W-H ENERGY SERVICES INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 000-31721

W-H ENERGY SERVICES, INC.
(Exact name of Registrant as specified in its charter)

TEXAS 76-0281502
(State or other jurisdiction of (IRS Employer
Incorporation or organization) Identification No.)

10370 RICHMOND AVENUE
SUITE 990
HOUSTON, TEXAS 77042
(Address of principal executive offices and zip code)

(713) 974-9071
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

As of August 2, 2002 there were outstanding 26,233,904 shares of Common
Stock, par value $0.0001 per share, of the Registrant.

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W-H ENERGY SERVICES, INC.

INDEX

i

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

W-H ENERGY SERVICES, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

The accompanying notes are an integral part of these
consolidated financial statements.

1

W-H ENERGY SERVICES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

The accompanying notes are an integral part of these
consolidated financial statements.

2

W-H ENERGY SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

The accompanying notes are an integral part of these
consolidated financial statements.

3

W-H ENERGY SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BUSINESS ORGANIZATION

Description of Company

W-H Energy Services, Inc., a Texas corporation, and its subsidiaries
(collectively, W-H) is a diversified oilfield service company that provides
products and services used primarily for the drilling, completion and production
of oil and natural gas wells. W-H has the following three primary lines of
business: (i) drilling related products and services, which include
logging-while-drilling (LWD), measurement-while-drilling (MWD), rental tools
(including drill pipe), downhole drilling motors and drilling fluids; (ii)
completion and workover related products and services, which include cased-hole
wireline logging, perforating and rental equipment, polymers and specialty
chemicals, tubing and coiled tubing; and (iii) maintenance and safety related
products and services, which include waste management and safety equipment.

Basis of Presentation

The unaudited Consolidated Financial Statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and the instructions to Form 10-Q and Rule 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles in the United States for complete
financial statements. In the opinion of management, all necessary adjustments
(which include only normal recurring adjustments) considered necessary for a
fair presentation have been included. Operating results for the three and six
months ended June 30, 2002 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2002. For further information,
refer to the December 31, 2001 Consolidated Financial Statements and footnotes
thereto included in W-H's 2001 Annual Report on Form 10-K/A filed with the
Securities and Exchange Commission.

Accounting Policies and Procedures

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, goodwill
and intangible assets with indefinite lives are no longer amortized but are
reviewed annually (or more frequently if impairment indicators arise) for
impairment. Separable intangible assets that are not deemed to have indefinite
lives will continue to be amortized over their useful lives (but with no maximum
life). W-H adopted SFAS No. 142 on January 1, 2002 as required, and will no
longer record goodwill amortization expense. The effect of this change increased
net income by $588,000 and $1,176,000, respectively, or $0.02 and $0.05 per
share, net of tax, for the three and six months ended June 30, 2002. On a fully
diluted basis, the effect of this change was $0.02 and $0.04 per share, net of
tax for the three and six months ended June 30, 2002.

According to SFAS No. 142, companies are required to identify their
reporting units and determine the aggregate carrying values and fair values of
all such reporting units. To the extent the carrying value of a reporting unit
exceeds its relative fair value, a second step of the SFAS No. 142 impairment
test is required. This second step requires the comparison of the implied fair
value of the reporting unit goodwill to its related carrying value, both of
which must be measured by the company at the same point in time each year. Any
initial loss resulting from a goodwill impairment test must be recorded as a
change in accounting principle. W-H has performed all such assessments in
accordance with SFAS No. 142 in the first quarter of 2002 which resulted in the
Company recording no goodwill impairment expense.

Recent Accounting Pronouncements

In June 2001, SFAS No. 143, "Accounting for Asset Retirement Obligations"
was issued. The standard requires that legal obligations associated with the
retirement of long-lived intangible assets be recorded at fair value when
incurred and will be effective for W-H on January 1, 2003. The adoption of this
statement is not expected to have a material impact on W-H's consolidated
financial position, results of operations or cash flows.

In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and
64, Amendment of FASB Statement No. 13, and Technical Corrections" was issued.
This statement provides guidance on the classification of gains and losses from
the

4

extinguishment of debt and on the accounting for certain specified lease
transactions. The adoption of this statement is not expected to have a material
impact on W-H's consolidated financial position, results of operations or cash
flows.

In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" was issued. This statement provides guidance on the
recognition and measurement of liabilities associated with disposal activities
and is effective for W-H on January 1, 2003. W-H is currently reviewing the
provisions of SFAS No. 146 to determine its impact upon adoption.

2. EARNINGS PER SHARE

Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per share is computed
considering the dilutive effect of stock options and warrants. For the three and
six months ended June 30, 2002, shares of 1,563,501 and 1,517,907, respectively,
resulting from the assumed exercise of options or warrants, were added to the
denominator because the inclusion of such shares would be dilutive. For the
three and six months ended June 30, 2001, shares of 1,974,628 and 1,913,413,
respectively, resulting from the assumed exercise of options or warrants, were
added to the denominator because the inclusion of such shares would be dilutive.
For the three and six months ended June 30, 2002, shares of 115,425 and 902,825,
respectively, were excluded from the computation of earnings per common share,
because the inclusion of such shares would be anti-dilutive.

