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 MARCH 31, 2005

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: 001-31346

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, as amended (the "Act") 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 [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]

As of May 2, 2005 there were outstanding 27,952,552 shares of common stock,
par value $0.0001 per share, of the registrant.
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W-H ENERGY SERVICES, INC.

INDEX

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PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

W-H ENERGY SERVICES, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER 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)
(UNAUDITED)

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)
(UNAUDITED)

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 primary lines of business:
(i) drilling related products and services, which include
logging-while-drilling, measurement-while-drilling, directional drilling,
down-hole drilling motors, rental tools (including drill pipe) and drilling
fluids; and (ii) completion and workover related products and services, which
include cased-hole wireline logging, perforating, tubing conveyed perforating
and associated rental equipment, polymers and specialty chemicals, rental tools
(including tubing) and coiled tubing.

BASIS OF PRESENTATION

The unaudited Consolidated Financial Statements have been prepared in
accordance with accounting principles generally accepted in the United States
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 accounting principles generally accepted in the United
States for complete financial statements. For further information, refer to the
Consolidated Financial Statements and footnotes thereto included in W-H's Annual
Report on Form 10-K for the year ended December 31, 2004 filed with the
Securities and Exchange Commission ("SEC"). 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 months ended March 31, 2005 are not necessarily indicative
of the results that may be expected for the year ending December 31, 2005.

DISCONTINUED OPERATIONS

In March 2004, W-H committed to the divestiture of its maintenance and
safety related products and services segment. Accordingly, this segment has been
included in the Consolidated Statements of Operations and Comprehensive Income
for 2004 as discontinued operations. In April 2004, W-H completed the sale of
Well Safe, Inc., one of the two companies that formerly comprised the
maintenance and safety related products and services segment, for cash
consideration of $28.0 million. In December 2004, W-H sold the remaining entity,
Charles Holston, Inc., that formerly comprised this segment, for consideration
of $2.0 million, consisting of $1.0 million in cash and a $1.0 million
subordinated promissory note due December 31, 2009. These sales resulted in a
loss of $5.1 million for the year ended December 31, 2004. Summary financial
results for this segment are as follows:

W-H sold Well Safe, Inc. and Charles Holston, Inc. pursuant to customary
stock purchase agreements in which it made customary representations and
warranties, agreed to customary covenants and agreed to indemnify the buyers of
these businesses for certain matters, subject to certain caps, limitations and
deductibles.

4

RECLASSIFICATIONS

Certain prior period amounts have been reclassified to conform to the
current presentation.

ACCOUNTING POLICIES AND PROCEDURES

W-H has not added to or changed its accounting policies since December 31,
2004. For a description of these policies, refer to Note 2 of the Consolidated
Financial Statements in W-H's Annual Report on Form 10-K for the year ended
December 31, 2004.

In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123R "Share-Based Payment"
("SFAS 123R"). SFAS 123R revises SFAS 123, supersedes APB No. 25 and requires
companies to recognize the cost of employee stock options and other awards of
stock-based compensation based on the fair value of the award as of the grant
date. The FASB established the beginning of the first interim or annual period
that begins after June 15, 2005 as the effective date for SFAS 123R. W-H had
planned to adopt the requirements of SFAS 123R effective January 1, 2005 and had
anticipated incurring stock-based compensation expense totaling approximately
$0.6 million in the first quarter of 2005. However, on April 14, 2005, the SEC
announced the adoption of a new rule that amended the required adoption dates
for SFAS 123R. The SEC's rule allows most larger reporting companies to
implement SFAS 123R at the beginning of their next fiscal year, instead of the
next reporting period, that begins after June 15, 2005. As a result of the SEC's
new rule, W-H plans to delay the adoption of the requirements of SFAS 123R until
the beginning of its fiscal year that begins on January 1, 2006.

