XNAS:FES Forbes Energy Services Ltd Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

    x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

 

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

Commission file number 001-35281

 

 

Forbes Energy Services Ltd.

(Exact name of registrant as specified in its charter)

 

 

 

Texas   98-0581100

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3000 South Business Highway 281

Alice, Texas

  78332
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code:

(361) 664-0549

 

 

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.    x  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).    ¨  Yes    x  No

Shares outstanding of each of the registrant’s classes of common stock as of August 10, 2012:

 

Class

 

Outstanding as of August 10, 2012

Common Stock, $.04 par value  

21,151,749

 

 

 


Table of Contents

FORBES ENERGY SERVICES LTD. AND SUBSIDIARIES (a/k/a the “Forbes Group”)

TABLE OF CONTENTS

 

          Page  

Part I—Financial Information

  

Item 1.

  

Condensed Consolidated Financial Statements

     4   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     33   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     40   

Item 4.

  

Controls and Procedures

     41   

Part II—Other Information

  

Item 1.

  

Legal Proceedings

     43   

Item 1A.

  

Risk Factors

     43   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     43   

Item 3.

  

Defaults Upon Senior Securities

     43   

Item 4.

  

Mine Safety Disclosures

     43   

Item 5.

  

Other Information

     43   

Item 6.

  

Exhibits

     44   
  

Signatures

     46   

 

2


Table of Contents

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q and any oral statements made in connection with it include certain forward-looking statements within the meaning of the federal securities laws. You can generally identify forward-looking statements by the appearance in such a statement of words like “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project” or “should” or other comparable words or the negative of these words. When you consider our forward-looking statements, you should keep in mind the risk factors we describe and other cautionary statements we make in this Quarterly Report on Form 10-Q. Our forward-looking statements are only predictions based on expectations that we believe are reasonable. Our actual results could differ materially from those anticipated in, or implied by, these forward-looking statements as a result of known risks and uncertainties set forth below and elsewhere in this Quarterly Report on Form 10-Q. These factors include or relate to the following:

 

   

supply and demand for oilfield services and industry activity levels;

 

   

potential for excess capacity;

 

   

spending by the oil and natural gas industry given the continuing worldwide economic downturn;

 

   

our level of indebtedness in the current market;

 

   

possible impairment of our long-lived assets;

 

   

our ability to maintain stable pricing;

 

   

competition;

 

   

substantial capital requirements;

 

   

significant operating and financial restrictions under our indenture and revolving credit facility;

 

   

technological obsolescence of operating equipment;

 

   

dependence on certain key employees;

 

   

concentration of customers;

 

   

substantial additional costs of compliance with reporting obligations, the Sarbanes-Oxley Act and indenture covenants;

 

   

material weaknesses in internal controls over financial reporting;

 

   

seasonality of oilfield services activity;

 

   

collection of accounts receivable;

 

   

environmental and other governmental regulation, including potential climate change legislation;

 

   

the potential disruption of business activities caused by the physical effects, if any, of climate change;

 

   

risks inherent in our operations;

 

   

market response to global demands to curtail use of oil and natural gas;

 

   

ability to fully integrate future acquisitions;

 

   

variation from projected operating and financial data;

 

   

variation from budgeted and projected capital expenditures;

 

   

volatility of global financial markets; and

 

   

the other factors discussed under “Risk Factors” beginning on page 9 of the Annual Report on Form 10-K for the year ended December 31, 2011.

We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. To the extent these risks, uncertainties and assumptions give rise to events that vary from our expectations, the forward-looking events discussed in this Quarterly Report on Form 10-Q may not occur. All forward-looking statements attributable to us are qualified in their entirety by this cautionary statement.

 

3


Table of Contents

PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Balance Sheets (unaudited)

 

     June 30,
2012
    December 31,
2011
 

Assets

    

Current assets

    

Cash and cash equivalents

   $ 9,806,995      $ 36,600,091   

Accounts receivable - trade, net of allowance of $5.1 and $6.4 million for 2012 and 2011, respectively

     105,231,897        132,024,147   

Accounts receivable - related parties

     463,987        1,573,132   

Accounts receivable - other

     433,986        3,324,759   

Prepaid expenses

     5,344,424        8,974,168   

Other current assets

     1,134,632        1,310,477   
  

 

 

   

 

 

 

Total current assets

     122,415,921        183,806,774   

Property and equipment, net

     354,418,149        285,944,684   

Other intangible assets, net

     29,445,791        30,876,389   

Deferred financing costs, net of accumulated amortization of $1.4 million and $0.7 million for 2012 and 2011, respectively

     8,751,688        9,403,817   

Restricted cash

     16,545,523        16,150,433   

Other assets

     3,869,088        30,876   

Noncurrent assets held for sale

     —          24,210,080   
  

 

 

   

 

 

 

Total assets

   $ 535,446,160      $ 550,423,053   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Current liabilities

    

Current portions of long-term debt

   $ 5,987,887      $ 10,517,232   

Accounts payable - trade

     31,636,096        50,569,454   

Accounts payable - related parties

     7,445,291        1,219,928   

Accrued dividends

     61,259        61,259   

Deposit on assets held for sale

     —          13,700,000   

Accrued interest payable

     1,180,027        1,220,316   

Accrued expenses

     13,226,802        19,752,868   
  

 

 

   

 

 

 

Total current liabilities

     59,537,362        97,041,057   

Long-term debt

     291,331,979        285,633,042   

Deferred tax liability

     33,914,414        27,491,812   
  

 

 

   

 

 

 

Total liabilities

     384,783,755        410,165,911   
  

 

 

   

 

 

 

Commitments and contingencies (Note 10)

    

Temporary equity

    

Series B senior convertible preferred shares

     14,497,525        14,476,783   
  

 

 

   

 

 

 

Shareholders’ equity

    

Common stock, $.04 par value, 112,500,000 shares authorized, 21,068,417 and 20,918,417 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively

     842,737        836,737   

Additional paid-in capital

     190,457,873        187,885,293   

Accumulated other comprehensive loss

     (634,690     (1,077,678

Accumulated deficit

     (54,501,040     (61,863,993
  

 

 

   

 

 

 

Total shareholders’ equity

     136,164,880        125,780,359   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 535,446,160      $ 550,423,053   
  

 

 

   

 

 

 

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

 

4


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statements of Operations (unaudited)

 

     Three months ended June 30,     Six months ended June 30,  
     2012     2011     2012     2011  

Revenues

        

Well servicing

   $ 51,314,385      $ 42,034,263      $ 103,554,199      $ 78,448,693   

Fluid logistics and other

     68,470,373        68,783,378        147,715,139        127,030,201   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     119,784,758        110,817,641        251,269,338        205,478,894   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Well servicing

     37,452,713        34,387,657        76,541,120        64,149,205   

Fluid logistics and other

     49,354,319        50,690,794        104,210,101        92,913,371   

General and administrative

     8,074,710        13,106,901        18,744,461        18,796,604   

Depreciation and amortization

     12,465,442        9,541,539        23,886,158        19,216,212   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     107,347,184        107,726,891        223,381,840        195,075,392   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     12,437,574        3,090,750        27,887,498        10,403,502   

Other income

        

Interest income

     16,304        13,460        50,136        26,358   

Interest expense

     (6,857,120     (6,813,321     (13,763,136     (13,754,478

Loss on early extinguishment of debt

     —          (35,414,833     —          (35,414,833

Other income, net

     —          68,204        —          69,104   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before taxes

     5,596,758        (39,055,740     14,174,498        (38,670,347

Income tax expense (benefit)

     2,950,257        (12,489,453     6,317,008        (12,191,067
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     2,646,501        (26,566,287     7,857,490        (26,479,280

Income from discontinued operations, net of tax expense (benefit) of ($0.4 million), $1.2 million, $0.4 million, $2.0 million, respectively

     (1,626,158     1,871,585        (494,537     3,689,096   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     1,020,343        (24,694,702     7,362,953        (22,790,184

Preferred stock dividends

     (194,139     1,084,271        (388,278     201,687   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common shareholders

   $ 826,204      $ (23,610,431   $ 6,974,675      $ (22,588,497
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) per share of common stock from continuing operations (Note 12)

        

Basic

   $ 0.12      $ (1.22   $ 0.36      $ (1.26

Diluted

   $ 0.10      $ (1.22   $ 0.30      $ (1.26

Income (loss) per share of common stock from discontinued operations (Note 12)

        

Basic

   $ (0.08   $ 0.09      $ (0.02   $ 0.18   

Diluted

   $ (0.06   $ 0.09      $ (0.02   $ 0.18   

Income (loss) per share of common stock (Note 12)

        

Basic

   $ 0.04      $ (1.13   $ 0.33      $ (1.08

Diluted

   $ 0.04      $ (1.13   $ 0.28      $ (1.08

Weighted average number of shares outstanding (Note 12)

        

Basic

     21,055,642        20,918,400        21,020,628        20,918,400   

Diluted

     26,625,452        20,918,400        26,621,044        20,918,400   

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

 

5


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statements of Comprehensive Income (Loss) (unaudited)

 

     Three months ended June 30,     Six months ended June 30,  
     2012      2011     2012      2011  

Net income (loss)

   $ 1,020,343       $ (24,694,702   $ 7,362,953       $ (22,790,184

Other comprehensive income (loss)

          

Foreign currency translation adjustments

     88,873         27,364        442,988         (434,222
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive income (loss)

   $ 1,109,216       $ (24,667,338   $ 7,805,941       $ (23,224,406
  

 

 

    

 

 

   

 

 

    

 

 

 

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

 

6


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statements of Changes in Shareholders’ Equity (unaudited)

 

    Preferred Shares     Common Stock     Additional
Paid-In
    Accumulated
Other
Comprehensive
    Accumulated     Total
Shareholders’
 
    Shares     Amount     Shares     Amount     Capital     Income     Deficit     Equity  

Balance: December 31,
2011

    588,059      $ 14,476,783        20,918,417      $ 836,737      $ 187,885,293      $ (1,077,678   $ (61,863,993   $ 125,780,359   

Share-based compensation

    —          —          —          —          2,896,858        —          —          2,896,858   

Net income

    —          —          —          —          —          —          7,362,953        7,362,953   

Foreign currency translation adjustment

    —          —          —          —          —          442,988        —          442,988   

Common shares issued under stock plan:

               

Exercise of stock options

    —          —          25,000        1,000        64,000        —          —          65,000   

Issuance of restricted stock

    —          —          125,000        5,000        —          —          —          5,000   

Preferred shares dividends and accretion

    —          20,742        —          —          (388,278     —          —          (388,278
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance: June 30, 2012

    588,059      $ 14,497,525        21,068,417      $ 842,737      $ 190,457,873      $ (634,690   $ (54,501,040   $ 136,164,880   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

7


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statements of Cash Flows (unaudited)

 

     Six months ended June 30,  
     2012     2011  

Cash flows from operating activities:

    

Net income (loss)

   $ 7,362,953      $ (22,790,184

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Depreciation expense

     22,455,560        18,681,709   

Amortization expense

     1,430,598        1,430,598   

Amortization of Second Priority Notes OID

     —          324,306   

Share-based compensation

     3,637,608        1,348,278   

Deferred tax benefit

     6,767,064        (11,386,772

Loss on disposal of assets, net

     187,957        803,145   

Loss on early extinguishment of debt

     —          10,403,237   

Gain on disposal of discontinued operations, net

     (3,546,583     —     

Bad debt expense

     376,906        510,469   

Amortization of deferred financing cost

     733,196        913,076   

Changes in operating assets and liabilities:

    

Accounts receivable

     30,921,742        (34,136,263

Accounts receivable - related party

     1,109,145        (552,893

Prepaid expenses and other current assets

     (4,784,985     (2,900,970

Accounts payable – trade

     (19,278,858     18,218,301   

Accounts payable - related party

     6,225,363        (9,480,916

Accrued expenses

     (8,615,681 )       13,260,569   

Income taxes payable

     —          (195,724

Accrued interest payable

     (40,289     (7,371,826
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     44,941,696        (22,921,860
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Proceeds from sale of property and equipment

     —          527,102   

Purchases of property and equipment

     (89,571,226     (23,678,077

Proceeds from sale of assets included in discontinued operations

     14,284,764        —     

Change in restricted cash

     (395,090     (7,085,210
  

 

 

   

 

 

 

Net cash used in investing activities

     (75,681,552     (30,236,185
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Payments for debt issuance costs

     (81,067 )       (2,557,308

Retirement of First and Second Priority Notes

     —          (212,500,000

Proceeds from issuance of Senior Notes

     —          280,000,000   

Payments for debt issuance costs

     —          (7,418,175

Proceeds from the exercise of stock options

     65,000        —     

Proceeds from issuance of restricted stock

     5,000        —     

Proceeds from revolving credit facility

     6,000,000        —     

Repayments of other debt

     (1,947,107     —     

Dividends paid on Series B Senior Convertible Preferred Shares

     (367,536 )       —     
  

 

 

   

 

 

 

Net cash provided by financing activities

     3,674,290        57,524,517   
  

 

 

   

 

 

 

Effect of currency translation on cash and cash equivalents

     272,470        94,435   

Net increase (decrease) in cash and cash equivalents

     (26,793,096     4,460,907   

Cash and cash equivalents:

    

Beginning of period

     36,600,091        30,458,457   
  

 

 

   

 

 

 

End of period

   $ 9,806,995      $ 34,919,364   
  

 

 

   

 

 

 

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

 

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Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Notes to Condensed Consolidated Financial Statements

1. Organization and Nature of Operations

Nature of Business

Forbes Energy Services Ltd. (“FES Ltd”) is an independent oilfield services contractor that provides a wide range of well site services to oil and natural gas drilling and producing companies to help develop and enhance the production of oil and natural gas. These services include fluid hauling, fluid disposal, well maintenance, completion services, workovers and recompletions, plugging and abandonment, and tubing testing. Our operations are concentrated in the major onshore oil and natural gas producing regions of Texas, with additional locations in Mississippi, in Pennsylvania and, prior to the disposition of our Mexican assets in January 2012, which is discussed in Note 17 below, in Mexico. We believe that our broad range of services, which extends from initial drilling, through production, to eventual abandonment, is fundamental to establishing and maintaining the flow of oil and natural gas throughout the life cycle of our customers’ wells.

As used in these condensed consolidated financial statements, the “Company,” the “Forbes Group,” “we,” and “our” mean FES Ltd and its direct and indirect subsidiaries, except as otherwise indicated.

2. Risk and Uncertainties

As an independent oilfield services contractor that provides a broad range of drilling-related and production-related services to oil and natural gas companies, primarily onshore in Texas, our revenue, profitability, cash flows and future rate of growth are substantially dependent on our ability to (1) maintain adequate equipment utilization, (2) maintain adequate pricing for the services we provide, and (3) maintain a trained work force. Failure to do so could adversely affect our financial position, results of operations, and cash flows.

Because our revenues are generated primarily from customers who are subject to the same factors generally impacting the oil and natural gas industry, our operations are also susceptible to market volatility resulting from economic, cyclical, weather related or other factors related to such industry. Changes in the level of operating and capital spending in the industry, decreases in oil and natural gas prices, or industry perception about future oil and natural gas prices could materially decrease the demand for our services, adversely affecting our financial position, results of operations and cash flows.