3. ACQUISITIONS

On April 25, 2002, W-H closed on the acquisition of U.S. Clay, LP. U.S.
Clay was formed to mine and market a significant sodium bentonite discovery in
West Texas. Sodium bentonite is a basic component of drilling fluids and is used
in the drilling of oil and natural gas wells. Consideration for this acquisition
was approximately $5.0 million in cash and $1.7 million in the form of
promissory notes payable.

On May 31, 2001, W-H acquired Louisiana-based Coil Tubing Services, L.L.C.
(CTS). CTS provides coiled tubing services for oil and natural gas wells located
on land, in the inland waterways and offshore through its facility in Broussard,
Louisiana. W-H acquired CTS for $33.1 million in cash, 372,340 shares of W-H
common stock and $4.5 million in convertible subordinated notes.

4. DEBT

Credit Facility

On May 31, 2001, in connection with the acquisition of CTS, W-H amended and
restated its $115 million credit facility, increasing the amount available for
borrowing to $165 million. The amended and restated credit facility consists of
a Term A and a Term B loan facility in the original amounts of $40.0 million and
$80.0 million, respectively. Additionally, the amended and restated credit
facility has a $45.0 million revolving loan commitment of which none was
outstanding at June 30, 2002. The Term A loan facility matures on October 16,
2005 and requires payments escalating from zero in the first year to $14.0
million in the fifth year. The Term B loan facility matures on April 16, 2007
and requires principal payments of $0.8 million in each of the first six years
with the outstanding balance being due on the maturity date. The revolving loan
commitment matures on October 16, 2005. At W-H's option, amounts borrowed under
the credit facility will bear interest at either a variable rate equal to the
reserve-adjusted LIBOR or an alternate base rate, plus in each case, an
applicable margin. The applicable margin ranges from 1.75% to 3.00% in the case
of a LIBOR based loan under the revolving credit facility or the Term A loan
facility and is 3.25% in the case of a LIBOR based loan under the Term B loan
facility. For alternate base rate loans, the applicable margin ranges from 0.75%
to 2.00% under the revolving credit facility and the Term A loan facility and is
2.25% under the Term B loan facility. The foregoing margins are subject to
adjustment based on a debt service coverage ratio and a leverage ratio. The
credit facility, among other things, requires that W-H maintain certain
financial ratios, limits the amount of capital expenditures that may be made and
the amount of debt that may be incurred outside of the credit facility, future
investments and restricts the ability to pay dividends. At June 30, 2002, W-H
was in compliance with these restrictive covenants.

The credit facility is secured by a lien on all of W-H's property and
assets, a pledge of all of the capital stock of W-H's material domestic
subsidiaries and a pledge of not greater than 65% of the capital stock of each
of W-H's foreign subsidiaries. In addition, the credit facility is guaranteed by
all of W-H's material domestic subsidiaries.

5

Convertible Subordinated Notes

In connection with the CTS acquisition, W-H issued $4.5 million in
convertible subordinated notes (the Notes) to eight individuals (the Sellers) as
partial consideration for the acquisition. The Notes bear interest at 9% per
annum, payment of which is due quarterly. The principal and accrued interest
matures on December 31, 2003. The Sellers may convert the Notes into shares of
common stock within 30 days of maturity at a rate of 0.0331 shares of common
stock for each $1.00 of principal, subject to adjustment based upon various
factors. W-H may redeem the Notes at its discretion at any time prior to
maturity with no prepayment penalty. However, the Sellers would have the option
to exercise the conversion feature prior to redemption. W-H has no present
intention to exercise the redemption feature.

Promissory Notes

In connection with the U.S. Clay acquisition, W-H issued a total of $1.7
million in promissory notes payable as partial consideration for the
acquisition. The notes are unsecured, do not bear interest and mature on the
earlier of April 25, 2003 or the completion of U.S. Clay's bentonite processing
facility to be located in Alpine, Texas

5. STOCK OPTIONS AND STOCK PURCHASE WARRANTS

In June 2001, W-H's shareholders approved an amendment to W-H's stock option
plan (the 1997 Option Plan) to increase the number of shares authorized for
issuance pursuant to the 1997 Option Plan to 3,750,000. Each option granted
under the 1997 Option Plan will contain such terms and conditions as may be
approved by the Board of Directors or compensation committee (the Committee). To
date, all options granted under the 1997 Option Plan vest over a four-year
period and expire ten years from the grant date. If an optionee's employment
terminates for any reason, the option may be exercised during the three month
period following such termination, but only to the extent vested at the time of
such termination. At June 30, 2002, 2,205,500 options were outstanding under the
1997 Option Plan.

Additionally, on March 29, 1999, W-H issued 900,900 options to its chief
executive officer (CEO) under a separate non-statutory option plan. The options
issued to its CEO have a 10-year term and an exercise price of $4.45 per share.
At June 30, 2002, all of these options were vested.

A summary of W-H's stock options and warrants as of June 30, 2002 and
December 31, 2001 is as follows:

Under SFAS No. 123, the fair value of each option was estimated on the date
of grant using the Black-Scholes option pricing model. The following assumptions
were used for the historical option grants: risk-free interest rates of between
4.8%-7.0%; dividend rates of zero; average expected lives of between 6.9 and 8.6
years and expected volatilities of 60.2%-65.9%. The 2,250,500 options
outstanding as of June 30, 2002 have a remaining contractual life of between 5.1
and 9.1 years.

