Geokinetics Inc (GOK)

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GEOKINETICS INC.

INDEX

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Glossary of Certain Defined Terms:

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PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

Geokinetics Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

See accompanying notes to the condensed consolidated financial statements.

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Geokinetics Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

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Geokinetics Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

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GEOKINETICS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: General

The Company, a Delaware corporation founded in 1980, is based in Houston, Texas.  The Company is a global provider of seismic data acquisition, data processing and integrated reservoir geoscience services, and a leader in providing land, transition zone and shallow water OBC environment geophysical services.  These geophysical services include acquisition of 2D, 3D, time-lapse 4D and multi-component seismic data surveys, data processing and integrated reservoir geoscience services for customers in the oil and natural gas industry, which include E&P companies in North America, Latin America (including Mexico), Africa, Asia-Pacific and the Middle East.  The Company also owns a multi-client data library whereby it maintains full or partial ownership of data acquired; client access is provided via licensing agreements.  The Company’s multi-client data library consists of data covering various areas in the United States, Canada, Brazil and Australia.

Basis of Presentation

The Company’s unaudited interim condensed consolidated financial statements included herein have been prepared in accordance with GAAP and pursuant to the rules and regulations of the SEC.  The Company believes that the presentations and disclosures herein are adequate for a fair presentation.  The unaudited interim condensed consolidated financial statements reflect all adjustments necessary for a fair presentation of the interim periods presented.  These unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its 2010 Form 10-K.  The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year.

The unaudited interim condensed consolidated financial statements include the accounts of Geokinetics Inc. and its subsidiaries.  All significant intercompany transactions have been eliminated in consolidation.  The consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with GAAP.  The results of operations of the Company for the six months ended June 30, 2010 include the results of operations of PGS Onshore since February 12, 2010, which may affect comparability of certain of the financial information included herein.

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

On April 1, 2011, the Company entered into Amendment No. 4, to the RBC Revolving Credit Facility and obtained a waiver of specific events of default that would have occurred on March 31, 2011 for failure to comply with financial reporting covenant requirements.  See note 4.

On May 16, 2011, the Company received a commitment from the New Lenders for a $50.0 million senior secured revolving credit facility.  On May 24, 2011, the Company consented to the assignment of the rights and obligations under the RBC Revolving Credit Facility to the New Lenders and contemporaneously entered into a Forbearance Agreement and Amendment No. 5 with the New Lenders.  See note 4.  An amended and restated credit agreement was executed among the Company and the New Lenders on August 12, 2011.  See note 15.

Recent Accounting Standards

In June 2011, the FASB issued an update to ASC 220, Presentation of Comprehensive Income.  This ASU provides that an entity that reports items of other comprehensive income has the option to present comprehensive income in either 1) a single statement  that presents the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and a total for comprehensive income; or 2) a two-statement approach which presents the components of net income and total net income in a first statement, immediately followed by a financial statement that presents the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income.  The option in current GAAP that permits the presentation of other comprehensive income in the statement of changes in equity was eliminated.  The guidance will be applied retrospectively and is effective for the Company for interim and annual periods beginning on January 1, 2012.  Early adoption is permitted.  The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

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In May 2011, the FASB issued an update to ASC 820, Fair Value Measurements.  This ASU clarifies the application of certain fair value measurement requirements and requires, among other things, expanded disclosures for Level 3 fair value measurements and the categorization by level for items for which fair value is required to be disclosed in accordance with ASC 825, Financial Instruments.  The guidance will be applied prospectively and is effective for the Company for interim and annual periods beginning on January 1, 2012.  Early adoption is not permitted.  The Company is currently evaluating the impact of this guidance.

Property and equipment and accumulated depreciation were as follows (in thousands):

The Company reviews the useful life and residual values of property and equipment on an ongoing basis considering the effect of events or changes in circumstances.  Depreciation expense related to the Company’s property and equipment for the three and six months ended June 30, 2011 was $18.5 million and $36.1 million, respectively.  Depreciation expense related to the Company’s property and equipment for the three and six months ended June 30, 2010 was $17.7 million and $32.3 million, respectively.

