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UNITED STATE 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 SEPTEMBER 30, 2004
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 1-2199
ALLIS-CHALMERS CORPORATION
--------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 39-0126090
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5075 WESTHEIMER, SUITE 890, HOUSTON, TEXAS 77056
------------------------------------------------
(Address of principal executive offices) (Zip code)
(713) 369-0550
--------------
Registrant's telephone number, including area code
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
At November 12, 2004, there were 13,042,081 shares of common stock outstanding.
ALLIS-CHALMERS CORPORATION
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
-----------------
PART I
ITEM PAGE
- ---- ----
1. Financial Statements
Consolidated Balance Sheets as of September 30, 2004 and
December 31, 2003...................................................... 3
Consolidated Statements of Operations for the three months and nine
months ended September 30, 2004 and 2003............................... 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2004 and 2003............................................. 5
Notes to Consolidated Financial Statements............................... 6
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................... 15
3. Qualitative and Quantitative Disclosures About Market Risk............... 31
4. Controls and Procedures.................................................. 31
PART II
1. Legal Proceedings........................................................ 32
2. Changes in Securities and Use of Proceeds................................ 32
5. Other Events............................................................. 33
6. Exhibits................................................................. 33
Signatures and Certifications............................................... 34
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLIS-CHALMERS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
2004 2003
-------------- --------------
ASSETS
Cash and cash equivalents $ 12,992 $ 1,299
Trade receivables, net 10,419 8,823
Lease receivable, current 180 180
Prepaids and other current assets 1,496 887
-------------- --------------
Total current assets 25,087 11,189
Property and equipment, net 28,818 26,339
Goodwill 10,331 7,661
Other intangible assets, net 3,089 2,290
Debt issuance costs, net 635 567
Lease receivable 590 787
Other assets 79 40
-------------- --------------
Total assets $ 68,629 $ 48,873
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current maturities of long-term debt $ 4,858 $ 5,150
Trade accounts payable 2,566 3,133
Accrued salaries, benefits and payroll taxes 481 591
Accrued interest 283 152
Accrued expenses 1,331 1,761
Accounts payable, related parties 406 787
-------------- --------------
Total current liabilities 9,825 11,574
Accrued postretirement benefit obligations 510 545
Long-term debt, net of current maturities 25,241 27,083
Other long-term liabilities 129 270
Redeemable warrants 1,500 1,500
Redeemable convertible preferred stock -- 4,171
-------------- --------------
Total liabilities 37,305 45,143
Commitments and Contingencies
Minority interests 886 2,523
COMMON SHAREHOLDERS' EQUITY
Common stock, $.01 par value (20,000,000 shares authorized;
13,042,081 and 3,926,668 issued and outstanding, respectively) 130 39
Capital in excess of par value 37,425 9,793
Accumulated (deficit) (7,117) (8,625)
-------------- --------------
Total shareholders' equity 30,438 1,207
-------------- --------------
Total liabilities and shareholders' equity $ 68,629 $ 48,873
============== ==============
This interim statement is unaudited.
The accompanying Notes are an integral part of the Consolidated Financial Statements.
3
ALLIS-CHALMERS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
--------- --------- --------- ---------
(in thousands, except per share)
Revenues $ 11,888 $ 8,089 $ 32,989 $ 22,428
Cost of sales 8,145 6,011 23,893 16,212
--------- --------- --------- ---------
Gross Profit 3,743 2,078 9,096 6,216
General and administrative expense 2,425 1,351 5,381 3,759
--------- --------- --------- ---------
Income/ (loss) from operations 1,318 727 3,715
2,457
Other Income (expense)
Interest expense (566) (521) (1,634) (1,797)
Minority interest (56) (26) (315) (337)
Settlement of lawsuit -- 1,034 -- 1,034
Other 19 10 224 (164)
--------- --------- --------- ---------
Net income/(loss) before income taxes 715 1,224 1,990 1,193
--------- --------- --------- ---------
Provision for income taxes 139 93 359 343
--------- --------- --------- ---------
Net income/ (loss) 576 1,131 1,631 850
--------- --------- --------- ---------
Preferred stock dividend -- (88) (124) (569)
--------- --------- --------- ---------
Net income/ (loss) attributed to common shares $ 576 $ 1,043 $ 1,507 $ 281
========= ========= ========= =========
Net income/ (loss) per common share basic $ 0.05 $ 0.27 $ 0.21 $ 0.07
========= ========= ========= =========
Net income/ (loss) per common share diluted $ 0.04 $ 0.16 $ 0.15 $ 0.04
========= ========= ========= =========
Weighted average number of common shares
outstanding
Basic 11,599 3,927 7,285 3,927
========= ========= ========= =========
Diluted 14,407 6,340 9,980 6,340
========= ========= ========= =========
This interim statement is unaudited.
The accompanying Notes are an integral part of the Consolidated Financial Statements.
4
ALLIS-CHALMERS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended
September 30,
-----------------------
2004 2003
--------- ---------
Cash flows from operating activities:
Net income (loss) $ 1,631 $ 850
Adjustments to reconcile net (loss) to net
cash provided by operating activities:
Depreciation and amortization expense 2,098 2,255
Fair value of warrant issued to consultant 14 --
(Gain) loss on settlement of lawsuit -- (1,034)
Amortization of discount on debt 143 442
Minority interest in income of subsidiary 315 337
Changes in working capital:
Decrease (increase) in accounts receivable (1,417) (2,882)
Decrease (increase) in other current assets (609) (697)
Decrease (increase) in other assets (39) 35
Decrease (increase) in lease deposit -- 525
Decrease (increase) in lease receivable 197 106
(Decrease) increase in accounts payable (725) 2,738
(Decrease) increase in accrued interest 131 (264)
(Decrease) increase in accrued expenses (471) (323)
(Decrease) increase in other long-term liabilities (141) --
(Decrease) increase in accrued employee benefits and payroll taxes (557) (90)
--------- ---------
Net cash provided by operating activities 570 2,178
Cash flows from investing activities:
Acquisition of Safco, net of cash acquired (959) --
Proceeds from sale of fixed assets -- 700
Purchase of equipment (2,120) (5,086)
--------- ---------
Net cash provided (used) by investing activities (3,079) (4,386)
Cash flows from financing activities:
Proceeds from issuance of common stock, net 16,946 --
Proceeds from issuance of long-term debt -- 9,616
Repayments of long-term debt (2,427) (6,925)
Debt issuance costs (317) (509)
--------- ---------
Net cash provided (used) by financing activities 14,202 (2,182)
--------- ---------
Net increase (decrease) in cash and cash equivalents 11,693 (26)
Cash and cash equivalents at beginning of year 1,299 146
--------- ---------
Cash and cash equivalents at end of period $ 12,992 $ 120
========= =========
Supplemental information - interest paid $ 1,491 $ 1,796
========= =========
This interim statement is unaudited.
The accompanying Notes are an integral part of the Consolidated Financial Statements.
5
NOTES TO UNAUDITED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (UNAUDITED)
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This interim financial data should be read in conjunction with the consolidated
financial statements and related notes, management's discussion and analysis and
other information included elsewhere in this report.
All normal and recurring adjustments considered necessary for a fair
presentation of the results of operations have been included in the unaudited
financial statements. In addition, all non-recurring adjustments necessary to
prevent the financial statements from being misleading have been included in the
unaudited financial statements. The results of operations for any interim period
are not necessarily indicative of the Company's operating results for a full
year.
ORGANIZATION OF BUSINESS
OilQuip Rentals, Inc., an oil and gas rental company ("OilQuip"), was
incorporated on February 4, 2000 to find and acquire acquisition targets to
operate as subsidiaries.
On February 6, 2001, OilQuip, through its subsidiary, Mountain Compressed Air
Inc. ("Mountain Air"), a Texas corporation, acquired certain assets of Mountain
Air Drilling Service Co., Inc. ("MADSCO"), whose business consisted of providing
equipment and trained personnel in the four corner area of the southwestern
United States. Mountain Air primarily provides compressed air equipment and
related products and services including trained operators to companies in the
business of drilling for natural gas.
On May 9, 2001, OilQuip merged into a subsidiary of Allis-Chalmers. In the
merger, all of OilQuip's outstanding common stock was converted into 2,000,000
shares of Allis-Chalmers' common stock.
For legal purposes, the Company acquired OilQuip, the parent company of Mountain
Air. However, for accounting purposes, OilQuip was treated as the acquiring
company in a reverse acquisition of Allis-Chalmers. The financial statements
prior to the merger reflect the operations of OilQuip. As a result of the
merger, the fixed assets and intangible assets of Allis-Chalmers were increased
by $2,691,000.
On February 6, 2002, the Company acquired 81% of the outstanding stock of Jens'
Oilfield Service, Inc. ("Jens'"), which supplies highly specialized equipment
and operations to install casing and production tubing required to drill and
complete oil and gas wells. The Company also purchased substantially all the
outstanding common stock and preferred stock of Strata Directional Technology,
Inc. ("Strata"), which provides high-end directional and horizontal drilling
services for specific targeted reservoirs that cannot be reached vertically.
In July 2003, through its subsidiary Mountain Air, the Company entered into a
limited liability company operating agreement with M-I L.L.C. ("M-I"), a joint
venture between Smith International and Schlumberger N.V. (Schlumberger
Limited), to form a Texas limited liability company named AirComp LLC
("AirComp"). Mountain Air contributed assets with a net book value of
approximately $6.3 million and M-I contributed assets with a net book value of
approximately $6.8 million to AirComp. In addition, AirComp issued a
subordinated note to M-I in the amount of $4.8 million. The Company owns 55% and
M-I owns 45% of AirComp. Because the Company controls AirComp, the Company has
consolidated the operations of the joint venture in its financial statements.
6
On June 10, 2004, the Company effected a reverse stock split in order to
increase the share price of the Common Stock. As a result of the reverse stock
split, every five shares of the Company's common stock were combined into one
share of common stock. The reverse stock split reduced the number of shares of
outstanding common stock from 31,393,789 to approximately 6,265,000 and reduced
the number of stockholders of the Company from 6,070 to approximately 2,140.
On September 23, 2004 the Company purchased, for $1.0 million, 100% of the
outstanding stock of Safco-Oil Field Products, Inc. ("Safco"). Safco leases
"hevi-wate" spiral drill pipe and provides related oilfield services to the oil
drilling industry.
On September 30, 2004, the Company acquired the remaining 19% of Jens in
exchange for 1,300,000 shares of its common stock.
UNAUDITED PERIODS
The financial information with respect to the nine months ended September 30,
2004 and 2003 is unaudited. In the opinion of management, such information
contains all adjustments, consisting only of normal recurring accruals,
necessary for a fair presentation of the results for such periods. The results
for the interim periods are not necessarily indicative of the results of
operations for the full fiscal year.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Future events and their effects cannot be predicted
with certainty. Accordingly, the Company's accounting estimates require the
exercise of judgment. While management believes that the estimates and
assumptions used in the preparation of the consolidated financial statements are
appropriate, actual results could differ from those estimates. Estimates are
used for, but are not limited to, determining the following: allowance for
doubtful accounts, recoverability of long-lived assets and intangibles, useful
lives used in depreciation and amortization, income taxes and related valuation
allowances. The accounting estimates used in the preparation of the consolidated
financial statements may change as new events occur, as more experience is
acquired, as additional information is obtained and as the Company's operating
environment changes.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Allis-Chalmers and
its subsidiaries Mountain Air, Jens', Strata and Safco, and its joint venture,
AirComp. All significant inter-company transactions have been eliminated.
