GEOKINETICS INC 10-Q 2010
Washington, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-33460
(Name of registrant as specified in its charter)
1500 CityWest Blvd., Suite 800
Telephone number: (713) 850-7600
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
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). Yes o No o
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 definition of accelerated filer, large accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (check one):
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No x
At November 5, 2010, there were 17,697,731 shares of common stock, par value $0.01 per share, outstanding.
Geokinetics Inc. and Subsidiaries
(In thousands, except share amounts)
See accompanying notes to the condensed consolidated financial statements.
(In thousands, except per share amounts)
See accompanying notes to the condensed consolidated financial statements.
Geokinetics Inc. and Subsidiaries
See accompanying notes to the condensed consolidated financial statements.
Geokinetics Inc. and Subsidiaries
and Other Comprehensive Income
(In thousands, except share data)
See accompanying notes to the condensed consolidated financial statements
NOTE 1: Organization and Recent Developments
Geokinetics Inc. (collectively with its subsidiaries, the Company), a Delaware corporation, founded in 1980, is based in Houston, Texas. The Company is a global provider of seismic data acquisition, processing and interpretation services, and a leader in providing land, marsh and swamp (Transition Zone) and shallow water ocean bottom cable (OBC) environment acquisition services to the oil and natural gas industry. Seismic data is used by oil and natural gas exploration and production (E&P) companies to identify and analyze drilling prospects and maximize successful drilling. The Company, which has been operating in some regions for over twenty years, provides seismic data acquisition services in North, Central and South America, Africa, the Middle East, Australia/New Zealand and the Far East. The Company primarily performs three-dimensional (3D) seismic data surveys for customers in the oil and natural gas industry, which include many national oil companies, major international oil companies and smaller independent E&P companies. In addition, the Company performs a significant amount of work for seismic data library companies that acquire seismic data to license to other E&P companies, and it also maintains its own multi-client data library whereby the Company maintains full or partial ownership of data acquired for future licensing. The Companys multi-client data library consists of data covering various areas in the United States and Canada.
On June 30 and September 30, 2010, the Company was unable to satisfy certain maintenance covenants in its revolving credit facility (RBC Credit Facility or credit facility) the terms of which is more fully described in Note 5. The Company received waivers of the covenants that it was unable to meet at June 30 and September 30, 2010. It expects to require an additional waiver of certain of the original financial covenants at December 31, 2010 and possibly beyond which are based on results from the trailing twelve months. In connection with these waivers, the revolving facility agreement was amended to reduce the maximum borrowings available from $50 to $40 million. In addition, the Company is required to adhere to monthly consolidated total revenue and monthly consolidated cumulative adjusted EBITDA targets commencing with the month ending September 30, 2010 through the month ending November 30, 2010. The Company complied with the financial covenant minimums of $50 million of revenue and $7.9 million cumulative monthly EBITDA for the month ending September 30, 2010.
The Company has experienced a recent increase in the number of seismic acquisition contracts awarded, which has resulted in increased crew mobilization costs and associated cash uses. In order to ensure that the Company will have sufficient liquidity to finance the increased business activity, meet existing debt service requirements and finance its business, Management has initiated the following actions,
· They continued to work with the credit facility lenders to receive the required waivers and increase the available borrowings under the facility;
· They are exploring the issuance of additional debt or equity securities; and
· They are exploring sales of non-core assets.
If unable to consummate one of the foregoing transactions, the Company may not be able to meet its liquidity needs in the short term. While no assurances can be made, management believes that given the increased business in the last several months, the Company should be able to execute on one of the foregoing alternatives.
NOTE 2: Basis of Presentation and Significant Accounting Policies
The unaudited condensed consolidated financial statements contained herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). The accompanying financial statements include all adjustments which are, in the opinion of management, necessary to provide a fair presentation of the financial condition and results of operations for the periods presented. All such adjustments are of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted in this Form 10-Q pursuant to the rules and regulations of the SEC. These financial statements should be read in conjunction with the consolidated financial statements and notes included in the Companys latest Annual Report on Form 10-K/A for the year ended December 31, 2009. The results of operations for the three and nine months ended September 30, 2010, are not necessarily indicative of the results to be expected for the full year ending December 31, 2010.
Effective February 12, 2010, the Company completed the acquisition of the onshore seismic data acquisition and multi-client data library business of Petroleum Geo-Services ASA (PGS Onshore). The results of operations and financial condition of the Company as of and for the three and nine months ended September 30, 2010 have been impacted by this acquisition, which may affect the comparability of certain of the financial information contained in this Quarterly Report on Form 10-Q. This acquisition is described in more detail in Note 3.
Certain reclassifications have been made to prior period financial statements to conform to the current presentation.
