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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-31983
----------------
TODCO
(Exact name of registrant as specified in its charter)
DELAWARE 76-0544217
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2000 W. SAM HOUSTON PARKWAY SOUTH, SUITE 800
HOUSTON, TEXAS 77042-3615
(Address, of registrant's principal executive offices)
(713) 278-6000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12-b-2 of the Act). Yes ( ) No (X)
The number of outstanding shares of each class of the registrant's common
stock as of November 1, 2004, was 32,047,140 shares of Class A common stock and
28,260,000 shares of Class B common stock.
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TABLE OF CONTENTS
PAGE
NUMBER
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Balance Sheets at September 30, 2004
and December 31, 2003 ........................................ 3
Condensed Consolidated Statements of Operations for the Three
and Nine Months ended September 30, 2004 and 2003 ............ 4
Condensed Consolidated Statements of Comprehensive Loss for
the Three and Nine Months ended September 30, 2004 and 2003 .. 5
Condensed Consolidated Statement of Equity for the Nine Months
ended September 30, 2004 ..................................... 6
Condensed Consolidated Statements of Cash Flows for the Nine
Months ended September 30, 2004 and 2003 ..................... 7
Notes to Condensed Consolidated Financial Statements ........... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 25
Item 3. Quantitative and Qualitative Disclosures about Market Risk ..... 57
Item 4. Controls and Procedures ........................................ 58
PART II - OTHER INFORMATION
Item 1. Legal Proceedings .............................................. 59
Item 6. Exhibits and Reports on Form 8-K ............................... 60
1
PART I
ITEM 1. FINANCIAL STATEMENTS UNAUDITED
The condensed consolidated financial statements of TODCO and its
consolidated subsidiaries (the "Company") included herein have been prepared,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and notes normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted pursuant to such
rules and regulations. These financial statements should be read in conjunction
with the audited consolidated financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2003.
2
TODCO AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- -------------
(UNAUDITED)
(IN MILLIONS,
EXCEPT SHARE DATA)
ASSETS
Cash and cash equivalents ...................................................... $ 53.8 $ 20.0
Accounts receivable, net
Trade ........................................................................ 56.2 52.3
Related party ................................................................ 11.2 0.9
Other ........................................................................ 2.0 4.6
Materials and supplies, net .................................................... 3.9 4.5
Deferred income taxes .......................................................... 5.9 --
Other current assets ........................................................... 3.8 3.2
Current assets related to discontinued operations .............................. -- 0.1
------------- -------------
Total current assets ..................................................... 136.8 85.6
------------- -------------
Property and equipment ......................................................... 916.2 924.9
Less accumulated depreciation .................................................. 326.4 264.0
------------- -------------
Property and equipment, net .................................................. 589.8 660.9
------------- -------------
Other assets ................................................................... 24.1 31.7
------------- -------------
Total assets ............................................................. $ 750.7 $ 778.2
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Trade accounts payable ......................................................... $ 17.7 $ 24.7
Short-term debt ................................................................ 0.7 --
Accrued income taxes ........................................................... 10.8 11.1
Accrued income taxes - related party ........................................... 1.3 --
Debt due within one year ....................................................... 8.2 1.2
Debt due within one year -- related party ...................................... 3.0 3.0
Interest payable -- related party .............................................. 0.2 4.3
Other current liabilities ...................................................... 39.8 43.4
Current liabilities related to discontinued operations ......................... 0.2 0.5
------------- -------------
Total current liabilities ................................................ 81.9 88.2
------------- -------------
Long-term debt ................................................................. 17.4 25.6
Long-term debt -- related party ................................................ -- 522.0
Deferred income taxes .......................................................... 172.1 --
Other long-term liabilities .................................................... 3.5 4.7
------------- -------------
Total long-term liabilities .............................................. 193.0 552.3
------------- -------------
Commitments and contingencies
Preferred stock, $0.01 par value, 50,000,000 shares authorized, none
outstanding at September 30, 2004 and December 31, 2003 ...................... -- --
Common stock, Class A, $0.01 par value, 500,000,000 shares authorized,
32,042,890 shares and 0 shares issued and outstanding at September 30,
2004 and December 31, 2003, respectively ..................................... 0.3 --
Common stock, Class B, $0.01 par value, 260,000,000 shares authorized,
28,260,000 shares and 12,144,751 shares issued and outstanding at
September 30, 2004 and December 31, 2003, respectively ....................... 0.3 0.1
Additional paid-in capital ..................................................... 6,509.1 6,136.3
Retained deficit ............................................................... (6,030.9) (5,998.7)
Unearned compensation .......................................................... (3.0) --
------------- -------------
Total shareholders' equity ............................................... 475.8 137.7
------------- -------------
Total liabilities and shareholders' equity ............................... $ 750.7 $ 778.2
============= =============
See accompanying notes.
3
TODCO AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2004 2003 2004 2003
-------- -------- -------- --------
(IN MILLIONS, EXCEPT PER
SHARE DATA)
OPERATING REVENUES ..................................................... $ 93.1 $ 58.5 $ 247.7 $ 167.3
COSTS AND EXPENSES
Operating and maintenance ............................................ 65.4 53.2 193.4 169.4
Operating and maintenance -- related party ........................... -- 3.4 -- 9.2
Depreciation ......................................................... 23.8 22.8 72.0 69.2
General and administrative ........................................... 6.9 3.9 26.3 11.2
General and administrative -- related party .......................... 0.1 0.1 0.3 1.4
Impairment loss on long-lived assets ................................. -- -- -- 11.6
Gain on disposal of assets, net ...................................... (0.8) (0.1) (5.4) (0.5)
-------- -------- -------- --------
95.4 83.3 286.6 271.5
-------- -------- -------- --------
OPERATING LOSS ......................................................... (2.3) (24.8) (38.9) (104.2)
OTHER INCOME (EXPENSE), NET
Equity in loss of joint ventures ..................................... -- (0.1) -- (2.7)
Interest income ...................................................... 0.2 0.1 0.3 0.5
Interest income -- related party ..................................... -- -- -- 3.3
Interest expense ..................................................... (1.1) (0.7) (3.1) (2.3)
Interest expense -- related party .................................... (0.1) (8.4) (3.3) (35.0)
Loss on retirement of debt ........................................... -- -- (1.9) (79.5)
Impairment of investment in and advance to joint venture ............. -- -- -- (21.3)
Other, net ........................................................... 0.7 0.2 1.3 (2.3)
-------- -------- -------- --------
(0.3) (8.9) (6.7) (139.3)
-------- -------- -------- --------
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES .................... (2.6) (33.7) (45.6) (243.5)
Income tax (benefit) expense ........................................... (0.1) 0.6 (13.4) (50.4)
Minority interest ...................................................... -- 0.7 -- 0.6
-------- -------- -------- --------
LOSS FROM CONTINUING OPERATIONS ........................................ (2.5) (35.0) (32.2) (193.7)
DISCONTINUED OPERATIONS:
Loss from operations of discontinued segment ......................... -- -- -- (43.9)
Income tax expense ................................................... -- -- -- 19.9
Minority interest .................................................... -- -- -- 1.2
-------- -------- -------- --------
Net loss from discontinued operations ............................... -- -- -- (65.0)
-------- -------- -------- --------
NET LOSS ............................................................... $ (2.5) $ (35.0) $ (32.2) $ (258.7)
======== ======== ======== ========
NET LOSS PER COMMON SHARE BASIC AND DILUTED
Continuing operations ................................................ $ (0.04) $ (2.88) $ (0.59) $ (15.95)
Discontinued operations .............................................. -- -- -- (5.35)
-------- -------- -------- --------
Net loss per common share basic and diluted ......................... $ (0.04) $ (2.88) $ (0.59) $ (21.30)
======== ======== ======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic and diluted .................................................... 60.3 12.1 54.3 12.1
See accompanying notes.
4
TODCO AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
-------- -------- -------- --------
(IN MILLIONS)
Net loss ................................................... $ (2.5) $ (35.0) $ (32.2) $ (258.7)
-------- -------- -------- --------
Other comprehensive income
Change in share of unrealized income in
unconsolidated joint venture's accumulated
other comprehensive income, net of tax of $1.1
for the nine months ended September 30, 2003 .......... -- -- -- 2.0
-------- -------- -------- --------
Other comprehensive income ................................ -- -- -- 2.0
-------- -------- -------- --------
Total comprehensive loss ................................... $ (2.5) $ (35.0) $ (32.2) $ (256.7)
======== ======== ======== ========
See accompanying notes.
5
TODCO AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF EQUITY
(UNAUDITED)
COMMON STOCK
-------------------------------
CLASS A CLASS B ADDITIONAL
-------------- --------------- PAID-IN RETAINED UNEARNED TOTAL
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT COMPENSATION EQUITY
------ ------ ------ ------ --------- --------- ------------ --------
(IN MILLIONS)
Balance at December 31, 2003 -- $ -- 12.1 $ 0.1 $6,136.3 $(5,998.7) $ -- $ 137.7
Net loss....................................... (32.2) (32.2)
Debt for equity exchange....................... 47.9 0.5 528.4 528.9
Conversions of common stock from Class B to
Class A...................................... 31.7 0.3 (31.7) (0.3) --
Distributions to parent........................ (181.4) (181.4)
Equity contributions from parent............... 13.5 13.5
Issuance of restricted stock, net of
forfeitures.................................. 0.3 -- 4.4 (4.4) --
Stock options granted.......................... 7.9 7.9
Amortization of unearned compensation.......... 1.4 1.4
------ ------ ------ ------ -------- --------- ------------ --------
Balance at September 30, 2004.................... 32.0 $ 0.3 28.3 $ 0.3 $6,509.1 $(6,030.9) $ (3.0) $ 475.8
====== ====== ====== ====== ======== ========= ============ ========
See accompanying notes.