REVENUE RECOGNITION
The Company's revenue recognition policy is significant because revenue is a key
component of results of operations. In addition, revenue recognition determines
the timing of certain expenses, such as commissions and royalties. The Company
provides rental equipment and drilling services to its customers on a day rate
or per job basis and recognizes the related revenue as work progresses and when
collectibility is reasonably assured. The Securities and Exchange Commission's
(SEC) Staff Accounting Bulletin (SAB) No. 104, REVENUE RECOGNITION IN FINANCIAL
STATEMENTS ("SAB No. 104"), provides guidance on the SEC staff's views on
application of generally accepted accounting principles to selected revenue
recognition issues. The Company's revenue recognition policy is in accordance
with generally accepted accounting principles and SAB No. 104.
7
CONCENTRATION OF CREDIT AND CUSTOMER RISK
SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH
OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT
RISK, requires disclosure of significant concentration of credit risk regardless
of the degree of such risk.
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash and cash equivalents and trade accounts
receivable. The Company transacts its business with several financial
institutions. However, the amount on deposit in three financial institutions
exceeded the $100,000 federally insured limit at September 30, 2004 by a total
of $12,592,025. Management believes that the financial institutions are
financially sound and the risk of loss is minimal.
The Company sells its services to major and independent domestic and
international oil and gas companies. The Company performs ongoing credit
valuations of its customers and provides allowance for probable credit losses
where necessary.
Two customers comprised 17.1% of the Company's domestic revenues for the nine
months ended September 30, 2004 as compared to 29.9% of the Company's domestic
revenues for the nine months ended September 30, 2003.
2004 % of Total 2003 % of Total
Customer Revenue Revenue Revenue Revenue
El Paso Production Oil and Gas $ 1,448 4.4 $ 3,038 13.6
Burlington Reserve Oil & Gas Co., L.P $ 4,183 12.7 $ 3,646 16.3
One customer comprised 100% of the Company's international revenues for the
years ended September 30, 2004 and 2003.
2004 % of Total 2003 % of Total
Customer Revenue Revenue Revenue Revenue
Materiales Y Equipo Petrolero $ 3,205 9.7 $ 2,457 11.0
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost less accumulated depreciation.
Maintenance and repairs are charged to operations when incurred. Maintenance and
repair costs were $282,000 and $287,000 for the nine months ended September 30,
2004 and September 30, 2003, respectively. Depreciation expense was $1,498,000
and $1,389,000 for the nine months ended September 30, 2004 and September 30,
2003, respectively.
RECLASSIFICATIONS AND RESTATEMENT OF FORM 10-Q
Certain prior period balances have been reclassified to conform to current year
presentation.
The accompanying 2003 financial statements have been restated from the
previously filed interim financial statements included in Form 10-Q for the
first, second and third quarters of 2003. As discussed in Note 7 in the
financial statements for the year ended December 31, 2003, an adjustment was
recorded in the fourth quarter of 2003 to reflect a change in estimate of the
recoverability of foreign taxes paid in 2003. The effect of the significant
fourth quarter adjustment on the individual interim financial statements is as
follows:
8
Nine Months Ended
September 30, 2003
(In thousands, except
earnings per share)
Net income (loss) attributed to common shareholders
Previously reported $ 624
Adjustment (343)
Restated 281
Net income (loss) per share, basic and diluted
Previously reported $ .016
Adjustment (0.09)
Restated $ 0.07
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
The Company discloses the results of its segments in accordance with SFAS No.
131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION ("SFAS
No. 131"). The Company designates the internal organization that is used by
management for allocating resources and assessing performance as the source of
the Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas and major customers. At September 30,
2004 and 2003, the Company operated in three segments organized by service line:
casing and tubing services, directional drilling services and compressed air
drilling services.
INCOME (LOSS) PER COMMON SHARE
The Company computes income (loss) per common share in accordance with the
provisions of SFAS No. 128, EARNINGS PER SHARE ("SFAS No. 128"). SFAS No. 128
requires companies with complex capital structures to present basic and diluted
earnings per share. Basic earnings per share are computed on the basis of the
weighted average number of shares of common stock outstanding during the period.
Preferred dividends are deducted from net income (loss) and have been considered
in the calculation of income available to common stockholders in computing basic
earnings per share. Diluted earnings per share is similar to basic earnings per
share, but presents the dilutive effect on a per share basis of potential common
shares (e.g., convertible preferred stock, stock options, etc.) as if they had
been converted. Potential dilutive common shares that have an anti-dilutive
effect (e.g., those that increase income per share or decrease loss per share)
are excluded from diluted earnings per share.
The components of basic and diluted earnings per share are as follows:
Nine months ended September 30, 2004 2003
(In thousands, except earnings
per share)
Net income available for common shareholders (A) $1,507 $ 281
Weighted average outstanding shares of common stock (B)
Dilutive effect of assumed conversion of preferred shares
Dilutive effect of employee stock options and awards 7,285 3,927
Common stock and common stock equivalents (C) 9,980 6,340
Earnings per share:
Basic (A/B) $ 0.21 $ 0.07
======= =======
Diluted (A/C) $ 0.15 $ 0.04
======= =======
9
NOTE 2 - ACQUISITIONS
In July 2003, through the subsidiary Mountain Air, the Company entered into a
limited liability company operating agreement with a division of M-I, a joint
venture between Smith International and Schlumberger N.V. (Schlumberger
Limited), to form a Texas limited liability company named AirComp. The formation
of AirComp has created the second largest provider of compressed air and related
products and services for the drilling, workover, completion, and transmission
segments of the oil, gas and geothermal industries.
Mountain Air contributed assets with a net book value of approximately $6.3
million and M-I contributed assets with a net book value of approximately $6.8
million to AirComp. In addition, the Company issued a subordinated note to M-I
in the amount of $4.8 million. The Company owns 55% and M-I owns 45% of AirComp.
Because the Company controls AirComp, the Company has consolidated the joint
venture into its financial statements.
On September 23, 2004 we purchased, for $1.0 million,
100% of the outstanding stock of Safco-Oil Field Products, Inc. ("Safco"). Safco
leases "hevi-wate" spiral drill pipe and provides related oilfield services to
the oil drilling industry.
The following unaudited pro forma consolidated summary financial information
illustrates the effects of the formation of AirComp on the Company's results of
operations as of September 30, 2003, based on the historical statements of
operations, as if the transaction had occurred as of the beginning of the period
presented.
Nine Months Ended
September 30,
2003
--------
(UNAUDITED)
(in thousands,
except earnings
per share)
Revenues $24,150
Operating income (loss) $ 2,841
Net income (loss) $ 1,369
Net income (loss) per common share $ 800
Basic $ 0.02
Diluted $ 0.13
NOTE 3 - DEBT
Debt at September 30, 2004 was as follows (in thousands):
Debt of Mountain Air
Note payable - Equipment leasing $ 211
Note payable to Seller of Mountain Air Drilling Service Company 1,577
Debt of Jens'
Line of Credit 209
Note payable - Term Note 3,091
Note payable - Real Estate Note 73
Subordinated Note payable to Seller of Jens' 4,000
Note payable to Seller of Jens' for non-compete agreement 576
Note payable - Term Note 315
Debt of Strata
Line of Credit 2,681
Vendor financing 1,746
Note payable to Sellers of Safco for non-compete agreement 150
Debt of Allis-Chalmers
Notes payable to certain former directors 398
Note payable - Subordinated debt 2,268
Debt of AirComp
Line of Credit 925
Note payable - Term Note 6,571
Note payable - Delayed Draw 490
Subordinated Note Payable to M-I LL C 4,818
Total Debt $30,099
--------
Less: short term debt and current maturities 4,858
Long-term debt obligations $25,241
========
10
Substantially all of the Company's assets are pledged as collateral to the
outstanding debt agreements.
Maturities of debt obligations at September 30, 2004 are as follows:
Maturities of Debt
(in thousands)
Year Ended:
September 30, 2005 $ 4,858
September 30, 2006 7,804
September 30, 2007 7,360
September 30, 2008 5,259
September 30, 2009 and thereafter 4,818
--------
Total $30,099
========
The debt agreements are summarized as follows:
MOUNTAIN AIR
A term loan in the original amount of $267,000 at an interest rates of 5%,
interest payable monthly, with monthly principal payments of $5,039 due on the
last day of the month. The maturity date of the loan is June 30, 2008. The
balance at September 30, 2004 was $211,000.
A note to the sellers of Mountain Air Drilling Service Company assets in the
original amount of $2,200,000 at 5.75% simple interest was reduced to $1,469,151
as a result of the settlement of a legal action against the sellers. The
principal and accrued interest is due on September 30, 2007 in the amount of
$1,863,195. The balance at September 30, 2004 was $1,577,000. As discussed in
Note 8, the holders of the note have brought a legal action seeking to
Accelerate payment of all amounts due under the note.
JENS'
A term loan in the original amount of $4,042,396 was increased in October 2003
to $5,100,000 at a floating interest rate (6.75% at September 30, 2004) with
monthly principal payments of $85,000 plus 25% of Jens' receipt of payments from
Matyep. The maturity date of the loan was extended in April 2004 to January 31,
2006. The balance at September 30, 2004 was $3,091,000.
A real estate loan in the amount of $532,000 at floating interest rate (6.75% at
September 30, 2004) with monthly principal payments of $14,778 plus accrued
interest. The principal is due on January 31, 2005. The balance at September 30,
2004 was $73,000.
At September 30, 2004, Jens had a $1,000,000 line of credit at Wells Fargo
Credit, Inc., of which $209,000 was outstanding at September 30, 2004. The
Maturity date was extended in April 2004 to January 31, 2006. Interest accrues
at a floating rate plus a margin (6.75% at September 30, 2004). Additionally,
Jens' pays a 0.5% per annum fee on the undrawn portion.
A subordinated seller's note in the original amount of $4,000,000 at 7.5% simple
interest. At September 30, 2004, $406,000 of interest was accrued and was
included in accounts payable, related parties. The principal and interest are
due on January 31, 2006. The note is subordinated to the Company's bank lenders.
In conjunction with the purchase of Jens', the Company agreed to cause Jens' to
pay a total of $1,234,560 payable to Jens Mortensen, our President, in exchange
for a non-compete agreement. Jens' is to make monthly payments of $20,576
through the period ended January 31, 2007. As of September 30, 2004 the balance
was approximately $576,000 including $247,000 classified as short-term.
11
A term loan in the original amount of $397,080 at a floating interest rate
(6.75% at September 30, 2004) with monthly principal payments of $11,000 plus
interest. The maturity date of the loan is September 17, 2006. As of September
30, 2004, the outstanding balance was $256,000.
A term loan in the original amount of $74,673 at a floating interest rate (6.75%
at September 30, 2004) with monthly principal payments of $1,946 plus interest.
The maturity date of the loan is January 12, 2007. As of September 30, 2004 the
outstanding balance was $59,000.