3. Basis of Presentation

Interim Financial Information

The unaudited condensed consolidated financial statements of the Forbes Group are prepared in conformity with accounting principles generally accepted in the United States of America, or “GAAP” for interim financial reporting. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted. Therefore, these condensed consolidated financial statements should be read along with the annual audited consolidated financial statements and notes thereto included in Forbes Group’s Annual Report on Form 10-K for the year ended December 31, 2011. In management’s opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented. Interim results for the three and six months ended June 30, 2012 may not be indicative of results that will be realized for the full year ending December 31, 2012. All significant intercompany accounts and transactions have been eliminated in consolidation.

Reclassification

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

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated balance sheets and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates. Management believes that these estimates and assumptions provide a reasonable basis for the fair presentation of the condensed consolidated financial statements.

 

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Table of Contents

Foreign Currency Gains and Losses

The functional currency at our Mexican subsidiary is the Mexican Peso. On January 12, 2012, we completed the disposition of substantially all of our assets and business located in Mexico. Nevertheless, we continue to collect accounts receivables related to these prior operations in Mexico and a significant portion of these accounts receivable is in pesos. Assets and liabilities are translated using the spot rate on the balance sheet date, while income and expense items are translated at average rates of exchange during the period. The resulting gains or losses arising from the translation of accounts from the functional currency to the U.S. dollar are included as a separate component of shareholders’ equity in other comprehensive income (loss). Transactions that are denominated in a currency other than the functional currency are re-measured into the functional currency each reporting period. Transaction gains and losses that arise from exchange rate fluctuations on transactions and balances denominated in a currency other than the functional currency are included in the results of operations and cash flows as incurred.

Share Consolidation

As of August 12, 2011, FES Ltd discontinued its existence in Bermuda and converted into a Texas corporation. In connection with and immediately prior to this Texas conversion, FES Ltd effected a 4-to-1 share consolidation, or the Share Consolidation. All references included in these financial statements and accompanying notes to the number of shares, par value and per share amounts of the common stock of FES Ltd prior to the Share Consolidation have been retroactively adjusted to give effect to the Share Consolidation.

Recent Accounting Pronouncements

In September 2011, the FASB issued ASU No. 2011-08, “Intangibles — Goodwill and Other” (“ASU 2011-08”). ASU 2011-08 allows a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the two-step impairment test for that reporting unit would be performed. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and early adoption is permitted. We adopted the provisions of ASU 2011-08 during the first quarter of 2012.

In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet” (“ASU 2011-11”). The standard amends and expands disclosure requirements about balance sheet offsetting and related arrangements. ASU 2011-11 becomes effective for Forbes on January 1, 2013. We do not anticipate any impact to our results of operations, financial position or liquidity when the guidance becomes effective.

4. Other Intangible Assets

Other intangible assets are subject to amortization for the period of time which the assets are expected to contribute directly or indirectly to future cash flows under the guidance of ASC 350.

Our major classes of intangible assets subject to amortization under ASC 350 consist of our customer relationships, trade names, safety training program, dispatch software, and other. The Company expenses costs associated with extensions or renewals of intangibles assets. There were no such extensions or renewals in the three and six months ended June 30, 2012 or June 30, 2011. Amortization expense is calculated using the straight-line method over the period indicated. Amortization expense for the three months ended June 30, 2012 and June 30, 2011 from continuing operations was $0.7 million and for the six months ended June 30, 2012 and June 30, 2011 was $1.4 million. Estimated amortization expense for each of the five succeeding fiscal years is $2.9 million per year. The weighted average amortization period remaining for intangible assets is 10.3 years.

 

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The following sets forth the identified intangible assets by major asset class:

 

            As of June 30, 2012      As of December 31, 2011  
     Useful
Life
(years)
     Gross
Carrying
Value
     Accumulated
Amortization
     Net Book
Value
     Gross
Carrying
Value
     Accumulated
Amortization
     Net Book
Value
 

Customer relationships

     15       $ 31,895,919       $ 9,568,776       $ 22,327,143       $ 31,895,919       $ 8,505,578       $ 23,390,341   

Trade names

     15         8,049,750         2,414,925         5,634,825         8,049,750         2,146,600         5,903,150   

Safety training program

     15         1,181,924         354,577         827,347         1,181,924         315,180         866,744   

Dispatch software

     10         1,135,282         510,877         624,405         1,135,282         454,112         681,170   

Other

     10         58,300         26,229         32,071         58,300         23,316         34,984   
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
      $ 42,321,175       $ 12,875,384       $ 29,445,791       $ 42,321,175       $ 11,444,786       $ 30,876,389   
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

5. Share-Based Compensation

Stock Options

From time to time, the Company grants stock options, restricted stock or other awards to its employees, including executive officers and directors. Prior to July 9, 2012, these awards were granted pursuant to the Company’s 2008 Incentive Compensation Plan, or the 2008 Plan. On July 9, 2012, at the Company’s 2012 Annual Meeting of Shareholders, the Company’s shareholders approved the Company’s 2012 Incentive Compensation Plan, or the 2012 Plan. No further awards will be made under the 2008 Plan, however, outstanding awards granted under the 2008 Plan will remain subject to the terms and conditions of the 2008 Plan. Any shares of common stock that are available to be granted under the 2008 Plan but which are not subject to outstanding awards under the 2008 Plan, including shares that become available due to the future lapse or forfeiture of outstanding awards, will be added to the 1,022,500 shares of common stock authorized for issuance under the 2012 Plan. As of June 30, 2012, no awards had been issued under the 2012 Plan.

Stock options issued in 2008 under the 2008 plan originally vested over a three-year period. On August 11, 2011, however, the Company exchanged 667,500 of these options, which constituted all of the outstanding options issued in 2008, in a 0.72 to 1 exchange for 480,600 options issued under the 2008 plan (the “Exchange Options”). These Exchange Options vest one-third every four months from the exchange date and the Company will recognize $0.1 million of compensation expense for this exchange over a 12 month period. With respect to the stock options issued in 2010, the standard option vests over a two year period with one fourth vesting every six months, until fully vested. With respect to options, unrelated to the Exchange Options issued in August 2011, vesting took place over a three-year period, with approximately one third vesting on the first, second and third anniversaries of the date of grant. For most grantees, vested options expire at the earlier of either one year after the termination of grantee’s employment by reason of death, disability or retirement, 90 days after termination of the grantee’s employment other than upon grantee’s death, disability or retirement, provided, however, that the Company may elect to extend the expiration beyond this 90-day period, or ten years after the date of grant.

The following table presents a summary of the Company’s stock option activity for the six months ended June 30, 2012.

 

     Shares     Weighted-
Average
Exercise
Price
     Weighted-
Average
Remaining
Contractual
Term
     Aggregate
Intrinsic
Value
 

Options outstanding at December 31, 2011

     2,285,425      $ 7.49         8.79 years       $ 2,297,344   

Stock options:

        

Granted

     —             

Exercised

     (25,000     2.60         

Forfeited

     (262,500     8.87         
  

 

 

   

 

 

    

 

 

    

 

 

 

Options outstanding at June 30, 2012

     1,997,925      $ 7.51         8.23 years       $ 1,077,563   
  

 

 

   

 

 

    

 

 

    

 

 

 

Vested and expected to vest at June 30, 2012

     703,444      $ 5.64         7.23 years       $ 808,172   
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable at June 30, 2012

     703,444      $ 5.64         7.23 years       $ 808,172   
  

 

 

   

 

 

    

 

 

    

 

 

 

During the three months ended June 30, 2012 and June 30, 2011 the Company recorded total stock based compensation expense from continuing operations of $1.1 million and $0.6 million, respectively. During the six months ended June 30, 2012 and June 30, 2011 the Company recorded total stock based compensation expense of $2.9 million and $1.3 million, respectively, from restricted stock and stock options. No stock-based compensation costs were capitalized for the periods ended

 

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June 30, 2012 or June 30, 2011. As of June 30, 2012, total unrecognized stock-based compensation costs amounted to $7.4 million (net of estimated forfeitures); and is expected to be recorded over a weighted-average period of 2.0 years. During the three and six months ended June 30, 2012 an additional $0.4 million and $0.7 million was recorded to accrue for the executive stock bonuses per the newly implemented, performance based, management bonus plan and is reflected as a current liability in our consolidated financial statements.

At June 30, 2012, after taking into account the amendments to the 2008 incentive compensation plan approved by the company’s shareholders at their special and general annual meeting on June 27, 2011, the subsequent Exchange Options issued August 11, 2011, new awards issued on August 15, 2011, restricted stock grants in first quarter of 2012 (as discussed in the Restricted Stock paragraph below), and 198,511 shares (calculated using the closing price of the common stock on June 30, 2012) reserved for the equity portion of the executive performance incentive compensation plan there were 547,732 shares available for future grants under the 2008 Plan. All of which will be added to the 1,022,500 shares of common stock authorized for issuance under the 2012 Plan approved by the Shareholders in July 2012.

Restricted Stock

In March of 2012, we granted 83,332 shares of restricted stock with a vesting period of one year. The aggregate fair value of this restricted stock is $497,117 which will be amortized over the next twelve months. In addition, we granted 125,000 shares of restricted stock with an aggregate fair value of $720,000 included in total stock-based compensation in February of 2012, which vested immediately and was expensed in the first quarter of 2012.

Grants Outside of the 2008 Incentive Compensation Plan

On August 23, 2010, the Company granted 65,000 stock options in an issuance outside the 2008 Incentive Compensation Plan. These options vest twenty-five percent on each six-month anniversary from the date of grant, and will become fully vested over a two year period.

6. Property and Equipment

Property and equipment consisted of the following:

 

     Estimated
Life in  Years
     June 30,
2012
    December 31,
2011
 

Well servicing equipment

     3-15 years       $ 376,820,736      $ 317,883,278   

Autos and trucks

     5-10 years         105,260,177        95,667,664   

Disposal wells

     5-15 years         30,397,527        11,957,960   

Building and improvements

     5-30 years         9,146,325        7,842,246   

Furniture and fixtures

     3-10 years         3,114,329        2,426,219   

Land

        989,219        257,425   

Other

     3-15 years         161,429        44,204   
     

 

 

   

 

 

 
        525,889,742        436,078,996   

Accumulated depreciation

        (171,471,593     (150,134,312
     

 

 

   

 

 

 
      $ 354,418,149      $ 285,944,684   
     

 

 

   

 

 

 

Depreciation expense from continuing operations was $11.8 million and $22.5 million for the three and six months ended June 30, 2012 and $9.2 million and $18.4 million for the three and six months ended June 30, 2011, respectively.

 

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7. Long-Term Debt

Long-term debt at June 30, 2012 and December 31, 2011 consisted of the following:

 

     June 30,
2012
    December 31,
2011
 

9% Senior Notes

   $ 280,000,000      $ 280,000,000   

Revolving credit facility

     6,000,000        —     

Insurance note

     2,365,972        7,119,310   

3rd party equipment notes

     8,953,894        9,030,964   
  

 

 

   

 

 

 
     297,319,866        296,150,274   

Less: Current portion

     (5,987,887     (10,517,232
  

 

 

   

 

 

 
   $ 291,331,979      $ 285,633,042   
  

 

 

   

 

 

 

9% Senior Notes

On June 7, 2011, FES Ltd issued $280.0 million in principal amount of 9% Senior Notes due 2019 (the “9% Senior Notes”). The proceeds of the 9% Senior Notes were used to purchase and redeem 100% of the First Priority Notes and the outstanding Second Priority Notes (described below)issued by two of FES Ltd’s subsidiaries, Forbes Energy Services LLC and Forbes Energy Capital Inc. The 9% Senior Notes mature on June 15, 2019, and require semi-annual interest payments, in arrears, at an annual rate of 9% on June 15 and December 15 of each year until maturity commencing December 15, 2011. No principal payments are due until maturity.

The 9% Senior Notes are guaranteed by the current domestic subsidiaries (the “Guarantor Subs”) of FES Ltd, which includes FES LLC, C.C. Forbes, LLC (“CCF”), TX Energy Services, LLC (“TES”), Superior Tubing Testers, LLC (“STT”) and Forbes Energy International, LLC (“FEI LLC”). All of the Guarantor Subs are 100% owned. Each guarantee of the Guarantor Subs is on a full and unconditional and joint and several basis, subject to customary release provisions. Prior to January 12, 2012, FES Ltd had two 100% owned indirect Mexican subsidiaries or the Non-Guarantor Subs that had not guaranteed the 9% Senior Notes. In January 2012, one of those two Mexican subsidiaries was sold along with the business and substantially all of our long-lived assets located in Mexico. The Guarantor Subs represent the majority of the Company’s operations. On or after June 15, 2015, the Company may, at its option, redeem all or part of the 9% Senior Notes from time to time at specified redemption prices and subject to certain conditions required by the indenture governing the 9% Senior Notes (the “9% Senior Indenture”). The Company is required to make an offer to purchase the notes and to repurchase any notes for which the offer is accepted at 101% of their principal amount, plus accrued and unpaid interest, if there is a change of control. The Company is required to make an offer to repurchase the notes and to repurchase any notes for which the offer is accepted at 100% of their principal amount, plus accrued and unpaid interest, following certain asset sales.

The Company is permitted under the terms of the 9% Senior Indenture to incur additional indebtedness in the future, provided that certain financial conditions set forth in the 9% Senior Indenture are satisfied. The Company is subject to certain covenants contained in the 9% Senior Indenture, including provisions that limit or restrict the Company’s and certain future subsidiaries’ abilities to incur additional debt, to create, incur or permit to exist certain liens on assets, to make certain dispositions of assets, to make payments on certain subordinated indebtedness, to pay dividends or certain other payments to equity holders, to engage in mergers, consolidations or other fundamental changes, to change the nature of its business or to engage in transactions with affiliates. As of June 30, 2012, we are in compliance with all covenants in the indenture.

Second Priority Notes

On February 12, 2008, FES LLC and FES CAP issued $205 million in principal amount of 11% senior secured notes due 2015 (together with notes issued in exchange therefore, the “Second Priority Notes”). In May 2011, we commenced a cash tender offer to purchase any and all of the Second Priority Notes then outstanding. In connection with that tender offer, we successfully solicited consents to and implemented amendments that eliminated most of the restrictive covenants and event of default provisions contained in the Indenture governing the Second Priority Notes the “Second Priority Indenture”. In June 2011, pursuant to this tender offer, we purchased 99.8% of the outstanding principal amount of the Second Priority Notes. On June 27, 2011, the Company commenced the redemption of the remaining outstanding Second Priority Notes which closed on July 27, 2011. As a result, the Second Priority Indenture was discharged and all liens relating thereto were released.

First Priority Notes

On October 2, 2009, FES LLC and FES CAP issued to Goldman, Sachs & Co. $20 million in aggregate principal amount of First Lien Floating Rate Notes due 2014 (the “First Priority Notes”), in a private placement in reliance on an exemption from registration under the Securities Act of 1933, as amended. On June 7, 2011, FES Ltd used a portion of the proceeds of the offering of the 9% Senior Notes to purchase all of the aggregate principal amount of the First Priority Notes outstanding at which time the indenture governing the First Priority Notes was discharged and the liens related thereto were released.