6
TODCO AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2004 2003
-------- --------
(IN MILLIONS)
CASH FLOWS FROM OPERATING ACTIVITIES -- CONTINUING OPERATIONS AND
DISCONTINUED OPERATIONS
Net loss ........................................................... $ (32.2) $ (258.7)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation ...................................................... 72.0 79.6
Deferred income taxes ............................................. (15.2) (34.9)
Stock-based compensation expense .................................. 10.8 --
Equity in earnings of joint ventures .............................. -- (2.8)
Net (gain) loss on disposal of assets ............................. (5.4) 9.4
Impairment loss on long-lived assets .............................. -- 11.6
Amortization of debt issue costs .................................. -- (4.9)
Deferred income, net .............................................. (6.6) (13.9)
Deferred expenses, net ............................................ 2.7 (0.8)
Loss on retirement of debt ........................................ 1.9 79.5
Impairment of investment in and advance to joint venture .......... -- 21.3
Changes in operating assets and liabilities, net of effect of
distributions to related parties
Accounts receivable, net ...................................... (1.2) 33.9
Accounts payable and other current liabilities ................ (3.8) (21.2)
Accounts receivable/payable to related party, net ............. 5.2 194.0
Income taxes receivable/payable, net .......................... 1.1 (3.3)
Other, net .................................................... 1.6 5.8
-------- --------
Net cash provided by operating activities ............................ 30.9 94.6
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES -- CONTINUING OPERATIONS AND
DISCONTINUED OPERATIONS
Capital expenditures ............................................... (8.3) (7.4)
Proceeds from disposal of assets, net .............................. 11.5 74.6
-------- --------
Net cash provided by investing activities ............................ 3.2 67.2
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES -- CONTINUING OPERATIONS AND
DISCONTINUED OPERATIONS
Net repayments of debt with related party .......................... -- (54.0)
Repayments on other debt instruments ............................... -- (78.8)
Cash of subsidiaries at distribution to affiliates ................. -- (103.9)
Other, net ......................................................... (0.3) 1.7
-------- --------
Net cash used in financing activities ................................ (0.3) (235.0)
-------- --------
Net increase (decrease) in cash and cash equivalents ................. 33.8 (73.2)
Cash and cash equivalents at beginning of period -- continuing
operations and discontinued operations ............................. 20.0 102.9
-------- --------
Cash and cash equivalents at end of period -- continuing
operations and discontinued operations ............................. $ 53.8 $ 29.7
======== ========
See accompanying notes.
7
TODCO AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 -- NATURE OF BUSINESS
TODCO (together with its subsidiaries and predecessors, unless the context
requires otherwise, the "Company," "we" or "our"), is a leading provider of
contract oil and gas drilling services, primarily in the United States ("U.S.")
Gulf of Mexico shallow water and inland marine region, an area referred to as
the U.S. Gulf Coast. At September 30, 2004, the Company owned, had partial
ownership interests in or operated 70 drilling rigs, consisting of 24 jackup
rigs, 30 barge rigs, three submersible rigs and one platform rig, as well as
nine land rigs and three lake barge rigs in Venezuela. The Company contracts its
drilling rigs, related equipment and work crews primarily on a dayrate basis to
drill oil and natural gas wells.
Effective January 31, 2001, a merger transaction between the Company and
Transocean Inc. ("Transocean") was completed (the "Transocean Merger"). A change
of control occurred and the Company became an indirect wholly owned subsidiary
of Transocean.
In July 2002, Transocean announced plans to divest its Gulf of Mexico
shallow and inland water ("Shallow Water") business through an initial public
offering of the Company. During 2003, the Company completed the transfer to
Transocean of all assets not related to its Shallow Water business ("Transocean
Assets"), including the transfer of all revenue-producing Transocean Assets.
Accordingly, the Transocean Assets and related operations have been reflected as
discontinued operations in the Company's historical financial statements and
notes thereto. The Company's historical financial statements and the notes
thereto have been restated for the effect of discontinued operations for all
periods presented, except for the statement of cash flows and related Note 9 for
which restatement is not required. See Note 15.
In February 2004, the Company completed an initial public offering, with
Transocean selling 13,800,000 shares of its TODCO Class A common stock (the
"IPO") and, in September 2004, Transocean sold an additional 17,940,000 shares
of TODCO Class A common stock in a secondary stock offering. As of September 30,
2004, Transocean owns 28,260,000 shares or 100 percent of the outstanding Class
B common stock of the Company, which represents 47 percent of the Company's
outstanding common stock. Transocean has 82 percent of the combined voting power
of the Company's outstanding common stock due to the five votes per share of
Class B common stock, as compared to the one vote per share of Class A common
stock. Transocean does not own any of the Company's outstanding Class A common
stock. See Note 3.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF CONSOLIDATION
Basis of Consolidation -- The accompanying condensed consolidated financial
statements of the Company have been prepared without audit in accordance with
accounting principles generally accepted in the United States ("GAAP") for
interim financial information. Accordingly, pursuant to such rules and
regulations, these financial statements do not include all disclosures required
by GAAP for complete financial statements. Operating results for the nine months
ended September 30, 2004 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2004 or for any future period. The
accompanying condensed consolidated financial statements and notes thereto
should be read in conjunction with the audited consolidated financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2003.
Intercompany transactions and accounts have been eliminated. For investments
in joint ventures that either do not meet the criteria of being a variable
interest entity or where the Company is not deemed to be the primary beneficiary
for accounting purposes, the equity method of accounting is used where the
Company's ownership in the joint venture is between 20 percent and 50 percent
and for investments in joint ventures where more than 50 percent is owned and
the Company does not have control of the joint venture. The cost method of
accounting is used for investments in joint ventures where the Company's
ownership is less than 20 percent and the Company does not have significant
influence over the joint venture. For investments in joint ventures that meet
the criteria of a
8
variable interest entity and where the Company is deemed to be the primary
beneficiary for accounting purposes, such entities are consolidated (see
Variable Interest Entities).
Accounting Estimates -- The preparation of consolidated financial statements
in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues, expenses and
disclosure of contingent assets and liabilities. The Company evaluates its
estimates on an ongoing basis, including those related to bad debts, materials
and supplies obsolescence, investments, property and equipment and other
long-lived assets, income taxes, personal injury claim liabilities, employment
benefits and contingent liabilities. The Company bases its estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results could differ from such
estimates.
Segments -- The Company's operations have been aggregated into four
reportable business segments, which, for our contract drilling services,
correspond to the principal geographic regions in which the Company operates:
- U.S. Inland Barge Segment -- The Company's barge rig fleet in this
market segment consists of 12 conventional and 18 posted barge rigs.
These units operate in marshes, rivers, lakes and shallow bay or
coastal waterways that are known as the "transition zone". This area
along the U.S. Gulf Coast, where jackup rigs are unable to operate,
is the world's largest market for this type of equipment.
- U.S. Gulf of Mexico Segment -- The Company currently has 20 jackup
and three submersible rigs in the U.S. Gulf of Mexico shallow water
market segment which begins at the outer limit of the transition
zone and extends to water depths of about 350 feet. The Company's
jackup rigs in this market segment consist of independent leg
cantilever type units, mat-supported cantilever type rigs and
mat-supported slot type jackup rigs that can operate in water depths
up to 250 feet.
- Other International Segment -- The Company's other international
operations are currently conducted in Mexico, Trinidad and
Venezuela. In Mexico, the Company operates two jackup rigs and is
preparing a platform rig to operate for PEMEX, the Mexican national
oil company. Additionally, the Company has two jackup rigs in
Trinidad and nine land rigs and three lake barges in Venezuela. From
December 2003 to September 2004, the Company also operated a jackup
rig offshore Venezuela. This rig has been relocated to the U.S. Gulf
of Mexico. The Company may pursue selected opportunities in other
regions from time to time.
- Delta Towing Segment -- The Company has a partial interest in a
joint venture that operates a fleet of U.S. marine support vessels
consisting primarily of shallow water tugs, crewboats and utility
barges ("Delta Towing"). See Note 4.
Impairment of Other Long-Lived Assets -- The carrying value of long-lived
assets, principally property and equipment, is reviewed for potential impairment
when events or changes in circumstances indicate that the carrying amount of
such assets may not be recoverable as prescribed by the Financial Accounting
Standards Board's ("FASB") Statement of Financial Accounting Standards ("SFAS")
No. 144, Accounting for Impairment on Disposal of Long-Lived Assets ("SFAS
144"). For property and equipment held for use, the determination of
recoverability is made based upon the estimated undiscounted future net cash
flows of the related asset or group of assets being evaluated. Property and
equipment held for sale are recorded at the lower of net book value or net
realizable value. See Note 5.
Operating Revenues and Expenses -- Operating revenues are recognized as
earned, based on contractual daily rates. In connection with drilling contracts,
the Company may receive revenues for preparation and mobilization of equipment
and personnel or for capital improvements to rigs. In connection with new
drilling contracts, revenues earned and incremental costs incurred directly
related to the preparation and mobilization of the rig are deferred and
recognized over the primary contract term of the drilling project for contracts
that have a primary contract term of two months or longer and where such amounts
are material. Costs of relocating drilling units without contracts to more
promising market areas are expensed as incurred. Revenues and expenses
associated with the demobilization of drilling units are recognized upon
completion of the related drilling contracts. Capital upgrade revenues received
9
are deferred and recognized over the primary contract term of the drilling
project. The actual cost incurred for the capital upgrade is depreciated over
the estimated remaining useful life of the asset.
At September 30, 2004 and December 31, 2003, $18.3 million and $21.2
million, respectively, in deferred preparation and mobilization costs were
included in other assets in the Company's condensed consolidated balance sheets.
During the three and nine months ended September 30, 2004, the Company amortized
$2.0 million and $9.8 million, respectively, of these costs to expense, which is
included in operating and maintenance expense in the Company's condensed
consolidated statements of operations. There were no similar costs amortized to
expense during the three and nine months ended September 30, 2003.
Interim Financial Information -- The condensed consolidated financial
statements reflect all adjustments, which are, in the opinion of management,
necessary for a fair statement of results of operations for the interim periods.
Such adjustments are considered to be of a normal recurring nature unless
otherwise identified.
