Disposal of Long-Lived Assets
. Circumstances that could indicate a
potential impairment include significant adverse changes in industry trends, economic climate,
legal factors, and an adverse action or assessment by a regulator. More specifically, significant
adverse changes in industry trends include significant declines in revenue rates, utilization
rates, oil and natural gas market prices and industry rig counts for drilling rigs and workover
rigs. In performing an impairment evaluation, the Company estimated the future undiscounted net
cash flows from the use and eventual disposition of long-lived assets and intangible assets grouped
at the lowest level that cash flows can be identified. If the sum of the estimated future
undiscounted net cash flows is less than the carrying amount of the long-lived assets and
intangible assets for these asset grouping levels, then the Company would recognize an impairment
charge. The amount of an impairment charge would be measured as the difference between the carrying
amount and the fair value of these assets. See Note 7,
Asset Sales and Held for Sale,
for
discussion of impairment of drilling rigs and related equipment due to their classification as held
for sale. See Note 8,
Discontinued Operations,
for discussion of well servicing segment property
and equipment impairment relating to its classification as held for sale. The assumptions used in
the impairment evaluation for long-lived assets and intangible assets are inherently uncertain and
require management judgment.
7
Income Taxes
Pursuant to ASC Topic 740,
Income Taxes,
the Company follows the asset and liability method of
accounting for income taxes, under which the Company recognizes deferred tax assets and liabilities
for the future tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities were measured using enacted tax rates expected to apply to taxable income in
the years in which the Company expects to recover or settle those temporary differences. A
statutory Federal tax rate of 35% and effective state tax rate of 3.7% (net of Federal income tax
effects) were used for the enacted tax rates for all periods.
As changes in tax laws or rates are enacted, deferred income tax assets and liabilities are
adjusted through the provision for income taxes. Deferred tax assets are reduced by a valuation
allowance if, based on available evidence, it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The classification of current and noncurrent
deferred tax assets and liabilities is based primarily on the classification of the assets and
liabilities generating the difference.
The Company applies the provisions of ASC Topic 740 which addresses the accounting for
uncertainty in income taxes recognized in an enterprises financial statements and prescribes a
recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. The Company
recognizes interest and/or penalties related to income tax matters as income tax expense. As of
March 31, 2011, the tax years ended December 31, 2006 through December 31, 2009 are open for
examination by U.S. taxing authorities.
Comprehensive Income (Loss)
Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income.
Other comprehensive income includes the translation adjustments of the financial statements of
Bronco MX at March 31, 2011. The following table sets forth the components of comprehensive income
(loss):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2011
|
|
|
2010
|
|
Net loss
|
|
$
|
(7,433
|
)
|
|
$
|
(7,419
|
)
|
Other
comprehensive income translation adjustment
|
|
|
799
|
|
|
|
827
|
|
|
|
|
|
|
|
|
Comprehensive loss
|
|
$
|
(6,634
|
)
|
|
$
|
(6,592
|
)
|
|
|
|
|
|
|
|
Equity Method Investments
Investee companies that are not consolidated, but over which the Company exercises significant
influence, are accounted for under the equity method of accounting. Whether or not the Company
exercises significant influence with respect to an Investee depends on an evaluation of several
factors including, among others, representation on the Investee companys board of directors and
ownership level, which is generally a 20% to 50% interest in the voting securities of the Investee
company. Under the equity method of accounting, an Investee companys accounts are not reflected
within the Companys Consolidated Balance Sheets and Statements of Operations; however, the
Companys share of the earnings or losses of the Investee company is reflected in the caption
Equity in income (loss) of Challenger and Equity in income (loss) of Bronco MX in the
Consolidated Statements of Operations. The Companys carrying value in an equity method Investee
company is reflected in the caption Investment in Challenger and Investment in Bronco MX in the
Companys Consolidated Balance Sheets.
Recent Accounting Pronouncements
In January 2010, the FASB issued a new accounting standard which requires reporting entities
to provide information about movements of assets among Levels 1 and 2 of the three-tier fair value
hierarchy established by ASC 820,
Fair Value Measurements
. Also required is a reconciliation of
purchases, sales, issuance, and settlements of financial instruments valued with a Level 3 method,
which is used to price the hardest to value instruments. Entities are required to provide fair
value measurement disclosures for each class of financial assets and liabilities. The guidance is
effective for fiscal years beginning after December 15, 2010. The adoption of this standard did
not impact our consolidated financial statements.
2. Equity Method Investments
On January 4, 2008, we acquired a 25% equity interest in Challenger Limited, or Challenger, in
exchange for six drilling rigs and cash. The Company also sold to Challenger four drilling rigs
and ancillary equipment. Challenger is an international provider of contract land drilling and
workover services to oil and natural gas companies with its principal operations in Libya. The
Company also entered into a term note with Challenger related to the sale of four drilling rigs and
ancillary equipment. The term note bears interest at 8.5%. Interest and principal payments of
$529 on the note are due quarterly until maturity at February 2, 2011. The note receivable is
collateralized by the assets sold to Challenger. The note receivable from Challenger at March 31,
2011 and December 31, 2010 was $1,639 and $1,607, respectively.
8
On February 20, 2008, the Company entered into a Management Services Agreement and Master
Services Agreement with Challenger. The Company agreed to make available to Challenger certain
employees of the Company for the purpose of providing land drilling services, certain business
consulting services and managerial support to Challenger. The Company invoices Challenger monthly
for the services provided. The Company had accounts receivable from Challenger of $1,546 and
$1,508 at March 31, 2011 and December 31, 2010, respectively, related to these services provided.
Recent civil and political disturbances in Libya have and will continue to affect Challengers
operations. Ongoing political unrest may result in loss of revenue and damage to Challengers
equipment. The political turmoil in Libya and elsewhere in North Africa and impact on Challengers
operations could negatively impact the Companys investment in Challenger, including the loss of
our investment and write off of our receivables from Challenger. Challenger was unable to provide
financial statements or other financial information for the three months ended March 31, 2011 due
to the events in Libya and disruptions in their operations. Because of the lack of information and
uncertainties caused by the events in Libya, we have not recorded or estimated any adjustments to
the carrying value of our investment in Challenger, receivable balances or equity in income (loss)
of Challenger. We will continue to monitor and evaluate the developments in Libya and our
investment in Challenger during 2011 and the Company intends to make required adjustments to equity
in income of Challenger in the period that financial statements or other reasonable information are
available.
At March 31, 2011 and December 31, 2010, the book value of the Companys ordinary share
investment in Challenger was $38,730. The Companys 25% interest of the net assets of Challenger
was estimated to be $35,428 at December 31, 2010. The basis difference between the Companys
ordinary equity investment in Challenger and the Companys 25% interest of the net assets of
Challenger primarily consists of certain property, plant and equipment and accumulated depreciation
in the net amount of $3,626 and $324 at March 31, 2011. These amounts are being amortized against
the Companys 25% interest of Challengers net income over the estimated useful lives of 15 years
for the property, plant and equipment. Amortization recorded during the three months ended March
31, 2011 and March 31, 2010 was $0 and $61, respectively. The Company recorded equity in loss of
investment of $0 and $(599) for the three months ended March 31, 2011 and 2010, respectively,
related to its equity investment in Challenger.
Summarized financial information of Challenger is presented below. As described above, we are
unable to provide summarized financial information as of and for the three months ended March 31,
2011.
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
|
|
2010
|
|
Condensed statement of operations:
|
|
|
|
|
Revenues
|
|
$
|
9,875
|
|
|
|
|
|
Gross margin
|
|
$
|
2,030
|
|
|
|
|
|
Net Loss
|
|
$
|
(2,153
|
)
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2010
|
|
Condensed balance sheet:
|
|
|
|
|
Current assets
|
|
$
|
56,010
|
|
Noncurrent assets
|
|
|
128,829
|
|
|
|
|
|
Total assets
|
|
$
|
184,839
|
|
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
$
|
21,675
|
|
Noncurrent liabilities
|
|
|
20,722
|
|
Equity
|
|
|
142,442
|
|
|
|
|
|
Total liabilities and equity
|
|
$
|
184,839
|
|
|
|
|
|
In September, 2009, Carso Infraestructura y Construcción, S.A.B. de C.V., or CICSA, purchased
from us 60% of the outstanding membership interests of Bronco MX. Upon closing of the transaction,
the Company owned the remaining 40% of the outstanding membership interests of Bronco MX.
Immediately prior to the sale of the membership interests in Bronco MX to CICSA, the Company
contributed six drilling rigs (Nos. 4, 43, 53, 58, 60 and 72), and the future net profit from rig
leases relating to three additional drilling rigs (Nos. 55, 76 and 78), which the Company
contributed to Bronco MX upon the expiration of the leases relating to such rigs.
9
The Company received $31,735 from CICSA in exchange for the 60% membership interest in Bronco
MX, which included reimbursement for 60% of value added taxes previously paid by, or on behalf of,
Bronco MX as a result of the importation to Mexico of the six drilling rigs that were contributed
by the Company to Bronco MX. Upon completion of the transaction, the Company treated Bronco MX as
a deconsolidated subsidiary in order to compute a loss in accordance with ASC Topic 810,
Consolidation,
due to the Company not retaining a controlling financial interest in Bronco MX
subsequent to the sale. The Company recorded a net loss of $23,964 for the nine months ended
September 30, 2009 relating to the transactions. The loss was computed based on the proceeds
received from CICSA of $31,735 and the value of the Companys 40% retained interest in Bronco MX of
$21,495 less the book value of the net assets of Bronco MX, including rigs contributed to Bronco
MX, of $77,194. The Company recorded a negative adjustment to the loss during the year ended 2010
of $1,487 due to post closing adjustments.
On July 1, 2010, CICSA contributed cash of approximately $45,100 in exchange for 735,356,219
shares of Bronco MX. As a result of the contribution, the Companys membership interest in Bronco
MX was decreased to approximately 20%. The Company accounted for the share issuance as if the
Company had sold a proportionate amount of its shares. The Company recorded a loss on the
transaction in the amount of $1,271.
Bronco MX is jointly managed, with CICSA having four representatives on its board of managers
and the Company having one representative on its board of managers. The Company and CICSA, and
their respective affiliates, have agreed to conduct all future land drilling and workover rig
services, rental, construction, refurbishment, transportation, trucking and mobilization in Mexico
and Latin America exclusively through Bronco MX, subject to Bronco MXs ability to perform.
According to a Schedule 13D/A filed with the SEC on April 19, 2011 by Carlos Slim Helú,
certain members of his family and affiliated entities (collectively, the Slim Affiliates), these
individuals and entities collectively own approximately 19.0% of our common stock. CICSA is also a
Slim Affiliate.
At March 31, 2011, the book value of the Companys ordinary share investment in Bronco MX was
$21,433. The Company recorded equity in income (loss) of investment of $1 and $(209) for the three
months ended March 31, 2011 and March 31, 2010, respectively, related to its equity investment in
Bronco MX. The Companys investment in Bronco MX was increased by $799 as a result of a currency
translation gain for the three months ended March 31, 2011.
