The following discussion is intended to assist you in understanding our financial position at
June 30, 2014and our results of operations for the three and six months ended June 30, 2014and 2013. The discussion should be read in conjunction with the financial statements and notes thereto, included in our Annual Report on Form 10-K for the year ended December 31, 2013. The results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future periods. Certain previously reported amounts have been reclassified to conform to the current year presentation. Overview We are an international offshore drilling company focused on operating a fleet of modern, high specification drilling units. Our principal business is to contract drilling units, related equipment and work crews, primarily on a dayrate basis to drill oil and natural gas wells for our customers. We also provide construction supervision services for, and will operate and manage, drilling units owned by others. Through our fleet of drilling units we provide offshore contract drilling services to major, national and independent oil and natural gas companies, focused primarily on international markets. The following table sets forth certain information concerning our offshore drilling fleet. Year Built/ Drilling Depth Expected Water Depth Capacity Name Ownership Delivery Rating (feet) (feet) Status Jackups Emerald Driller 100 % 2008 375 30,000 Operating Sapphire Driller 100 % 2009 375 30,000 Operating Aquamarine Driller 100 % 2009 375 30,000 Operating Topaz Driller 100 % 2009 375 30,000 Operating Drillships (1) Platinum Explorer 100 % 2010 12,000 40,000 Operating Titanium Explorer 100 % 2012 12,000 40,000 Operating Tungsten Explorer 100 % 2013 12,000 40,000 Operating Cobalt Explorer 100 % 2015 12,000 40,000 Under construction (1) The drillships are designed to drill in up to 12,000 feet of water. The
Platinum Explorer, Titanium Explorer and Tungsten Explorer are currently
equipped to drill in 10,000 feet of water. The Cobalt Explorer will be equipped to drill in 10,000 feet of water with a dual derrick and two seven-ram blowout preventers.
Expectations about future oil and natural gas prices have historically been a key driver of demand for our services. The price of oil, while volatile, remains at historically elevated levels which reflects growing demand as the economies around the world continue to show economic growth, albeit at a slow pace.
The International Energy Agencyestimates that demand growth for 2014 will increase by approximately 1.3 million barrels per day or 1.4%. The mid-year updates to the annual exploration and development spending surveys indicate that, while total spending growth remains consistent, the spending will be more focused on North American land exploration and development as improvements in shale drilling technology have increased the recovery of both oil and gas from shale based reserves. In one survey, the forecasted growth of exploration and development spending internationally has been reduced to approximately 1.3% as compared to 3.8% growth in the previous survey. This reduced spending, combined with the newbuild deliveries discussed below, is putting downward pressure on dayrates for offshore drilling rigs. Our customers continue to favor newer, more technically capable rigs over older, less efficient rigs. However, during periods with a high rate of newbuild deliveries, competitors may significantly reduce the rates for the older, less efficient rigs in order to induce customers to contract their rigs. This tends to put downward pressure on dayrates for modern, high-specification assets as well, as the owners of those units reduce rates to be more competitive. The order book for jackups currently indicates that 21 additional jackups are scheduled for delivery through the end of 2014 with another 64 jackups scheduled for delivery in 2015. The order book for ultra deepwater floaters, including drillships and semisubmersibles, indicates that 19 additional floaters are scheduled for delivery in 2014 with another 27 floaters scheduled for delivery in 2015. We believe that all of the newbuild rigs will ultimately be contracted as either replacements for older rigs or through market expansion to meet growing demand. An additional factor that impacts our ability to contract our drilling rigs is geopolitical risk. Geopolitical risk in the Middle East, North Africaand West Africahas reduced access to these markets in recent years, leading to supply disruption. The timing and magnitude of incremental oil production from these regions potentially becoming available to the world market has made it difficult 22 -------------------------------------------------------------------------------- for our customers to estimate the total oil supply and related impact on world oil prices. Additionally, the possibility of easing international sanctions against Irancould increase oil supply from the Middle East. In response to political pressure to support social agendas and promote localization of the workforce and production spending, countries in West Africaand Latin Americahave adopted additional local spending requirements and taxes on oil and gas producing activities, which has increased the costs of developing these oil and gas reserves. As a result, some exploration and production projects in these countries have been delayed while the new regulations and contracting requirements are evaluated. We believe that we are well positioned for these market changes as our fleet has significant backlog for 2014 and 2015. We believe that our marketing efforts and current customer mix is also reflective of these trends as we have long-term relationships with national oil companies that have drilling programs which are expected to be less impacted by short-term volatility in the market. A summary of our backlog coverage of days contracted and related revenue is as follows: Revenues Contracted Percentage of Days Contracted (in thousands) 2014 2015 2014 2015 Beyond Jackups 94% 34% $ 111,252 $ 80,417$ - Drillships 100% 100% $ 349,970 $ 643,054 $ 1,296,202Results of Operations The first two of our jackup rigs began operations under their initial contracts in February and August 2009, respectively. Our third and fourth jackup rigs commenced operations in January and March 2010, respectively. Our first drillship, the Platinum Explorer, commenced operations in December 2010. Our second drillship, the Titanium Explorer, commenced operations in December 2012. Our third drillship, the Tungsten Explorer, commenced operations in September 2013.