Comprehensive Income (Loss) -- The Company reports comprehensive income in
accordance with SFAS 130, Reporting Comprehensive Income. Comprehensive income
consists of net income (loss) and other gains and losses affecting shareholders'
equity that, under GAAP, are excluded from net income. From time to time, the
Company may recognize components of other comprehensive income such as
unrealized gains and losses on marketable equity investments and foreign
currency translation gains and losses. The Company had no accumulated other
comprehensive income (loss) as of September 30, 2004 and December 31, 2003.
Stock-Based Compensation -- Through December 31, 2002 and in accordance with
the provisions of SFAS 123, Accounting for Stock-based Compensation, the Company
elected to follow the Accounting Principles Board Opinion ("APB") 25, Accounting
for Stock Issued to Employees, and related interpretations in accounting for
awards under its employee stock-based compensation plans using the intrinsic
value method. Effective January 1, 2003, the Company adopted the fair value
method of accounting for stock-based compensation using the prospective method
of transition under SFAS 123. Under the prospective method and in accordance
with the provisions of SFAS 148, Accounting for Stock-Based Compensation --
Transition and Disclosure, the recognition provisions are applied to all
employee awards granted, modified or settled after January 1, 2003. See Note 14.
If the Company had elected to adopt the fair value recognition provisions of
SFAS 123 as of its original effective date, pro forma net loss and diluted net
loss per share would have been as follows (in millions, except per share
amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net loss, as reported ............................... $ (2.5) $ (35.0) $ (32.2) $ (258.7)
Add: stock-based employee compensation expense
included in reported net loss, net of related
tax effects .................................... 0.9 -- 7.0 0.1
Deduct: total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects ..... 0.9 0.1 7.0 0.2
-------- -------- -------- --------
Pro forma net loss .................................. $ (2.5) $ (35.1) $ (32.2) $ (258.8)
======== ======== ======== ========
Loss per share:
Basic and diluted-as reported .................... $ (0.04) $ (2.88) $ (0.59) $ (21.30)
Basic and diluted-pro forma ...................... $ (0.04) $ (2.89) $ (0.59) $ (21.31)
Variable Interest Entities -- In January 2003, the FASB issued
Interpretation No. 46, Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin No. 51 ("FIN 46"). FIN 46
requires that an enterprise consolidate a variable interest entity ("VIE") if
the enterprise has a variable interest that will absorb a majority of the
entity's expected losses and/or receives a majority of the entity's expected
residual returns as a result of ownership, contractual or other financial
interests in the entity, if such loss or residual return occurs. If one
enterprise absorbs a majority of a VIE's expected losses and another enterprise
receives a majority of that entity's expected residual returns, the enterprise
absorbing a majority of the expected losses is required to consolidate the VIE
and will be deemed the primary beneficiary for accounting purposes. The Company
adopted and applied the provisions of FIN 46, as amended, effective December 31,
2003. See Note 4.
10
Reclassifications -- Certain reclassifications have been made to prior
period amounts to conform to the current period's presentation.
NOTE 3 -- CAPITAL STOCK AND RELATED TRANSACTIONS
Capital Structure -- In February 2004, the Company amended its articles of
incorporation to, among other things, create two classes of common stock, Class
A and Class B, increase its authorized capital stock and to convert any issued
and outstanding shares of the Company's common stock into Class B common stock.
As amended, the Company's authorized capital stock consists of (i) 500,000,000
shares of Class A common stock, par value $.01 per share, and 260,000,000 shares
of Class B common stock, par value $.01 per share, and (ii) 50,000,000 shares of
preferred stock, par value $.01 per share. The Class B common stock is
convertible at any time, at the sole option of Transocean, into shares of Class
A common stock on a share per share basis.
Capital Stock Transactions and Retirement of Related Party Debt -- In
February 2004, prior to the Company's IPO, the Company exchanged $45.8 million
in principal amount of its outstanding 7.375% Senior Notes held by Transocean
Holdings Inc. (a wholly owned subsidiary of Transocean, "Transocean Holdings"),
plus accrued interest thereon, for 359,638 shares of the Company's Class B
common stock (4,367,714 shares of Class B common stock after giving effect to
the stock dividend discussed below). Immediately following this exchange, the
Company exchanged $152.5 million and $289.8 million principal amount of its
outstanding 6.75% and 9.5% Senior Notes, respectively, held by Transocean, plus
accrued interest thereon, for 3,580,768 shares of the Company's Class B common
stock (43,487,535 shares of Class B common stock after giving effect to the
stock dividend). The determination of the number of shares issued in the
exchange transactions was based on a method that took into account the IPO price
of $12.00 per share. The net effect of these transactions was to decrease notes
payable -- related party and interest payable -- related party by $528.9 million
with an offsetting increase in common stock of $0.5 million and additional
paid-in capital of $528.4 million.
Immediately following the debt-for-equity exchanges, the Company declared a
dividend of 11.145 shares of its Class B common stock with respect to each share
of its Class B common stock outstanding. The stock dividend of 11.145 shares of
Class B common stock for each outstanding share of Class B common stock was
retroactively applied to the 1,000,000 shares of common stock held by Transocean
prior to the debt-for-equity exchanges and has been reflected in the Company's
historical consolidated financial statements. The effect of this retroactive
application was to increase the authorized common shares of the Company's Class
B common stock to 260,000,000 shares and issued and outstanding to 12,144,751
shares as of December 31, 2003 with a corresponding decrease to additional
paid-in capital.
As a result of the debt-for-equity exchanges and stock dividend, Transocean
held an aggregate of 60,000,000 shares of Class B common stock prior to the
closing of the IPO. A portion of these shares (13,800,000) of Class B common
stock was converted into shares of Class A common stock and sold in the IPO.
Also in connection with the closing of the IPO, Transocean made additional
equity contributions totaling $2.8 million, including $1.0 million in
intercompany payable balances owed by the Company to Transocean as of the IPO
date.
Initial Public Offering and Related Events -- In February 2004, the Company
completed the IPO, with Transocean selling 13,800,000 shares of TODCO Class A
common stock at $12.00 per share. The Company did not receive any proceeds from
the initial sale of Class A common stock.
11
Before completion of the IPO, the Company entered into various agreements to
complete the separation of the Shallow Water business from Transocean, including
an employee matters agreement, a master separation agreement and a tax sharing
agreement. The master separation agreement provides for, among other things, the
assumption by the Company of liabilities relating to the Shallow Water business
and the assumption by Transocean of liabilities unrelated to the Shallow Water
business, including the indemnification of losses that may occur as a result of
certain of the Company's ongoing legal proceedings.
In February 2004, the Company recorded an increase in equity related to net
liabilities attributable to Transocean's business of $0.4 million for which
legal title had not been transferred to Transocean as of the IPO date in
accordance with the business indemnity between the Company and Transocean. The
indemnification by Transocean was recorded as a credit to additional paid-in
capital and a corresponding related party receivable from Transocean.
In conjunction with the IPO, the Company entered into a tax sharing
agreement with Transocean. See Note 10.
Secondary Stock Offering -- In September 2004, Transocean sold an additional
17,940,000 shares of TODCO Class A common stock at $15.75 per share in a
secondary public offering. Prior to the completion of the secondary stock
offering, Transocean converted 17,940,000 shares of the Company's Class B common
stock held by them into an equal number of shares of Class A common stock. The
Company did not receive any proceeds from this offering.
NOTE 4 -- DELTA TOWING
The Company owns a 25 percent equity interest in Delta Towing, a joint
venture formed to own and operate the Company's U.S. marine support vessel
business, consisting primarily of shallow water tugs, crewboats and utility
barges. The Company previously contributed its support vessel business to the
joint venture in return for a 25 percent ownership interest and certain secured
notes receivable from Delta Towing with a face value of $144.0 million. The
Company valued these notes at $80.0 million immediately prior to the Transocean
Merger. No value was assigned to the ownership interest in Delta Towing. The
note agreement was subsequently amended to provide for a $4.0 million,
three-year revolving credit facility which has since been cancelled. Delta
Towing's property and equipment, with a net book value of $41.6 million at
September 30, 2004, are collateral for the Company's notes receivable. The
remaining 75 percent ownership interest is held by Beta Marine LLC ("Beta
Marine"), which also loaned $3.0 million to Delta Towing. See Note 7.
As a result of its issuance of notes to the Company, Delta Towing is highly
leveraged. In January 2003, Delta Towing defaulted on the notes by failing to
make its scheduled quarterly interest payments and remains in default as a
result of its continued failure to make its quarterly interest payments, as well
as a scheduled principal repayment due in January 2004. As a result of the
Company's continued evaluation of the collectibility of the notes, the Company
recorded a $21.3 million impairment of the notes in September 2003 based on
Delta Towing's discounted cash flows over the terms of the notes, which
deteriorated in the second quarter of 2003 as a result of the continued decline
in Delta Towing's business outlook. As permitted in the notes in the event of
default, the Company began offsetting a portion of the amount owed by the
Company to Delta Towing against the interest due under the notes. Additionally,
in the third quarter of 2003, the Company established a $1.6 million reserve for
interest income earned during the quarter on the notes receivable.
Under FIN 46, Delta Towing is considered a VIE because its equity is not
sufficient to absorb the joint venture's expected future losses. The Company is
deemed to be the primary beneficiary of Delta Towing for accounting purposes
because it has the largest percentage of investment at risk through the secured
notes held by the Company and would thereby absorb the majority of the expected
losses of Delta Towing. The Company adopted FIN 46, as amended, and,
accordingly, consolidated Delta Towing effective December 31, 2003.
As of September 30, 2004 and December 31, 2003 all intercompany accounts
have been eliminated in consolidation as a result of the adoption of FIN 46, as
well as all intercompany transactions during the three and nine months ended
September 30, 2004.
12
Prior to December 31, 2003, the Company accounted for its investment in
Delta Towing under the equity method. In the three and nine months ended
September 30, 2003, the Company recorded $0.1 million and $2.6 million,
respectively, in equity losses related to Delta Towing, including the Company's
share of a $2.5 million non-cash impairment charge on the carrying value of idle
equipment recorded by the joint venture.