 

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Revolving Credit Facility

On September 9, 2011, FES Ltd and its current domestic subsidiaries entered into a loan and security agreement with Regions Bank, SunTrust Bank, CIT Bank and Capital One Leverage Finance Corp., as lenders, and Regions Bank, as agent for the secured parties, or the Agent. The loan and security agreement provides for an asset based revolving credit facility with a maximum initial borrowing credit of $75.0 million, subject to borrowing base availability. As of June 30, 2012, $69.0 million was available under this new credit facility. The loan and security agreement has a stated maturity of September 9, 2016. The proceeds of this credit facility can be used for the purchase of well services equipment, permitted acquisitions, general operations, working capital and other general corporate purposes. There was $6.0 million outstanding under this facility at June 30, 2012 and no borrowings outstanding at August 10, 2012. As of August 10, 2012, there were $1.7 million in letters of credit outstanding against this facility.

Under the loan and security agreement, our borrowing base at any time is equal to (i) 85% of eligible accounts, which are determined by Agent in its reasonable discretion, plus (ii) the lesser of 85% of the appraised value, subject to certain adjustments, of our well services equipment that has been properly pledged and appraised, is in good operating condition and is located in the United States, or 100% of the net book value of such equipment, minus (iii) any reserves established by the Agent in its reasonable discretion.

At our option, borrowings under this new credit facility will bear interest at a rate equal to either (i) the LIBOR rate plus an applicable margin of between 2.25% to 2.75% based on borrowing availability or (ii) a base rate plus an applicable margin of between 1.25% to 1.75% based on borrowing availability, where the base rate is equal to the greater of the prime rate established by Regions Bank, the overnight federal funds rate plus 0.5% or the LIBOR rate for a one month period plus 1%.

In addition to paying interest on outstanding principal under the facility, a fee of 0.375% per annum will accrue on unutilized availability under the credit facility. We are required to pay a fee of between 2.25% to 2.75%, based on borrowing availability, with respect to the principal amount of any letters of credit outstanding under the facility. We are also responsible for certain other administrative fees and expenses. In connection with the execution of the loan and security agreement, we paid the lenders an upfront fee of $0.5 million.

FES LLC, FEI LLC, TES, CCF and STT are the borrowers under the loan and security agreement. Their obligations have been guaranteed by one another and by FES Ltd. Subject to certain exceptions and permitted encumbrances, including the exemption of real property interests from the collateral package, the obligations under this facility are secured by a first priority security interest in all of our assets.

We are able to voluntarily repay outstanding loans at any time without premium or penalty (subject to the fees discussed above). If at anytime our outstanding loans under the credit facility exceed the availability under our borrowing base, we may be required to repay the excess. Further, we are required to use the net proceeds from certain events, including certain judgments, tax refunds or insurance awards to repay outstanding loans; however, we may reborrow following such repayments if the conditions to borrowing are met.

The loan and security agreement contains customary covenants for an asset-based credit facility, which include (i) restrictions on certain mergers, consolidations and sales of assets; (ii) restrictions on the creation or existence of liens; (iii) restrictions on making certain investments; (iv) restrictions on the incurrence or existence of indebtedness; (v) restrictions on transactions with affiliates; (vi) requirements to deliver financial statements, report and notices to the Agent and (vii) a springing requirement to maintain a consolidated fixed charge coverage ratio (which is defined in the loan and security agreement) of 1.1:1.0 in the event that our excess availability under the credit facility falls below the greater of $11.3 million or 15% of our maximum credit under the facility for sixty consecutive days; provided that, the restrictions described in (i)—(v) above are subject to certain exceptions and permissions limited in scope and dollar value. The loan and security agreement also contains customary representations and warranties and event of default provisions. As of June 30, 2012, we are in compliance with all covenants in the loan and security agreement.

The company recently entered into an amendment to the loan agreement governing our new credit facility, or the Second Amendment. Similar to the first amendment to the Loan Agreement, this Second Amendment modifies certain provisions of the Loan Agreement to, among other things, provide more flexibility on the Borrower Subsidiaries’ ability to enter into equipment leases, purchase money financings and insurance financing transactions. This amendment was effective on July 6, 2012 after the payment of an amendment fee.

Third Party Equipment Notes

During the past few years, the Forbes Group financed the purchase of certain vehicles and equipment through commercial loans with Paccar Financial Group, Mack Financial Services, and Enterprise Fleet Management with aggregate principal amounts outstanding as of June 30, 2012 and December 31, 2011 of approximately $9.0 million. These loans are repayable in a range of 42 to 60 monthly installments with the maturity dates ranging from May 2013 to August 2016. Interest

 

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accrues at rates ranging from 4.7% to 7.6% and is payable monthly. The loans are collateralized by equipment purchased with the proceeds of such loans. The Forbes Group paid total principal payments of approximately $1.1 million and $4.3 million for the three months ended June 30, 2012 and year ended December 31, 2011, respectively.

Insurance Notes

During 2011, the Forbes Group entered into a promissory note with First Insurance Funding for the payment of insurance premiums during the period of insurance coverage with an aggregate principal amount outstanding as of June 30, 2012 and December 31, 2011 of approximately $2.4 million and $7.1 million, respectively. This note is payable in 12 monthly installments with maturity date of September 15, 2012. Interest accrues at a rate of approximately 3.6% and is payable monthly. The amount outstanding could be substantially offset by the cancellation of the related insurance coverage.

8. Fair Value of Financial Instruments

The following is a summary of the carrying amounts and estimated fair values of our financial instruments as of June 30, 2012 and December 31, 2011. Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The carrying amounts of cash and cash equivalents, accounts receivable-trade, accounts receivable-related parties, accounts receivable – other, prepaid expenses, other current assets, accounts payable – trade, accounts payable – related parties, insurance notes, deposits on assets held for sale, and accrued expenses approximate fair value because of the short maturity of these instruments. The fair values of third party notes and equipment notes, which approximate their carrying values, are based on current market rates at which the company could borrow funds with similar maturities.

 

     June 30, 2012      December 31, 2011  
     Carrying Amount      Fair Value      Carrying Amount      Fair Value  
     (dollars in thousands)  

9.0% Senior Notes

   $ 280,000       $ 260,400       $ 280,000       $ 261,800   

9. Related Party Transactions

The Company and its subsidiaries enter into transactions with related parties in the normal course of conducting business. References in this section to the Company include the Company’s subsidiaries, unless the context indicates otherwise. Accounts receivable – related parties and accounts payable – related parties result from the transactions with related parties, which the company believes are on terms consistent with those available to third-party customers from third-party vendors.

Messrs. John E. Crisp and Charles C. Forbes, Jr., executive officers and directors of FES Ltd, are also owners and managers of Alice Environmental Holdings, LLC or AEH, and indirect owners and managers of Alice Environmental Services, LP, or AES. The Company has entered into the following transactions with AES and AEH:

 

   

AEH owns aircraft that the Company uses on a regular basis.

 

   

The Company entered into long-term operating leases with AES for well service rigs, vacuum trucks and related equipment and has subsequently purchased these assets from AES.

 

   

The Company entered into long-term real property leases, disposal well leases and disposal well operating agreements with AES and has subsequently purchased all but one of these leased disposal wells.

In June 2011, the Company purchased from AES certain workover rigs, trucks, tanks, swab units and other well servicing equipment being leased pursuant to two operating leases, as well as certain other frac tank equipment being rented from AES on a month-to-month basis. The Company paid AES and aggregate purchase price of approximately $18.0 million, plus a payment for estimated sales tax of $1.7 million.

The Company had been leasing the workover rigs that it purchased in June 2011 pursuant to a five-year operating lease entered into with AES in October 2008. The gross lease amount of this agreement was approximately $15.2 million with monthly payments of approximately $0.3 million.

The Company had been leasing certain other well servicing equipment purchased in June 2011 pursuant to an operating lease it entered into with AES effective January 2010. Prior to January 2010, this equipment was being rented month-to-month. The gross agreement amount was approximately $3.2 million with monthly payments of approximately $67,000.

In March 2012, the Company purchased ten vacuum trucks and trailers from AES for an aggregate purchase price of approximately $1.1 million.

 

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Expenses paid to AES related to equipment and aircraft rental were approximately $0.3 million and $0.6 million for the three and six months ended June 30, 2012 and $0.7 million and $1.3 million for the three and six months ended June 30, 2011, respectively.

The Company entered into a waste water disposal operating agreement dated January 1, 2007, with AES pursuant to which AES leased its rights in a certain well bore and receives payments in the form of a minimum fee of $5,000 per month plus $0.15 per barrel injected over 50,000 barrels. Under this agreement, AES also received a “skim oil” payment of 20% of the amount realized by the Company for all oil and hydrocarbons removed from liquids injected into the premises. The agreement term was for three years and was automatically renewed on January 1, 2010 for a three year term. Beginning in January 2008, the Company began paying AES for the use of three additional disposal wells, on a month-to-month basis, without a written contract. The terms of this rental arrangement was on a usage basis. In April 2012, these four disposal wells were purchased by the Company for $14.5 million. The Company paid $7.5 million in April 2012 and the remainder will be paid in October 2012.

The Company continues to operates one additional disposal well from AES pursuant to a waste water disposal lease agreement with AES dated April 1, 2007. Under this agreement, the Company is entitled to use leased land for the disposal of waste water for a term of five years with three successive three year renewal periods. The Company pays a monthly rental of $2,500 per month plus $0.05 per barrel for any barrel over 50,000 barrels of waste water injected per month. Additionally, the Company pays an amount equal to 10% of all oil or other hydrocarbons removed from the liquids injected into the premises. The Company also pays AES to dispose of a portion of the solid waste products generated from its salt water disposal wells.

Expenses paid to AES related to salt water disposal wells were approximately $0.6 million and $1.2 million related to the disposal of waste water for the three and six months ended June 30, 2012 and $0.4 million and $0.7 million for the three and six months ended June 30, 2011, respectively.

The Company has thirteen separate rental or lease agreements with AES for separate parcels of land and buildings. Ten of the leases were entered into at various dates subsequent to December 31, 2006. Ten of the leases are written and three are oral. Each written lease has a five-year term with the Company having the option to extend from between one and five years. Aggregate amounts paid for the thirteen rentals and leases were $0.3 million and $0.7 million for the three and six months ended June 30, 2012 and $0.3 million and $0.7 million for the three and six months ended June 30, 2011, respectively.

For the three months ended June 30, 2012 and 2011 the Company recognized no revenue from AES, total expenses of approximately $1.2 million and $2.6 million, respectively, and capital expenditures of $7.5 million and $17.2 million, respectively. For the six months ended June 30, 2012 and 2011, the Company recognized no revenues, expense of approximately $2.5 million and $5 million, and capital expenditures of approximately $8.6 million and $17.2 million, respectively. Accounts payable to AES as of June 30, 2012 and December 31, 2011 resulting from such transactions were $7.2 million and $0.6 million, respectively. The Company had accounts receivable of $0.4 million from AES as of June 30, 2012 and December 31, 2011.

CJ Petroleum Service LLC, or CJ Petroleum, is a company that owns salt water disposal wells and is owned by Messrs. Crisp and Forbes, two sons of Mr. Crisp, and Janet Forbes, a director of the FES Ltd. In 2010, we began paying CJ Petroleum to use their three disposal wells. The Company recognized no revenue, expenses of approximately $0.2 million, and no capital expenditures for the three months ended June 30, 2012 and June 30, 2011. The Company recognized no revenue, approximate expenses of $0.3 million ,and no capital expenditures for the six months ended June 30, 2012 and June 30, 2011. We had no accounts receivable from CJ Petroleum as of June 30, 2012 and December 31, 2011, respectively. We had accounts payable of approximately $0.1 million to CJ Petroleum as of June 30, 2011 and December 31, 2011.

Dorsal Services, Inc. is a trucking service provider that provides services to the Company. Mr. Crisp, an executive officer and director of FES, Ltd, and Denyce Crisp, the ex-wife of John Crisp, are partial owners of Dorsal Services, Inc. The Company recognized no revenues, expenses of approximately $50,000 and $0.1 million and no capital expenditures to Dorsal Services Inc. for the three months ended June 30, 2012 and June 30, 2011, respectively. The company recognized no revenues, expenses of approximately $0.1 million and $0.3 million for the six months ended June 30, 2012 and June 30, 2011, respectively. The Company had accounts payable to Dorsal Services, Inc. of $2,000 and $12,000 as of June 30, 2012 and December 31, 2011 respectively. The Company had accounts receivable from and accounts payable to Dorsal Services, Inc. of approximately $0.1 million as of June 30, 2012 and December 31, 2011.

Tasco Tool Services, Inc. is a down-hole tool company that is partially owned and managed by a company that is owned by Mr. Forbes, both an executive officer and director of FES Ltd., along with Robert Jenkins, a manager of one of the subsidiaries of FES Ltd. Tasco rents and sells tools to the Company from time to time. The Company had no revenues from Tasco and recognized expenses of approximately $34,000 and $51,000 and no capital expenditures related to transactions with Tasco for the three months ended June 30, 2012 and June 30, 2011, respectively. For the six months ended June 30, 2012 and June 30, 2011 the company had no revenues, expenses of approximately $49,000 and $0.1 million, and no capital expenditures. The Company had no accounts receivable and accounts payable to Tasco as of June 30, 2012 and December 31, 2011 were $0 and $0.1 million, respectively resulting from these transactions.

 

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FCJ Management, LLC or FCJ, is an entity that leases land and facilities to the Company and is owned by Messrs. Crisp and Forbes and Robert Jenkins, a manager of one of the subsidiaries of FES Ltd. The Company recognized expenses of $9,000 for the three months ended June 30, 2012 and June 30, 2011. The Company had expenses of $18,000 for the six months ended June 30, 2012 and June 30, 2011. No revenues have been recognized from FCJ for any period. The Company had no accounts receivable from or accounts payable to FCJ as of June 30, 2012 and December 31, 2011.

C&F Partners, LLC is an entity that is owned by Messrs. Crisp and Forbes. The Company recognized no revenues, expenses of approximately $36,000 and $0.1 million and no capital expenditures for the three months ended June 30, 2012 and June 30, 2011, respectively. All expenses are related to aircraft rental. The Company recognized no revenues, expenses of approximately $0.2 million and no capital expenditures for the six months ended June 30, 2012 and June 30, 2011. There were no accounts receivable or accounts payable as of June 30, 2012 and December 31, 2011, respectively. As of April 2012, the Company has no further transactions with this entity.

Resonant Technology Partners is a computer networking group that provides services to the Company. Travis Burris, a director of the Company has a noncontrolling interest in the computer networking company. The company recognized expenses of approximately $0.2 million and $0.1 million and capital expenditures of approximately $0.1 million and $0 for the three months ended June 30, 2012 and June 30, 2011, respectively. The company recognized expenses of $0.3 million and $0.1 million and capital expenditures of approximately $0.2 million and $0 million for the six months ended June 30, 2012 and June 30, 2011, respectively. The Company had accounts payable of approximately $0.2 million and $0.1 million as of June 30, 2012 and December 31, 2011, respectively.

Wolverine Construction, Inc. is an entity that is owned by two sons and a brother of Mr. Crisp, an executive officer and director of FES Ltd., and a son of Mr. Forbes, an executive officer and director of FES Ltd. During the time when Wolverine was engaged by the Company to provide construction and site preparation services to certain customers of the Company, the sons and brother of Mr. Crisp were full time employees of the Company. The Company provided additional services to customers that were sub-contracted to Wolverine beginning in the fiscal year 2010 until June 2011 when the Company ceased offering such services.

