As of March 9, 2007, we had 18 manufacturing facilities strategically located throughout North America. We focus on providing our customers rapid response times for our products and services. In the last twelve to eighteen months, we have experienced increased demand and have begun to expand, and will continue to expand, our manufacturing and repair capacity to meet our customers’ needs.
From April 2003 through March 9, 2007, we have introduced 43 new products, and plan to continue to focus on new product development. We believe that the products we design or manufacture, which we call original equipment products, have gained market acceptance, resulting in greater sales to customers that use our products in both domestic and international operations.
The information below highlights our results of operations for the year ending December 31, 2006 as compared to the same period in 2005:
| • | Our revenues increased approximately 58% to $163.1 million from $103.2 million; | ||
| • | Our percentage of revenues from original equipment products increased to 65% from 57%; | ||
| • | Our income from operations increased approximately 108% to $28.8 million from $13.8 million; and | ||
| • | Our backlog increased approximately 110% to $63.3 million from $30.1 million. |
We have three product lines: pressure and flow control, wellhead and pipeline, which generated 73%, 18% and 9% of our total revenue, respectively, for the year ended December 31, 2006. We offer new products and aftermarket parts and services for each product line. Aftermarket parts and services include all remanufactured products and parts, repair and field services. Original equipment products generated 65% and aftermarket parts and services generated 35% of our total revenues, respectively, for the year ended December 31, 2006.
Pressure and Flow Control . We design, manufacture and provide aftermarket parts and services for pressure and flow control products used in the drilling, completion, production and workover of onshore and offshore oil and gas wells. Our pressure and flow control products include:
| • | blow-out preventers, or BOPs; | ||
| • | BOP control systems; | ||
| • | elastomer products; | ||
| • | production, drilling and well service chokes; | ||
| • | manifolds; and | ||
| • | control valves. |
Wellhead. We design, manufacture and provide aftermarket parts and services for wellhead equipment used for onshore oil and gas production. Our wellhead products include wellheads, production chokes and production valves. Wellhead products are sold to oil and gas producers and are used during both the drilling and completion phases of an oil or gas well as well as during the productive life of a well. Currently, our wellhead products and services are focused on product remanufacturing, installation and repair.
Pipeline . We design, manufacture and provide aftermarket parts and services for a wide variety of valves primarily for onshore pipeline applications. Our pipeline products include a wide variety of valves for pipeline applications, including gate, ball, control and check valves. Our pipeline valves and related products are used in field or gathering systems and in interstate pipeline transmission systems. Currently, our pipeline products and services are focused on product remanufacturing, installation and repair.
Recent Developments
During the first quarter of 2007, we expanded into Arkansas by opening a facility in Conway, Arkansas to provide wellhead and pipeline products and repair and field services to oil and gas production and pipeline transmission companies whose operations are actively involved in the Fayetteville Shale in the Arkoma Basin. In addition, we entered into an agreement with Gefro Oilfield Services ASA to market our products and services and serve as an authorized repair center from its base in Stavanger, Norway.
Corporate History
We were formerly a Texas corporation named Industrial Holdings, Inc., or IHI, which was a public company with its common stock traded on The Nasdaq National Market. Our predecessor, T-3 Energy Services, Inc., or former T-3, was incorporated in Delaware in October 1999 and initially was capitalized by First Reserve Fund VIII, L.P., or First Reserve Fund VIII, in 2000.
In December 2001, former T-3 merged into IHI, with IHI as the surviving entity. Immediately after the merger, the combined company was reincorporated in Delaware under the name “T-3 Energy Services, Inc.” and completed a one for ten reverse split of its common stock, which began trading on The Nasdaq National Market under the symbol “TTES” on the day after the merger. As of March 9, 2007, First Reserve Fund VIII beneficially owned approximately 44% of our common stock.
We historically operated in three segments: pressure control, distribution and products. In mid-year 2003, we hired a new president and chief executive officer, Gus D. Halas, commenced an in-depth evaluation of our businesses and adopted a plan to position us for future growth. As part of the plan, we hired new senior operating management, and undertook an initiative to improve our manufacturing and engineering capabilities. In addition, we sold our products business in 2004 and our distribution business in 2005. We are now focused on our pressure control business, and in particular, upon our original equipment products.
Our Industry
Demand for our pressure and flow control and wellhead products and services is driven by exploration and development activity levels, which in turn are directly related to current and anticipated oil and gas prices. Demand for our pipeline products and services is driven by maintenance, repair and construction activities for pipeline, gathering and transmission systems. Market conditions have resulted in a significant increase in demand for drilling and production equipment and services.
We believe our business will benefit from the following:
| • | Strong drilling rig activity. Approximately 250 new drilling rigs entered the
market during 2006. Spears & Associates, Inc. estimates that approximately the same
number of drilling rigs will enter the
U.S. market over the next year. According to Baker Hughes, the average U.S. drilling rig
count is expected to increase by approximately 9% in 2007 while the number of wells
drilled is expected to increase by approximately 12%. According to the Energy Information
Administration, or EIA, the number of wells drilled during the year ended December 31,
2006 increased 21% over the number of wells drilled over the same period in 2005. We
believe these additional drilling rigs and the expected increase in wells drilled will
positively impact demand for our products and services. |
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| • | U.S. hydrocarbon demand growth outpacing U.S. supply growth. According to
the EIA, from 1990 to 2006, demand for natural gas in the U.S. grew at an annual rate of
0.7% while the U.S. domestic supply |
grew at an annual rate of 0.2%. The EIA recently estimated that U.S. domestic consumption of natural gas exceeded domestic production by 12% in 2006, a gap that the EIA forecasts will expand to 19% by 2010.