In addition, during the three and nine months ended September 30, 2003, the
Company earned interest income of $0 million and $3.3 million, respectively,
related to interest-bearing debt due from Delta Towing. During the three and
nine months ended September 30, 2003, the Company incurred charges totaling $3.4
million and $9.2 million, respectively, for services rendered by Delta Towing
under a charter agreement with the Company, which were reflected in operating
and maintenance -- related party expense.
The creditors of Delta Towing have no recourse to the general credit of the
Company.
NOTE 5 -- IMPAIRMENT OF LONG-LIVED ASSETS
In the second quarter of 2003, the Company decided to remove five jackup
rigs from drilling service and market the rigs for alternative uses. The Company
does not anticipate returning the five rigs to drilling service as it would be
cost prohibitive. As a result of this decision and in accordance with SFAS 144,
the Company tested the carrying value of the rigs for impairment during the
second quarter of 2003 and recorded a pre-tax $10.6 million non-cash impairment
charge as a result of the impairment test.
As a result of the lack of success of the original business strategy of
Energy Virtual Partners, Inc. and Energy Virtual Partners, LP, the Company
determined that the assets of those entities did not support the Company's $1.0
million recorded investment and recorded a pre-tax $1.0 million non-cash
impairment charge in the second quarter of 2003. The liquidation of these
entities was completed in early 2004.
The impairment losses noted above have been included in the Company's
reportable segments' results based on the segment of each of the assets
impaired. See Note 16.
NOTE 6 -- VENEZUELAN WORKING CAPITAL FACILITY AND FOREIGN CURRENCY MATTERS
In the second quarter of 2003, the Company established a currency valuation
allowance of $2.4 million pertaining to cash and receivables in Venezuela in
order to adjust the Company's Venezuelan financial assets to net realizable
value as of June 30, 2003. This valuation allowance was deemed necessary due to
the continuing political instability in Venezuela and the continuation of
foreign exchange controls, which limit the Company's ability to convert local
currency into U.S. dollars and transfer excess funds out of Venezuela. In
September 2004, the Company reversed $0.7 million of the currency valuation
allowance that was no longer deemed necessary due to a sustained decrease in the
net carrying value of assets denominated in the local currency in 2004,
primarily as a result of an agreement with the Company's primary customer in
Venezuela to pay the majority of the U.S. dollar denominated accounts receivable
in U.S. dollars to the Company in the United States.
Additionally, in response to the increase in U.S. dollar remittances, the
Company entered into an unsecured line of credit with a bank in Venezuela in the
third quarter of 2004 to provide a maximum of 4.5 million Venezuela Bolivars
($2.3 million U.S. dollars at the current exchange rate at September 30, 2004)
in order to establish a source of local currency to meet the Company's current
obligations in Venezuela Bolivars. Each draw on the line of credit is
denominated in Venezuela Bolivars and is evidenced by a 30-day promissory note
that bears interest at the then market rate as designated by the bank. The
promissory notes are pre-payable at any time at the Company's option; however,
if not repaid within 30 days, the promissory notes automatically renew for an
additional 30-day period at the then designated interest rate. There are no
commitment fees payable on the unused portion of the line of credit, and the
facility is reviewed annually by the bank's board of directors.
At September 30, 2004, the Company had $0.7 million (1.4 million Venezuela
Bolivars) in borrowings outstanding with respect to the line of credit, which
bear interest at 17 percent per annum. This amount is reported as short-term
debt in the Company's condensed consolidated balance sheet at September 30,
2004.
13
NOTE 7 -- LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt and capital lease obligations, net of unamortized discounts,
premiums, and fair value adjustments, were comprised of the following (in
millions):
THIRD PARTY RELATED PARTY
-------------------------------- --------------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
2004 2003 2004 2003
------------- ------------- ------------- -------------
6.75% Senior Notes, due April 2005 ..... $ 7.8 $ 7.8 $ -- $ 153.2
6.95% Senior Notes, due April 2008 ..... 2.2 2.2 -- --
7.375% Senior Notes, due April 2018 .... 3.5 3.5 -- 45.9
9.5% Senior Notes, due December 2008 ... 11.3 11.4 -- 322.9
Other Debt ............................. -- -- 3.0 3.0
Capital Lease Obligations .............. 0.8 1.9 -- --
------------- ------------- ------------- -------------
Total ................................ 25.6 26.8 3.0 525.0
Less debt due within one year ........ 8.2 1.2 3.0 3.0
------------- ------------- ------------- -------------
Total long-term debt ................. $ 17.4 $ 25.6 $ -- $ 522.0
============= ============= ============= =============
6.75%, 6.95%, 7.375% and 9.5% Senior Notes and Exchange Offer -- In March
2002, Transocean and the Company completed exchange offers and consent
solicitations for the Company's 6.5%, 6.75%, 6.95%, 7.375%, 9.125% and 9.5%
Senior Notes (the "Exchange Offer"). As a result of the Exchange Offer,
approximately $234.5 million, $342.3 million, $247.8 million, $246.5 million,
$76.9 million and $289.8 million principal amount of the Company's outstanding
6.75%, 6.95%, 7.375% and 9.5% senior notes, respectively, were exchanged by
Transocean (the "Exchanged Notes") for newly issued Transocean notes having the
same principal amount, interest rate, redemption terms and payment and maturity
dates. Both the Exchanged Notes and the notes not exchanged remained the
obligation of the Company as Transocean became the holder of the Exchanged
Notes.
In April 2003, the Company repaid the entire $5.0 million principal amount
outstanding of the 6.5% Senior Notes payable to third parties, plus accrued and
unpaid interest, in accordance with their scheduled maturities.
In the first half of 2003, the Company retired $529.7 million of its
outstanding Exchanged Notes and other notes payable to Transocean (see " --
Transocean Revolver"), in separate transactions, as consideration for the sale
of certain of the Transocean Assets to Transocean. See Note 15 for a further
discussion of these individual transactions and retirement of related party
debt.
In February 2004, prior to the Company's IPO, the Company exchanged $488.1
million in principal amount of the then outstanding Exchanged Notes, plus
accrued interest thereon, for 3,940,406 shares of the Company's Class B common
stock (47,855,249 shares of Class B common stock after giving effect to the
stock dividend, as described in Note 3). There were no Exchanged Notes payable
to Transocean outstanding at September 30, 2004.
In connection with the Exchange Offer, the Company had made an aggregate of
$8.3 million in consent payments to holders of the notes that were exchanged.
The consent payments were amortized as an increase to interest expense over the
remaining terms of the exchanged notes using the interest method and amounted to
$0.1 million and $0.4 million for the three and nine months ended September 30,
2003, respectively. In connection with the retirement of the Exchanged Notes
prior to the completion of the IPO, the Company expensed the remaining balance
of these deferred consent fees of approximately $1.9 million in February 2004,
which has been reflected as a loss on retirement of debt in the Company's
condensed consolidated statement of operations.
The Company recognized $0.5 million, $1.2 million, $0.6 million and $1.9
million in interest expense during the three and nine months ended September 30,
2004 and 2003, respectively, related to its senior notes held by third parties.
The Company also recognized $0, $3.1 million, $8.4 million and $34.2 million in
interest expense--related party during the three and nine months ended September
30, 2004 and 2003, respectively, related to the Exchanged Notes held by
Transocean.
14
At September 30, 2004, approximately $7.7 million, $2.2 million, $3.5
million, and $10.2 million principal amount of the 6.75%, 6.95%, 7.375%, and
9.5% Senior Notes, respectively, due to third parties were outstanding. The fair
value of these notes at September 30, 2004 was approximately $7.8 million, $2.3
million, $3.3 million, and $11.3 million, respectively, based on the estimated
yield to maturity which takes into account TODCO's credit worthiness as a
separate entity.
$75 Million Revolving Credit Facility -- In December 2003, the Company
entered into a two-year $75 million floating-rate secured revolving credit
facility that will decline to $60 million in December 2004. The facility is
secured by most of the Company's drilling rigs, receivables, and the stock of
most of its U.S. subsidiaries and is guaranteed by some of its subsidiaries.
Borrowings under the facility bear interest at our option at either (1) the
higher of (A) the prime rate and (B) the federal funds rate plus 0.5 percent,
plus a margin in either case of 2.50 percent or (2) the Eurodollar rate plus a
margin of 3.50 percent. Commitment fees on the unused portion of the facility
are 1.5 percent of the average daily balance and are payable quarterly.
Borrowings and letters of credit issued under the facility are limited by a
borrowing base equal to the lesser of (A) 20 percent of the orderly liquidated
value of the drilling rigs securing the facility, as determined from time to
time by a third party selected by the agent under the facility, and (B) the sum
of 10 percent of the orderly liquidated value of the drilling rigs securing the
facility plus 80 percent of the U.S. accounts receivable outstanding less than
90 days, net of any provision for bad debt associated with such U.S. accounts
receivable.
Financial covenants include maintenance of certain financial and other
ratios, including working capital, liquidity, and debt-to-total capitalization
ratios, and a minimum tangible net worth by the Company.
The revolving credit facility provides, among other things, for the issuance
of letters of credit that the Company may utilize to guarantee its performance
under some drilling contracts, as well as insurance, tax and other obligations
in various jurisdictions. The facility also provides for customary fees and
expense reimbursements and includes other covenants (including limitations on
the incurrence of debt, mergers and other fundamental changes, asset sales and
dividends) and events of default (including a change of control) that are
customary for similar secured non-investment grade facilities.
As of September 30, 2004 and December 31, 2003, the Company had no
borrowings outstanding under this facility.
During the three and nine months ended September 30, 2004, the Company
recognized $0.3 million and $0.9 million, respectively, in interest expense
related to commitment fees on the unused portion of the facility and amortized
$0.3 million and $0.9 million, respectively, in deferred financing costs as a
component of interest expense in the same periods.