The Company recognized no capital expenditures, no revenues and expenses of less than $0.1 million and approximately $3 million, for the three months ended June 30, 2012 and June 30, 2011, respectively. The company had no revenues and expenses of approximately $31,000 and $5 million for the six months ended June 30, 2012 and June 30, 2011, respectively. The Company had no accounts receivable from Wolverine as of June 30, 2012 and approximately $1.1 million as of December 31, 2011. The Company had accounts payable due Wolverine of approximately $0.1 million and $7,000 as of June 30, 2012 and December 31, 2011 respectively.

JITSU Services, LLC, or JITSU, is a financial leasing company that, since October 2010, provides services to the Company. The Company currently leases ten vacuum trucks from JITSU. Janet Forbes and Mr. Crisp are owners of JITSU. For the three months ended June 30, 2012 and June 30, 2011, the Company recognized no revenues and expenses of approximately $0.1 million and no capital expenditures from transactions with JITSU. The Company recognized no revenues, expenses of approximately $0.2 million, and no capital transactions for the six months ended June 30, 2012 and June 30, 2011. As of June 30, 2012 and December 31, 2011, the company had no accounts receivable from or accounts payable to JITSU.

Texas Quality Gate Guard Services, LLC, or Texas Quality Gate Guard Services, is an entity owned by Messrs. Crisp and Forbes and a son of Mr. Crisp, an executive officer and director of FES Ltd., which said son during that time was also a full time employee of the Company. Since October 2010, Texas Quality Gate Guard Services has provided security services to the Company. The Company bills its customers for these services without a markup. For the three months ended June 30, 2012 and June 30, 2011, the Company recognized no revenues, expenses of approximately $0.1 million and $0.1 million and no capital expenditures from transactions with Texas Quality Gate Guard Services. The Company recognized no revenues, expenses of approximately $0.3 million and $0.1 million, and no capital expenditures for the six months ended June 30, 2012 and June 30, 2011, respectively. As of June 30, 2012 and December 31, 2011, the company had no accounts receivable and accounts payable to Texas Quality Gate Guard of approximately $0 and $0.1 million, respectively.

Animas Holdings, LLC, or Animas, is a property and disposal company that is owned by the two sons of Mr. Crisp and three children of Mr. Forbes and Ms. Forbes. As of April 26, 2010, TES entered into a waste water disposal operating agreement with Animas whereby TES agrees to pay a monthly operational fee of $4,000 per month, plus $0.08 per barrel over 50,000 barrels per month. Animas agrees to pay TES ten percent of all skim oil payments obtained from this waste water disposal. The Company also has an oral agreement with Animas for the rental of two truck yards. The Company pays Animas $8,500 per month for the use of the two properties. For the three months ended June 30, 2012 and June 30, 2011, the Company

 

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recognized no revenues; expenses of approximately $0 and $0.1 million and no capital expenditures from transactions with Animas Holding, LLC. For the six months ended June 30, 2012 and June 30, 2011, the Company recognized no revenues; expenses of $26,000 and $0.2 million, and no capital expenditures, respectively. As of June 30, 2012 and December 31, 2011, the Company had no accounts receivable and accounts payable of $0 and $31,000 to Animas Holding, LLC.

The Company has a relationship with Texas Champion Bank. Travis Burris, one of the directors of FES Ltd., is also the President, Chief Executive Officer, and director of Texas Champion Bank. Mr. Crisp, our President and Chief Executive Officer, serves on the board of directors of Texas Champion Bank. As of June 30, 2012 and December 31, 2011, the Company had $0.6 million and $2.4 million, respectively, on deposit with this bank.

Daniel Crisp, a son of John E. Crisp, the Chief Executive Officer of the Company, was employed as a manager by C.C. Forbes, LLC and TX Energy Services, LLC, both subsidiaries of the Company, until March 2012. Daniel Crisp received salary compensation of $199,831 in 2011 and $99,000 during the portion of 2012 when he was working for the Company. Daniel Crisp received an option to purchase 200,000 shares of common stock at $28.00 per share in May 2008, which award vested over three years. He received an option to purchase 25,000 shares of common stock at $2.60 per share in August 2010, which award vests over two years. Daniel Crisp tendered his May 2008 options in the previously discussed 2011 Option Exchange and received new options to purchase 36,000 shares of common stock, at an exercise price of $9.32 per share, which award vests over one year. On August 15, 2011, Daniel Crisp received options to purchase 214,000 shares of common stock, at an exercise price of $9.16 per share, which award vests over three years. When Daniel Crisp ceased working for the Company all unvested options were for forfeited. Daniel Crisp exercised 18,750 stock options on June 1, 2012 and the remaining vested options were forfeited on June 6, 2012.

Marcus Crisp, a brother of John E. Crisp, is employed as the West Texas Fluids Manager by C.C. Forbes, LLC and TX Energy Services, LLC, both subsidiaries of the Company. Marcus Crisp received salary compensation of $171,567 in 2011 and $121,644 during for the first half of 2012. Marcus Crisp received an option to purchase 12,500 shares of common stock at $28.00 per share in May 2008, which award vested over three years. He received an option to purchase 18,750 shares of common stock at $2.60 per share in August 2010, which award vests over two years. Marcus Crisp tendered his May 2008 options in the previously discussed 2011 Option Exchange and received new options to purchase 9,000 shares of common stock, at an exercise price of $9.32 per share. In August 2011, Marcus Crisp received options to purchase 125,000 shares of common stock, at an exercise price of $9.16 per share, which award vests over three years. In February 2012, Marcus Crisp was granted a restricted stock award in the amount of 41,666 shares, vesting one year from the date of grant.

Messrs. Crisp and Forbes are directors and shareholders of Brush Country Bank, an institution with which the Company conducts business. As of June 30, 2012 and December 31, 2011, the Company had $0.1 million and $0.9 million on deposit with this bank.

10. Commitments and Contingencies

Concentrations of Credit Risk

Financial instruments which subject the Forbes Group to credit risk consist primarily of cash balances maintained in excess of federal depository insurance limits and trade receivables. All of our non-interest bearing cash balances were fully insured at June 30, 2012 due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances may again exceed federally insured limits. The Forbes Group restricts investment of temporary cash investments to financial institutions with high credit standings. The Forbes Group’s customer base consists primarily of multi-national and independent oil and natural gas producers. The Forbes Group does not require collateral on its trade receivables. For the three months ended June 30, 2012 the Company's largest customer, five largest customers, and ten largest customers constituted 9.5%, 38.2%, and 58.9% of revenues, respectively. For the six months ended June 30, 2012 the Company's largest customer, five largest customers, and ten largest customers constituted 11.5%, 39.3%, 58.0% and of revenues, respectively. The loss of any one of our top five customers would have a negative impact on the revenues and profits of the company. Further, our trade accounts receivable are from companies within the oil and natural gas industry and as such the Forbes Group is exposed to normal industry credit risks. The Forbes Group continually evaluates its reserves for potential credit losses and establishes reserves for such losses.

Self-Insurance

The Forbes Group is self-insured under its Employee Group Medical Plan for the first $125,000 per individual plus a $235,000 aggregate specific deductible. Incurred and unprocessed claims as of June 30, 2012 and December 31, 2011 amount to approximately $4.7 and $3.9 million, respectively. These claims are unprocessed and therefore their values are estimated and included in accrued expenses in the accompanying condensed consolidated balance sheets.

 

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Litigation

The Forbes Group is subject to various other claims and legal actions that arise in the ordinary course of business. We do not believe that any of these claims and actions, separately or in the aggregate, will have a material adverse effect on our business, financial condition, results of operations or cash flows, although we cannot guarantee that a material adverse effect will not occur.

Off-Balance Sheet Arrangements

We are often party to certain transactions that require off-balance sheet arrangements such as performance bonds, guarantees, operating leases for equipment, and bank guarantees that are not reflected in our condensed consolidated balance sheets. These arrangements are made in our normal course of business and they are not reasonably likely to have a current or future material adverse effect on our financial condition, results of operations, liquidity or cash flows.

11. Supplemental Cash Flow Information

 

     Three months ended June 30,      Six months ended June 30,  
     2012     2011      2012     2011  

Cash paid for

         

Interest

   $ 12,815,820      $ 11,359,783       $ 13,009,848      $ 24,268,829   

Income tax

   $ 225,025      $ —         $ 450,025      $ —     

Supplemental schedule of non-cash investing and financing activities

         

Changes in accounts payable related to capital expenditures

   $ (8,822,182   $ 1,078,562       $ (241,392   $ 1,792,137   

Capital leases on equipment

   $ 1,067,111      $ 2,045,638       $ 1,947,107      $ 2,557,308   

Preferred shares dividends and accretion costs

   $ 10,371      $ 1,084,271       $ 20,742      $ 201,687   

Adjustment to reclass dividends payable from temporary equity to liabilities

   $ —        $ 612,565       $ —        $ 612,565   

12. Earnings per Share

Basic earnings per share (“EPS”) is computed by dividing net income available to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings (loss) per share takes into account the potential dilution that could occur if securities or other contracts to issue common shares, such as warrants, options and convertible preference shares, were exercised and converted into common shares. Potential common stock equivalents that have been issued by the Forbes Group relate to outstanding stock options and restricted stock which are determined using the treasury stock method, and the Series B Senior Convertible Preferred Shares (the “Series B Preferred Shares”), which are determined using the “if converted” method. In applying the if-converted method, conversion is not assumed for purposes of computing diluted EPS if the effect would be antidilutive. As of June 30, 2012 and June 30, 2011, there were 2.0 million and 1.3 million options to purchase common shares outstanding, respectively and 588,059 Series B Senior Convertible Preferred Shares. The preferred stock is convertible at a rate of nine common shares to one Series B Preferred Share.

The Company has determined that the Series B Preferred Shares are participating securities under ASC 260. Under ASC 260, a security is considered a participating security if the security may participate in undistributed earnings with common stock, whether that participation is conditioned upon the occurrence of a specified event or not. In accordance with ASC 260, a company is required to use the two-class method when computing EPS when a company has a security that qualifies as a “participating security.” The two-class method is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. A participating security is included in the computation of basic EPS using the two-class method. Under the two-class method, basic EPS for the Company’s common shares is computed by dividing net income applicable to common shares by the weighted-average common shares outstanding during the period. Under the certificate of designation for our Series B Preferred Shares (the “Series B Certificate of Designation”), if at any time the Company declares a dividend in cash which is greater in value than five percent on a cumulative basis over the previous twelve month period of the then current “Common Share Fair Market Value,” as that term is defined in the Series B Certificate of Designation, the Series B Preferred Shares will be entitled to receive a dividend payable in cash equal to the amount in excess of five percent of the then Common Share Fair Market Value per common share they would have received if all outstanding Series B Preferred Shares had been converted into common shares. There were no earnings allocated to the Series B Preferred Shares for the quarter ended June 30, 2012 since

 

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earnings for the quarter were not in excess of amounts prescribed by the Series B Certificate of Designation for our Series B Preferred Shares. Diluted EPS for the Company’s common shares is computed using the more dilutive of the two-class method or the if-converted method. The following table sets forth the reconciliation of weighted average shares outstanding and diluted weighted average shares outstanding:

 

     Three months ended June 30,      Six months ended June 30,  
     2012      2011      2012      2011  

Weighted average shares outstanding

     21,055,642         20,918,400         21,020,628         20,918,400   

Dilutive effect of stock options and restricted stock

     277,279         —           307,885         —     

Dilutive effect of preferred shares

     5,292,531         —           5,292,531         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted weighted average shares outstanding

     26,625,452         20,918,400         26,621,044         20,918,400   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were 1,997,925 shares subject to outstanding stock options and 83,332 restricted stock units outstanding as of June 30, 2012, and 5,292,531 common share equivalents underlying the Series B Preferred Shares that were included in the calculation of diluted EPS for the three and six months ended June 30, 2012. There were 1,305,000 million stock options outstanding as of June 30, 2011 and 5,292,531 common share equivalents underlying the Series B Preferred Shares that were not included in the calculation of diluted EPS for the three and six months ended June 30, 2011 because their effect would have been antidilutive.

The following table sets forth the computation of basic and diluted earnings per share:

 

     Three months ended June 30,     Six months ended June 30,  
     2012     2011     2012     2011  

Basic:

        

Net income (loss)

   $ 1,020,343      $ (24,694,702   $ 7,362,953      $ (22,790,184

Preferred stock dividends and accretion

     (194,139     1,084,271        (388,278     201,687   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to common stockholders

     826,204        (23,610,431     6,974,675        (22,588,497
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares

     21,055,642        20,918,400        21,020,628        20,918,400   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic income per share

   $ 0.04      $ (1.13   $ 0.33      $ (1.08
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Net income

   $ 1,020,343      $ (24,694,702   $ 7,362,953      $ (22,790,184

Preferred stock dividends and accretion

     —          1,084,271        —          201,687   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to common stockholders

     1,020,343        (23,610,431     7,362,953        (22,588,497
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares

     26,625,452        20,918,400        26,621,044        20,918,400   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted income per share

   $ 0.04      $ (1.13   $ 0.28      $ (1.08
  

 

 

   

 

 

   

 

 

   

 

 

 

13. Income Taxes

The Company’s tax expense from application of the effective tax rate for the six months ended June 30, 2012 was estimated to be 44.6% based on pre-tax income of $14.2 million. For the six months ended June 30, 2011, the Company’s effective tax rate was 31.5%. The difference between the effective rate and 35.0% statutory rate is primarily related to changes in forecast, Texas Margins Tax and other non-deductible expenses.

The Forbes Group is subject to the Texas Margins Tax. The Texas Margins Tax is a tax equal to one percent of Texas-sourced revenue reduced by the greater of (a) cost of goods sold (as defined by Texas law), (b) compensation (as defined by Texas law) or (c) thirty percent of the Texas-sourced revenue. The Forbes Group accounts for the revised Texas Franchise tax in accordance with ASC 740, as the tax is derived from a taxable base that consists of income less deductible expenses. As of June 30, 2012, the estimated annual franchise tax expense is estimated to be approximately $0.8 million for 2012.

 

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14. Business Segment Information

The Forbes Group has determined that it has two reportable segments organized based on its products and services—well servicing and fluid logistics and other. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.

Well Servicing

The well servicing segment consists of operations in the U.S. that provides (i) well maintenance, including remedial repairs and removal and replacement of down-hole production equipment, (ii) well workovers, including significant down-hole repairs, re-completions and re-perforations, (iii) completion and swabbing activities, and (iv) plugging and abandoning services. In addition, the Forbes Group has tubing testing units that are used to conduct pressure testing of oil and natural gas production tubing.