•
Increased decline rates in natural gas basins in the U.S. As the chart below shows, even though the number of U.S. natural gas wells drilled per year has increased approximately 231% over the past decade from 9,539 to 31,587, a corresponding increase in production has not been realized. We believe that supply has not increased, in part, because of the accelerating decline rates of production from new wells drilled. A study published by the National Petroleum Council in September 2003 concluded that as a result of domestic natural gas decline rates of 25% to 30% per year, 80% of natural gas production in ten years will be from wells that had not yet been drilled. We believe this should create incentives to increase drilling activities in the U.S., which should increase the market for our products and services.
Source: Energy Information Administration
Our Strategy
Our strategy is to better position ourselves to capitalize on increased drilling activity in the oil and gas industry. We believe this increased activity will result in additional demand for our products and services. We intend to:
•
Expand our manufacturing capacity through facility expansions and improvements . We have expanded our manufacturing capacity to increase the volume and number of products we manufacture, with an emphasis on our pressure and flow control product line. We invested approximately $5.4 million during 2006 on this expansion effort, which includes increasing our BOP manufacturing capacity from ten to 25 units per month by upgrading and expanding our machining capabilities at our existing facilities, along with our expansion into Buffalo and Tyler, Texas, Casper, Wyoming and Indianapolis, Indiana by opening four facilities during 2006. We expect to invest up to $9.7 million in 2007 to expand capacity by:
• expanding our BOP repair capacity from 7 stacks per month to 11 stacks per month;
| • | opening additional facilities for our wellhead product line; | ||
| • | opening additional facilities for our pipeline product line; and | ||
| • | expanding our elastomer producing capacity in North America. |
| • | Continue new product development. Since April 2003, we have introduced 43 new
products, and we will continue to focus on new product development across all of our
product lines, with a continued focus on pressure and flow control products and more
recently on wellhead products. To support our expansion, we have increased our
engineering department staff to 21 employees and contract personnel as of December 31,
2006, compared to eight employees at December 31, 2005. A significant portion of this
increase in engineering staff is related to our increased focus on our wellhead product
line. |
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| • | Expand our geographic areas of operation. We intend to expand our geographic areas of
operation, with particular focus on field services for our wellhead and pipeline product
lines. We are expanding our wellhead and pipeline repair and remanufacturing services by
establishing facilities in areas we believe will have high drilling activity, such as the
Barnett Shale in North Texas, the Cotton Valley trend in the East Texas Basin, the
Fayetteville Shale in the Arkoma Basin and the Rocky Mountain and Appalachian regions.
For example, during 2006, we continued our expansion into the Rocky Mountain region by
acquiring KC Machine LLC, located in Rock Springs, Wyoming, and opening a facility in
Casper, Wyoming. In addition, we expanded into the East Texas Region by opening two
facilities and the Midwest region by opening a facility in Indianapolis, Indiana. Also,
during 2007 we established a presence in the Arkoma Basin by opening a facility in
Conway, Arkansas. |
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| • | Pursue strategic acquisitions and alliances. Our acquisition strategy will focus on
broadening our markets and existing product offerings. For example, in the first quarter
of 2007 we entered into an agreement with Gefro Oilfield Services ASA to market our
products and services and serve as an authorized repair center from their base in
Stavanger, Norway. In 2006, we acquired KC Machine LLC, located in Rock Springs,
Wyoming, to continue our expansion of our pressure and flow control, wellhead and
pipeline products and services to customers located in the Rocky Mountain region. In
addition, in July 2005, we entered into a joint participation agreement with SYMMSA, a
subsidiary of GRUPO R, a conglomerate of companies that provides services to the energy
and industrial sectors in Mexico. We will continue to seek similar strategic acquisition
and alliance opportunities in the future. |
Our Products and Services
We manufacture, repair and service products used in the drilling and completion of new oil and gas wells, the workover of existing wells and the production and transportation of oil and gas. These products include the following:
| • | BOPs. A BOP is a large pressure valve located at the top of a well. During drilling
operations, a series of BOPs are installed to provide pressure control. When activated,
BOPs seal the well and prevent fluids and gases from escaping, protecting the safety of
the crew and maintaining the integrity of the rig and wellbore. |
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| • | BOP control systems. Our BOP control systems are actuators that are used to remotely
open and close BOPs utilizing hydraulic pressure. |
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| • | Elastomer products. Elastomer products, which are constructed of molded rubber and
metal, are the sealing elements in BOPs and wellhead equipment. Elastomer products
require frequent replacement in order to ensure proper BOP
functioning. |
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| • | Chokes. A choke is a valve used to control fluid flow rates or reduce system pressure.
