ITEM 1. BUSINESS AND PROPERTIES
GENERAL
Dailey International Inc. ("Dailey" or the "Company") is an integrated provider of specialty services and technologically-advanced downhole tools to the oil and gas industry on a worldwide basis. The Company currently manages its operations in two business segments: (i) downhole products and services and (2) underbalanced drilling services. Downhole products and services are comprised of the Company's directional drilling services, electric wireline services, tubing conveyed perforating services and downhole tool rentals. The Company's underbalanced drilling services were acquired through the Company's acquisition of Air Drilling International, Inc. in June 1997. For additional information relating to the Company's business segments, see Note 20 to the Company's Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
ACQUISITIONS
During 1998 Dailey completed four major acquisitions, each of which is summarized below.
o International Nitrogen Services, LLC. In December 1998, the Company, through its subsidiary Air Drilling International, Inc., purchased a 51% interest in International Nitrogen Services, LLC., ("INS"), a joint venture with MG Generon (the "INS Acquisition"). INS, based in Houston, Texas, provides non-cryogenic nitrogen generators and production units for use in the on-site production of nitrogen for injection in downhole drilling of oil and gas wells. The Company paid $7.1 million cash, subject to a purchase price adjustment based on future earnings.
o Transocean. In August 1998, Dailey acquired substantially all of the assets of the directional drilling business of Transocean Petroleum Technology Limited ("Transocean"), a company located in Aberdeen, Scotland, for approximately $10 million cash (the "Transocean Acquisition"). As a result of this acquisition, the Company expanded its directional drilling services to the North Sea.
o Integrated Drilling Services Limited. In March 1998, the Company acquired the outstanding capital stock of Integrated Drilling Services Limited ("IDS"), a specialized provider of directional drilling services, for $18.8 million in cash and 755,084 shares of Class A Common Stock, plus assumption or repayment of debt of approximately $6.5 million (the "IDS Acquisition"). The Company believes that the acquisition of IDS provided it with key directional drilling technologies, including a resistivity tool for logging while drilling.
o DWS/DAMCO. In January 1998, Dailey acquired substantially all of the operating assets and liabilities of Directional Wireline Services, Inc., DAMCO Services, Inc. and DAMCO Tong Services, Inc. (collectively "DWS/DAMCO") for $61 million in cash, subject to adjustment based on levels of working capital (the "DWS/DAMCO Acquisition"). DWS/DAMCO provides electric wireline and tubular services in the U.S. Gulf of Mexico region and, to a lesser extent, Nigeria.
DOWNHOLE PRODUCTS AND SERVICES
Directional Drilling Services
Directional drilling services involve assisting oil and gas operators in the controlled drilling of a wellbore to a prescribed bottomhole location. Directional drilling can be used to develop a field with multiple wells drilled from the same offshore platform or, in environmentally sensitive areas, from fewer surface facilities than conventional drilling would require. In addition, drilling horizontally through a formation characterized by multiple vertical fractures can result in substantial reductions in drilling costs and improved well productivity because fewer wells are required compared to a vertical development program. Recent developments in multilateral technology, which allows two or more wells to be drilled from the same vertical wellbore, have further enhanced well productivity and development efficiency.
Dailey began offering directional drilling services in 1984, primarily along the Texas and Louisiana Gulf Coast, and has since expanded both its directional drilling technical capabilities and the geographic areas in which its services are regularly offered. Dailey currently participates in selected international markets including Abu Dhabi, Thailand, the North Sea and Venezuela.
The Company provides skilled personnel to manage the drilling of directional wells. The directional drilling services offered by the Company consist of well planning, on-site supervisory services to maximize drilling efficiency, measurement-while-drilling ("MWD") services and related equipment rentals, downhole motor rentals and post-well analysis. The Company also derives revenue from its directional drilling services by renting MWD units, downhole motors and nonmagnetic stabilizers. Through the acquisition of IDS, the Company acquired key technologies, including a resistivity tool for logging-while-drilling ("LWD") that is compatible with Dailey's MWD equipment. The Company believes that the addition of LWD technology to Dailey's MWD fleet will enable it to offer more fully integrated directional drilling systems in the Gulf of Mexico, North Sea, and selected international markets once a sizeable inventory of LWD units can be manufactured. The Company currently has two LWD units available for rental.
The skill, experience and reputation of a service company's directional drillers are the primary competitive factors in the directional drilling services market. Because of this, the competition among directional drilling service companies to employ the most reputable, qualified and experienced directional drilling personnel is intense. In addition, the scope of services offered as well as price are important competitive factors. As of January 31, 1999, Dailey employed 36 directional drillers.
Electric Wireline and Tubing Conveyed Perforating Services
As a result of the DWS/DAMCO Acquisition, the Company provides electric wireline and tubing conveyed perforation ("TCP") services in the U.S. Gulf of Mexico region and Nigeria. The Company's electric wireline services are utilized in both the exploration and production phases of an oil and gas well and include pipe recovery, cased hole logging, electric wireline perforating services and other cased hole services such as installation of bridge plugs, packers, retainers, pressure control equipment and thru-tubing bridge plugs. TCP services involve the use of tubing string to lower and retrieve perforating charges from the wellbore.
Tubular Testing and Handling Services
As a result of the DWS/DAMCO Acquisition, the Company provides tubular testing and handling services to the onshore and offshore oil and gas industry in the U.S. Gulf of Mexico region. The Company's tubular testing services consist of hydrostatic and gas pressure testing services that detect leaks and flaws in tubulars as they are run into the wellbore. Operators contract tubular testing services to avoid incurring costly downtime and the expense of pulling a defective tubular string.
The Company's tubular handling services include assembling production pipe and tubing, dual completion strings, premium threaded connectors and ultra-high torque tubulars. Mistakes in torquing tubulars can be costly in terms of downtime and damaged equipment; therefore, operators rely on experienced tubular companies for handling services.
Downhole Tools
The Company currently offers an array of technologically-advanced downhole tools, which it selectively markets in every major oil and gas exploration and production region in the world. Dailey began renting downhole tools in 1945 and introduced the first drilling jar to the oil and gas industry in 1965. The Company is currently the leading supplier of drilling jars to the rental tool market worldwide.
The Company's line of drilling jars and related products include mechanical and hydraulic drilling jars and jar slingers. A drilling jar is an impact tool that is placed in the lower section of a drillstring as part of the bottomhole assembly. Activated from the surface, the drilling jar delivers a sharp, powerful impact to free the drillstring should it become lodged in the hole. The potential risks of the drillstring becoming stuck in the hole include interruption of the drilling process, loss of drillstring components and loss of the well. Drilling jars must be capable of reliably delivering frequent and consistent impacts to the drillstring, sometimes over a period of many days. As a result, reliability and consistent performance and service by qualified personnel are key criteria in a customer's selection of drilling jars.
Drilling jars and jar slingers generally are used in drilling applications where there is significant risk of, or cost associated with, the bottomhole assembly of the drillstring becoming stuck in the wellbore. As the risk or potential cost of a stuck drillstring increases, the likelihood that the operator of the well will employ a drilling jar typically increases. Drilling applications where drilling jars are used regularly include high-cost wells, wells drilled using directional, horizontal or underbalanced techniques, deeper wells, and wells penetrating unstable geologic formations that increase the risk of well bore collapse. Drilling jars generally are considered essential components in most directional drilling bottomhole assemblies. The Company believes that the proprietary designs of its drilling jars deliver superior performance over competing jars for longer periods of time in their intended operating environments and are compatible with virtually any drilling condition a customer may encounter.
In addition to drilling jars, the Company rents other proprietary downhole tools including hydraulic fishing jars, coiled tubing jars, drilling shock absorbers, drilling thrusters and drilling slingers. The Company also derives revenues from the sale of mechanical drilling jars and from downhole tools that are lost-in-hole by the operator.
UNDERBALANCED DRILLING SERVICES
Underbalanced drilling involves maintaining the pressure in a well at less than that of the surrounding formation using air, nitrogen, mist, foam or lightweight drilling fluids as the circulation medium instead of mud. The Company is a worldwide leader in providing air drilling services, which are used in underbalanced drilling applications, and has developed internally the ability to provide other services utilized in underbalanced drilling applications. The Company provides underbalanced drilling equipment packages consisting of compressors, boosters, mist pumps and related equipment along with specially trained personnel to operate the equipment. Underbalanced drilling techniques can lead to substantial increases in rates of penetration and drill bit life resulting in substantially less time and cost for a drilling program and can reduce substantially the risks of formation damage.
Horizontal and directional wells frequently are drilled using underbalanced drilling technology to reduce the risk of formation damage and improve the flow of hydrocarbons in low pressure or depleted reservoirs. The use of underbalanced drilling in geothermal wells often avoids the problem of losing drilling fluids in porous geothermal formations or, in certain cases, causing the formation to be plugged.
A typical package of equipment used in an underbalanced drilling job consists of two compressors, a booster and a mist pump. Compressors are used to force air into the borehole. Depending on the pressure and air volume requirements, additional compressors may be needed. Boosters are used to increase the pressure of air exiting a compressor and can increase the air pressure up to fivefold. Mist pumps are used to mix and distribute water, soaps and other fluids in underbalanced drilling applications.
In addition, in connection with its underbalanced drilling operations, the Company is one of the largest fully-integrated pipeline testing companies in Canada and is the leading provider of hydrostatic testing services to major Canadian pipeline construction companies that lack the capability to perform such testing in-house.
MARKETING AND DISTRIBUTION
The Company markets its products and services primarily to major oil companies, independent oil and gas exploration companies, drilling contractors and drilling services consultants. In international markets, state-owned oil and gas companies also are a significant customer group. Domestic marketing of the Company's products and services is conducted by the Company's direct sales force. International marketing of the Company's products and services is conducted through the Company's direct sales force or through independent international agents and also through cooperative marketing arrangements with local companies.
INTERNATIONAL OPERATIONS
Dailey's international operations (including Canada) accounted for approximately 42%, 39%, 52% and 48% of total revenues for fiscal 1996 and 1997, the eight months ended December 31, 1997 and the twelve months ended December 31, 1998, respectively. As of January 31, 1999, Dailey had operations in approximately 41 foreign countries. See Note 20 of the Notes to Consolidated Financial Statements of Dailey contained elsewhere in this Form 10-K for additional information regarding foreign and domestic revenues.
The Company's international agents are responsible for international marketing of the Company's downhole tools and air drilling services in certain of its markets. International agents also perform maintenance of the Company's downhole tools in their custody at their own facilities. International marketing and distribution is organized into four major regions: Europe/West Africa, the Middle East, Southeast Asia and Latin America. Each region is further divided into multiple and sometimes overlapping territories, generally based on political boundaries. Regional supervisors are assigned by the Company to oversee international operations, particularly with respect to proper maintenance and redressing of tools and to provide sales support and technical assistance to customers.
The Company's international operations (including Canada) are subject to special risks inherent in doing business outside the United States, including governmental instability, war and other international conflicts, civil and labor disturbances, requirements of local ownership, partial or total expropriation, nationalization, currency devaluation, foreign exchange controls, and foreign laws and policies, each of which may limit the movement of assets or funds or result in the deprivation of contract rights or the taking of property without fair compensation. Although the Company maintains insurance to protect itself from such risks, such insurance may be insufficient to protect the Company in all circumstances, and any failure to do so could have a material adverse effect on the Company's results of operations and financial condition. In addition, although most of the Company's international revenues are derived from transactions denominated in United States dollars, the Company has and likely will continue to conduct some business in currencies other than the United States dollar. The Company currently does not hedge against foreign currency fluctuations. Accordingly, its profitability has been and will continue to be affected by fluctuations in foreign exchange rates. The Company believes revenues from transactions denominated in foreign currencies will increase as a percentage of total revenues due to the Transocean Acquisition, the DWS/DAMCO Acquisition and the IDS Acquisition. In addition, collections and recovery of rental tools from international customers and agents may prove more difficult due to the uncertainties of foreign law and judicial procedure. The Company may therefore experience significant difficulty resulting from the political or judicial climate in countries in which it operates. From time to time the United States has passed laws and imposed regulations prohibiting or restricting trade with certain nations. There can be no assurance that future laws and regulations will not limit materially the Company's international business.
MANUFACTURING AND MAINTENANCE
The manufacturing processes generally required to produce the Company's downhole tools are machining, fabrication, assembly of components manufactured by the Company or outside suppliers, and quality control testing. The Company attempts to outsource those manufacturing processes that can be performed more efficiently and cost effectively by outside third parties. The Company believes that its manufacturing capabilities and arrangements are sufficient in order to meet the demand and timing needs of the Company's customers for the next twelve months. Machining of larger components and spare parts, including the most complex components, is done by the Company at its manufacturing plant in Conroe, Texas. Fabrication, assembly and packaging of the Company's wireline units, compression equipment and tubular handling equipment are performed at the Company's Houma, Louisiana, Casper, Wyoming and Edmonton, Canada locations. Through the IDS Acquisition, the Company acquired IDS' manufacturing operations in Scotland relating to various directional drilling equipment. The manufacturing processes performed in-house by the Company require a ready supply of high-quality, special alloy steel and other raw materials. The Company purchases its raw materials from various vendors, none of which supplied a majority of Dailey's supply of such materials during fiscal 1998. Although the Company typically places orders for its steel at least three months in advance and usually stores with a third party a reserve supply of steel adequate to cover the Company's demand for steel for at least one month, any prolonged disruption in steel supply could affect the Company's ability to meet production schedules and commitments, which could have a material adverse effect on the Company's financial condition and results of operations.
Maintenance of the Company's downhole tools is conducted in the United States at six of the Company's facilities, each of which is specially equipped for that purpose. In the United Kingdom, Colombia and Venezuela, maintenance is conducted by Company personnel, and elsewhere by the Company's international agents who are subject to periodic quality control inspection and supervision by Company personnel.