Other Debt -- Related Party -- In connection with the acquisition of the
U.S. marine support vessel business, Delta Towing entered into a $3.0 million
note agreement with Beta Marine dated January 30, 2001. The note bears interest
at 8 percent per annum, payable quarterly. The $3.0 million note has been
classified as a current obligation in the Company's condensed consolidated
balance sheet at September 30, 2004 and December 31, 2003 as Delta Towing
remains in default on this note payable to a related party. In the first nine
months of 2004, Delta Towing repaid a portion of accrued interest payable to
Beta Marine from proceeds from the sales of five marine vessels. The Company has
no obligation to fund this debt on behalf of Delta Towing. Interest expense
related to the note agreement with Beta Marine was $0.1 million and $0.2 million
for the three and nine months ended September 30, 2004, respectively.
Capital Lease Obligations -- From time to time the Company enters into
capital lease agreements for certain drilling equipment. In January 2004 and
during 2003, the Company entered into three such capital lease agreements and
exercised options to buy-out the remaining terms of these lease agreements for
$2.3 million in the second quarter of 2004. In August 2004, the Company entered
into a two-year capital lease agreement with a final maturity date in July 2006.
Future lease payments under this agreement are $0.8 million, including principal
and interest of which $0.1 million, $0.4 million and $0.3 million are payable in
2004, 2005 and 2006, respectively.
15
Transocean Revolver -- The Company was party to a $1.8 billion two-year
revolving credit agreement (the "Transocean Revolver") with Transocean, dated
April 6, 2001. Amounts outstanding under the Transocean Revolver bore interest
quarterly at a rate of the London Interbank Offered Rate plus 0.575 percent to
1.3 percent depending on Transocean's non-credit enhanced senior unsecured
public debt rating. On April 6, 2003 the approximately $81.2 million then
outstanding under the Transocean Revolver was converted into a 2.76 percent
fixed rate promissory note, which was cancelled in full in connection with the
sale of certain of the Transocean Assets to Transocean in September 2003. During
the three and nine months ended September 30, 2003, the Company recognized
interest expense of $0 and $0.8 million, respectively, related to the Transocean
Revolver.
NOTE 8 -- OTHER CURRENT LIABILITIES
Other current liabilities are comprised of the following (in millions):
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------ ------------
Accrued self-insurance claims............. $ 27.1 $ 28.0
Deferred income........................... 1.4 7.3
Accrued payroll and employee benefits..... 5.8 5.7
Accrued taxes, other than income.......... 3.6 1.6
Accrued interest.......................... 0.9 0.2
Other..................................... 1.0 0.6
------- -------
Total other current liabilities......... $ 39.8 $ 43.4
======= =======
NOTE 9 -- SUPPLEMENTARY CASH FLOW INFORMATION
Supplementary information about non-cash financing activities relating to
both continuing and discontinued operations is as follows (in millions):
NINE MONTHS ENDED
SEPTEMBER 30,
2004 2003
-------- --------
Non-cash financing activities:
Net distribution of assets to parent(a)........................ $ -- $ 224.7
Debt-for-equity exchange (b)................................... (528.9) --
Equity contributions from parent, net of distributions(c)...... 167.9 --
- ----------
(a) In the first half of 2003, four subsidiaries, ownership interests in two
majority-owned subsidiaries, a platform rig and certain other assets were
sold or distributed to affiliated companies (see Note 15). The $103.9
million in cash held by subsidiaries at the time of the sales or
distributions was reflected in financing activities in the consolidated
statement of cash flows. The non-cash effect on the consolidated balance
sheet was reflected as a decrease in accounts receivable-trade and other
receivables of $21.4 million, a decrease in accounts receivable-related
party of $298.8 million, an $8.3 million decrease in other current assets, a
$752.2 million decrease in non-current assets related to discontinued
operations, a $39.0 million decrease in other assets, a decrease in accounts
payable trade and other current liabilities of $31.9 million, a decrease in
accounts payable-related party of $108.4 million, a $15.5 million decrease
in deferred taxes, a decrease in other long-term liabilities of $28.3
million, a decrease in notes payable of $88.0 million, a $524.7 million
decrease in long-term debt-related party, a $98.2 million decrease in
minority interest and a decrease in additional paid-in capital of $224.7
million.
(b) Prior to the closing of the Company's IPO in February 2004, the Company
completed a non-cash exchange of $528.9 million in long-term related party
notes payable to Transocean and related accrued interest payable for shares
of the Company's Class B common stock (see Notes 3 and 7).
(c) In connection with the closing of the IPO, the Company completed certain
equity transactions related to the Company's separation from Transocean. In
February 2004, the Company recorded business and tax indemnities of the
Company by Transocean of $10.7 million as an increase in accounts
receivable-related party and an increase in additional paid-in capital and
transferred to Transocean $1.0 million of intercompany payable balances as
of the IPO date as an increase in additional paid-in capital (see Note 3).
Additionally, the Company recorded the book transfer of substantially all
pre-closing income tax benefits to Transocean of $181.4 million as a
decrease in deferred income tax assets and a decrease in additional paid-in
capital.
NOTE 10 -- INCOME TAXES
In conjunction with the IPO, the Company entered into a tax sharing
agreement with Transocean whereby Transocean will indemnify the Company against
substantially all pre-IPO income tax liabilities. However, the Company must pay
Transocean for substantially all pre-closing income tax benefits utilized
subsequent to the closing of the IPO. As of September 30, 2004, the Company had
approximately $535 million of estimated pre-
16
closing income tax benefits subject to this obligation to reimburse Transocean
of which approximately $173 million of the tax benefits were reflected in the
Company's December 31, 2003 historical financial statements. The additional
estimated tax benefits resulted from the closing of the IPO, specified ownership
changes, statutory allocations of tax benefits among Transocean's consolidated
group members and other events. Depending upon certain tax planning strategies
that may be executed by Transocean and actual Transocean taxable income for
2004, this pre-closing tax benefit amount will change and is currently estimated
to be approximately $360 million.
As part of the tax sharing agreement, the Company must pay Transocean for
substantially all pre-closing income tax benefits utilized or deemed to have
been utilized subsequent to the closing of the IPO. Accordingly, the Company
recorded an equity transaction in February 2004 to reflect this liability to
Transocean of approximately $174 million, equal to the pre-closing income tax
benefits as a corresponding obligation within the deferred income tax asset
accounts and a reduction in additional paid-in capital. In September 2004, as a
result of a 2003 return-to-provision adjustment, the liability to Transocean was
revised to approximately $182 million, and the Company recorded an equity
adjustment of $7.7 million and the additional liability to Transocean as a
reduction in additional paid-in capital and an obligation within the deferred
income tax asset accounts. This adjustment had no effect on the Company's
results of operations.
In addition, Transocean agreed to indemnify TODCO for certain tax
liabilities that existed as of the IPO date of $10.3 million. The tax
indemnification by Transocean was recorded as a credit to additional paid-in
capital with a corresponding offset to a related party receivable from
Transocean.
The Company currently anticipates that it will be in a net tax liability
position at the end of 2004 and expects to utilize a portion of the pre-closing
income tax benefits to offset its federal income tax obligation. As of September
30, 2004, the Company had utilized $3.7 million of these pre-closing income tax
benefits to offset its current federal income tax obligation for the nine months
then ended. The liability to Transocean for the utilization of these pre-closing
income tax benefits of $1.3 million is presented within accrued income taxes -
related party in the Company's condensed balance sheet at September 30, 2004 and
is payable January 15, 2005.
Additionally, the tax sharing agreement provides that if any person other
than Transocean or its subsidiaries becomes the beneficial owner of greater than
50% of the total voting power of the Company's outstanding voting stock, it will
be deemed to have utilized all of these pre-closing tax benefits, and the
Company will be required to pay Transocean an amount for the deemed utilization
of these tax benefits adjusted by a specified discount factor. This payment is
required even if the Company is unable to utilize the pre-closing tax benefits.
If an acquisition of beneficial ownership had occurred on September 30, 2004,
the estimated amount that the Company would have been required to pay to
Transocean would have been approximately $290 million based upon Transocean's
tax planning strategies and estimated 2004 taxable income.
The Company had an "ownership change" for purposes of Section 382 of the
Internal Revenue Code of 1986, as amended, in connection with its secondary
stock offering. As a result, the Company's ability to utilize certain of its tax
benefits is subject to an annual limitation. However, the Company believes that,
in light of the amount of the annual limitation, it should not have a material
effect on the Company's ability to utilize its tax benefits for the foreseeable
future.
The tax sharing agreement with Transocean provides that the Company must pay
Transocean for most pre-closing tax benefits that are utilized on a tax return
with respect to a period after the closing of the IPO. If the utilization of a
pre-closing tax benefit defers or precludes the Company's utilization of any
post-closing tax benefit, its payment obligation with respect to the pre-closing
tax benefit generally will be deferred until the Company actually utilizes that
post-closing tax benefit. This payment deferral will not apply with respect to,
and the Company will have to pay currently for the utilization of pre-closing
tax benefits to the extent of:
- up to 20% of any deferred or precluded post-closing tax benefit
arising out of the Company's payment of foreign income taxes, and
- 100% of any deferred or precluded post-closing tax benefit arising
out of a carryback from a subsequent year.
17
Therefore, the Company may not realize the full economic value of tax
deductions, credits and other tax benefits that arise post-closing until it has
utilized all of the pre-closing tax benefits, if ever.
Until February 2004, the Company was a member of an affiliated group that
includes its parent company, Transocean Holdings. Current and deferred taxes are
allocated based upon what the Company's tax provision (benefit) would have been
had the Company filed a separate tax return.
Income taxes have been provided based upon the tax laws and rates in the
countries in which operations are conducted and income is earned. Deferred tax
assets and liabilities are recognized for the anticipated future tax effects of
temporary differences between the financial statement basis and the tax basis of
the Company's assets and liabilities using the applicable tax rates in effect. A
valuation allowance for deferred tax assets is recorded when it is more likely
than not that some or all of the benefit from the deferred tax assets will not
be realized.
The amount of tax benefit recognized is primarily dependent on the loss
realized and the valuation of operating loss carryforwards during the period.