The Black-Scholes option valuation model and other existing models were
developed for use in estimating the fair value of traded options that have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of and are highly sensitive to subjective assumptions,
including the expected stock price volatility. W-H's stock options have
characteristics significantly different from those of traded options, and
changes in the subjective input assumptions can materially effect the fair value
estimate.

6

Had compensation cost for the stock options granted to employees been
determined under SFAS No. 123, net income and basic and diluted net income per
share for the three and six months ended June 30, 2002 would have changed as
indicated in the following pro forma amounts:

W-H recorded deferred compensation totaling approximately $1.5 million for
options granted in the first quarter of 2000. The deferred compensation will be
amortized over the four-year vesting period of the individual stock options
issued. The fair value of the common stock on the date of grant was determined
based on a third-party entity valuation and taking into consideration certain
industry and company-specific factors. During the three months and six months
ended June 30, 2002, W-H recognized $101,000 and $202,000 in compensation
expense relating to these options, respectively.

6. SEGMENTS

SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" requires that companies report separately information about each
significant operating segment reviewed by the chief operating decision maker.
Management has elected to organize segments based on differences in each
segment's customers and the products and services offered without aggregating
operating segments. All segments that meet a threshold of 10% of revenues,
reported profit or loss, or combined assets are defined as significant segments.
Based on these requirements, management has identified three reportable
segments, drilling related products and services, completion and workover
related products and services, and maintenance and safety related products and
services.

Drilling Related Products and Services

The drilling related products and services segment provides products and
services used by oil and natural gas companies, drilling contractors and other
oilfield service companies for the drilling of oil and natural gas wells. These
products and services are used primarily onshore in the United States, Canada,
Brazil and the Middle East and offshore in the Gulf of Mexico, the North Sea,
the Mediterranean Sea and Brazil. This segment consists of five primary business
lines: (i) LWD; (ii) MWD; (iii) rental tools; (iv) downhole drilling motors; and
(v) drilling fluids.

Completion and Workover Related Products and Services

The completion and workover related products and services segment provides
products and services primarily to customers onshore in the Gulf Coast region
and offshore in the Gulf of Mexico. These products include: (i) wireline
logging, perforating and rental equipment; (ii) polymers and specialty
chemicals; (iii) tubing; and (iv) coiled tubing.

Maintenance and Safety Related Products and Services

The maintenance and safety related products and services segment provides
products and services primarily for refinery and petrochemical plant
applications and major and independent oil and natural gas companies, including:
(i) waste management and (ii) safety equipment.

7

W-H recognizes revenues, cost of products and services, selling, general and
administrative, and depreciation and amortization by segment. Interest expense
and other income (expense) are not monitored by segment. Summarized information
for W-H's reportable segments is contained in the following tables (in
thousands):

As of and for the three months ended June 30, 2002 (unaudited):

As of and for the three months ended June 30, 2001 (unaudited):

As of and for the six months ended June 30, 2002 (unaudited):

As of and for the six months ended June 30, 2001 (unaudited):

- --------

(a) W-H calculates EBITDA as earnings before interest income and expense,
income taxes, depreciation and amortization, and non-cash stock-based
compensation expense. EBITDA should not be considered as an alternative
to net income or any other measure of operating performance calculated in
accordance with generally accepted accounting principles. EBITDA is
widely used by financial analysts as a measure of financial performance.
W-H's calculation of EBITDA may not be comparable to similarly titled
measures reported by other companies.

8

W-H operates in the United States, the North Sea and other geographic
regions. The following is summary information by geographic region (in
thousands) (unaudited):

Revenues:

Operating Income:

Long-Lived Assets:

7. SUBSEQUENT EVENTS

On August 9, 2002, W-H closed on the acquisition of Boyd's Rental Tools.
Boyd's provides a full line of wireline rental equipment including grease
injector units, pipe recovery lubricators, air compressors, high-pressure
risers, wireline blowout preventors and flanges to the oil and natural gas
industry, primarily in the Southeastern United States and the Gulf of Mexico.
Consideration for this acquisition was approximately $14.6 million in cash and
279,287 shares of W-H common stock, of which 122,887 shares will be held in
escrow for a period of two years to satisfy any indemnification claims of W-H.

9

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD-LOOKING STATEMENTS

The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with our Consolidated Financial
Statements and related notes appearing elsewhere in this Form 10-Q. This
discussion and analysis may contain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended that involve risks,
uncertainties and assumptions. The words "believe," "expect," "plan," "intend,"
"estimate," "project," "will," "could," "may," and similar expressions are
intended to identify forward-looking statements. No assurance can be given that
actual results will not differ materially from the results discussed in the
forward-looking statements as a result of important risk factors including, but
not limited to, the current and expected future prices of crude oil and natural
gas, capital expenditures by customers, the development and implementation of
new technologies, weather conditions in offshore markets, risks associated with
the occurrence of personal injuries, loss of life, damage or destruction of
property, equipment or the environment and suspension of operations, our ability
to attract and retain skilled workers, the loss of key members of management,
competition in our industry, compliance with and developments in environmental
and other governmental regulations, the loss of the use of certain technologies,
the concentration of customers in the energy industry, our ability to
successfully integrate future acquisitions, political and economic risks, an
impairment of goodwill and restrictions on our ability to raise additional
funds. For additional discussion of these risks, please see the discussion set
forth under the heading "Factors That May Affect Future Results and Accuracy of
Forward Looking Statements" contained in our most recent Annual Report filed on
Form 10-K/A with the Securities and Exchange Commission.