Fluid Logistics and Other

The fluid logistics and other segment consists of operations in the U.S., which provide, transport, store and dispose of a variety of drilling and produced fluids used in and generated by oil and natural gas production activities. These services are required in most work-over and completion projects and are routinely used in daily producing well operations. In the fiscal year 2010, the Company began providing site preparation services which were complementary to the traditional services offered by the Company. Wolverine Construction, Inc., a related party, was sub-contracted to complete such services. The Company ceased offering these services in June 2011. The following table sets forth certain financial information from continuing operations with respect to the Company’s reportable segments in (000)’s for the three and six months ended June 30, 2012 and June 30, 2011:

 

     Three months ended June 30,      Six months ended June 30,  
     Well
Servicing
     Fluid
Logistics
     Consolidated      Well
Servicing
     Fluid
Logistics
     Consolidated  

2012

                 

Operating revenues

   $ 51,315       $ 68,470       $ 119,785       $ 103,554       $ 147,715       $ 251,269   

Direct operating costs

     37,453         49,354         86,807         76,541         104,210         180,751   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment profits

   $ 13,862       $ 19,116       $ 32,978       $ 27,013       $ 43,505       $ 70,518   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Depreciation and amortization

   $ 5,689       $ 6,776       $ 12,465       $ 11,271       $ 12,615       $ 23,886   

Capital expenditures

     7,437         30,134         37,571         18,122         73,219         91,341   

Total assets

     505,676         443,135         948,811         505,676         443,135         948,811   

2011

                 

Operating revenues

   $ 42,035       $ 68,783       $ 110,818       $ 78,449       $ 127,030       $ 205,479   

Direct operating costs

     34,388         50,690         85,078         64,149         92,913         157,062   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment profits

   $ 7,647       $ 18,093       $ 25,740       $ 14,300       $ 34,117       $ 48,417   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Depreciation and amortization

   $ 5,053       $ 4,489       $ 9,542       $ 10,247       $ 8,969       $ 19,216   

Capital expenditures

     15,980         7,485         23,465         20,399         7,673         28,072   

Total assets

     398,079         315,436         713,515         398,079         315,436         713,515   

 

     Three months ended June 30,     Six months ended June 30,  
     2012     2011     2012     2011  

Reconciliation of the Forbes Group Operating Income As Reported:

      

Segment profits

   $ 32,978      $ 25,740      $ 70,518      $ 48,417   

General and administrative expense

     8,075        13,107        18,745        18,797   

Depreciation and amortization

     12,465        9,542        23,886        19,216   

Operating income

     12,438        3,091        27,887        10,404   

Other income and expenses, net

     (6,841     (42,147     (13,713     (49,074
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

   $ 5,597      $ (39,056   $ 14,174      $ (38,670
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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     June 30, 2012     December 31, 2011  

Reconciliation of the Forbes Group Assets As Reported:

  

Total reportable segments

   $ 948,811      $ 859,869   

Elimination of internal transactions

     (1,399,449     (1,280,509

Parent

     986,084        971,063   
  

 

 

   

 

 

 

Total assets

   $ 535,446      $ 550,423   
  

 

 

   

 

 

 

15. Guarantor and Non-Guarantor Condensed Consolidating Financial Statements

Prior to January 12, 2012, when the Company completed the disposition of its business and substantially all of its assets in Mexico, the Company had certain foreign significant subsidiaries that did not guarantee the 9% Senior Notes discussed in Note 7 and is required to present the following condensed consolidating financial information pursuant to Rule 3-10 of Regulation S-X. These schedules are presented using the equity method of accounting for all periods presented. Under this method, investments in subsidiaries are recorded at cost and adjusted for the Company’s share in the subsidiaries’ cumulative results of operations, capital contributions and distributions and other changes in equity. Elimination entries relate primarily to the elimination of investments in subsidiaries and associated intercompany balances and transactions.

There are no significant restrictions on FES Ltd’s ability or the ability of any guarantor to obtain funds from its subsidiaries by such means as a dividend or loan.

 

Supplemental financial information for Forbes Energy Services Ltd., the parent and issuer, our combined subsidiary guarantors and our non-guarantor subsidiaries is presented below.

 

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Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Balance Sheets (unaudited)

As of June 30, 2012

 

     Parent/Issuer     Guarantors      Non-Guarantors     Eliminations     Consolidated  

Assets

           

Current assets

           

Cash and cash equivalents

   $ 940,156      $ 8,866,839       $ —        $ —        $ 9,806,995   

Accounts receivable

     1,176,189        105,317,279         —          (363,598     106,129,870   

Other current assets

     450,000        6,029,056         —          —          6,479,056   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total current assets

     2,566,345        120,213,174         —          (363,598     122,415,921   

Property and equipment, net

     —          354,418,149         —          —          354,418,149   

Investments in affiliates

     63,597,849        208,166,568         —          (271,764,417     —     

Intercompany receivables

     328,711,659        —           10,972,799        (339,684,458     0   

Intercompany note receivable

     —          —           —          —          —     

Other intangible assets, net

     —          29,445,791         —          —          29,445,791   

Deferred financing costs—net

     6,560,714        2,190,974         —          —          8,751,688   

Restricted cash

     —          16,545,523         —          —          16,545,523   

Other assets

     3,000        3,866,088         —          —          3,869,088   

Noncurrent assets held for sale

     —          —           —          —          —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total assets

   $ 401,439,567      $ 734,846,267       $ 10,972,799      $ (611,812,473   $ 535,446,160   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

           

Current liabilities

           

Current portions of long-term debt

   $ —        $ 5,987,887       $ —        $ —        $ 5,987,887   

Trade accounts payable

     16,450        39,428,535         —          (363,598     39,081,387   

Accrued dividends

     61,259        —           —          —          61,259   

Other liabilities

     351,610        14,055,219         —          —          14,406,829   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total current liabilities

     429,319        59,471,641         —          (363,598     59,537,362   

Long-term debt—net

     280,000,000        11,331,979         —          —          291,331,979   

Intercompany payables

     —          326,490,716         13,193,741        (339,684,457     —     

Intercompany notes payable

     —          —           —          —          —     

Deferred tax liability

     (29,652,157     63,627,640         (61,069     —          33,914,414   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total liabilities

     250,777,162        460,921,976         13,132,672        (340,048,055     384,783,755   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Series B convertible shares

     14,497,525        —           —          —          14,497,525   

Shareholders’ equity:

     136,164,880        273,924,291         (2,159,873     (271,764,418     136,164,880   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total liabilities and equity

   $ 401,439,567      $ 734,846,267       $ 10,972,799      $ (611,812,473   $ 535,446,160   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

23


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Balance Sheets

As of December 31, 2011

 

     Parent/Issuer     Guarantors      Non-Guarantors     Eliminations     Consolidated  

Assets

           

Current assets

           

Cash and cash equivalents

   $ 15,565,491      $ 20,988,105       $ 46,495      $ —        $ 36,600,091   

Accounts receivable

     29,566,358        106,853,245         1,493,791        (991,356     136,922,038   

Other current assets

     10,599        10,274,046         —          —          10,284,645   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total current assets

     45,142,448        138,115,396         1,540,286        (991,356     183,806,774   

Property and equipment, net

     —          285,944,684         —          —          285,944,684   

Investments in affiliates

     26,209,153        163,532,443         —          (189,741,596     —     

Intercompany receivables

     335,660,170        —           11,502,122        (347,162,292     —     

Intercompany note receivable

     1,024,301        —           —          (1,024,301     —     

Other intangible assets, net

     —          30,876,389         —          —          30,876,389   

Deferred financing costs—net

     6,976,241        2,427,576         —          —          9,403,817   

Restricted cash

     —          16,150,433         —          —          16,150,433   

Other assets

     14,890        11,482         4,504        —          30,876   

Noncurrent assets held for sale

     2,138,704        21,572,656         498,720        —          24,210,080   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total assets

   $ 417,165,907      $ 658,631,059       $ 13,545,632      $ (538,919,545   $ 550,423,053   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

           

Current liabilities

           

Current portions of long-term debt

   $ —        $ 10,517,233       $ —        $ —        $ 10,517,233   

Trade accounts payable

     10,684,760        41,120,820         (16,198     —          51,789,382   

Accrued dividends

     61,259        —           —          —          61,259   

Other liabilities

     22,237,502        10,870,949         1,564,732        —          34,673,183   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total current liabilities

     32,983,521        62,509,002         1,548,534        —          97,041,057   

Long-term debt—net

     280,000,000        5,633,042         —          —          285,633,042   

Intercompany payables

     —          334,959,907         13,193,742        (348,153,649     —     

Intercompany notes payable

     —          —           1,024,301        (1,024,301     —     

Deferred tax liability

     (36,074,758     63,627,638         (61,069     —          27,491,811   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total liabilities

     276,908,763        466,729,589         15,705,508        (349,177,950     410,165,910   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Series B convertible shares

     14,476,783        —           —          —          14,476,783   

Shareholders’ equity:

     125,780,361        191,901,470         (2,159,876     (189,741,595     125,780,360   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total liabilities and equity

   $ 417,165,907      $ 658,631,059       $ 13,545,632      $ (538,919,545   $ 550,423,053   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

24


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statement of Operations (unaudited)

For the three months ended June 30, 2012

 

     Parent/Issuer     Guarantors     Non-Guarantors      Eliminations     Consolidated  

Revenue

    

Well servicing

   $ —        $ 51,514,002      $ —         $ (199,617   $ 51,314,385   

Fluid logistics and other

     —          68,538,846        —           (68,473     68,470,373   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total revenues

     —          120,052,848        —           (268,090     119,784,758   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Expenses

    

Well servicing

     279,085        37,242,101        —           (68,473     37,452,713   

Fluid logistics and other

     —          49,553,936        —           (199,617     49,354,319   

General and administrative

     1,224,833        6,849,877        —           —          8,074,710   

Depreciation and amortization

     —          12,465,442        —           —          12,465,442   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total expenses

     1,503,918        106,111,356        —           (268,090     107,347,184   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Operating income (loss)

     (1,503,918     13,941,492        —           —          12,437,574   

Other income (expense)

    

Interest expense - net

     (6,517,019     (323,797     —           —          (6,840,816

Equity in income of affiliates

     13,617,695        —          —           (13,617,695     —     
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Income before taxes

     5,596,758        13,617,695        —           (13,617,695     5,596,758   

Income tax expense

     2,950,257        —          —           —          2,950,257   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income from continuing operations

     2,646,501        13,617,695        —           (13,617,695     2,646,501   

Net loss from discontinued operations, net of tax expense

     (1,626,158     —          —           —          (1,626,158
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 1,020,343      $ 13,617,695      $ —         $ (13,617,695   $ 1,020,343   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

25


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statement of Operations (unaudited)

For the three months ended June 30, 2011

 

     Parent/Issuer     Guarantors     Non-Guarantors      Eliminations     Consolidated  

Revenue

           

Well servicing

   $ —        $ 42,034,263      $ —         $ —        $ 42,034,263   

Fluid logistics and other

     —          68,783,378        —           —          68,783,378   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total revenues

     —          110,817,641        —           —          110,817,641   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
           

Expenses

           

Well servicing

     758,199        33,629,458        —           —          34,387,657   

Fluid logistics and other

     —          50,690,794        —           —          50,690,794   

General and administrative

     8,333,651        4,773,250        —           —          13,106,901   

Depreciation and amortization

     —          9,541,539        —           —          9,541,539   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total expenses

     9,091,850        98,635,041        —           —          107,726,891   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Operating income (loss)

     (9,091,850     12,182,600        —           —          3,090,750   

Other income (expense)

           

Interest expense - net

     (6,674,763     (125,098     —           —          (6,799,861

Other income (expense) - net

     (35,415,733     69,104        —           —          (35,346,629

Equity in income of affiliates

     12,126,606        —          —           (12,126,606     —     
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before taxes

     (39,055,740     12,126,606        —           (12,126,606     (39,055,740

Income tax benefit

     (12,489,453     —          —           —          (12,489,453
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss) from continuing operations

     (26,566,287     12,126,606        —           (12,126,606     (26,566,287

Net income from discontinued operations, net of tax expense

     1,871,585        —          —           —          1,871,585   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ (24,694,702   $ 12,126,606      $ —         $ (12,126,606   $ (24,694,702
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

26


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statement of Operations (unaudited)

For the six months ended June 30, 2012

 

     Parent/Issuer     Guarantors     Non-Guarantors      Eliminations     Consolidated  

Revenue

      

Well servicing

   $ —        $ 103,753,816      $ —         $ (199,617   $ 103,554,199   

Fluid logistics and other

     —          147,783,612        —           (68,473     147,715,139   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total revenues

     —          251,537,428        —           (268,090     251,269,338   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Expenses

      

Well servicing

     911,676        75,697,917        —           (68,473     76,541,120   

Fluid logistics and other

     —          104,409,718        —           (199,617     104,210,101   

General and administrative

     2,761,413        15,983,048        —           —          18,744,461   

Depreciation and amortization

     —          23,886,158        —           —          23,886,158   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total expenses

     3,673,089        219,976,841        —           (268,090     223,381,840   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Operating income (loss)

     (3,673,089     31,560,587        —           —          27,887,498   

Other income (expense)

      

Interest expense - net

     (13,032,528     (680,472     —           —          (13,713,000

Equity in income of affiliates

     30,880,115        —          —           (30,880,115     —     
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Income before taxes

     14,174,498        30,880,115        —           (30,880,115     14,174,498   

Income tax expense

     6,317,008        —          —           —          6,317,008   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income from continuing operations

     7,857,490        30,880,115        —           (30,880,115     7,857,490   

Net loss from discontinued operations, net of tax expense

     (494,537     —          —           —          (494,537
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 7,362,953      $ 30,880,115      $ —         $ (30,880,115   $ 7,362,953   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

27


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statement of Operations (unaudited)

For the six months ended June 30, 2011

 

     Parent/Issuer     Guarantors     Non-Guarantors      Eliminations     Consolidated  

Revenue

           

Well servicing

   $ —        $ 78,448,693      $ —         $ —        $ 78,448,693   

Fluid logistics and other

     —          127,030,201        —           —          127,030,201   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total revenues

     —          205,478,894        —           —          205,478,894   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Expenses

           

Well servicing

     1,293,876        62,855,329        —           —          64,149,205   

Fluid logistics and other

     —          92,913,371        —           —          92,913,371   

General and administrative

     10,628,283        8,168,321        —           —          18,796,604   

Depreciation and amortization

     —          19,216,212        —           —          19,216,212   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total expenses

     11,922,159        183,153,233        —           —          195,075,392   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Operating income (loss)

     (11,922,159     22,325,661        —           —          10,403,502   

Other income (expense)

           

Interest expense - net

     (13,234,231     (493,889     —           —          (13,728,120

Other income (expense) - net

     (35,414,833     69,104        —           —          (35,345,729

Equity in income of affiliates

     21,900,876        —          —           (21,900,876     —     
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before taxes

     (38,670,347     21,900,876        —           (21,900,876     (38,670,347

Income tax benefit

     (12,191,067            —           —          (12,191,067
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss) from continuing operations

     (26,479,280     21,900,876        —           (21,900,876     (26,479,280

Net income from discontinued operations, net of tax expense

     3,689,096        —          —           —          3,689,096   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ (22,790,184   $ 21,900,876      $ —         $ (21,900,876   $ (22,790,184
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

28


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statement of Cash Flows (unaudited)

For the six months ended June 30, 2012

 

     Parent/Issuer     Guarantors     Non-Guarantors     Consolidated  

Cash flows from operating activities:

      

Net cash provided by (used in) operating activities

   $ (20,600,269   $ 65,588,460      $ (46,495   $ 44,941,696   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Proceeds from sale of property and equipment