Chokes are used in oil and gas production, drilling and well servicing applications and
are often susceptible to erosion from exposure to abrasive and corrosive fluids. Chokes
are available for both fixed and adjustable modes of operation. |
| • | Manifolds and control valves. Manifolds are arrangements of piping and valves used to
control, distribute and monitor fluid flow. Control valves, which can be manually,
hydraulically or electrically actuated, are valves used to control flow in a wide variety
of oilfield and industrial applications. Our manifolds and control valves are used in oil
and gas production, drilling and well servicing applications. |
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| • | Custom coatings. Our protective coatings consist of thin liquid or powder material
that once applied over a structure prevents corrosion, wear and leakage problems. Our
protective coatings are applied to a wide variety of oilfield and
industrial products. |
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| • | Wellhead products. Our wellhead equipment includes wellheads, production chokes and
production valves used for onshore oil and gas production. Wellhead equipment is
installed directly on top of a completed well to ensure the safe and efficient flow of
oil or gas from the wellbore to downstream separation and pipeline equipment. Wellhead
equipment generally consists of a complex series of flanges, fittings
and valves. |
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| • | Pipeline products. Our pipeline products include a wide variety of valves for pipeline
applications, including gate, ball, control and check valves. Pipeline valves and related
products are used in gathering systems (pipelines connecting individual wellheads to a
larger pipeline system) and interstate pipelines (pipelines used to deliver oil, gas and
refined products over long distances). |
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| • | Aftermarket parts and services. Equipment used in the oil and gas industry operates in
harsh conditions and frequently requires new parts, ongoing refurbishment and repair
services. Our aftermarket parts and services are focused on repair and remanufacture of
BOPs, valves and other products and the installation and repair of wellhead and pipeline
products. We provide aftermarket services for our products as well as other brands,
including BOPs sold by our major competitors. |
Customers and Markets
Our products are used in both onshore and offshore applications. Our customer base, which operates in active oil and gas basins throughout the world, consists of leading drilling contractors, exploration and production companies and pipeline companies. Demand for our pressure and flow control and wellhead products and services is driven by exploration and development activity levels, which in turn are directly related to current and anticipated oil and gas prices. Demand for our pipeline products and services is driven by maintenance, repair and construction activities for pipeline, gathering and transmission systems. No single customer accounted for greater than 10% of our total revenues during 2006, 2005 or 2004.
Financial Information About Geographic Areas
Substantially all revenues are from domestic sources and Canada and all assets are held in the United States and Canada. See footnote 15 to the consolidated financial statements for further discussion.
Marketing
We market our products through a direct sales force, which consisted of 40 persons at December 31, 2006. We believe that our proximity to customers is a key to maintaining and expanding our business. Almost all of our sales are on a purchase order basis at fixed prices on normal 30-day trade terms. Large orders may be filled on negotiated terms appropriate to the order. International sales typically are made with agent or representative arrangements, and significant sales are secured by letters of credit. Although we do not typically maintain supply or service contracts with our customers, a significant portion of our sales represents repeat business.
Suppliers and Raw Materials
In each of our product lines, new and used inventory and related equipment and parts are acquired from suppliers, including individual brokers, remanufacturing companies and original equipment manufacturers. The loss of any single supplier would not be significant to our business. We have not experienced a shortage of products that we sell or incorporate into our manufactured products.
However, there is a strong demand for forgings, castings and outsourced coating services necessary for us to make our products. There can be no assurance that we will be able to continue to purchase these raw materials on a timely basis or at acceptable prices.
Insurance
We currently carry a variety of insurance for our operations. We are partially self-insured for certain claims in amounts we believe to be customary and reasonable. Although we believe we currently maintain insurance coverage adequate for the risks involved, there is a risk our insurance may not be sufficient to cover any particular loss or that our insurance may not cover all losses.
Competition
Our products are sold in highly competitive markets. We compete in all areas of our operations with a number of other companies, some of which have financial and other resources comparable to or greater than us. Our primary competitors, who are dominant in our business, are Cameron International Corporation, Hydril Company and National Oilwell Varco, Inc. We also have numerous smaller competitors. We believe the principal competitive factors are timely delivery of products and services, reputation, price, manufacturing capabilities, availability of plant capacity, performance and dependability. We believe several factors give us a strong competitive position relative to our competitors. Most significant are our rapid response times to our customers’ original equipment product manufacturing and aftermarket demands and the market acceptance of our original equipment products with most of the leading drilling contractors.
Backlog
As of December 31, 2006 and 2005, we had a backlog of $63.3 million and $30.1 million, respectively, consisting of written orders or commitments believed to be firm contracts for our pressure and flow control and pipeline products and services. These contracts are occasionally varied or modified by mutual consent and in some instances may be cancelable by the customer on short notice without substantial penalty. As a result, our backlog as of any particular date may not be indicative of our actual operating results for any future period. We believe that approximately 93% of the orders and commitments included in backlog at December 31, 2006 will be completed by December 31, 2007.
Patents and Trademarks
Our business has historically relied upon technical know-how and experience rather than patented technology. We own, or have a license to use, a number of patents covering a variety of products. Although these patents are important, no single patent is essential to our business.
We also rely on trade secret protection for our confidential and proprietary information. We routinely enter into confidentiality agreements with our employees, partners and suppliers. There can be no assurance, however, that others will not independently obtain similar information or otherwise gain access to our trade secrets.
Environmental and Other Regulations
We operate facilities in the U.S. and abroad that are subject to stringent federal, state, provincial and local laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws and regulations can affect our operations in many ways, such as requiring the acquisition of permits to conduct regulated activities; restricting the manner in which we can release materials into the environment; requiring capital expenditures to maintain compliance with laws; and imposing substantial liabilities on us for pollution resulting from our operations. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of remedial obligations, and the issuance of injunctions limiting or preventing our activities.
The trend in environmental regulation has been to place more restrictions and limitations on activities that may affect the environment, and thus, any changes in environmental laws and regulations that result in more stringent and costly waste handling, storage, transport, disposal or remediation requirements could have a material adverse effect on our business. In the event of future increases in costs, we may be unable to pass on those increases
to our customers. While we believe that we are in substantial compliance with existing environmental laws and regulations and that continued compliance with current requirements would not have a material adverse effect on us, there is no assurance that this trend will continue in the future.