For the nine months ended September 30, 2003, the Company provided additional
taxes of $5.8 million for a portion of losses of RBF Rig Corporation for which a
deferred tax benefit had been previously provided.
NOTE 11 -- COMMITMENTS AND CONTINGENCIES
In October 2001, the Company was notified by the U.S. Environmental
Protection Agency ("EPA") that the EPA had identified a subsidiary of the
Company as a potentially responsible party in connection with the Palmer Barge
Line superfund site located in Port Arthur, Jefferson County, Texas. Based upon
the information provided by the EPA and the Company's review of its internal
records to date, the Company disputes its designation as a potentially
responsible party and does not expect that the ultimate outcome of this case
will have a material adverse effect on its business or consolidated financial
position. The Company continues to monitor this matter.
In December 2002, the Company received an assessment for corporate income
taxes from SENIAT, the national Venezuelan tax authority, of approximately $16.0
million (based on the current exchange rates at the time of the assessment)
relating to calendar years 1998 through 2000. In March 2003 the Company paid
approximately $2.6 million of the assessment, plus approximately $0.3 million in
interest, and the Company is contesting the remainder of the assessment. After
the Company made the partial assessment payment, the Company received a revised
assessment in September 2003 of approximately $18.8 million (based on the
current exchange rates at the time of the assessment and inclusive of
penalties). The resolution of this assessment is not expected to impact the
Company as Transocean has agreed to indemnify the Company against any payments
as long as it cooperates and provides assistance to Transocean in resolution of
the assessment.
The Company has recently learned that certain of its subsidiaries have been
named, along with other defendants, in several complaints that have been filed
in the Circuit Courts of the State of Mississippi involving over 700 persons
that allege personal injury arising out of asbestos exposure in the course of
their employment by some of these defendants between 1965 and 1986. The
complaints also name as defendants certain of Transocean's subsidiaries to whom
the Company may owe indemnity and other unaffiliated defendant companies,
including companies that allegedly manufactured drilling related products
containing asbestos that are the subject of the complaints. The number of
unaffiliated defendant companies involved in each complaint ranges from
approximately 20 to 70. The complaints allege that the defendant drilling
contractors used those asbestos- containing products in offshore drilling
operations, land based drilling operations and in drilling structures, drilling
rigs, vessels and other equipment and assert claims based on, among other
things, negligence and strict liability, and claims authorized under the Jones
Act. The plaintiffs seek, among other things, awards of unspecified compensatory
and punitive damages. Based on a recent decision of the Mississippi Supreme
Court, the Company anticipates that the trial courts may grant motions requiring
each plaintiff to name the specific defendant or defendants against whom such
plaintiff makes a claim and the time period and location of asbestos exposure so
that the cases may be properly severed. These complaints were only recently
filed and the Company has not yet had an opportunity to conduct any discovery
nor has it been able to determine the number of plaintiffs, if any, that were
employed by it's subsidiaries or Transocean's subsidiaries or otherwise have any
connection with the Company's or Transocean's drilling operations. The Company
intends to defend itself vigorously and, based on the limited information
available to it at
18
this time, the Company does not expect the ultimate outcome of these lawsuits to
have a material adverse effect on its business or consolidated financial
position.
Due to the limited information available to the Company at this time, the
Company has not yet made a determination whether it or Transocean is financially
responsible under the terms of the master separation agreement for any losses
the Company or Transocean may incur as a result of the legal proceedings
described in the foregoing paragraph.
Under the master separation agreement, Transocean has agreed to indemnify
the Company for any losses it incurs as a result of the legal proceedings
described in the following three paragraphs. See Note 3.
In March 1997, an action was filed by Mobil Exploration and Producing U.S.
Inc. and affiliates, St. Mary Land & Exploration Company and affiliates and
Samuel Geary and Associates, Inc. against a subsidiary of the Company, Cliffs
Drilling, its underwriters at Lloyd's (the "Underwriters") and an insurance
broker in the 16th Judicial District Court of St. Mary Parish, Louisiana. The
plaintiffs alleged damages amounting to in excess of $50 million in connection
with the drilling of a turnkey well in 1995 and 1996. The case was tried before
a jury in January and February 2000, and the jury returned a verdict of
approximately $30 million in favor of the plaintiffs for excess drilling costs,
loss of insurance proceeds, loss of hydrocarbons, expenses and interest. The
Company and the Underwriters appealed such judgment, and the Louisiana Court of
Appeals reduced the amount for which the Company may be responsible to less than
$10 million. The plaintiffs requested that the Supreme Court of Louisiana
consider the matter and reinstate the original verdict. The Company and the
Underwriters also appealed to the Supreme Court of Louisiana requesting that the
Court reduce the verdict or, in the case of the Underwriters, eliminate any
liability for the verdict. Prior to the Supreme Court of Louisiana ruling on
these petitions, the Company settled with the St. Mary group of plaintiffs and
the State of Louisiana. Subsequently, the Supreme Court of Louisiana denied the
applications of all remaining parties. The Company has settled with all
remaining plaintiffs. The Company believes that any amounts, apart from a small
deductible, paid in settlement are covered by relevant primary and excess
liability insurance policies. However, the insurers and Underwriters have denied
all coverage. The Company has instituted litigation against those insurers and
Underwriters to enforce its rights under the relevant policies. One group of
insurers has asserted a counterclaim against the Company claiming that they
issued the policy as a result of a misrepresentation. The settlements did not
have a material adverse effect on the Company's business or consolidated
financial position, and the Company does not expect the ultimate outcome of the
case involving the insurers and Underwriters will have a material adverse effect
on its business or consolidated financial position.
In 1984, in connection with the financing of the corporate headquarters, at
that time, for ("R&B"), a predecessor to one of the Company's subsidiaries, in
Tulsa, Oklahoma, the Greater Southwestern Funding Corporation ("Southwestern")
issued and sold, among other instruments, Zero Coupon Series B Bonds due 1999
through 2009 with an aggregate $189 million value at maturity. Paine Webber
Incorporated purchased all of the Series B Bonds for resale and in 1985 acted as
underwriter in the public offering of most of these bonds. The proceeds from the
sale of the bonds were used to finance the acquisition and construction of the
headquarters. R&B's rental obligation was the primary source for repayment of
the bonds. In connection with the offering, R&B entered into an indemnification
agreement to indemnify Southwestern and Paine Webber from loss caused by any
untrue statement or alleged untrue statement of a material fact or the omission
or alleged omission of a material fact contained or required to be contained in
the prospectus or registration statement relating to that offering. Several
years after the offering, R&B defaulted on its lease obligations, which led to a
default by Southwestern. Several holders of Series B bonds filed an action in
Tulsa, Oklahoma in 1997 against several parties, including Paine Webber,
alleging fraud and misrepresentation in connection with the sale of the bonds.
In response to a demand from Paine Webber in connection with that lawsuit and a
related lawsuit, R&B agreed in 1997 to retain counsel for Paine Webber with
respect to only that part of the referenced cases relating to any alleged
material misstatement or omission relating to R&B made in certain sections of
the prospectus or registration Statement. The agreement to retain counsel did
not amend any rights and obligations under the indemnification agreement. There
has been only limited progress on the substantive allegations in the case. The
trial court has denied class certification, and the plaintiffs' appeal of this
denial to a higher court has been denied. The plaintiffs have further appealed
that decision. The Company disputes that there are any matters requiring the
Company to indemnify Paine Webber. In any event, the Company does not expect
that the ultimate outcome of this matter will have a material adverse effect on
its business or consolidated financial position.
19
In April 2003, Gryphon Exploration Company ("Gryphon") filed suit against
some of the Company's subsidiaries, Transocean and other third parties in the
United States District Court in Galveston, Texas claiming damages in excess of
$6 million. In its complaint, Gryphon alleges the defendants were responsible
for well problems experienced by Gryphon with respect to a well in the Gulf of
Mexico drilled by the Company's subsidiaries in 2001. The Company disputes the
allegations of Gryphon and intends to vigorously defend this claim. While the
Company continues to investigate this matter, the Company does not currently
expect the ultimate outcome of this matter to have a material adverse effect on
its business or consolidated financial position.
The Company and its subsidiaries are involved in a number of other
lawsuits, all of which have arisen in the ordinary course of the Company's
business. The Company does not believe that ultimate liability, if any,
resulting from any such other pending litigation will have a material adverse
effect on its business or consolidated financial position.
The Company cannot predict with certainty the outcome or effect of any of
the litigation matters specifically described above or of any such other pending
litigation. There can be no assurance that the Company's belief or expectations
as to the outcome or effect of any lawsuit or other litigation matter will prove
correct and the eventual outcome of these matters could materially differ from
management's current estimates.
Surety Bonds -- As is customary in the contract drilling business, the
Company also has various surety bonds totaling $12.3 million in place as of
September 30, 2004 that secure customs obligations and certain performance and
other obligations. These bonds were issued primarily in connection with the
Company's contracts with PEMEX. These bonds have been issued under a Transocean
facility. The master separation agreement with Transocean requires the Company
to use its best efforts to replace this facility with its own and to indemnify
Transocean for any claims related to the bonds. Transocean has agreed to leave
these bonds in place, subject to certain conditions.
NOTE 12 -- OTHER RELATED PARTY TRANSACTIONS
Allocation of Administrative Costs -- Prior to September 30, 2003 and the
transfer of the Transocean Assets to Transocean, general and administrative
expense included an allocation from Transocean for certain administrative
support based on estimates of the percentage of work the individual Transocean
departments performed for the Company. In the opinion of management, Transocean
has charged the Company for all costs incurred on its behalf under a
comprehensive and reasonable cost allocation method. After September 30, 2003,
general and administrative expense includes costs for services provided to us
under a transition services agreement with Transocean. The amount of expense
allocated or charged to the Company was $0.1 million, $0.3 million, $0.1 million
and $1.4 million for the three and nine months ended September 30, 2004 and
2003, respectively, which was classified as general and administrative --
related party expense.