STRATA
In December 2003, Strata entered into a short-term vendor financing agreement in
the original amount of $1,746,000 with a major supplier of drilling motors for
drilling motor rentals, motor lease costs and motor repair costs. The agreement
provides for repayment of all amounts due no later than December 30, 2005.
Payment of the interest on the note is due monthly and three principal payments
are due in October 2004, April 2005 and December 2005. The vendor financing
incurs interest at a rate of 8.0%. As of September 30, 2004, the outstanding
balance was $1,746,000.
Strata has a $4,000,000 line of credit at Wells Fargo Credit, Inc., of which
$2,681,000 was outstanding at September 30, 2004. The committed line of credit
was extended in April 2004 to January 31, 2006. Interest accrues at a floating
interest rate plus a margin (7.75% at September 30, 2004). Additionally, Strata
pays a 0.5% per annum fee on the undrawn portion.
In conjunction with the purchase of Safco, the Company agreed to cause Safco to
pay a total of $150,000 to the Sellers of Safco in exchange for a
non-competetition agreement. Safco is to make yearly payments of $50,000 through
the period ended September 30, 2007. As of September 30, 2004, the balance was
$150,000 including $50,000 classified as short-term.
ALLIS-CHALMERS
Subordinated Debt and amortization of Redeemable Warrant - Secured subordinated
debt issued to partially finance the acquisitions of Jens' and Strata in the
original amount of $3,000,000 at 12% interest payable monthly. Of this amount
$2,309,000 was outstanding at September 30, 2004. The maturity date was extened
in April 2004 to February 1, 2006. In connection with incurring the debt, the
Company issued redeemable warrants valued at $900,000, which have been recorded
as a discount to the subordinated debt and as a liability (see Redeemable
Warrants below). The discount was amortizable over three years beginning
February 6, 2002 but in April 2004 was extended to 5 years as additional
interest expense of which $190,000 has been recognized for the nine months ended
September 30, 2004. The debt is recorded at $2,268,000 at September 30, 2004,
net of the unamortized portion of the put obligation.
The Allis-Chalmers Board established an arrangement to compensate former and
continuing Board members who had served from 1989 to March 31, 1999 without
compensation. Pursuant to the arrangement in 1999, Allis-Chalmers issued
promissory notes totaling $325,000 to current or former directors and officers.
The notes bear interest at the rate of 5.0%, compounded quarterly, and are due
March 28, 2005. At September 30, 2004 the notes were recorded at $398,000,
including accrued interest.
REDEEMABLE WARRANTS - The Company issued redeemable warrants that are
exercisable for up to 233,000 shares of the Company's common stock at an
exercise price of $0.75 per share and non-redeemable warrants that are
exercisable for a maximum of 67,000 shares of the Company's common stock at
$5.00 per share. The warrants were issued in connection with the issuance of a
subordinated debt instrument for Mountain Air
12
in 2001, subsequently repaid in connection with the formation of AirComp in July
2003 and the related issuance of the $3 million subordinated debt discussed
above (collectively, the "Subordinated Debt"). The warrants exerciseable for
$0.75 per share are subject to cash redemption provisions ("puts") in the amount
of $1,500,000, at the discretion of the warrant holders beginning at the earlier
of the final maturity date of the Subordinated Debt or three years from the
closing of the Subordinated Debt (January 31, 2005). In April 2004 the maturity
date of the debt was extended to February 1, 2006. The Company has recorded a
liability of $600,000 at Mountain Air and $900,000 at Allis-Chalmers for a total
of $1,500,000 and is amortizing the effects of the puts to interest expense over
the life of the Subordinated Debt.
The Company guarantees many of its subsidiaries' obligations. In addition, the
Company's Chief Executive Officer and Chairman, Munawar H. Hidayatallah, and his
wife, guarantee substantially all of the Company's obligations.
AIRCOMP LLC
A $1,000,000 line of credit at Wells Fargo bank, of which $925,000 was
outstanding at September 30, 2004. Interest accrues at a floating interest rate
plus a margin (6.75% at September 30, 2004) and is payable quarterly starting in
September 2003. Additionally, AirComp pays a 0.5% per annum fee on the undrawn
portion. The line of credit matures on June 27, 2007.
A term loan - A term loan in the original amount of $8,000,000 at variable
interest rates related to the Prime or LIBOR rates (5.50% at September 30,
2004), interest payable quarterly, with quarterly principal payments of $286,000
due on the last day of the quarter beginning in July 2003. The maturity date of
the loan is June 27, 2007. The balance at September 30, 2004 was
$6,571,000.
A delayed draw term loan in the amount of $1,000,000 with interest at a rate
equal to the LIBOR rate plus a margin with quarterly payments of interest and
quarterly payments of principal equal to 5.0% of the outstanding balance
commencing in the first quarter of 2005. The maturity date of the loan is
June 27, 2007. The balance at September 30, 2004 was $490,000.
A subordinated debt in the amount of $4,818,000 bearing an annual interest rate
of 5.0% in conjunction with the joint venture. The note is due and payable when
M-I sells its interest or a termination of AirComp occurs. At September 30,
2004, $212,000 of interest was accrued and included in accrued interest.
NOTE 4 - SHAREHOLDERS' EQUITY
On March 3, 2004, the Company entered into an agreement with Morgan Joseph
whereby Morgan Joseph would provide underwriting and fundraising activities on
behalf of the Company. In exchange for their services, Morgan Joseph received a
stock purchase warrant to purchase 340,000 shares of common stock at an exercise
price of $2.50 per share. For purposes of calculating fair value under SFAS No.
123, the fair value of the warrant grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions: no dividend yield; expected volatility rate of 170.69% risk-free
interest rate of 6.25%; and average life of 5 years. The resulting fair value of
$2,650,000 assigned to the warrant issuance was offset against the proceeds
collected from the Company's private placements of common stock.
On April 2, 2004, the Company completed the following transactions:
o In exchange for an investment of $2,000,000, the Company
issued 620,000 shares of common stock for a purchase price equal to
$2.50 per share, and issued warrants to purchase 800,000 shares of
common stock at an exercise price of $2.50 per share, expiring on April
1, 2006, to an investor group (the "Investor Group") consisting of
13
entities affiliated with Donald and Christopher Engel and directors
Robert Nederlander and Leonard Toboroff. The aggregate purchase price
for the common stock was $1,550,000, and the aggregate purchase price
for the warrants was $450,000.
o Energy Spectrum converted its 3,500,000 shares of Series A
10% Cumulative Convertible Preferred Stock, including accrued dividend
rights, into 1,718,090 shares of common stock. The conversion of the
preferred stock will have an impact on the earnings per share in future
periods since the Company will not record any dividends.
o The Company, the Investor Group, Energy Spectrum, and
director Saeed Sheikh, and officers and directors Munawar H.
Hidayatallah and Jens H. Mortensen entered into a stockholders
agreement pursuant to which the parties have agreed to vote for the
election to the board of directors of the Company three persons
nominated by Energy Spectrum, two persons nominated by the Investor
Group and one person nominated by Messrs. Hidayatallah, Mortensen and
Sheikh. In addition, the parties and the Company agreed that in the
event the Company has not affected a public offering of its shares
prior to September 30, 2005, then, at the request of Energy Spectrum,
the Company will retain an investment banking firm to identify
candidates for a transaction involving the sale of the Company or its
assets.
On August 10, 2004, the Company completed the private placement of 3,504,667
shares of the Company's common stock at a price of $3.00 per share. Net proceeds
to the Company, after selling commissions and expenses, were approximately $9.6
million. The Company issued shares pursuant to an exemption from the Securities
Act of 1933, and agreed to subsequently register the common stock under the
Securities Act of 1933 to allow investors to resell the common stock in public
markets.
On September 30, 2004, the Company completed the private placement of 1,956,668
shares of the Company's common stock at a price of $3.00 per share. Net proceeds
to the Company, after selling commission and expenses, were approximately $5.5
million. The Company issued shares pursuant to an exemption from the Securities
Act of 1933, and agreed to subsequently register the common stock under the
Securities Act of 1933 to allow investors to resell the common stock in public
markets.
On September 30, 2004, the Company acquired Jens Mortensen's 19% minority
interest in Jens' Oilfield Service, Inc. in exchange for 1,300,000 shares of the
Company's common stock.
NOTE 5 - REVERSE STOCK SPLIT
The Company affected a reverse stock split on September 10, 2004 in order to
increase the share price of the common stock. As a result of the reverse stock
split, every five shares of the Company's common stock were combined into one
share of common stock. The reverse stock split reduced the number of shares of
outstanding common stock from 31,393,789 to approximately 6,265,000 and reduced
the number of stockholders of the Company from 6,070 to approximately 2,140. On
September 13, 2004, the Company's common stock began trading on the American
Stock Exchange. All share and related amounts presented have been retroactively
adjusted for the stock split.
NOTE 6 - SEGMENT INFORMATION
The Company has three operating segments including Casing Services (Jens'),
Directional Drilling Services (Strata) and Compressed Air Drilling Services
(AirComp). All of the segments provide services to the petroleum exploration and
14
production industry. The revenues, operating income (loss), depreciation and
amortization, interest, capital expenditures and assets of each of the reporting
segments plus the General Corporate function are reported below for the quarters
and the nine months ended September 30, 2004 and 2003:
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
--------- --------- --------- ---------
(in thousands)
REVENUES:
Casing services $ 2,831 $ 2,559 $ 7,218 $ 7,712
Directional drilling services 6,677 3,353 18,352 10,336
Compressed air drilling services 2,380 2,177 7,419 4,380
--------- --------- --------- ---------
Total revenues $ 11,888 $ 8,089 $ 32,989 $ 22,428
========= ========= ========= =========
OPERATING INCOME (LOSS):
Casing services $ 949 $ 913 $ 2,174 $ 3,070
Directional drilling services 1,048 120 2,435 613
Compressed air drilling services 209 171 1,021 52
General corporate (888) (477) (1,915) (1,277)
--------- --------- --------- ---------
Total income/(loss) from operations $ 1,318 $ 727 $ 3,715 $ 2,457
========= ========= ========= =========
DEPRECIATION AND AMORTIZATION EXPENSE:
Casing services $ 359 $ 345 $ 1,075 $ 1,035
Directional drilling services 117 56 331 175
Compressed air drilling services 209 242 616 967
General corporate 25 18 76 78
--------- --------- --------- ---------
Total depreciation and amortization expense $ 710 $ 661 $ 2,098 $ 2,255
========= ========= ========= =========
INTEREST EXPENSE:
Casing services $ 173 $ 146 $ 494 $ 469
Directional drilling services 69 42 210 166
Compressed air drilling services 170 164 487 655
General corporate 154 169 443 507
--------- --------- --------- ---------
Total interest expense $ 566 $ 521 $ 1,634 $ 1,797
========= ========= ========= =========
CAPITAL EXPENDITURES
Casing services $ 32 $ 973 $ 457 $ 1,215
Directional drilling services 94 850 882 893
Compressed air drilling services 107 1,765 771 2,259
General corporate 8 3 10 19
--------- --------- --------- ---------
Total capital expenditures $ 214 $ 3,591 $ 2,120 $ 4,386
========= ========= ========= =========
ASSETS:
Casing services $ 21,273 $ 17,360 $ 21,273 $ 17,360
Directional drilling services 14,225 9,122 14,225 9,122
Compressed air drilling services 18,530 20,020 18,530 20,020
General corporate 14,601 1,169 14,601 1,169
--------- --------- --------- ---------
Total assets $ 68,629 $ 47,671 $ 68,629 $ 47,671
========= ========= ========= =========
REVENUES:
United States $ 10,493 $ 7,070 $ 29,402 $ 19,748
Mexico 1,395 1,019 3,587 2,680
--------- --------- --------- ---------
Total $ 11,888 $ 8,089 $ 32,989 $ 22,428
========= ========= ========= =========
15
NOTE 7 - SUPPLEMENTAL CASH FLOWS INFORMATION
Non-cash investing and financing transactions in connection with the acquisition
of Safco Oil Field Products, Inc. for the nine months ended September 30, 2004:
Fair value of net assets $ (842)
Goodwill and other intangibles (150)
Fair value of common stock exchanged 33
-------
Net cash paid to acquire subsidiary $ (959)
=======
NOTE 8 - LEGAL MATTERS
The Company is a defendant in an action (the "Action") brought in April 2004
(No. 04CV308) in the District Court of Mesa County Colorado by the former owner
of Mountain Air Drilling Service Company, Inc. nka Pattongill & Murphy, Inc.,
from whom the Company's Mountain Compressed Air, Inc. ("MCA") acquired assets in
2001. The plaintiff seeks to accelerate payment of a note (the "Note") issued in
connection with the acquisition and is seeking $1,863,000 in damages
(representing principal and interest due under the Note), on the basis that MCA
has failed to provide financial statements required by the Note. The Company
believes the claim is without merit because the holder has failed to comply with
the terms and conditions of the Note, MCA no longer maintains separate financial
statements and the Company provides plaintiff with the Company's publicly
available financial statements. The financial statements disclose as a separate
segment the operations of AirComp, which conducts business using the assets
acquired from plaintiff. The Company has asserted defenses based on these facts
and based upon substantial performance and impossibility of performance.