During April 2011, the Company experienced a loss of certain equipment as a result of a wild fire in Colorado, in the United States, which reached the Company’s staging area.  The lost assets were fully insured and the claims process is underway.  During the second quarter of 2011, the Company recorded a net gain of $0.2 million in connection with this event consisting of the write-off of the net book value of the lost equipment of $1.3 million and insurance proceeds received to date of $1.5 million.  The net gain is included in loss from disposal of assets, net in the consolidated statement of operations.   The Company expects to receive additional insurance proceeds during 2011 related to this event.

The Company stores and maintains property and equipment in the countries in which it does business.  In connection with the acquisition of PGS Onshore in February 2010, the Company acquired certain property and equipment in Libya and entered into an agreement with PGS to operate the business there on the Company’s behalf.  See note 13.  The Company subsequently completed the formation of a subsidiary and acquired certain required licenses to operate its seismic acquisition business.  However, as a result of the civil unrest in Libya, the Company has been unable to operate its business or utilize its equipment in Libya and is currently evaluating options regarding transfer of this equipment out of the area.  At June 30, 2011, the net book value of the equipment in Libya was $11.8 million.  While the Company maintains insurance coverage on these assets, including political risk coverage, this coverage is limited only to certain defined loss events.  To date, these defined events have not occurred.

Goodwill

The changes in the carrying amounts of goodwill were as follows (in thousands):

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Multi-Client Data Library

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 depreciation of the assets used in production of the surveys.

Multi-client seismic library costs and accumulated amortization were as follows (in thousands):

Multi-client seismic library revenues for the three and six months ended June 30, 2011 were $21.5 million and $50.6 million, respectively.  Multi-client seismic library revenues for the three and six months ended June 30, 2010 were $12.6 million and $18.8 million, respectively.

Amortization expense related to the Company’s multi-client data library for the three and six months ended June 30, 2011 was $17.7 million and $39.4 million, respectively.  Amortization expense related to the Company’s multi-client data library for the three and six months ended June 30, 2010 was $6.1 million and $10.4 million, respectively.

The Company had deferred financing costs of $8.9 million and $11.8 million at June 30, 2011 and December 31, 2010, respectively.  During the three and six months ended June 30, 2011, the Company amortized approximately $1.8 million and $2.4 million, respectively, to interest expense, which includes $1.1 million written off in connection with Amendment No. 4 to the RBC Revolving Credit Facility.  See note 4.  During the three and six months ended June 30, 2010, the Company amortized approximately $0.7 million and $1.3 million, respectively, to interest expense.

In connection with the assignment of the RBC Revolving Credit Facility rights and obligations to the New Lenders on May 24, 2011, the Company wrote off $1.1 million of deferred financing costs (included in other income (expense) in the consolidated statement of operations) related to the early extinguishment of the RBC Revolving Credit Facility.  During February 2010, the Company wrote off $2.5 million of deferred financing costs (included in other income (expense) in the consolidated statement of operations) related to the early extinguishment of certain debt.  See note 4.

Other Assets, Net

Other assets, net, are as follows (in thousands):

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Amortization expense related to the above assets was $0.6 million and $1.8 million, respectively, for the three and six months ended June 30, 2011.  Amortization expense related to the above assets was $0.8 million and $1.5 million, respectively, for the three and six months ended June 30, 2010.

NOTE 2: Sales of Certain Accounts Receivable

In order to improve the Company’s liquidity, one of the Company’s international subsidiaries in Latin America sells certain eligible trade accounts receivable without recourse under a program sponsored by a financial agent of the foreign government to accelerate collections.  There is no recourse to the subsidiary for uncollectible receivables and, once sold, the subsidiary’s effective control over the accounts is ceded.  The cost associated with these sales is calculated based on LIBOR plus five percentage points and the value and due date of the accounts receivable sold.