In the U.S., the Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA or Superfund, and comparable state laws impose liability without regard to fault or the legality of the original conduct, on certain classes of persons considered to be responsible for the release of a hazardous substance into the environment. Under CERCLA, these “responsible persons” may be subject to joint and several, strict liability for the costs of cleaning up hazardous substances released into the environment, for damages to natural resources, and for the costs of certain health studies, and it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the release of the hazardous substances into the environment. We also may incur liability under the Resource Conservation and Recovery Act, as amended, or RCRA, which imposes requirements related to the handling and disposal of solid and hazardous wastes. We generate materials in the course of our operations that may be regulated as hazardous substances and/or solid or hazardous wastes.
We currently own or lease, and have in the past owned or leased, properties in the U.S. that for many years have been used as manufacturing facilities for industrial purposes. Although we used operating and disposal practices that were standard in the industry at the time, petroleum hydrocarbons or wastes may have been disposed of or released on or under such properties owned, leased or used by us or on or under other locations where such hydrocarbons or wastes have been taken for reclamation or disposal. In addition, some of these properties have been operated by third parties whose treatment and disposal or release of petroleum hydrocarbons and other wastes was not under our control. These properties and the materials disposed or released on them may be subject to CERCLA, RCRA and analogous state laws. Under such laws, we could be required to remove or remediate previously disposed wastes or property contamination, or to perform remedial activities to prevent future contamination. While we have been identified as a potentially responsible party, or PRP, with respect to one site identified on the CERCLA National Priorities List designated for cleanup, we believe that our involvement at that site has been minimal, and that our liability for this matter will not have a material adverse effect on our business.
The Federal Water Pollution Control Act, or the Clean Water Act, and analogous state laws impose restrictions and controls on the discharge of pollutants into waters of the U.S. or the states. Such discharges are prohibited, except in accord with the terms of a permit. Discharges in violation of the Clean Water Act could result in penalties, as well as significant remedial obligations. We believe that we hold all necessary permits for discharges for our U.S. facilities and that we are in material compliance with this act.
The Clean Air Act and comparable state laws restrict the emission of air pollutants from many sources in the U.S., including paint booths, and may require us to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce air emissions, impose stringent air permit requirements, or utilize specific equipment or technologies to control emissions. We believe that our U.S. operations are in material compliance with the Clean Air Act. In response to studies suggesting that emissions of certain gases may be contributing to warming of the Earth’s atmosphere, many foreign nations, including Canada, have agreed to limit emissions of these gases, generally referred to as “greenhouse gases,” pursuant to the United Nations Framework Convention on Climate Change, also known as the “Kyoto Protocol.” Methane, a primary component of natural gas, and carbon dioxide a byproduct of the burning of fossil fuels, are examples of greenhouse gases. Although the U.S. is not participating in the Kyoto Protocol, the current session of Congress is considering climate change legislation, with multiple bills having already been introduced in the Senate that propose to restrict greenhouse gas emissions. In addition, several states have already adopted legislation, regulations and/or regulatory initiatives to reduce emissions of greenhouse gases. Also, on November 29, 2006, the U.S. Supreme Court heard arguments on a case appealed from the U.S. Circuit Court of Appeals for the District Columbia, Massachusetts, et al. v. EPA, in which the appellate court held that the U.S. Environmental Protection Agency had discretion under the federal Clean Air Act to refuse to regulate carbon dioxide emissions from mobile sources. Passage of climate change legislation by Congress or a Supreme Court reversal of the appellate decision could result in federal regulation of carbon dioxide emissions and other greenhouse gases. The oil and gas industry, which is to whom we supply our products, may be directly affected by such legislation. Consequently, any federal or state restrictions on emissions of greenhouse gases that may be imposed in areas of the United States in which we conduct business could adversely affect our operations and demand for our products.
Our U.S. operations are subject to the requirements of the federal Occupational Safety and Health Act, or OSHA, and comparable state laws that regulate the protection of the health and safety of employees. In addition, OSHA’s hazard communication standard requires that information be maintained about hazardous materials used or produced in our operations and that this information be provided to employees, state and local government authorities and citizens. We believe that our U.S. operations are in substantial compliance with these OSHA requirements.
Our operations outside of the U.S. are potentially subject to similar foreign governmental controls governing the discharge of material into the environment and environmental protection. We believe that our foreign operations are in substantial compliance with current requirements of those governmental entities, and that compliance with these existing requirements has not had a materially adverse effect on our results of operations or finances. However, there is no assurance that this trend of compliance will continue in the future or that such compliance will not be material. For instance, any future restrictions on emissions of greenhouse gases that are imposed in foreign countries in which we operate, such as in Canada, pursuant to the Kyoto Protocol or other locally enforceable requirements could adversely affect demand for our products.
Employees
As of December 31, 2006, we had 573 employees, 140 of whom were salaried and 433 of whom were paid on an hourly basis. The entire work force is employed within the United States and Canada. We consider our relations with our employees to be good. None of our employees are covered by a collective bargaining agreement.
Available Information
Access to our filings of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 with the United States Securities and Exchange Commission, or SEC, may be obtained through the Investor Relations section of our website ( http://www.t3energyservices.com ). Our website provides a hyperlink to a third party SEC filings website where these reports may be viewed and printed at no cost as soon as reasonably practicable after we have electronically filed such material with the SEC. The contents of our website are not, and shall not be deemed to be, incorporated into this report.