RELIANCE ON CERTAIN SUPPLIERS
Most of the Company's downhole tools incorporate certain products or technology supplied in part by third parties. Although the Company is not presently experiencing and does not anticipate any significant supply or quality control problems with its vendors, such problems, if they were to occur, could have a material adverse effect on the Company's ability to meet future production and sales commitments, which could adversely affect the Company's results of operations. In addition, during the past five years, one vendor has been the Company's only supplier of filters used in the Company's hydraulic downhole tools. The Company has not identified alternative suppliers for such filters. To date, the Company has not experienced supply problems with this vendor; however, any difficulty with such supplier combined with any difficulty in finding and utilizing alternative sources for these filters could have a material adverse effect on the Company's results of operations.
The Company purchases all of its MWD units used in connection with its directional drilling services from a single supplier. The Company believes that reliable MWD units are available for third-party purchase from only a few vendors worldwide. In addition, the Company's LWD technology currently functions only when operated in connection with MWD units provided by the Company's current supplier, and any inability to obtain MWD units from this supplier could adversely affect the Company's ability to utilize this LWD technology. Although the Company has not experienced significant supply or quality control problems to date with its supplier, there can be no assurance that the Company will be able to purchase reliable, high-quality MWD units from other vendors at competitive prices and terms. Any difficulty in obtaining MWD units from its supplier, as a result of manufacturing delays or other reasons, could have a material adverse effect on the Company's results of operation and financial condition.
INTELLECTUAL PROPERTY
The markets for the Company's specialized services and downhole tools are characterized by continual technological developments that have resulted in, and likely will continue to result in, substantial improvements in the scope and quality of directional drilling and underbalanced drilling services and product function and performance. Whether the Company can develop and produce successfully, on a timely basis, new and enhanced downhole tools that embody new technology, meet evolving industry standards and practice, and achieve levels of capability and price that are acceptable to its customers will be significant factors in determining the Company's ability to compete. There can be no assurance that the Company will not encounter resource constraints or technical or other difficulties that could delay introduction of new products and services in the future. If the Company is unable, for technological or other reasons, to develop and commercialize competitive products in a timely manner in response to changes in the directional drilling, underbalanced drilling or rental tool industries, its results of operations and financial condition could be materially adversely affected.
The Company believes that the proprietary aspects of many of its products and services provide it with certain competitive advantages. In particular, the Company believes that the trademarks and servicemarks protecting the Dailey name in domestic and international markets are of primary importance. In addition, pursuant to the DWS/DAMCO Acquisition and IDS Acquisition, the
Company acquired additional key patents relating to its TCP services and directional drilling services. The Company relies on a combination of patents, trade secrets, trademarks and servicemarks and copyrights to protect its proprietary technologies and intellectual properties. Patents protect features of the Dailey Hydraulic Jar and Dailey Hydraulic Fishing Jar, as well as other of the Company's products and services. Although the Company does not consider its business to be wholly dependent on any single patent or trademark, the unexpected loss of patent protection for the Dailey Hydraulic Jar or Dailey Hydraulic Fishing Jar could have a material adverse effect on the Company.
COMPETITION
The markets for the Company's products and services are highly competitive and characterized by continual changes in technology. Many of the Company's existing and potential competitors have substantially greater marketing, distribution, financial and technical resources than the Company. There can be no assurance that the Company's services, rentals and sales will continue at current volumes or prices if its current competitors or new market entrants introduce new products or services with better features, performance, prices or characteristics than the Company's products and services. Competitive pressures or other factors also may result in significant price competition that could have a material adverse effect on the Company's results of operations and financial condition. In this regard, during the past 18 months, there has been increased consolidation of oil service companies with which the Company competes as well as a consolidation of customers for the Company's products and services. The Company believes this consolidation has increased competitive pressures within the industries and markets that it operates. Furthermore, the competition among energy service companies to employ the most reputable, qualified and experienced personnel is intense. There can be no assurance that the Company will be able to continue to recruit and retain highly-qualified personnel. Any difficulty in recruiting or retaining such personnel could have a material adverse effect on the Company's results of operations and financial condition.
The Company believes that its leading competitors are fully-integrated service companies, but it also competes on a regional basis with numerous smaller, independent companies that offer only relatively limited lines of products and services compared to fully-integrated competitors. Management expects competition and customer price pressures to continue for the foreseeable future.
EMPLOYEES
At January 31, 1999, the Company had 759 employees, approximately 70% of whom were located in the United States. The Company has never experienced a work stoppage and considers its employee relations to be excellent. The Company has no collective bargaining agreements.
OPERATING RISKS AND INSURANCE
The operations of the Company's customers are subject to hazards inherent in the oil and gas industry, such as fires, explosions, craterings, blowouts and oil spills, which can cause serious personal injury or loss of life, damage to or destruction of property, equipment, the environment and marine life, and suspension of operations. Claims for loss of oil and gas production and damages to formations can occur in drilling and workover operations. If a catastrophic event were to occur at a location where the Company's products or services are being provided, the Company could be named as a defendant or third-party defendant in lawsuits asserting potentially large claims. The Company maintains insurance coverage that it believes to be customary in the industry against certain of these hazards, however, such insurance provides for substantial deductibles and premium adjustments based on claims experience and excludes coverage for damages resulting from environmental damage and pollution or breach of contract or claims based on alleged fraud or deceptive trade practices. Insurance cannot provide complete protection against casualty losses. There can be no assurance that the Company will be able to maintain adequate insurance in the future at rates it considers reasonable or that insurance will continue to be available on terms as favorable as those of its existing arrangements. A claim or suit against the Company in excess of the coverage limits maintained by the Company or for which the Company is not insured could have a material adverse effect on the Company's financial condition and results of operations.
REGULATION
Various federal, state and local laws and regulations covering the release of materials into the environment, or otherwise relating to the protection of the public health and the environment, affect the Company's and its customers' domestic operations, expenses and costs. The trend in environmental regulation has been to place more restrictions and limitations on activities that may impact the environment, such as emissions of pollutants, generation and disposal of wastes, and use and handling of chemical substances. Increasingly strict environmental restrictions and limitations, as well as the obligation to remediate existing contamination, have resulted in increased operating costs for the Company and other similar businesses throughout the United States. The costs of compliance with environmental laws and regulations may continue to increase, both for the Company and its customers. In this regard,
the Resource Conservation and Recovery Act ("RCRA"), a federal statute governing the disposal of solid and hazardous wastes, includes a statutory exemption that allows oil and gas exploration and production wastes to be classified as nonhazardous waste. A similar exemption is contained in many of the state counterparts to RCRA. If oil and gas exploration and production wastes were required to be managed and disposed of as hazardous waste, either as a result of a change in RCRA or the imposition of more stringent state regulations, domestic oil and gas producers, including many of the Company's customers, could be required to incur substantial obligations with respect to such wastes. Because of the potential impact on the Company's customers, any regulatory changes that impose additional restrictions or requirements on the disposal of oil and gas wastes could adversely affect demand for the Company's products and services. In addition, the Company is subject to laws and regulations concerning occupational health and safety. The Company's international operations also are subject to international laws respecting environmental and worker safety matters in the countries in which they operate. The Company believes that it is in substantial compliance with the requirements of environmental and occupational health and safety laws and regulations, but inasmuch as such laws and regulations are frequently changed, the Company is unable to predict the ultimate impact of such laws and regulations on the Company's business. Any violation of such laws could subject the Company to fines, penalties or other liabilities.
Capital expenditures for property and equipment for environmental control facilities during fiscal 1998 were not material. Based on the Company's experience to date, the Company currently does not anticipate any material adverse effect on its results of operations or financial condition as a result of future compliance with existing environmental laws and regulations controlling the discharge of materials into the environment. However, future events, such as changes in existing laws and regulations or their interpretation, more vigorous enforcement policies of regulatory agencies, or stricter or different interpretations of existing laws and regulations, may require additional expenditures by the Company, which may be material.
PROPERTIES
The following table summarizes the Company's material owned and leased properties as of March 24, 1999:
LEGAL PROCEEDINGS
The Company is not a party to, nor is any of its property the subject of, any pending legal proceedings, other than ordinary routine litigation incidental to its business, including litigation relating to the Company's intellectual property. Each of such matters is believed to be either covered by insurance or not material in amount. The Company knows of no pending or threatened legal proceedings, or judgments entered against, any director or officer of the Company in his capacity as such.
ITEM 2.
ITEM 2. PROPERTIES
See Item 1 for information with respect to properties.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
See Item 1 for information with respect to legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the three months ended December 31, 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Class A Common Stock, constituting the only class of common equity of the Company currently outstanding that is freely tradeable, is quoted on the NASD OTC Bulletin Board (the "OTC") under the symbol "DALY". The table below provides price information for the Common Stock for the period beginning August 14, 1996, the first day of trading of the Class A Common Stock following the Company's initial public offering of the Class A Common Stock. Prior to February 9, 1999, the Company's Class A Common Stock was quoted on the Nasdaq National Market System. On February 8, 1999, the Company's Class A Common Stock was delisted and now trades on the OTC.
At March 26, 1999, the closing price for the Company's Class A Common Stock on the OTC was $0.59. At March 22, 1999, the Company's Class A Common Stock was held of record by approximately 130 persons, and, in management's estimation, beneficially owned by approximately 1,247 persons.
During the two most recent fiscal years, the Company has not paid a cash dividend on its Class A Common Stock, and it is not anticipated that any cash dividend will be paid on the Common Stock for the foreseeable future. The indenture governing the Company's 9 1/2% Senior Notes Due 2008 currently prohibits the payment of dividends.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data of the Company as of and for each of the periods indicated. The selected financial data for each of the four years in the period ended April 30, 1997, the eight months ended December 31, 1997, and the twelve months ended December 31, 1998 are derived from the Company's audited consolidated financial statements. The financial data for the twelve months ended December 31, 1997 and the eight months ended December 31, 1996 are derived from the Company's unaudited financial statements. The unaudited financial statements include all adjustments, consisting of normal recurring accruals, which the Company considers necessary for a fair presentation of the financial position and the results of operations for these periods. The information presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto included elsewhere herein. See Note 2 to Consolidated Financial Statements for a discussion of the Company's change in fiscal year.
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(1) The DWS/DAMCO Acquisition was consummated in January 1998. IDS was acquired in March 1998. The Transocean Acquisition was consummated in August 1998. The INS Acquisition was consummated in December 1998. See "Notes to Consolidated Financial Statements."
(2) ADI was acquired on June 20, 1997. See "Notes to Consolidated Financial Statements."
(3) Reorganization costs relate primarily to staff reductions, severance settlements and various costs associated with a cost reduction program implemented in June 1997 and September 1998 to flatten Dailey's management structure and streamline its operations.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
From time to time, the Company may make certain statements that contain "forward-looking" information (as defined in the Private Securities Litigation Reform Act of 1995) and that involve risk and uncertainty. Words such as "anticipate", "expect", "estimate", "project" and similar expressions are intended to identify such forward-looking statements. These forward-looking statements may include, but are not limited to, future cash flows and capital expenditure plans and information systems plans, including plans and expectations relating to the year 2000, anticipated results from current and future operations, earnings, margins, acquisitions, market trends in the oilfield services industry, including demand for the Company's drilling services and downhole tools, competition and various business trends. Forward-looking statements may be made by management orally or in writing including, but not limited to, the Managements' Discussion and Analysis of Financial Condition and Results of Operations section and other sections of the Company's filings with the Securities and Exchange Commission under the Securities Act of 1933 and the Securities Exchange Act of 1934.
Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Such forward-looking statements are subject to certain risks, uncertainties and assumptions, including without limitation those identified in this Management's Discussion and Analysis of Financial Condition and Results of Operations and in "Business and Properties" contained elsewhere in this Annual Report on Form 10-K. Should one or more of these risks or uncertainties materialize, or should any of the underlying assumptions prove incorrect, actual results of current and future operations may vary materially from those anticipated, estimated or projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates.
Among the factors that may have a direct bearing on the Company's results of operations and the oilfield services industry in which it operates are changes in the price of oil and natural gas; the impact of competitive products and pricing; the presence of competitors with greater financial resources; product demand and acceptance risks, including product obsolescence risks with respect to its downhole tools and directional drilling technology; risks associated with acquisitions including failure to successfully manage the Company's growth and integrate the operations acquired in such acquisitions; the Company's substantial leverage, including risks that available cash and cashflow from operations will be insufficient to cover future interest payments; the ability of the Company to borrow additional funds to finance capital expenditures and other necessary operating expenses; the inability of the Company to decrease certain costs due to unfavorable terms in employment agreements, leases, supply contracts, licenses and other agreements entered into by the Company; risks that the Company or its third party vendors and customers will not be Year 2000 compliant in a timely manner; typical operating risks inherent in the oilfield services industry, including risks of environmental liability; delays in receiving raw materials utilized in the manufacture and assembly of the Company's downhole tools and other difficulties in the manufacture, assembly or delivery of the Company's downhole tools, including those acquired in the Company's recent acquisitions; worldwide political stability and economic growth and other risks associated with international operations, including foreign exchange and other currency risks; and the Company's successful execution of internal operating plans, including the ability of the Company to streamline and reorganize operations in light of current market conditions to bring its cost structure in line with current industry conditions, as well as regulatory uncertainties and legal proceedings.
DETERIORATING OPERATING RESULTS AND FINANCIAL CONDITION
During 1998, the Company's results of operations and financial condition deteriorated significantly over prior year levels, and have continued to decline during the first quarter of 1999. This deterioration is a result of a combination of factors, including adverse industry conditions, failure to successfully integrate and realize anticipated benefits from acquired companies and the significant debt burden incurred by the Company in 1997 and 1998 in order to finance its acquisition strategy. The following chart sets forth financial data for the Company as of and for the twelve month periods ending on December 31, 1998 and 1997 and April 30, 1997 and 1996.
- ---------- (1) Revenues, earnings per share and cash flow from operations amounts are derived from unaudited financial information.