2. EARNINGS PER SHARE

Basic earnings per share excludes dilution and is computed by dividing
income from continuing and discontinued operations 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 restricted shares. For the three months ended March 31,
2005 and 2004, shares of 903,474 and 711,966, respectively, resulting from the
assumed exercise of outstanding options and the existence of outstanding
restricted shares were added to the denominator because the inclusion thereof
would be dilutive. For the three months ended March 31, 2005 and 2004, shares of
zero and 2,053,550, respectively, resulting from the assumed exercise of
outstanding options and the existence of outstanding restricted shares were
excluded from the computation of earnings per common share, because the
inclusion thereof would be anti-dilutive.

3. INVENTORY

The components of inventories as of March 31, 2005 and December 31, 2004
are as follows (in thousands):

4. DEBT

CREDIT FACILITY

As of March 31, 2005, W-H had an outstanding loan balance of $200.0 million
and approximately $5.6 million in letters of credit issued under its credit
facility, leaving W-H with available borrowing capacity on such date of $31.9
million. As more fully described in Note 8 below, W-H entered into an amendment
to

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its credit facility on May 5, 2005. The following description of the credit
facility does not give effect to such amendment.

The credit facility bears interest, at W-H's election, at either a variable
rate equal to LIBOR, plus a margin ranging from 1.5% to 2.5% depending upon
W-H's leverage ratio, or an alternate base rate equal to the higher of (1) the
prime rate or (2) the federal funds rate plus 0.5%, plus a margin ranging from
0.5% to 1.5% depending upon W-H's leverage ratio. As of March 31, 2005, W-H had
elected to pay interest on its outstanding borrowings at LIBOR plus the then
applicable margin of 2.0%. The credit facility matures on June 30, 2009.

The credit facility is secured by a lien on substantially all of W-H's
property and assets, a pledge of all the capital stock of W-H's domestic
subsidiaries and a pledge of not greater than 65% of the capital stock of each
of W-H's top tier foreign subsidiaries. In addition, the credit facility is
guaranteed by all of W-H's domestic subsidiaries. The credit facility requires,
among other things, that W-H maintain certain financial ratios, including a
leverage ratio and a debt service coverage ratio, and a specified net worth. The
credit facility further limits the amount of capital expenditures W-H may make,
the amount of debt W-H may incur outside of the credit facility, the amount of
future investments W-H may make, the ability of W-H to pay dividends and the
ability of W-H to engage in certain business combination transactions.

Financing costs associated with the credit facility were approximately $1.6
million, which are being ratably amortized to interest expense over the five
year term of the credit facility. As a result of the repayment of W-H's previous
credit facility, W-H expensed approximately $3.1 million in financing costs
during the second quarter of 2004 that had previously been deferred.

5. STOCK OPTIONS

A summary of W-H's stock options as of March 31, 2005 and December 31, 2004
is as follows:

The fair value of each option was estimated on the date of grant using the
Black-Scholes option valuation model. The following assumptions were used for
the historical option grants: risk-free interest rate of 4.5%; dividend rates of
zero; average expected life of 5.7 years and expected volatility of 50.3%. The
3,575,833 options outstanding as of March 31, 2005 have a weighted average
remaining contractual life of 6.8 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 affect the fair value
estimate.

6

Had compensation expense for the stock options granted to employees and
directors been determined using the fair value method, net income and diluted
net income per share for the three months ended March 31, 2005 and 2004,
respectively would have been reduced to the following pro forma amounts:

6. INCOME TAXES

In December 2004, the FASB published the following two final FASB Staff
Positions, effective immediately. FAS 109-1, "Application of FASB Statement No.
109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004," giving guidance
on applying FASB Statement No. 109, Accounting for Income Taxes, to the tax
deduction on qualified production activities provided by the American Jobs
Creation Act of 2004. FAS 109-2 "Accounting and Disclosure Guidance for that
Foreign Earnings Repatriation Provision within the American Jobs Creation Act of
2004" provides guidance on the Act's repatriation provision. W-H is in the
process of reviewing the FAS 109-1 and FAS 109-2; however, at this time, W-H
does not believe that the adoption of FAS 109-1 or FAS 109-2 will have a
material impact on our consolidated financial position, results of operations or
cash flows.