The following table sets forth selected contract drilling operational information for the periods indicated:
Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 Jackups Operating rigs, end of period 4 4 4 4 Available days (1) 364 364 724 724 Utilization (2) 99.2 % 89.5 % 99.6 % 93.9 % Average daily revenues (3)
$ 162,057 $ 186,329 $ 161,718 $ 167,907Average daily revenues (4) $ 162,057 $ 154,475 $ 161,718 $ 152,648Deepwater Operating rigs, end of period 3 2 3 2 Available days (1) 273 182 543 362 Utilization (2) 83.1 % 97.3 % 89.8 % 92.9 %
Average daily revenues (3)
(1) Available days are the total number of rig calendar days in the period.
Newbuild rigs are included upon acceptance by the customer.
(2) Utilization is calculated as a percentage of the actual number of revenue
earning days divided by the available days in the period. A revenue earning
day is defined as a day for which a rig earns dayrate after commencement of
operations. (3) Average daily revenues are based on contract drilling revenues divided by revenue earning days. Average daily revenue will differ from average
contract dayrate due to billing adjustments for any non-productive time,
mobilization fees and demobilization fees.
The following table is an analysis of our operating results for the three and six months ended
Three Months Ended
Six Months Ended
2014 2013 Change 2014 2013 Change Revenues (In thousands) Contract drilling services
$ 198,279 $ 155,803 $ 42,476 $ 413,211 $ 290,467 $ 122,744Management fees 5,969 2,410 3,559 10,551 5,608 4,943 Reimbursables 15,470 12,424 3,046 28,421 21,563 6,858 Total revenues 219,718 170,637 49,081 452,183 317,638 134,545 Operating costs and expenses Operating costs 98,002 77,117 (20,885 ) 199,724 152,434 (47,290 ) General and administrative 8,366 7,054 (1,312 ) 16,481 14,481 (2,000 ) Depreciation 31,630 24,980 (6,650 ) 63,255 49,841 (13,414 ) Total operating expenses 137,998 109,151 (28,847 ) 279,460 216,756 (62,704 ) Income (loss) from operations 81,720 61,486 20,234 172,723 100,882 71,841 Other income (expense) Interest income 11 74 (63 ) 24 170 (146 ) Interest expense and financing charges (54,286 ) (51,255 ) (3,031 ) (108,773 ) (110,917 ) 2,144 Loss on debt extinguishment (1,407 ) - (1,407 ) (1,513 ) (98,327 ) 96,814 Other income (539 ) 988 (1,527 ) 240 1,889 (1,649 ) Total other income (expense) (56,221 ) (50,193 ) (6,028 ) (110,022 ) (207,185 ) 97,163 Income (loss) before income taxes 25,499 11,293 14,206 62,701 (106,303 ) 169,004 Income tax provision (benefit) 15,321 7,077 8,244
27,699 12,682 15,017 Net income (loss)
Revenue: Total revenue increased 29% and contract drilling revenue increased 27% in the three months ended
June 30, 2014as compared to the three months ended June 30, 2013. The increase in drilling revenue was primarily due to the commencement of operations of the Tungsten Explorer in September 2013, which added $33.8 millionof revenue, and to improved performance on the Titanium Explorer in 2014, which contributed additional revenue of $10.3 million. Jackup utilization for the three months ended June 30, 2014increased 9.7% compared to the prior year period. Jackup utilization in the prior year was lower due to days out of service following the early termination of the Sapphire Driller contract in May 2013. Deepwater utilization for the three months ended June 30, 2014decreased approximately 14% compared to the prior year due to the mobilization of the Tungsten Explorer to West Africaduring the current quarter. Management fees and reimbursable revenue for the three months ended June 30, 2014were $6.0 millionand $15.5 million, respectively, as compared to $2.4 millionand $12.4 millionin the prior year period. The increase in management fees was due to having multiple construction management services projects in 2014 and to managing the operations of two jackups for a contractor in Mexico. The increase in reimbursable revenue was primarily due to higher reimbursables on the Tungsten Explorer and the Titanium Explorer. Total revenue for the six months ended June 30, 2014increased 42% as compared to the six months ended June 30, 2013and