At the time of sale, the related accounts receivable are removed from the balance sheet and the proceeds and cost are recorded.  Accounts receivable sold under this arrangement totaled $45.5 million during the six months ended June 30, 2011.  The loss on the sale of these accounts for the three and six months ended June 30, 2011 was $0.1 million and $0.2 million, respectively, and is included in operating expenses in the Company’s consolidated statement of operations.  There were no sales of trade accounts receivable during the same period in 2010.

On December 3, 2009, the Company entered into an agreement with PGS to acquire PGS Onshore.  The Company closed this transaction on February 12, 2010 for cash and stock consideration valued at $202.8 million.  The acquisition of PGS Onshore provided the Company with a significant business expansion of its Data Acquisition segment into Mexico, North Africa, the Far East, and in the United States, including Alaska.  In addition, the acquisition substantially increased the Company’s multi-client data library with data covering approximately 5,500 square miles of 3D data 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.  Disclosure of earnings of PGS Onshore since the acquisition is not practicable as it is not being operated as a standalone subsidiary.

The acquisition date fair value of the total consideration transferred consisted of the following (in thousands):

The following table summarizes the final fair values of the assets acquired and liabilities assumed at the acquisition date (in thousands):

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The acquisition of PGS Onshore was accounted for by the purchase method, with the purchase price being allocated to the fair value of assets purchased and liabilities assumed.  During the first quarter of 2011, the Company finalized the fair values of the assets acquired and liabilities assumed and recorded an adjustment to reduce the value of property and equipment by $1.1 million and increase goodwill by the same amount.  The adjustment reflects the Company’s assessment of certain damaged equipment.

The allocation of the purchase price included multi-client data library, which consisted of data surveys covering portions of the United States and Canada.  Other intangible assets consisted of order backlog and a marine vibrator patented technology license.  The Company determined the fair values for the multi-client data library and other intangibles using the income approach.  Under this method, an intangible asset’s fair value is equal to the present value of the incremental after-tax cash flows (excess earnings) attributable solely to the intangible asset over its remaining useful life.  To calculate fair value, the Company used probability-weighted cash flows discounted at rates considered appropriate given the inherent risks associated with each type of asset.  The Company believes that the level and timing of cash flows appropriately reflect market participant assumptions.

The valuation of the intangible assets acquired and related amortization periods at the acquisition date are as follows (in thousands):

The Company provided deferred taxes and other tax liabilities as part of the acquisition accounting related to the fair market value adjustments for acquired multi-client data library, property and equipment, intangible assets, and other deferred items as well as for uncertain tax positions taken in prior year tax returns.  The fair value of the deferred taxes and other tax liabilities was $18.9 million at the acquisition date.  As part of the purchase agreement, PGS retained the liability for taxes related to prior years and up to the purchase date and agreed to indemnify the Company for taxes imposed.  Accordingly, we have included compensating amounts in receivables for amounts known at the acquisition date.

Goodwill of approximately $59.0 million was recognized for this acquisition and is calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized.  It specifically includes the synergies and other benefits from combining the operations of PGS Onshore with the operations of the Company.  The Company allocated the goodwill to the seismic data acquisition business segment in recognition of the estimated present value of the future synergies paid for in this transaction that will directly benefit that segment.  As described above, the final determination of the fair value of property and equipment in the first quarter of 2011 resulted in a $1.1 million increase to goodwill.  The entire amount of goodwill of $59.0 million is not deductible for tax purposes.

Costs associated with the acquisition of PGS Onshore totaled $5.2 million.  Of this amount, $3.5 million and $5.0 million are included in general and administrative expenses for the three and six months ended June 30, 2010, respectively.