7. OPERATING SEGMENTS

Management has elected to aggregate W-H's business unit segments based on
the differences in each segment's customers, the products and services offered
and other economic characteristics. Based on these criteria, management has
identified the following reportable segments: (i) drilling related products and
services and (ii) completion and workover related products and services. The
accounting policies of the operating segments are the same as those described in
the summary of significant accounting policies in W-H's Annual Report on Form
10-K for the year ended December 31, 2004.

DRILLING RELATED PRODUCTS AND SERVICES

The drilling 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 throughout North America and in select areas internationally. This
segment includes the following business lines: (i) logging-while-drilling; (ii)
measurement-while-drilling; (iii) directional drilling; (iv) down-hole drilling
motors; (v) rental tools (including drill pipe) and (vi) drilling fluids.

7

COMPLETION AND WORKOVER RELATED PRODUCTS AND SERVICES

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

SUMMARY INFORMATION

W-H recognizes revenues, operating income, depreciation and amortization
expense, total assets and capital expenditures 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 March 31, 2005 (unaudited):

As of and for the three months ended March 31, 2004 (unaudited):

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

8

LONG-LIVED ASSETS

8. SUBSEQUENT EVENTS

On April 17, 2005, a Houston warehouse and facility operated by Superior
Packaging & Distribution, L.P. ("Superior"), a W-H subsidiary, was destroyed in
a fire. The facility was closed at the time and there were no persons at the
facility that suffered injuries as a result of the fire. The cause of the fire
is not yet known. W-H expects that Superior will incur, primarily in the second
quarter of 2005, a variety of costs, including clean-up and debris removal
costs, associated with the fire. W-H believes that a majority of the costs and
expenses that Superior incurs in connection with this event will be covered by
insurance, but the precise nature and extent of insurance coverage for this
incident is still being evaluated.

On May 5, 2005, W-H entered into a First Amendment to its credit facility
(the "First Amendment"). The First Amendment, among other things, increased the
amount W-H may borrow under its credit facility to $375.0 million from $237.5
million, extended the maturity date to May 5, 2010 from June 30, 2009, improved
certain of the pricing terms associated with the credit facility and relaxed
certain of the operational and financial covenants imposed by the credit
facility.

9

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

FORWARD-LOOKING STATEMENTS

In addition to historical information, this report contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934 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. Actual results may differ
materially from the results discussed in the forward-looking statements as a
result of important risk factors including, but not limited to, trends in oil
and natural gas prices, capital expenditures by customers, oil and natural gas
industry activity, difficulty in continuing to develop, produce and
commercialize technologically advanced products and services, weather conditions
in offshore markets, risks associated with events that result in personal
injuries, loss of life, damage to or destruction of property, equipment or the
environment and suspension of operations, unavailability of or costs associated
with insurance, 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, loss of 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, as well as 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 with the Securities and Exchange Commission ("SEC").

OVERVIEW OF OUR PRODUCTS AND SERVICES

We provide drilling related products and services and completion and
workover related products and services to major and independent oil and natural
gas companies, drilling contractors and other oilfield service companies. The
majority of our revenues are generated from charging our customers day rates,
based on the number of days our products and services are used. We also sell
certain products used in the exploration for and production of oil and natural
gas and receive revenues from our customers in connection with these sales. Our
primary expenses are salaries for our personnel and the costs associated with
expendable parts and supplies, research and development, repair and maintenance
of equipment and costs of products sold as well as general operational costs.

Prices for oil and natural gas are subject to large fluctuations in
response to relatively minor changes in the supply of and demand for oil and
natural gas, market uncertainty and a variety of other factors. Any prolonged
increase or decrease in oil and natural gas prices affects the levels of
exploration, development and production activity as well as the entire health of
the oil and natural gas industry. Demand for our drilling related products and
services is directly affected by the level of exploration, development and
production activity of, and the corresponding capital spending by, oil and
natural gas companies. Demand for our completion and workover related products
and services depends more on oil and natural gas production activity, which is
less immediately affected by changes in oil and natural gas prices.