contract drilling revenue increased 42% in the first six months of 2014 as compared to the same period in 2013. The increase in drilling revenue was primarily due to the commencement of operations of the Tungsten Explorer in September 2013, which added $88.2 millionof revenue, and to improved performance on the Titanium Explorer in 2014, which contributed additional revenue of $31.3 million. Jackup utilization for the six months ended June 30, 2014increased 5.7% compared to the prior year due to the early termination of the Sapphire Driller contract in May 2013. Deepwater utilization for the six months ended June 30, 2014decreased approximately 3% compared to the prior year due to the mobilization of the Tungsten Explorer to West Africaduring the current period. Management fees and reimbursable revenue increased in the six months ended June 30, 2014compared to the prior year primarily due to having multiple construction management services projects in 2014 and to managing the operations of two jackups for a contractor in Mexico. 24 -------------------------------------------------------------------------------- Operating costs: Operating costs for the three months ended June 30, 2014increased 27% compared to the three months ended June 30, 2013, due primarily to an increase in operating costs on the Tungsten Explorer of approximately $12.0 million, to an increase in reimbursable costs of $2.3 millionand to increased costs of approximately $4.8 millionassociated with the relocation of the Titanium Explorer from the U.S. Gulf of Mexicoto West Africa. Operating costs for the six months ended June 30, 2014increased 31% compared to the six months ended June 30, 2013, due primarily to an increase in operating costs on the Tungsten Explorer of approximately $28.6 million, to an increase in reimbursable costs of $5.5 millionand to increased costs of approximately $6.5 millionassociated with the relocation of the Titanium Explorer to West Africa. General and administrative expenses: Increases in general and administrative expenses for both the three and six-month periods ended June 30, 2014as compared to the three and six-month periods ended June 30, 2013were primarily due to increased legal fees related to ongoing litigation. Depreciation expense: The increase in depreciation expense for the three and six-month periods ended June 30, 2014as compared to the same periods of 2013 were primarily due to the addition of the Tungsten Explorer to our operating fleet in the third quarter of 2013. Interest expense and other financing charges: Interest expense and other financing charges for the three-month period ended June 30, 2014increased over the same period in 2013 primarily because we had less capitalized interest in 2014 compared to 2013. We were capitalizing interest in 2013 on the Tungsten Explorer, until it commenced operations in September 2013. Interest expense and other financing charges for the six-month period ended June 30, 2014decreased over the same period in 2013 primarily because of the refinancing of higher interest rate debt in October 2012and March 2013, thus reducing our overall interest rates. We capitalized $1.2 millionand $2.4 millionof interest and amortization costs in the three and six-month periods ended June 30, 2014, respectively. We capitalized $3.6 millionand $7.8 millionof interest and amortization costs, respectively, in the three and six-month periods ended June 30, 2013. The reduction in capitalized interest was due to the Tungsten Explorer commencing operations in September 2013. Loss on extinguishment of debt: In connection with the additional principal payment of $42.0 millionin June 2014on the 2017 Term Loan, we recognized a loss of $1.4 millionresulting from the write-off of deferred financing costs of $820,000and original debt issuance discount of $576,000. During the six months ending June 30, 2014, we repurchased in the open market $7.5 millionof our 7.125% Senior Notes and recognized a loss of $117,000resulting from the write-off of deferred financing costs. In the six-month period ended June 30, 2013, in connection with the early retirement