     —          14,284,764        —          14,284,764   

Change in restricted cash

     —          (395,090     —          (395,090

Purchases of property and equipment

     —          (89,571,226     —          (89,571,226

Change in deposits on assets held for sale

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     —          (75,681,552     —          (75,681,552
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

      

Payments on debt

     —          (1,947,107     —          (1,947,107

Proceeds from revolving credit facility

     6,000,000        —          —          6,000,000   

Other

     (297,536     (81,067     —          (378,603
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     5,702,464        (2,028,174     —          3,674,290   
  

 

 

   

 

 

   

 

 

   

 

 

 

Effect of currency translation

     272,470        —          —          272,470   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net decrease in cash

     (14,625,335     (12,121,266     (46,495     (26,793,096

Cash and cash equivalents

      

Beginning of period

     15,565,491        20,988,105        46,495        36,600,091   
  

 

 

   

 

 

   

 

 

   

 

 

 

End of period

   $ 940,156      $ 8,866,839      $ —        $ 9,806,995   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

29


Table of Contents

Forbes Energy Services Ltd. and Subsidiaries (a/k/a the “Forbes Group”)

Condensed Consolidated Statement of Cash Flows (unaudited)

For the six months ended June 30, 2011

 

     Parent/Issuer     Guarantors     Non-Guarantors     Consolidated  

Cash flows from operating activities:

        

Net cash provided by (used in) operating activities

   $ (34,161,267   $ 11,305,357      $ (65,950   $ (22,921,860
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

        

Proceeds from sale of property and equipment

     —          527,102        —          527,102   

Change in restricted cash

     (23,213,666     16,128,456        —          (7,085,210

Purchases of property and equipment

     —          (23,678,077     —          (23,678,077

Change in deposits on assets held for sale

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (23,213,666     (7,022,519     —          (30,236,185
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

        

Payments on debt

     —          (2,557,308     —          (2,557,308

Retirement of Second Priority Notes

     (212,500,000     —          —          (212,500,000

Proceeds from issuance of Senior Notes

     280,000,000        —          —          280,000,000   

Other

     (7,418,175     —          —          (7,418,175 )  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     60,081,825        (2,557,308     —          57,524,517   
  

 

 

   

 

 

   

 

 

   

 

 

 

Effect of currency translation

     94,435        —          —          94,435   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net decrease in cash

     2,801,327        1,725,530        (65,950     4,460,907   

Cash and cash equivalents

        

Beginning of period

     8,954,723        21,388,712        115,022        30,458,457   
  

 

 

   

 

 

   

 

 

   

 

 

 

End of period

   $ 11,756,050      $ 23,114,242      $ 49,072      $ 34,919,364   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

16. Equity Securities

Common Stock

Holders of common stock have no pre-emptive, redemption, conversion, or sinking fund rights. Holders of common stock are entitled to one vote per share on all matters submitted to a vote of holders of common stock. Unless a different majority is required by law or by the bylaws, resolutions to be approved by holders of common stock require approval by a simple majority of votes cast at a meeting at which a quorum is present. In the event of the liquidation, dissolution, or winding up of the Company, the holders of common stock are entitled to share equally and ratably in the Company’s assets, if any, remaining after the payment of all of its debts and liabilities, subject to any liquidation preference on any issued and outstanding preferred stock.

Series B Senior Convertible Preferred Stock

Under our Certificate of Designation, we are authorized to issue 825,000 shares of Series B Senior Convertible Preferred Stock (the “Series B Preferred Shares”), par value $0.01 per share. On May 28, 2010 the Company completed a private placement of 580,800 Series B Preferred Stock at a price per share of CAD $26.37 for an aggregate purchase price in the amount of USD $14,520,000 based on the exchange rate between U.S. dollars and Canadian dollars then in effect of $1.00 to CDN $1.0547. The Company received net proceeds of USD $13,828,205 after closing fee paid to investors of $290,400 and legal fees and other offering costs of $401,395. This is presented as temporary equity on the balance sheet. The common stock into which the Series B Preferred Stock is convertible has certain demand and “piggyback” registration rights.

The Company paid a closing fee to the Investors of $290,400 which is netted with the proceeds from the sale of the Series B Preferred Stock in temporary equity on the consolidated balance sheet. The value of the Series B Preferred Stock, for accounting purposes, is being accreted up to redemption value from the date of issuance to the earliest redemption date of the instrument using the effective interest rate method. If the Series B Preferred Stock had been redeemed as of June 30, 2012 and December 31, 2011, the redemption amount would have been approximately $14.5 million in each instance.

 

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Dividends

The Series B Preferred Stock is entitled to receive preferential dividends equal to five percent (5%) per annum of the original issue price per share, payable quarterly in February, May, August and November of each year. Such dividends may be paid by the Company in cash or in kind (in the form of additional shares of Series B Preferred Stock). In the event that the payment in cash or in kind of any such dividend would cause the Company to violate a covenant under its debt agreements, the obligation to pay, in cash or in kind, will be suspended until the earlier to occur of (i) and only to the extent any restrictions under the debt agreements lapse or are no longer applicable or (ii) February 16, 2015. During any such suspension period, the preferential dividends shall continue to accrue and accumulate. As shares of the Series B Preferred Stock are convertible into shares of our common stock, each dividend paid in kind will have a dilutive effect on our shares of common stock.

Preferred stock dividends are recorded at their fair value. If paid in cash, the amount paid represents fair value. If paid in kind, the fair value of the preferred stock dividends is determined using valuation techniques that include a component representing the intrinsic value of the dividends (which represents the fair value of the common stock into which the preferred stock could be converted) and an option component (which is determined using a Black-Scholes Option Pricing Model). Dividends and accretion for the three and six months ended June 30, 2012 were $0.2 million and $0.4 million. Dividends for the quarterly periods ended November 28, 2011, February 28, 2011, and May 28, 2011 were not paid on the Series B preferred shares. Amounts were accrued representing the fair value of shares expected to be paid in kind.The Company had not paid these dividends in cash at that time due to certain restrictions in the indentures governing the Second Priority Notes and the First Priority Notes, and had not paid these dividends in-kind because the Toronto Stock Exchange had taken the position that, in light of the market price of the Company’s common shares, the issuance of additional shares of Series B Preferred Stock as a dividend in-kind would violate Toronto Stock Exchange rules regarding the issuance of discounted shares, unless the Company received shareholder approval for such an issuance (which we subsequently received). After the extinguishment of the Second Priority Notes and the First Priority Notes, the Company was no longer restricted from paying cash dividends as the indenture governing the 9% Senior Notes specifically allowed cash dividends on the Series B Preferred Stock up to specific levels. During the quarter ended June 30, 2011, cumulative preferred dividends were remeasured using the contractual 5% rate. An adjustment of $1.1 million and $0.2 million was reflected as a component of preferred shares dividends in the statement of operations for the three and six months ended June 30, 2011. Since then, quarterly dividends have been paid in cash. The Company currently intends to pay all future dividends in cash.

17. Discontinued Operations

On January 12, 2012, the Company completed the previously announced sale of substantially all of its assets located in Mexico, as well as its equity interests in Forbes Energy Services México Servicios de Personal, S. de R.L. de C.V., for aggregate cash consideration of approximately $30 million (excluding amounts paid to cover certain Mexican taxes). The Company recognized a gain on disposal of approximately $3.5 million on this transaction.

The Company has retained a small office in Mexico, which will operate on a temporary basis while the Company collects outstanding receivables from PEMEX. In connection with the expiration of its contract with PEMEX, the Company expects the release of the performance bond posted in connection with such contract, which should result in approximately $13.6 million being released from restricted cash.

 

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The following table presents the results of discontinued operations:

 

     Three months ended June 30,     Six months ended June 30,  
     2012     2011     2012     2011  
     (dollars in thousands)        

Revenues

   $ —        $ 16,236      $ 2,787      $ 28,538   

Expenses

    

Direct costs

     —          11,930        3,683        20,777   

General and administrative

     2,173        801        2,887        1,028   

Depreciation and amortization

     —          461        —          895   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     2,173        13,192        6,570        22,700   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     (2,173     3,044        (3,783     5,838   

Interest income

     —          7        —          13   

Interest expense

     —          (2     (1     (4

Other income (expense)

     —          —          —          —     

Gain on sale of assets

     121        1        3,668        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     (2,052     3,050        (116     5,847   

Income tax expense (benefit)

     (426     1,178        379        2,158   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (1,626   $ 1,872      $ (495   $ 3,689   
  

 

 

   

 

 

   

 

 

   

 

 

 

18. Subsequent Events

Subsequent events have been evaluated through the filing date of this 10-Q.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with the audited consolidated financial statements for the year ended December 31, 2011 included in our Annual Report on Form 10-K. Any forward-looking statements made by or on our behalf are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Readers are cautioned that such forward-looking statements involve risks and uncertainties in that the actual results may differ materially from those projected in the forward-looking statements. Important factors that could cause actual results to differ include risks set forth in the Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011.

Overview

Forbes Energy Services Ltd., or FES Ltd, is an independent oilfield services contractor that provides a wide range of well site services to oil and natural gas drilling and producing companies to help develop and enhance the production of oil and natural gas. These services include fluid hauling, fluid disposal, well maintenance, completion services, workovers and recompletions, plugging and abandonment, and tubing testing. Our operations are concentrated in the major onshore oil and natural gas producing regions of Texas, with additional locations in Mississippi, in Pennsylvania and, prior to the disposition of our Mexican assets in January 2012, which is discussed below, in Mexico. We believe that our broad range of services, which extends from initial drilling, through production, to eventual abandonment, is fundamental to establishing and maintaining the flow of oil and natural gas throughout the life cycle of our customers’ wells. Our headquarters and executive offices are located at 3000 South Business Hwy 281, Alice, Texas 78332. We can be reached by phone at (361) 664-0549.

As used in this Quarterly Report on Form 10-Q, the “Company,” the “Forbes Group,” “we,” and “our” mean FES Ltd and its subsidiaries, except as otherwise indicated. Unless otherwise indicated, all financial or operational data presented herein relates to our continuing operations, excluding our operations in Mexico, which were sold in January 2012.

We currently provide a wide range of services to a diverse group of companies. Through the six months ended June 30, 2012, we provided services to over 550 companies. Our blue-chip customer base includes Anadarko Petroleum Corporation, Chesapeake Energy Corporation, ConocoPhillips Company, Rosetta Resources, Inc., and Shell Oil Company, among others. John E. Crisp, Charles C. Forbes, and our senior management team, have cultivated deep and ongoing relationships with these customers during their average of over 35 years of experience in the oilfield services industry. For the three and six months ended June 30, 2012, we generated consolidated revenues of approximately $119.8 million and $251.3 million.

We currently conduct our operations through the following two business segments:

 

   

Well Servicing. Our well servicing segment comprised 42.8% and 41.2% of consolidated revenues for the three and six months ended June 30, 2012. At June 30, 2012, our well servicing segment utilized our modern fleet of 162 owned well servicing rigs, which included 152 workover rigs, 10 swabbing rigs, and related assets and equipment. These assets are used to provide (i) well maintenance, including remedial repairs and removal and replacement of downhole production equipment, (ii) well workovers, including significant downhole repairs, re-completions and re-perforations, (iii) completion and swabbing activities, and (iv) plugging and abandoning services. In addition, we have a fleet of nine tubing testing units that are used to conduct pressure testing of oil and natural gas production tubing.

 

   

Fluid Logistics and Other. Our fluid logistics and other segment comprised 57.2% and 58.8% of consolidated revenues for the three and six months ended June 30, 2012. Our fluid logistics segment utilized our fleet of owned or leased fluid transport trucks and related assets, including specialized vacuum, high-pressure pump and tank trucks, frac tanks, water wells, salt water disposal wells and facilities, and related equipment. These assets are used to provide, transport, store, and dispose of a variety of drilling and produced fluids used in, and generated by, oil and natural gas production. These services are required in most workover and completion projects and are routinely used in daily operations of producing wells. Beginning in the fiscal year 2010, the Company began providing additional services in which Wolverine Construction, Inc., a related party, completed such services as a sub-contractor. These services involved site preparation and were complementary to the traditional services offered by the Company. The Company ceased offering these services in June 2011. Prior to such termination, we would pay Wolverine for their services and materials and then would bill the cost to the customer with a margin of approximately 5%. There was no revenue associated with the sub-contractor work for the three or six months ending June 30, 2012 and $2.0 million and $5.2 million for the three and six months ending June 30, 2011, respectively.

 

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We believe that our two business segments are complementary and create synergies in terms of selling opportunities. Our multiple lines of service allow us to capitalize on our existing customer base to grow within existing markets, generate more business from existing customers, and increase our operating profits. By offering our customers the ability to reduce the number of vendors they use, we believe we help improve our customers’ efficiency. This is demonstrated by the fact that 81.6% and 80.5% of our revenues for the three and six months ended June 30, 2012 , respectively, were from customers that utilized services from both of our business segments. Further, by having multiple service offerings that span the life cycle of the well, we believe we have a competitive advantage over smaller competitors offering more limited services.

Factors Affecting Results of Operations

Oil and Natural Gas Prices

Demand for well servicing and fluid logistics services is generally a function of the willingness of oil and natural gas companies to make operating and capital expenditures to explore for, develop and produce oil and natural gas, which in turn is affected by current and anticipated levels of oil and natural gas prices. Exploration and production spending is generally categorized as either operating expenditures or capital expenditures. Activities by oil and natural gas companies designed to add oil and natural gas reserves are classified as capital expenditures, and those associated with maintaining or accelerating production, such as workover and fluid logistics services, are categorized as operating expenditures. Operating expenditures are typically more stable than capital expenditures and are less sensitive to oil and natural gas price volatility. In contrast, capital expenditures by oil and natural gas companies for drilling are more directly influenced by current and expected oil and natural gas prices and generally reflect the volatility of commodity prices.

Workover Rig Rates

Our well servicing segment revenues are dependent on the prevailing market rates for workover rigs. Rates and utilization for workover rigs increased in March 2010 through the third quarter of 2011, then rates and utilization stabilized in the fourth quarter 2011 and have continued through the first half of 2012.

Fluid Logistics Rates

Our fluid logistics and other segment revenues are dependent on the prevailing market rates for fluid transport trucks and the related assets, including specialized vacuum, high-pressure pump and tank trucks, frac tanks and salt water disposal wells. Pricing and utilization increased in the latter portion of the first quarter 2010 and have generally continued, although at a slower rate of increase in recent quarters. In fact, rates stabilized during the second half of 2011 and through the first half of 2012.

Operating Expenses

Utilization and demand increased in 2010 and 2011 and the first half of 2012, we have experienced cost pressures in areas such as labor where we have incurred additional cost increases primarily in the form of increased pay rates. So far, we have been able to cover these increased costs through rate increases passed on to our customers. Future earnings and cash flows will be dependent on our ability to manage our overall cost structure and either maintain our existing prices or obtain price increases from our customers as our operating costs increase.

Equipment rental cost continues to be a significant component of our operating expenses. As described in the following paragraph, we made certain capital expenditures in the first half of 2012 that are intended to replace certain leased or rented equipment. Nevertheless, we expect that we will continue to meet certain equipment needs through rental or leasing arrangements and, to that end, in the first half of 2012, we entered into operating leases with respect to 70 additional vacuum trucks, 11 vacuum trailers, 17 support trucks and a transport trailer for the coiled tubing units.