Summarized financial information of Bronco MX is presented below:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2011
|
|
|
March 31, 2010
|
|
Condensed statement of operations:
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
8,832
|
|
|
$
|
6,514
|
|
|
|
|
|
|
|
|
Gross margin
|
|
$
|
337
|
|
|
$
|
(485
|
)
|
|
|
|
|
|
|
|
Net Income (loss)
|
|
$
|
7
|
|
|
$
|
(521
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2011
|
|
|
2010
|
|
Condensed balance sheet:
|
|
|
|
|
|
|
|
|
Current assets
|
|
$
|
29,005
|
|
|
$
|
25,497
|
|
Noncurrent assets
|
|
|
104,453
|
|
|
|
100,687
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
133,458
|
|
|
$
|
126,184
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
$
|
26,299
|
|
|
$
|
23,031
|
|
Noncurrent liabilities
|
|
|
|
|
|
|
|
|
Equity
|
|
|
107,159
|
|
|
|
103,153
|
|
|
|
|
|
|
|
|
Total liabilities and equity
|
|
$
|
133,458
|
|
|
$
|
126,184
|
|
|
|
|
|
|
|
|
10
3. Long-term Debt and Warrant
Long-term debt consists of the following:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2011
|
|
|
2010
|
|
Revolving credit facility with Banco Inbursa S.A., collateralized by the Companys assets,
and matures on September 17, 2014. Loans under the revolving credit facility
bear interest at variable rates as defined in the credit agreement. (1)
|
|
|
3,000
|
|
|
|
5,555
|
|
|
|
|
|
|
|
|
|
|
Note payable to Ameritas Life Insurance Corp., collateralized by a building, payable in
principal and interest
installments of $14, interest on the note is 6.0%, maturity date of January 1,
2021. (2)
|
|
|
1,246
|
|
|
|
1,270
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,246
|
|
|
$
|
6,825
|
|
Less current installments
|
|
|
96
|
|
|
|
95
|
|
|
|
|
|
|
|
|
|
|
|
4,150
|
|
|
|
6,730
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
On September 18, 2009, the Company entered into a new senior secured revolving credit
facility with Banco Inbursa S.A., or Banco Inbursa, as lender and as the issuing bank. The
Company utilized (i) borrowings under the credit facility, (ii) proceeds from the sale of the
membership interests of Bronco MX and (iii) cash-on-hand to repay all amounts outstanding
under the Companys prior revolving credit agreement with Fortis Bank SA/NV, New York Branch,
which was replaced by this credit facility.
|
|
|
|
The credit facility initially provided for revolving advances of up to $75.0 million and the
borrowing base under the credit facility was initially set at $75.0 million, subject to
borrowing base limitations. On February 9, 2011 we amended our credit facility which reduced
the commitment to $45.0 million. The Company incurred a loss from extinguishment of debt of
approximately $1,975 related to the reduction in availability under the credit facility. The
credit facility matures on September 17, 2014. Outstanding borrowings under the credit
facility bear interest at the Eurodollar rate plus 5.80% per annum, subject to adjustment
under certain circumstances. The effective interest rate was 6.51% at March 31, 2011.
|
|
|
|
The Company pays a quarterly commitment fee of 0.5% per annum on the unused portion of the
credit facility and a fee of 1.50% for each letter of credit issued under the facility. In
addition, an upfront fee equal to 1.50% of the aggregate commitments under the credit
facility was paid by the Company at closing. The Companys domestic subsidiaries have
guaranteed the loans and other obligations under the credit facility. The obligations under
the credit facility and the related guarantees are secured by a first priority security
interest in substantially all of the assets of the Company and its domestic subsidiaries,
including the equity interests of the Companys direct and indirect subsidiaries. Commitment
fees expense for the three months ended March 31, 2011 and 2010 was $50 and $10,
respectively.
|
|
|
|
The credit facility contains customary representations and warranties and various affirmative
and negative covenants, including, but not limited to, covenants that restrict the Companys
ability to make capital expenditures, incur indebtedness, incur liens, dispose of property,
repay debt, pay dividends, repurchase shares and make certain acquisitions, and a financial
covenant requiring that the Company maintain a ratio of consolidated debt to consolidated
earnings before interest, taxes, depreciation and amortization as defined in the credit
agreement for any four consecutive fiscal quarters of not more than 3.5 to 1.0. The Company
was in compliance with all covenants at March 31, 2011. A violation of these covenants or
any other covenant in the credit facility could result in a default under the credit facility
which would permit the lender to restrict the Companys ability to access the credit facility
and require the immediate repayment of any outstanding advances under the credit facility.
|
|
|
|
In conjunction with its entry into the credit facility, the Company entered into a
Warrant Agreement with Banco Inbursa and, pursuant thereto, issued a three-year warrant (the
Warrant) to Banco Inbursa evidencing the right to purchase up to 5,440,770 shares of the
Companys common stock, $0.01 par value per share (the Common Stock) subject to the terms
and conditions set forth in the Warrant, including the limitations on exercise set forth
below, at an exercise price of $6.50 per share of Common Stock from the date of issuance of
the Warrant (the Issue Date) through the first anniversary of the Issue Date, $7.00 per
share following the first anniversary of the Issue Date through the second anniversary of the
Issue Date, and $7.50 per share following the second anniversary of the Issue Date through
the third anniversary of the Issue Date. Banco Inbursa subsequently transferred the Warrant
to CICSA.
|
|
|
|
In accordance with accounting standards, the proceeds from the revolving credit facility were
allocated to the credit facility and Warrant based on their respective fair values. Based on
this allocation, $50,321 and $4,679 of the net proceeds were allocated to the credit facility
and Warrant, respectively. The Warrant has been classified as a liability on the
consolidated balance sheet due to the Companys obligation to pay the seller of the Warrant a
make-whole payment, in cash, under certain circumstances. The fair value of the Warrant was
determined using a pricing model based on a version of the Black Scholes model, which is
adjusted to account for the dilution resulting from the additional shares issued for the
Warrant. The valuation was determined by computing the value of the Warrant if exercised in
Year 1 3 with the values weighted by the probability that the warrant would actually be
exercised in that year. Some of the assumptions used in the model were a volatility of 45%
and a risk free interest rate that ranged from 0.41% to 1.57%.
|
11
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|
|
|
|
The resulting discount to the revolving credit facility is amortized to interest expense over
the term of the revolving credit facility. Accordingly, the Company will recognize annual
interest expense on the debt at an effective interest rate of Eurodollar rate plus 6.25%.
Imputed interest expense recognized for the three months ended March 31, 2011 and 2010 was
$229 and $225, respectively.
|
|
|
|
In accordance with accounting standards, the Company revalued the Warrant as of March 31,
2011 and 2010 and recorded the change in the fair value of the Warrant on the consolidated
statement of operations. The fair value of the Warrant was determined using a pricing model
based on a version of the Black Scholes model, which is adjusted to account for the dilution
resulting from the additional shares issued for the Warrant. The valuation was determined by
computing the value of the Warrant if exercised in Year 2 3 with the values weighted by
the probability that the Warrant would actually be exercised in that year. Some of the
assumptions used in the model were volatility between 39% and 49% and a risk free interest
rate that ranged from 0.16% to 0.56%. The fair value of the warrant was $14,690 at March 31,
2011. The Company recorded a change in the fair value of the Warrant on the consolidated
statement of operations in the amount of $10,283 and $272 for the three months ended March
31, 2011 and 2010, respectively.
|
|
(2)
|
|
On January 2, 2007, the Company assumed a term loan agreement with Ameritas Life Insurance
Corp. related to the acquisition of a building. The loan provides for term installments in an
aggregate not to exceed $1,590.
|
|
|
|
Long-term debt maturing each year subsequent to March 31, 2011 is as follows:
|
|
|
|
|
|
2012
|
|
$
|
96
|
|
2013
|
|
|
102
|
|
2014
|
|
|
108
|
|
2015
|
|
|
3,115
|
|
2016
|
|
|
122
|
|
2017 and thereafter
|
|
|
703
|
|
|
|
|
|
|
|
$
|
4,246
|
|
|
|
|
|
4. Workers Compensation and Health Insurance
The Company is insured under a large deductible workers compensation insurance policy. The
policy generally provides for a $1,000 deductible per covered accident. The Company maintains
letters of credit in the aggregate amount of $8,525 for the benefit of various insurance companies
as collateral for retrospective premiums and retained losses which may become payable under the
terms of the underlying insurance contracts. The letters of credit are typically renewed annually.
No amounts have been drawn under the letters of credit. Accrued expenses at March 31, 2011 and
December 31, 2010 included approximately $3,481 and $3,695, respectively, for estimated incurred
but not reported costs and premium accruals related to our workers compensation insurance.
On November 1, 2005, the Company initiated a self-insurance program for major medical,
hospitalization and dental coverage for employees and their dependents, which is partially funded
by payroll deductions. The Company provided for both reported and incurred but not reported medical
costs in the accompanying consolidated balance sheets. We have a maximum liability of $125 per
employee/dependent per year. Amounts in excess of the stated maximum are covered under a separate
policy provided by an insurance company. Accrued expenses at March 31, 2011 and December 31,
2010 included approximately $718 and $735, respectively, for our estimate of incurred but not
reported costs related to the self-insurance portion of our health insurance.
5. Transactions with Affiliates
The Company had receivables from affiliates of $1,546 and $1,508 at March 31, 2011 and
December 31, 2010, respectively.
Additional information about our transactions with affiliates is included in Note 2,
Equity
Method Investments
.
6. Commitments and Contingencies
Various claims and lawsuits, incidental to the ordinary course of business, are pending
against the Company. In the opinion of management, all matters are adequately covered by insurance
or, if not covered, are not expected to have a material effect on the Companys consolidated
financial position, results of operations or cash flows.
12
On April 14, 2011, we entered into an Agreement and Plan of Merger with Chesapeake Energy
Corporation and Nomac Acquisition, Inc., an indirect wholly owned subsidiary of Chesapeake
(Purchaser), as previously disclosed on a Form 8-K we filed with the SEC on April 18, 2011. Under
the terms of the merger agreement, Chesapeake has agreed to acquire the Company through a two-step
transaction, consisting of a tender offer by the Purchaser for all of our outstanding common stock
at a price of $11.00 per share without interest thereon and less any applicable withholding or
stock transfer taxes, followed by the merger of the Purchaser with and into the Company, with the
Company surviving as an indirect, wholly owned subsidiary of Chesapeake.
Ten putative class action lawsuits relating to the merger agreement and the transactions
contemplated therein have been commenced against the Company and current members of our board of
directors, including our chief executive officer (the Individual Defendants). Six putative class
action lawsuits were filed in the District Court of Oklahoma County, Oklahoma (collectively, the
Oklahoma Suits). Two of the Oklahoma Suits have been voluntarily dismissed. Four putative class
action lawsuits were filed in the Court of Chancery of the State of Delaware (the Delaware Suits
and together with the four remaining Oklahoma Suits, the Class Actions). The Delaware Suits were consolidated into a single action on May 6, 2011. The Class Actions each
seek certification of a class of all holders of our common stock and variously allege, among other
things, that: (1) the Individual Defendants have breached and continue to breach their fiduciary
duties to our stockholders; (2) the offer and the merger are unfair to our public stockholders as
the proposed transactions underestimate the value of the Company; (3) the Individual Defendants are
pursuing a course of conduct that does not maximize the value of the Company; and (4) the Company
aided and abetted the alleged breaches of duties by the Individual Defendants. On April 29, 2011, the Delaware Suits were amended, adding allegations that the Schedule 14D-9 filed by the
Company and the Schedule TO filed by Chesapeake did not adequately describe the process that
resulted in the offer and that the Schedule 14D-9 did not include adequate information concerning
the fairness opinion Johnson Rice & Company L.L.C. provided to our board of directors. The Class
Actions seek, among other things, an injunction prohibiting consummation of the tender offer and
the merger (each as defined below), attorneys fees and expenses and rescission or damages in the
event the proposed transactions are consummated. We believe the Class Actions are entirely without
merit and intend to defend against them vigorously.
7. Recent Asset Sales and Assets Held for Sale
On March 21, 2011, the Company sold one complete drilling rig (rig 6) in a private sale to
Atlas Drilling, LLC, an unaffiliated third party, for net proceeds of $1,550. The Company recorded
a $4 loss on the sale of the assets based on a net book value of $1,554.
On March 31, 2011, the Company sold one complete drilling rig (rig 62) in a private sale to
Windsor Drilling, LLC, an unaffiliated third party, for net proceeds of $4,651. The Company
recorded a $1,175 loss on the sale of the assets based on a net book value of $5,826.
On February 25, 2011, the Company entered into an agreement with Windsor Drilling, LLC, an
unaffiliated third party, to sell an additional drilling rig (rig 56). Because the drilling rig
meets the held for sale criteria, the Company is required to present such assets, comprised of
property and equipment, at the lower of carrying amount or fair value less the anticipated costs to
sell. The Company evaluated these assets for impairment as of March 31, 2011, which resulted in
recognizing a $679 impairment charge. The net book value for rig 56 was $7,000 at March 31, 2011
and is included in Non-current assets held for sale and discontinued operations on the consolidated
balance sheet.
The sale of drilling rigs and related equipment sold are part of a broader strategy by
management to divest of older drilling rigs and use the proceeds to pay down existing indebtedness.