Industry Conditions. Demand for the Company's products and services depends to a large extent upon the level of exploration and production activity in the oil and gas industry and the industry's willingness to spend capital on drilling operations, which in turn depends in part on oil and gas prices, expectations about future prices, the cost of exploring for, producing and delivering oil and gas, the discovery rate of new oil and gas reserves, domestic and international political, military, regulatory and economic conditions and the ability of oil and gas companies to raise capital. Prices for oil and gas historically have been extremely volatile and have reacted to changes in the supply of and demand for oil and natural gas, domestic and worldwide economic conditions and political instability in oil producing countries. During 1996 and much of 1997, the oil field service industry experienced a general improvement in product demand and pricing as relatively stable and improved oil and natural gas prices combined with a strong world economy to increase exploration and development activity worldwide. This trend benefited the Company and its results during 1996 and 1997.
Beginning in late 1997, the worldwide price of oil began to decline significantly and prices for natural gas weakened. As prices for oil continued to decline throughout 1998, oil and gas companies began to curtail drilling and reduce spending on exploration and development activities, which significantly negatively impacted the Company's results of operations during 1998. As a result, the Company's revenues and operations during 1998 declined significantly from the comparable periods in 1997. Operations during 1998 also were adversely affected by work stoppages in the Gulf of Mexico for the Company's products and services as a result of adverse weather conditions. The Company views the worldwide rig count, and in particular, the rig count in the United States, as a general barometer of demand for a substantial portion of the Company's products and services. The following chart summarizes the estimated U.S. rig count and international rig count at various points over the past 15 months, as reported by Baker Hughes, Inc.
Acquisitions and Substantial Indebtedness. Beginning in late 1996, the Company implemented a growth strategy aimed at completing strategic and complementary acquisitions that would expand the products and services the Company offered to the oil and gas industry. As a result of this strategy, the Company completed various acquisitions during 1997 and 1998, the most significant of which are summarized in the table set forth below:
The Company financed these acquisitions primarily through borrowings under then-existing credit facilities and issuances of debt securities. In this regard, in August 1997, the Company issued $115 million principal amount of its $9 3/4 Senior Notes due 2007 (the "Old Notes"), from which the Company realized net proceeds of approximately $109.6 million. These net proceeds were utilized to repay outstanding borrowings under the Company's credit facility incurred to finance the Company's acquisition of ADI in June 1997, to finance capital expenditures of $24.8 million for the eight months ended December 31, 1997 and to finance a portion of the DWS/DAMCO Acquisition consummated in January 1998. On February 13, 1998, the Company issued $275 million principal amount of its 9 1/2% Senior Notes due 2008 (the "Senior Notes"). Of the $268.1 million net proceeds to the Company from the sale of the Senior Notes, approximately $127.7 million were utilized to repurchase at a premium of 111% of their principal amount all of the outstanding principal amount of the Old Notes, approximately $7.5 million was utilized to repay outstanding debt under the Company's credit facility incurred to finance a portion of the purchase price for the DWS/DAMCO Acquisition, and a portion was utilized to fund the cash portion of the purchase price for the IDS, Transocean and INS acquisitions. The remaining net proceeds from the sale of the Senior Notes have been utilized to fund capital expenditures of $49.7 million for the year ended December 31, 1998 and for general and working capital purposes. The Senior Notes require annualized interest payments of approximately $26.1 million per year. As a result of the repurchase of the Old Notes, the Company recorded an extraordinary loss in the first quarter of 1998 of approximately $17.6 million representing the excess of the purchase price for the Old Notes over their carrying value on the date of repurchase.
These transactions significantly increased the Company's debt over historical levels. The Company's increased level of indebtedness has had, and will have, several important effects on the Company's operations, including (i) a substantial portion of the Company's cash flows from operations has been and will be dedicated to the payment of interest and principal on its indebtedness, (ii) the Company's leveraged position has substantially increased its vulnerability to adverse changes in general economic and industry conditions (including current industry conditions), as well as to competitive pressure, and (iii) the Company's ability to obtain additional financing for working capital, capital expenditures and general corporate and other purposes may be limited.
Due to the continued decline in industry conditions during 1998, the Company does not believe it has yet been able to realize the anticipated benefits from each of these acquisitions, in particular the DWS/DAMCO acquisition, which was consummated in January 1998. Operations acquired in the DWS/DAMCO Acquisition also have been depressed due to the loss of market share caused by the loss of key personnel that the Company expected to, but was unable to, retain or replace in connection with the acquisition. In this regard, the 1998 revenue and cash flow from operations acquired in the DWS/DAMCO Acquisition are significantly lower than the revenues and cash flow from operations generated by DWS/DAMCO during 1997. The Company also has not yet been able to realize anticipated benefits from the IDS Acquisition due to its limited inventory of LWD units and its unanticipated inability to manufacture and produce additional LWD units in a timely manner. The Company currently is generating negative cash flow from its IDS operations.
Going Concern. In response to these adverse industry conditions, the Company began during the third quarter of 1998 to review and implement cost saving strategies to reduce its cost structure to bring it more in line with then current industry conditions, including consolidating or eliminating operations and reducing overhead. As a result of these efforts, the Company recorded a reorganization charge during 1998 of $3.4 million. The Company has continued to review methods in which it can reduce its cost structure and reduce overhead; however, the Company believes that its ability to further reduce costs is severely limited due to unfavorable terms in employment agreements, which require an aggregate of approximately $9.8 million in severance costs in the event of early termination.
In addition, the Company retained an investment bank to advise the Company on alternatives to enhance shareholder value, including acquisitions and/or divestitures of certain business. Although the Company will continue to review opportunities presented to it for the sale or divestiture of businesses, the Company currently does not have any intention of disposing of any of its assets or businesses.
Assuming no further deterioration in market conditions and demand for the Company's products and services, the Company believes its existing cash as well as its capacity to obtain additional financing from third parties will allow it to continue to finance its operations through 1999. In this regard, the Company currently has no outstanding debt other than under the Senior Notes and debt assumed in the IDS acquisition, and believes that it has capacity, utilizing all or a part of its assets as security, to borrow additional funds from a bank or other lender that will be sufficient to allow the Company to fund its operations through 1999. However, the Company currently does not have any commitment or other indication from any third party of its willingness to lend the Company such additional funds and no assurance can be given that such a financing transaction can be completed on terms acceptable to the Company. In the event the Company is unable to obtain such third party financing, the Company does not believe its cash on hand and current level of operations will be sufficient to fund its operations during 1999, in which case the Company will be required to sell assets, negotiate a restructuring of its debt obligations with the holders of its Senior Notes or seek protection under the United States bankruptcy code. Based upon the Company's significant operating losses and negative operating cash flows in recent periods and a deficiency in stockholders' equity at December 31, 1998, the Company's independent auditors issued their audit opinion on the Company's December 31, 1998 financial statements with a "going concern" qualification, indicating their concern that these conditions raise substantial doubt about the Company's ability to continue as a going concern.
Impairment of Long-Lived Assets. Statement of Financial Accounting Standards No. 121 ("SFAS No. 121") and Accounting Principles Board Opinion No. 17 ("APB No. 17") require that long-lived assets, including goodwill, be reviewed for impairment whenever events or changes in circumstances indicate the carrying value of the long-lived assets may not be recoverable. Based upon the decline in market conditions and the poor performance of acquired businesses discussed above, the Company performed an impairment review to determine whether any long-lived assets that had been recorded by it should be impaired. In performing this review, the Company considered its estimates of future undiscounted net cash flows from each of these businesses as of December 31, 1998, which estimates were based upon market conditions existing at December 31, 1998 and the size and level of activities at these businesses as of December 31, 1998. The Company also considered offers and indications of interest that it had received on these businesses during its review of strategic alternatives.
Based upon this review, the Company recorded an impairment charge of $53.0 million to reflect the impairment of unamortized goodwill and other long-lived assets. Of this amount, $31.3 million related to the full impairment of unamortized goodwill associated with the DWS/DAMCO Acquisition, $19.4 million related to the full impairment of unamortized goodwill associated with the IDS Acquisition and $2.3 million related to the impairment of capitalized information technology costs and other assets. No impairment charge was recorded with respect to goodwill recorded in connection with the ADI or Transocean acquisitions. In determining to fully impair goodwill associated with the DWS/DAMCO Acquisition, the Company determined that due to reductions in revenues caused by depressed industry conditions as well as losses of market share, which the Company had not been able to recover as of December 31, 1998, its estimates of future undiscounted net cash flows as of December 31, 1998 did not support the goodwill recovery relating to DWS/DAMCO's operations over the remaining amortization period, and accordingly, reduced the carrying value of these assets to their estimated fair value based upon current estimates and conditions. In determining to fully impair goodwill associated with the IDS Acquisition, the Company determined that the revenues and cash flows that could be generated from IDS' operations could not support the goodwill recovery relating to the acquired business over the remaining amortization period, and accordingly, reduced the carrying value of these assets to their estimated fair value based upon current estimates and conditions. Based upon the its estimates of future undiscounted future net cash flows as of December 31, 1998 for the businesses acquired in the ADI and Transocean acquisitions, as well as offers and indications of interest from third parties with respect to the purchase of such businesses, the Company determined that the goodwill associated with such acquisitions had not been impaired; however, there can be no assurance that, if depressed industry conditions continue or other events occur that cause the operations of these acquired businesses to further decline, a partial or complete impairment of goodwill associated with these acquisitions will not be required. In determining the impairment of capitalized information technology costs and other assets, the Company determined these costs were not likely to provide future economic benefit to the Company.
RESIGNATION OF OFFICERS AND OUTSIDE DIRECTORS
In August, 1998, James F. Farr resigned as CEO of the Company. Mr. Farr was later replaced by Mr. Al Kite as interim CEO. As a result of Mr. Farr's resignation, the Company incurred a severance charge of approximately $1.8 million that was included with restructuring charges in the Company's financial statements. On January 27, 1999, David Tighe resigned as CFO and as a Director and the Company recorded a severance charge of approximately $500,000 during the first quarter of 1999 relating to Mr. Tighe's resignation. In February 1999, each of the Company's outside Directors resigned from the Board of Directors. Currently, the Company's Board of Directors consists of Mr. J.D. Lawrence, Mr. Al Kite and Mr. William D. Sutton, each of which is an employee of the Company. The Company has not yet identified any individuals to replace the current vacancies on the Company's Board of Directors.
DELISTING OF SECURITIES
The Nasdaq National Market rules, which govern the listing of securities such as the Company's Class A Common Stock on the Nasdaq National Market System ("Nasdaq NMS"), require that the Company maintain a minimum bid price of $5.00 per share on its Class A Common Stock and a minimum market value for the Class A Common Stock's public float (i.e., securities not owned by officers, directors or 10% stockholders) of $15 million. The market value of the Company's Class A Common Stock has deteriorated, and, as a result, the Company no longer meets the Nasdaq NMS' standards with respect to minimum bid price or public float market value. The Company's Class A Common Stock began trading on the NASD OTC Bulletin Board on February 9, 1999.
CHANGE IN FISCAL YEAR
Effective December 31, 1997, the Company changed its fiscal year end to December 31 from April 30. The Company believes such a change allows the Company's stockholders and other investors to more easily compare the Company's operating results with those of other oil field services companies. The operating results and financial condition of the Company for the year ended December 31, 1998 represents the first full calendar year reported since the Company changed from an April 30 fiscal year. Previously reported amounts have not been restated in the consolidated financial statements. The unaudited results for the year ended December 31, 1997 have been included in this Management's Discussion and Analysis of Financial Condition and Results of Operations to assist in the analysis of the operating results of the Company. In addition, since the eighth-month period ending December 31, 1997 is not considered a full fiscal year, the Company's analysis of results of operations also includes a comparison between the twelve month periods ending April 30, 1997 and 1996.
RESULTS OF OPERATIONS
The Company currently manages its operations in two business segments: (1) downhole products and services and (2) underbalanced drilling services. Downhole products and services are comprised of the Company's directional drilling services, electric wireline services, tubing conveyed perforating services and downhole tool rentals. The Company's underbalanced drilling services were acquired through the Company's acquisition of ADI in June 1997. Revenues derived from the Company's downhole products and services are reported as rental income and sales of products and services and the direct costs associated with such operations are reported as cost of rentals and cost of products and services. Revenues and costs from the Company's underbalanced drilling services are reported as underbalanced drilling service revenue and cost of underbalanced drilling service.
The Company derives rental income from its fleet of downhole tools and, to a lesser extent, from downhole tools owned by third parties. The Company typically charges its customers a daily rental rate for downhole tools, except for its downhole drilling motors, which are rented at an hourly rate. In international markets, the Company also often charges its customers a refurbishment charge, which is included in rental income.
Revenues from sales of products and services consist of directional drilling services, lost-in-hole charges and sales of its mechanical drilling jars and, to a lesser extent, from pipeline testing operations acquired in the ADI Acquisition. Although pipeline testing operations are managed as part of the Company's underbalanced drilling segment, the Company does not believe their inclusion with operations of the Company's downhole products and services segment is material to the reporting of such segments due to the insignificant nature of these pipeline testing operations. Revenues from the acquired DWS/DAMCO operations also are reflected in sales of products and services. Revenues from services of the Company's directional drillers and MWD technicians are generally billed on a per person/per day basis for the time on assignment at the customer's drill site. Although the Company considers rentals of its downhole drilling motors and MWD equipment to be a significant part of its directional drilling services, revenues from such rentals are currently recorded as rental income for financial statement purposes. The Company's lost-in-hole revenues consist of replacement charges that its customers pay each time a downhole tool is lost-in-hole. The Company sells mechanical drilling jars in a limited number of international markets, primarily to state-owned oil and gas companies.
The Company derives underbalanced revenues from rentals of air drilling equipment used for underbalanced drilling applications, including compressors, boosters, mist pumps and related equipment, which are typically rented at an hourly or daily rate. The Company also derives underbalanced revenues by providing specially-trained personnel, who are typically billed out on a per person/per day basis, to operate its air drilling equipment.