DRILLING RELATED PRODUCTS AND SERVICES

Revenue from our drilling related products and services segment constituted
approximately 64% of our consolidated revenue in the first quarter in 2005.
Approximately 84% of our drilling segment revenue for the first quarter of 2005
was generated in the United States, including the Gulf of Mexico. The remaining
16% was generated in various international locations.

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, at which point the United
States drilling rig count levels reached a low of 738, which was comprised of
110 offshore rigs and 628 land rigs. As natural gas prices climbed and remained
relatively strong, rig count levels began to recover in 2003 and this recovery
continued through the first quarter of 2005. This increase, however, resulted
almost entirely from an increase in land-based rigs. According to statistics
published by Baker Hughes, the average number of rotary rigs operating in the
United States was 1,032, 1,192 and 1,283 for 2003,

10

2004 and the three months ended March 31, 2005, respectively. Of these figures,
land rigs comprised 924, 1,095 and 1,183, respectively, and offshore rigs
comprised 108, 97 and 100, respectively, for the same periods.

The recovery in exploration and development activity levels in the United
States has impacted our revenue and earnings generated in this market. Although
the overall rig count in the United States has increased each of the last nine
consecutive quarters, the offshore rig count has not responded in the same
manner. In fact, the average offshore rig count during the first quarter of
2005, while 3% higher than the same period in the prior year, was approximately
19% lower than the preceding five year average for the same period. The offshore
rig count did improve modestly in the fourth quarter of 2004 and into early
2005, but has since retreated to the level of mid-2004 activity. Whether this
trend will continue throughout 2005 is unclear at this time. We do believe that
the overall outlook for domestic natural gas exploration and development
activity remains positive as natural gas production has yet to respond to the
higher level of natural gas prices and higher rig counts. This factor should
keep upward pressure on natural gas prices.

Outside of the United States, the North Sea remains our largest drilling
segment market. According to statistics published by Baker Hughes, the number of
rotary rigs operating in the North Sea declined from an average of 67 in January
2002 to an average of 44 in March 2005, after having reached a low of 31 in July
2004. We expect a modest increase in activity levels in the North Sea in the
near term.

As the primary area of improvement in drilling activity in the United
States has been onshore, the importance of improving our market share for
land-based services became critical. We started to see this trend developing
and, in October 2002, we made a strategic decision to enter the directional
drilling business in North America. As a result of this decision and the growth
in the United States land rig count, we have successfully leveraged our new
directional drilling business to effect an increase in the utilization of our
measurement-while-drilling and down-hole drilling motor fleet. The increased
utilization of our measurement-while-drilling and down-hole drilling motor fleet
has helped to offset decreases in utilization of our higher margin
logging-while-drilling fleet, which is primarily driven by the United States
offshore rig count.

Another key challenge that our drilling related products and services
segment faces is the demand by our customers for more efficient and
technologically advanced services and tools. We have invested a substantial
amount of our time and capital into developing and commercializing technologies
that are of value to our customers and that enable us to compete effectively
with the major integrated oilfield service companies. During the third quarter
of 2004, we began to market our PathMaker(R) 12 1/4" 3-Dimensional Rotary
Steerable technology. We expect commercialization of the 3-Dimensional Rotary
Steerable technology to improve the utilization of our logging-while-drilling,
measurement-while-drilling and directional drilling services, as our customers
are increasingly requiring this type of technology as a prerequisite for a
drilling project or contract. We are currently developing a PathMaker(R) 8 1/2"
3-Dimensional Rotary Steerable tool and we expect to be able to offer this tool
on a commercial basis during the second half of 2005.

Introduced on a commercial basis in late 2004, our Array Wave Resistivity
technology is the first of our next generation of logging-while-drilling tools.
We believe that our Array Wave Resistivity tools provide a more robust and
accurate resistivity measurement. Tools and data analysis in this technology
improve the precision and reliability of formation data obtained through the
analysis of electromagnetic wave transmissions through the formation surrounding
a well-bore. Our Array Wave Resistivity tools are also designed to withstand
high pressure (25,000 psi) and high temperature (3507F) well conditions.