Capital Expenditures

During the first half of 2012 we purchased three 550 horsepower well service rig and related equipment, four pump-down units, 1,235 frac tanks, eight vacuum trucks and eight salt water disposal wells. capital expenditures for the six months ended june 30, 2012 were $91.3 million. Certain of these purchased assets are intended either to take the place of equipment that the Company had been leasing or renting or to allow the Company to provide services to customers that it had previously offered through third party contractors. Other purchases were made to increase the Company’s overall capacity. In addition to the assets purchased in the first half of 2012, as of July, the Company has also placed orders for additional equipment, including five coil tubing spreads and related equipment that should be delivered in the third and fourth quarters of 2012, the first of which was received in July. The aggregate purchase price of this additional equipment on order is approximately $32 million. Other than equipment on order that has not yet been delivered, the Company does not plan on making any further significant capital expenditures in the immediate future.

 

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We plan to finance some of the remaining equipment on order, including four additional coil tubing units, pursuant to an agreement with Regions Equipment Finance Corporation and Regions Commercial Equipment Finance, LLC, collectively, Regions Finance, discussed in further detail below. However, this agreement does not constitute a commitment to finance any additional operating lease or loan schedules. Nevertheless, we believe that our cash flows from operations and availability under our $75 million revolving credit facility, on their own, will be sufficient to fund or otherwise satisfy the obligations related to this equipment on order.

Operating Income Margins

We have experienced less margin pressure on our fluid logistics and other segment, which resulted in more favorable margins in that segment relative to the well servicing segment and this continues through the current period. A significant portion of the additional activity in the fluid logistics and other segment relates to expanded fracing operations in our market areas.

Presentation

The following discussion and analysis is presented on a consolidated basis to reflect the results of continuing operations and financial condition of the Forbes Group. The financial information as of and for the three and six months ended June 30, 2012 and June 30, 2011 is presented on a consolidated basis for FES Ltd and its subsidiaries. Unless otherwise indicated, all financial or operational data presented herein relates to our continuing operations, excluding our operations in Mexico, which were sold in January 2012. Notwithstanding the foregoing, financial information regarding cash flows presented herein includes cash flows from our discontinued operations.

Results of Operations

The following discussion, as well as the discussion found under “Liquidity and Capital Resources,” compares our consolidated financial information for the three and six months ended June 30, 2012 to the three and six months ended June 30, 2011.

Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011

Consolidated Revenues. For the three months ended June 30, 2012, revenues increased by $9.0 million, or 8.1%, to $119.8 million when compared to the same period in the prior year. This is a direct result of increased utilization in our well servicing segment in 2012 as compared to 2011.

Well Servicing—Revenues from the well servicing segment increased by $9.3 million for the period, or 22.1% to $51.3 million compared to the corresponding period in the prior year. Of this increase, approximately 23.3% was due to increased prices and 76.7% was due to increased rig hours for well services. We utilized 162 well service rigs as of June 30, 2012 and 2011. The average rate charged per hour during the three months ended June 30, 2012 as compared to the same period in 2011 increased approximately 4.4%. Average utilization of our well service rigs during the three months ended June 30, 2012 and June 30, 2011 was 91.0% and 80.4%, respectively, based on a twelve hour day, working five days a week, except holidays in the U.S.

Fluid Logistics and Other—Revenues from the fluid logistics segment and other for the three months ended June 30, 2012 decreased by $0.3 million, or 0.5%, to $68.5 million compared to the prior year primarily due to the cessation of the other contract services performed in the second quarter of 2011, but not in the second quarter of 2012. This decrease was offset by an increase in revenues from our core operating activities, in line with general industry trends. Our principal fluid logistics assets at June 30, 2012 and June 30, 2011 were as follows:

 

     June 30     

%

Increase

 
     2012      2011      (Decrease)  

Fluid logistics and other segment:

        

Vacuum trucks

     475         356         33.4

High-pressure pump trucks

     21         19         10.5

Other heavy trucks

     84         61         37.7

Frac tanks

     3,114         1,400         122.4

Salt water disposal wells

     23         15         53.3

Consolidated Operating Expenses—Our operating expenses increased to $86.8 million for the three months ended June 30, 2012, from $85.1 million for the three months ended June 30, 2011, an increase of $1.7 million, or 2.0%, due to

 

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increases in utilization. Operating expenses as a percentage of revenues were 72.5% for the three months ended June 30, 2012, compared to 76.8% for the three months ended June 30, 2011. The decrease in operating expense as a percentage of our revenues is generally attributable to increases in utilization.

Well Servicing—Operating expenses from the well servicing segment increased by $3.1 million, or 8.9%, to $37.5 million. Well servicing operating expenses as a percentage of well servicing revenues were 73.0% for the three months ended June 30, 2012, compared to 81.8% for the three months ended June 30, 2011, a decrease of 8.8%. This increase in operating expense as a percentage of revenue was due to an increase in utilization to 91.0% for the three months ended June 30, 2012 from 80.4% for the three months ended June 30, 2011, which allowed the Company to spread its fixed costs over greater revenues, thereby increasing the gross margin. The large portion of the increase in expenses was due to the increase in employee count and resulted in an increase in labor of $3.6 million, or 23.2% to $19.4 million. The employee count at June 30, 2012 was 1,106, compared to 961 employees as of June 30, 2011. Fuel expense increased by $1.1 million or 45.3% due to an increase rig hours. These increases were partially offset by a decrease in the rental of equipment of $1.7 million or 79.0% due to the rigs purchased from AES, a related party, that were previously leased. The remaining $0.1 million is related to various expenses and is in line with management’s expectations.

Fluid Logistics and Other—Operating expenses from the fluid logistics and other segment decreased by $1.3 million, or 2.6%, to $49.4 million. Fluid logistics operating expenses as a percentage of fluid logistics revenues were 72.1% for the three months ended June 30, 2012, compared to 73.7% for the three months ended June 30, 2011. The decrease in fluid logistics and other operating expenses of $1.3 million was partially due to a decrease in contract services cost of $6.7 million, or 78.3% to $1.9 million, when compared to the same period in the prior year. Rent equipment expense decreased $1.7 million or 27.3%, to $4.4 million. Both of these expenses decreased due to the acquisition of additional equipment to satisfy customer demand and decreasing the need to utilize outside services. The decrease in contract services also includes the Company terminating services in June of 2011 where Wolverine Construction, Inc., a related party, completed services as a sub-contractor. This decrease in contract services was partially offset by the increase in labor costs of $4.1 million, or 29.7% to $18.0 million as a direct result of workforce headcount increases. The employee count at June 30, 2012 was 1,217, as compared with 941 employees as of June 30, 2011. Supplies and parts expense increased $0.6 million or 629.7%, to $0.7 million. Fuel costs increased $0.5 million, or 6.6% to $8.6 million. Insurance costs increased $0.5 million, or 46.7% to $1.5 million. The remaining $1.4 million relates to various expenses in line with management’s expectations.

General and Administrative Expenses. General and administrative expenses from the consolidated operations decreased by approximately $5.0 million, or 38.4%, to $8.1 million for the three months ended June 30, 2012. General and administrative expense as a percentage of revenues was 6.7% and 11.8% for the three months ended June 30, 2012 and June 30, 2011, respectively. The decrease of $5.0 million was due to additional expense of $6.9 million associated with a litigation settlement and the related legal fees incurred in 2011, which was offset by a net increase in compensation expense of approximately $1.6 million. Compensation expense for the current quarter included discretionary management bonuses of approximately $0.3 million and an accrual of approximately $0.6 million to reflect an estimate of the quarterly expense related to a newly implemented, performance based, management bonus plan.

Depreciation and Amortization. Depreciation and amortization expenses increased by $2.9 million, or 30.6%, to $12.5 million. The additional depreciation expense resulted from capital expenditures, including those incurred for the three months ended June 30, 2012 which were $37.6 million compared to $23.4 million for the three months ended June 30, 2011.

Interest and Other Expenses. Interest and other expenses decreased by approximately $35.4 million from the three months ended June 30, 2011 to the current quarter due to the loss on early extinguishment of debt resulting from the retirement of the First and Second Priority Notes. This financing cost was comprised of a penalty on the early redemption of the First Priority Notes of $0.6 million, total unamortized deferred financing charges written off in connection with the redemption of First and Second Priority Notes of $10.4 million and tender purchase price premium and consent fee related to the Second Priority Notes of $24.4 million.

Income Taxes. We recognized an income tax expense of $3.0 million and a benefit of $12.5 million for the three months ended June 30, 2012 and June 30, 2011, respectively. Our effective tax rate for the three months ended June 30, 2012 is 52.7% due to higher earnings in the quarter, non-deductible expenses, and related Texas margins tax.

Discontinued Operations—We recorded a net loss from discontinued operations of $1.6 million for the three months ended June 30, 2012, compared to net income from discontinued operations of $1.9 million for the three months ended June 30, 2011. The decrease in net income relates mainly to the winding down of operations in Mexico including bad debt expense of approximately $1.5 million. See Note 17—

 

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Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011

Consolidated Revenues. For the six months ended June 30, 2012, revenues increased by $45.8 million, or 22.3%, to $251.3 million when compared to the same period in the prior year. This is a result of increased utilization in both our well servicing and fluid logistics segments in 2012 as compared to 2011.

Well Servicing—Revenues from the well servicing segment increased by $25.1 million for the six month period, or 32.0% to $103.6 million compared to the corresponding period in the prior year. Of this increase, approximately 27.4% was due to increased prices and 72.6% was due to increased rig hours for well services. We utilized 162 well service rigs as of June 30, 2012 and 172 well service rigs as of June 30, 2011. The average rate charged per hour during the six months ended June 30, 2012 as compared to the same period in 2011 increased approximately 7.3%. Average utilization of our well service rigs during the six months ended June 30, 2012 and June 30, 2011 was 93.4% and 76.2% , respectively, based on a twelve hour day, working five days a week, except holidays in the U.S.

Fluid Logistics and Other—Revenues from the fluid logistics segment and other for the six months ended June 30, 2012 increased by $20.7 million, or 16.3%, to $147.7 million compared to the prior year, as a result of the general industry increase in pricing and activity. Our revenue increased $20.7 million due to an increase in rates of approximately 1.2% in the six months ended June 2012 compared to the six months ended June 2011 and the remainder was due to an increase in hours offset in part by the cessation of the other contract services performed in the first half of 2011, but not in the first half of 2012.

Consolidated Operating Expenses—Our operating expenses increased to $180.8 million for the six months ended June 30, 2012, from $157.1 million for the six months ended June 30, 2011, an increase of $23.7 million, or 15.1%, due to increases in utilization. Operating expenses as a percentage of revenues were 71.9% for the six months ended June 30, 2012, compared to 76.4% for the six months ended June 30, 2011. The decrease in operating expense as a percentage of our revenues is generally attributable to increases in utilization and pricing. The Company was able to increase customer rates in amounts adequate to offset additional operating cost as well as increase margins.

Well Servicing—Operating expenses from the well servicing segment increased by $12.4 million, or 19.3%, to $76.5 million. Well servicing operating expenses as a percentage of well servicing revenues were 73.9% for the six months ended June 30, 2012, compared to 81.8% for the six months ended June 30, 2011, a decrease of 7.9%. The large portion of the increase in expenses was due to the increase in employee count and resulted in an increase in labor of $9.1 million, an increase in insurance premiums of $1.2 million, and an increase in safety expense of $0.4 million. The employee count at June 30, 2012 was 1,106 compared to 961 employees as of June 30, 2011. Fuel expense increased by $2.1 million or 44.2% due to an increase in rig hours in conformity with increased activity levels for the industry. These increases were partially offset by a decrease in the rental of equipment of $1.7 million or 58.9% due to the rigs purchased from AES, a related party, that were previously leased. The contract labor expense increased $1.3 million or 341.2% due to increase in rig count, rig hours and labor hours for the P & A division.

Fluid Logistics and Other—Operating expenses from the fluid logistics and other segment increased by $11.3 million, or 12.2%, to $104.2 million. Fluid logistics operating expenses as a percentage of fluid logistics revenues were 70.5% for the six months ended June 30, 2012, compared to 73.1% for the six months ended June 30, 2011. The increase in fluid logistics and other operating expenses of $11.5 million was partially due to an increase in labor costs of $9.4 million, or 36.2% to $35.5 million as a direct result of workforce headcount increases. The employee count at June 30, 2012 was 1,217, as compared with 941 employees as of June 30, 2011. Contract services cost decreased $7.4 million, or 47.8% to $8.1 million, when compared to the same period in the prior year due to the acquisition of additional equipment to satisfy customer demand and decreasing the need to utilize outside services. The decrease in contract services also includes the Company terminating services in June of 2011 where Wolverine Construction, Inc., a related party, completed services as a sub-contractor. Fuel costs increased $2.4 million, or 16.5% to $17.2 million for the six months ended June 30, 2012, due to fuel price increase of 4.9% and higher activity in drilling and well services when compared to the same period in the prior year. Repairs and maintenance cost increased $1.9 million, or 19.8% to $11.5 million as a result of activity increases. Insurance cost increased $1.3 million, or 70.5% to $3.3 million for the six months ended June 30, 2012, when compared to the same period in the prior year due to headcount increases and acquisition of additional equipment. Tire cost increased $1.1 million, or 59.0% to $2.9 million also due to acquisition of additional equipment. Supplies and parts costs increased $0.8 million, or 551.7% to $1.0 million. The remaining $2.0 million change is related to various expenses that were consistent with the activity of the business.

General and Administrative Expenses. General and administrative expenses from consolidated operations decreased by approximately $0.1 million, or 0.3%, to $18.7 million for the six months ended June 30, 2012. General and administrative expense as a percentage of revenues was 7.5% and 9.1% for the six months ended June 30, 2012 and June 30, 2011, respectively. The decrease of $0.1 million was due to a decrease litigation, settlement, and legal fees of $6.9 million, which was offset by an increase in compensation expense of approximately $5.6 million in the first half of 2012 related mainly to discretionary management bonuses of approximately $2.1 million, expense of approximately $1.3 million related to a newly implemented, performance based, management bonus plan and stock compensation expense of $1.8 million due to the issuance of stock options and restricted stock. The balance of the increase was in line with the normal growth of the business.

 

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Depreciation and Amortization. Depreciation and amortization expenses increased by $4.7 million, or 24.3%, to $23.9 million. Capital expenditures incurred for the six months ended June 30, 2012 were $91.3 million compared to $27.9 million for the six months ended June 30, 2011.

Interest and Other Expenses. Interest and other expenses decreased by approximately $35.4 million due to the loss of $35.4 million on early extinguishment of debt due to the retirement of the First and Second Priority Notes and was comprised of a penalty on the early redemption of the First Priority Notes of $0.6 million, total unamortized deferred financing charges written off in connection with the redemption of First and Second Priority Notes of $10.4 million and tender purchase price premium and consent fee related to the Second Priority Notes of $24.4 million.

Income Taxes. We recognized an income tax expense of $6.3 million and a benefit of $12.2 million for the six months ended June 30, 2012 and June 30, 2011, respectively. Our effective tax rate for the six months ended June 30, 2012 is 44.6% due to higher earnings in the quarter, non-deductible expenses, and related Texas margins tax.