The operating costs associated with the Company's rentals consist primarily of expenses associated with depreciation, transportation, maintenance and repair and related direct overhead. The costs associated with the Company's sales of products and services consist primarily of the undepreciated portion of the capitalized cost of its downhole tools sold or lost-in-hole and the salaries and related costs associated with the Company's directional drillers and MWD technicians and, to a lesser extent, costs associated with its pipeline testing operations. The costs associated with the Company's underbalanced drilling services consist of costs of third party rentals, repair and maintenance costs and personnel costs.
TWELVE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO THE UNAUDITED TWELVE MONTHS ENDED DECEMBER 31, 1997
Rental Income. Rental income for the year ended December 31, 1998 was $61.3 million, an increase of 5% from $58.2 million for the same period last year. Exclusive of revenues from IDS, which was acquired in March 1998, and Transocean, which was acquired in August 1998, of $3.9 million, rental revenues decreased 2% from the same period last year. Domestic rental income increased $435,000. Rental income from domestic directional drilling activities increased $3.3 million primarily from the expansion of these activities into the U.S. mid-continent region. This increase in domestic rental income was partially offset by decreased rental income of $2.8 million from downhole tools as the result of decreased demand caused by adverse industry conditions. Internationally, rental income decreased $1.4 million. This was the result of decreased directional drilling revenues of $2.3 million in Venezuela due to adverse market conditions in this region resulting in the curtailment by the Company of directional drilling activity in that area and a decrease in rental income from downhole tools primarily in Latin America and Europe of $1.3 million as a result of decreased demand due to adverse industry conditions. This decrease in international rental income was offset by increased downhole tool rental income in the Middle East, Far East and East Africa of $1.9 million and to the expansion of directional drilling activities into Thailand in the third quarter of 1998 of $150,000.
Sales of Products and Services. Sales of products and services for the year ended December 31, 1998 were $40.0 million compared to $20.5 million for the same period last year. Excluding revenues of $22.2 million associated with DWS/DAMCO, which was acquired in January 1998, Transocean, which was acquired in August 1998, and the first two quarters of 1998 for pipeline testing operations acquired in June 1997, revenues decreased $2.7 million primarily due to decreased directional revenue in Venezuela of $850,000 resulting from the decline in directional drilling activity in that region, decreased revenue from tools lost-in-hole of $1.3 million, decreased pipeline service revenues of $1.0 million and decreased sales of $352,000. This was partially offset by increased revenues from domestic directional drilling operations of $385,000, domestic downhole tool rentals of $299,000, and the expansion of directional drilling operations into Thailand of $392,000.
Underbalanced Drilling Services Revenue. Underbalanced drilling services revenue for the year ended December 31, 1998 was $31.0 million compared to $18.7 million for the same period last year resulting from the acquisition of ADI on June 20, 1997. Revenues for the last two quarters of 1998 were $15.2 million compared to $18.0 million for the same two quarters last year.
Cost of Rentals. Cost of rentals for the twelve months ended December 31, 1998 was $43.4 million, an increase of 23% from $35.3 million for the same period last year. Excluding costs associated with IDS, which was acquired in March 1998, and Transocean, which was acquired in August 1998, of $2.8 million, costs increased 15%. Margins, exclusive of IDS and Transocean, decreased from 39% for the twelve months ended December 31, 1997 to 29% for the twelve months ended December 31, 1998, primarily due to an increase in fixed costs associated with the expansion of directional drilling operations in the U.S. mid-continent region and the increased use of third party tools which typically generated lower margins as a result of expansion into new applications for the Company's directional drilling services. The margins on IDS and Transocean from their respective acquisition dates were 28% and 31%, respectively.
Cost of Products and Services. Cost of products and services for the twelve months ended December 31, 1998 was $24.4 million, which was a $12.7 million increase from the same twelve months last year. Excluding costs associated with DWS/DAMCO, which was acquired in January 1998, Transocean, which was acquired in August 1998, and the first two quarters of 1998 for pipeline testing operations, which were acquired in June 1997, of $11.6 million, costs increased $1.1 million. The margin on sales of products and services for the twelve months ended December 31, 1998, excluding the impact of acquisitions, decreased to 28% from 43% for the same twelve months last year primarily due to the hiring of additional directional drillers and MWD technicians combined with increased costs to retain qualified personnel in those positions and to decreased revenues from tools lost-in-hole.
Cost of Underbalanced Drilling Services. Cost of underbalanced drilling services for the twelve months ended December 31, 1998 was $19.6 million compared to $10.1 million for the same period last year. Excluding costs incurred during the first two quarters of 1998 for ADI, which was acquired in June 1997, costs decreased $1.2 million. Margins on underbalanced drilling services were 45% compared to 48% during the same period last year, primarily due to the increase in lower margin project management services in Venezuela during the third quarter and to start up costs associated with the expansion of underbalanced drilling services in the U.S. net of this start-up activity, margins increased to 49%.
Selling, General and Administrative. Selling, general and administrative expenses for the twelve months ended December 31, 1998 were $34.1 million, compared to $16.6 million for the same twelve months last year. Excluding costs of $12.9 million associated with ADI for the first and second quarters, DWS/DAMCO and IDS, costs increased by $5.0 million primarily as a result of increased personnel and compensation costs, increased costs related to business expansion and development activity and increased costs related to an evaluation of an enterprise-wide computer system.
Depreciation and Amortization. Depreciation and amortization expenses for the twelve months ended December 31, 1998 were $24.5 million compared to $10.3 million for the same twelve months last year. Depreciation expense increased $10.7 million due primarily to increased depreciation expense related to assets acquired in the acquisitions of ADI, DWS/DAMCO, IDS and Transocean and the increased manufacture and purchase of downhole tools and directional equipment. Amortization expense increased $3.4 million primarily as the result of the amortization of goodwill associated with these acquisitions.
Reorganization Costs. Reorganization costs for the twelve months ended December 31, 1998 were $3.4 million compared to $2.5 million for the same period last year. These costs, which were incurred in the third quarter of 1998, were primarily related to the resignation of the former chief executive officer and to the elimination of corporate leased facilities.
Non-cash Compensation. Non-cash compensation for the twelve months ended December 31, 1998 was $711,000 which was primarily related to vesting of restricted stock granted to certain executive officers of the Company on October 7, 1997 in connection with the 1997 Long-Term Incentive Plan, compared to $3.5 million for the same period last year related to the vesting of prior grants.
Research and Development. Research and development expense for the twelve months ended December 31, 1998 was $1.2 million compared to $794,000 during 1997. The increase was primarily the result of costs incurred by IDS in the development of a resistivity tool for its LWD technology.
Provision for Asset Impairment. As previously discussed, the Company recognized a $53.0 million impairment charge in 1998 primarily relating to the impairment of goodwill.
Interest Income. Interest income for the twelve months ended December 31, 1998 was $3.4 million compared to $1.6 million for the same twelve months last year. This increase in interest income was the result of interest earned on temporary, short term investments utilizing excess funds from the issuance of the Old Notes through mid-February and the Senior Notes from that date forward.
Interest Expense. Interest expense for the twelve months ended December 31, 1998 was $24.4 million compared to $5.4 million for the same twelve months last year. This increase was due to the interest on the Old Notes through mid-February and the Senior Notes from that date forward.
Income Tax Provision. Income tax expense for the twelve months ended December 31, 1998 was $2.1 million, an increase from $1.1 million for the same twelve months last year. Income tax expense exceeded the amount that would have resulted from applying the U.S. federal statutory tax rate due to foreign income taxes and withholding taxes with no offsetting benefit from U.S. net operating losses, net of valuation allowances.
Extraordinary Item. As a result of the repurchase of the Old Notes, the Company recorded an extraordinary loss in the first quarter of 1998 of approximately $17.6 million, representing the excess of the purchase price for the notes over the carrying value on the date of the repurchase.
TRANSITION PERIOD ENDED DECEMBER 31, 1997 COMPARED TO THE CORRESPONDING PERIOD ENDED DECEMBER 31, 1996
Rental Income. Rental income for the eight months ended December 31, 1997 (the "Transition Period"), was $42.5 million, an increase of 26% from $33.8 million for the corresponding period ended December 31, 1996. This increase was due primarily to increased demand for directional drilling services and related products in Latin America, the Gulf of Mexico and the U.S. Gulf Coast region, which resulted in a $4.5 million increase in rentals from MWD equipment, downhole motors and other directional drilling tools. In addition, rental income from drilling and fishing jars and slingers increased $1.6 million domestically primarily due to increased demand as the average rig count in the United States increase 21% and $2.5 million internationally, primarily in the Far East, Australia, Middle East and Europe.
Sales of Products and Services. Sales of products and services for the Transition Period ended December 31, 1997, were $15.0 million, an increase of 31% from $11.5 million for the corresponding period ended December 31, 1996. This increase was primarily the result of pipeline testing revenue of $1.5 million being included in operating results for the first time, an increase in revenue from tools lost-in-hole of $1.1 million and increased demand for directional drilling services and related products in Latin America, the Gulf of Mexico and the U.S. Gulf Coast region, which resulted in a $1.2 million increase in directional services revenue. This was partially offset by decreased sales of tools and parts of $388,000.
Underbalanced Drilling Services Revenue. Underbalanced drilling services revenue for the Transition Period ended December 31, 1997 was $18.7 million resulting from ADI revenue being included in operating results since June 20, 1997.
Cost of Rentals. Cost of rentals for the Transition Period ended December 31, 1997, was $29.6 million, an increase of 17% from $25.4 million for the corresponding period ended December 31, 1996. This increase in cost was due primarily to increased variable costs, primarily tool repair costs and commissions, associated with increased rental activity in regions where Dailey had an existing operating and administrative infrastructure. Gross margins increased from 25% for the eight months ended December 31, 1996 to 30% for the eight months ended December 31, 1997 due to the primarily fixed nature of Dailey's cost base.
Cost of Products and Services. Cost of products and services for the Transition Period ended December 31, 1997, was $9.2 million, including a $904,000 increase due to ADI being included in operating results since June 20, 1997, an increase of 49% from $6.2 million for the corresponding period ended December 31, 1996. Excluding the impact of ADI, the gross profit margin on sales of products and services for the Transition Period ended December 31, 1997 was 38% compared to 46% for the corresponding period last year. This decrease in margin was primarily due to a decrease in higher margin export sales of mechanical jars combined with increased revenues from lower margin directional drilling services.
Cost of Underbalanced Drilling Services. Cost of underbalanced drilling services for the Transition Period ended December 31, 1997 was $12.0 million resulting from ADI being included in operating results since June 20, 1997.
Selling, General and Administrative Expenses. For the Transition Period ended December 31, 1997, selling, general and administrative expenses were $14.7 million, an increase of 84% from $8.0 million for the corresponding period ended December 31, 1996. This increase was primarily the result of increased compensation expense related to salary increases and incentive compensation programs, costs related to Dailey's acquisition program, amortization of costs related to the ADI Acquisition and the inclusion of ADI in operating results since June 20, 1997. Cost savings from reorganization efforts partially offset this increase.
Reorganization Costs. Reorganization costs for the Transition Period ended December 31, 1997 were $2.5 million. In June 1997, a cost-reduction program was implemented to flatten the corporate management structure and streamline operations. The reorganization costs primarily consist of the cost of staff reductions, severance settlements and various restructuring costs.
Non-cash Compensation Expense. Non-cash compensation for the Transition Period ended December 31, 1997 was $661,000, which related to restricted stock that had been granted to certain executive officers of Dailey in connection with the 1996 IPO and the Company's 1997 Long-Term Incentive Plan (the "1997 Plan").
Research and Development Expenses. Research and development expenses for the Transition Period ended December 31, 1997, were $190,000, compared to $549,000 for the corresponding period ended December 31, 1996. This decrease is the result of having substantially completed research and development projects related to mud motors, fishing jars, and adapting fishing jars to coiled tubing operation.
Interest Income. Interest income for the Transition Period ended December 31, 1997, was $1.3 million, compared to $410,000 from the corresponding period ended December 31, 1996. This was the result of interest earned on short-term investments utilizing net proceeds from the issuance of the Old Notes in August 1997.
Interest Expense - Nonaffiliates. Interest expense to nonaffiliates for the Transition Period ended December 31, 1997 was $5.3 million compared to $486,000 for the corresponding period ended December 31, 1996. This increase was primarily the result of interest incurred on the Old Notes issued in August 1997.
Income Tax Expense. Income tax expense for the Transition Period ended December 31, 1997, was $1.3 million, a decrease of 28% from $1.8 million for the corresponding period ended December 31, 1996. This decrease was primarily the result of lower income before income taxes. This decrease was partially offset by an increase in the effective tax rate to 44% for the Transition Period from 36% for the corresponding period due to the full utilization of state net operating loss carryforwards during the year ended April 30, 1996 and the non-deductibility of goodwill recorded in connection with the ADI Acquisition.
YEAR ENDED APRIL 30, 1997 COMPARED TO YEAR ENDED APRIL 30, 1996
Rental Income. Rental income for the year ended April 30, 1997, was $49.5 million, an increase of 15% from $43.0 million for the year ended April 30, 1996. This increase was due primarily to increased demand for directional drilling services and related products in Latin America, the Gulf of Mexico and the U.S. Gulf Coast region, which resulted in a $5.8 million increase in rentals from MWD equipment, downhole motors and other directional drilling tools. In addition, domestic rental income from drilling and fishing jars and slingers increased $1.3 million which was partially offset by decreased foreign rental income from drilling and fishing jars and slingers of $892,000.