The following unaudited condensed consolidated income statement information for the six months ended June 30, 2011 and unaudited pro forma consolidated income statement information for the six months ended June 30, 2010 assumes that the acquisition of PGS Onshore had occurred at the beginning of the period.  The Company prepared the unaudited pro forma financial results for comparative purposes only.  The unaudited pro forma financial results may not be indicative of the results that would have occurred if Geokinetics had completed the acquisition at the beginning of the period presented or the results that may be attained in the future.  Amounts presented below are in thousands, except for the per share amounts:

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Long-term debt and capital lease obligations were as follows (in thousands):

WhiteBox Revolving Credit Facility

On May 16, 2011, the Company received a commitment and summary of principal terms from the New Lenders for a $50.0 million senior secured revolving credit facility.  On May 24, 2011, the Company consented to the assignment of the rights and obligations under the RBC Revolving Credit Facility to the New Lenders.  Contemporaneously with the assignment, the Company entered into a Forbearance Agreement and Amendment No. 5 whereby the New Lenders agreed to waive compliance with certain terms and conditions under the RBC Revolving Credit Facility agreement, as previously modified and amended,  and to forbear from exercising any rights and remedies in connection with certain specified defaults under the RBC Revolving Credit Facility agreement until the earlier of August 22, 2011 or the execution of an amended and restated credit agreement.  Upon the assignment of the RBC Revolving Credit Facility to the New Lenders, the Company borrowed $48.3 million under the Whitebox Revolving Credit Facility, with a reserve of $1.7 million for cash costs associated with the closing of the amended and restated credit agreement.  The amount borrowed includes funds used to repay the RBC Revolving Credit Facility and funds used for general working capital purposes.  Until such time that the amended and restated credit agreement is executed, the Company incurs interest and fees on the Whitebox Revolving Credit Facility based on the terms of the RBC Revolving Credit Facility, as amended.  Accordingly, the Company incurs a ticking fee of 1% per quarter based on the maximum availability under the facility, a 1.5% fee for unused commitments and borrowings bear interest at a floating rate based on a specific formula.  At June 30, 2011, the interest rate based on this formula was 8.75%. Upon execution of the amended and restated credit agreement, borrowings outstanding under the facility will bear interest at 11.125%, amounts in excess of the amount outstanding and the total amount available of $50.0 million will be subject to an unused commitment fee of 11.125% and the ticking fee of 1% per quarter will no longer be applicable.

The amended and restated credit agreement facility was executed among the Company and the New Lenders on August 12, 2011.  See note 15.

Senior Secured Notes Due 2014

On December 23, 2009, Holdings issued $300.0 million of Notes in a private placement to institutional buyers at an issue price of $294.3 million or 98.093% of the principal amount.  The discount is accreted as an increase to interest expense over the term of the Notes.  At June 30, 2011 and December 31, 2010, the effective interest rate on the Notes was 11.1%, which includes the effect of the discount accretion and deferred financing costs amortization.  The stated interest rate on the Notes is 9.75% and is 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 Company’s current and future domestic subsidiaries (other than Holdings, which is the issuer of the Notes).  Pursuant to the terms of an inter-creditor agreement, the Notes are junior to the Whitebox Revolving Credit Facility as to receipt of collateral and/or collateral proceeds securing both the Whitebox Revolving Credit Facility and the Notes.  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 until the second anniversary following their issuance.  Thereafter, the Company may redeem all or part of the Notes at a prepayment premium which will decline over time.  In the event of occurrence of a change of control, the Company will be required to make an offer to repurchase the Notes at 101% of the principal amount plus accrued interest.  The indenture governing the Notes contains customary covenants for non-investment grade indebtedness, including restrictions on the Company’s 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 and Vendor Financing Obligations

From time to time, the Company enters into capital leases and vendor financing arrangements to purchase certain equipment.  The equipment purchased from these vendors is paid over a period of time.  During the six months ended June 30, 2011, the Company entered into various capital leases, due in 2014, for certain transportation equipment for a total amount of $3.8 million.

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The amounts due under all capital leases and vendor financing arrangements at June 30, 2011 and December 31, 2010 were approximately $5.6 million and $2.4 million, respectively.

Foreign Revolving Credit Lines

The Company maintains various foreign bank overdraft facilities used to fund short-term working capital needs.  At June 30, 2011, and December 31, 2010, the Company had approximately $4.0 million and $3.9 million, respectively, of available credit and no borrowings were outstanding under these facilities.