Working Capital Contribution -- The master separation agreement between
the Company and Transocean contains an acknowledgement that the Company's cash
and cash equivalents were $25.0 million as of June 30, 2003. In August 2003,
Transocean paid the Company $11.4 million in order for the Company to have the
amount of cash and cash equivalents agreed to in the master separation
agreement. The amount paid by Transocean equaled the difference between $25.0
million and the amount of the Company's cash and cash equivalents as of June 30,
2003, prior to giving effect to the payment by Transocean. The master separation
agreement provides that the Company will retain all cash and cash equivalents
generated by the Shallow Water business following June 30, 2003. Transocean is
not required to make any additional payments to the Company for working capital
needs under the master separation agreement.
NOTE 13 -- EARNINGS (LOSS) PER SHARE
The Company's basic earnings (loss) per share, which is based upon the
weighted average common shares outstanding without the dilutive effects of
common stock equivalents (options, warrants, etc.), was $(0.04), $(0.59),
$(2.88) and $(21.30) for the three and nine months ended September 30, 2004 and
2003, respectively. For the three and nine months ended September 30, 2004,
there were 1,658,617 and 1,408,180 weighted average options outstanding to
purchase Class A common stock of the Company, respectively, at a weighted
average exercise price of $12.03 that were not included in the computation of
diluted earnings per share because the effect of including the
20
incremental shares was anti-dilutive for the periods. There were no common stock
equivalents outstanding during 2003. No adjustments to net loss were made in
calculating diluted earnings (loss) per share for the three-month and nine-month
periods ended September 30, 2004 and 2003.
NOTE 14 -- STOCK-BASED COMPENSATION PLANS
TODCO Long-Term Incentive Plan -- In February 2004, the Company adopted a
long-term incentive plan for certain employees and non-employee directors of the
Company in order to provide additional incentives through the grant of awards
(the "Plan"). The Plan provides for the grant of options to purchase shares of
the Company's Class A common stock, restricted stock, deferred stock units,
share appreciation rights, cash awards, supplemental payments to cover tax
liabilities associated with the aforementioned types of awards, and performance
awards. Most awards under the Plan vest over a three-year period. A maximum of
3,000,000 shares of the Company's Class A common stock has been reserved for
issuance under the Plan.
In conjunction with the closing of the IPO, the Company granted options to
purchase 1,633,617 shares of the Company's Class A common stock at an exercise
price of $12.00 per share, of which, options to purchase 705,000 shares of
common stock vested immediately on the IPO date. The remainder of the options
has a weighted average vesting period of approximately 2.24 years and a
contractual life of 10 years. In May 2004, the Company granted options to
purchase 25,000 shares of the Company's Class A common stock at an exercise
price of $13.78 to non-employee directors of the Company, which vested
immediately on the grant date.
The following table summarizes information about TODCO stock options held
by employees and non-employee directors of the Company at September 30, 2004:
WEIGHTED- OPTIONS OUTSTANDING OPTIONS EXERCISABLE
AVERAGE ----------------------------------- ----------------------------------
RANGE OF REMAINING NUMBER WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
EXERCISE PRICES CONTRACTUAL LIFE OUTSTANDING EXERCISE PRICE OUTSTANDING EXERCISE PRICE
- ------------------ ------------------ ------------- -------------------- ------------ -------------------
$12.00-$13.78 9.37 years 1,658,617 $12.03 730,000 $ 12.06
The fair value of the options granted under the Plan in 2004 was estimated
using the Black-Scholes options pricing model with the following weighted
average assumptions:
Dividend yield......................................... 0.00%
Expected price volatility.............................. 55.2%
Risk-free interest rate................................ 3.20%
Expected life of options (in years).................... 5.0
Weighted-average fair value of options granted......... $7.94
The Company recognized compensation expense of $0.8 million and $7.9
million related to stock options granted under the Plan during the three and
nine months ended September 30, 2004, respectively.
Also in conjunction with the IPO, the Company granted 294,175 shares of
restricted stock to certain employees and non-employee directors of the Company
with a weighted average vesting period of 2.39 years. These IPO-related awards
of restricted stock were valued at $14.39 per share and were recorded as
unearned compensation. Additionally, in May 2004, the Company granted 15,000
shares of restricted stock to non-employee directors of the Company with a
vesting period of 10 years. The May 2004 awards of restricted stock were valued
at $13.70 per share and were recorded as unearned compensation. The value of
these awards will be amortized as compensation expense over the vesting period
of the stock awards. During the first nine months of 2004, 6,285 shares of
restricted stock (valued at $14.39 per share) were forfeited and are available
for re-issuance under the Plan. Unearned compensation relating to the Company's
restricted stock awards of $3.0 million at September 30, 2004 is shown as a
reduction of shareholders' equity. Compensation expense recognized for the three
and nine months ended September 30, 2004 related to stock awards totaled $0.5
million and $1.4 million, respectively.
Transocean Stock Options -- Certain of the Company's employees hold
options to acquire Transocean ordinary shares, which were granted prior to the
IPO under the Transocean Incentive Plan. The employees holding these options
were treated as terminated for the convenience of Transocean on the IPO date. As
a result, the 250,797 options outstanding on February 10, 2004 became fully
vested and were modified to remain exercisable over the
21
original contractual life. In connection with the modification of these options,
the Company recognized $1.5 million of additional compensation expense in the
first quarter of 2004. No further compensation expense will be recorded in the
future related to the Transocean options.
NOTE 15 -- DISCONTINUED OPERATIONS
There were no revenues related to discontinued operations for the three
and nine months ended September 30, 2004. Operating revenues related to
discontinued operations were $0 and $53.4 million for the three and nine months
ended September 30, 2003, respectively.
At September 30, 2004, liabilities related to discontinued operations
consisted primarily of other current liabilities of $0.2 million. At December
31, 2003, net liabilities related to discontinued operations consisted of other
current receivables of $0.1 million and accounts payable and other current
liabilities of $0.5 million.
During the first quarter of 2003, the Company transferred to Transocean
certain of the Transocean Assets, including distributions in-kind of certain
accounts receivable balances from related parties, a 12.5 percent undivided
interest in an aircraft, the stock of two subsidiaries of the Company, R&B
Falcon (A) Pty. Ltd. and Cliffs Drilling de Brasil Servicos de Petroleo S/C
Ltda., and other miscellaneous Transocean Assets with an aggregate net book
value of $247.9 million. These transactions were recorded as decreases to
additional paid-in capital. In March 2003, the Company also assigned the
drilling contract for the Deepwater Frontier to Transocean for no consideration.
In addition, certain assets were sold to Transocean during the first half
of 2003. In March 2003, the Company sold the stock of Arcade Drilling AS for net
proceeds of $264.1 million and recorded a net pre-tax loss of $11.0 million,
which is included in the results of discontinued operations. The sale
transaction was at fair value determined based on an independent third party
appraisal. In consideration for the sale of the subsidiary, Transocean cancelled
$233.3 million principal amount of the Company's 6.95% notes due April 2008. The
market value attributable to the notes, 113.21 percent of the principal amount,
was based on available market information. The Company recorded a net pre-tax
loss of approximately $30.0 million in the first quarter of 2003 related to the
retirement of these notes.
In May 2003, the Company sold Cliffs Platform Rig 1 to Transocean in
consideration for the cancellation of $13.9 million of the 6.95% Exchanged
Notes. The Company recorded the excess of the sales price over the net book
value of $1.6 million as an increase to additional paid-in capital and a pre-tax
loss on the retirement of debt of $1.5 million in the second quarter of 2003.
Also in May 2003, the Company sold its 50 percent interest in Deepwater
Drilling L.L.C. ("DD LLC"), and its 60 percent interest in Deepwater Drilling II
L.L.C. ("DDII LLC") in consideration for the cancellation of $43.7 million
principal amount of the Company's debt held by Transocean. The value of the
Company's interests in DD LLC and DDII LLC was determined based on a similar
third party transaction. The Company recorded the excess of the sales price over
the net book value of the membership interests of $21.6 million as an increase
to additional paid-in capital.
In June 2003, the Company sold its membership interests in its
wholly-owned subsidiary, R&B Falcon Drilling (International & Deepwater) Inc.
LLC. As consideration for the interests sold, Transocean cancelled $238.8
million of the Company's outstanding debt held by them. The sales transaction
was based on a valuation which took into account valuations of the drilling
units owned by the entities sold. The Company recorded the excess of the net
book value over the sales price of the membership interests of $60.9 million as
a loss on sale of assets, which was included in the results of discontinued
operations, and a pre-tax loss on the retirement of debt of $48.0 million in the
second quarter of 2003.
NOTE 16 -- SEGMENTS, GEOGRAPHICAL ANALYSIS AND MAJOR CUSTOMERS
The Company's drilling assets consist of jackup and submersible drilling
rigs and inland drilling barges located in the U.S. Gulf of Mexico and Trinidad,
two jackup drilling rigs and a platform rig in Mexico, as well as land and lake
barge drilling units located in Venezuela. The Company provides contract oil and
gas drilling services and reports the results of those operations in three of
the Company's business segments which correspond to the
22
principal geographic regions in which the Company operates: U.S. Gulf of Mexico,
U.S. Inland Barge Segment and Other International Segment. The Company also has
a partial interest in a joint venture that operates a fleet of U.S. marine
support vessels, which is reported in the Delta Towing Segment. The accounting
policies of the reportable segments are the same as those described in Note 2.