Cautionary Note Regarding Forward-Looking Statements
Certain statements contained in or incorporated by reference in this Annual Report on Form 10-K, our filings with the Securities and Exchange Commission, or the Commission, and our public releases, including, but not limited to, information regarding the status and progress of our operating activities, the plans and objectives of our management, assumptions regarding our future performance and plans, and any financial guidance provided therein are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. The words “believe,” “may,” “will,” “estimate,” “continues,” “anticipate,” “intend,” “budget,” “predict,” “project,” “expect” and similar expressions identify these forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements are made subject to certain risks and uncertainties that could cause actual results to differ materially from those stated. Risks and uncertainties that could cause or contribute to such differences include, without limitation, those discussed in the section entitled “Risk Factors” included in this Annual Report on Form 10-K and our subsequent Commission filings.
These forward-looking statements are largely based on our expectations and beliefs concerning future events, which reflect estimates and assumptions made by our management. These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control.
Although we believe our estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control. Our assumptions about future events may prove to be inaccurate. We caution you that the forward-looking statements contained in this Annual Report on
Form 10-K are not guarantees of future performance, and we cannot assure you that those statements will be realized or the forward-looking events and circumstances will occur. Actual results may differ materially from those anticipated or implied in the forward-looking statements due to the factors listed in the section entitled “Risk Factors” included in this Annual Report on Form 10-K and our subsequent Commission filings. All forward-looking statements speak only as of the date of this report. We do not intend to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise, except as required by law. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.
Item 1A. Risk Factors
An investment in our securities involves a high degree of risk. You should carefully consider the risk factors described below, together with the other information included in this Annual Report on Form 10-K before you decide to invest in our securities. The risks described below are the material risks of which we are currently aware; however, they may not be the only risks that we may face. Additional risks and uncertainties not currently known to us or that we currently view as immaterial may also impair our business. If any of these risks develop into actual events, it could materially and adversely affect our business, financial condition, results of operations and cash flows, the trading price of your shares could decline and you may lose all or part of your investment.
Risks Related to Our Business
If we are unable to successfully manage our growth and implement our business plan, our results of operations will be adversely affected.
We have experienced significant revenue growth in 2006. To maintain our advantage of delivering original equipment products and providing aftermarket services more rapidly than our competitors, we plan to further expand our operations by adding new facilities, upgrading existing facilities and increasing manufacturing and repair capacity. We believe our future success depends in part on our ability to manage this expansion. The following factors could present difficulties for us:
| • | inability to integrate operations between existing and new or expanded facilities; | ||
| • | lack of a sufficient number of qualified technical and operating personnel; | ||
| • | shortage of operating equipment and raw materials necessary to operate our expanded business; and | ||
| • | managing the increased costs associated with our expansion. |
Our business depends on spending by the oil and gas industry, and this spending and our business may be adversely affected by industry conditions that are beyond our control.
We depend on our customers’ willingness to make operating and capital expenditures to explore for, develop and produce oil and gas. Industry conditions are influenced by numerous factors over which we have no control, such as:
| • | the level of drilling activity; | ||
| • | the level of oil and gas production; | ||
| • | the demand for oil and gas related products; | ||
| • | domestic and worldwide economic conditions; | ||
| • | political instability in the Middle East and other oil producing regions; | ||
| • | the actions of the Organization of Petroleum Exporting Countries; | ||
| • | the price of foreign imports of oil and gas, including liquefied natural gas; |
| • | natural disasters or weather conditions, such as hurricanes; | ||
| • | technological advances affecting energy consumption; | ||
| • | the level of oil and gas inventories; | ||
| • | the cost of producing oil and gas; | ||
| • | the price and availability of alternative fuels; | ||
| • | merger and divestiture activity among oil and gas producers; and | ||
| • | governmental regulation. |
The volatility of the oil and gas industry and the consequent impact on drilling activity could reduce the level of drilling and workover activity by some of our customers. Any such reduction could cause a decline in the demand for our products and services.
A decline in or substantial volatility of oil and gas prices could adversely affect the demand and prices for our products and services.
The demand for our products and services is substantially influenced by current and anticipated oil and gas prices and the related level of drilling activity and general production spending in the areas in which we have operations. Volatility or weakness in oil and gas prices (or the perception that oil and gas prices will decrease) affects the spending patterns of our customers and may result in the drilling of fewer new wells or lower production spending for existing wells. This, in turn, could result in lower demand and prices for our products and services.
Historical prices for oil and gas have been volatile and are expected to continue to be volatile. For example, since 1999, oil prices have ranged from as low as $11.37 per barrel to as high as $77.03 per barrel and natural gas prices have ranged from as low as $1.65 per million British thermal units, or MMBtu, to as high as $19.38 per MMBtu. This volatility has in the past and may in the future adversely affect our business. A prolonged low level of activity in the oil and gas industry will adversely affect the demand for our products and services.
We rely on a few key employees whose absence or loss could disrupt our operations or be adverse to our business.
Many key responsibilities within our business have been assigned to a small number of employees. The loss of their services, particularly the loss of our Chairman, President and Chief Executive Officer, Gus D. Halas, and the managers of our wellhead and pipeline product lines, Alvin Dueitt and Jimmy Ray, respectively, could be adverse to our business. Although we have employment and non-competition agreements with Mr. Halas and some of our other key employees, as a practical matter, those agreements will not assure the retention of our employees, and we may not be able to enforce all of the provisions in any employment or non-competition agreement. In addition, we do not maintain “key person” life insurance policies on any of our employees. As a result, we are not insured against any losses resulting from the death or disability of our key employees.
Our inability to deliver our backlog on time could affect our future sales and profitability and our relationships with our customers.