Extinguished Obligations

RBC Revolving Credit Facility

On February 12, 2010, the Company entered into a $50.0 million revolving credit and letters of credit facility, with a group of lenders led by RBC.  The RBC Revolving Credit Facility had an initial maturity date of February 12, 2013.  In the period between June 2010 and December 2010, the Company entered into Amendments No. 1, No. 2 and No. 3 to the RBC Revolving Credit Facility whereby the maximum borrowings were limited to the lesser of $40.0 million or a borrowing base and certain financial covenants were waived and modified.  Borrowings outstanding under the RBC Revolving Credit Facility bore interest at a floating rate based on a specific formula.  At March 31, 2011 and December 31, 2010, the rate was 8.75%.  The outstanding balance under the facility was $29.8 million and $23.0 million at May 24, 2011 and December 31, 2010, respectively.

On April 1, 2011, the Company entered into a waiver of specific events of default that would have occurred on March 31, 2011 for failure to comply with certain financial reporting covenant requirements.  Additionally, the Company entered into Amendment No. 4, which modified the monthly maximum total leverage ratio, monthly cumulative adjusted EBITDA (as defined in the agreement) targets and the Company’s interest cost.  This amendment also modified the final maturity date of the revolving credit facility to April 15, 2012.  In connection with Amendment No. 4 the Company wrote off $1.1 million related to the modification of the final maturity date, included in interest expense in the Company’s consolidated statement of operations.

On May 24, 2011, RBC and the other lenders assigned their rights and obligations under the RBC Revolving Credit Facility to the New Lenders under the Whitebox Revolving Credit Facility and received full payment of the amounts then outstanding under the facility plus unpaid accrued interest and fees for a total payment of $30.5 million.  The Company did not incur any pre-payment fees or penalties related to the retirement of the RBC Revolving Credit Facility.  The Company wrote off $1.1 million of deferred financing costs (included in other income (expense) in the consolidated statement of operations) associated with the early extinguishment of the RBC Revolving Credit Facility.

On February 12, 2010, in conjunction with the closing of the acquisition of PGS Onshore, the Company fully extinguished certain borrowings and obligations as follows:

PNC Credit Facility.  Until February 12, 2010, the Company had a Revolving Credit, Term Loan and Security Agreement with PNC, as lead lender, which provided the Company with a $70.0 million revolving credit facility maturing in May 2012.  On February 12, 2010, the outstanding balance of $45.8 million was repaid and the revolving credit facility was terminated.  The Company recorded a loss of $1.0 million on the redemption of the revolving credit facility which consisted of $0.8 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.  The loss is included in other income (expense) in the Company’s consolidated statement of operations.

CIT Group Equipment Financing.  The Company had several equipment lease agreements with CIT on seismic and other transportation equipment.  The outstanding balance at December 31, 2009 was approximately $12.1 million.  The Company recorded a loss of approximately $0.3 million on the redemption of these obligations related to prepayment penalties.  The loss is included in other income (expense) in the Company’s consolidated statement of operations.

Other Equipment Financing.  The Company had several other vendor financing arrangements for purchase of equipment.  At December 31, 2009, these obligations totaled approximately $9.9 million.  The Company recorded a loss of $1.0 million related to prepayment penalties to fully extinguish certain equipment financing agreements outstanding on February 12, 2010.  The loss is included in other income (expense) in the Company’s consolidated statement of operations.

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NOTE 5:   Mandatorily Redeemable Preferred Stock

The Company classifies preferred stock, which is not convertible or exchangeable for the Company’s common stock, as a long-term liability as it is considered a mandatorily redeemable financial instrument.  Dividends paid or accrued are reflected as interest expense.