8. Discontinued Operations
Well Servicing
In the second quarter of 2010, management determined that our well servicing business segment
was no longer consistent with the Companys long-term strategic objectives and that the Company
should seek to market this business for sale. During Q1 and Q2 2010 the market for workover
services continued at depressed levels within the primary geographic market of our well servicing
assets (Oklahoma). Management determined that higher return projects were available within the
core drilling segment of the business and chose to deploy capital in this segment rather than
commit the capital required to restructure operations in the well servicing segment. In 2010
management made a decision to market the assets constituting the well servicing segment for sale
and redeploy the proceeds to reduce debt and to support the Companys core drilling business. Well
servicing operating results are included in discontinued operations in our Consolidated Statements
of Operations.
13
The results of operations for the three months ended March 31, 2011 and 2010 are below:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
Revenue
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
Impairment of intangibles
|
|
$
|
|
|
|
$
|
224
|
|
|
|
|
|
|
|
|
|
|
Loss from
discontinued operations before income tax
|
|
$
|
549
|
|
|
$
|
1,973
|
|
Trucking Assets
In July 2010, the Company completed the sale of all of the Companys trucking assets, property
and equipment, for $11,299 in cash, net of selling expenses of $403. As drilling activity
decreased in 2008 and 2009 the utilization of these trucking assets fell sharply. The ongoing
operating losses in our trucking division required resources to be directed away from the core
drilling business. As such, management made the decision in the second quarter 2010 to sell these
assets as their operations were not considered core. Proceeds from this sale were used to prepay
existing indebtedness under our revolving credit facility with Banco Inbursa in July 2010.
Operating results are included as a component of discontinued operations in our Consolidated
Statements of Operations for all periods presented. The trucking assets and operating activities
were previously presented as part of our land drilling reportable segment. The results of
operations for the three months ended March 31, 2011 and 2010 are below:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
Revenue
|
|
$
|
|
|
|
$
|
203
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from discontinued operations before income tax
|
|
$
|
398
|
|
|
$
|
(333
|
)
|
14
9. Net Income Per Common Share
The following table presents a reconciliation of the numerators and denominators of the basic
and diluted earnings per share (EPS) and diluted EPS comparisons as required by ASC Topic 260:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2011
|
|
|
2010
|
|
Basic:
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
|
(7,339
|
)
|
|
|
(6,005
|
)
|
Discontinued operations
|
|
|
(94
|
)
|
|
|
(1,414
|
)
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(7,433
|
)
|
|
$
|
(7,419
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares (thousands)
|
|
|
27,468
|
|
|
|
26,651
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations per share
|
|
|
(0.27
|
)
|
|
|
(0.23
|
)
|
Discontinued operations per share
|
|
|
(0.00
|
)
|
|
|
(0.05
|
)
|
|
|
|
|
|
|
|
Net loss per share
|
|
$
|
(0.27
|
)
|
|
$
|
(2.16
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
|
(7,339
|
)
|
|
|
(6,005
|
)
|
Discontinued operations
|
|
|
(94
|
)
|
|
|
(1,414
|
)
|
|
|
|
|
|
|
|
Net Loss
|
|
$
|
(7,433
|
)
|
|
$
|
(7,419
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares:
|
|
|
|
|
|
|
|
|
Outstanding (thousands)
|
|
|
27,468
|
|
|
|
26,651
|
|
Restricted Stock and Options (thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
27,468
|
|
|
|
26,651
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations per share
|
|
|
(0.27
|
)
|
|
|
(0.23
|
)
|
Discontinued operations per share
|
|
|
(0.00
|
)
|
|
|
(0.05
|
)
|
|
|
|
|
|
|
|
Income (loss) per share
|
|
$
|
(0.27
|
)
|
|
$
|
(2.16
|
)
|
|
|
|
|
|
|
|
The weighted average number of diluted shares excludes 464,429 and 55,873 shares for the three
months ended March 31, 2011 and 2010, respectively, subject to restricted stock awards due to their
antidilutive effects.
10. Fair Value Measurements
As defined in ASC 820, fair value is defined as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants at the
measurement date (referred to as an exit price). Authoritative guidance on fair value
measurements and disclosures clarifies that a fair value measurement for a liability should reflect
the entitys non-performance risk. In addition, a fair value hierarchy is established that
prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the
highest priority to unadjusted quoted market prices in active markets for identical assets and
liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3
measurements). The three levels of the fair value hierarchy are:
Level 1
:
Unadjusted quoted prices in active markets that are accessible at the measurement date for
identical, unrestricted assets or liabilities.
Level 2
:
Quoted prices in markets that are not active, or inputs which are observable, either
directly or indirectly, for substantially the full term of the asset or liability. This category
includes quoted prices for similar assets or liabilities in active markets; quoted prices for
identical or similar assets or liabilities in markets that are not active; inputs other than quoted
prices that are observable for the asset or liability; and inputs that are derived principally from
or corroborated by observable market data by correlation or other means.
Level 3
:
Measured based on prices or valuation models that require inputs that are both significant
to the fair value measurement and less observable from objective sources.
15
Fair Value on Recurring Basis
The Company issued a Warrant in conjunction with its revolving credit facility with Banco
Inbursa, which Banco Inbursa subsequently transferred to CICSA. In accordance with accounting
standards, the Company revalued the Warrant as of March 31, 2011 and recorded the change in the
fair value of the Warrant on the consolidated statement of operations. The fair value of the
Warrant was determined using level 3 inputs. The Company used a pricing model based on a version
of the Black Scholes model, which is adjusted to account for the dilution resulting from the
additional shares issued for the Warrant. The valuation was determined by computing the value of
the Warrant if exercised in Year 2 3 with the values weighted by the probability that the
Warrant would actually be exercised in that year. Some of the assumptions used in the model were
volatility of 39% and 49% and a risk free interest rate that ranged from 0.16% to 0.56%. The fair
value of the Warrant was $14,690 at March 31, 2011. The Company recorded a change in the fair
value of the Warrant on the consolidated statement of operations in the amount of $10,283 and $272
for the three months ended March 31, 2011 and 2010, respectively.
The fair values of our cash equivalents, trade receivables and trade payables approximated
their carrying values due to the short-term nature of these instruments.
Fair Value on Non-Recurring Basis
In the first quarter of 2011, management entered into an agreement to sell one drilling rig
(rig 56). Because the drilling rig meets the held for sale criteria, the Company is required to
present these assets held for sale at the lower of carrying amount or fair value less anticipated
cost to sell. The Company evaluated these assets as of March 31, 2011, for impairment. The fair
value of the drilling rig was determined using the agreed upon sales price for the rig. The
analysis as of March 31, 2011 resulted in a $679 impairment charge.
11. Restricted Stock
The Companys board of directors and a majority of our stockholders approved our 2006 Stock
Incentive Plan, which the Company refers to as the 2006 Plan, effective April 20, 2006. Effective
December 10, 2010, the Companys board of directors and a majority of our shareholders approved an
amendment to the 2006 Plan to increase the shares available for issuance thereunder by
2,500,000 shares. The purpose of the 2006 Plan is to provide a means by which eligible
recipients of awards may be given an opportunity to benefit from increases in value of our common
stock through the granting of one or more of the following awards: (1) incentive stock options, (2)
nonstatutory stock options, (3) restricted awards, (4) performance awards and (5) stock
appreciation rights.
The purpose of the plan is to enable the Company, and any of its affiliates, to attract
and retain the services of the types of employees, consultants and directors who will contribute to
our long range success and to provide incentives that are linked directly to increases in share
value that will inure to the benefit of our stockholders.
Eligible award recipients are employees, consultants and directors of the Company and its
affiliates. Incentive stock options may be granted only to our employees. Awards other than
incentive stock options may be granted to employees, consultants and directors. The shares that may
be issued pursuant to awards consist of our authorized but unissued common stock, and the maximum
aggregate amount of such common stock that may be issued upon exercise of all awards under the
plan, including incentive stock options, may not exceed 2,500,000 shares, subject to adjustment to
reflect certain corporate transactions or changes in our capital structure.
Under all restricted stock awards to date, nonvested shares are subject to forfeiture for
failure to fulfill service conditions. Restricted stock awards consist of our common stock that
vest over a two or three year period. Total shares available for future stock option grants and
restricted stock grants to employees and directors under existing plans were 2,208,272 as of March
31, 2011. Restricted stock awards are valued at the grant date market value of the underlying
common stock and are being amortized to operations over the respective vesting period.
Compensation expense for the three months ended March 31, 2011 and 2010 was $779 and $395,
respectively. Restricted stock activity for the three months ended March 31, 2011 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
|
Grant Date
|
|
|
|
Shares
|
|
|
Fair Value
|
|
Outstanding at December 31, 2010
|
|
|
1,222,496
|
|
|
$
|
4.82
|
|
Granted
|
|
|
510,740
|
|
|
|
6.97
|
|
Vested
|
|
|
(531,167
|
)
|
|
|
4.96
|
|
Forfeited/expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2011
|
|
|
1,202,069
|
|
|
$
|
5.70
|
|
|
|
|
|
|
|
|
There was $6,642 of total unrecognized compensation cost related to nonvested restricted
stock awards to be recognized over a weighted-average period of 1.5 years as of March 31, 2011.
16
12. Subsequent Event
On April 14, 2011, we entered into an Agreement and Plan of Merger with Chesapeake Energy
Corporation and Nomac Acquisition, Inc., an indirect wholly owned subsidiary of Chesapeake
(Purchaser), as previously disclosed on a Form 8-K we filed with the SEC on April 18, 2011. Under
the terms of the merger agreement, Chesapeake has agreed to acquire the Company through a two-step
transaction, consisting of a tender offer by the Purchaser for all of our outstanding common stock
at a price of $11.00 per share without interest thereon and less any applicable withholding or
stock transfer taxes, followed by the merger of the Purchaser with and into the Company, with the
Company surviving as an indirect, wholly owned subsidiary of Chesapeake. If, after completion of
the tender offer, stockholder adoption of the merger agreement is required under Delaware law, we
have agreed to hold a meeting of our stockholders for the purpose of adopting the merger agreement.
In the Merger, each outstanding share of our common stock, other than shares of our common stock
owned by the Company, Chesapeake or Purchaser or their respective wholly owned subsidiaries, or by
stockholders who have validly exercised their appraisal rights under Delaware law, will be
converted into the right to receive cash in an amount equal to the $11.00 per share offer price,
without interest thereon and less any applicable withholding or stock transfer taxes.
Purchaser commenced the tender offer on April 26, 2011. Consummation of the tender offer and the
merger is subject to the satisfaction or waiver of a number of customary closing conditions set
forth in the merger agreement. We currently expect that the tender offer and merger will be
completed during the second quarter of 2011, however, no assurance can be given as to when, or if,
the merger will occur.
|
|
|
ITEM 2.
|
|
Managements Discussion and Analysis of Financial Condition and Results of Operations
|
The following discussion and analysis should be read in conjunction with the Managements
Discussion and Analysis of Financial Condition and Results of Operations section and audited
consolidated financial statements and related notes thereto included in our Annual Report on Form
10-K, filed with the Securities and Exchange Commission, or SEC, on March 15, 2011 and with the
unaudited consolidated financial statements and related notes thereto presented in this Quarterly
Report on Form 10-Q.
Disclosure Regarding Forward-Looking Statements
Our disclosure and analysis in this Form 10-Q may include forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act,
Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the
Private Securities Litigation Reform Act of 1995, that are subject to risks and uncertainties.
Forward-looking statements give our current expectations and projections relating to our financial
condition, results of operations, plans, objectives, future performance and business. You can
identify these statements by the fact that they do not relate strictly to historical or current
facts. These statements may include words such as anticipate, estimate, expect, project,
intend, plan, believe and other words and terms of similar meaning in connection with any
discussion of the timing or nature of future operating or financial performance or other events.
All statements other than statements of historical facts included in this Form 10-Q that address
activities, events or developments that we expect, believe or anticipate will or may occur in the
future are forward-looking statements.
These forward-looking statements are largely based on our expectations and beliefs concerning
future events, which reflect estimates and assumptions made by our management. These estimates and
assumptions reflect our best judgment based on currently known market conditions and other factors
relating to our operations and business environment, all of which are difficult to predict and many
of which are beyond our control.