Discontinued Operations—We recorded a net loss from discontinued operations of $0.5 million for the six months ended June 30, 2012, compared to a net income from discontinued operations of $3.7 million for the six months ended June 30, 2011. The decrease in net income relates to the winding down of operations in Mexico. See Note 17—

Liquidity and Capital Resources

Overview

In June 2011, we issued $280.0 million aggregate principal amount of 9% Senior Notes. We used a substantial portion of the proceeds from such offering to purchase or redeem all outstanding Second Priority Notes and First Priority Notes.

On September 9, 2011, we entered into a loan and security agreement with certain lenders and Regions Bank, as agent for the secured parties, or the Agent. The loan and security agreement provides for an asset based revolving credit facility with a maximum initial credit of $75.0 million, subject to, as described in more detail in our annual report on Form 10-K for the year ended December 31, 2011, borrowing base availability, any reserves established by the facility agent in its discretion and, if availability under the facility falls below certain thresholds, compliance with certain financial covenants. As of June 30, 2012, $67.3 million was available under this new credit facility.

Two subsidiaries of FES Ltd, TX Energy Services, LLC and C.C. Forbes, LLC, entered into that certain Master Agreement dated as of June 6, 2012 with Regions Equipment Finance Corporation and Regions Commercial Equipment Finance, LLC, collectively, Regions Finance. Subsequently, these subsidiaries have entered into various operating lease and loan schedules under this Master Agreement to finance recent acquisitions of a coil tubing unit, trucks, trailers and other related equipment. Concurrently with the funding of each of these schedules, Regions Finance provided notice to the TES and CCF that they had assigned their rights and obligations thereunder to a third party. These operating lease or loan schedules have been assigned to CapitalSource Bank, NewStar Equipment Finance I, LLC, CIT Bank, CapitalSource Bank and the United States Life Insurance Company in the City of New York. FES Ltd has agreed to guaranty the obligations under these schedules pursuant to that certain Guaranty Agreement dated as of June 6, 2012, between the Company and Regions Finance.

The term for both the operating lease and loan schedules varies from 48 months to 60 months, with the term for the operating leases automatically extending for consecutive additional two-month periods unless either party provides notice of termination. Further, under the operating lease schedules, we have the right to purchase the property subject to each lease schedule at fair market value, which is determined by a formula set forth in each schedule. The aggregate amount funded under all the loan schedules pursuant to the Master Agreement is approximately $3.8 million and the aggregate lease payments under all the operating lease schedules pursuant to the Master Agreement is approximately $8.1million.

The indenture governing the 9% Senior Notes and the loan agreement governing our senior secured revolving credit facility impose significant restrictions on us and increase our vulnerability to adverse economic and industry conditions that could limit our ability to obtain additional or replacement financing. For example, the indenture governing the 9% Senior Notes only allows us to incur indebtedness, other than certain specific types of permitted indebtedness, if such indebtedness is unsecured and if the Fixed Charge Coverage Ratio (as defined in each indenture) for the most recently completed four full fiscal quarters is at least 2.0 to 1.0. We are currently able to incur indebtedness under this ratio. Our new credit facility only allows us to incur specific types of permitted indebtedness, which includes a $40.0 million basket of permitted indebtedness for capital leases, mortgage financings or purchase money obligations incurred for the purpose of installation or improvement of property, plant or equipment.

 

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Our inability to satisfy our obligations under the indenture governing the 9% Senior Notes, the loan agreement governing our credit facility and any future debt agreements we may enter into could constitute an event of default under one or more of such agreements. Further, due to cross-default provisions in our debt agreements, a default and acceleration of our outstanding debt under one debt agreement may result in the default and acceleration of outstanding debt under the other debt agreements. Accordingly, an event of default could result in all or a portion of our outstanding debt becoming immediately due and payable. If this should occur, we might not be able to obtain waivers or secure alternative financing to satisfy all of our obligations simultaneously. Given the state of global events, our ability to access the capital markets or to consummate any asset sales might be restricted at a time when we would like or need to raise capital. These events could have a material adverse effect on our business, financial position, results of operations and cash flows and our ability to satisfy our obligations.

Within certain constraints, we can conserve capital by reducing or delaying capital expenditures, deferring non-regulatory maintenance expenditures and further reducing operating and administrative costs.

We have historically funded our operations, including capital expenditures, with bank borrowings, vendor financings, cash flow from operations, the issuance of senior notes, and the proceeds from our Canadian initial public equity offering and simultaneous U.S. private placement, our October 2008 and December 2009 common stock offerings, and our May 2010 Series B Preferred Stock private placement.

As of June 30, 2012, we had $297.3 million in total outstanding debt. As of June 30, 2012, we had 588,059 outstanding Series B Senior Convertible Preferred Shares which is reflected in the balance sheet as temporary equity in an amount of $14.5 million. The preferred stock is redeemable for cash or common stock at 95% of the fair market value of the common stock as determined in accordance with the certificate of designation of the Series B Preferred Stock in May 2017.

As of June 30, 2012, we had $9.8 million in cash and cash equivalents, $291.3 million in long-term debt outstanding, $6.0 million in short-term debt outstanding, and $14.8 million of short-term equipment vendor financings for well servicing rigs and other equipment included in accounts payable. Our $6.0 million of short-term debt consisted of $3.6 million payable to equipment lenders under various installment notes, and $2.4 million payable related to financing of our insurance premiums over the term of the insurance coverage. We incurred $37.6 million for capital equipment acquisitions during the three months ended June 30, 2012 as compared to $23.5 million during the three months ended June 30, 2011. Capital equipment added for the six months ended June 30, 2012 includes three well service rigs and related equipment, four pump down units, 1,235 frac tanks, eight vacuum trucks, and eight salt water disposal wells. These items were funded from cash flows from operations and financing.

Although additional equipment will be received through the second half 2012 based on outstanding orders, in May 2012 management stopped making further orders for vacuum trucks, trailers, and frac tanks based on a review of customer demand relative to the current levels of equipment the Company has available for servicing these customers. The Company has five coil tubing spreads on order. The first coil tubing spread arrived in July 2012 and the remaining four will be received before year end. There are no other significant capital expenditures anticipated for 2012.

We project that cash flows from operations, the Regions equipment Master Agreement, and availability under our revolving credit facility will be adequate to meet our operating needs and working capital requirements over the next twelve months.

Cash Flows

Our cash flows depend, to a large degree, on the level of spending by oil and gas companies development and production activities. Sustained increases or decreases in the price of natural gas or oil could have a material impact on these activities, and could also materially affect our cash flows. Certain sources and uses of cash, such as the level of discretionary capital expenditures, purchases and sales of investments, issuances and repurchases of debt and of our common shares are within our control and are adjusted as necessary based on market conditions.

Cash Flows from Operating Activities

Net cash provided by operating activities totaled $44.9 million for the six months ended June 30, 2012, compared to net cash used in operating activities of $22.9 million for the six months ended June 30, 2011.

The increase in cash provided by operating activities was $67.9 million for the six months ending June 30, 2012 primarily due to an increase in net income of $30.2 million due to a general improvement in industry conditions, a decrease in the change in accounts receivable of $66.7 million due in part to the sale of our Mexico operations, and a decrease in the deferred tax benefit of $18.2 million. These increased cash flows from operting activities were offset by a decrease in the change in accounts payable of $21.8 million as the company reduced the amount of equipment in accounts payable and a decrease in the change in accrued expenses of $21.9 million mainly resulting from the sale of our Mexico operations.

 

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Cash Flows Used in Investing Activities

Net cash flows used in investing activities was $75.7 million for the six months ending June 30, 2012 compared to $30.2 million for the same period in 2011. The change was primarily related to a change in the purchase of property and equipment which increased $65.9 million from the six months ended June 30, 2011 to the current period. The increased capital expenditures were offset by $14.3 million in cash received in the current period related to hte sale of our Mexico operations and other miscellaneous pieces of equipment. The Company purchased three well service rigs and related equipment, four pump down units, 1,235 frac tanks, eight vacuum trucks, and eight salt water disposal wells during the first half of 2012.

Cash Flows Used in Financing Activities

Cash flows provided by financing activities for the six months ended June 30, 2012 was $3.7 million compared to $57.5 million for the six months ended June 30, 2011. The primary reasons for these changes were due to the payoff of the first and second priority notes and the proceeds from the issuance of the Senior Notes and their issuance costs in the second quarter of 2011 and the proceeds from borrowings on the revolving credit facility in the second quarter of 2012 of $6.0 million.

Cash Flows From Discontinued Operations

Cash flows used in discontinued operations for the six months ended June 30, 2012 amounted to $6.5 million, compared to $0.9 for the six months ended June 30, 2011. This increase was due to the expenses associated with the winding down of our operations in Mexico, bad debt expense, and the payment of outstanding payables and other liabilities.

Off-Balance Sheet Arrangements

We are often party to certain transactions that require off-balance sheet arrangements such as performance bonds, guarantees, operating leases for equipment, and bank guarantees that are not reflected in our condensed consolidated balance sheets. These arrangements are made in our normal course of business and they are not reasonably likely to have a current or future material adverse effect on our financial condition, results of operations, liquidity or cash flows.

Contractual Obligations and Financing

On May 28, 2017, the Company is required to redeem any of its Series B Preferred Shares then outstanding. Such mandatory redemption may, at the Company’s election, be paid in cash or Common Shares (valued for such purpose at 95% of the then fair market value of the Common Shares). As of June 30, 2012 we had 588,059 Series B Preferred Shares outstanding.

Seasonality

Our operations are impacted by seasonal factors. Historically, our business has been negatively impacted during the winter months due to inclement weather, fewer daylight hours, and holidays. Our well servicing rigs are mobile, and we operate a significant number of oilfield vehicles. During periods of heavy snow, ice or rain, we may not be able to move our equipment between locations, thereby reducing our ability to generate rig or truck hours. In addition, the majority of our well servicing rigs work only during daylight hours. In the winter months when daylight time becomes shorter, this reduces the amount of time that the well servicing rigs can work and, therefore, has a negative impact on total hours worked. Finally, during the fourth quarter, we historically have experienced significant slowdowns during the Thanksgiving and Christmas holiday seasons.

Critical Accounting Policies and Estimates

The preparation of our condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenue and expenses during the applicable reporting periods. On an ongoing basis, management reviews its estimates, particularly those related to depreciation and amortization methods, useful lives and impairment of long-lived assets, and asset retirement obligations, using currently available information. Changes in facts and circumstances may result in revised estimates, and actual results could differ from those estimates.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

In addition to the risks inherent in our operations, we are exposed to financial, market and economic risks. Changes in interest rates may result in changes in the fair market value of our financial instruments, interest income and interest expense. Our financial instruments that are exposed to interest rate risk are long-term borrowings. The following discussion provides information regarding our exposure to the risks of changing interest rates and fluctuating currency exchange rates.

 

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Our primary debt obligations are the outstanding 9% Senior Notes and the new credit facility. Changes in interest rates do not affect interest expense incurred on our 9% Senior Notes as such notes bear interest at a fixed rate. However, changes in interest rates would affect their fair values. In general, the fair market value of debt with a fixed interest rate will increase as interest rates fall. Conversely, the fair market value of debt will decrease as interest rates rise. A hypothetical change in interest rates of 10% relative to interest rates as of June 30 2012 would have no impact on our interest expense for the 9% Senior Notes.

Our revolving credit facility has a variable interest rate and, therefore, is subject to interest rate risk. As of August 10, 2012, we had no amounts drawn on this facility. For this reason, a 100 basis point increase in interest rates on our variable rate debt would not result in significant additional annual interest expense.

Historically, we have not been exposed to significant foreign currency fluctuation; however, during 2010 our Mexican operations changed its functional currency from the U.S. dollar to the Mexican peso. This exposed us to certain risks typically associated with foreign currency fluctuation as our operations in Mexico collected revenues and paid expenses in Mexico. On January 12, 2012, we completed the disposition of substantially all of our assets and business located in Mexico. Nevertheless, we continue to collect receivables from our operations previous in Mexico. As of June 30, 2012, a 10% unfavorable change in the Mexican peso-to-U.S. dollar exchange rate would not materially impact our consolidated balance sheet. To date, we have not taken any action to hedge against any foreign currency rate fluctuations and, as we have sold our operations in Mexico, we do not expect we will be subject to material foreign currency risk in the near future.

We have not entered into any derivative financial instrument transactions to manage or reduce market risk or for speculative purposes.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2012. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2012, our chief executive officer and chief financial officer concluded that, as of such date, our internal control over financial reporting and disclosure controls and procedures were not effective. See “Material Weakness” below.

Change in Internal Control over Financial Reporting

Other than the remediation measure described below under “Remediation” no change in our internal control over financial reporting (as defined in Rules 13a- 15(f) and 15d- 15(f) under the Exchange Act) occurred during the fiscal quarter ended June 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Material Weakness

In connection with the preparation of the Forbes Group’s consolidated financial statements for the year ended December 31, 2011, we identified control deficiencies that constitute a material weakness in the design and operation of our internal control over financial reporting. The following material weakness was present at December 31, 2011 and continues to exist.

 

   

We did not design or maintain effective controls over the billing process to ensure timely recognition of revenue. Specifically, we identified field tickets, which represented completed but unbilled revenue that had not been entered resulting in a post-closing adjustment.

 

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This control deficiency could result in a future material misstatement to the annual or interim combined financial statements that would not be prevented or detected. Accordingly, we have determined that the above control deficiency represents a material weakness.

Remediation

As mentioned above, we have identified a material weakness that existed as of June 30, 2012 in our internal control over the billing cycle.

We have modified the design of our information system, processes and procedures which we believe addresses the material weakness. The new processes and procedures have been communicated to senior management and to the field personnel. Testing will begin in the third quarter to monitor compliance.

 

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PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

There are no pending material legal proceedings, and the Forbes Group is not aware of any material threatened legal proceedings, to which the Forbes Group is a party or to which its property is subject.

Item 1A. Risk Factors

There were no material changes from the risk factors previously disclosed in the registrant’s Annual Report on Form 10-K for the year ended December 31, 2011 in response to “Item 1A. Risk Factors” to Part II of Form 10-Q.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

Item 3. Default Upon Senior Securities

None.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

None

 

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Item 6. Exhibits

 

Number

      

Description of Exhibits

    2.1

  —             Agreement and Plan of Reorganization effective January 1, 2008 among Forbes Energy Services LLC and the respective members of C.C. Forbes, LLC, TX Energy Services, LLC and Superior Tubing Testers, LLC (incorporated by reference to Exhibit 2.1 to the Company’s Registration Statement on Form S-4/A filed June 27, 2008, Registration No. 333-150853).

    2.2

  —     Agreement and Plan of Reorganization effective May 29, 2008 among Forbes Energy Services Ltd. and the members of Forbes Energy Services LLC (incorporated by reference to Exhibit 2.2 to the Company’s Registration Statement on Form S-4/A filed June 27, 2008, Registration No. 333-150853).

    2.3

  —     Plan of Conversion of Forbes Energy Services Ltd. (incorporated by reference to Exhibit 2.1 to the Company’s Registration Statement on Form 8-A filed August 12, 2011).

    2.4

  —     Certificate of Conversion of Forbes Energy Services, Ltd (incorporated by reference to exhibit 2.2 to the Company’s Registration Statement on Form 8-A filed August 12, 2011)