COMPLETION AND WORKOVER RELATED PRODUCTS AND SERVICES

Our completion and workover related products and services segment provided
approximately 36% of our total consolidated revenue for the first quarter in
2005. Revenues provided by this segment are almost entirely derived from the
United States and the Gulf of Mexico. While revenues from this segment are
affected by the level of oil and natural gas prices, activity in this segment is
only modestly affected by drilling activity (see the discussion under Drilling
Related Products and Services above). As a result, our completion and workover
segment has provided stability during prolonged downturns in drilling activity.

11

We have increased our revenue capacity in this segment through capital
spending in 2003, 2004 and the first three months of 2005, which, when combined
with our acquisitions, has strengthened and further diversified our operations.
Continued growth in this segment will be dependent upon, among other factors,
industry activity levels, prices of oil and natural gas, our capital expenditure
program and our ability to attract and retain qualified service personnel and
field engineers required to operate the specialized equipment used in this
business.

DISCONTINUED OPERATIONS

In March 2004, we committed to the divestiture of our maintenance and
safety related products and services segment. Accordingly, this segment has been
included in the Consolidated Statements of Operations and Comprehensive Income
for 2004 as discontinued operations. In April 2004, we completed the sale of
Well Safe, Inc., one of the two companies that formerly comprised the
maintenance and safety related products and services segment, for cash
consideration of $28.0 million. Additionally, in December 2004, we sold the
remaining entity that formerly comprised this segment, Charles Holston, Inc.,
for consideration of $2.0 million, consisting of $1.0 million in cash and a $1.0
million subordinated promissory note due December 31, 2009. We sold Well Safe
and Charles Holston pursuant to customary stock purchase agreements in which we
made customary representations and warranties, agreed to customary covenants and
agreed to indemnify the buyers of these businesses for certain matters, subject
to certain caps, limitations and deductibles. These sales resulted in a loss of
$5.1 million for the year ended December 31, 2004.

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 10-Q.

THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2004

Revenues. Revenues increased by $34.9 million, or approximately 32%, to
$142.4 million for the three months ended March 31, 2005 from $107.5 million for
the three months ended March 31, 2004. This increase was primarily attributable
to higher demand for certain of our products and services, combined with the
benefit of increased revenue capacity from our capital expenditures.

Revenues from our drilling related products and services increased by $18.7
million, or approximately 26%, to $91.8 million for the three months ended March
31, 2005 from $73.1 million for the three months ended March 31, 2004. This
increase was primarily attributable to higher demand for our directional
drilling services, rental tools and drilling fluids products.

Revenues from our completion and workover related products and services
increased by $16.1 million, or approximately 47%, to $50.6 million for the three
months ended March 31, 2005 from $34.5 million for the three months ended March
31, 2004. This increase was the result of higher utilization of our coiled
tubing and cased-hole wireline fleet and higher demand for our completion
fluids.

Cost of Revenues. Cost of revenues increased by $18.1 million, or
approximately 29% to $81.0 million for the three months ended March 31, 2005
from $62.9 million for the three months ended March 31, 2004. As a percentage of
revenues, cost of revenues decreased to 56.9% for the three months ended March
31, 2005 from 58.5% for the three months ended March 31, 2004. The decrease in
cost of revenues as a percentage of revenues was primarily due to a change in
our revenue mix. In particular, our revenue mix was affected by sales increases
in our higher margin rental tool, coiled tubing and cased-hole wireline
operations.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $4.4 million, or approximately 20%, to
$25.9 million for the three months ended March 31, 2005 from $21.5 million for
the three months ended March 31, 2004. The increase was primarily attributable
to increased personnel costs related to expansion efforts within all of our
business lines. As a percentage of revenues, selling, general and administrative
expenses decreased to 18.2% for the three months ended March 31, 2005 from 20.0%
for the three months ended March 31, 2004.