Although we believe our estimates and assumptions to be reasonable, they are inherently
uncertain and involve a number of risks and uncertainties that are beyond our control. In addition,
managements assumptions about future events may prove to be inaccurate. Management cautions all
readers that the forward-looking statements contained in this Form 10-Q are not guarantees of
future performance, and we cannot assure any reader that those statements will be realized or the
forward-looking events and circumstances will occur. Actual results may differ materially from
those anticipated or implied in the forward-looking statements due to the factors listed in the
Managements Discussion and Analysis of Financial Condition and Results of Operations and Risk
Factors sections of this Quarterly Report on Form 10-Q and our most recent Annual Report on Form
10-K. All forward-looking statements speak only as of the date of this Form 10-Q. We do not intend
to publicly update or revise any forward-looking statements as a result of new information, future
events or otherwise, except as required by law. These cautionary statements qualify all
forward-looking statements attributable to us or persons acting on our behalf.
Overview
We provide contract land drilling services to oil and gas exploration and production
companies throughout the United States. We commenced operations in 2001 with the purchase of one
stacked 650-horsepower drilling rig that we refurbished and deployed. We subsequently made
selective acquisitions of both operational and inventoried drilling rigs, as well as ancillary
equipment. Our management team has significant experience not only with acquiring rigs, but also
with building, refurbishing and deploying inventoried rigs. We have successfully refurbished and
brought into operation 25 inventoried drilling rigs during the period from November 2003 through
March 2011. In addition, we have a 41,000 square foot machine shop in Oklahoma City, which allows
us to build, refurbish and repair our rigs and equipment in-house. This facility, which complements
our two drilling rig refurbishment yards, significantly reduces our reliance on outside machine
shops and the attendant risk of third-party delays in our rig refurbishment program.
17
Additionally, we have exposure to the international drilling market through a 20% equity
investment in Bronco MX S.A. de C.V., a company organized under the laws of Mexico, or Bronco MX.
Bronco MX provides contract land drilling services and leases land drilling rigs to Petroleos
Mexicanos, or PEMEX, and/or companies contracted with PEMEX. We also have a 25% equity investment
in Challenger Limited, a company organized under the laws of the Isle of Man, or Challenger.
Challenger is an international provider of contract land drilling and workover services to oil and
natural gas companies with its principal operations in Libya.
Recent Developments
On April 14, 2011, we entered into an Agreement and Plan of Merger with Chesapeake Energy
Corporation and Nomac Acquisition, Inc., an indirect wholly owned subsidiary of Chesapeake
(Purchaser), as previously disclosed on a Form 8-K we filed with the SEC on April 18, 2011. Under
the terms of the merger agreement, Chesapeake has agreed to acquire the Company through a two-step
transaction, consisting of a tender offer by the Purchaser for all of our outstanding common stock
at a price of $11.00 per share without interest thereon and less any applicable withholding or
stock transfer taxes, followed by the merger of the Purchaser with and into the Company, with the
Company surviving as an indirect, wholly owned subsidiary of Chesapeake. If, after completion of
the tender offer, stockholder adoption of the merger agreement is required under Delaware law, we
have agreed to hold a meeting of our stockholders for the purpose of adopting the merger agreement.
In the Merger, each outstanding share of our common stock, other than shares of our common stock
owned by the Company, Chesapeake or Purchaser or their respective wholly owned subsidiaries, or by
stockholders who have validly exercised their appraisal rights under Delaware law, will be
converted into the right to receive cash in an amount equal to the $11.00 per share offer price,
without interest thereon and less any applicable withholding or stock transfer taxes.
Purchaser commenced the tender offer on April 26, 2011. Consummation of the tender offer and the
merger is subject to the satisfaction or waiver of a number of customary closing conditions set
forth in the merger agreement. We currently expect that the tender offer and merger will be
completed during the second quarter of 2011, however, no assurance can be given as to when, or if,
the merger will occur.
Operating Segments
We currently conduct our operations through one operating segment: contract land drilling. In
June of 2009 we made the decision to suspend operations in our well servicing segment because of
deteriorating market conditions resulting from the decrease in oil and natural gas prices which
began in the third quarter of 2008, as well as the inability of many customers to obtain financing
related to their drilling and workover programs.
Through the second quarter of 2010, we explored alternatives to restructure the well servicing
segment. During Q1 and Q2 2010 the market for workover services continued at depressed levels
within our primary geographic well servicing market (Oklahoma). Late in Q2 2010, we determined
that higher NPV projects were available within our drilling segment and chose to deploy capital in
this segment rather than commit the capital required to restructure operations in the well
servicing segment.
In late June 2010 we made a decision to market the assets constituting the well servicing
segment for sale and redeploy the proceeds to reduce debt and to support our drilling segment. We
have presented all well servicing operating results as discontinued operations in our Consolidated
Statements of Operations for all periods presented. In September 2010, substantially all of the
assets of the well servicing segment were sold at auction to multiple bidders. We used the
proceeds to pay down existing indebtedness under our revolving credit facility.
In September and November 2010, we sold at auction in separate lots to multiple bidders two
complete mechanical drilling rigs and components comprising six other drilling rigs (rigs 2, 9, 51,
52, 54, 70, 75 and 94), and ancillary equipment. The mechanical drilling rigs and equipment sold
at auction were not being utilized currently in our business. In an unrelated transaction on
September 23, 2010, we sold two mechanical drilling rigs (rigs 41 and 42) in a private sale to
Windsor Permian LLC, an unaffiliated third party. On November 29, 2010, the Company sold two
mechanical drilling rigs (rigs 5 and 7) in a private sale to Atlas Drilling, LLC, an unaffiliated
third party. On March 21, 2011, the Company sold a mechanical drilling rig (rig 6) in a private
sale to Atlas Drilling, LLC, an unaffiliated third party. On March 31, 2011, the Company sold a
mechanical drilling rig (rig 62) in a private sale to Windsor Drilling, LLC, an unaffiliated third
party.
In the first quarter we entered into an agreement to sell an additional mechanical drilling
rig (rig 56). This transaction closed on April 11, 2011. The drilling rigs and related equipment
sold at auction and held for sale are being sold as part of our broader strategy to divest of older
mechanical drilling rigs and use the proceeds to pay down existing indebtedness and invest in next
generation drilling equipment.
18
The following is a description of our operating segment.
Contract Land Drilling
Our contract land drilling segment provides contract land drilling
services. As of April 30, 2011, we owned a fleet of 22 operating land drilling rigs. We currently
operate our drilling rigs in North Dakota, Pennsylvania, Oklahoma, and Texas. A majority of the
wells we drill for our customers are drilled in unconventional basins also known as resource plays.
These plays are generally characterized by complex geologic formations that often require higher
horsepower, premium rigs and experienced crews to reach targeted depths. Our current fleet of 22
operating drilling rigs range from 650 to 2,000 horsepower. Accordingly, such rigs can reach the
depths required and have the capability of drilling horizontal and directional wells, which are
increasing as a percentage of total wells drilled in North America and are frequently utilized in
unconventional resource plays. We believe our premium rig fleet, inventory and experienced crews
position us to benefit from the natural gas drilling activity in our core operating areas.
We obtain our contracts for drilling oil and natural gas wells either through competitive
bidding or through direct negotiations with customers. We typically enter into drilling contracts
that provide for compensation on a daywork basis. Occasionally, we enter into drilling contracts
that provide for compensation on a footage basis. We have not historically entered into turnkey
contracts; however, we may decide to enter into such contracts in the future. It is also possible
that we may acquire such contracts in connection with future acquisitions. Contract terms we offer
generally depend on the complexity and risk of operations, the on-site drilling conditions, the
type of equipment used and the anticipated duration of the work to be performed. Although, we
currently have 22 of our drilling rigs operating under term contracts, our contracts generally
provide for the drilling of a single well and typically permit the customer to terminate on short
notice, usually upon payment of an agreed fee.
A significant performance measurement that we use to evaluate this segment is operating rig
utilization. We compute operating drilling rig utilization rates by dividing revenue days by total
available days during a period. Total available days are the number of calendar days during the
period that we have owned the operating rig. Revenue days for each operating rig are days when the
rig is earning revenues under a contract, i.e. when the rig begins moving to the drilling location
until the rig is released from the contract. On daywork contracts, during the mobilization period
we typically receive a fixed amount of revenue based on the mobilization rate stated in the
contract. We begin earning our contracted daywork rate and mobilization revenue when we begin
drilling the well. Occasionally, in periods of increased demand, we will receive a percentage of
the contracted dayrate during the mobilization period. We account for these revenues as
mobilization fees.
For the three months ended March 31, 2011 and 2010 and years ended December 31, 2010, 2009 and
2008, our rig utilization rates, revenue days and average number of marketed rigs were as follows:
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Three Months Ended
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March 31,
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Years Ended December 31,
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2011
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2010
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2010
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2009
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2008
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Average number of
marketed rigs
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24
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37
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33
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44
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44
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Revenue days
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2,088
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1,428
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7,450
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5,699
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12,712
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Utilization Rates
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96
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%
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43
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%
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62
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%
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36
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%
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79
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%
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The increase in the number of revenue days for the three month-period ended March 31, 2011 as
compared to the same period in 2010 is primarily attributable to the increase in oil and natural
gas drilling activity in response to strong commodity prices and the availability of financing to
our customers to fund their drilling programs.
Market Conditions in Our Industry
The United States contract land drilling industry is highly cyclical. Volatility in oil and
natural gas prices can produce wide swings in the levels of overall drilling activity in the
markets we serve and affect the demand for our drilling services and the revenue rates we can
charge for our drilling rigs. The availability of financing sources, past trends in oil and natural
gas prices and the outlook for future oil and natural gas prices strongly influence the capital
expenditure budgets of exploration and production companies our business depends on.
Our business environment was adversely affected by the decline in oil and natural gas prices
and the deteriorating global economic environment beginning in the third quarter of 2008. As a
result of this deterioration, there was and continues to be significant uncertainty in the capital
markets and access to financing has been adversely impacted. As a result of these conditions, our
customers reduced their exploration budgets which resulted in a significant decrease in demand for
our services and a reduction in revenue rates and utilization. During 2010, demand for drilling
activity improved as certain commodity prices strengthened in the latter half of the year.
On April 29, 2011, the closing prices for near month delivery contracts for crude oil and
natural gas as traded on the NYMEX were $113.93 per barrel and $4.51 per MMbtu, respectively. The
Baker Hughes domestic land rig drilling rig count as of April 30, 2011 was 1,789. Baker Hughes is
a large oil field services firm that has issued the rotary rig counts as a service to the petroleum
industry since 1944.
19
The following table depicts the prices for near month delivery contracts for crude oil and
natural gas as traded on the NYMEX, as well as the most recent Baker Hughes domestic land rig
count, on the dates indicated:
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At March 31,
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At December 31,
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2011
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2010
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2009
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2008
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Crude oil (Bbl)
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$
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106.72
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$
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91.38
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$
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79.36
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$
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44.60
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Natural gas (Mmbtu)
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$
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4.39
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$
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4.41
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$
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5.57
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$
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5.62
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U.S. Land Rig Count
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1,749
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1,670
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1,150
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1,653
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Increased expenditures for exploration and production activities generally lead to increased
demand for our services. Until mid-2008, rising oil and natural gas prices and the corresponding
increase in onshore oil and natural gas exploration and production spending led to expanded
drilling as reflected by the increases in the U.S. land rig counts over the previous several years.
Falling commodity prices and the oversupply of rigs, similar to what we began experiencing in the
third quarter of 2008, generally leads to lower demand for our services.
The decline in oil and natural gas prices and the deteriorating global economic environment
resulted in reductions in our rig utilization and revenue rates in 2009. During 2010, these
commodity prices strengthened and the overall demand for drilling activity increased in oil and
natural gas resource plays. We expect continued increases in exploration and production spending
during the remainder of 2011, which we expect will result in modest increases in industry rig
utilization and revenue rates in 2011, as compared to 2010. Continued fluctuations in the demand
for gas and oil, among other factors including supply, could contribute to price volatility which
may continue to affect demand for our services and could materially affect our future financial
results.