Series C Mandatorily Redeemable 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 (“2008 Warrants”) to purchase 240,000 shares of Geokinetics common stock to Avista and an affiliate of Avista for net proceeds of $29.1 million.  See note 6.  In December 2009, in conjunction with the financing of the acquisition of PGS Onshore, the Company agreed to exchange its Series B-2 Preferred Stock for new Series C redeemable preferred stock (“Series C Preferred Stock”) plus 750,000 shares of Geokinetics common stock.  The fair value of the Series C Preferred Stock at the date of exchange was $32.1 million.  The shares of Series C Preferred Stock were issued to Avista and have an aggregate liquidation preference equal to the liquidation preference of the series B-2 Preferred Stock of $33.5 million.  The Company is required to redeem the Series C Preferred Stock on December 16, 2015.  The Series C Preferred Stock accrues dividends at a rate of 11.75%.  Dividends may accrue or be paid in kind with additional shares of Series C Preferred Stock, at the election of Avista, until December 16, 2015.  The Series C Preferred Stock is not convertible or exchangeable for Geokinetics’ common stock.  The Series C Preferred Stock has liquidation preference over the Series D preferred stock (see below).

For the three and six months ended June 30, 2011, the Company recognized interest expense of $1.3 million and $2.4  million, respectively, related to the Series C Preferred Stock, which includes accretion of discount of $0.1 million and $0.1 million, respectively .  For the three and six months ended June 30, 2010, the Company recognized interest expense of $1.1 million and $2.3 million, respectively, related to the Series C Preferred Stock, which includes an immaterial amount for accretion of discount.

Series D Mandatorily Redeemable Junior Preferred Stock

In December 2010, the Company completed a $30.0 million private placement of 120,000 shares of a new series of junior preferred stock (“Series D Preferred Stock”) and warrants (“2010 Warrants”) to purchase 3,495,000 shares of Geokinetics common stock.  The Series D Preferred Stock was issued to related parties including Avista and its affiliates, PGS, Levant and certain directors of the Company.  Dividends on the Series D Preferred Stock accrue from the date of issuance and are paid in cash or accrued at the election of Geokinetics at a rate of 10.5% per annum and compounded quarterly if paid in cash, and 11.5% per annum and compounded quarterly if accrued but not paid.  The Series D Preferred Stock is subject to mandatory redemption on December 15, 2016, and subject to redemption at the option of Geokinetics at the liquidation preference of $30.0 million.  The preferred stock was issued at a value of $8.3 million.  The original discount of $21.7 million will be accreted through December 15, 2016, as additional interest expense using the effective interest rate method.  The Series D Preferred Stock is not convertible or exchangeable for Geokinetics’ common stock.

For the three and six months ended June 30, 2011, the Company recognized total interest expense of $1.2 million and $2.3 million, respectively, related to the Series D Preferred Stock, which includes accretion of discount of $0.3 million and $0.5 million, respectively.

The 2010 Warrants have an initial exercise price of $9.64 per share, subject to an adjustment, and expire on December 15, 2016.  The initial exercise price was equal to 105% of the closing price of the Company’s common stock on December 13, 2010.  The 2010 Warrants contain certain price protection provisions such that if the Company issues certain equity securities for a price that is lower than the warrant conversion price during the two-year period following the issuance date of the 2010 Warrants, the exercise price of the warrants will be adjusted to the price of the newly issued equity securities.  After the two-year period, the exercise price adjusts in accordance with the same formula as the Series B-1 Preferred Stock.  See note 6.  As a result of the anti-dilution provisions, the 2010 Warrants are recorded as derivative liabilities in the consolidated balance sheets at June 30, 2011 and December 31, 2010.

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Mandatorily redeemable preferred stock consisted of (in thousands):

On December 15, 2006, in connection with the repayment of a $55.0 million subordinated loan, the Company issued 228,683 shares of its Series B-1 Preferred Stock, $10.00 par value, pursuant to the terms of the Securities Purchase Agreement dated September 8, 2006, with Avista, an affiliate of Avista and another institutional investor (“Series B-1 Preferred Stock”).  Effective December 18, 2009, the holders of the Series B-1 Preferred Stock and the Company agreed to revised terms including (i) an extension of the redemption date to December 16, 2015; (ii) a reduction of the conversion rate to $17.436; (iii) an option to pay dividends in kind until December 15, 2015; and (iv) an increase in the dividend rate to 9.75%.  In connection with the issuance of the Series D Preferred Stock on December 14, 2010, the conversion price of the Series B-1 Preferred Stock was reset to $16.40.