Multi-client Data Library
The multi-client data library consists of seismic surveys that are licensed to customers on a non-exclusive basis. The Company capitalizes all costs directly associated with acquiring and processing the data, including the depreciation of the assets used in production of the surveys. The capitalized cost of the multi-client data is charged to depreciation and amortization in the period the sales occur based on the greater of the percentage of total estimated costs to the total estimated sales multiplied by actual sales, known as the sales forecast method, or the straight-line amortization method over five years. This minimum straight-line amortization is recorded only if minimum amortization exceeds the cost of services calculated using the sales forecast method. Amortization for the three and nine months ended September 30, 2010 was $7.0 million and $17.4 million, respectively. Amortization for the three and nine months ended September 30, 2009 was $2.4 million and $2.7 million, respectively.
The Company periodically reviews the carrying value of the multi-client data library to assess whether there has been a permanent impairment of value and records losses when it is determined that estimated future sales are not expected to be sufficient to cover the carrying value of the asset.
The Company accounts for multi-client data sales as follows:
(a) Pre-funding arrangementsThe Company obtains funding from a limited number of customers before a seismic project is completed. In return for the pre-funding, the customer typically gains the ability to direct or influence the project specifications, to access data as it is being acquired and to pay discounted prices. The Company recognizes pre-funding revenue as the services are performed on a proportional performance basis usually determined by comparing the completed square miles of a seismic survey to the survey size unless specific facts and circumstances warrant another measure. Progress is measured in a manner generally consistent with the physical progress on the project, and revenue is recognized based on the ratio of the projects progress to date, provided that all other revenue recognition criteria are satisfied.
(b) Late salesThe Company grants a license to a customer, which entitles the customer to have access to a specifically defined portion of the multi-client data library. The customers license payment is fixed and determinable and typically is required at the time that the license is granted. The Company recognizes revenue for late sales when the customer executes a valid license agreement and has received the underlying data or has the right to access the licensed portion of the data and collection is reasonably assured.
(c) Sales of data jointly owned by the Company and a partnerOn certain surveys, the Company jointly acquires data with a partner whereby the Company may share the costs of acquisition and earn license revenues when processed data is delivered by the Companys partner to the ultimate client. As such, these revenues are recognized when the processed data is delivered to the ultimate client.
In June 2010, the Company acquired a working interest in a drilling program in Australia in an area where the Company expects to complete a seismic survey in 2010. The carrying cost of this investment is approximately $3.3 million as of September 30, 2010 which is included in other assets. The Company accounts for this investment using the full cost method of accounting.
Deferred Financing Costs
Deferred financing costs include costs related to the issuance of debt which are amortized to interest expense using the straight-line method, which approximates the effective interest method, over the maturity periods of the related debt. During the first nine months of 2010, in connection with the PGS Onshore acquisition, the Company recorded approximately $0.8 million of additional costs related to the registration of its Senior Secured Notes. Also, the Company recorded approximately $2.2 million of additional costs primarily related to its new credit facility with Royal Bank of Canada (RBC). Amortization of deferred financing costs for the nine months ended September 30, 2010 was $2.0 million. Write-off of deferred financing costs for the nine months ended September 30, 2010, was $1.0 million.
As further described in Note 6, Preferred and Common Stock, the Company has convertible preferred stock issued and outstanding and common stock warrants issued in connection with a preferred stock issuance in July 2008. Both the convertible preferred stock conversion feature and warrants contain a price protection provision (or down-round provision) which reduces their price in the event the Company issues additional shares at a more favorable price than the strike price.
The Financial Accounting Standard Board (FASB) accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts is included in Accounting Standards Codification (ASC) 815-40-15 Derivatives and Hedging-Contracts in Entitys Own Equity-Scope and Scope Exceptions,. This standard provides that an instruments strike price or the number of shares used to calculate the settlement amount are not fixed if its terms provide for any potential adjustment, regardless of the probability of such adjustment(s) or whether such adjustments are in the entitys control. If equity-linked financial instrument (or embedded feature) is indexed to its own stock, based on the instruments contingent exercise and settlement provisions, for periods ended after the adoption date of January 1, 2009, the fair value of the conversion feature is bifurcated from the host instrument and recognized as a liability on the Companys condensed consolidated balance sheet. The warrants are recognized at fair value as a liability on the Companys condensed consolidated balance sheet. The fair value of the conversion feature, the warrants and other issuance costs of the preferred stock financing transaction, are recognized as a discount to the preferred stock host. The discount will be accreted to the preferred stock host from the Companys paid in capital, treated as a deemed dividend, over the period from the issuance date through the earliest redemption date of the preferred stock.
Fair Values of Financial Instruments
Effective January 1, 2008, the Company adopted ASC Topic 820 as it relates to financial assets and financial liabilities, which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principals and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements.