Recent civil and political disturbances in Libya have and will continue to affect Challengers
operations. Ongoing political unrest may result in loss of revenue and damage to Challengers
equipment. The political turmoil in Libya and elsewhere in North Africa and impact on Challengers
operations could negatively impact the Companys investment in Challenger, including the loss of
our investment and write off of our receivables from Challenger. Challenger was unable to provide
financial statements or other financial information for the three months ended March 31, 2011 due
to the events in Libya and disruptions in their operations. Because of the lack of information and
uncertainties caused by the events in Libya, we have not recorded or estimated any adjustments to
the carrying value of our investment in Challenger, receivable balances or equity in income (loss)
of Challenger. We will continue to monitor and evaluate the developments in Libya and our
investment in Challenger during 2011 and the Company intends to make required adjustments to equity
in income of Challenger in the period that financial statements or other reasonable information are
available.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based
upon our consolidated financial statements, which have been prepared in accordance with accounting
policies that are described in the notes to our consolidated financial statements. The preparation
of the consolidated financial statements requires management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure
of contingent assets and liabilities. We continually evaluate our judgments and estimates in
determining our financial condition and operating results. Estimates are based upon information
available as of the date of the financial statements and, accordingly, actual results could differ
from these estimates, sometimes materially. Critical accounting policies and estimates are defined
as those that are both most important to the portrayal of our financial condition and operating
results and require managements most subjective judgments. The most critical accounting policies
and estimates are described below.
Revenue and Cost Recognition
Our contract land drilling segment earns revenues by
drilling oil and natural gas wells for our customers typically under daywork contracts, which
usually provide for the drilling of a single well. We occasionally enter into footage contracts,
which also usually provide for the drilling of a single well. We recognize revenues on daywork
contracts for the days completed based on the dayrate each contract specifies. Mobilization
revenues and costs are deferred and recognized over the drilling days of the related drilling
contract. Individual contracts are usually completed in less than 120 days. We follow the
percentage-of-completion method of accounting for footage contract drilling arrangements. Under
this method, drilling revenues and costs related to a well in progress are recognized
proportionately over the time it takes to drill the well. Percentage of completion is determined
based upon the amount of expenses incurred through the measurement date as compared to total
estimated expenses to be incurred drilling the well. Mobilization costs are not included in costs
incurred for percentage-of-completion calculations. Mobilization costs on footage contracts and
daywork contracts are deferred and recognized over the days of actual drilling. Under the
percentage-of-completion method, management estimates are relied upon in the determination of the
total estimated expenses to be incurred drilling the well. When estimates of revenues and expenses
indicate a loss on a contract, the total estimated loss is accrued.
Our management has determined that it is appropriate to use the percentage-of-completion
method to recognize revenue on our footage contracts, which is the predominant practice in the
industry. Although our footage contracts do not have express terms that provide us with rights to
receive payment for the work that we perform prior to drilling wells to the agreed upon depth, we
use this method because, as provided in applicable accounting literature, we believe we achieve a
continuous sale for our work-in-progress and we believe, under applicable state law, we ultimately
could recover the fair value of our work-in-progress even in the event we were unable to drill to
the agreed upon depth in breach of the applicable contract. However, ultimate recovery of that
value, in the event we were unable to drill to the agreed upon depth in breach of the contract,
would be subject to negotiations with the customer and the possibility of litigation.
20
We are entitled to receive payment under footage contracts when we deliver to our customer a
well completed to the depth specified in the contract, unless the customer authorizes us to drill
to a shallower depth. Since inception, we have completed all our footage contracts. Although our
initial cost estimates for footage contracts do not include cost estimates for risks such as stuck
drill pipe or loss of circulation, we believe that our experienced management team, our knowledge
of geologic formations in our areas of operations, the condition of our drilling equipment and our
experienced crews enable us to make reasonably dependable cost estimates and complete contracts
according to our drilling plan. While we do bear the risk of loss for cost overruns and other
events that are not specifically provided for in our initial cost estimates, our pricing of footage
contracts takes such risks into consideration. When we encounter, during the course of our drilling
operations, conditions unforeseen in the preparation of our original cost estimate, we immediately
adjust our cost estimate for the additional costs to complete the contracts. If we anticipate a
loss on a contract in progress at the end of a reporting period due to a change in our cost
estimate, we immediately accrue the entire amount of the estimated loss, including all costs that
are included in our revised estimated cost to complete that contract, in our consolidated statement
of operations for that reporting period. We had no footage contracts in progress at March 31, 2011
or December 31, 2010. When we enter into footage contracts, we are more likely to encounter losses
on them in years in which revenue rates are lower for all types of contracts.
Revenues and costs during a reporting period could be affected by contracts in progress at the
end of a reporting period that have not been completed before our financial statements for that
period are released. At March 31, 2011 and December 31, 2010, our unbilled receivables totaled
$856,000 and $428,000, respectively, all of which relates to the revenue recognized but not yet
billed or costs deferred on daywork contracts in progress.
We accrue estimated contract costs on footage contracts for each day of work completed based
on our estimate of the total costs to complete the contract divided by our estimate of the number
of days to complete the contract. Contract costs include labor, materials, supplies, repairs and
maintenance and operating overhead allocations. In addition, the occurrence of uninsured or
under-insured losses or operating cost overruns on our footage contracts could have a material
adverse effect on our financial position and results of operations. Therefore, our actual results
could differ significantly if our cost estimates are later revised from our original estimates for
contracts in progress at the end of a reporting period that were not completed prior to the release
of our financial statements.
Accounts Receivable
We evaluate the creditworthiness of our customers based on their
financial information, if available, information obtained from major industry suppliers, current
prices of oil and natural gas and any past experience we have with the customer. Consequently, an
adverse change in those factors could affect our estimate of our allowance for doubtful accounts.
In some instances, we require new customers to establish escrow accounts or make prepayments. We
typically invoice our customers at 15-day intervals during the performance of daywork contracts and
upon completion of the daywork contract. Footage contracts are invoiced upon completion of the
contract. Our typical contract provides for payment of invoices in 30 days. We generally do not
extend payment terms beyond 30 days. We are currently involved in legal actions to collect various
overdue accounts receivable. Our allowance for doubtful accounts was $1.8 million and $1.7 million
at March 31, 2011 and December 31, 2010, respectively. Any allowance established is subject to
judgment and estimates made by management. We determine our allowance by considering a number of
factors, including the length of time trade accounts receivable are past due, our previous loss
history, our customers current ability to pay its obligation to us and the condition of the
general economy and the industry as a whole. We write off specific accounts receivable when they
become uncollectible and payments subsequently received on such receivables reduce the allowance
for doubtful accounts.
If a customer defaults on its payment obligation to us under a footage contract, we would need
to rely on applicable law to enforce our lien rights, because our contracts do not expressly grant
to us a security interest in the work we have completed under the contract and we have no ownership
rights in the work-in-progress or completed drilling work, except any rights arising under
applicable law. If we were unable to drill to the agreed on depth in breach of a footage contract,
we might also need to rely on equitable remedies to recover the fair value of our work-in-progress
under a footage contract.
Asset Impairment and Depreciation
We evaluate for potential impairment of long-lived assets
and intangible assets subject to amortization when indicators of impairment are present, as defined
in ASC Topic 360,
Accounting for the Impairment or Disposal of Long-Lived Assets
. Circumstances
that could indicate a potential impairment include significant adverse changes in industry trends,
economic climate, legal factors, and an adverse action or assessment by a regulator. More
specifically, significant adverse changes in industry trends include significant declines in
revenue rates, utilization rates, oil and natural gas market prices and industry rig counts for
drilling rigs and workover rigs. In performing an impairment evaluation, we estimate the future
undiscounted net cash flows from the use and eventual disposition of long-lived assets and
intangible assets grouped at the lowest level that cash flows can be identified. If the sum of the
estimated future undiscounted net cash flows is less than the carrying amount of the long-lived
assets and intangible assets for these asset grouping levels, then we would recognize an impairment
charge. The amount of an impairment charge would be measured as the difference between the carrying
amount and the fair value of these assets. The assumptions used in the impairment evaluation for
long-lived assets and intangible assets are inherently uncertain and require management judgment.
21
In the first quarter of 2011, management entered into an agreement to sell an additional
drilling rig (rig 56). Because the drilling rig met the held for sale criteria, we are required to
present these assets held for sale at the lower of carrying amount or fair value less anticipated
cost to sell. We evaluated these assets of March 31, 2011, for impairment. The fair value of the
drilling rig was determined using the agreed upon sales price for the rig. The analysis as of
March 31, 2011 resulted in a $679,000 impairment charge.
Our determination of the estimated useful lives of our depreciable assets, directly affects
our determination of depreciation expense and deferred taxes. A decrease in the useful life of our
drilling equipment would increase depreciation expense and reduce deferred taxes. We provide for
depreciation of our drilling rigs, transportation and other equipment on a straight-line method
over useful lives that we have estimated and that range from three to fifteen years after the rig
was placed into service. We record the same depreciation expense whether an operating rig is idle
or working. Depreciation is not recorded on an inventoried rig until placed in service. Our
estimates of the useful lives of our drilling, transportation and other equipment are based on our
experience in the drilling industry with similar equipment.
We capitalize interest cost as a component of drilling and workover rigs refurbished for our
own use. During the three months ended March 31, 2011 and 2010, we capitalized interest in the
amount of $40 and $0, respectively.
Stock Based Compensation
We have adopted ASC Topic 718,
Stock Compensation,
upon granting our
first stock options on August 16, 2005. ASC Topic 718 requires a public entity to measure the
costs of employee services received in exchange for an award of equity or liability instruments
based on the grant-date fair value of the award. That cost will be recognized over the periods
during which an employee is required to provide service in exchange for the award. Stock
compensation expense was $779,000 and $395,000 for the three months ended March 31, 2011 and 2010,
respectively.
Deferred Income Taxes
We provide deferred income taxes for the basis difference in our
property and equipment, stock compensation expense and other items between financial reporting and
tax reporting purposes. For property and equipment, basis differences arise from differences in
depreciation periods and methods and the value of assets acquired in a business acquisition where
we acquire the stock in an entity rather than just its assets. For financial reporting purposes, we
depreciate the various components of our drilling rigs and refurbishments over fifteen years, while
federal income tax rules require that we depreciate drilling rigs and refurbishments over five
years. Therefore, in the first five years of our ownership of a drilling rig, our tax depreciation
exceeds our financial reporting depreciation, resulting in our providing deferred taxes on this
depreciation difference. After five years, financial reporting depreciation exceeds tax
depreciation, and the deferred tax liability begins to reverse. Deferred tax assets are reduced by
a valuation allowance if, based on available evidence, it is more likely than not that some portion
or all of the deferred tax assets will not be realized.
Equity Method Investments
Investee companies that are not consolidated, but over which we
exercise significant influence, are accounted for under the equity method of accounting. Whether or
not we exercise significant influence with respect to an Investee depends on an evaluation of
several factors including, among others, representation on the Investee companys board of
directors and ownership level, which is generally a 20% to 50% interest in the voting securities of
the Investee company. Under the equity method of accounting, an Investee companys accounts are not
reflected within our Consolidated Balance Sheets and Statements of Operations; however, our share
of the earnings or losses of the Investee company is reflected in the captions Equity in loss of
Bronco MX and Equity in loss of Challenger in the Consolidated Statements of Operations. Our
carrying value in an equity method Investee company is reflected in the captions Investment in
Bronco MX and Investment in Challenger in our Consolidated Balance Sheets.
Other Accounting Estimates
Our other accrued expenses as of March 31, 2011 and December
31, 2010 included accruals of approximately $3.5 million and $3.7 million, respectively, for costs
under our workers compensation insurance. We have a deductible of $1.0 million per covered
accident under our workers compensation insurance. We maintain letters of credit in the aggregate
amount of $8.5 million for the benefit of various insurance companies as collateral for
retrospective premiums and retained losses which may become payable under the terms of the
underlying insurance contracts. The letters of credit are typically renewed annually. No amounts
have been drawn under the letters of credit. We accrue for these costs as claims are incurred based
on cost estimates established for each claim by the insurance companies providing the
administrative services for processing the claims, including an estimate for incurred but not
reported claims, estimates for claims paid directly by us, our estimate of the administrative costs
associated with these claims and our historical experience with these types of claims. We also
have a self-insurance program for major medical, hospitalization and dental coverage for employees
and their dependents. We recognize both reported and incurred but not reported costs related to
the self-insurance portion of our health insurance. Since the accrual is based on estimates of
expenses for claims, the ultimate amount paid may differ from accrued amounts.
Recent Accounting Pronouncements
In January 2010, the FASB issued a new accounting
standard which requires reporting entities to provide information about movements of assets among
Levels 1 and 2 of the three-tier fair value hierarchy established by ASC 820,
Fair Value
Measurements
. Also required will be a reconciliation of purchases, sales, issuance, and
settlements of financial instruments valued with a Level 3 method, which is used to price the
hardest to value instruments. Entities will have to provide fair value measurement disclosures for
each class of financial assets and liabilities. The guidance will be effective for fiscal years
beginning after December 15, 2010. The adoption of this standard did not impact our consolidated
financial statements.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements.