GENERAL

We are a diversified oilfield service company that provides products and
services used primarily for the drilling, completion and production of oil and
natural gas wells. We have the following three primary lines of business: (i)
drilling related products and services, which include logging-while-drilling
(LWD), measurement-while-drilling (MWD), rental tools (including drill pipe),
downhole drilling motors and drilling fluids; (ii) completion and workover
related products and services, which include cased-hole wireline logging,
perforating and rental equipment, polymers and specialty chemicals, tubing and
coiled tubing; and (iii) maintenance and safety related products and services,
which include waste management and safety equipment.

OVERVIEW OF THE MARKETS FOR OUR PRODUCTS AND SERVICES

Drilling Segment

The drilling related products and services segment constituted approximately
66% of our total consolidated revenue through the first half of 2002.
Approximately 29% of our 2002 drilling segment revenue was generated in various
international locations which include Canada, the Middle East, the Mediterranean
Sea, Europe, Brazil and the North Sea. However, the most significant portion of
our drilling segment revenues is generated in the United States, including the
Gulf of Mexico. Demand for our products and services began to increase during
the fourth quarter of 1999 and further increased throughout 2000 and the first
half of 2001, primarily as a result of higher oil and natural gas prices. In
July 2001, exploration and development activity levels in the United States
peaked and began to decline primarily as a result of lower natural gas prices.
This decline continued through April 2002 and has since modestly recovered.
According to statistics published by Baker Hughes, the average number of rotary
rigs operating in the United States was 918, 1,156 and 811, respectively for
2000, 2001 and the six months ended June 30, 2002. The decline in exploration
and development activity levels in the United States has significantly impacted
our revenue and earnings generated in this key market. We anticipate that
natural gas prices will increase to levels that will stimulate an increase in
exploration and production activity, which we expect will also increase our
revenues and EBITDA. However, the extent and timing of the recovery is difficult
to predict as it will be dependent on several factors including, among others,
general economic conditions, weather, the level of natural gas in storage and
the level of natural gas production by gas producers.

Outside of the United States, the North Sea remains our second key drilling
segment market, particularly for LWD and MWD services. However, due to an
unexpected enactment of UK tax law whereby a 10% supplementary tax is due on oil
and gas profits derived from the North Sea, many of our customers have reduced
drilling activity in this region. Since the beginning of 2002, the number of
rotary rigs operating in the North Sea has declined from an average of 67 in
January 2002 to an average of 42 in July 2002. We do not expect any marked
increase in activity levels through the remainder of this year.

10

Completion Segment

This sector is our second largest business segment and provided
approximately 24% of our total consolidated revenue through the first half of
2002. Revenues and EBITDA provided by the completion segment are almost
exclusively derived from the United States and the Gulf of Mexico. Although
activity levels in the completion and workover of existing oil and natural gas
wells are undoubtedly linked to commodity prices, these endeavors are less
commodity price sensitive than those found in the drilling segment. As a result,
our completion segment has and continues to provide stability during
prolonged downturns in drilling activity. Our focus on increased capital
spending throughout 2001 and 2002, combined with our acquisition of Coil Tubing
Services, LLC in May 2001, has strengthened and further diversified this segment
of our business.

Maintenance and Safety Segment

Providing approximately 10% of our total consolidated revenue through the
first half of 2002, this segment is focused entirely in and along the Gulf Coast
region of the United States. Although somewhat seasonal in nature with higher
activity levels in the early and late portions of the year, this segment is
dependent upon the maintenance activity levels of refineries and petrochemical
plants.

RESULTS OF OPERATIONS

The following information should be read in conjunction with our
Consolidated Financial Statements and the accompanying notes presented elsewhere
in this Form 10Q.

Three Months Ended June 30, 2002 Compared to the Three Months Ended June 30,
2001

Revenues. Revenues decreased by $21.0 million, or approximately 22%, to
$73.3 million for the three months ended June 30, 2002 from $94.3 million for
the three months ended June 30, 2001. This decrease was attributable to reduced
activity levels within the oil and natural gas industry, including the effects
of softness in pricing, partially offset by the revenue contribution of CTS,
which was acquired in May 2001.

Revenues from our drilling related products and services decreased by $20.7
million, or approximately 31% to $47.0 million for the three months ended June
30, 2002 from $67.7 million for the three months ended June 30, 2001. This
decrease was primarily attributable to a reduction in drilling activity,
including the effects of softness in pricing.

Revenues from our completion and workover related products and services
decreased by $0.3 million, or approximately 1%, to $19.2 million for the three
months ended June 30, 2002 from $19.5 million for the three months ended June
30, 2001. Although revenue declined as a result of lower activity levels and
pricing, most of the decline was offset by the revenue contribution of CTS,
which was acquired in May 2001.