This guidance defines fair value as the price 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. Hierarchical levels, as defined in this guidance and directly related to the amount of subjectivity associated with the inputs to fair valuations of these assets and liabilities are as follows:
Level 1Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3Inputs that are both significant to the fair value measurement and unobservable. Unobservable inputs reflect the Companys judgment about assumptions market participants would use in pricing the asset or liability estimated impact to quoted market prices.
The reported fair values for financial instruments that use Level 2 and Level 3 inputs to determine fair value are based on a variety of factors and assumptions. Accordingly, certain fair values may not represent actual values of the Companys financial instruments that could have been realized as of September 30, 2010 or that will be realized in the future and do not include expenses that could be incurred in an actual sale or settlement. The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and short-term debt approximate their fair value due to the short maturity of those instruments. The Companys liabilities measured at fair value on a recurring basis were determined using the following inputs (in thousands):
Beginning January 1, 2009, the Company records derivative liabilities on its balance sheet as derivative liabilities related to certain warrants and the conversion feature embedded in the preferred stock. As of September 30, 2010, it determined that, using a Monte Carlo Valuation Model, the fair value of the conversion feature embedded in the Series B preferred stock and warrants to be $7.8 million and $0.7 million, respectively. These derivatives have increased in fair value since June 30, 2010 and the Company recognized a loss on the change in fair value of $3.5 million for the three months ended September 30, 2010. The change in fair value since December 31, 2009 was a gain of $1.4 million for the nine months ended September 30, 2010.
At December 31, 2009, the assumptions used in the model to determine the fair value of the warrants included the warrant exercise price of $9.25 per share. The assumptions used in the model to determine the fair value of the embedded conversion feature included the Series B conversion price of $17.44 per share on December 31, 2009. The Companys stock price on December 31, 2009 of $9.62, risk-free discount rate of 3.03% (embedded conversion feature) and 1.99% (warrants) and volatility of 106.31% were used in both models to determine the fair value.
At September 30, 2010, the assumptions used in the model to determine the fair value of the warrants included the warrant exercise price of $9.25 per share. The assumptions used in the model to determine the fair value of the embedded conversion feature included the Series B conversion price of $17.44 per share on September 30, 2010. The Companys stock price on September 30, 2010 of $6.20, risk-free discount rate of 1.34% (embedded conversion feature) and 0.60% (warrants) and volatility of 87.78% were used in both models to determine the fair value.
The accretion of the additional discount to the preferred stock resulting from bifurcating the Series B conversion feature totaled $0.2 million, and $0.7 million for the three and nine months ended September 30, 2010, respectively. The fair value of the Series B conversion feature, related to preferred shares issued, were $0.2 million, and $0.6 million for the three and nine months ended September 30, 2010, respectively.
A reconciliation of the Companys liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) were as follows (in thousands):
The Company is not a party to any hedge arrangements, commodity swap agreement or any other derivative financial instruments. The seismic data acquisition and seismic data processing segments utilize foreign subsidiaries and branches to conduct operations outside of the United States. These operations expose the Company to market risks from changes in foreign exchange rates.
Recent Accounting Pronouncements
In October 2009, the FASB issued ASU 2009-13 on Topic 605, Revenue Recognition Multiple Deliverable Revenue Arrangements a consensus of the FASB Emerging Issues Task Force. The ASU provides guidance on accounting for products or services (deliverables) separately rather than as a combined unit utilizing a selling price hierarchy to determine the selling price of a deliverable. The selling price is based on vendor-specific evidence, third-party evidence or estimated selling price. The Company will be required to apply the standard prospectively to any contracts that may contain multiple-element arrangements entered into or materially modified on or after January 1, 2011; however, earlier application is permitted. The Company does not currently expect the adoption of this new accounting update to have a material impact on its condensed consolidated financial statements.
In January 2010, the FASB issued new accounting guidance to require additional fair value related disclosures including transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosure guidance about the level of disaggregation and about inputs and valuation techniques. This new guidance is effective for the first reporting period beginning after December 15, 2009 except for the requirement to separately disclose purchases, sales, issuances and settlements relating to Level 3 measurements, which is effective for the first reporting period beginning after December 15, 2010. The Companys adoption of this new guidance did not have a material impact on its financial position, results of operations or cash flows. The Company has included additional disclosure related to early adoption of the Level 3 related gross disclosure requirement, which is effective in 2011; disclosures had no impact on the condensed consolidated financial statements.
In February 2010, the FASB amended its guidance on subsequent events to remove the requirement for SEC filers to disclose the date through which an entity has evaluated subsequent events. The guidance was effective upon issuance. The Company adopted this guidance in the period ended March 31, 2010.