Finally, the Company has claims in the amount of $12,000 for legal fees and
other expenses that the plaintiff agreed to pay the Company in connection with
the settlement of an earlier lawsuit involving the acquisition of assets from
plaintiff.
The Company is involved in various other legal proceedings arising in the
ordinary course of business. The legal proceedings are at different stages. In
the opinion of management and their legal counsel, the ultimate gain or loss, if
any, to the Company from all such proceedings either cannot be reasonably
estimated at this time or are deemed to be only remotely probable of occurring.
NOTE 9 - SUBSEQUENT EVENTS
On November 10, 2004 AirComp completed the acquisition of Diamond Air Drilling
Services, Inc. and its affiliated company, Marquis Bit Co., LLC for $4.6 million
in cash. Diamond Air and Marquis Bit (collectively referred to as "Diamond Air")
provide air drilling technology and products to the oil and gas industry in West
Texas, New Mexico and Oklahoma. Diamond Air is a leading provider of air hammers
and hammer bit products. The acquisition was funded through capital
contributions from Allis-Chalmers and M-I in the amount of $2.5 million and $2.1
million, respectively.
In connection with the Diamond Air acquisition described above, on November 15,
2004 we executed an agreement with the current bank lender to AirComp to amend
and increase the existing credit facilities. Under the amendment, a $1.0 million
revolving line of credit was increased to $3.5 million, and a $6.6 million term
loan was increased to $7.1 million by adding the $490,000 amount outstanding
under the existing delayed draw facility to the term loan. Repayment of the $7.1
million term loan remained unchanged at $286,000 per quarter. Finally, the $1.0
million delayed draw term loan facility was increased to $1.5 million and its
availability period was extended to December 31, 2005
16
from December 31, 2004. Repayment of this facility will be in equal quarterly
principal payments equal to 5.0% of amounts outstanding as of December 31, 2005,
beginning March 31, 2006, with a final maturity of June 27, 2007. The amended
credit facilities contain customary events of default and covenants which are
substantially similar to the existing facilities.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE INFORMATION IN THIS ITEM 2 CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. OUR ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF RISKS AND UNCERTAINTIES, INCLUDING, BUT NOT LIMITED
TO, THOSE DISCUSSED HEREIN, AND IN OTHER REPORTS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION, AND IN PARTICULAR THOSE DISCUSSED UNDER "RISK FACTORS" IN
OUR ANNUAL REPORT ON FORM 10-K. YOU SHOULD NOT PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS REPORT. WE
ARE UNDER NO OBLIGATION TO REVISE OR UPDATE ANY FORWARD-LOOKING STATEMENTS.
OVERVIEW
We provide services and equipment to the oil and gas drilling industry. Our
customers are principally small independent and major oil and gas producers
engaged in the exploration and development of oil and gas. Our operations are
conducted principally in the Texas Gulf Coast, offshore in the United States
Gulf of Mexico, West Texas, and the Rocky Mountain regions of New Mexico and
Colorado. We also operate in Mexico through a Mexican partner.
We provide casing and tubing handling services and drilling services, which
includes our directional drilling services segment and compressed air drilling
services segment. Our casing and tubing services segment supplies specialized
equipment and trained operators to install casing and tubing, change out drill
pipe and retrieve production tubing for both onshore and offshore drilling and
workover operations. Our directional drilling operations provide directional,
horizontal and "measure while drilling" services to oil and gas companies
operating both onshore and offshore in Texas and Louisiana. Our compressed air
drilling segment provides compressed air and related products and services for
the air drilling, workover, completion, and transmission segments of the oil,
gas and geothermal industries. We plan to broaden the geographic regions in
which we operate and to
expand the types of services and equipment we provide to the oil and gas
drilling industry.
We derive operating revenues from rates per day and rates per job that we charge
for the labor and equipment required to provide a service. The rates vary widely
from project to project depending upon the scope of services we are asked to
provide. The price we charge for our services depends upon several factors,
including the level of oil and gas drilling activity in the particular
geographic regions in which we operate and the competitive environment.
Contracts are awarded based on price, quality of service and equipment, and
general reputation and depth of operations and management personnel. The demand
for drilling services has historically been volatile and is affected by the
capital expenditures of oil and gas exploration and development companies, which
in turn are impacted by the prices of oil and natural gas, or the expectation
for the prices of oil and natural gas.
The number of working drilling rigs is an important indicator of activity levels
in the oil and gas industry, typically referred to as the "rig count". The rig
count in the U.S. increased from 862 as of December 31, 2002 to 1,126 on
December 31, 2003, according to the Baker Hughes rig count. According to the
Baker Hughes rig count, the directional and horizontal rig counts increased from
283 as of December 31, 2002 to 381 on December 31, 2003, which accounted for
32.8% and 33.8% of the total U.S. rig count, respectively. As of October 29,
2004, this trend has continued, with directional and horizontal rigs climbing to
464, which was 37.1% of the 1,251 total U.S. rig count on such date.
17
In July 2003, through Mountain Compressed Air, we entered into a limited
liability company operating agreement with M-I L.L.C., a joint venture between
Smith International and Schlumberger N.V. to form a Texas limited liability
company named AirComp LLC. We own 55% and M-I owns 45% of AirComp. We have
consolidated AirComp into our financial statements beginning with the quarter
ended September 30, 2003.
We effected a reverse stock split on June 10, 2004 in order to increase the
share price of the common stock. As a result of the reverse stock split, every
five shares of our common stock were combined into one share of common stock.
The reverse stock split reduced the number of shares of outstanding common stock
from 31,393,789 to approximately 6,276,015 and reduced the number of
stockholders from 6,070 to 2,140. On September 13, 2004, our common stock began
trading on the American Stock Exchange.
RESULTS OF OPERATIONS
Comparison of the Three Months Ended September 30, 2004 and 2003
- ----------------------------------------------------------------
Our revenues for the three months ended September 30, 2004 were $11.9 million,
an increase of 47.0% compared to $8.1 million for the three months ended
September 30, 2003. We increased revenues in all our business segments due to an
increase in demand for our services resulting from the general increase in oil
and gas drilling activity. The increase in revenues was experienced principally
by our directional drilling services segment due to the addition of operations
and sales personnel which increased our capacity and market presence.
Our gross profit for the third quarter of 2004 increased by 80.1% to $3.7
million, or 31.5% of revenues, compared to $2.1 million, or 25.7 % of revenues
for the third quarter of 2003, due primarily to the increase in revenues and
increased gross margins in our directional drilling segment as a result of the
increase in oil and gas drilling activity. The increase in revenues more than
offset increases in operating expenses due to the addition of personnel and
increases in wages and benefits. Our cost of revenues consists principally of
our labor costs and benefits, equipment rentals, maintenance and repairs of our
equipment, insurance, fuel and depreciation.
General and administrative expense was $2.4 million in the third quarter of 2004
compared to $1.4 million in the comparable period of 2003. General and
administrative expense increased in 2004 due to the hiring of additional sales
and administrative personnel at each of the our subsidiaries due to increased
activity levels, increased professional fees and other expenses related to our
financing activities, including the listing of our common stock on the American
Stock Exchange, and increased corporate accounting and administrative staff. As
a percentage of revenues, general and administrative expenses were 20.4% in the
2004 quarter and 16.7% in the 2003 quarter.
Depreciation and amortization was $709,793 in the third quarter of 2004 compared
to $660,325 for the third quarter of 2003.
Income from operations consists of our revenues less cost of sales, general and
administrative expenses, and depreciation and amortization. Income from
operations for the three months ended September 30, 2004 totaled $1.3 million,
an 81.3% increase over the $727,000 in income from operations for the comparable
period in 2003, reflecting the increased revenues from all of our business
segments and the increase in our gross profit which was partially offset by the
increase in general and administrative expenses.
Our interest expense increased to $566,000 for the third quarter of 2004,
compared to $521,000 for the comparable 2003 period due to higher average debt
outstanding and higher interest rates.
18
Minority interest in income of subsidiaries for the third quarter of 2004 was
$56,000 compared to $26,000 in the third quarter of 2003 due to the increase in
the net income of our casing and tubing services subsidiary, which was owned 19%
by Jens Mortensen until September 30, 2004, and due to the increase in the net
income of AirComp, our compressed air drilling services segment.
We had net income attributed to common shareholders of $576,000 for the third
quarter of 2004 compared with net income attributed to common shareholders of
$1.0 million for the third quarter of 2003. The 2003 third quarter included a
$1.0 million gain from the settlement of a lawsuit.
The following table compares revenues and income from operations for each of our
business segments for the third quarter ended September 30, 2004 and 2003.