Sales of Products and Services. Sales of products and services for the year ended April 30, 1997, were $17.0 million, an increase of 6% from $16.0 million for the year ended April 30, 1996. This increase was due primarily to increased demand for directional drilling services and related products in Latin America, the Gulf of Mexico and the U.S. Gulf Coast region, which resulted in a $1.4
million increase in directional services revenue. In addition, revenues from license fees related to a proprietary directional drilling method increased by $300,000. This was partially offset by decreased sales of tools and parts of $684,000.
Cost of Rentals. Cost of rentals for the year ended April 30, 1997, was $37.7 million, an increase of 14% from $33.0 million for the year ended April 30, 1996. This increase was due primarily to the variable costs associated with an increase in rental activity, such as tool repair costs and third-party tool charges. As a percentage of rental income, cost of rentals decreased from 77% in the fiscal year ended April 30, 1996 to 76% in the fiscal year ended April 30, 1997, which reflects the fixed nature of the cost base.
Cost of Products and Services. Cost of products and services for the year ended April 30, 1997, was $8.9 million, an increase of 12% from $7.9 million for the year ended April 30, 1996. The increase was due primarily to higher personnel costs associated with an increase in directional drilling services in the Gulf of Mexico, the U.S. Gulf Coast region and Venezuela. The gross profit margin on sales of products and services for the fiscal year ended April 30, 1997 was 48% compared to 50% for the fiscal year ended April 30, 1996. This decrease in gross profit margin was due to a decrease in higher margin export sales of mechanical jars.
Selling, General and Administrative Expenses. For the year ended April 30, 1997, selling, general and administrative expenses, including a $2.8 million non-cash compensation expense, were $14.7 million, an increase of 22% from the $12.1 million for the year ended April 30, 1996. The noncash compensation expense was the result of noncash stock awards granted to certain officers pursuant to the 1996 Key Employee Stock Plan. Exclusive of these non-cash changes, selling, general and administrative expenses were $11.9 million, a 2% decrease from the fiscal year ended April 30, 1996.
Interest Income. Interest income for the year ended April 30, 1997, was $640,000, an increase of $536,000 from the year ended April 30, 1996. This was the result of interest earned on short-term investments utilizing net proceeds from the 1996 IPO.
Interest Expense -- Nonaffiliates. Interest expense to nonaffiliates for the year ended April 30, 1997 was $671,000, a decrease of 15% from $785,000 for the year ended April 30, 1996. This decrease was primarily the result of scheduled payments of principal and interest on bank debt.
Interest Expense -- Affiliate. Interest expense to affiliate for the year ended April 30, 1997, was $162,000, a 11% decrease from $182,000 for the year ended April 30, 1996. This decrease was primarily the result of the repayment of a term loan to an affiliate with proceeds from the 1996 IPO, partially offset by interest paid on a promissory note to an affiliate that was issued in connection with a dividend on June 27, 1996 and repaid with proceeds from the 1996 IPO.
Income Tax Expense. Income tax expense for the year ended April 30, 1997, was $1.5 million, an increase of 6% from $1.4 million for the year ended April 30, 1996. This increase was primarily the result of an increase in the effective tax rate to 38% for the fiscal year ended April 30, 1997 from 35% for the fiscal year ended April 30, 1996 due to the full utilization of state net operating loss carryforwards for the fiscal year ended April 30, 1996.
LIQUIDITY AND CAPITAL RESOURCES
Working Capital. Cash used in operating activities was $9.5 million during the twelve months ended December 31, 1998. The primary source of cash was the net proceeds from the issuance of the Senior Notes of $268.1 million. Principal uses of cash were to fund acquisitions (net of cash acquired) of $104.0 million, repurchase the Old Notes at a premium for $127.7 million, pay interest on the Senior Notes of $13.2 million and fund capital expenditures of $49.7 million. During the past several years, working capital requirements have been funded through cash generated from operations, additional borrowings, credit facilities, asset sales and proceeds from equity and debt offerings.
Senior Notes. The Senior Notes were issued pursuant to an indenture dated February 13, 1998 (the "Indenture"). The Indenture contains various covenants customary in such instruments, including covenants that (i) restrict the Company's ability to incur additional indebtedness; (ii) restrict the Company's ability to make restricted payments, including dividends; (iii) restrict the Company's ability to sell assets; (iv) restrict the Company's ability to grant liens on its assets; (v) limit transactions with affiliates and (vi) limit the Company's ability to engage in certain extraordinary transactions, including transactions involving a change in control of the Company or the sale of substantially all of the Company's assets. The Senior Notes are guaranteed by all of the Company's domestic subsidiaries, bear interest at 9 1/2% that is payable semi-annually on February 15 and August 15 of each year, mature on February 15, 2008 and are redeemable at the option of the Company for stipulated redemption prices on or after February 15, 2003. The issuance of the Senior Notes substantially increased the Company's level of indebtedness over historical levels. The Company's increased level of indebtedness has had, and will have several important affects on the Company's operations, including (i) a substantial portion of the Company's cash flows from operations must be dedicated to the payment of interest and principal on its indebtedness, (ii) the Company's leveraged position will substantially increase its vulnerability to adverse changes in general economic and industry conditions (including current industry conditions), as well as to competitive pressure, and (iii) the Company's ability to obtain additional financing for working capital, capital expenditures and general corporate and other purposes may be limited.
Capital Expenditures. Capital expenditures, exclusive of acquisitions, of approximately $49.7 million were made during the twelve months ended December 31, 1998. Of this amount, $40.3 million was for downhole tools, primarily MWD and other directional equipment, hydraulic drilling jars, hydraulic fishing jars and related inventory. The Company currently has budgeted capital expenditures for 1999 of $6.5 million. The level of capital expenditures in 1999 will be determined based upon a variety of factors, including the Company's assessment of future demand for its products and services, the level of cash flows being generated by the Company's operations and the success of the Company's plans for streamlining and reorganizing operations to current industry conditions and the level of funds necessary to service the Company's debt burden.
Funding of 1999 Operations. The Company believes that, assuming no further deterioration in market conditions and demand for the Company's products and services, the Company's existing cash as well as additional capacity to obtain financing from third parties will allow it to continue to finance its operations through 1999. In this regard, the Company currently has no significant outstanding debt other than under the Senior Notes and debt assumed in the IDS acquisition, and believes that it has capacity, utilizing all or a part of its assets as security, to borrow additional funds from a bank or other lender that will be sufficient to allow the Company to fund its operations through 1999. However, the Company currently does not have any commitment or other indication from any third party of its willingness to lend the Company such additional funds and no assurance can be given that such a financing transaction can be completed on terms acceptable to the Company. In the event the Company is unable to obtain such third party financing, the Company does not believe its cash on hand and current level of operations will be sufficient to fund its operations during 1999 or make the August 1999 interest payment due on the Senior Notes, in which case the Company will be required to sell assets, negotiate a restructuring of its debt obligations with the holders of its Senior Notes or seek protection under the United States bankruptcy code.
INFLATION AND FOREIGN EXCHANGE
Inflation has not had a significant impact on Dailey's comparative results of operations. For the year ended December 31, 1998, transactions conducted in United States dollars accounted for approximately 84% of the Company's total revenues. The Company believes that the percentage of its total revenues relating to transactions conducted in foreign currencies will continue to increase due to continued expansion of the Company's international operations and the DWS/DAMCO Acquisition. The Company currently does not engage in hedging transactions to protect itself against foreign currency fluctuations but rather seeks to protect itself from fluctuations in foreign currencies by accelerating conversion of such currencies into United States dollars and by continual evaluation of the Company's level of operations in such markets.
NEW ACCOUNTING PRONOUNCEMENTS
SFAS No. 130. In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income, which establishes standards for reporting and display of comprehensive income and its components. SFAS No. 130 requires that all items that are recognized under accounting standards as components of comprehensive income be reported in a financial statement displayed in equal prominence with the other financial statements. SFAS No. 130 is effective for both interim and annual periods beginning after December 15, 1997. The Company adopted the provisions on January 1, 1998.
SFAS No. 131. Also, in June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, which is effective for fiscal years beginning after December 15, 1997. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company adopted the new requirements on October 1, 1998.
SFAS NO. 133. In June 1998, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"), Accounting for Derivative Instruments and Hedging Activities, which establishes standards for the recognition and measurement of derivatives and hedging activities. SFAS No. 133 requires all derivatives to be recorded on the balance sheet at fair value and establishes "special accounting" for the following three different types of hedges: hedges of changes in the fair value of assets, liabilities, or firm commitments (referred to as fair value hedges); hedges of the variable cash flows of forecasted transactions (cash flow hedges); and hedges of foreign currency exposures of net investments in foreign operations. Changes in fair value of derivatives that do not meet the criteria of one of these three categories of hedges are included in income. SFAS No. 133 is effective for years beginning after June 15, 1999, at which time the Company will adopt this provision. The Company does not expect SFAS No. 133 to have a material effect on the Company's financial statements.
IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. As a result, those computer programs have time sensitive software that recognizes a date using "00" as the year 1900 rather than the year 2000. If not corrected, this could cause a system failure or miscalculations causing disruptions of operations, including, among other things, temporary inability to process transactions, send invoices or engage in similar normal business activities.
The Company's plan to resolve the Year 2000 issue involves the following four phases for both internal systems and operating equipment and third party systems: assessment, remediation, testing and implementation. For internal systems and operating equipment, the Company has reviewed all domestic systems and hardware and is in the process of performing the same for international systems and hardware and operating equipment. The Company estimates that it is approximately 90% complete in the assessment and remediation phases and 50% complete in the testing and implementation phases for internal systems and operating equipment. For third party systems, the Company has mailed a survey to all customers and vendors requesting evaluation of their Year 2000 issues and currently expects receipt of responses by June, 1999. The Company will compile and analyze these responses and establish appropriate action at that time.
The Company will utilize both internal and external resources to reprogram, or replace, test, and implement software and operating equipment for Year 2000 modifications. The total cost of the Year 2000 project is estimated to be $350,000 and is being
funded using existing working capital. To date, the Company has expensed approximately $39,000 related to all phases of the Year 2000 project. Of the total remaining costs, approximately $250,000 is attributable to the purchase of new software and operating equipment, which will be capitalized. The remaining $61,000 relates to repair of hardware and software and will be expensed as incurred.
The Company believes that it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the Company has not completed all phases of the Year 2000 project. Although the Company currently expects to complete its Year 2000 project prior to the millennium, in the event the Company does not complete additional phases or if such phases are ineffective in addressing the Year 2000 issue, the Company would be unable to perform certain international directional drilling operations, process international financial ledgers, and track inventory. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. In addition, if the Company's third party vendors, suppliers or customers are not Year 2000 compliant, the Company's operations could be adversely affected if such third parties cannot supply goods and services required by the Company in a timely manner, causing the Company to be unable to provide its goods and services in a timely manner or at the Company's current standards of quality, which could subject the Company to third party lawsuits and reduce demand for the Company's goods and services. In addition, demand for the Company's goods and services will be adversely affected if its customers operations are adversely affected by the Year 2000 issue. The Company could be subject to litigation for computer systems product failure, for example, equipment shutdown or failure to properly date business records. The amount of potential liability and lost revenue cannot be reasonably estimated at this time.
The Company has no contingency plans in the event it does not complete all phases of the Year 2000 program. The Company plans to evaluate the status of completion of its Year 2000 project in July 1999 and determine whether such plans are necessary.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's exposure to market risk for changes in interest rates relates primarily to the Company's long-term debt obligations. The tables below provide information about the Company's financial instruments that are sensitive to changes in interest rates.
For debt obligations, the tables below present expected cash flows and related weighted-average interest rates expected by maturity dates. The fair value of the Senior Notes is based on information provided by an investment bank at year end. The fair value of the Company's long-term bank notes and other debt are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
EXPECTED MATURITY DATE
(a) Assumes scheduled maturities are funded with available resources.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements of the Company meeting the requirements of Regulation S-X (except Section 210.305 and Article 11 thereof) are included herein on pages through hereof.
Other financial statements and schedules required under Regulation S-X, if any, are filed pursuant to Item 14, Exhibits, Financial Statement Schedules and Reports on Form 8-K of this Annual Report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
The information required by Part III, Items 10 through 13, inclusive, of Form 10-K is hereby incorporated by reference from the Company's Definitive Proxy Statement for the 1999 Annual Meeting of Stockholders, which shall be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year to which this Annual Report on Form 10-K relates.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following consolidated financial statements are filed as part of this Annual Report on Form 10-K:
All other schedules are omitted because either they are not applicable or because the required information is included in the consolidated financial statements or notes thereto.
(b) The following Exhibits are filed as part of this Annual Report on Form 10-K:
EXHIBIT NUMBER DESCRIPTION ----------- ------------------------------------------------------
3.1 -- Restated Certificate of Incorporation. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
3.2 -- Restated Bylaws of the Company. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
3.3 -- Amendment to Restated Certificate of Incorporation dated October 7, 1997. (Incorporated by reference from the Company's Registration Statement on Form S-4 (File No. 333-47345))
4.1 -- Form of Class A Common Stock Certificate. (Incorporated by reference from the Company's Registration Statement on Form S-4 (File No. 333-47345))
4.2 -- See Exhibits 3.1, 3.2 and 3.3 for provisions of the Restated Certificate of Incorporation and Restated Bylaws of the Company defining the rights of the holders of Class A Common Stock.
4.3 -- Indenture Dated February 13, 1998, by and between the Company, the Subsidiary Guarantors and the U.S. Trust Company of Texas, N.A. relating to the Company's 9 1/2% Senior Notes Due 2008. (Incorporated by reference from the Company's Registration Statement on Form S-4 (File No. 333-47345))
4.4 -- Form of Note for the Company's Senior Notes Due 2008. (Incorporated by reference from the Company's Registration Statement on Form S-4 (File No. 333-47345))
4.5 -- Registration Rights Agreement dated March 23, 1998, between the Company and the former shareholders of IDS (incorporated by reference from amendment No. 1 to the Company's registration statement on Form S-4 (file no. 333-47345)).