22
Recent Highlights
Asset Sales and Held for Sale
On September 21, 2010 through September 23, 2010, we sold at auction in separate lots to
multiple bidders two complete drilling rigs and components comprising four other drilling rigs
(rigs 2, 9, 52, 70, 75 and 94), and ancillary equipment. The drilling rigs and equipment sold at
auction were not being utilized currently in our business. We received net proceeds of
approximately $8.3 million, net of selling expenses of $817,000, for the drilling rigs and related
equipment. We recorded losses of $19.9 million related to the sale of the drilling rigs and
ancillary equipment. The loss was based on net book values of approximately $28.2 million for the
drilling rigs and ancillary equipment. We used the entire proceeds to pay down existing
indebtedness under our revolving credit facility.
In an unrelated transaction on September 23, 2010, we sold two drilling rigs (rigs 41 and 42)
in a private sale to Windsor Permian LLC, an unaffiliated third party, for estimated net proceeds
of $7.2 million. We recorded a $1.7 million loss on the sale of these assets based on a net book
value of $8.9 million.
The decision was made by management in the third quarter to sell an additional five drilling
rigs (rigs 5, 6, 7, 51, and 54). Because the drilling rigs met the held for sale criteria, we were
required to present such assets, comprised of property and equipment, at the lower of carrying
amount or fair value less the anticipated costs to sell. We evaluated these assets for impairment
as of September 30, 2010, which resulted in recognizing a $7.8 million impairment charge which
includes estimated selling expenses of approximately $125,000. At September 30, 2010, the fair
value estimate was derived from the sale price of similar assets sold at auction during the third
quarter and negotiated prices with interested parties. The drilling rigs and related equipment
were presented as part of our land drilling segment.
On November 17, 2010, the Company sold at auction in separate lots to multiple bidders two
complete drilling rigs (rigs 51 & 54) and ancillary equipment. The drilling rigs and equipment
sold at auction were not being utilized currently in the Companys business. The Company received
net proceeds of approximately $1.7 million, net of selling expenses of $115,000, for the drilling
rigs and related equipment. The Company recorded a loss of $2.2 million related to the sale of the
drilling rigs and ancillary equipment. The loss was based on net book values of approximately $3.9
million for the drilling rigs and ancillary equipment.
On November 29, 2010, the Company sold two drilling rigs (rigs 5 and 7) in a private sale to
Atlas Drilling, LLC, an unaffiliated third party, for estimated net proceeds of $2.7 million. The
Company recorded a $14,000 gain on the sale of these assets based on a net book value of $2.7
million.
On March 21, 2011, the Company sold one complete drilling rig (rig 6) in a private sale to
Atlas Drilling, LLC, an unaffiliated third party, for net proceeds of $1.6 million. The Company
recorded a $4,000 loss on the sale of the assets based on a net book value of $1.6 million.
On March 31, 2011, the Company sold one complete drilling rig (rig 62) in a private sale to
Windsor Drilling, LLC, an unaffiliated third party, for net proceeds of $4.7 million. The Company
recorded a $1.2 million loss on the sale of the assets based on a net book value of $5.8 million.
On February 25, 2011, the Company entered into an agreement with Windsor Drilling, LLC, an
unaffiliated third party, to sell an additional drilling rig (rig 56). Because the drilling rig
meets the held for sale criteria, the Company is required to present such assets, comprised of
property and equipment, at the lower of carrying amount or fair value less the anticipated costs to
sell. The Company evaluated these assets for impairment as of March 31, 2011, which resulted in
recognizing a $679,000 impairment charge.
The drilling rigs and related equipment sold at auction and the drilling rig held for sale are
being sold as part of a broader strategy by management to divest of older drilling rigs and use the
proceeds to pay down existing indebtedness.
Well Servicing Segment
In June 2009, management made the decision to temporarily suspend operations in the well
servicing segment. As previously discussed, market conditions had sharply deteriorated. The
dramatic decline in activity was evident as revenue hours decreased 87% from a peak of 25,533 hours
in the third quarter of 2008 to 3,374 hours in the second quarter of 2009. This represents a
utilization rate of 75% and 10% for the respective quarters. The decrease in activity was coupled
with similar erosions in pricing and margin. As such, the segment was unable to generate
adequate rates of return on capital in the near future. Because the core drilling business is very
capital intensive and was at the same time experiencing a similar slowdown, management felt it
prudent to temporarily suspend operations in the well service segment.
Through the second quarter of 2010, Bronco senior management explored alternatives to
restructure the well servicing segment. During Q1 and Q2 2010 the market for workover services
continued at depressed levels within the primary geographic market of our well servicing
assets (Oklahoma). Late in Q2 2010, management determined that higher NPV projects were available
within the core drilling segment of the business and chose to deploy capital in this segment rather
than commit the capital required to restructure operations in the well servicing segment.
23
In late June management made a decision to market the assets constituting the well servicing
segment for sale and redeploy the proceeds to reduce debt and to support the Companys core
drilling business. Since the well servicing property and equipment met the held for sale
criteria, we were required to present its property and equipment held for sale at the lower of
carrying amount or fair value less cost to sell. Accordingly, in the second quarter of 2010, we
evaluated well servicings respective assets held for sale for impairment. We engaged a third
party independent appraisal company to determine the fair value of the well servicing assets. The
analysis resulted in $23.4 million impairment charge ($14.3 million after tax).
In September 2010, substantially all of the assets of the well servicing segment were sold at
auction to multiple bidders. We received proceeds of $12.4 million, net of selling expenses of
$638,000. The sale of the assets of the well servicing segment resulted in a loss of $8.9 million,
which is reflected as a component of loss from discontinued operations in our Consolidated
Statements of Operations. We used the proceeds to pay down existing indebtedness under our
revolving credit facility.
Bronco MX
In September of 2009, CICSA purchased 60% of the outstanding membership interests of Bronco MX
from us. Immediately prior to the sale of the membership interests in Bronco MX to CICSA, the
Company contributed six drilling rigs (Nos. 4, 43, 53, 58, 60 and 72), and the future net profit
from rig leases relating to three additional drilling rigs (Nos. 55, 76 and 78), which the Company
contributed to Bronco MX upon the expiration of the leases relating to such rigs.
The Company received $31.7 million from CICSA in exchange for the 60% membership interest in
Bronco MX. CICSA also reimbursed the Company for 60% of the value added taxes previously paid by,
or on behalf of, Bronco MX as a result of the importation of six drilling rigs that were
contributed by the Company to Bronco MX to Mexico.
On July 1, 2010, CICSA contributed cash of approximately $45.1 million in exchange for
735,356,219 shares of Bronco MX. The cash contributed was used to purchase five drilling rigs. As
a result of the contribution, our membership interest in Bronco MX was decreased to approximately
20%. We accounted for the share issuance as if we had sold a proportionate amount of our shares.
The Company recorded a loss on the transaction in the amount of $1.3 million, which was included in
our consolidated statements of operations in the second quarter of 2010.
Bronco MX is jointly managed, with CICSA having four representatives on its board of managers
and the Company having one representative on its board of managers. The Company and CICSA, and
their respective affiliates, agreed to conduct all future land drilling and workover rig services,
rental, construction, refurbishment, transportation, trucking and mobilization in Mexico and Latin
America exclusively through Bronco MX, subject to Bronco MXs ability to perform.
Senior Secured Revolving Credit Facility with Banco Inbursa
On February 9, 2011, the Company amended its senior secured revolving credit facility with
Banco Inbursa. The borrowing base under the credit facility has been reduced from $75.0 million to
$45.0 million. Outstanding borrowings under the credit facility bear interest at the Eurodollar
rate plus 5.80% per annum, subject to adjustment under certain circumstances.
24
Global Financial Markets
Events, both within the United States and the world, have brought about significant and
immediate changes in the global financial markets which in turn have affected the United States
economy, our industry and us. In the United States, these events and others have had a significant
impact on the prices for oil and natural gas as reflected in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural Gas Price
|
|
|
|
|
|
|
per Mcf
|
|
|
Oil Price per Bbl
|
|
Quarter
|
|
High
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|
|
Low
|
|
|
High
|
|
|
Low
|
|
2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second (through
April 30, 2011)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
$
|
4.74
|
|
|
$
|
3.78
|
|
|
$
|
106.72
|
|
|
$
|
84.32
|
|
2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fourth
|
|
$
|
4.61
|
|
|
$
|
3.29
|
|
|
$
|
91.51
|
|
|
$
|
79.49
|
|
Third
|
|
$
|
4.92
|
|
|
$
|
3.65
|
|
|
$
|
82.55
|
|
|
$
|
71.63
|
|
Second
|
|
$
|
5.19
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|
|
$
|
3.91
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|
|
$
|
86.79
|
|
|
$
|
68.01
|
|
First
|
|
$
|
6.01
|
|
|
$
|
3.84
|
|
|
$
|
83.76
|
|
|
$
|
71.19
|
|
2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fourth
|
|
$
|
5.99
|
|
|
$
|
4.25
|
|
|
$
|
81.37
|
|
|
$
|
69.57
|
|
Third
|
|
$
|
4.88
|
|
|
$
|
2.51
|
|
|
$
|
74.37
|
|
|
$
|
59.52
|
|
Second
|
|
$
|
4.45
|
|
|
$
|
3.25
|
|
|
$
|
72.68
|
|
|
$
|
45.88
|
|
First
|
|
$
|
6.07
|
|
|
$
|
3.63
|
|
|
$
|
54.34
|
|
|
$
|
33.98
|
|
2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fourth
|
|
$
|
7.73
|
|
|
$
|
5.29
|
|
|
$
|
98.53
|
|
|
$
|
33.87
|
|
Third
|
|
$
|
13.58
|
|
|
$
|
7.22
|
|
|
$
|
145.29
|
|
|
$
|
95.71
|
|
Second
|
|
$
|
13.35
|
|
|
$
|
9.32
|
|
|
$
|
140.21
|
|
|
$
|
100.98
|
|
First
|
|
$
|
10.23
|
|
|
$
|
7.62
|
|
|
$
|
110.33
|
|
|
$
|
86.99
|
|
As noted in the table, oil and natural gas prices declined significantly in late calendar
2008 and there was a deteriorating national and global economic environment. During 2009, the
economic recession, including the decline in oil and natural gas prices and deterioration in the
credit markets, had a significant effect on customer spending and drilling activity. When drilling
activity and spending decline for any sustained period of time our dayrates and utilization rates
also tend to decline. In addition, lower commodity prices for any sustained period of time could
impact the liquidity condition of some of our customers, which, in turn, might limit their ability
to meet their financial obligations to us.
The impact on our business and financial results as a consequence of the volatility in oil and
natural gas prices and the global economic crisis is uncertain in the long term, but in the short
term, it has had a number of consequences for us, including the following:
|
|
|
In December 2008, we incurred goodwill impairment of our contract land drilling and
well servicing segments of $24.3 million due to the fair value of the segments being
less than their carrying value;
|
|
|
|
In June 2009, we temporarily suspended operations in our well servicing segment;
|
|
|
|
In September 2009, we incurred an impairment charge to our investment in Challenger
of $21.2 million due to the fair value of the investment being less than its carrying
value;
|
|
|
|
In June 2010, management made a decision to sell the assets in the well servicing
segment. We recorded a $23.4 million impairment charge ($14.3 million after tax).
|
|
|
|
In July 2010, subsequent to the end of our second quarter, we completed the sale of
the property and equipment of our trucking assets for $11.3 million in cash, net of
selling expenses in the amount of $403,000. Proceeds from this sale were used to
repay existing indebtedness under our revolving credit facility with Banco Inbursa.
|
|
|
|
In September 2010, we sold at auction in separate lots to multiple bidders
substantially all of the assets of our discontinued well servicing segment, two
complete drilling rigs and components comprising four other drilling rigs (rigs 2, 9,
52, 70, 75 and 94), and ancillary equipment. We recorded losses of $8.9 million and
$19.9 million from the sale of the assets of our well servicing segment and drilling
rigs and related equipment, respectively.
|
|
|
|
In September 2010, we sold two drilling rigs (rigs 41 and 42) in a private sale to
Windsor Permian LLC, an unaffiliated third party, for estimated proceeds of $7.2
million. We recorded a loss of $1.7 million on the sale of these assets.
|
25
Additionally, in the third quarter of 2010 management made the decision to continue to divest
of smaller legacy mechanical rigs and invest the proceeds into new generation drilling rigs and
equipment. That decision resulted in the following transactions.
|
|
|
In September 2010, management made a decision to sell five drilling rigs (rigs 5,
6, 7, 51 and 54). We recorded a $7.9 million impairment charge on these rigs.
|
|
|
|
In November 2010, we sold at auction in separate lots to multiple bidders two
complete drilling rigs (rigs 51 and 54) and ancillary equipment. We recorded a loss
of $2.2 million on the sale of these assets.
|
|
|
|
In November 2010, we sold two drilling rigs (rigs 5 and 7) in a private sale to
Atlas Drilling, LLC, an unaffiliated third party, for proceeds of $2.7 million. The
Company recorded a $14,000 gain on the sale.
|
|
|
|
In February 2011, we agreed to sale two drilling rigs (rigs 56 and 62) in a private
sale to Windsor Permian LLC, an unaffiliated third party, for proceeds of $11.5
million.
|
|
|
|
In March 2011, we sold one drilling rig (rig 6) in a private sale to Atlas
Drilling, LLC, an unaffiliated third party, for proceeds of $1.6 million. We recorded
a $4,000 loss on the sale.
|
Results of Operations
Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010
Contract Drilling Revenue.