In May 2010, the FASB issued ASU No. 2010-19, which is included ASC under Topic 830, Foreign Currency. This update addresses the multiple foreign currency exchange rates and the impact of highly inflationary accounting in Venezuela. Current operations in Venezuela are immaterial; therefore, the adoption of this update did not have an impact on its consolidated financial position, results of operations or cash flows. The Company will continue to monitor newly identified highly inflationary economies as identified by FASB.
NOTE 3: Acquisition
On December 3, 2009, the Company agreed with Petroleum Geo-Services ASA and certain of its subsidiaries (PGS) to acquire PGS Onshore. The Company closed this transaction on February 12, 2010. The PGS Onshore acquisition (the Acquisition) provides the Company a significant business expansion into Mexico, North Africa, the
Far East, and in the United States, including Alaska. In addition, the Acquisition substantially increased the Companys multi-client data library. As a result of the Acquisition, the Company has acquired a multi-client data library covering approximately 5,500 square miles located primarily in Texas, Oklahoma, Wyoming and Alaska.
The operations of PGS Onshore have been combined with those of the Company since February 12, 2010. The Acquisition was accounted for by the purchase method, with the purchase price being allocated to the fair value of assets purchased and liabilities assumed. The allocation of the purchase price of PGS Onshore was based upon fair value studies and was computed using various estimates and assumptions. These estimates and assumptions are subject to change upon managements review of the final valuations and the completion of various audits that could impact the beginning balance sheet of PGS Onshore. The preliminary allocations of the purchase price for the Acquisition are as follows (in thousands):
The purchase price is subject to certain additional working capital adjustments. In addition, in connection with the acquisition, the Company agreed to reimburse PGS for certain costs incurred through the acquisition date related to two ongoing multi-client data library projects subject to certain requirements being met. The Company paid approximately $202.8 million at closing.
To fund the cash portion of the purchase price, Geokinetics Holdings USA, Inc, a wholly-owned subsidiary of Geokinetics, issued $300 million aggregate principal amount of its 9.75% senior secured notes due 2014 in a private offering in 2009. The proceeds of this sale were held in escrow until the closing of the PGS Onshore acquisition. On February 12, 2010, the Company used the restricted cash amounts held in escrow to finance the cash portion of the Acquisition for approximately $183.4 million. The Company also repaid its existing revolving credit facility with an outstanding balance of approximately $45.8 million and repaid outstanding capital leases and other vendor financing for approximately $22.0 million. Costs associated with the Acquisition of approximately $1.3 million in the fourth quarter of 2009 and $1.5 million in the first quarter of 2010 are included in general and administrative expenses.
The following summarized unaudited pro forma consolidated income statement information for the three months and nine months ended September 30, 2009 and 2010, assumes that the PGS Onshore acquisition had occurred as of the beginning of the periods presented. The Company has prepared these unaudited pro forma financial results for comparative purposes only. These unaudited pro forma financial results may not be indicative of the results that would have occurred if Geokinetics had completed the acquisition as of the beginning of the periods presented or the results that may be attained in the future. Amounts presented below are in thousands, except for the per share amounts:
NOTE 4: Multi-client Data Library
At December 31, 2009 and September 30, 2010, multi-client data library costs and accumulated amortization consisted of the following (in thousands):
The change in the carrying amount of multi-client seismic library costs and accumulated amortization consisted of the following (in thousands):
NOTE 5: Debt and Capital Lease Obligations
The Companys long-term debt and capital lease obligations were as follows (in thousands):
Revolving Credit Facilities
PNC Credit Facility. Until February 12, 2010, the Company had a Revolving Credit, Term Loan and Security Agreement with PNC Bank, National Association (PNC), as lead lender, which provided the Company with a $70.0 million revolving credit facility (Revolver) maturing May 24, 2012. At December 31, 2009, the Company had a balance of $44.6 million drawn under the Revolver. The rate of the PNC facility was the prime rate plus 1.5%, 4.75% at December 31, 2009. On February 12, 2010, the Companys Revolver balance of $45.8 million was repaid in connection with the closing of the PGS Onshore acquisition. The Company recorded a loss of $1.2 million on the redemption of the facility which consisted of $1 million related to the acceleration of costs that were being amortized over the expected life of the facility, and approximately $0.2 million related to prepayment penalties.
RBC Credit Facility. On February 12, 2010, Geokinetics Holdings entered into a revolving credit and letters of credit, with a group of lenders lead by RBC (the RBC Facility or the revolving credit facility The revolving credit facility matures on February 12, 2013. Effective June 30, 2010, the Company entered into Amendment No. 1 to the revolving credit facility which reset certain financial covenants for the quarters ending June 30, 2010 and September 30, 2010 and reduced the permitted outstanding borrowing under the facility from $50 million to $40 million. On September 30, 2010, Geokinetics Holdings entered into Waiver and Amendment No. 2 which provides a waiver of specific events of default that would have occurred on September 30, 2010 for failure to comply with financial covenant requirements (minimum total leverage ratio, minimum interest coverage ratio and maximum fixed charge coverage ratio) and revise certain covenant and reporting requirements for future periods.