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Research and Development Expenses. Research and development expenses
increased by $1.7 million, or approximately 57%, to $4.7 million for the three
months ended March 31, 2005 from $3.0 million for the three months ended March
31, 2004. This increase was the result of increased research and development
spending on our PathFinder Energy Services, Inc. technologies, including our
PathMaker(R) 8 1/2" 3-Dimensional Rotary Steerable tool and other research and
development initiatives.

Depreciation and Amortization. Depreciation and amortization increased by
$3.1 million, or approximately 29%, to $13.8 million for the three months ended
March 31, 2005 from $10.7 million for the three months ended March 31, 2004.
This increase was largely the result of depreciation expense associated with our
capital expenditures.

Interest and Other Expense. Interest and other expense for the three
months ended March 31, 2005 was $2.4 million, an increase of $0.2 million, or
approximately 9% from $2.2 million for the three months ended March 31, 2004.
This increase was primarily due to the increase in the amounts outstanding under
our credit facility, offset by improved pricing on our credit facility, which
was entered into in June 2004.

Net Income. Net income for the three months ended March 31, 2005 was $8.7
million, an increase of $3.7 million, or approximately 74%, from the $5.0
million reported for the three months ended March 31, 2004.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123R "Share-Based Payment"
("SFAS 123R"). SFAS 123R revises SFAS 123, supersedes APB No. 25 and requires
companies to recognize the cost of employee stock options and other awards of
stock-based compensation based on the fair value of the award as of the grant
date. The FASB established the beginning of the first interim or annual period
that begins after June 15, 2005 as the effective date for SFAS 123R, and we had
planned to adopt the requirements of SFAS 123R effective January 1, 2005.
However, on April 14, 2005, the SEC announced the adoption of a new rule that
amended the required adoption dates for SFAS 123R. The SEC's rule allows most
larger reporting companies to implement SFAS 123R at the beginning of their next
fiscal year, instead of the next reporting period, that begins after June 15,
2005. As a result of the SEC's new rule, we plan to delay the adoption of the
requirements of SFAS 123R until the beginning of our fiscal year that begins on
January 1, 2006.

LIQUIDITY AND CAPITAL RESOURCES

Our primary uses for cash are working capital, capital expenditures,
research and development expenditures, acquisitions and principal and interest
payments on indebtedness. Our primary sources of liquidity are cash reserves,
cash generated by operations and amounts available to be drawn under our
revolving credit facility. To the extent our cash requirements exceed our
sources of liquidity, we will be required to fund our cash requirements through
other means, such as through debt and equity financing activities, or we will be
required to curtail our expenditures.

CASH FLOW

Working capital was $135.9 million as of March 31, 2005 and $121.6 million
as of December 31, 2004. Net cash provided by operating activities was $11.5
million for the three months ended March 31, 2005 and $10.1 million for the
three months ended March 31, 2004. The increase in working capital and cash flow
from operating activities was largely due to increases in activity levels across
all business lines.

Net cash used in investing activities was $32.1 million for the three
months ended March 31, 2005 and $9.1 million for the three months ended March
31, 2004. The increase in net cash used in investing activities was principally
the result of increased capital expenditures on tools and equipment and a
decrease in net proceeds from the sale of assets.

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Net cash provided by financing activities was $20.4 million for the three
months ended March 31, 2005 and $3.7 million for the three months ended March
31, 2004. The increase in net cash provided by financing activities was
primarily the result of increased borrowings and decreased repayments under our
credit facility.

For the three months ended March 31, 2005, we made capital expenditures,
primarily for rental tools, logging-while-drilling and
measurement-while-drilling tools, of $34.4 million, including expenditures for
the replacement of equipment lost-in-hole. In addition, we incurred $4.7 million
in research and development expenses for the three months ended March 31, 2005.

CAPITAL RESOURCES

As of March 31, 2005, we had an outstanding loan balance of $200.0 million
and approximately $5.6 million in letters of credit issued under our credit
facility, resulting in an available borrowing capacity on such date of
approximately $31.9 million. As of March 31, 2005, we had elected to pay
interest on our outstanding borrowings at LIBOR plus the then applicable margin
of 2.0%.