Revenue, depreciation, operating income (loss) and identifiable assets by
reportable business segment was as follows (in millions):
U.S. GULF OF U.S. INLAND OTHER DELTA
MEXICO BARGE INTERNATIONAL TOWING CORPORATE
SEGMENT SEGMENT SEGMENT SEGMENT & OTHER(A) TOTAL
------------ ----------- ------------- ------- ---------- ---------
THREE MONTHS ENDED:
SEPTEMBER 30, 2004
Revenues $ 37.1 $ 28.7 $ 19.0 $ 8.3 $ -- $ 93.1
Depreciation 12.4 5.6 4.7 1.1 -- 23.8
Operating income (loss) 2.4 2.8 (1.6) (0.1) (5.8) (2.3)
SEPTEMBER 30, 2003
Revenues $ 28.3 $ 19.3 $ 10.9 $ -- $ -- $ 58.5
Depreciation 14.1 5.7 3.0 -- -- 22.8
Operating loss (8.7) (11.6) (0.5) -- (4.0) (24.8)
NINE MONTHS ENDED:
SEPTEMBER 30, 2004
Revenues $ 93.7 $ 76.6 $ 55.5 $ 21.9 $ -- $ 247.7
Depreciation 37.0 16.8 14.5 3.7 -- 72.0
Operating income (loss) (9.5) (1.8) (4.8) 0.8 (23.6) (38.9)
SEPTEMBER 30, 2003
Revenues $ 71.9 $ 63.7 $ 31.7 $ -- $ -- $ 167.3
Depreciation 42.8 17.4 9.0 -- -- 69.2
Operating loss (b) (58.7) (30.9) (2.0) -- (12.6) (104.2)
- ----------
(a) Represents general and administrative expenses which were not allocated to
a reportable segment.
(b) Includes impairment losses of $10.6 million and $1.0 million for the nine
months ended September 30, 2003 related to the U.S. Gulf of Mexico and
Other International segments, respectively. See Note 5.
Total assets by segment were as follows (in millions):
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
U.S. Gulf of Mexico Segment $ 302.5 $ 334.6
U.S. Inland Barge Segment 161.1 170.4
Other International Segment 159.0 171.3
Delta Towing Segment 50.7 63.5
Corporate and Other 77.4 38.4
-------- --------
Total assets $ 750.7 $ 778.2
======== ========
23
The Company provides contract oil and gas drilling services with different
types of drilling equipment in several countries, as well as other marine
support services in the U.S. coastal and inland water regions through the
Company's interest in Delta Towing. Geographic information about the Company's
operations was as follows (in millions):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ --------------------
2004 2003 2004 2003
------- ------- -------- --------
OPERATING REVENUES
United States $ 74.1 $ 47.6 $ 192.2 $ 135.6
Other countries 19.0 10.9 55.5 31.7
------- ------- -------- --------
Total operating revenues $ 93.1 $ 58.5 $ 247.7 $ 167.3
======= ======= ======== ========
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
LONG-LIVED ASSETS
United States $ 478.4 $ 542.5
Other countries 135.5 150.1
A substantial portion of the Company's assets are mobile. Asset
locations at the end of the period are not necessarily indicative of the
geographic distribution of the earnings generated by such assets during the
periods.
The Company's international operations are subject to certain political
and other uncertainties, including risks of war and civil disturbances (or other
events that disrupt markets), expropriation of equipment, repatriation of income
or capital, taxation policies, and the general hazards associated with certain
areas in which operations are conducted.
The Company provides drilling rigs, related equipment and work crews
primarily on a dayrate basis to customers who are drilling oil and gas wells.
The Company provides these services mostly to independent oil and gas companies,
but it also services major international and government-controlled oil and gas
companies.
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with our condensed
consolidated financial statements and the related notes included in Item 1 of
this report. Except for the historical financial information contained herein,
the matters discussed below may be considered "forward-looking" statements.
Please see " -- Cautionary Statement About Forward-Looking Statements," for a
discussion of the uncertainties, risks and assumptions associated with these
statements.
OVERVIEW OF OUR BUSINESS
We are a leading provider of contract oil and natural gas drilling
services, primarily in the United States ("U.S. Gulf of Mexico") shallow water
and inland marine region, an area that we refer to as the U.S. Gulf Coast. We
provide these services primarily to independent oil and natural gas companies,
but we also service major international and government-controlled oil and
natural gas companies. Our customers in the U.S. Gulf Coast typically focus on
drilling for natural gas.
We provide contract oil and gas drilling and other support services and
report the results of those operations in four business segments which, for our
contract drilling services, correspond to the principal geographic regions in
which we operate:
- U.S. Inland Barge Segment -- Our barge rig fleet in this market
segment consists of 12 conventional and 18 posted barge rigs. These
units operate in marshes, rivers, lakes and shallow bay or costal
waterways that are known as the "transition zone". This area along
the U.S. Gulf Coast, where jackup rigs are unable to operate, is the
world's largest market for this type of equipment.
- U.S. Gulf of Mexico Segment -- We currently have 20 jackup and three
submersible rigs in the U.S. Gulf of Mexico shallow water market
segment which begins at the outer limit of the transition zone and
extends to water depths of about 350 feet. Our jackup rigs in this
market segment consist of independent leg cantilever type units,
mat-supported cantilever type rigs and mat-supported slot type
jackup rigs that can operate in water depths up to 250 feet.
- Other International Segment -- Our other international operations
are currently conducted in Mexico, Trinidad and Venezuela. In
Mexico, we operate two jackup rigs and are preparing our platform
rig to operate for PEMEX, the Mexican national oil company.
Additionally, we have two jackup rigs in Trinidad and nine land rigs
and three lake barges in Venezuela. From December 2003 to September
2004, we operated a jackup rig offshore Venezuela which has been
relocated to the U.S. Gulf of Mexico. We may pursue selected
opportunities in other regions from time to time.
- Delta Towing Segment -- We have a partial interest in a joint
venture that operates a fleet of U.S. marine support vessels
consisting primarily of shallow water tugs, crewboats and utility
barges ("Delta Towing"). We are also a substantial creditor of Delta
Towing.
Our operating revenues for our drilling segments are based on dayrates
received for our drilling services and the number of operating days during the
relevant periods. The level of our operating revenues depends on dayrates, which
in turn are primarily a function of industry supply and demand for drilling
units in the market segments in which we operate. Supply and demand for drilling
units in the U.S. Gulf Coast, which is our primary operating region, has
historically been volatile. During periods of high demand, our rigs typically
achieve higher utilization and dayrates than during periods of low demand.
Our operating and maintenance costs for our drilling segments represent
all direct and indirect costs associated with the operation and maintenance of
our drilling rigs. The principal elements of these costs are direct and indirect
labor and benefits, freight costs, repair and maintenance, insurance, general
taxes and licenses, boat and helicopter rentals, communications, tool rentals
and services. Labor, repair and maintenance and insurance costs represent the
most significant components of our operating and maintenance costs.
25
Operating and maintenance expenses may not necessarily fluctuate in
proportion to changes in operating revenues because we seek to preserve crew
continuity and maintain equipment when our rigs are idle. In general, labor
costs increase primarily due to higher salary levels, rig staffing requirements
and inflation. Equipment maintenance expenses fluctuate depending upon the type
of activity the unit is performing and the age and condition of the equipment.
Our current deductible level under our hull and machinery and protection and
indemnity policies is $1.0 million and $5.0 million per occurrence,
respectively. Prior to October 2004, our deductible level under each of these
policies was $10.0 million per occurrence.
INDUSTRY BACKGROUND, TRENDS AND OUTLOOK
The drilling industry in the U.S. Gulf Coast is highly cyclical and is
typically driven by general economic activity and changes in actual or
anticipated oil and gas prices. We believe that both our earnings and demand for
our rigs will typically be correlated to our customers' expectations of energy
prices, particularly natural gas prices, and that sustained energy price
increases will generally have a positive impact on our earnings.
There are several trends that should benefit our operations, including:
- Redeployment of Jackup Rigs. Greater demand for jackup rigs in
international areas over the last two years has reduced the
overall supply of jackups in the U.S. Gulf of Mexico. This has
created a more favorable supply environment for the remaining
jackups, including ours. This favorable supply environment has
led to increased jackup dayrates.
- High Natural Gas Prices. While U.S. natural gas prices are
volatile, the rolling twelve-month average price of natural
gas has increased from $2.11 in January 1994 to $5.59 in
September 2004. We believe high natural gas prices in the
United States, if sustained, should result in more exploration
and development drilling activity and higher utilization and
dayrates for drilling companies like us.
- Need for Increased Natural Gas Drilling Activity. From 1994 to
2003, U.S. demand for natural gas grew at an annual rate of
0.6% while its supply grew at an annual rate of 0.2%. We
believe that this supply and demand growth imbalance will
continue if demand for natural gas continues to increase and
production decline rates continue to accelerate. Even though
the number of U.S. gas wells drilled has increased overall in
recent years, a corresponding increase in production has not
been realized. We believe that an increase in U.S. drilling
activity will be required for the natural gas industry to meet
the expected increased demand for, and compensate for the
slowing production of, natural gas in the United States.
- Trend Towards Drilling Deeper Shallow Water Gas Wells. A
current trend by oil and gas companies is to drill deep gas
wells along the U.S. Gulf Coast in search of new and
potentially prolific untapped natural gas reserves. We believe
that this trend towards deeper drilling will benefit premium
jackup rigs as well as barge rigs and submersible rigs that
are capable of drilling deep gas wells. In addition, we
believe this trend will indirectly benefit conventional jackup
fleets as the use of premium rigs in the U.S. Gulf Coast to
drill deep wells should reduce the supply of rigs available to
drill conventional wells.
We believe that the drilling industry in the U.S. Gulf Coast has emerged
from a cyclical low point, and we expect further strengthening in the near term.
Market conditions for our U.S. Gulf Coast jackup fleet improved beginning in the
third quarter of 2003 and continuing through the first nine months of 2004. As
shown in the following table, from the third quarter of 2003 through the third
quarter of 2004, our average revenue per day for U.S. Gulf of Mexico jackups and
submersibles improved by 56%. During the same period, average revenue per day
for our U.S. inland barges improved by 25%. As of November 1, 2004, our 12
jackup rigs working in the U.S. Gulf Coast were contracted at dayrates ranging
from $33,800 to $38,800. As of November 1, 2004, our 13 operating inland barges
were contracted at dayrates ranging from $15,000 to $27,800. We anticipate that
the declining jackup rig supply in the U.S. Gulf Coast and the trend towards
more deep gas well drilling will continue to result in improved utilization and
higher dayrates.
26