At December 31, 2006, our backlog was approximately $63.3 million. The ability to meet customer delivery schedules for this backlog is dependent on a number of factors including, but not limited to, access to the raw materials required for production, an adequately trained and capable workforce, project engineering expertise for certain large projects, sufficient manufacturing plant capacity and appropriate planning and scheduling of manufacturing resources. Our failure to deliver in accordance with customer expectations may result in damage to existing customer relationships and result in the loss of future business. Failure to deliver backlog in accordance with expectations could negatively impact our financial performance and thus cause adverse changes in the market price of our outstanding common stock. In addition, the cancellation by our customers of existing backlog orders, as a result of an economic downturn or otherwise, could adversely affect our business.
Our industry has recently experienced shortages in the availability of qualified personnel. Any difficulty we experience replacing or adding qualified personnel could adversely affect our business.
Our operations require the services of employees having technical training and experience in our business. As a result, our operations depend on the continuing availability of such personnel. Shortages of qualified personnel are occurring in our industry. If we should suffer any material loss of personnel to competitors, or be unable to employ additional or replacement personnel with the requisite level of training and experience, our operations could be adversely affected. A significant increase in the wages paid by other employers could result in a reduction in our workforce, increases in wage rates, or both.
Shortages of raw materials may restrict our operations.
The forgings, castings and outsourced coating services necessary for us to make our products are in high demand from our competitors and from participants in other industries. There can be no assurance that we will be able to continue to purchase these raw materials on a timely basis or at acceptable prices. Shortages could result in increased prices that we may be unable to pass on to customers. In addition, during periods of shortages, delivery times may be substantially longer. Any significant delay in our obtaining raw materials would have a corresponding delay in the manufacturing and delivery of our products. Any such delay might jeopardize our relationships with our customers and result in a loss of future business.
We intend to expand our business through strategic acquisitions. Our acquisition strategy exposes us to various risks, including those relating to difficulties in identifying suitable acquisition opportunities and integrating businesses and the potential for increased leverage or debt service requirements.
We have pursued and intend to continue to pursue strategic acquisitions of complementary assets and businesses. Acquisitions involve numerous risks, including:
| • | unanticipated costs and exposure to unforeseen liabilities; | ||
| • | difficulty in integrating the operations and assets of the acquired businesses; | ||
| • | potential loss of key employees and customers of the acquired company; | ||
| • | our ability to properly establish and maintain effective internal controls over an acquired company; and | ||
| • | risk of entering markets in which we have limited prior experience. |
Our failure to achieve consolidation savings, to incorporate the acquired businesses and assets into our existing operations successfully or to minimize any unforeseen operational difficulties could have an adverse effect on our business.
In addition, we may incur indebtedness to finance future acquisitions and also may issue equity securities in connection with such acquisitions. Debt service requirements could represent a burden on our results of operations and financial condition and the issuance of additional equity securities could be dilutive to our existing stockholders.
The oilfield service industry in which we operate is highly competitive, which may result in a loss of market share or a decrease in revenue or profit margins.
Our products and services are subject to competition from a number of similarly sized or larger businesses. Factors that affect competition include timely delivery of products and services, reputation, price, manufacturing capabilities, availability of plant capacity, performance and dependability. Any failure to adapt to a changing competitive environment may result in a loss of market share and a decrease in revenue and profit margins. One of our competitive advantages is our short production and delivery lead times relative to our competitors. If we cannot maintain our rapid response times, or if our competitors are able to reduce their response times, we may lose future business. In addition, many of our competitors have greater financial and other resources than we do, which may allow them to address these factors more effectively than we can or weather industry downturns more easily than we can.
If we do not develop and commercialize new competitive products, our revenue may decline.
To remain competitive in the market for pressure control products and services, we must continue to develop and commercialize new products. If we are not able to develop commercially competitive products in a timely manner in response to industry demands, our business and revenues will be adversely affected. Our future ability to develop new products depends on our ability to:
| • | design and commercially produce products that meet the needs of our customers; | ||
| • | successfully market new products; and | ||
| • | protect our proprietary designs from our competitors. |
We may encounter resource constraints or technical or other difficulties that could delay introduction of new products and services. Our competitors may introduce new products before we do and achieve a competitive advantage.
Additionally, the time and expense invested in product development may not result in commercial products or provide revenues. Moreover, we may experience operating losses after new products are introduced and commercialized because of high start-up costs, unexpected manufacturing costs or problems, or lack of demand.
The cyclical nature of or a prolonged downturn in our industry could affect the carrying value of our goodwill.
Since 2003, we have incurred goodwill impairments related to continuing and discontinued operations totaling $29.5 million. As of December 31, 2006, we had approximately $70.6 million of goodwill. Our estimates of the value of our goodwill could be reduced as a result of various factors, some of which are beyond our control.
We may be faced with product liability claims.
Most of our products are used in hazardous drilling and production applications where an accident or a failure of a product can cause personal injury, loss of life, damage to property, equipment or the environment, or suspension of operations. Despite our quality assurance measures, defects may occur in our products. Any defects could give rise to liability for damages, including consequential damages, and could impair the market’s acceptance of our products. To mitigate our risk of liability for damages, we attempt to disclaim responsibility for consequential damages, but our disclaimers may not be effective. We carry product liability insurance as a part of our commercial general liability coverage of $1 million per occurrence with a $2 million general aggregate annual limit. Additional coverage may also be available under our umbrella policy. Our insurance may not adequately cover our costs arising from defects in our products or otherwise.
Liability to customers under warranties may materially and adversely affect our earnings.