Income from operations consists of our revenues less cost of revenues, general
and administrative expenses, and depreciation and amortization:
Revenues Income (Loss) from Operations
-------------------------------- ----------------------------------
2004 2003 Change 2004 2003 Change
-------- -------- -------- -------- -------- --------
(in thousands)
Casing services $ 2,831 $ 2,559 $ 272 $ 949 $ 913 $ 36
Directional drilling services 6,677 3,353 3,324 1,048 120 928
Compressed air drilling services 2,380 2,177 203 209 171
38
General corporate -- -- -- (888) (477) (410)
-------- -------- -------- -------- -------- --------
Total $11,888 $ 8,089 $ 3,779 $ 1,318 $ 727 $ 592
======== ======== ======== ======== ======== ========
CASING AND TUBING SERVICES SEGMENT
Revenues for the three months ended September 30, 2004 for the casing and tubing
services segment were $2.8 million, an increase of 10.6% from the $2.6 million
in revenues for the comparable 2003 period. Revenues from domestic operations
decreased from $1.5 million in the third quarter of 2003 to $1.4 million in the
third quarter of 2004 as a result of increased competition in South Texas,
resulting in fewer contracts awarded to us and lower pricing for our services.
Revenues from Mexican operations, however, increased from $1.0 million in the
third quarter of 2003 to $1.4 million in the third quarter of 2004 as a result
of increased drilling activity in Mexico and the addition of equipment that
increased our capacity. Income from operations increased 3.9% to $949,000 for
the third quarter of 2004, from $913,000 for the same period in 2003. Income
from operations did not increase as much as the increase in revenues due to
decreased revenues from domestic operations and an increase in wages and
benefits domestically, which was partially offset by increased revenues from
Mexico.
19
DIRECTIONAL DRILLING SERVICES SEGMENT
Revenues for the three months ended September 30, 2004 for our directional
drilling services segment were $6.7 million, an increase of 97.1% from $3.4
million for the comparable 2003 period. Income from operations increased by
773.3% to $1.0 million for the three-month period of 2004 from $120,000 for the
same period in 2003. The improved results for this segment are due to an
increase in drilling activity in the Texas and Gulf Coast areas and the addition
of operations and sales personnel which increased our capacity and market
presence. Increased operating expenses as a result of the addition of personnel
were more than offset by the growth in revenues and cost savings as a result of
purchases, in late 2003 and in 2004, of most of the down-hole motors used in
directional drilling. Previously we leased these motors.
COMPRESSED AIR DRILLING SERVICES SEGMENT
Our compressed air drilling revenues were $2.4 million for the third quarter of
2004, an increase of 9.3% compared to $2.2 million in revenues for the
comparable 2003 period. Income from operations was $209,000 for the 2004 period
compared to $171,000 for the comparable period of 2003. Increased revenues for
compressed air drilling services in West Texas and the Rocky Mountain areas was
partially offset by a decrease in activity in California.
Comparison of Nine Months Ended September 30, 2004 and 2003
- -----------------------------------------------------------
Our revenues for the nine months ended September 30, 2004 were $33.0 million, an
increase of 47.0% compared to $22.4 million for the first nine months of 2003.
Revenues increased due to increased demand due to the general increase in oil
and gas drilling activity. Revenues increased most significantly at our
directional drilling services segment due to the addition of operations and
sales personnel, which increased our capacity and market presence. Additionally,
our compressed air drilling services revenues for the first nine months of 2004
increased compared to the first nine months of 2003 due to the inclusion, for a
full nine months in the 2004 period, of the business contributed by M-I in
connection with the formation of AirComp in July 2003.We have consolidated
AirComp, our compressed air drilling joint venture, into our financial
statements beginning with the quarter ending September 30, 2003. The increase in
revenues in our directional drilling and compressed air drilling services was
partially offset by a decrease in revenues in our casing and tubing services
segment due to increased competition for casing and tubing services in South
Texas.
Our gross profit for the first nine months of 2004 increased 46.3% to $9.1
million, or 27.6% of revenues, compared to $6.2 million, or 27.7 % of revenues
for the first nine months of 2003, due to the increase in revenues. Our cost of
revenues consists principally of our labor costs and benefits, equipment
rentals, maintenance and repairs of our equipment, insurance and fuel.
General and administrative expense was $5.4 million in the 2004 nine-month
period compared to $3.8 million for the comparable period of 2003. General and
administrative expense increased in 2004 due to additional expenses associated
with the inclusion of AirComp for a full nine months, the hiring of additional
sales and administrative personnel at each of the our subsidiaries, increased
professional fees and other expenses related to our financing activities,
including the listing of our common stock on the American Stock Exchange, and
increased corporate accounting and administrative staff. As a percentage of
revenues, general and administrative expenses were 16.3% in the 2004 nine-month
period and 16.8% in the 2003 nine-month period.
Depreciation and amortization was $2.1 million for the nine months ended
September 30, 2004 compared to $2.2 million for the nine months ended September
30, 2003.
20
Income from operations for the nine months ended September 30, 2004 totaled $3.7
million, a 51.2% increase over the $2.5 million in income from operations for
the comparable period in 2003, reflecting the increased revenues from
directional drilling services and the inclusion of revenues and operating income
of AirComp for a full nine months in the 2004 period, offset in part by a
decrease in revenues and income from operations from our casing and tubing
services segment due to increased competition and increases in wages and
benefits in South Texas, and an increase in general and administrative expenses.
Our interest expense decreased to $1.6 million for the first nine months of
2004, compared to $1.8 million for the first nine months of the prior year due
to the acceleration in 2003 of the amortization of the put obligation related to
subordinated debt at Mountain Compressed Air. Interest expense for 2003 includes
$216,000 of amortization expense for the put obligation. The subordinated
debt and accrued interest was paid off with the formation of AirComp.
Minority interest in income of subsidiaries for the first nine months of 2004
was $315,000 compared to $337,000 for the first nine months of 2003 due to the
decrease in net income from Jens'.
We had net income attributed to common shareholders of $1.5 million, for the
nine months ended September 30, 2004 compared with net income attributed to
common shareholders of $281,000 for the nine months ended September 30, 2003.
The 2003 period included a $1.0 million gain from the settlement of a lawsuit.
The following table compares revenues and income from operations for each of our
business segments for the nine months ended September 30, 2004 and 2003. Income
from operations consists of our revenues less cost of revenues, general and
administrative expenses, and depreciation and amortization:
Revenues Income (Loss) from Operations
----------------------------------- -------------------------------------
2004 2003 Change 2004 2003 Change
--------- --------- --------- --------- --------- ---------
(in thousands)
Casing services $ 7,218 $ 7,712 $ (494) $ 2,174 $ 3,070 $ (896)
Directional drilling services 18,352 10,336 8,016 2,435 613 1,822
Compressed air drilling services 7,419 4,380 3,039 1,021 52 969
General corporate -- -- -- (1,915) (1,278) (637)
--------- --------- --------- --------- --------- ---------
Total $ 32,989 $ 22,428 $ 10,561 $ 3,715 $ 2,457 $ 1,258
========= ========= ========= ========= ========= =========
21
CASING AND TUBING SERVICES SEGMENT
Revenues for the nine months ended September 30, 2004 for the casing and tubing
services segment were $7.2 million, a decrease of 6.4% from the $7.7 million in
revenues for the comparable 2003 period. Revenues from domestic operations
decreased from $5.0 million in the first nine months of 2003 to $3.6 million in
the first nine months of 2004 as a result of increased competition in South
Texas, resulting in fewer contracts awarded to us and lower pricing for our
services. Revenues from Mexican operations, however, increased from $2.7 million
in the first nine months of 2003 to $3.6 million in the comparable 2004 period
as a result of increased drilling activity in Mexico and the addition of
equipment that increased our capacity. Income from operations decreased by 29.2
% to $2.2 million for the nine-month period of 2004 from $3.1 million for the
same period in 2003. The decrease in this segment's revenues and operating
income is due to the decrease in revenues from domestic operations and increases
in wages and benefits domestically, which was partially offset by increased
revenues from Mexico.
DIRECTIONAL DRILLING SERVICES SEGMENT
Revenues for the nine months ended September 30, 2004 for our directional
drilling services segment were $18.4 million, an increase of 77.6% from the
$10.3 million in revenues for the comparable 2003 period. Income from operations
increased by 297.2% to $2.4 million for the nine-month period of 2004 from
$613,000 for the same period in 2003. The improved results for this segment are
due to the increase in drilling activity in the Texas and Gulf Coast areas and
the addition of operations and sales personnel which increased our capacity and
market presence. Increased operating expenses as a result of the addition of
personnel were more than offset by the growth in revenues and cost savings as a
result of purchases, in late 2003 and in 2004, of most of the down-hole motors
used in directional drilling. Previously we had leased these motors.
COMPRESSED AIR DRILLING SERVICES SEGMENT
Our compressed air drilling revenues were $7.4 million for the first nine months
of 2004, an increase of 69.4% compared to $4.4 million in revenues in the 2003
period. Income from operations increased to $1.0 million for the nine-month
period of 2004 compared to income from operations of $52,000 for the same period
in 2003. Our compressed air drilling revenues and operating income for the first
nine months of 2004 increased compared to the first nine months of 2003 due to
the inclusion, for a full nine months in the 2004 period, of the business
contributed by M-I, in connection with the formation of AirComp in July 2003.
Through this joint venture we have been able to expand the geographical areas in
which our compressed air drilling segment operates to include natural gas
drilling in the Rocky Mountains and West Texas areas.
Pro Forma Comparison of Nine Months Ended September 30, 2004 and 2003
- ---------------------------------------------------------------------
The following unaudited pro forma consolidated summary financial information
illustrates the effects of the formation of AirComp on our results of
operations, based on the historical statements of operations, as if the
transaction had occurred as of the beginning of the periods presented. Pro forma
results of operations set forth below includes results of operations for the
nine months ended September 30, 2004 and 2003.
Pro forma revenues for the first nine months of 2004 totaled $33.0 million,
compared to pro forma revenues for the first nine months of 2003 of $24.2
million, an increase of approximately 36.3%. The increase in revenues is
principally due to increased revenues at our directional drilling services
segment due to the general increase in oil and gas drilling activity. The
increase in revenues in our directional drilling services segment was partially
offset by a decrease in revenues in our casing and tubing services segment due
22
to increased competition for casing and tubing services in South Texas. Pro
forma revenues for the first nine months of 2004 for AirComp totaled $7.4
million, compared to pro forma revenues in the first nine months of 2003 of $6.1
million. The $1.3 million increase in pro forma revenues in 2004 for AirComp is
due to increased drilling activity in West Texas and a slight increase in
activity in the Rocky Mountains over the same period in 2003.
Pro forma gross profit for the first nine months of 2004 was $9.1 million, or
27.6% of revenues, compared to $6.4 million, or 26.6% of revenues for the first
nine months of 2003, as increased gross margins in our directional drilling
segment was offset by increased competition and weaker pricing and increases in
wages and benefits in our casing and tubing services segment. Our cost of
revenues consists principally of our labor costs and benefits, equipment
rentals, maintenance and repairs of our equipment, insurance and fuel.
Pro forma depreciation and amortization was flat at $2.1 million in the first
nine months of 2004 and 2003.
Pro forma general and administrative expense was $5.4 million in for the first
nine months of 2004 compared to $3.4 million for the 2003 period. Pro forma
general and administrative expense increased in 2004 due to the hiring of
additional sales and administrative personnel at each of the our subsidiaries,
increased professional fees and other expenses related to our financing
activities, including the listing of our common stock on the American Stock
Exchange, and increased corporate accounting and administrative staff.