Revenues from our maintenance and safety related products and services
remained flat at $7.1 million for the three months ended June 30, 2002 and 2001.

Cost of Revenues. Cost of revenues decreased by $7.7 million, or
approximately 16%, to $40.4 million for the three months ended June 30, 2002
from $48.1 million for the three months ended June 30, 2001. As a percentage of
revenues, cost of revenues increased to 55.1% for the three months ended June
30, 2002 from 51.0% for the three months ended June 30, 2001. This increase was
due to the effects of softness in pricing and lower utilization of our equipment
and services during a period of reduced drilling and workover activity levels.
In addition, our cost of revenues as a percentage of revenues was negatively
impacted by our strategy of maintaining an optimal level of staffing and
infrastructure to ensure that we are capable of benefiting fully from an
increase in industry activity levels.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased by $1.9 million, or approximately 12% to $14.7
million for the three months ended June 30, 2002 from $16.6 million for the
three months ended June 30, 2001. The decrease was attributable to a reduction
in sales incentives, bonuses and marketing expenses resulting from the decreased
activity levels within the oil and natural gas industry, offset by additional
expenses attributable to the operations of CTS, which was acquired in May 2001.
As a percentage of revenues, selling, general and administrative expenses
increased to 20.1% for the three months ended June 30, 2002 from 17.6% for the
three months ended June 30, 2001, due to our strategy of maintaining an optimal
level of staffing and infrastructure to ensure that we are capable of benefiting
fully from an increase in industry activity levels.

11

Research and Development Expenses. Research and development expenses
increased by $0.5 million, or approximately 25%, to $2.5 million for the three
months ended June 30, 2002 from $2.0 million for the three months ended June 30,
2001. This increase was the result of increased research and development
spending on our MWD/LWD and related technologies. We believe it is necessary to
maintain our investment in developing new technologies during the current
downturn in drilling to ensure that we are able to benefit fully from future
increases in industry activity levels.

Depreciation and Amortization. Depreciation and amortization increased by
$1.2 million, or approximately 19%, to $7.6 million for the three months ended
June 30, 2002 from $6.4 million for the three months ended June 30, 2001. This
increase was the result of depreciation associated with our continued capital
expenditures, as well as additional depreciation and amortization due to our
acquisition of CTS.

Interest and Other Expense. Interest and other expense for the three months
ended June 30, 2002 was $1.6 million, a decrease of $0.4 million, or
approximately 20% from $2.0 million for the three months ended June 30, 2001.
This decrease was primarily due to an overall reduction of interest rates, as
well as realization of interest income from our marketable securities.

Net Income. Net income for the three months ended June 30, 2002 was $4.0
million, a decrease of $7.6 million, from the $11.6 million reported for the
three months ended June 30, 2001.

Six Months Ended June 30, 2002 Compared to the Six Months Ended June 30, 2001

Revenues. Revenues decreased by $23.6 million, or approximately 14%, to
$149.6 million for the six months ended June 30, 2002 from $173.2 million for
the six months ended June 30, 2001. This decrease was attributable to reduced
activity levels within the oil and natural gas industry, including the effects
of softness in pricing, partially offset by the revenue contribution of CTS
which was acquired in May 2001.

Revenues from our drilling related products and services decreased by $26.1
million, or approximately 21%, to $98.8 million for the six months ended June
30, 2002 from $124.9 million for the six months ended June 30, 2001. This
decrease was primarily attributable to a reduction in drilling activity,
including the effects of softness in pricing.

Revenues from our completion and workover related products and services
increased by $2.7 million, or approximately 8%, to $36.5 million for the six
months ended June 30, 2002 from $33.8 million for the six months ended June 30,
2001. Revenue increased as a result of the revenue contribution of CTS which was
acquired in May 2001, offset by the effects of lower activity levels and prices.

Revenues from our maintenance and safety related products and services
decreased by $0.2 million, or approximately 1%, to $14.3 million for the six
months ended June 30, 2002 from $14.5 million for the six months ended June 30,
2001. This decrease was primarily the result of a slight decline in activity.

Cost of Revenues. Cost of revenues decreased by $8.2 million, or
approximately 9%, to $81.5 million for the six months ended June 30, 2002 from
$89.7 million for the six months ended June 30, 2001. As a percentage of
revenues, cost of revenues increased to 54.5% for the six months ended June 30,
2002 from 51.8% for the six months ended June 30, 2001. This increase was due to
the effects of softness in pricing and lower utilization of our equipment and
services during a period of reduced drilling and workover activity levels. In
addition, our cost of revenues as a percentage of revenues was negatively
impacted by our strategy of maintaining an optimal level of staffing and
infrastructure to ensure that we are capable of benefiting fully from an
increase in industry activity levels.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $0.5 million, or approximately 2% to $30.5
million for the six months ended June 30, 2002 from $30.0 million for the six
months ended June 30, 2001. The increase was attributable to additional expenses
related to the operations of CTS which was acquired in May 2001, offset by a
reduction in sales incentives, bonuses and marketing expenses resulting from the
decreased activity levels within the oil and natural gas industry. As a
percentage of revenues, selling, general and administrative expenses increased
to 20.4% for the six months ended June 30, 2002 from 17.3% for the six months
ended June 30, 2001, due to our strategy of maintaining an optimal level of
staffing and infrastructure to ensure that we are capable of benefiting fully
from an increase in industry activity levels.