4.6 -- See Exhibits 10.3 through 10.5 and Exhibit 10.12 for additional instruments defining the rights of holders common stock of the Company and of long-term debt of the Company and its Subsidiaries.
10.1 -- Relationship Agreement by and between the Company and Lawrence Industries, Inc. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
10.2 -- Office Lease Agreement by and between the Company as lessee and Lawrence International, Inc. as lessor. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
10.3 -- Registration Rights Agreement by and between the Company and Lawrence Industries, Inc. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
+10.4 -- Dailey Petroleum Services Corp. 1996 Key Employee Stock Plan. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
+10.5 -- Dailey Petroleum Services Corp. 1996 Non-Employee Director Stock Option Plan. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
10.6 -- Tax Allocation Agreement by and between the Company and Lawrence Industries, Inc. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
10.7 -- Form of Indemnification Agreement between the Company and its directors. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
10.8 -- Form of Indemnification Agreement between the Company and its executive officers. (Incorporated by reference from the Company's Registration Statement on Form S-1 (File No. 333-04593))
+10.9 -- Amended Employment Agreement between the Company and William D. Sutton dated December 31, 1997. (Incorporated by reference from the Company's Registration Statement on Form S-4 (File No. 333-47345))
+10.10 -- Employment Agreement between the Company and J.D. Lawrence dated November 27, 1996. (Incorporated by reference from the Company's Quarterly Report on Form 10-Q for the three months ended January 31, 1997)
10.11 -- 1997 Long-Term Incentive Plan. (Incorporated by reference from the Company's Registration Statement on Form S-4 (File No. 333-47345))
10.12 -- Employment Agreement between the Company and John Beard, as amended
10.13 -- Employment Agreement between the Company and Al Kite
21.1 -- List of Subsidiaries of the Company. (Incorporated by reference from the Company's Registration Statement on Form S-4 (File No. 333-47345))
23.1 -- Consent of Ernst & Young LLP
27.1 -- Financial Data Schedule.
- ----------
+ Management Contract.
As permitted by Item 601(b)(4)(iii)(A) of Regulation S-K, the Company has not filed with this Annual Report certain instruments defining the rights of holders of long-term debt of the Company and its subsidiaries because the total amount of securities authorized under any of such instruments does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to furnish a copy of any such agreement to the Commission upon request.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DAILEY INTERNATIONAL INC.
By: /s/ AL KITE ------------------------------- A. E. Kite Interim Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURES
Pursuant to the requirements of Section 15 of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on the 31st day of March, 1999.
AIR DRILLING SERVICES, INC.
By: /s/ CHAMAN MALHOTRA --------------------------------- Chaman Malhotra President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities indicated on the 31st day of March, 1999.
SIGNATURES
Pursuant to the requirements of Section 15 of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on the 31st day of March, 1999.
AIR DRILLING INTERNATIONAL, INC.
By: /s/ CHAMAN MALHOTRA ----------------------------------- Chaman Malhotra President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities indicated on the 31st day of March, 1999.
SIGNATURES
Pursuant to the requirements of Section 15 of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on the 31st day of March, 1999.
DAILEY WORLDWIDE SERVICES, CORP.
By: /s/ A. E. KITE ---------------------------------- A. E. Kite President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities indicated on the 31st day of March, 1999.
SIGNATURES
Pursuant to the requirements of Section 15 of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on the 31st day of March, 1999.
DAILEY ENVIRONMENTAL REMEDIATION TECHNOLOGIES, INC.
By: /s/ A. E. KITE ---------------------------------- A. E. Kite President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities indicated on the 31st day of March, 1999.
SIGNATURES
Pursuant to the requirements of Section 15 of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on the 31st day of March, 1999.
INTERNATIONAL PETROLEUM SERVICES, INC.
By: /s/ A. E. KITE ---------------------------------- A. E. Kite President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities indicated on the 31st day of March, 1999.
SIGNATURES
Pursuant to the requirements of Section 15 of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on the 31st day of March, 1999.
COLUMBIA PETROLEUM SERVICES CORP.
By: /s/ A. E. KITE ---------------------------------- A. E. Kite President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities indicated on the 31st day of March, 1999.
SIGNATURES
Pursuant to the requirements of Section 15 of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on the 31st day of March, 1999.
DAILEY INTERNATIONAL SALES CORP.
By: /s/ A. E. KITE ---------------------------------- A. E. Kite President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities indicated on the 31st day of March, 1999.
SIGNATURES
Pursuant to the requirements of Section 15 of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on the 31st day of March, 1999.
DAILEY ENERGY SERVICES, INC.
By: /s/ A. E. KITE ---------------------------------- A. E. Kite President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the indicated on the 31st day of March, 1999.
CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of Dailey International Inc.
We have audited the accompanying consolidated balance sheets of Dailey International Inc. as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year ended December 31, 1998, the eight month period ended December 31, 1997 and for each of the two years in the period ended April 30, 1997. Our audits also included the consolidated financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Dailey International Inc. at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for the year ended December 31, 1998, eight month period ended December 31, 1997 and for each of the two years in the period ended April 30, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As more fully described in Note 1, the Company has incurred significant operating losses and negative operating cash flows in recent periods and has a deficiency in stockholders' equity at December 31, 1998. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regards to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty.
ERNST & YOUNG LLP
Houston, Texas March 29, 1999
DAILEY INTERNATIONAL INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
DAILEY INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
DAILEY INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes.
DAILEY INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
DAILEY INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
1. GOING CONCERN
In response to adverse industry conditions, the Company began during the third quarter of 1998 to review and implement cost saving strategies to reduce its cost structure to bring it more in line with then current industry conditions, including consolidating or eliminating operations and reducing overhead. As a result of these efforts, the Company recorded a reorganization charge during 1998 of $3.4 million. (See Note 17). The Company has continued to review methods in which it can reduce its cost structure and reduce overhead; however, the Company believes that its ability to further reduce costs is severely limited due to unfavorable terms in employment agreements, which require an aggregate of approximately $9.8 million in severance costs in the event of early termination.
In addition, the Company retained an investment bank to advise the Company on alternatives to enhance shareholder value, including acquisitions and/or divestitures of certain businesses. Although the Company will continue to review opportunities presented to it for the sale or divestiture of businesses, the Company currently does not have any intent of disposing of any of its assets or businesses.
Assuming no further deterioration in market conditions and demand for the Company's products and services, the Company believes its existing cash as well as its capacity to obtain additional financing from third parties will allow it to continue to finance its operations through 1999. In this regard, the Company currently has no outstanding debt other than under the Senior Notes (see Note 10) and debt assumed in the IDS acquisition (see Note 4), and believes that it has capacity, utilizing all or part of its assets as security, to borrow additional funds from a bank or other lender, that will be sufficient to allow the Company to fund its operations through 1999. However, the Company currently does not have any commitment or other indication from any third party of its willingness to lend the Company such additional funds and no assurance can be given that such a financing transaction can be completed on terms acceptable to the Company. In the event the Company is unable to obtain such third party financing, the Company does not believe its cash on hand and current level of operations will be sufficient to fund its operations during 1999, in which case the Company will be required to sell assets, negotiate a restructuring of debt obligations with the holders of its Senior Notes or seek protection under the United States bankruptcy code. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty.
2. ORGANIZATION AND PUBLIC OFFERING
The accompanying consolidated financial statements reflect the operations of Dailey International Inc. (formerly Dailey Petroleum Services Corp.), a Delaware corporation. In June 1996, Dailey Petroleum Services Corp. was merged with Dailey Corporation (which changed its name to Dailey Petroleum Services Corp.). In October 1997, Dailey Petroleum Services Corp. changed its name to Dailey International Inc., hereinafter referred to as the "Company" or "Dailey."
In October 1997, the Company changed its fiscal year end to December 31, effective December 31, 1997. For purposes of this financial statement presentation, the eight month period ended December 31, 1997 represents the transition period from May 1, 1997 (April 30, 1997 being the last fiscal year end) through December 31, 1997. The unaudited results for the eight months ended December 31, 1996 have been presented for comparative purposes.
The Company currently manages its operations in two business segments: (1) downhole products and services and (2) underbalanced drilling services. Downhole products and services are comprised of the Company's directional drilling services, electric wireline services, tubing conveyed perforating services and downhole tool rentals. The Company's underbalanced drilling services were acquired through the Company's acquisition of Air Drilling International, Inc. ("ADI") in June 1997. Founded in 1945 as a rental tool company, Dailey began offering directional drilling services in 1984 and currently provides such services in the Gulf of Mexico, the United States Gulf Coast region, and most recently, Venezuela, Louisiana and the Austin Chalk formation in Texas. In June 1997, the Company acquired ADI and, as a result, became a leading provider worldwide of air drilling services for underbalanced drilling applications. The Company operates in one business segment. In January 1998, the Company acquired the operating assets and liabilities of Directional Wireline Services, Inc. ("DWS"), DAMCO Tong Services, Inc. and DAMCO Services, Inc. (collectively, "DAMCO", and with DWS, "DWS/DAMCO"), which are headquartered in Houma, Louisiana. DWS/DAMCO provides specialized drilling, workover, completion and production services to the Gulf of Mexico and Nigerian markets. In March 1998, the Company acquired Integrated Drilling Systems, Limited ("IDS"), which is headquartered in Aberdeen, Scotland. IDS manufactures directional drilling tools. In August 1998, the Company acquired substantially all of the assets of the directional drilling business of Transocean Petroleum Technology Limited ("Transocean") located in Aberdeen, Scotland. In December 1998 Dailey, through its subsidiary Air Drilling Services, Inc., acquired 51% of International Nitrogen Services, Inc. ("INS"), a joint venture with MG Generon, Inc. The company, headquartered in Houston, Texas, provides non-cryogenic nitrogen generators and production units for use in the on-site production of nitrogen for injection in downhole drilling of oil and gas.
Prior to June 1996, Dailey was a wholly-owned subsidiary of Lawrence Industries, Inc. ("Lawrence"). In June 1996, in preparation for the initial public offering of Class A Common Stock of Dailey, Lawrence reorganized its ownership of the Company into a holding company structure through a forward triangular merger of Dailey Petroleum Services Corp., into a newly-formed, wholly-owned indirect subsidiary of Lawrence called Dailey Corporation (the "Reorganization"), which is now Dailey International Inc. The effect of the forward triangular merger has been reflected retroactively in the accompanying financial statements. In August 1996, the Company completed its initial public offering of 3,910,000 shares of Class A Common Stock (the "1996 IPO").
Dailey's Restated Certificate of Incorporation provides for three classes of stock: Class A Common Stock, Class B Common Stock and Preferred Stock. The Board of Directors is empowered to authorize the issuance of Preferred Stock in one or more series and to fix the rights, powers, preferences and limitations of each series. A holder of Class B Common Stock may convert its Class B Common Stock into Class A Common Stock at any time at the ratio of one share of Class A Common Stock for each share of Class B Common Stock. In the event of liquidation, holders of Class A Common Stock and Class B Common Stock share with each other on a ratable basis as a single class in the net assets of the Company available for distribution. In addition, shares of Class B Common Stock convert automatically into a like number of shares of Class A Common Stock upon the sale or transfer of such shares to a person or entity that is not a member of the Lawrence Group (as defined in the Company's Restated Certificate of Incorporation).
Net proceeds from the sale of the stock in the 1996 IPO were $27.6 million. The Company used $5.0 million of the proceeds from the 1996 IPO to repay the outstanding balance of a $10.0 million promissory note, which was incurred in connection with a dividend declared on June 27, 1996 (the "Dividend"). Prior to commencement of the IPO, the Company's sole stockholder contributed to the capital of the Company $5.0 million of the outstanding principal of such note. The statement of operations for the year ended April 30,
1996 includes pro forma per share data which gives effect to the number of shares from which proceeds would have been used to pay the Dividend (an additional 1,250,000 shares assuming a per share offering price of $8.00, thus earnings per share for the year ended April 30, 1996, were based on 6,610,000 shares of Common Stock outstanding). Historical earnings per share excluding the pro forma effect of the dividend was $0.49 per share for the year ended April 30, 1996.
Effective July 14, 1998, the shareholders of Dailey's Class B Common Stock changed the structure under which they owned their Class B Common Stock through a reorganization whereby the shareholders contributed all of the stock in a company controlled by the shareholders (which company's assets consisted solely of 5,000,000 shares of Class B Common Stock of Dailey) to Dailey in exchange for 5,000,000 new shares of Dailey's Class B Common Stock. As a result of these transactions, Dailey acquired the net operating loss carryforward of the company, for which an offsetting allowance was provided. These transactions had no effect on Dailey's financial position or results of operation or number of outstanding shares of Class B Common Stock.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation.
The Company has historically had significant transactions with Lawrence and its affiliates which are reflected in the accompanying consolidated financial statements on the basis established between the Company and Lawrence. See Notes 9 and 13.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all investments with maturities of three months or less when purchased to be cash and cash equivalents.
Accounts Receivable
Accounts receivable are net of allowances for doubtful accounts of $4.4 million and $1.8 million at December 31, 1998 and 1997,respectively.
Revenue-Producing Tools and Inventory
Revenue-producing tools and inventory are stated at cost utilizing the first-in, first-out method. Revenue-producing tools are depreciated on the straight-line method over their estimated useful lives of 5 to 7 years. Tools lost in hole and billed to customers and tools abandoned are included in sales of products and services and the related write-off of the tools' net book values are included in costs of products and services in the accompanying consolidated statements of operations.
Tools manufactured and assembled are transferred to revenue-producing tools as completed at the total cost of components, subassemblies, expendable parts, direct labor and indirect costs of each tool. For U.S. and certain international locations, components, subassemblies and expendable parts are capitalized as inventory and expensed as tools are repaired and maintained. Components, subassemblies and expendable parts are expensed when shipped to certain international locations.