We had pro forma income from operations for the first nine months of 2004 of
$3.7 million an increase of 32.1% as compared to pro forma income from
operations of $2.8 million in the first nine months of 2003. The increase in pro
forma income from operations for the 2004 period was primarily due to higher
revenues resulting from the general improvement in oil and gas drilling
activity. The increase in income from operations primarily reflects the
increased revenues from directional drilling services, offset in part by a
decrease in revenues and income from operations from our casing and tubing
services segment due to increased competition, weaker pricing and increases in
wages and benefits in South Texas, and an increase in general and administrative
expenses.
Our pro-forma interest expense decreased to $1.6 million for the first nine
months of 2004, compared to $1.8 million for the first nine months of the prior
year due to the acceleration of the amortization of the put obligation related
to subordinated debt at Mountain Compressed Air. Interest expense for 2003
includes of $216,000 of amortization expense for the put obligation. The
subordinated debt and accrued interest was paid off with the formation of
AirComp.
Pro forma minority interest in income of subsidiaries for the first nine months
of 2004 was $315,000 compared $235,000 in the first nine months of 2003 due to
the decrease in the net income of our casing and tubing services subsidiary,
which was owned 19% by Jens Mortensen until September 30, 2004.
We recorded pro forma net income of $1.5 million for the nine months ended
September 30, 2004 compared with a pro forma net income of $800,000 for the nine
months ended September 30 2003, which included a one-time $1.0 million gain
resulting from the settlement of a lawsuit.
LIQUIDITY AND CAPITAL RESOURCES
Our on-going capital requirements arise primarily from our need to service our
debt, to retire redeemable securities, to acquire and maintain equipment, to
acquire additional businesses and for working capital. Our primary sources of
liquidity are borrowings under our revolving lines of credit, proceeds from the
issuance of equity securities and cash flows from operations. We had cash and
cash equivalents of $13.0 million at September 30, 2004 compared to $1.3 million
at December 31, 2003.
23
OPERATING ACTIVITIES
In the nine months ended September 30, 2004 we generated $570,000 in cash from
operating activities compared to $2.0 million in cash from operating activities
for the same period in 2003. Net income before preferred stock dividend for the
first nine months of 2004 increased to $1.6 million, compared to $850,000 in the
comparable 2003 period. Net income in 2003 includes a $1.0 million gain from the
settlement of a lawsuit. Non-cash adjustments to net income totaled $2.6 million
in the 2004 period compared to $1.8 million in the 2003 period, consisting
principally of depreciation and amortization expense and minority interest in
the income of a subsidiary. During the first nine months of 2004, the changes in
working capital used $3.6 million in cash compared to a use of $852,000 in cash
in the 2003 period, principally due, in the 2004 period, to a decrease in
accrued expenses of $1.0 million, an increase in accounts receivables and other
current assets of $1.9 million and a decrease of $726,000 in accounts payable.
During the comparable 2003 period, accounts receivable and other current assets
increased $2.9 million, and accounts payable and accrued expenses increased $2.1
million, net.
INVESTING ACTIVITIES
During the first nine months of 2004, we used $3.1 million in investing
activities, consisting of capital expenditures of approximately $882,000 to
purchase equipment for our directional drilling services segment, approximately
$457,000 to purchase casing equipment and approximately $771,000 to make capital
repairs to existing equipment at our compressed air drilling segment. On
September 23, 2004 we also completed, for $1.0 million, the acquisition of 100%
of the outstanding stock of Safco-Oil Field Products, Inc. ("Safco). Safco
leases "hevi-wate" spiral drill pipe and provides related oilfield services to
the oil drilling industry. This compares to net cash used in investing
activities of $4.4 million in the comparable 2003 period primarily for the
purchase of equipment.
FINANCING ACTIVITIES
During the first nine months of 2004, financing activities provided a net of
$14.2 million in cash. We received $16.9 million in net proceeds from the
issuance of common stock which was offset in part by the repayment of $2.4
million of long-term debt and $317,000 in debt issuance costs. This compares to
the first nine months of 2003 when we received $9.6 million in proceeds from the
issuance of long-term debt offset by $6.9 million in the repayment of long-term
debt and $304,000 in debt issuance costs.
In April 2004, Energy Spectrum the holder of our preferred stock, converted its
3,500,000 shares of Series A 10% cumulative Convertible Preferred Stock,
including accrued dividend rights, into 1,718,090 shares of common stock.
On August 10, 2004 we completed the private placement of 3,504,667 shares of our
common stock at a price of $3.00 per share. Net proceeds to us, after selling
commissions and expenses, was approximately $9.6 million. On September 30, 2004,
we completed the private placement of 1,956,634 shares of our common stock at a
price of $3.00 per share. Net proceeds to us, after selling commissions and
expenses, was approximately $5.4 million. We will use the net proceeds of the
private placement offerings to reduce debt, to purchase equipment, to acquire
new businesses, and for general corporate purposes.
On September 30, 2004, we issued 1,300,000 shares of our common stock to Jens
Mortensen, our president, in exchange for his 19% interest in Jens' Oilfield
Service, Inc. As a result of this transaction, we now own 100% of Jens' Oilfield
Service, Inc.
24
We have several bank credit facilities and other debt instruments at
Allis-Chalmers and at our three operating subsidiaries. Allis-Chalmers
guarantees the loans owed by Jens' and Strata, and Mountain Compressed Air, a
wholly-owned subsidiary, guarantees AirComp's bank debt. All three of our
subsidiaries are consolidated on our financial statements. At September 30, 2004
we had $30.1 million in outstanding indebtedness, of which $25.2 million was
long-term debt and $4.9 million was the current portion of long-term debt.
Through Jens', our casing and tubing services subsidiary, we have two principal
bank facilities. We have a term loan in the original amount of $4.0 million that
was increased, in October 2003, to $5.1 million. We are required to make monthly
principal payments of $85,000 plus 25% of our collections from our operations in
Mexico. Interest accrues at a floating rate plus a margin. The interest rate on
the term loan was 6.75% at September 30, 2004 and the outstanding amount was
$3.0 million. We also have a $1.0 million bank line of credit of which $209,000
was outstanding at September 30, 2004. Interest accrues at a floating rate plus
a margin. The interest rate on the line of credit was 6.75% at September 30,
2004. We pay a 0.5% per annum fee on the undrawn portion. The final maturity
date of both the term loan and the line of credit is January 31, 2006. The term
loan and the line of credit are secured by liens on substantially all of the
Jens' assets. Borrowings under the line of credit are subject to a borrowing
base consisting of the Jens' eligible accounts receivables as defined in the
credit agreement. The credit agreement contains customary events of default and
financial covenants. It also limits our ability to incur additional
indebtedness, make capital expenditures, pay dividends or make other
distributions, create liens, and sell assets.
Our Jens' subsidiary also has a note payable to Jens Mortensen, who sold Jens'
to us and is our president and a director. The note is in the original amount of
$4.0 million at 7.5% simple interest with quarterly interest payments. At
September 30, 2004, $406,000 of interest was accrued and was included in account
payable to related parties. The principal and interest are due on January 31,
2006. In connection with the purchase of Jens', we also agreed to pay a total of
$1.2 million to Mr. Mortensen in exchange for a non-compete agreement. We are
required to make monthly payments of $20,576 through January 31, 2007. As of
September 30, 2004, the balance due is approximately $576,000, including
$247,000 classified as short-term.
Jens' also has outstanding three term loans. One is a real estate bank loan in
the amount of $532,000 at a floating interest rate with monthly principal
payments of $14,778 plus interest. The interest rate was 6.75% at September 30,
2004 and the outstanding amount due was $73,000. The final principal payment is
due on January 31, 2005. The second term loan is a bank loan in the original
amount of $397,080 at a floating interest rate with monthly principal payments
of $11,000 plus interest. The interest was 6.75% at September 30, 2004 and the
balance was $256,000. The final maturity date of the loan is September 17, 2006.
The third term loan is a bank term loan in the original amount of $74,673 at a
floating interest rate with monthly principal payments of $1,946 plus interest.
The interest was 6.75% at September 30, 2004 and the balance at September 30,
2004 was $59,000. The final maturity date of the loan is January 12, 2007.
Through Strata, our directional drilling services operating subsidiary, we have
a $4.0 million bank line of credit of which $2.7 million was outstanding at
September 30, 2004. The line of credit matures on January 31, 2006 and interest
accrues at a floating rate plus a margin. The interest rate was 7.75% at
September 30, 2004 and we pay a 0.5% per annum fee on the undrawn portion of the
line. Borrowings under the line of credit are subject to a borrowing base
consisting of Strata's eligible accounts receivable as defined in the credit
agreement. The credit agreement contains customary events of default and
requires that we satisfy various financial covenants. It also limits our ability
to incur additional indebtedness, make capital expenditures, pay dividends or
make other distributions, create liens, and sell assets.
25
In December 2003, Strata entered into a short-term vendor financing agreement in
the original amount of $1.7 million with a major supplier for drilling motor
rentals, motor lease costs and motor repair costs. The agreement provides for
repayment of all amounts not later than December 30, 2005. Payment of interest
is due monthly and principal payments of $582,000 are due in each of October
2004, April 2005, and December 2005. The interest rate is fixed at 8.0%. As of
September 30, 2004, the outstanding balance was $1.7 million.
In connection with the purchase of Safco, we also agreed to pay a total of
$150,000 to the sellers in exchange for a non-compete agreement. We are required
to make yearly payments of $50,000 through September 30, 2007. As of September
30, 2004, the balance due is $150,000.
We are working to increase our financial flexibility and to simplify our debt
and capital structure. On November 4, 2004 we received a commitment from our
existing lender to provide new credit facilities to Allis-Chalmers which would
be used to repay and consolidate the credit facilities currently owed by our
Jens' and Strata subsidiaries, and to provide additional credit availability for
working capital and for acquisitions and capital expenditures. The commitment
consists of a $10.0 million revolving line of credit to replace and increase the
existing lines of credit at Jens' of $1.0 million and at Strata of $4.0 million.
Borrowings would be subject to a borrowing base based on eligible accounts
receivables, as defined, of all Allis-Chalmers wholly-owned subsidiaries which
are a party to the credit agreement. Secondly, the new commitment includes a new
term loan in the amount of approximate $6.4 million to be repaid in equal
monthly installments based on a five-year repayment schedule. Proceeds of the
term loan would be used to prepay the term loan owed by our Jens' subsidiary and
to prepay our 12% $2.3 million subordinated note and retire its related warrants
described below. The commitment also includes a $6.0 million capital expenditure
and acquisition line of credit. Borrowings under this facility would be repaid
monthly based on a four-year repayment schedule after a one year, interest only,
availability period. Availability of this capital expenditure term loan facility
would be subject to security acceptable to the lender in the form of equipment
or other collateral purchased or obtained through an acquisition. The new credit
facilities would have a final maturity of three years and are to be secured by
liens on substantially all of the assets of Allis-Chalmers and its wholly-owned
subsidiaries. The agreement governing these credit facilities would contain
customary events of default and financial covenants. It would also limit our
ability to incur additional indebtedness, make capital expenditures, pay
dividends or make other distributions, create liens, and sell assets. The
interest rate would be based on the prime rate plus a margin. The commitment is
subject to negotiation of final terms and execution of mutually satisfactory
credit and security agreements. We are evaluating the commitment.