We provide warranties as to the proper operation and conformance to specifications of the products we manufacture. Failure of our products to operate properly or to meet specifications may increase our costs by requiring additional engineering resources and services, replacement of parts and equipment or monetary reimbursement to a customer. We have in the past received warranty claims, and we expect to continue to receive them in the future. To the extent that we incur substantial warranty claims in any period, our reputation, our ability to obtain future business and our earnings could be adversely affected.
Uninsured or underinsured claims or litigation or an increase in our insurance premiums could adversely impact our results.
We maintain insurance to cover potential claims and losses, including claims for personal injury or death resulting from the use of our products. We carry comprehensive insurance, including business interruption insurance, subject to deductibles, at levels we believe are sufficient to cover existing and future claims. It is possible an unexpected judgment could be rendered against us in cases in which we could be uninsured or underinsured and beyond the amounts we currently have reserved or anticipate incurring. Significant increases in the cost of insurance and more restrictive coverage may have an adverse impact on our results of operations. In addition, we may not be able to maintain adequate insurance coverage at rates we believe are reasonable.
Our operations are subject to stringent environmental laws and regulations that may expose us to significant costs and liabilities.
Our operations in the U.S. and abroad are subject to stringent federal, state, provincial and local environmental laws and regulations governing the discharge of materials into the environment and environmental protection. These laws and regulations require us to acquire permits to conduct regulated activities, and to incur capital expenditures to limit or prevent releases of materials from our facilities, and to respond to liabilities for pollution resulting from our operations. Governmental authorities enforce compliance with these laws and regulations and the permits issued under them, oftentimes requiring difficult and costly actions. Failure to comply with these laws, regulations and permits may result in the assessment of administrative, civil and criminal penalties, the imposition of remedial obligations, and the issuance of injunctions limiting or preventing some or all of our operations.
There is inherent risk of incurring significant environmental costs and liabilities in our business. Joint and several, as well as strict, liability may be incurred in connection with discharges or releases of petroleum hydrocarbons and wastes on, under or from our properties and facilities, many of which have been used for industrial purposes for a number of years, oftentimes by third parties not under our control. Private parties who use our products and facilities where our petroleum hydrocarbons or wastes are taken for reclamation or disposal may also have the right to pursue legal actions to enforce compliance as well as to seek damages for non-compliance with environmental laws and regulations and for personal injury or property damage. In addition, changes in environmental laws and regulations occur frequently, and any such changes that result in more stringent and costly requirements could have a material adverse effect on our business. For example, passage of climate change legislation that restricts emissions of certain gases, commonly referred to as greenhouse gases, in areas that we operate could adversely affect demand for our products. We may not be able to recover some or any of these costs from insurance.
We will be subject to political, economic and other uncertainties as we expand our international operations.
We intend to continue our expansion into international markets such as Mexico, Canada and Norway. Our international operations are subject to a number of risks inherent in any business operating in foreign countries including, but not limited to:
| • | political, social and economic instability; | ||
| • | currency fluctuations; and | ||
| • | government regulation that is beyond our control. |
Our operations have not yet been affected to any significant extent by such conditions or events, but as our international operations expand, the exposure to these risks will increase. To the extent we make investments in foreign facilities or receive revenues in currencies other than U.S. dollars, the value of our assets and our income could be adversely affected by fluctuations in the value of local currencies.
If we are unable to complete our assessment of the adequacy of our internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.
Under Section 404 of the Sarbanes-Oxley Act of 2002, we will be required to include in each of our future annual reports on Form 10-K, beginning with our annual report for the fiscal year ended December 31, 2007, a report containing our management’s assessment of the effectiveness of our internal control over financial reporting and a related attestation of our independent auditors. We are currently undertaking a comprehensive effort in preparation for compliance with Section 404. This effort includes the documentation and evaluation of our internal controls under the direction of our management. We have been making various changes to our internal control over financial reporting as a result of our review efforts. To date, we have not identified any material weaknesses in our internal control over financial reporting, as defined by the Public Company Accounting Oversight Board. However, due to the number of controls to be examined, the complexity of the project, as well as the subjectivity involved in determining effectiveness of controls, we cannot be certain that all our controls will be considered effective. Therefore, we can give no assurances that our internal control over financial reporting will satisfy the new
regulatory requirements. If we are unable to successfully implement the requirements of Section 404, it will prevent our independent auditors from issuing an unqualified attestation report on a timely basis as required by Section 404. In that event, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.
Risks Relating to Our Common Stock
The market price of our common stock may be volatile or may decline regardless of our operating performance.
The market price of our common stock has experienced, and may continue to experience, substantial volatility. During 2006, the sale prices of our common stock on The Nasdaq Global Market has ranged from a low of $10.00 to a high of $28.10 per share. We expect our common stock to continue to be subject to fluctuations. Broad market and industry factors may adversely affect the market price of our common stock, regardless of our actual operating performance. Factors that could cause fluctuation in the stock price may include, among other things:
| • | actual or anticipated variations in quarterly operating results; | ||
| • | announcements of technological advances by us or our competitors; | ||
| • | current events affecting the political and economic environment in the United States; | ||
| • | conditions or trends in our industry, including demand for our products and services,
technological advances and governmental regulations; |
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| • | litigation involving or affecting us; | ||
| • | changes in financial estimates by us or by any securities analysts who might cover our stock; and | ||
| • | additions or departures of our key personnel. |
The realization of any of these risks and other factors beyond our control could cause the market price of our common stock to decline significantly. In particular, the market price of our common stock may be influenced by variations in oil and gas prices, because demand for our services is closely related to those prices.
Our largest stockholder is able to exercise significant influence over our company, and its interests may conflict with those of our other stockholders.