Capitalized Interest
Interest costs for the construction of revenue-producing tools are capitalized. The Company capitalized interest costs of $1.2 million and $396,000 on work in progress for the twelve months ended December 31, 1998 and eight months ended December 31, 1997, respectively. Such amounts were not significant in other prior periods.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated primarily on the straight-line method over the estimated useful lives of 5 to 30 years for buildings and improvements, 3 to 10 years for machinery and equipment, 4 to 10 years for furniture and fixtures and 3 to 7 years for other property and equipment.
Maintenance and repairs are charged to expense as incurred. Major repairs and improvements are capitalized and depreciated. The cost and accumulated depreciation of property and equipment retired or otherwise disposed of are removed from the related accounts and any gain or loss is recognized in operations.
Investment in Joint Venture
The Company accounts for its 51% investment in INS using the equity method of accounting. The equity method is utilized due to the participating rights of the minority shareholder.
Intangible Assets
Patents and other intangibles are amortized over 5 to 17 years and goodwill is amortized over 20 to 40 years. Accumulated amortization, including goodwill amortization, was $4.0 million and $1.2 million, as of December 31, 1998 and December 31, 1997, respectively. (See Note 18).
Impairment of Long-Lived Assets
The carrying value of long-lived assets, principally revenue-producing tools, goodwill and property and equipment, is reviewed for potential impairment when events or changes in circumstance indicate that the carrying amount of such assets may not be recoverable. The determination of recoverability is made based upon the estimated undiscounted future net cash flows of the related asset. The amount of impairment, if any, is determined by comparing the carrying value of the related asset to its determined current fair value. (See Note 18).
Stock Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") establishes alternative methods of accounting and disclosure for employee stock-based compensation arrangements. The Company has elected to use the "intrinsic value based method" of accounting for its stock option plans. This method does not result in the recognition of compensation expense at the time employee stock options are granted, if the exercise price of the option equals or exceeds the fair market value of the stock at the date of grant. (See Note 16).
Income Taxes
The Company was included in the consolidated U.S. federal income tax return of Lawrence for taxable periods ending on the closing of the 1996 IPO. The Company and Lawrence are jointly and severally liable with respect to taxes related to periods prior to the 1996 IPO. The Company and its subsidiaries currently file separate income tax returns. The accompanying consolidated financial statements reflect the income tax provisions of the Company on a separate return basis for all years with no U.S. federal tax operating loss, tax credit, or foreign credit carryforwards generated prior to May 1, 1988 allocated to the Company by Lawrence.
Pursuant to the Tax Allocation Agreement entered into by the Company and Lawrence, the Company paid to Lawrence an amount equal to the federal income tax computed on the Company's (and its subsidiaries) taxable income less any tax credits generated by the Company or its subsidiaries. The Tax Allocation Agreement applies to the Company for all years in which the Company (or any predecessor) is or was included in the Lawrence consolidated federal income tax return. To the extent a state or other taxing jurisdiction requires or permits a consolidated, combined or unitary tax return to be filed by Lawrence and its affiliates and such return includes the Company, the principles expressed with respect to the consolidated federal tax allocation will apply.
Foreign Currency Exchange
The U.S. dollar is the functional currency for the majority of the Company's operations. Foreign exchange gain (loss) for the twelve months ended December 31, 1998 was $256,000, and for the eight months ended December 31, 1997 and 1996 was $296,000 and ($135,000), respectively, and for the fiscal years ended April 30, 1997 and 1996 was $19,000 and $239,000, respectively.
Earnings Per Share
The Company has reported earnings per share for all periods in accordance with Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"). Under the new requirements for calculating basic earnings per share, the dilutive effect of stock options has been excluded. The method of calculating diluted earnings
per share is similar to fully diluted earnings per share which was previously not required to be reported if the effect of the dilution was less than three percent. Earnings per share amounts for all periods have been presented, and where appropriate, restated to conform to the SFAS No. 128 requirements. SFAS No. 128 resulted in no change in restated basic earnings per share for the years ended April 30, 1997 and 1996.
Reclassifications
Certain reclassifications have been made to the eight months ended December 31, 1997 and years ended April 30, 1997 and 1996 financial statements to conform to the current year presentation.
New Accounting Pronouncements
SFAS No. 130. In June 1997, the Financial Accounting Standards Board ("the FASB") issued SFAS No. 130, "Reporting Comprehensive Income", which establishes standards for reporting and display of comprehensive income and its components. SFAS No. 130 requires that all items that are recognized under accounting standards as components of comprehensive income be reported in a financial statement displayed in equal prominence with the other financial statements. SFAS No. 130 is effective for both interim and annual periods beginning after December 15, 1997. The Company adopted the provisions on January 1, 1998.
SFAS No. 131. Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which is effective for fiscal years beginning after December 15, 1997. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company adopted the new requirements at December 31, 1998.
SFAS NO. 133. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities", which establishes standards for the recognition and measurement of derivatives and hedging activities. SFAS No. 133 requires all derivatives to be recorded on the balance sheet at fair value and establishes "special accounting" for the following three different types of hedges: hedges of changes in the fair value of assets, liabilities, or firm commitments (referred to as fair value hedges); hedges of the variable cash flows of forecasted transactions (cash flow hedges); and hedges of foreign currency exposures of net investments in foreign operations. Changes in fair value of derivatives that do not meet the criteria of one of these three categories of hedges are included in income. SFAS No. 133 is effective for years beginning after June 15, 1999, at which time the Company will adopt this provision. The Company does not expect SFAS No. 133 to have a material effect on the Company's financial statements.
4. ACQUISITIONS
ADI Acquisition: In June 1997, the Company purchased the stock of ADI (a provider of air drilling services for underbalanced drilling applications) for $46.4 million, including the repayment of approximately $16.8 million of ADI indebtedness, financed with bank debt of $45.5 million and proceeds from the Company's initial public offering in 1996. The ADI acquisition was accounted for under the purchase method of accounting. As a result, the assets and liabilities of ADI were recorded at their estimated fair market values as of the date of the ADI Acquisition. The Company recorded goodwill of approximately $21.1 million relating to the excess of the purchase price over the fair market value of ADI's assets, which will be amortized over 20 years and result in approximately $1.1 million in amortization expense per year.
DWS/DAMCO Acquisition: In January 1998, the Company acquired the operating assets and liabilities of DWS/DAMCO. The aggregate purchase price for DWS/DAMCO was $61 million financed with proceeds from a $115 million 9 3/4% senior notes offering in August 1997 and borrowings under the Company's revolving credit facility. The acquisition was accounted for under the purchase method of accounting, accordingly the assets and liabilities of DWS/DAMCO were recorded at their estimated fair market values as of the date of acquisition. The Company recorded goodwill of approximately $32.5 million relating to the excess of the purchase price over the fair market value of the assets, which was to be amortized over 25 years and result in approximately $1.2 million in amortization expense per year. Based on the Company's review of long-lived assets, including goodwill, the remaining unamortized goodwill balance of $31.3 million at December 31, 1998 was deemed to be fully impaired. (See Note 18).
IDS Acquisition: The Company acquired the outstanding capital stock of IDS in March 1998 (with additional consideration paid in July 1998 in connection with the resolution of certain contingencies) for approximately $18.8 million in cash and 1,064,000 shares of Class A Common Stock (309,516 shares were returned in July 1998), plus assumption of debt of approximately $6.5 million. The IDS Acquisition was accounted for under the purchase method of accounting. The assets and liabilities of IDS were recorded at their estimated fair market values as of the date of acquisition. The Company recorded approximately $20.3 million in goodwill, representing the excess of the purchase price over the estimated fair market value of the IDS assets, which was to be amortized over 25 years and result in additional annual amortization expense of $788,000. Based on the Company's review of long-lived assets, including goodwill, the remaining unamortized goodwill of $19.7 million at December 31, 1998 was deemed to be fully impaired. (See Note 18).
Transocean Acquisition: In August 1998, the Company acquired substantially all of the assets of the directional drilling business of Transocean located in Aberdeen, Scotland for $10 million in cash. The Company assumed certain Transocean directional contracts and operations in the North Sea and Europe. The Transocean Acquisition was accounted for under the purchase method of accounting. The assets and liabilities were recorded at their estimated fair market value as of the date of the acquisition. The Company recorded goodwill of $1.2 million relating to the excess of purchase price over the fair market value of the assets, which will be amortized over 25 years and result in approximately $48,000 in amortization expense per year. The purchase price allocation was based on preliminary estimates and may be revised at a later date.
INS Acquisition: In December 1998, the Company acquired 51% of INS for approximately $7.1 million cash, subject to a purchase price adjustment of up to $500,000 based on future earnings. INS, a joint venture with MG Generon, provides non-cryogenic nitrogen generators and production units for use in the on-site production of nitrogen for injection in downhole drilling of oil and gas wells. The joint venture is accounted for using the equity method of accounting.
The pro forma unaudited results of operations for the years ended December 31, 1998 and April 30, 1997 and the eight months ended December 31, 1997 and 1996, assuming consummation of the purchase of ADI and DWS/DAMCO as of January 1, 1997, utilizing a portion of the proceeds from the issuance of the $275 million Senior Notes, are as follows:
(a) Before extraordinary item related to ADI.
The pro forma information includes adjustments for additional depreciation and amortization expense associated with the purchase price allocation using the respective lives for goodwill and an average life of seven years for fixed assets, increased interest expense for the additional borrowings under the credit facility as if they were incurred at the beginning of the period and related adjustments for income taxes. The pro forma information is not necessarily indicative of the results of operations had the acquisition been effected on the assumed dates or the results of operations for any future period. The IDS Acquisition, Transocean Acquisition and the INS joint venture were not significant acquisitions and have not been included in the pro forma unaudited results above.
5. REVENUE-PRODUCING TOOLS AND INVENTORY
6. PROPERTY AND EQUIPMENT
7. OTHER ASSETS
8. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
9. RELATED PARTY TRANSACTIONS
The accompanying consolidated statements of operations include annual rental charges from Lawrence and from Company executives for office facilities and manufacturing and service center facilities. See Note 13.
The affiliate balances are non-interest bearing and have no fixed repayment terms.
During 1998 the Company paid an aggregate of $167,000 to relatives of, and entities controlled by, the Company's Chairman of the Board relating to miscellaneous goods and services.
The Company provided Lawrence and certain of its affiliates with various administrative and management services including cash management, accounting, tax, data processing, human resources and legal services in all periods presented. During the year ended April 30, 1996, the Company also utilized from time to time the aircraft owned by a Lawrence subsidiary. The effect of the estimated fair values of these services rendered less services received was not significant to the results of operations.
The Company participates in the "Lawrence Companies Retirement Plan", a defined contribution benefit plan, covering all Dailey employees. Contributions are determined as 50% of the employee's contribution up to 3% of the employee's total compensation. Amounts charged to benefit costs and contributed to the plan for the years ended December 31, 1998 and April 30, 1997 and 1996 totaled $527,000, $203,000 and $178,000, respectively and for the eight months ended December 31, 1997 and 1996 were $212,000 and $142,000, respectively.
10. BORROWING ARRANGEMENTS AND EXTRAORDINARY ITEM
Long-term debt consisted of the following:
Interest paid during the years ended December 31, 1998 and April 30, 1997 and 1996 was $24,429,000, $858,000 and $956,000, respectively. Interest paid for the eight months ended December 31, 1997 and 1996 was $683,000 and $658,000, respectively.
At December 31, 1998, the Company had term loans of $1.1 million with a bank, approximately $1 million of which mature in 1999. The term loans were assumed in the IDS Acquisition and bear interest at various rates ranging from 8.75% to 10.50%.
On August 19, 1997, the Company issued $115.0 million of 9 3/4% Senior Notes due 2007 at a discount of 0.785%, and a portion of the proceeds was used to repay the outstanding note payable to a bank.
On February 13, 1998, the Company issued $275 million of 9 1/2% Senior Notes due 2008 (the "Senior Notes"). Of the $268.1 million net proceeds to the Company, approximately $127.7 million were utilized to repurchase at a premium of 111% of their principal amount all of the outstanding principal amount of the Company's 9 3/4% Senior Notes (the "Old Notes") and approximately $7.5 million were utilized to repay outstanding debt under the Company's revolving credit facility. As a result of the repurchase of the Old Notes, the Company recorded an extraordinary loss of approximately $17.6 million, or $1.79 per diluted share, with no related
income tax benefit, representing the excess of the purchase price for the Old Notes over their carrying value on the date of repurchase. The Senior Notes are unsecured senior obligations of the Company. The Senior Notes are redeemable at the option of the Company on or after February 15, 2003 at stipulated redemption prices.
The Company had two letters of credit outstanding totaling $281,000 and $384,000 at December 31, 1998 and 1997, respectively.
11. INCOME TAXES
Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. A summary of the components of deferred tax liabilities and assets are as follows:
The difference between the United States statutory rate and the Company's effective income tax rate is reconciled as follows:
At December 31, 1998, the Company had foreign net operating loss carryforwards of approximately $9.1 million which can be carried forward indefinitely. A valuation allowance in the amount of $1.9 million has been recorded as the Company believes the corresponding deferred tax asset will not be realized. The Company also had approximately $54.5 million of domestic net operating loss carryforwards which
will begin to expire in 2011. Approximately $1.6 million of the domestic net operating loss carryforwards are subject to certain separate return and change in ownership limitations. Accordingly, the Company has recorded a valuation allowance of $553,000 against these net operating loss carryforwards as the Company believes that the corresponding deferred tax asset may not be realizable. In addition, the Company has recorded a valuation allowance of $31.5 million against the remaining domestic net operating loss carryforward as the Company believes the corresponding deferred tax asset may not be realizable.
The valuation allowance increased from $553,000 to $33.9 million at December 31, 1998 due to foreign and domestic operating losses generated during the year, which the Company believes may not be realizable. The valuation allowance decreased from $1.1 million to $553,000 at December 31, 1997. In connection with the Company's decision to change its fiscal year end to December 31, the Company determined that the net foreign tax credit carryforward could not be utilized and was therefore written off resulting in a $1.1 million decrease in the valuation allowance. In addition, the Company recorded a $553,000 valuation allowance against its domestic net operating loss carryforwards.