Borrowings outstanding under the revolving credit facility bear interest at a floating rate based on the greater of: (i) 3% per year, (ii) the Prime Rate, (iii) 0.5% above the Federal Funds Rate, or iv) 1% above one month LIBOR; plus an applicable margin from 4.5% to 6.5% depending on the Companys total leverage ratio. The rate was 8.75% at September 30, 2010. The outstanding balance of this revolving credit facility was $26 million as of September 30, 2010 and $29 million on November 5, 2010.
Borrowings under the revolving credit facility are guaranteed by Geokinetics and each of its existing and subsequently acquired or organized direct or indirect wholly-owned U.S. subsidiaries. Each of the entities guaranteeing the revolving credit facility will secure the guarantees on a first priority basis with a lien on substantially all of the assets of such guarantor. Borrowings under the facility are effectively senior to the outstanding senior secured notes pursuant to an inter-creditor agreement. The facility also contains restrictions on liens, investments, indebtedness, mergers and acquisitions, dispositions, certain payments, and other specific transactions.
The revised financial covenants, in Amendment No. 2, include monthly minimum total consolidated total revenues and consolidated cumulative adjusted EBITDA for the months ending September 30, October 31, and November 30, 2010. Minimum total consolidated revenues per month must total $50 million, $60 million, and $60 million for the months ended September 30, October 31, and November 30, 2010, respectively. Monthly minimum consolidated cumulative adjusted EBITDA must total $7.9 million, $17.6 million, and $30.1 million for the period beginning on September 1, 2010 until and including September 30, October 31, and November 30, 2010, respectively. The Company was in compliance with the revised covenant minimums of $50 million of total
consolidated revenue and $7.9 million cumulative EBITDA for the month ending September 30, 2010. While the Company believes it will remain in compliance with the revised covenants, at least through November 30, 2010, our actual results may differ from our forecasts, and these differences may be material. Our ability to comply with these restrictions and covenants, including meeting financial ratios and tests, and may be affected by events beyond the Companys control. As a result, we cannot assure you that we will be able to comply with these restrictions and covenants or meet such financial ratios and tests.
Further, the financial covenants defined in the original revolving credit facility have not been amended for the December 31, 2010 measurement date and beyond. Based on our current forecasts, it is likely that we will be unable to comply with certain of the original financial covenants in our senior revolving credit facility at the December 31, 2010 measurement date and possibly beyond which have not been amended beyond the November 30, 2010 measurement date and which are based on results from the trailing twelve months. We are in ongoing discussions with the lenders under the credit facility to amend the covenants, but no assurance can be made that we will be successful in such negotiations, or as to the terms or costs of any such amendment or waiver if agreed to. Therefore, the outstanding balance of $26 million has been presented as short term debt in the September 30, 2010 balance sheet.
If we are unable to comply with the restrictions and covenants in our debt agreements, including our senior secured revolving credit facility, there could be a default under the terms of these agreements. In the event of a default under these agreements, lenders could terminate their commitments to lend or accelerate the loans and declare all amounts borrowed due and payable. Borrowings under other debt instruments that contain cross-acceleration or cross-default provisions may also be accelerated and become due and payable. If any of these events occur, our assets might not be sufficient to repay in full all of our outstanding indebtedness and we may be unable to find alternative financing. Even if we could obtain alternative financing, it might not be on terms that are favorable or acceptable to us. Additionally, we may not be able to amend its debt agreements or obtain needed waivers on satisfactory terms or without incurring substantial costs. Failure to maintain existing or secure new financing could have a material adverse effect on our liquidity and financial position.
Senior Secured Notes Due 2014
On December 23, 2009, Geokinetics Holdings, a wholly owned subsidiary of the Company, issued $300 million of 9.75% Senior Secured Notes due 2014 (the Notes) in a private placement to institutional buyers at an issue price of 98.093% of the principal amount. The discount is being accreted as an increase to interest expense over the term of the Notes. At September 30, 2010, the effective interest rate on the Notes was 10.2%, which includes the effect of the discount accretion.
The Notes bear interest at the rate of 9.75% per year, payable semi-annually in arrears on June 15 and December 15 of each year. The Notes are fully and unconditionally guaranteed, by the Company, and by each of the Companys current and future domestic subsidiaries (other than Geokinetics Holdings, which is the issuer of the Notes).