The Series B-1 Preferred Stock contains certain anti-dilution provisions.  Under these provisions, if the Company issues certain equity securities at a price lower than the conversion price of the Series B-1 Preferred Stock, the conversion price is adjusted to the price per share of the newly issued equity securities.  However, if prior to the issuance of new equity securities, the Company has issued certain equity securities valued at over $50.0 million, the conversion price is adjusted downward pursuant to a specific formula.

Each holder of Series B-1 Preferred Stock is 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 Company’s option through December 16, 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.  Dividends on the Series B-1 Preferred Stock have been accrued or paid in kind exclusively to date.  During the six months ended June 30, 2011, the Company accrued dividends of 15,746 shares with an issuance value of $3.9 million.

At each issuance of the Series B-1 Preferred Stock, including accrued share dividends, the fair value of the Series B-1 Preferred Stock conversion feature is bifurcated and recorded as a derivative liability.  The fair value of the Series B-1 Preferred Stock conversion feature which was bifurcated and recorded as a derivative liability during the six months ended June 30, 2011 was $0.6 million.  The difference between the fair value of the conversion feature and the liquidation preference amount is recorded as additional discount of the Series B-1 Preferred Stock.  The accretion of the additional discount to the preferred stock resulting from bifurcating the Series B conversion feature was $0.2 million and $0.4 million for the three and six months ended June 30, 2011, respectively.  The accretion of the additional discount to the preferred stock resulting from bifurcating the Series B conversion feature was $0.3 million and $0.5 million for the three and six months ended June 30, 2010, respectively.  At June 30, 2011 and December 31, 2010, the Series B-1 preferred stock is presented as mezzanine equity.

On July 28, 2008, the Company issued 120,000 shares of Series B-2 Preferred Stock, $10.00 par value and warrants to purchase 240,000 shares of Geokinetics common stock to Avista and an affiliate of Avista for net proceeds of $29.1 million.  On December 18, 2009, the Company exchanged the Series B-2 Preferred Stock for new Series C Preferred Stock, which is classified as a long-term liability.  See note 5.

The 2008 Warrants contain anti-dilution provisions substantially identical to the Series B Preferred Stock, and are classified as derivative liabilities in the condensed consolidated balance sheets.  There were 240,000 2008 Warrants to purchase common stock outstanding at an exercise price of $9.25 as of June 30, 2011.  These warrants expire on July 28, 2013.

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NOTE 7:   Fair Value of Financial Instruments

Fair Value Measurements

The Company categorizes the fair value measurements of its financial assets and liabilities into a three level fair value hierarchy, based on the inputs used in determining fair value.  The categories in the fair value hierarchy are as follows:

Level 1— Financial assets and liabilities whose values are based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.  The Company had no assets or liabilities in this category as of June 30, 2011 or December 31, 2010.

Level 2— Financial assets and liabilities whose values are based on quoted market prices for similar assets and liabilities, quoted market prices in markets that are not active or other inputs that can be corroborated by observable market data.  The Company had no assets or liabilities in this category at June 30, 2011 or December 31, 2010.

Level 3— Financial assets and liabilities whose values are based on inputs that are both significant to the fair value measurement and unobservable.  Internally developed valuations reflect the Company’s judgment about assumptions market participants would use in pricing the asset or liability estimated impact to quoted market prices.  The Company records derivative liabilities on its balance sheet related to the 2008 and the 2010 Warrants and the conversion feature embedded in the Series B Preferred Stock in this category.  The fair value of these liabilities was determined using a Monte Carlo valuation model.

The assumptions used in the Monte Carlo valuation model to determine the fair value of the Company’s derivative liabilities are as follows:

(1)         Anti-dilution provisions for these financial instruments will be triggered upon the execution of the amended and restated credit agreement for the Whitebox Revolving Credit Facility which will impact the exercise and conversion prices.  See note 15.

(2)         Based on the remaining life of the instruments.

The Company’s derivative liabilities measured at fair value on a recurring basis were as follows (in thousands):