Through AirComp, our 55%-owned compressed air drilling joint venture company, we
have a $1.0 million bank line of credit of which $925,000 was outstanding at
September 30, 2004. Interest accrues at a floating rate plus a margin and was
6.75% at September 30, 2004. We also pay a 0.5% per annum fee on the undrawn
portion. AirComp also has two term loans outstanding. We have a term loan in the
original amount of $8.0 million with a floating interest rate based on either
prime or the London interbank offered rate ("Libor") plus a margin. The interest
rate averaged 5.50% at September 30, 2004. Principal payments of $286,000 are
due quarterly, plus interest, with a final maturity date of June 27, 2007. The
remaining balance at September 30, 2004 was $6.6 million. We also have a
"delayed draw" term loan facility in the amount of $1.0 million to be used for
capital expenditures. Interest accrues at a rate equal to LIBOR plus a margin.
Quarterly principal payments commence on March 31, 2005 in an amount equal to
5.0% of the outstanding balance as of December 31, 2004. The outstanding balance
of this facility at September 30, 2004 was $490,000. The AirComp credit
facilities mature on June 27, 2007 and are secured by liens on substantially all
of AirComp's assets. Borrowings under the line of credit are subject to a
borrowing base consisting of eligible accounts receivable. The agreement
governing these credit facilities contain customary events of default and
requires that AirComp satisfy various financial covenants. It also limits
AirComp's ability to incur additional indebtedness, make capital expenditures,
pay dividends or make other distributions, create liens, and sell assets.
Mountain Compressed Air guarantees the obligations of AirComp under these
facilities.
26
On November 10, 2004 AirComp completed the acquisition of Diamond Air Drilling
Services, Inc. and its affiliated company, Marquis Bit Co., LLC for $4.6 million
in cash. Diamond Air and Marquis Bit (collectively referred to as "Diamond Air")
provide air drilling technology and products to the oil and gas industry in West
Texas, New Mexico and Oklahoma. Diamond is a leading provider of air hammers and
hammer bit products. The acquisition was funded through capital contributions
from Allis-Chalmers and M-I in the amount of $2.5 million and $2.1 million,
respectively.
In connection with the Diamond Air acquisition described above, on November 15,
2004 we executed an agreement with the current bank lender to AirComp to amend
and increase the existing credit facilities. Under the amendment, the $1.0
million revolving line of credit was increased to $3.5 million. Secondly, the
$6.6 million term loan was increased to $7.1 million by adding the $490,000
amount outstanding under the existing delayed draw facility to the term loan.
Repayment of the $7.1 million term loan remained unchanged at $286,000 per
quarter. Finally, the $1.0 million delayed draw term loan facility was increased
to $1.5 million and its availability period was extended to December 31, 2005
from December 31, 2004. Repayment of this facility will be in equal quarterly
principal payments equal to 5.0% of amounts outstanding as of December 31, 2005,
beginning March 31, 2006, with a final maturity of June 27, 2007. The amended
credit facilities contain customary events of default and covenants which are
substantially similar to the existing facilities.
AirComp also has a subordinated note payable to M-I in the amount of $4.8
million bearing interest at an annual rate of 5.0%. In 2007 each party has the
right to cause AirComp to sell its assets (or the other party may buy out such
party's interest), and in such event this note (including accrued interest) is
due and payable. The note is also due and payable if M-I sells its interest in
AirComp or upon a termination of AirComp. At September 30, 2004, $283,000
of interest was included in accrued interest. Neither Allis-Chalmers nor
Mountain Compressed Air is liable for the obligations of AirComp under this
note.
At Allis-Chalmers we also have a subordinated note in the original amount of
$3.0 million with a fixed interest rate of 12.0%. The outstanding balance was
$2.3 million at September 30, 2004 and has a final maturity of February 1, 2006.
In connection with this note, we issued redeemable warrants, which have been
recorded as a liability of $900,000 and as a discount to the face amount of the
debt. This amount is being amortized as additional interest expense over the
term of the note. The debt is recorded at $2.3 million net of unamortized
portion of the put obligation.
In connection with the issuance of the $3.0 million subordinated note, we issued
redeemable warrants that are exercisable for up to 233,000 shares of our common
stock at an exercise price of $0.75 per share and non-redeemable warrants that
are exercisable for a maximum of 67,000 shares of our common stock at $5.00 per
share. The warrants exercisable for $0.75 per share are subject to cash
redemption provisions in the amount of $1.5 million at the discretion of the
warrant holders at any time after January 31, 2005. We have recorded a liability
of $1.5 million in respect of the warrant redemption rights. We are amortizing
the effects of the puts to interest expense over the life of the $3.0 million
subordinated debt.
In 1999 we compensated directors who served on the board of directors from 1989
to March 31, 1999 without compensation by issuing promissory notes totaling
$325,000. The notes bear interest at the rate of 5.0% and are due on March 28,
2005. At September 30, 2004, the principal and accrued interest on these notes
totaled approximately $398,000.
27
As part of the acquisition of Mountain Air in 2001, we issued a note to the
sellers of Mountain Air in the original amount of $2.2 million at 5.75% simple
interest which was reduced to $1.5 million as a result of the settlement of a
legal action against the sellers. At September 30, 2004 the outstanding amount
due, including accrued interest, was $1.6 million. The principal and accrued
interest is due on September 30, 2007. As discussed in Item 1 of Part II under
Legal Proceedings, the holder of this note has brought legal action seeking to
accelerate its payment.
Mountain Air has a term loan in the original amount of $267,000 at an interest
rate of 5.0%, with principal and interest payments of $5,039 due on the last day
of each month. At September 30, 2004, the outstanding amount due was $211,000
and the final maturity date is June 30, 2008.
In connection with incurring subordinated debt that was subsequently
extinguished in connection with the formation of AirComp, Mountain Air issued
redeemable warrants, which have been recorded as a liability of $600,000. The
redeemable warrants remain outstanding.
The following table summarizes our obligations and commitments to make future
payments under our notes payable, operating leases, employment contracts and
consulting agreements for the periods specified as of September 30, 2004.
PAYMENTS BY PERIOD
------------------
(IN THOUSANDS)
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
------------ ------------ ------------ ------------ ------------
CONTRACTUAL OBLIGATIONS
Notes Payable $ 30,099 $ 4,858 $ 15,164 $ 10,077 $ --
Interest Payments on notes payable 2,032 328 1,024 680 --
Operating Lease 1,298 275 539 398 86
Employment Contracts 2,425 1,006 1,419 -- --
------------ ------------ ------------ ------------ ------------
Total Contractual Cash Obligations $ 35,854 $ 6,467 $ 18,146 $ 11,155 $ 86
============ ============ ============ ============ ============
We have no off balance sheet arrangements that have or are likely to have a
current or future effect on our financial condition, changes in financial
condition, revenues, expenses, results of operations, liquidity, capital
expenditures or capital resources. We do not guarantee obligations of any
unconsolidated entities.
We currently believe that we will make $4.0 million of capital expenditures for
the remainder of 2004, excluding any potential acquisitions. We believe that our
current cash generated from operations, cash available under our credit
facilities and net proceeds from the equity private placements will provide
sufficient funds for our identified projects.
We intend to implement a growth strategy of increasing the scope of services
through both internal growth and acquisitions. We are regularly involved in
discussions with a number of potential acquisition candidates. We expect to make
capital expenditures to acquire and to maintain our existing equipment. Our
performance and cash flow from operations will be determined by the demand for
our services which in turn are affected by our customers' expenditures for oil
and gas exploration and development and industry perceptions and expectations of
future oil and gas prices in the areas where we operate. We will need to
refinance our existing debt facilities as they become due and provide funds for
capital expenditures and acquisitions. To effect our expansion plans, we will
require additional equity or debt financing in excess of our current working
capital and amounts available under credit facilities. There can be no assurance
that we will be successful in raising the additional debt or equity capital or
that we can do so on terms that will be acceptable to us.
28
Critical Accounting Policies
- ----------------------------
We have identified the policies below as critical to our business operations and
the understanding of our results of operations. The impact and any associated
risks related to these policies on our business operations is discussed
throughout Management's Discussion and Analysis of Financial Condition and
Results of Operations where such policies affect our reported and expected
financial results. For a detailed discussion on the application of these and
other accounting policies, see Note 1 in the Notes to the Consolidated Financial
Statements in Item 1 of Part I underI Financial Statements. Our preparation of
this report requires us to make estimates and assumptions that affect the
reported amount of assets and liabilities, disclosure of contingent assets and
liabilities at the date of our financial statements, and the reported amounts of
revenue and expenses during the reporting period. There can be no assurance that
actual results will not differ from those estimates.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The determination of the collectibility of
amounts due from our customers requires us to use estimates and make judgments
regarding future events and trends, including monitoring our customer payment
history and current credit worthiness to determine that collectibility is
reasonably assured, as well as consideration of the overall business climate in
which our customers operate. Those uncertainties require us to make frequent
judgments and estimates regarding our customers' ability to pay amounts due us
in order to determine the appropriate amount of valuation allowances required
for doubtful accounts. Provisions for doubtful accounts are recorded when it
becomes evident that the customers will not be able to make the required
payments at either contractual due dates or in the future. Over the past two
years, reserves for doubtful accounts, as a percentage of total accounts
receivable before reserves, have ranged from 1% to 2%. At December 31, 2003 and
2002, reserves for doubtful accounts totaled $168,000, or 2%, and $32,000, or 1%
of total accounts receivable before reserves, respectively. We believe that our
reserve for doubtful accounts is adequate to cover anticipated losses under
current conditions; however, changes in the financial condition of our
customers could impact the amount of provisions for doubtful accounts.
REVENUE RECOGNITION. Our revenue recognition policy is significant because
revenue is a key component of the results of operations. In addition, revenue
recognition determines the timing of certain expenses, such as commissions and
royalties. We provide rental equipment and drilling services to our customers at
per day and per job contractual rates and recognize the drilling related revenue
as the work progresses and when collectibility is reasonably assured. The
Securities and Exchange Commission's (SEC) Staff Accounting Bulletin (SAB) No.
104, REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB No. 104"), provides
guidance on the SEC staff's views on application of generally accepted
accounting principles to selected revenue recognition issues. Our revenue
recognition policy is in accordance with generally accepted accounting
principles and SAB No. 104.
IMPAIRMENT OF LONG-LIVED ASSETS. Long-lived assets, which include property,
plant and equipment, goodwill and other intangibles, comprise a significant
amount of the Company's total assets. The Company makes judgments and estimates
in conjunction with the carrying value of these assets, including amounts to be
capitalized, depreciation and amortization methods and useful lives.
Additionally, the carrying values of these assets are reviewed for impairment or
whenever events or changes in circumstances indicate that the carrying amounts
may not be recoverable. An impairment loss is recorded in the period in which it
is determined that the carrying amount is not recoverable. This requires the
Company to make long-term forecasts of its future revenues and costs related to
the assets subject to review. These forecasts require assumptions about demand
for the Company's products and services, future market conditions and
technological developments. Significant and unanticipated changes to these
assumptions could require a provision for impairment in a future period.
29
GOODWILL AND OTHER INTANGIBLES. The Company has recorded approximately
$10,331,000 of goodwill and $3,089,000 of other identifiable intangible assets.