Until the second anniversary following their issuance, the Company may redeem up to 10% of the original principal amount of the Notes during each 12-month period at 103% of the principal amount plus accrued interest. Thereafter, the Company may redeem all or part of the Notes at a prepayment premium which will decline over time. The Company will be required to make an offer to repurchase the Notes at 101% of the principal amount plus accrued interest if the Company experiences a change of control. The indenture for the Notes contains customary covenants for non-investment grade indebtedness, including restrictions on the Companys ability to incur indebtedness, to declare or pay dividends and repurchase its capital stock, to invest the proceeds of asset sales, and to engage in transactions with affiliates.
Capital Lease Obligations
The Company had several equipment lease agreements with CIT Group Equipment Financing, Inc. (CIT) on seismic and other transportation equipment with terms of up to 36 months and various interest amounts. The original amount of the leases was approximately $39.9 million and the balance at December 31, 2009 was approximately $12.1 million. These amounts were repaid on February 12, 2010 in connection with the closing of the PGS Onshore acquisition. The Company recorded a loss of approximately $0.3 million on the redemption of these obligations related to prepayment penalties.
The Company also has four equipment lease agreements with Bradesco Leasing in Brazil with terms of 36 months at a rate of 10.1% per year. The original amount of the leases was approximately $3.0 million and the balance at September 30, 2010 was approximately $1.2 million.
The Company had vendor financing arrangements to purchase certain equipment. The total balance of vendor financing arrangements at December 31, 2009, was approximately $9.9 million. These amounts were repaid on February 12, 2010 in connection with the closing of the PGS Onshore acquisition. The Company recorded a loss of $1.0 million on the redemption of these financing arrangements related to prepayment penalties.
The Company maintains various foreign bank lines of credit and overdraft facilities used to fund short-term working capital needs. At September 30, 2010, the balance of the foreign line of credit facilities was $1.6 million. There were no outstanding balances under the overdraft facilities at September 30, 2010, and the Company had approximately $5.1 million of availability.
NOTE 6: Preferred and Common Stock
On December 15, 2006, the Company issued 228,683 shares of its Series B Preferred Stock, $10.00 par value, to Avista Capital Partners, L.P. (Avista), an affiliate of Avista and another institutional investor (the Series B-1 Preferred Stock).
On July 28, 2008, the Company issued 120,000 shares of its Series B Preferred Stock, $10.00 par value (the Series B-2 Preferred Stock) and warrants to purchase 240,000 shares of common stock to Avista and an affiliate of Avista for net proceeds of $29.1 million. The Company recorded the preferred stock net of the fair value of the warrants issued and recorded the fair value of the warrants for approximately $1.5 million as additional paid in capital. Effective January 1, 2009 the company adopted ASC 815-15 which requires the Company to bifurcate the embedded derivative relating to the conversion feature in the Companys preferred stock (see accounting policy relating to derivative liabilities in Note 2).
The Company may cause the conversion of the Series B Preferred Stock into common stock if the Company issues common stock at a price per share yielding net proceeds to the Company of not less than $35.00 per share in an underwritten public offering pursuant to an effective registration statement under the Securities Act of 1933 (the Securities Act), which provides net proceeds to the Company and selling stockholders, if any, of not less than $75 million.
As long as at least 55,000 shares of Series B Preferred Stock are outstanding, the consent of the holders of a majority of the Companys Series B Preferred Stock is required to, among other things, make any material change to the Companys certificate of incorporation or by-laws, declare a dividend on the Companys common stock, enter into a business combination, or increase or decrease the size of its board of directors, holders of the preferred stock are allowed to elect one member of the board of directors.
If the Company authorizes the issuance and sale of additional shares of its common stock other than pursuant to an underwritten public offering registered under the Securities Act, or for non-cash consideration pursuant to a merger or consolidation approved by its board of directors, the Company must first offer in writing to sell to each holder of its Series B Preferred Stock an equivalent pro rata portion of the securities being issued. The conversion price in the preferred stock is subject to a down-round provision whereby subsequent equity issuances at a price below the existing conversion price will result in a downward adjustment to the conversion price.
On December 18, 2009, the holders of the Series B-1 Preferred Stock and the Company, as a condition of the common stock offering on the same date and agreement for the issuance of shares in connection with the closing of the PGS Onshore acquisition, agreed to the following changes:
· the conversion price was reduced from the previous $25 to $17.436;
· the Company will be able to pay dividends in kind until December 15, 2015;
· the Company will not be required to redeem the series B-1 preferred stock until December 15, 2015; and
· the Company increased the dividend rate on the series B-1 preferred stock from 8% to 9.75%;
· the Company paid a cash fee of 2% of the liquidation amount, $2.1 million, plus accrued and unpaid dividends of the series B-1 and B-2 preferred stock
As of September 30, 2010, the series B-1 preferred stock is presented as mezzanine equity due to the series B preferred stock characteristics described below:
Each holder of Series B-1 Preferred Stock is also entitled to receive cumulative dividends at the rate of 9.75% per annum on the liquidation preference of $250 per share, compounded quarterly. At the Companys option through December 15, 2015, dividends may be paid in additional shares of Series B-1 Preferred Stock. After such date, dividends are required to be paid in cash if declared.