Research and Development Expenses. Research and development expenses
increased by $0.9 million, or approximately 25%, to $4.5 million for the six
months ended June 30, 2002 from $3.6 million for the six months ended June 30,
2001. This increase was the result of increased research and development
spending on our MWD/LWD and related technologies. We believe it is necessary to
maintain our investment in developing new technologies during the current
downturn in drilling to ensure that we are able to benefit fully from future
increases in industry activity levels.

12

Depreciation and Amortization. Depreciation and amortization increased by
$2.5 million, or approximately 21%, to $14.6 million for the six months ended
June 30, 2002 from $12.1 million for the six months ended June 30, 2001. This
increase was the result of depreciation associated with our continued capital
expenditures, as well as additional depreciation and amortization due to our
acquisition of CTS.

Interest and Other Expense. Interest and other expense for the six months
ended June 30, 2002 was $3.1 million, a decrease of $0.8 million, or
approximately 21% from $3.9 million for the six months ended June 30, 2001. This
decrease was primarily due to an overall reduction of interest rates as well as
realization of interest income from our marketable securities.

Net Income. Net income for the six months ended June 30, 2002 was $9.5
million, a decrease of $11.1 million, from the $20.6 million reported for the
six months ended June 30, 2001.

Recent Accounting Pronouncements

In June 2001, SFAS No. 143, "Accounting for Asset Retirement Obligations"
was issued. The standard requires that legal obligations associated with the
retirement of long-lived intangible assets be recorded at fair value when
incurred and will be effective on January 1, 2003. The adoption of this
statement is not expected to have a material impact on our consolidated
financial position, results of operations or cash flows.

In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and
64, Amendment of FASB Statement No. 13, and Technical Corrections" was issued.
This statement provides guidance on the classification of gains and losses from
the extinguishment of debt and on the accounting for certain specified lease
transactions. The adoption of this statement is not expected to have a material
impact on our consolidated financial position, results of operations or cash
flows.

In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" was issued. This statement provides guidance on the
recognition and measurement of liabilities associated with disposal activities
and is effective on January 1, 2003. We are currently reviewing the provisions
of SFAS No. 146 to determine its impact upon adoption.

LIQUIDITY AND CAPITAL RESOURCES

Our primary uses for cash are working capital, capital expenditures,
acquisitions, and principal and interest payments on indebtedness. To the extent
our cash requirements for working capital, capital expenditures, acquisitions
and principal and interest payments on indebtedness exceed cash flow from
operations, we must fund our cash requirements primarily through debt and equity
financing activities.

Working capital was $74.1 million as of June 30, 2002 and $86.9 million as
of December 31, 2001. Net cash provided by operating activities was $19.8
million and $26.0 million for the six months ended June 30, 2002 and 2001,
respectively. Decreases in working capital and cash flow from operating
activities are principally the result of decreased levels of operating activity.

Net cash used in investing activities was $21.7 million and $56.6 million
for the six months ended June 30, 2002 and 2001, respectively. Net cash used in
investing activities was principally the result of our capital expenditures
program and the acquisitions of U.S. Clay in April 2002 and CTS in May 2001.

Net cash used in financing activities was $3.1 million for the six months
ended June 30, 2002. Net cash provided by financing activities was $62.7 million
for the six months ended June 30, 2001. Net cash used in financing activities in
2002 was primarily due to the repayment of debt obligations. Net cash provided
by financing activities in 2001 was primarily from the increase in our credit
facility to finance the CTS acquisition and the proceeds obtained from our
secondary offering in the second quarter of 2001.

On June 27, 2001, we closed on a follow-on equity offering comprised of
900,000 shares of common stock offered by us and 4,600,000 shares of common
stock offered by selling shareholders at a price to the public of $24 per share.
We received approximately $19.9 million from the sale of the 900,000 shares of
common stock, after deducting underwriting fees and offering expenses; and
approximately $4.0 million in respect of the aggregate exercise price of
warrants that were sold by the selling shareholders to, and exercised by, the
underwriters. The net proceeds of the offering have been invested in short-term,
investment grade, interest-bearing securities.

13

On May 31, 2001, in connection with our acquisition of CTS, we amended and
restated our $115.0 million credit facility increasing borrowing availability to
$165.0 million. Our amended and restated credit facility includes the following
features:

o a Term A loan facility in the original amount of $40.0 million that will
amortize over five years, will mature on October 16, 2005 and will
require that we make annual principal repayments ranging from 0% of the
original loan amount in the first year of the credit facility to 35% of
the original loan amount on October 16, 2005;

o a Term B loan facility in the original amount of $80.0 million that will
amortize over six and one-half years, will mature on April 16, 2007 and
will require that we make annual principal repayments of 1% of the
original loan amount in each of the first six years of the credit
facility with the outstanding balance due on April 16, 2007; and

o a revolving credit facility of $45.0 million that may be borrowed,
prepaid and reborrowed from time to time and will mature on October 16,
2005.