On May 5, 2005, we entered into a First Amendment to our credit facility
(the "First Amendment") with Wells Fargo Bank, National Association, as
Administrative Agent, Co-Lead Arranger and Sole Book Running Manager; JPMorgan
Chase Bank, N.A., as Co-Lead Arranger and Co-Syndication Agent; Comerica Bank,
as Co-Syndication Agent; The Bank of Nova Scotia, as Co-Documentation Agent;
Wachovia Bank, N.A., as Co-Documentation Agent; Citibank Texas, N.A., as
Managing Agent; and various other financial institutions parties thereto. The
First Amendment, among other things, increased the amount we may borrow under
our credit facility to $375.0 million from $237.5 million, extended the maturity
date of such borrowings to May 5, 2010 from June 30, 2009, improved certain of
the pricing terms associated with our credit facility and relaxed certain of the
operational and financial covenants imposed by our credit facility. Our credit
facility, as amended by the First Amendment, also provides for a $25.0 million
letter of credit and a $15.0 million swing line sublimit.

Amounts borrowed under our credit facility, as amended by the First
Amendment, bear interest, at our election, at either a variable rate equal to
LIBOR, plus a margin ranging from 1.0% to 2.0% depending upon our leverage
ratio, or an alternate base rate equal to the higher of (1) the prime rate or
(2) the federal funds rate plus 0.5%, plus a margin ranging from zero to 1.0%
depending upon our leverage ratio. As of May 6, 2005, borrowings under our
credit facility, as amended by the First Amendment, bore interest at LIBOR plus
the then applicable margin of 1.5%.

Our credit facility is secured by a lien on substantially all of our
property and assets, a pledge of all of the capital stock of our domestic
subsidiaries and a pledge of not greater than 65% of the capital stock of each
of our top tier foreign subsidiaries. In addition, our credit facility is
guaranteed by all of our domestic subsidiaries. Our credit facility, as amended
by the First Amendment, requires, among other things, that we maintain certain
financial ratios, including a leverage ratio and an interest coverage ratio, and
a specified net worth. Our credit facility limits the amount of capital
expenditures we may make, the amount of debt we may incur outside of the credit
facility, the amount of future investments we may make, our ability to pay
dividends and our ability to engage in certain business combination
transactions.

Our credit facility contains customary events of default, including payment
defaults, breaches of representations and warranties, covenant defaults,
cross-defaults to certain other indebtedness agreements in excess of specified
amounts, certain events of bankruptcy and insolvency, judgments in excess of
specified amounts, ERISA defaults, certain failures of guaranty or security
documents supporting our credit facility to be in full force and effect and a
change of control.

Certain of the banks that are parties to the credit agreement, as amended
by the First Amendment, and certain of their respective affiliates have
performed in the past, and may perform in the future, banking, investment
banking and/or advisory services for us and our affiliates from time to time for
which they have received customary compensation.

Financing costs associated with our credit facility of approximately $1.6
million and estimated financing costs associated with the First Amendment of
approximately $1.1 million will be ratably amortized to interest

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expense over the five year term of the credit facility. As a result of the
approximate $160.0 million repayment of our previous credit facility in June
2004, we wrote off approximately $3.1 million in financing costs during the
second quarter of 2004 that had previously been deferred.

The descriptions of our credit facility and the First Amendment are
qualified in their entirety by reference to the credit facility which is filed
as Exhibit 10.8 to our Quarterly Report on Form 10-Q for the quarter ended June
30, 2004 and to the First Amendment which is filed as Exhibit 10.8(a) hereto.

FUTURE CAPITAL REQUIREMENTS

We anticipate that acquisitions of complementary companies, assets and
product lines will continue to play an important role in our business strategy.
While there are currently no unannounced agreements or ongoing negotiations for
the acquisition of any material businesses or assets, such transactions can be
effected quickly and may occur at any time. Likewise, we will continue to need
to make capital expenditures for tools and equipment and to make research and
development expenditures to maintain and improve the quality of our products and
services. We currently estimate that we will make capital expenditures of
approximately $75.0 million in 2005 and will make research and development
expenditures of approximately $18.0 million in 2005.