For the three months ended March 31, 2011, we reported contract
drilling revenues of $37.0 million, a 66% increase from revenues of $22.3 million for the same
period in 2010. The increase is primarily due to an increase in average dayrates and total revenue
days for the three months ended March 31, 2011 as compared to the same period in 2010. Average
dayrates for our drilling services increased $2,439, or 15%, to $18,389 for the three months ended
March 31, 2011 from $15,949 for the same period in 2010. Revenue days increased 46% to 2,088 days
for the three months ended March 31, 2011 from 1,428 days during the same period in 2010. The
increase in the number of revenue days for the three months ended March 31, 2011 as compared to the
same period in 2010 is primarily due to an increase in the utilization rate for the same period.
Utilization increased to 96% for the three months ended March 31, 2011 from 43% for the same period
in 2010. The 123% increase in utilization was primarily due to an increase in demand for our
services related to increased drilling activity as a result of higher oil and natural gas prices.
Equity in Income (Loss) of Challenger.
Equity in loss of Challenger was $599,000 for the
three months ended March 31, 2010 related to our investment in Challenger. The equity in income
(loss) of Challenger represents our 25% share of Challengers income (loss). For the three months
ended March 31, 2010, Challenger had operating revenues of $9.9 million and operating costs of
$7.8 million.
Recent civil and political disturbances in Libya have and will continue to affect Challengers
operations. Ongoing political unrest may result in loss of revenue and damage to Challengers
equipment. The political turmoil in Libya and elsewhere in North Africa and impact on Challengers
operations could negatively impact the Companys investment in Challenger, including the loss of
our investment and write off of our receivables from Challenger. Challenger was unable to provide
financial statements or other financial information for the three months ended March 31, 2011 due
to the events in Libya and disruptions in their operations. Because of the lack of information and
uncertainties caused by the events in Libya, we have not recorded or estimated any adjustments to
the carrying value of our investment in Challenger, receivable balances or equity in income (loss)
of Challenger. We will continue to monitor and evaluate the developments in Libya and our
investment in Challenger during 2011 and the Company intends to make required adjustments to equity
in income of Challenger in the period that financial statements or other reasonable information are
available.
Equity in Income (Loss) of Bronco MX.
Equity in income of Bronco MX was $1,000 for the three
months ended March 31, 2011 related to our investment in Bronco MX compared to equity in loss of
$209,000 for the three months ended March 31, 2010. The equity in loss of Bronco MX represents our
25% share of Bronco MXs loss. For the three months ended March 31, 2011, Bronco MX had operating
revenues of $8.8 million and operating costs of $8.5 million compared to $6.5 million and $7.0
million for the three months ended March 31, 2010.
Contract Drilling Expense.
Direct rig cost increased $5.6 million to $23.8 million for the
three months ended March 31, 2011 from $18.2 million for the same period in 2010. This 31% increase
is primarily due to the increase in revenue days for the three months ended March 31, 2011 as
compared to the same period in 2010. As a percentage of contract drilling revenue, drilling
expense decreased to 64% for the three-month period ended March 31, 2011 from 81% for the same
period in 2010. The decrease is due primarily to fixed costs on idle rigs and start up costs for
rigs incurred in 2010.
Depreciation and Amortization Expense.
Depreciation expense decreased $2.0 million to
$5.7 million for the three months ended March 31, 2011 from $7.7 million for the same period in
2010. The decrease is primarily due to the sale of 17 drilling rigs throughout 2010.
General and Administrative Expense
. General and administrative expense was flat at $4.2
million for the three months ended March 31, 2011 and 2010. Significant fluctuations from the
three months ended March 31, 2010 to the same period in 2011 included a decrease in accounts
receivable write offs of $828,000, partially offset by an increase in yard expense of $322,000, an
increase in stock compensation expense of $301,000, and an increase in payroll and related costs of
$160,000.
26
Interest Expense
. Interest expense decreased $885,000 to $571,000 for the three months ended
March 31, 2011 from $1.5 million for the same period in 2010. The decrease is due to a decrease in
the average outstanding balance under our revolving credit facilities. We capitalized $40,000 of
interest expense for the three months ended March 31, 2011. We did not capitalize any interest for
the three months ended March 31, 2010.
Income Tax Expense
. We recorded an income tax benefit of $4.0 million for the three months
ended March 31, 2011. This compares to an income tax benefit of $2.6 million for the three months
ended March 31, 2010. This increase is primarily due to a $2.7 million increase in the pre-tax
loss to a pre-tax loss of $11.3 million for the three months ended March 31, 2011 from a pre-tax
loss of $8.6 million for the three months ended March 31, 2010.
Liquidity and Capital Resources
Operating Activities
.
Net cash provided by operating activities was $7.6 million for the three
months ended March 31, 2011 as compared to $838,000 in 2010. The increase of $6.8 million from 2010
to 2011 was primarily due to a increase in cash receipts from customers and lower cash payments to
suppliers.
Investing Activities
.
We use a significant portion of our cash flows from operations and
financing activities for acquisitions and the refurbishment of our rigs. Cash used by investing
activities was $1.3 million for the three months ended March 31, 2011 as compared to $4.6 million
for the same period in 2010. For the three months ended March 31, 2011, we used $7.6 million to
purchase fixed assets. This amount was offset by $6.3 million of proceeds received from the sale
of assets. For the three months ended March 31, 2010, we used $7.8 million to purchase fixed
assets. This amount was partially offset by $3.3 million of proceeds received from the sale of
assets and payments received from notes receivable in the amount of $483,000.
Financing Activities
.
Our cash flows used in financing activities was $6.1 million for the
three months ended March 31, 2011 as compared to $5.0 million provided by financing activities for
the same period in 2010. For the three months ended March 31, 2011 our net cash used in financing
activities related to borrowings of $3.0 million under our credit facility with Banco Inbursa,
partially offset by payments of $9.1 million under our credit facility with Banco Inbursa. For
the three months ended March 31, 2010, our net cash provided by financing activities related to
borrowings of $5.0 million under our credit facility with Banco Inbursa, partially offset by
principal payments of $22,000 to various lenders.
Sources of Liquidity
.
Our primary sources of liquidity are cash from operations and debt and
equity financing.
Debt Financing
. On September 18, 2009, we entered into a new senior secured revolving credit
facility with Banco Inbursa, as lender and as the issuing bank. We utilized (i) borrowings under
the credit facility, (ii) proceeds from the sale of the membership interests of Bronco MX, and
(iii) cash-on-hand to repay all amounts outstanding under our prior revolving credit agreement with
Fortis Bank SA/NV, which has been replaced by the credit facility.
The credit facility provided for revolving advances of up to $75.0 million and matures on
September 17, 2014. The commitment under the credit facility was initially set at $75.0 million,
subject to borrowing base limitations. On February 9, 2011 we amended the credit facility to
reduce the commitment to $45.0 million. The Company incurred a loss from extinguishment of debt of
approximately $2.0 million related to the reduction in availability under the credit facility.
Outstanding borrowings under the credit facility bear interest at the Eurodollar rate plus 5.80%
per annum, subject to adjustment under certain circumstances.
We pay a quarterly commitment fee of 0.5% per annum on the unused portion of the credit
facility and a fee of 1.50% for each letter of credit issued under the facility. In addition, an
upfront fee equal to 1.50% of the aggregate commitments under the credit facility was paid by us at
closing. Our domestic subsidiaries have guaranteed the loans and other obligations under the credit
facility. The obligations under the credit facility and the related guarantees are secured by a
first priority security interest in substantially all of our assets and our domestic subsidiaries,
including the equity interests of our direct and indirect subsidiaries.
The credit facility contains customary representations and warranties and various affirmative
and negative covenants, including, but not limited to, covenants that restrict our ability to make
capital expenditures, incur indebtedness, incur liens, dispose of property, repay debt, pay
dividends, repurchase shares and make certain acquisitions, and a financial covenant requiring that
we maintain a ratio of consolidated debt to consolidated earnings before interest, taxes,
depreciation and amortization for any four consecutive fiscal quarters of not more than 3.5 to 1.0.
We were in compliance with all covenants at March 31, 2011. A violation of these covenants or any
other covenant in the credit facility could result in a default under the credit facility which
would permit the lender to restrict our ability to access the credit facility and require the
immediate repayment of any outstanding advances under the credit facility. The credit facility also
provides for mandatory prepayments in certain circumstances.
In conjunction with our entry into the credit facility, we entered into a Warrant Agreement,
pursuant to which we, issued a three-year warrant (the Warrant) to Banco Inbursa evidencing the
right to purchase up to 5,440,770 shares of our common stock, $0.01 par value per share (the
Common Stock), subject to the terms and conditions set forth in the Warrant, including the
limitations on exercise set forth below, at an exercise price of $6.50 per share of Common Stock
from the date of issuance of the Warrant (the Issue Date) through the first anniversary of the
Issue Date, $7.00 per share following the first anniversary of the Issue Date through the second
anniversary of the Issue Date, and $7.50 per share following the second anniversary of the Issue
Date through the third anniversary of the Issue Date. The Warrant may be exercised by the payment
of the exercise price in cash or through a cashless exercise whereby we withhold shares issuable
under the Warrant having a value equal to the aggregate exercise price. Banco Inbursa subsequently
transferred the Warrant to CICSA.
27
In accordance with accounting standards, the proceeds from the revolving credit facility were
allocated to the credit facility and Warrant based on their respective fair values. Based on this
allocation, $50.3 million and $4.7 million of the net proceeds were allocated to the credit
facility and Warrant, respectively. The Warrant has been classified as a liability on the
consolidated balance sheet due to our obligation to pay the seller of the Warrant a make-whole
payment, in cash, under certain circumstances. The fair value of the Warrant was determined using
a pricing model based on a version of the Black Scholes model, which is adjusted to account for the
dilution resulting from the additional shares issued for the Warrant. The valuation was determined
by computing the value of the Warrant if exercised in Year 1 3 with the values weighted by the
probability that the Warrant would actually be exercised in that year. Some of the assumptions
used in the model were a volatility of 45% and a risk free interest rate that ranged from 0.41% to
1.57%.
The resulting discount to the revolving credit facility will be amortized to interest expense
over the term of the revolving credit facility such that, in the absence of any conversions, the
carrying value of the revolving credit facility at maturity would be equal to $55.0 million.
Accordingly, we will recognize annual interest expense on the debt at an effective interest rate of
Eurodollar rate plus 6.25%. The discount was reclassified to debt issue costs at March 31, 2011.
In accordance with accounting standards, we revalued the Warrant as of March 31, 2011 and
recorded the change in the fair value of the Warrant on the consolidated statement of operations.