At our option, amounts borrowed under the credit facility will bear interest
at either a variable rate equal to the reserve-adjusted LIBOR or an alternate
base rate, plus, in each case, an applicable margin. The applicable margin
ranges from 1.75% to 3.00% in the case of a LIBOR based loan under the revolving
credit facility or the Term A loan facility and is 3.25% in the case of a LIBOR
based loan under the Term B loan facility. For alternate base rate loans, the
applicable margin ranges from 0.75% to 2.00% under the revolving credit facility
and the Term A loan facility and is 2.25% under the Term B loan facility. The
foregoing margins are subject to adjustment based on a debt service coverage
ratio and a leverage ratio.

Our credit facility is secured by a lien on all of our property and assets,
a pledge of all of the capital stock of our material domestic subsidiaries and a
pledge of not greater than 65% of the capital stock of each of our foreign
subsidiaries. In addition, our credit facility is guaranteed by all of our
material domestic subsidiaries. The credit facility, among other things,
requires that we maintain certain financial ratios, limits the amount of capital
expenditures we may make, the amount of debt we may incur outside of the credit
facility, future investments and restricts our ability to pay dividends.
As of June 30, 2002 and December 31, 2001, we had outstanding borrowings under
our credit facility of $114.3 million and $117.7 million, respectively.

In connection with the CTS acquisition, we issued $4.5 million in
convertible subordinated notes (the Notes) to eight individuals (the Sellers) as
partial consideration for the acquisition. The Notes bear interest at 9% per
annum, payment of which is due quarterly. The principal and accrued interest
matures on December 31, 2003. The Sellers may convert the Notes into shares of
common stock within 30 days of maturity at a rate of 0.0331 shares of common
stock for each $1.00 of principal, subject to adjustment based upon various
factors. We may redeem the Notes at our discretion at any time prior to maturity
with no prepayment penalty. However, the Sellers would have the option to
exercise the conversion feature prior to redemption. We have no present
intention to exercise the redemption feature.

In connection with the U.S. Clay acquisition, we issued a total of $1.7
million in promissory notes payable as partial consideration for the
acquisition. The notes are unsecured, do not bear interest and mature on the
earlier of April 25, 2003 or the completion of U.S. Clay's bentonite processing
facility to be located in Alpine, Texas

For the six months ended June 30, 2002, we made capital expenditures,
primarily for additional rental tool inventory, additional LWD and MWD tools,
wireline equipment and coil tubing units, of $33.2 million, including
expenditures for the replacement of equipment lost in hole. In addition, we
incurred $4.5 million in research and development expenses for the six months
ended June 30, 2002. Management believes that cash generated from operations,
cash on-hand and amounts available under our revolving line of credit will
provide sufficient funds for our identified capital projects, debt service and
working capital requirements. However, part of our strategy involves the
acquisition of companies that have products and services complementary to our
existing strategic base of operations. Depending on the size of any future
acquisitions, we may require additional debt financing, possibly in excess of
the limits of the credit facility, or additional equity financing.

With the exception of the operating leases on real property and automobiles,
we have no off-balance sheet debt or other off-balance sheet financing
arrangements.

14

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk. Market risk is the potential loss arising
from adverse changes in market prices and rates. We do not enter into derivative
or other financial instruments for trading or speculative purposes. Our market
risk could arise from changes in interest rates, foreign currency exchange rates
and volatility of our stock price.

Interest Rate Risk. We are subject to market risk exposure related to
changes in interest rates. Assuming our current level of borrowings, a 100 basis
point increase in interest rates under these borrowings would increase our as
adjusted interest expense by approximately $603,000, for the six months ended
June 30, 2002.

Foreign Currency Exchange Risk. Our earnings and financial position are
affected by foreign exchange rate fluctuations. We currently do not hedge
against foreign currency translation risks, and we believe that foreign currency
exchange risk is not significant to our operations.

Stock Price Volatility. Our ability to raise capital at a reasonable cost
of capital is, in part, affected by the price of our stock. The market price of
our stock may be influenced by many factors including variations in earnings of
the company, variations in oil and natural gas prices, investor perceptions of
us and other oilfield service companies and the liquidity of the market for our
common stock.

15

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

For a description of certain previously disclosed legal proceedings to which
we are a party, please see the discussions set forth in Item 1 under the heading
"-- Licenses, Patents and Trademarks" and in Item 3 contained in our Annual
Report on Form 10-K/A filed on March 25, 2002.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The 2002 annual meeting of the shareholders of the Company was held on May
22, 2002. The purpose of the annual meeting was to elect directors to the
Company's Board of Directors. The Board of Directors is composed of six members.
At the annual meeting, each of the Company's then current directors was
re-elected. The votes cast for each nominee and the votes withheld were as
follows:

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a. Exhibits

EXHIBIT
NUMBER DESCRIPTION
------- -----------

3.1 -- Restated Articles of Incorporation of the
Company (incorporated by reference to Exhibit
3.1 of the Company's Registration Statement
No. 333-43411 on Form S-1)

3.2 -- Amended and Restated Bylaws of the Company
(incorporated by reference to Exhibit 3.2 of
the Company's Registration Statement No.
333-43411 on Form S-1)