We believe that our internally generated cash flow, combined with access to
our credit facility will be sufficient to meet the liquidity requirements
necessary to fund our operations, capital expenditures, research and development
and debt service requirements for at least the next 12 months. However, our
ability to maintain our credit facility and the sufficiency of our internally
generated cash flow can be impacted by economic conditions outside of our
control.

The continuation of our acquisition strategy will require substantial
capital. We currently intend to finance future acquisitions through issuances of
our equity or debt securities and through borrowings under our credit facility.
Using debt to complete acquisitions could substantially limit our operational
and financial flexibility and using stock could dilute the ownership interests
of our existing shareholders. The extent to which we will be able or are willing
to use our common stock to make acquisitions will depend on its market value
from time to time and the willingness of potential sellers to accept it as full
or partial payment. If we are unable to obtain additional capital on acceptable
terms, we may be unable to grow through acquisitions.

OFF BALANCE SHEET ARRANGEMENTS

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

OTHER MATTERS

On April 17, 2005, a Houston warehouse and facility operated by our
subsidiary, Superior Packaging & Distribution, L.P. ("Superior"), was destroyed
in a fire. The facility was closed at the time and there were no persons at the
facility that suffered injuries as a result of the fire. The cause of the fire
is not yet known.

We expect that Superior will incur, primarily in the second quarter of
2005, a variety of costs, including clean-up and debris removal costs,
associated with the fire. We believe that a majority of the costs and expenses
that Superior incurs in connection with this event will be covered by insurance,
but the precise nature and extent of insurance coverage for this incident is
still being evaluated.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks. Market risk is the potential loss arising
from adverse changes in market prices and rates. We have not entered into
derivative or other financial instruments for trading or speculative purposes.
Our market risk could arise from changes in interest rates and foreign currency
exchange rates.

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

15

would have increased our interest expense by approximately $0.5 million for the
three months ended March 31, 2005 and 2004.

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 unlikely to be significant to our operations.

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

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. We maintain disclosure controls and
procedures, which are controls and procedures designed to ensure that the
information we are required to disclose in the reports we file with the SEC is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the SEC. Based on an evaluation of our disclosure
controls and procedures as of the end of the period covered by this report
conducted by our management, with the participation of our Chief Executive
Officer and Chief Financial Officer, our Chief Executive Officer and Chief
Financial Officer believe that these controls and procedures are effective to
ensure that we are able to collect, process and disclose the information we are
required to disclose in the reports we file with the SEC within the required
time periods.

Internal Control over Financial Reporting. During the period covered by
this report, there were no changes in our internal control over financial
reporting that have materially affected or are reasonably likely to materially
affect our internal control over financial reporting.

Our management, including our Chief Executive Officer and Chief Financial
Officer, does not expect that our disclosure controls and procedures or our
internal control over financial reporting will prevent and/or detect all error
and all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within our company have been
detected.

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PART II

OTHER INFORMATION

ITEM 5. OTHER INFORMATION

The information included under "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources -- Capital Resources" is hereby incorporated herein by
reference.

ITEM 6. EXHIBITS

a. Exhibits

The documents listed on the Exhibit Index following the signature pages
hereto are filed with this Quarterly Report on Form 10-Q, and the contents of
such Exhibit Index are hereby incorporated herein by reference.

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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: May 6, 2005 By: /s/ JEFFREY L. TEPERA
----------------------------------------------------------
Jeffrey L. Tepera
Vice President and Chief Financial Officer
(Principal Financial Officer)

Date: May 6, 2005 By: /s/ ERNESTO BAUTISTA, III
----------------------------------------------------------
Ernesto Bautista, III
Vice President and Corporate Controller
(Principal Accounting Officer)

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EXHIBIT INDEX

- ---------------

* Filed herewith