The Company performs purchase price allocations to intangible assets when it
makes a business combination. Business combinations and purchase price
allocations have been consummated for purchase of the Mountain Air, Strata and
Jens' operating segments. The excess of the purchase price after allocation of
fair values to tangible assets is allocated to identifiable intangibles and
thereafter to goodwill. Subsequently, the Company has performed its initial
impairment tests and annual impairment tests in accordance with Financial
Accounting Standards Board No. 141, BUSINESS COMBINATIONS, and Financial
Accounting Standards Board No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. These
initial valuations required the use of third-party valuation experts who in turn
developed assumptions to value the carrying amount of the individual reporting
units. Significant and unanticipated changes to these assumptions could require
a provision for impairment in future periods.
STOCK BASED COMPENSATION. The Company accounts for its stock-based compensation
using Accounting Principles Board's Opinion No. 25 ("APB No. 25"). Under APB No.
25, compensation expense is recognized for stock options with an exercise price
that is less than the market price on the grant date of the option. For stock
options with exercise prices at or above the market value of the stock on the
grant date, the Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation"
("SFAS 123"). The Company has adopted the disclosure-only provisions of SFAS 123
for the stock options granted to the employees and directors of the Company.
Accordingly, no compensation cost has been recognized for these options. Many
equity instrument transactions are valued based on pricing models such as
Black-Scholes, which require judgments by management. Values for such
transactions can vary widely and are often material to the financial statements.
Quantitative and Qualitative Disclosure About Market Risk.
- ----------------------------------------------------------
We are exposed to market risk primarily from changes in interest rates and
foreign currency exchange risks.
INTEREST RATE RISK.
Fluctuations in the general level of interest rates on our current and future
fixed and variable rate debt obligations expose us to market risk. We are
vulnerable to significant fluctuations in interest rates on our variable rate
debt and on any future repricing or refinancing of our fixed rate debt and on
future debt.
At September 30, 2004, we were exposed to interest rate fluctuations on
approximately $14.0 million of notes payable and bank credit facility borrowings
carrying variable interest rates. A hypothetical one hundred basis point
increase in interest rates for these notes payable would increase our annual
interest expense by approximately $140,000. Due to the uncertainty of
fluctuations in interest rates and the specific actions that might be taken by
us to mitigate the impact of such fluctuations and their possible effects, the
foregoing sensitivity analysis assumes no changes in our financial structure.
We have also been subject to interest rate market risk for short-term invested
cash and cash equivalents. The principal of such invested funds would not be
subject to fluctuating value because of their highly liquid short-term nature.
As of September 30, 2004, we had $13.0 million invested in short-term maturing
investments.
30
FOREIGN CURRENCY EXCHANGE RATE RISK.
We conduct business in Mexico through our Mexican partner, Matyep. This business
exposes us to foreign exchange risk. To control this risk, we provide for
payment in U.S. dollars. However, we have historically provided our partner a
discount upon payment equal to 50% of any loss suffered by our partner as a
result of devaluation of the Mexican peso between the date of invoicing and the
date of payment. During 2003 and 2002 the discounts have not exceeded $10,000
per year.
Failure to Maintain Effective Internal Controls Could Have
- ----------------------------------------------------------
a Material Adverse Effect on Our Operations.
- --------------------------------------------
We are in the process of documenting and testing our internal control procedures
in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act,
which requires annual management assessments of the effectiveness of our
internal controls over financial reporting and a report by our Independent
Auditors addressing these assessments. During the course of our testing we may
identify deficiencies which we may not be able to remediate in time to meet the
deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements
of Section 404. In addition, if we fail to achieve and maintain the adequacy of
our internal controls, as such standards are modified, supplemented or amended
from time to time, we may not be able to ensure that we can conclude on an
ongoing basis that we have effective internal controls over financial reporting
in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, effective
internal controls are necessary for us to produce reliable financial reports and
are important to helping prevent financial fraud. If we cannot provide reliable
financial reports or prevent fraud, our business and operating results could be
harmed, investors could lose confidence in our reported financial information,
and the trading price of our stock could drop significantly.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 2 of Part I under Liquidity and Capital Resources -- Quantitative and
Qualitative Disclosure About Market Risk.
ITEM 4. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Our chief executive officer
and our chief accounting officer have evaluated the effectiveness of the
Company's "disclosure controls and procedures" (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) as of the end of the period covered by this Report (the
"Evaluation Date"), and have concluded that, as of the Evaluation Date, our
disclosure controls and procedures are effective in enabling us to record,
process, summarize, and report information required to be included in our SEC
filings within the required time period. Since the Evaluation Date, there have
not been any significant changes in our internal controls, or in other factors
that could significantly affect these controls subsequent to the Evaluation
Date.
It should be noted that any system of controls, however well designed and
operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system will be met. In addition, the design of any control
system is based in part upon certain assumptions about the likelihood of future
events.
31
PART II
ITEM 1. LEGAL PROCEEDINGS.
Mountain Compressed Air, Inc. is a defendant in an action brought in April 2004
(No. 04CV308) in the District Court of Mesa County, Colorado, by the former
owner of Mountain Air Drilling Service Co., Inc. nka Pattongill & Murphy, Inc.,
from whom Mountain Compressed Air acquired assets in 2001. The plaintiff seeks
to accelerate payment of the note issued in connection with the acquisition and
is seeking $1,863,000 in damages (representing principal and interest due under
the note), on the basis that Mountain Compressed Air has failed to timely
provide financial statements required by the note. We have raised several
defenses to the plaintiff's claim, including the holder's failure to comply with
the terms and conditions of the note, as well others including substantial
performance and impossibility of performance. We believe the claim is without
merit because of these defenses. For example, Mountain Compressed Air no longer
maintains separate financial statements and the Company provided plaintiff with
the Company's publicly available financial statements. The financial statements
disclose as a separate segment the operations of AirComp, which conducts
business using the assets acquired from plaintiff. Discovery is presently
ongoing, and based upon present information, the Company intends to vigorously
defend the case. Finally, we have claims in the amount of approximately $20,000
for legal fees and other expenses that the plaintiff agreed to pay in connection
with the settlement of an earlier lawsuit involving the acquisition of assets
from the plaintiff.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
On September 30, 2004, we issued 1,300,000 shares of our common stock to Jens H.
Mortensen, our President, Chief Operating Officer and a director, pursuant to a
merger between Jens' Oilfield Service, Inc. and a newly formed subsidiary of the
Company. As a result of the merger, we acquired Mr. Mortensen's 19% interest in
and now own 100% of Jens' Oilfield Service, Inc. The transaction was exempt from
the registration requirements of the Securities Act of 1933 pursuant to Section
4(2) of said Act.
On September 30, 2004, we completed a private placement of 1,956,634 shares of
our common stock to the following investors: Basic Energy Limited;
Milton H. Dresner Revocable Living Trust; Joseph S. Dresner; J. Steven Emerson
Roth IRA; Waverly Limited Partnership; Rosebury, L.P.; Meteoric, L.P.; Barbara
C. Crane; Bristol Investment Fund, Ltd.; L.H. Schmieding; Meadowbrook
Opportunity Fund LLC; and Kenneth Malkes. Each investor is a selling
stockholder. Pursuant to the terms of a stock purchase agreement, we sold to the
selling stockholders an aggregate of 3,504,667 shares of common stock at a price
per share of $3.00. The transaction was exempt from the registration
requirements of the Securities Act of 1933 pursuant to Regulation D promulgated
by the Securities and Exchange Commission under said Act. We paid a fee of
$410,893 to Morgan Keegan & Company, Inc. for its services as a placement agent
in connection with the offering.
On August 10, 2004 we completed a private placement of 3,504,667 shares of our
common stock to the following investors: Bear Stearns Securities Corp.,
Custodian, J. Steven Emersen Roth IRA; Bear Stearns Securities Corp., Custodian,
J. Steven Emersen IRA RO II; Bear Stearns Securities Corp., Custodian, Emerson
Partners; GSSF Master Fund, LP; Gerald Lisac, IRA C/O Union Bank of California,
Custodian; May Management, Inc.; Micro Cap Partners, L.P.; MK Employee Early
Stage Fund, L.P.; Morgan Keegan Early Stage Fund, L.P.; Palo Alto Global Energy
Fund, L.P.; RRCM Onshore I, L.P.; Earl Schatz, IRA C/O Union Bank of California,
Custodian; Straus Partners, L.P., Straus-GEPT Partners, LP; UBTI Free, L.P.;
U.S. Bank NA as Custodian of the Holzman Foundation; U.S. Bank NA as Trustee of
the Reliable Credit Association Inc. Pension & Trust; and U.S. Bank NA as
Trustee of the Reliable Credit Association Inc. Profit Sharing Plan & Trust.
Pursuant to the terms of a stock purchase agreement, we sold to the selling
stockholders an aggregate of 3,504,667 shares of common stock at a price per
share of $3.00 for an aggregate purchase price of $10,514,000. The transaction
was exempt from the registration requirements of the Securities Act of 1933
pursuant to Regulation D of said Act. We paid a fee of $735,984 to Morgan Keegan
& Company, Inc. for its services as a placement agent in connection with the
offering.
32
ITEM 5. OTHER EVENTS
On November 10, 2004 AirComp acquired Diamond Air Drilling
Services, Inc. and its affiliated company, Marquis Bit Co., LLC for $4.6 million
in cash. Diamond Air and Marquis Bit (collectively referred to as "Diamond Air")
provide air drilling technology and products to the oil and gas industry in West
Texas, New Mexico and Oklahoma. Diamond is a leading provider of air hammers and
hammer bit products. The acquisition was funded through capital contributions
from Allis-Chalmers and M-I in the amount of $2.5 million and $2.1 million,
respectively.
In connection with the Diamond Air acquisition described above, on November 15,
2004 we executed an agreement with the current bank lender to AirComp to amend
and increase the existing credit facilities. Under the amendment, the $1.0
million revolving line of credit was increased to $3.5 million. Secondly, the
$6.6 million term loan was increased to $7.1 million by adding the $490,000
amount outstanding under the existing delayed draw facility to the term loan.
Repayment of the $7.1 million term loan remained unchanged at $286,000 per
quarter. Finally, the $1.0 million delayed draw term loan facility was increased
to $1.5 million and its availability period was extended to December 31, 2005
from December 31, 2004. Repayment of this facility will be in equal quarterly
principal payments equal to 5.0% of amounts outstanding as of December 31, 2005,
beginning March 31, 2006, with a final maturity of June 27, 2007. The amended
credit facilities contain customary events of default and covenants which are
substantially similar to the existing facilities.
ITEM 6. EXHIBITS
The exhibits listed on the Exhibit Index located at Page 35 of this Quarterly
Report are filed as part of this Form 10-Q.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on November 15,
2004.
ALLIS-CHALMERS CORPORATION
---------------------------
(REGISTRANT)
/S/ MUNAWAR H. HIDAYATALLAH
---------------------------
MUNAWAR H. HIDAYATALLAH
CHIEF EXECUTIVE OFFICER AND
CHAIRMAN
34
EXHIBIT INDEX
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Accounting Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer and Chief Accounting
Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
35