There was no income tax expense or benefits associated with the components of accumulated other comprehensive income for the year ended December 31, 1998 and the eight month period ended December 31, 1997.
No provision is made for U.S. income and foreign withholding taxes applicable to undistributed earnings of foreign subsidiaries as those earnings are considered to be permanently reinvested.
The Company is currently engaged in tax audits and appeals in various tax jurisdictions. The years covered by each audit or appeal vary considerably among legal entities. Assessments, if any, are not expected to have a material adverse effect on the financial statements.
Income taxes paid during the year ended December 31, 1998 and April 30, 1997 and 1996 were $ 785,000, $608,000 and $538,000, respectively. Income taxes paid for the eight months ended December 31, 1997 and 1996 were $2.0 million and $461,000, respectively.
12. ROYALTIES
In 1986, the Company purchased the design, patents and rights to certain hydraulic tools and entered into a royalty agreement with the seller which expires in 1999 and 2003. Royalty agreements were executed between the Company and the royalty owner in 1993 and 1994 on patents related to a double-acting drilling accelerator and improvements to hydraulic drilling jars. In March 1994, the royalty agreements were amended to cap royalties through December 1999, with the royalty percentage decreasing from January 2000 to expiration of the applicable patents. Upon expiration of the patents, no royalties will be required. For the years ended December 31, 1998 and April 30, 1997 and 1996, royalty expense was $1,068,000 $879,000 and $843,000, respectively. For the eight months ended December 31, 1997 and 1996 royalty expense was $742,000 and $608,000, respectively. The owner of the royalty was an officer of the Company until October 1994.
13. COMMITMENTS AND CONTINGENCIES
The Company leases office space, transportation equipment and other property under noncancelable operating leases with third parties and office facilities and manufacturing and service center facilities with related parties. See Note 9. Future minimum lease commitments under noncancelable operating leases at December 31, 1998 are as follows:
Rental expense under operating leases with third parties, inclusive of month-to-month rentals, totaled $4.7 million, $2.2 million and $2.4 million for the years ended December 31, 1998, and April 30, 1997 and 1996, respectively, and, with related parties, totaled $1.1 million, $915,000, and $1.3 million for the years ended December 31, 1998 and April 30, 1997 and 1996, respectively. For the eight months ended December 31, 1997 and 1996, rental expense under operating leases with third parties, inclusive of month-to-month rentals, totaled $2.7 million and $2.0 million respectively, and, with related parties, totaled $671,000 and $593,000, respectively. Rental expense is included in selling, general and administrative expenses and cost of rentals.
The Company is the defendant in various legal proceedings and claims which arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the consolidated financial statements of the Company. The Company is also the plaintiff in certain actions defending its patents and proprietary designs.
The Company has employment agreements with several of its employees. The aggregate amount of these employment agreements is approximately $9.8 million at December 31, 1998. The average remaining length of these agreements is approximately 1.5 years.
14. CONCENTRATIONS OF CREDIT RISK AND FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company is subject to credit risk and other risks inherent in international operations. Generally, in excess of 50% of the Company's receivables are due from oil and gas exploration companies and drilling contractors operating in countries other than the United States and from the Company's international agents. United States receivables are generally due from major oil and gas exploration and drilling contractors throughout the oil field areas of the United States. The Company routinely monitors its cash and receivable positions with customers and international agents.
Carrying amount and fair values: The carrying amount and estimated fair values of financial instruments are as follows:
Fair value methods: The following methods and assumptions were used in estimating fair values:
For cash and short-term financial assets, the carrying amount is a reasonable estimate of fair value due to the short maturity of those instruments.
For Senior Notes, estimated fair value is based on information provided by an investment bank at year end. The fair values of the Company's long-term bank notes and other debt are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
15. EARNINGS PER SHARE
The reconciliation of the numerator and denominator used for the computation of basic and diluted earnings per share is as follows:
Options to purchase 976,031 shares of common stock at prices from $2.06 to $13.25 per share were outstanding during the year ended December 31,1998 but were not included in the computation of diluted earnings per share because the exercise price was greater than the average market price of the common shares, and therefore, the effect would be antidilutive.
Restricted stock grants of 130,000 shares of common stock were unvested at December 31, 1998, but were not included in the computation of diluted earnings per share because their inclusion would be antidilutive.
16. STOCK OPTIONS AND AWARDS
Prior to the 1996 IPO, the Company established the 1996 Key Employee Stock Plan (the "1996 Plan") and the 1996 Non-Employee Director Stock Option Plan (the "1996 Director Plan"). Pursuant to the 1996 Plan, the Board of Directors of the Company is authorized to issue up to 900,000 shares of the Company's Class A Common Stock. On October 7, 1997, the Board of Directors approved the 1997 Long-Term Incentive Plan (the "1997 Plan"). Pursuant to the 1997 Plan, the Board of Directors of the Company is authorized to issue up to 720,000 shares of the Company's Class A Common Stock.
The Company applied Accounting Principals Board Opinion No. 25 ("APB No. 25") and related interpretations in accounting for these plans. Accordingly, no compensation cost has been recognized during the year ended December 31, 1998, eight months ended December 31,1997 and the year ended April 30, 1997 for these plans. Based on information available at the grant date, the Company estimated a five to eight year expected life for options granted during the year, volatility of .84 and risk free interest rates ranging from 4.30% to 4.78%. The Company does not presently anticipate issuing dividends in the future. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method available under SFAS No. 123, the Company's net income and earnings per share for the year ended December 31, 1998, eight months ended December 31,1997 and the year ended April 30, 1997 would have been reduced to the pro forma amounts listed below. There were no options issued in the year ended April 30, 1996.
Stock options under the Plans are for Class A Common Stock and have exercise prices equal to fair market values at dates of grant. Options issued under the 1996 Plan may not be exercised within six months of, nor after ten years from, the date of grant. Options issued under the 1996 Director Plan may not be exercised within one year of, nor after ten years from, the date of grant. Options issued under the 1997 plan may not be exercised after ten years from the date of grant. The average remaining contractual life of options outstanding is approximately nine years. Effective August 12, 1998, all options outstanding with employees which had an option price above $6.00 were repriced to $6.00. Option activity for the year ended December 31, 1998, the eight months ended December 31, 1997 and year ended April 30, 1997 was as follows:
At December 31, 1998, 515,200 of the 976,031 options outstanding were exercisable.
Immediately following the 1996 IPO, restricted stock awards totaling 360,000 shares of Class A Common Stock were granted to key officers. In October 1996, a restricted stock award of 45,000 shares of Class A Common Stock was granted to an executive officer. Awards do not require any payment by the executive officers and were to vest over a three year period. Subsequently, the Board approved accelerated vesting of the restricted stock awards which resulted in the Company recognizing $2.8 million and $478,000 in non-cash compensation expense for the year ended April 30, 1997 and the eight months ended December 31, 1997, respectively. In October 1997, restricted stock awards totaling 230,000 shares of Class A Common Stock were granted to certain officers. The awards do not require any payment by the officers and vest over a four year period. During the eight months ended December 31, 1997, the Company recognized $183,000 of non-cash compensation expense related to these awards. During 1998, the Board approved accelerated vesting of 100,000 shares of the 230,000 shares that were granted as restricted stock awards in October 1997. The non-cash compensation expense recognized by the Company for the year ended December 31, 1998 was $711,000. Restricted stock activity for the year ended December 31, 1998, the eight months ended December 31, 1997 and the year ended April 30, 1997 was as follows:
17. REORGANIZATION
Reorganization costs of $3.4 million incurred in 1998 were primarily related to the resignation of the former chief executive officer and to the consolidation of corporate leased facilities, termination of aircraft lease and other employee severance costs.
In June 1997, the Company implemented a cost reduction program to flatten its corporate management structure and streamline the Company's operations. As a result, the Company incurred a $2.5 million restructuring charge during June 1997 associated primarily with staff reductions, severance settlements and various reorganization costs.
18. IMPAIRMENT OF LONG-LIVED ASSETS
SFAS No. 121 and Accounting Principles Board Opinion No. 17 ("APB 17") require that long-lived assets, including goodwill, be reviewed for impairment whenever events or changes in circumstances indicate the carrying value of the long-lived assets may not be recoverable. Based upon depressed market conditions and the size and level of activities at each of the businesses acquired by the Company during the past two years, the Company performed an impairment review to determine whether any long-lived assets that had been recorded by it should be impaired. In performing this review, the Company considered its estimates of future undiscounted net cash flows from each of these businesses as of December 31, 1998, which estimates were based upon market conditions existing at December 31, 1998 and the size and level of activities at these business as of December 31, 1998. The Company also considered offers and indications of interest that it had received during its review of strategic alternatives.
Based upon this review, the Company recorded an impairment charge of $53.0 million to reflect the impairment of unamortized goodwill and other long-lived assets. Of this amount, $31.3 million related to the full impairment of unamortized goodwill associated with the DWS/DAMCO acquisition, $19.4 million related to the full impairment of unamortized goodwill associated with the IDS acquisition, and $2.3 million related to the impairment of capitalized information technology costs and other assets. No impairment charge was recorded with respect to goodwill recorded in connection with the ADI or Transocean acquisitions. In determining to fully impair goodwill associated with the DWS/DAMCO acquisition, the Company determined that due to reductions in revenues caused by depressed industry conditions as well as losses of market share, which it had not been able to recover as of December 31, 1998, its estimates of future undiscounted net cash flows as of December 31, 1998 and offers and indications of interest from third parties with respect to the purchase of DWS/DAMCO did not support the goodwill amortization related to DWS/DAMCO's operations over the remaining amortization period. In determining to fully impair goodwill associated with the IDS acquisition, the Company determined that the revenues and cash flows that could be generated from IDS' operations could not support the goodwill amortization relating to the acquired business over the remaining amortization period. Based on the estimated undiscounted future net cash flows as of December 31, 1998 for the businesses acquired in the ADI and Transocean acquisitions, as well as offers and indications of interest from third parties with respect to the purchase of such businesses, the Company determined that the goodwill associated with such acquisitions had not been impaired; however, there can be no assurance that, if depressed industry conditions continue or other events occur that cause the operations of these acquired businesses to further decline, a partial or complete impairment of goodwill associated with these acquisitions will not be required. In assessing the impairment of capitalized information technology costs and other assets, the Company determined these costs were not likely to provide future economic benefit to the Company. Assets have been written down to estimated fair values based on current estimates and market conditions. The Company's estimates of future cash flows and estimated fair values are based on reasonable and supportable assumptions.
19. CONSOLIDATING FINANCIAL STATEMENTS
The $275 million 9 1/2% Senior Notes due 2008 issued on February 13, 1998 are unconditionally guaranteed on a joint and several basis by certain subsidiaries of the Company. Accordingly, the following condensed consolidating balance sheets as of December 31, 1998 and 1997, and the related condensed consolidating statements of operations and cash flows for the twelve months ended December 31, 1998, and for the eight months ended December 31, 1997 and 1996, and the years ended April 30, 1997 and 1996 have been provided. The condensed consolidating financial statements herein are followed by notes which are an integral part of these statements.
CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 1998 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 1997 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1998 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE EIGHT MONTHS ENDED DECEMBER 31, 1997 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE EIGHT MONTHS ENDED DECEMBER 31, 1996 (UNAUDITED) (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED APRIL 30, 1997 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED APRIL 30, 1996 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1998 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE EIGHT MONTHS ENDED DECEMBER 31, 1997 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE EIGHT MONTHS ENDED DECEMBER 31, 1996 (UNAUDITED) (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR YEAR ENDED APRIL 30, 1997 (IN THOUSANDS)
See accompanying notes.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR YEAR ENDED APRIL 30, 1996 (IN THOUSANDS)
See accompanying notes.
A. SIGNIFICANT ACCOUNTING POLICIES
Elimination Entries
Revenues and related cost of sales have been presented net of intercompany transactions.
B. OTHER
Notes 1 through 18 should be read in conjunction with the Condensed Consolidating Financial Statements.
20. REPORTABLE SEGMENTS
The Company has two reportable segments: Downhole Products and Services and Underbalanced Drilling. The Downhole Products and Services segment primarily provides downhole hole tools for rental, directional drilling services,electric wireline and tubing conveyed perforating services and tubular testing and handling services. The Underbalanced Drilling segment provides air drilling services and underbalanced drilling equipment packages. The accounting policies used to determine the segment information are the same as those described in Note 3.
Export sales to unaffiliated customers included in domestic revenues were $406,000, $977,000 and $1.8 million in the years ended December 31, 1998 and April 30, 1997 and 1996, respectively. $430,000 for the eight month period ended December 31, 1997.
21. QUARTERLY INFORMATION
Selected unaudited quarterly data for the years ended December 31 are as follows:
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(a) Reflects the impact of non-cash compensation expense during the period of $894,000 pretax and $572,000 after tax in the third quarter and $1.9 million pretax and $1.3 million after tax in the fourth quarter.
(b) Reflects the impact of non-cash compensation expensed during the period of $185,000, $286,000, $133,000, and $107,000 pretax in the first, second, third and fourth quarters, respectively.
(c) Reflects the impact of the provision for asset impairment of $53.0 million incurred in the fourth quarter.
(d) Reflects the impact of reorganization costs of $2.4 million and $1.0 million in the third and fourth quarters, respectively.
DAILEY INTERNATIONAL INC.
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
EXHIBIT INDEX
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+ Management Contract.
As permitted by Item 601(b)(4)(iii)(A) of Regulation S-K, the Company has not filed with this Annual Report certain instruments defining the rights of holders of long-term debt of the Company and its subsidiaries because the total amount of securities authorized under any of such instruments does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to furnish a copy of any such agreement to the Commission upon request.