The fair value of the Warrant was determined using a pricing model based on a version of the Black
Scholes model, which is adjusted to account for the dilution resulting from the additional shares
issued for the Warrant. The valuation was determined by computing the value of the Warrant if
exercised in Year 2 3 with the values weighted by the probability that the warrant would
actually be exercised in that year. Some of the assumptions used in the model were volatilities of
39% and 49% and a risk free interest rate that ranged from 0.16% to .56%. The fair value of the
Warrant was $14.7 million at March 31, 2011. We recorded a change in the fair value of the Warrant
on the consolidated statement of operations in the amount of $10.3 million for the three months
ended March 31, 2011.
The description of the credit facility set forth herein is a summary, is not complete and is
qualified in its entirety by reference to the full text of such agreement, which was filed as
exhibit 10.1 to the Companys Current Report on Form 8-K filed with the SEC on September 23, 2009.
We are party to a term loan agreement with Ameritas Life Insurance Corp. for an aggregate
principal amount of approximately $1.6 million related to the acquisition of a building. This term
loan is payable in 166 monthly installments, matures in 2021 and has an interest rate of 6%.
Working Capital.
Our working capital was $33.4 million at March 31, 2011 compared to $35.7
million at December 31, 2010. Our current ratio, which we calculate by dividing our current assets
by our current liabilities, was 2.9 at March 31, 2011 compared to 3.2 at December 31, 2010.
We believe that the liquidity shown on our balance sheet as of March 31, 2011, which includes
approximately $33.4 million in working capital (including $14.8 million in cash) and availability
under our $45.0 million credit facility of $33.5 million at March 31, 2011 (net of outstanding
letters of credit of $8.5 million), together with cash expected to be generated from operations,
provides us with sufficient ability to fund our operations for at least the next twelve months.
However, additional capital may be required for future rig acquisitions. While we would expect to
fund such acquisitions with additional borrowings and the issuance of debt and equity securities,
we cannot assure you that such funding will be available or, if available, that it will be on terms
acceptable to us. The changes in the components of our working capital were as follows (amounts in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
|
|
|
2011
|
|
|
2010
|
|
|
Change
|
|
Cash and cash equivalents
|
|
$
|
14,797
|
|
|
$
|
11,854
|
|
|
$
|
2,943
|
|
Restricted cash
|
|
|
|
|
|
|
2,700
|
|
|
|
(2,700
|
)
|
Trade and other receivables
|
|
|
22,796
|
|
|
|
24,656
|
|
|
|
(1,860
|
)
|
Affiliate receivables
|
|
|
1,546
|
|
|
|
1,508
|
|
|
|
38
|
|
Unbilled receivables
|
|
|
856
|
|
|
|
428
|
|
|
|
428
|
|
Income tax receivable
|
|
|
5,671
|
|
|
|
5,700
|
|
|
|
(29
|
)
|
Current deferred income taxes
|
|
|
2,558
|
|
|
|
2,765
|
|
|
|
(207
|
)
|
Current maturities of note receivable
|
|
|
1,639
|
|
|
|
1,607
|
|
|
|
32
|
|
Prepaid expenses
|
|
|
1,038
|
|
|
|
329
|
|
|
|
709
|
|
|
|
|
|
|
|
|
|
|
|
Current assets
|
|
|
50,901
|
|
|
|
51,547
|
|
|
|
(646
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current debt
|
|
|
96
|
|
|
|
95
|
|
|
|
1
|
|
Accounts payable
|
|
|
8,674
|
|
|
|
7,945
|
|
|
|
729
|
|
Accrued
liabilities and deferred revenues
|
|
|
8,757
|
|
|
|
7,847
|
|
|
|
910
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
17,527
|
|
|
|
15,887
|
|
|
|
1,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Working capital
|
|
$
|
33,374
|
|
|
$
|
35,660
|
|
|
$
|
(2,286
|
)
|
|
|
|
|
|
|
|
|
|
|
28
|
|
|
Item 3.
|
|
Quantitative and Qualitative Disclosures About Market Risks
|
We are subject to market risk exposure related to changes in interest rates on our outstanding
floating rate debt. Borrowings under our revolving credit facility bear interest at a floating rate
equal to LIBOR plus a margin of 5.80%. An increase or decrease of 1% in the interest rate would
have a corresponding decrease or increase in our net income (loss) of approximately $18,000
annually, based on the $3.0 million outstanding in the aggregate under our credit facility as of
March 31, 2011.
|
|
|
Item 4.
|
|
Controls and Procedures
|
Evaluation of Disclosure Control and Procedures.
As of the end of the period covered by this Quarterly Report on Form 10-Q, our management,
under the supervision and with the participation of our Chief Executive Officer and Chief Financial
Officer, evaluated the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934,
as amended). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that as of March 31, 2011 our disclosure controls and procedures are effective.
Disclosure controls and procedures are controls and procedures designed to ensure that
information required to be disclosed in our reports filed or submitted under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms; and include controls and procedures designed to ensure that
information is accumulated and communicated to our management, and made known to our Chief
Executive Officer and Chief Financial Officer, particularly during the period when this Quarterly
Report on Form 10-Q was prepared, as appropriate to allow timely decision regarding the required
disclosure.
Changes in Internal Control over Financial Reporting
.
There were no changes in our internal control over financial reporting that occurred during
the first quarter of 2011 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
29
PART II: OTHER INFORMATION
|
|
|
Item 1.
|
|
Legal Proceedings
|
Various claims and lawsuits, incidental to the ordinary course of business, are pending
against the Company. In the opinion of management, all matters are adequately covered by insurance
or, if not covered, are not expected to have a material effect on the Companys consolidated
financial position, results of operations or cash flows.
In addition, please see the lawsuits referenced in Note 6 Commitments and Contingencies to
Part I, Item 1 above.
Our business is subject to many risks. We describe the risks and factors that could
materially adversely affect our business, financial condition, operating results or liquidity and
the trading price of our common stock under Risk Factors in Item 1A of our Annual Report on Form
10-K for the year ended December 31, 2010 filed with the SEC on March 15, 2011. This information
should be considered carefully together with the other information in this report and other reports
and materials we file with the SEC. There have been no material changes from the risk factors
disclosed in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December
31, 2010, other than the following:
Failure to complete our proposed merger with Chesapeake could negatively impact our stock price
and our future business and financial results.
On April 14, 2011, we entered into an Agreement and Plan of Merger with Chesapeake Energy
Corporation and Nomac Acquisition, Inc., an indirect wholly owned subsidiary of Chesapeake
(Purchaser), as previously disclosed on a Form 8-K we filed with the SEC on April 18, 2011. Under
the terms of the merger agreement, Chesapeake has agreed to acquire the Company through a two-step
transaction, consisting of a tender offer by the Purchaser for all of our outstanding common stock
at a price of $11.00 per share without interest thereon and less any applicable withholding or
stock transfer taxes, followed by the merger of the Purchaser with and into the Company, with the
Company surviving as an indirect, wholly owned subsidiary of Chesapeake. If the proposed tender
offer and merger are not completed, our ongoing businesses may be adversely affected and, without
realizing any of the benefits of having completed the merger, we would be subject to a number of
risks, including the following:
|
|
|
we may experience negative reactions from our customers and employees;
|
|
|
|
the current market price of our common stock may reflect a market assumption that the
tender offer and merger will occur and a failure to complete the tender offer or the
merger could result in a negative perception by the stock market and a resulting decline
in the market price of our common stock;
|
|
|
|
certain costs relating to the tender offer and merger, including certain investment
banking, financing, legal and accounting fees and expenses, must be paid even if the
merger is not completed, and we may be required to pay a fee of $13.0 million plus
expense reimbursements up to $1.5 million to Chesapeake if the merger agreement is
terminated under specified circumstances; and
|
|
|
|
there may be substantial disruption to our business and distraction of our management
and employees from day-to-day operations because matters related to the tender offer and
merger (including integration planning) may require substantial commitments of time and
resources, which could otherwise have been devoted to other opportunities that could
have been beneficial to us.
|
There can be no assurance that the risks described above will not materialize, and if any of
them do, they may materially adversely affect our business, financial results and stock price.
We may have difficulty attracting, motivating and retaining officers and other key employees in
light of our recently announced merger agreement with Chesapeake.
Uncertainty about the effect of the proposed tender offer and merger on our officers and
employees may have an adverse effect on us. This uncertainty may impair our ability to attract,
retain and motivate key personnel during the pendency of the merger, as employees may experience
uncertainty about their future roles with us and with Chesapeake. If we are unable to attract,
retain and motivate key personnel, we could face disruptions in our operations, loss of existing
customers and loss of key information, expertise or know-how, which may adversely affect our
business and financial results.
30
Business uncertainties and contractual restrictions while the proposed tender offer and merger is
pending may have an adverse effect on us.
Uncertainty about the effect of the proposed tender offer and merger on suppliers, partners
and customers may have an adverse effect on us. These uncertainties may cause suppliers, customers
and others that deal with us to defer purchases or other decisions concerning us or seek to change
existing business relationships with us. In addition, the merger agreement restricts us from
making certain acquisitions and taking other specified actions without Chesapeakes approval.
These restrictions could prevent us from pursuing certain business opportunities that may arise
prior to the completion of the merger. The adverse effect of such disruptions could be exacerbated
by a delay in the completion of the tender offer or merger or termination of the merger agreement.
|
|
|
Item 2.
|
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
None.
|
|
|
Item 3.
|
|
Defaults Upon Senior Securities
|
None.
|
|
|
Item 5.
|
|
Other Information
|
None.
Exhibits:
|
|
|
|
|
Exhibit No.
|
|
Description
|
|
2.1
|
|
|
Agreement and Plan of Merger, dated as of April 14, 2011,
by and among Bronco Drilling Company, Inc., Chesapeake
Energy Corporation and Nomac Acquisition, Inc.
(incorporated by reference to Exhibit 2.1 to the Current
Report on Form 8-K, File No. 000-51471, filed by the
Company with the SEC on April 18, 2011).
|
|
|
|
|
|
|
3.1
|
|
|
Amended and Restated Certificate of Incorporation of the
Company, dated August 11, 2005 (incorporated by reference
to Exhibit 2.1 to the Registration Statement on Form S-1,
File No. 333-128861, filed by the Company with the SEC on
October 6, 2005).
|
|
|
|
|
|
|
3.2
|
|
|
Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to Amendment No. 1 to the Registration
Statement on Form S-1, File No. 333-125405, filed by the
Company with the SEC on July 14, 2005).
|
|
|
|
|
|
|
4.1
|
|
|
Form of Common Stock certificate (incorporated by
reference to Exhibit 4.1 to Amendment No. 2 to the
Registration Statement on Form S-1, File No. 333-125405,
filed by the Company with the SEC on August 2, 2005).
|
|
|
|
|
|
|
*31.1
|
|
|
Certification of Chief Executive Officer of Bronco
Drilling Company, Inc. pursuant to Rule 13a-14(a)
promulgated under the Securities Exchange Act of 1934, as
amended.
|
|
|
|
|
|
|
*31.2
|
|
|
Certification of Chief Financial Officer of Bronco
Drilling Company, Inc. pursuant to Rule 13a-14(a)
promulgated under the Securities Exchange Act of 1934, as
amended.
|
31
|
|
|
|
|
Exhibit No.
|
|
Description
|
|
*32.1
|
|
|
Certification of Chief Executive Officer of Bronco
Drilling Company, Inc. pursuant to Rule 13a-14(b)
promulgated under the Securities Exchange Act of 1934, as
amended, and Section 1350 of Chapter 63 of Title 18 of the
United States Code.
|
|
|
|
|
|
|
*32.2
|
|
|
Certification of Chief Financial Officer of Bronco
Drilling Company, Inc. pursuant to Rule 13a-14(b)
promulgated under the Securities Exchange Act of 1934, as
amended, and Section 1350 of Chapter 63 of Title 18 of the
United States Code.
|
|
|
|
*
|
|
Filed herewith.
|
|
+
|
|
Management contract, compensatory plan or arrangement
|
32
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on their behalf by the undersigned, thereunto duly authorized.
|
|
|
|
|
Dated: May 9, 2011
|
BRONCO DRILLING COMPANY, INC.
|
|
|
By:
|
/s/ Matthew S. Porter
|
|
|
|
Matthew S. Porter
|
|
|
|
Chief Financial Officer
(Principal Accounting and Financial Officer)
|
|
|
|
|
Dated: May 9, 2011
|
By:
|
/s/ D. Frank Harrison
|
|
|
|
D. Frank Harrison
|
|
|
|
Chief Executive Officer
(Authorized Officer and Principal Executive Officer)
|
|
33
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