First Reserve Fund VIII, L.P., or First Reserve Fund VIII, currently holds approximately 44.3% of our common stock. We have registered for resale all of the shares owned by First Reserve Fund VIII, including shares underlying warrants held by First Reserve Fund VIII. However, First Reserve Fund VIII may not choose to sell its shares and, if it does sell, may not be able to sell all of our common stock owned by it. Thus, First Reserve Fund VIII may, for at least some period of time, continue to own a substantial portion of our common stock. As a result, First Reserve Corporation, because it controls First Reserve Fund VIII, may continue to exercise significant influence over matters requiring stockholder approval, including the election of directors, changes to our charter documents and significant corporate transactions. This concentration of ownership makes it unlikely that any other holder or group of holders of our common stock will be able to affect the way we are managed or the direction of our business. The interests of First Reserve Corporation with respect to matters potentially or actually involving or affecting us, such as future acquisitions, financings and other corporate opportunities and attempts to acquire us, may conflict with the interests of our other stockholders. First Reserve Fund VIII’s continued concentrated ownership may have the effect of delaying or preventing a change of control of us, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices.
We may incur increased costs as a result of no longer being a “controlled company.”
On November 30, 2006, First Reserve Fund VIII sold 4.5 million shares of our common stock. Prior to this sale, because First Reserve Fund VIII held in excess of 50% of our outstanding common stock, we were considered
to be controlled by First Reserve Fund VIII under The Nasdaq Global Market rules and were, therefore, eligible for exemptions from provisions of these rules requiring that our board have a majority of independent directors, nominating and corporate governance and compensation committees composed entirely of independent directors and written charters addressing specified matters. As a result of First Reserve Fund VIII’s sale, which reduced First Reserve Fund VIII’s beneficial ownership of our common stock to under 50%, we ceased to be a controlled company within the meaning of The Nasdaq Global Market rules and we will be required to comply with these provisions after the specified transition periods. These rules and regulations may increase our legal and financial compliance costs and make activities more time consuming and costly. We are currently evaluating these new rules, and cannot predict or estimate the amount of additional costs, if any, we may incur or the timing of such costs.
One of our directors may have conflicts of interest because he is also an officer of First Reserve Corporation. The resolution of these conflicts of interest may not be in our or our stockholders’ best interests.
One of our directors, Joseph R. Edwards, is also an officer of First Reserve Corporation, which controls the general partner of First Reserve Fund VIII, our largest stockholder. Even though not constituting a majority of our board, this may create conflicts of interest because this director has responsibilities to First Reserve Fund VIII and its partners. His duties as an officer of First Reserve Corporation may conflict with his duties as our director regarding business dealings between First Reserve Corporation and us and other matters. The resolution of these conflicts may not always be in our or our stockholders’ best interests.
We renounced any interest in specified business opportunities, and First Reserve Fund VIII and its director designees on our board of directors generally will have no obligation to offer us those opportunities.
First Reserve Fund VIII has investments in other oilfield service companies that compete with us, and private equity funds managed by First Reserve Corporation and its affiliates, other than T-3, may invest in other such companies in the future. We refer to First Reserve Corporation, its other affiliates and its portfolio companies as the First Reserve group. Our certificate of incorporation provides that, so long as First Reserve Fund VIII, First Reserve Corporation and their respective affiliates continue to own at least an aggregate of 20% of our common stock, we renounce any interest in specified business opportunities. Our certificate of incorporation also provides that if an opportunity in the oilfield services industry is presented to a person who is a member of the First Reserve group, including any individual who also serves as First Reserve Fund VIII’s director designee of our company:
| • | no member of the First Reserve group or any of those individuals will have any
obligation to communicate or offer the opportunity to us; and |
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| • | such entity or individual may pursue the opportunity as that entity or individual sees fit, |
unless:
| • | it was presented to a member of the First Reserve group in that person’s capacity as a director or officer of T-3; or | ||
| • | the opportunity was identified solely through the disclosure of information by or on behalf of T-3. |
These provisions of our certificate of incorporation may be amended only by an affirmative vote of holders of at least 80% of our outstanding common stock. As a result of these charter provisions, our future competitive position and growth potential could be adversely affected.
Our ability to issue preferred stock could adversely affect the rights of holders of our common stock.
Our certificate of incorporation authorizes us to issue up to 5,000,000 shares of preferred stock in one or more series on terms that may be determined at the time of issuance by our board of directors. Accordingly, we may issue shares of any series of preferred stock that would rank senior to the common stock as to voting or dividend rights or rights upon our liquidation, dissolution or winding up.
Certain provisions in our charter documents have anti-takeover effects.
Certain provisions of our certificate of incorporation and bylaws may have the effect of delaying, deferring or preventing a change in control of us. Such provisions, including those regulating the nomination and election of directors and limiting who may call special stockholders’ meetings, together with the possible issuance of our preferred stock without stockholder approval, may make it more difficult for other persons, without the approval of our board of directors, to make a tender offer or otherwise acquire substantial amounts of our common stock or to launch other takeover attempts that a stockholder might consider to be in such stockholder’s best interest.
Because we have no plans to pay any dividends for the foreseeable future, investors must look solely to stock appreciation for a return on their investment in us.
We have never paid cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain any future earnings to support our operations and growth. Any payment of cash dividends in the future will be dependent on the amount of funds legally available, our earnings, financial condition, capital requirements and other factors that our board of directors may deem relevant. Additionally, our senior credit facility restricts the payment of dividends. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not purchase our common stock.
Item 1B. Unresolved Staff Comments
None.