After December 15, 2015, holders of not less than a majority of outstanding shares of Series B-1 Preferred Stock may require payment, upon written notice of the redemption of all outstanding shares of Series B-1 Preferred Stock, in cash, at a price equal to $250 per share, plus any accrued dividends.
Dividends on the Series B Preferred Stock have been paid in kind exclusively to date.
Mandatorily Redeemable Preferred Stock
In December, 2009, in conjunction with the structuring of the PGS Onshore acquisition, the Company agreed to exchange its series B-2 preferred stock for new series C redeemable preferred stock plus the issuance of 750,000 shares of common stock. The fair value of the series C preferred stock at the date of exchange was $32.1 million.
The series C redeemable preferred stock were issued to Avista, and have an aggregate liquidation preference equal to the liquidation preference of the series B-2 preferred stock ($32.3 million), and are not required to be redeemed until one year after the maturity date of the Senior Secured Notes. The series C preferred stock accrue dividends at a rate of 11.75%. Dividends may accrue or may be paid in kind with additional shares of series C preferred stock, at the election of Avista, until December 13, 2015. The series C preferred stock is not convertible or exchangeable for the Companys common stock. This stock is classified as long-term liability as it is considered a mandatorily redeemable financial instrument in accordance with ASC Topic 480, Distinguishing liabilities from equity. Dividends paid are reflected as interest expense in results of operations of $1,047 and $3,194 for the three and nine months ended September 30, 2010, respectively.
The holders of common stock have full voting rights on all matters requiring stockholder action, with each share of common stock entitled to one vote. Holders of common stock are not entitled to cumulate votes in elections of directors. No stockholder has any preemptive right to subscribe to an additional issue of any stock or to any security convertible into such stock.
In addition, as long as any shares of the Series B-1 and C Preferred Stock discussed above are outstanding, the Company may not pay or declare any dividends on common stock unless the Company has paid, or at the same time pays or provides for the payment of, all accrued and unpaid dividends on the Series B-1 Preferred Stock. In addition, the credit facilities restrict the Companys ability to pay dividends on common stock. No dividends on common stock have been declared for any periods presented.
On December 18, 2009, the Company issued 4,000,000 shares of its common stock at a public offering price of $9.25 per share. In connection with this public offering, underwriters subsequently exercised their overallotment option, resulting in issuance of 207,200 shares of common stock. In 2009, the Company issued 750,000 shares to Avista in connection with the exchange of the Series B-2 preferred stock for the new series C preferred stock.
On February 12, 2010, the Company issued 2,153,616 shares of its common stock to PGS in connection with the Acquisition of PGS Onshore.
Common Stock Warrants
As part of the Trace acquisition in December 2005, the Company issued 274,105 warrants at an exercise price of $20.00, which expire on December 1, 2010.
As part of the issuance of Series B-2 Preferred Stock on July 28, 2008, the Company issued an additional 240,000 warrants at an exercise price of $20.00, which expire on July 28, 2013. The exercise price of these warrants is subject to a down-round provision whereby subsequent equity issuances at a price below the existing exercise price will result in a downward adjustment to the exercise price and may extend the expiration date of the warrants.
On December 18, 2009, the exercise price of the July 28, 2008 warrants was adjusted to $9.25 per share as a result of the issuance in December 2009 of common stock in accordance with price adjustment provisions. At December 31, 2009 and September 30, 2010, there are 514,105 warrants outstanding.
NOTE 7: Loss per Common Share
The following table sets forth the computation of basic and diluted earnings per common share (in thousands, except per share data):
The denominator used for the calculation of diluted earnings per common share for the three months and nine months ended September 30, 2009 and 2010, excludes the effect of any stock options, restricted stock, warrants and convertible preferred stock because the effect is anti-dilutive. At September 30, 2010, there were options to purchase 282,471 shares of common stock, 406,888 shares of unvested restricted stock, warrants to purchase 514,105 shares of common stock, and preferred stock convertible into 4,472,643 shares of common stock.
The numerator used for the calculation of diluted earnings per share for the three and nine months ended September 30, 2009 and 2010, is Income applicable to common stockholders as the convertible preferred stock was deemed to be anti-dilutive in that period.
NOTE 8: Segment Information
The Company has two reportable segments: seismic data acquisition and seismic data processing and interpretation. The Company further breaks down its seismic data acquisition segment into two geographic reporting units: North American seismic data acquisition and international seismic data acquisition. The North American reporting unit acquires data for customers by conducting seismic shooting operations in the United States and Canada; and the international seismic data acquisition reporting unit operates in Latin America (including Mexico), Africa, the Middle East, Australia, New Zealand and the Far East. The data processing and interpretation segment operates processing centers in Houston, Texas and London, United Kingdom to process seismic data for oil and gas exploration companies worldwide.