4.1 -- Specimen Common Stock Certificate
(incorporated by reference to Exhibit 4.1 of
the Company's Registration Statement No.
333-43411 on Form S-1)

9.1 -- Amended and Restated Stockholders
Agreement, dated March 26, 1999 (incorporated
by reference to Exhibit 9.1 of the Company's
Registration Statement No. 333-43411 on Form
S-1)

10.1(a) -- Amendment No. 1 to Amended and Restated
Employment Agreement of Kenneth T. White, Jr.,
dated January 24, 2001 (incorporated by
reference to Exhibit 10.1(a) of the Company's
Annual Report on Form 10-K for the Year Ended
December 31, 2000)**

10.1(b) -- Amended and Restated Employment Agreement
of Kenneth T. White, Jr., dated March 27, 1999
(incorporated by reference To Exhibit 10.1 of
the Company's Registration Statement No.
333-43411 on Form S-1)**

10.2 -- Employment Agreement of Jeffery L. Tepera,
dated May 1, 2000, as amended (incorporated by
reference to Exhibit 10.2 Of the Company's
Registration Statement No. 333-43411 on Form
S-1)**

10.3 -- Employment Agreement of William J. Thomas
III, dated May 1, 2000 (incorporated by
reference to Exhibit 10.3 of the Company's
Registration Statement No. 333-43411 on Form
S-1)**

16

10.4 -- W-H Energy Services, Inc. 1997 Stock Option
Plan (incorporated by reference to Exhibit
10.4 of the Company's Registration Statement
No. 333-43411 on Form S-1)**

10.5 -- Warrant Agreement for Kenneth T. White,
Jr. (incorporated by reference to Exhibit
10.6 of the Company's Registration Statement
No. 333-43411 on Form S-1)

10.6 -- Non-Statutory Stock Option Agreement, dated
March 29, 1999 (incorporated by reference to
Exhibit 10.5 of the Company's Registration
Statement No. 333-43411 on Form S-1.)**

10.7 -- Warrant Agreement of William J. Thomas III
(incorporated by reference to Exhibit 10.7
of the Company's Registration Statement No.
333-43411 on Form S-1)

10.8 -- Form of Indemnification Agreement
(incorporated by reference to Exhibit 10.8 of
the Company's Registration Statement No.
333-43411 on Form S-1)**

10.9 -- Amended and Restated TJC Transaction
Advisory Agreement With TJC Management Corp.,
dated March 26, 1999 (incorporated by
reference to Exhibit 10.11 of the Company's
Registration Statement No. 333-43411 on Form
S-1)

10.10 -- Purchase and Sale Agreement by and between
W-H Energy Services, Inc. and Halliburton
Energy Services, Inc., a Halliburton Company,
dated January 22, 1999, as amended
(incorporated by reference to Exhibit 10.12 of
the Company's Registration Statement No.
333-43411 on Form S-1)

10.11 -- Amended and Restated Credit Agreement dated
as of May 31, 2001 among W-H Energy Services,
Inc., the Financial Institutions named,
therein as lenders, Credit Suisse First
Boston, as Syndication Agent, and Wells Fargo
Bank Texas, N.A., as Administrative Agent
(incorporated by reference to Exhibit 10.12 of
the Company's Registration Statement No.
333-62140 on Form S-1)

10.12 -- Employment Agreement of Ernesto Bautista,
III, dated June 1, 2000 (incorporated by
reference to Exhibit 10.15 of The Company's
Annual Report on Form 10-K for the Year Ended
December 31, 2000) **

10.13 -- Employment Agreement of Stuart J. Ford,
dated February 27, 2002 (incorporated by
reference to Exhibit 10.16 of the Company's
Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002)**

10.14 -- Rights Agreement, dated as of May 31, 2002,
between the Company and Computershare Trust
Company, Inc., as Rights Agent (incorporated
by reference to Exhibit 1 to the Company's
Registration Statement on Form 8-A filed with
the Securities Exchange Commission on June 5,
2002).

11.1 -- Computation of Per Share Earnings*

21.1 -- List of Significant Subsidiaries of the
Company*

- ----------

* Filed herewith

** Management contracts or compensatory plans or arrangements

b. REPORTS ON FORM 8-K

Form 8-K filed on April 17, 2002 (date of reported event April 12,
2002) reporting the termination of Arthur Andersen LLP as W-H's independent
public accountants and the engagement of PricewaterhouseCoopers LLP as W-H's
independent public accountants for 2002.

On June 3, 2002 the Company filed a Current Report on Form 8-K
reporting the adoption of a shareholder rights plan. The Current Report was
subsequently amended by Form 8-K/A filed on June 5, 2002.

17

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

W-H ENERGY SERVICES, INC.

Date: August 14, 2002 By: /s/ JEFFREY L. TEPERA
----------------------------------------
Jeffrey L. Tepera
Vice President, Secretary and
Chief Financial Officer
(Principal Financial Officer)

Date: August 14, 2002 By: /s/ ERNESTO BAUTISTA, III
--------------------------------------
Ernesto Bautista, III
Vice President and
Corporate Controller
(Principal Accounting Officer)

18

EXHIBIT INDEX

- ----------

* Filed herewith

** Management contracts or compensatory plans or arrangements

19