The Companys reportable segments are strategic business units that offer different services to customers. Each segment is managed separately, has a different customer base, and requires unique and sophisticated technology. The accounting policies of the segments are the same as those described in Note 2: Basis of Presentation and Significant Accounting Policies. There are no significant inter-segment sales or transfers.
The following unaudited table sets forth significant information concerning the Companys reportable segments and geographic reporting units as of and for the three and nine months ended September 30, 2009 and 2010 (in thousands):
NOTE 9: Income Taxes
The provision for income tax for the three and nine months ended September 30, 2009 was $1,482 and $18,281 compared to $311 and $2,625 for the three and nine months ended September 30, 2010, respectively. While the Company had pretax losses during the three and nine months ended September 30, 2010 the income tax provision for these periods relate primarily to taxes due in countries with deemed profit tax regimes, withholding taxes and the release of valuation allowance in certain foreign jurisdictions with current year operating profits based on the Companys reevaluation of the realizability of these future tax benefits.
The following summarizes changes in the Companys uncertain tax positions for the nine months ended September 30, 2010 (in thousands):
All additions or reductions to the above liability affect the Companys effective tax rate in the respective period of change. The Company accounts for any applicable interest and penalties on uncertain tax positions, which was $0.6 million for the nine months ended September 30, 2010, as a component of income tax expense. At December 31, 2009, and September 30, 2010, the Company had $1.2 million and $1.8 million of accrued interest related to unrealized tax benefits, respectively. The tax years that remain subject to examination by major tax jurisdictions are from 2004 to 2010.
NOTE 10: Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable and short-term debt approximate their fair value due to the short maturity of those instruments, and therefore, have been excluded from the table below. The fair value of the Notes is determined by multiplying the principal amount by the market price. The fair value of the mandatorily redeemable preferred stock and the Series B Preferred stock was calculated by using the discounted cash flow method of the income approach. In addition, the Monte-Carlo Pricing Model was used to determine the value of the conversion feature of the Series B Preferred stock. The following table sets forth the fair value of the Companys remaining financial assets and liabilities as of December 31, 2009 and September 30, 2010 (in thousands):
The Company is not a party to any hedge arrangements, commodity swap agreement or other derivative financial instruments. The Companys seismic data acquisition and seismic data processing segments utilize foreign subsidiaries and branches to conduct operations outside of the United States. These operations expose the Company to market risks from changes in foreign exchange rates.
NOTE 11: Commitments & Contingencies
The Company is involved in various claims and legal actions arising in the ordinary course of business. Management is of the opinion that none of the claims and actions will have a material adverse impact on the Companys financial position, results of operations, or cash flows.
NOTE 12: Related Party Transactions
During fiscal 2009, the Company received food, drink, and other catering services for its crews in one of its international locations from a company that was substantially owned by certain employees and former employees of the Company. For the nine months ended September 30, 2009 the Company spent approximately $3.3 million with this Company. The Company believes that all transactions were arms-length on terms at least as favorable as market rates. The Company stopped receiving services from this Company in the third quarter of 2009.
PGS owns 2,153,616 shares or approximately 12% of the Companys common shares outstanding. In connection with the Acquisition, the Company entered into a transition services agreement with PGS effective February 12, 2010 for up to a maximum of 120 days. This agreement includes office facilities, accounting, information, payroll and human resource services. The Company stopped receiving services from PGS as of June 30, 2010; accordingly there were no billed services from PGS for the three months ended September 30, 2010. Total services of $3.2 million were billed to date in 2010. These costs are included in the Companys general and administrative expenses for the same period.
In addition, PGS and the Company have agreed to reimburse each other for certain amounts resulting from adjustments from the Acquisition as follows (in thousands):
(1)This amount is included in accounts payable and primarily consists of an outstanding payable of approximately $2.3 million related to the transition services agreement with PGS, and approximately $0.8 related to income taxes payable.
NOTE 13: Condensed Consolidating Financial Information
On February 12, 2010, upon completion of the PGS Onshore acquisition, the $300 million Notes due 2014 became fully and unconditionally guaranteed, jointly and severally, by the Company, and by each of the Companys current and future domestic subsidiaries (other than Geokinetics Holdings, which is the issuer of the Notes). The non-guarantor subsidiaries consist of all subsidiaries and branches outside of the United States. Separate condensed consolidating financial statement information for the parent, guarantor subsidiaries and non-guarantor subsidiaries as of December 31, 2009 and September 30, 2010 and for the three and nine months ended September 30, 2009 and 2010 is as follows (in thousands):