of the remaining $1.0 billionof our prior 11.5% Senior Notes, we recognized a loss of $98.3 millionresulting from the payment of early redemption fees and consent fees of $92.3 millionand the write-off of deferred financing costs of $24.0 million, which were offset by the early recognition of debt issuance premium of $18.0 million. Income tax expense: Income tax expense was $15.3 millionand $27.7 million, respectively for the three and six-month periods ended June 30, 2014, as compared to $7.1 millionand $12.7 million, respectively, for the comparable periods in 2013. Our income taxes are generally dependent upon the results of our operations and the local income taxes in the jurisdictions in which we operate. The increase in taxes during the three and six-month periods of 2014 was primarily due to tax expense related to the Tungsten Explorer, which was not in operation in the comparable periods of 2013, an increase in non-deductible expenses and an increase in income in jurisdictions with high statutory rates or jurisdictions where we are taxed on a deemed profit basis. In some jurisdictions we do not pay taxes or receive benefits for certain income and expense items, including interest expense and loss on extinguishment of debt.
Liquidity and Capital Resources
June 30, 2014we had working capital of approximately $111.0 million, including approximately $89.0 millionof cash available for general corporate purposes. Additionally we have posted $6.6 millioncash as collateral for bid tenders and performance bonds. We have approximately $257.0 millionin available liquidity, including our available cash and $168.0 millionavailable under our Credit Agreement. Under our Credit Agreement $32.0 millionis reserved for letters of credit. As of June 30, 2014, we had issued letters of credit for $21.5 million. Over the next 12 months, we are forecasting expenditures of approximately $245.3 millionfor principal (excluding voluntary prepayments) and interest payments on our outstanding debt, including scheduled maturities of $53.5 millionon our long-term debt. For the remainder of 2014, we anticipate spending approximately $27.0 millionon capital expenditures, including $15.9 millionon 25 -------------------------------------------------------------------------------- sustaining capital expenditures and our fleet capital spares program and $11.1 millionon the Cobalt Explorer. In January 2015, we have the second milestone shipyard payment of $59.5 milliondue on the Cobalt Explorer. The third, and final, milestone payment is due upon delivery, which is currently expected to be in the fourth quarter of 2015. Additionally, we are currently forecasting spending an additional $36.8 millionon capital expenditures, including the Cobalt Explorer, and fleet capital spares in the first six months of 2015. These amounts do not include any capitalized interest related to the Cobalt Explorer construction project. We expect to fund these expenditures from our available working capital, cash flow from operations and advances under the Credit Agreement, if necessary. In the second half of 2014, we will be exploring financing alternatives for the remaining shipyard funding commitments for the Cobalt Explorer. We are currently pursuing drilling contracts for the Cobalt Explorer, and the timing and extent of any such contracts is a significant factor that will affect our financing alternatives, which will have a significant impact on our liquidity position in 2015.
June 30, December 31, 2014 2013 (Unaudited) (In thousands) 7.5% Senior Notes, issued at par
7.125% Senior Notes, issued at par 767,473
$500 million2017 Term Loan, net of discount of $5,419and $7,109390,081
$350 million2019 Term Loan, net of discount of $4,117and $4,561341,508
5.50% Convertible Notes, net of discount of
7.875% Convertible Notes, net of discount of
Revolving credit agreement -
F3 Capital Note, net of discount of
Less current maturities of long-term debt and revolving credit facility 53,500 63,500 Long-term debt
$ 2,782,024 $ 2,852,050In February 2014, we repurchased in the open market, and subsequently cancelled, $6.0 millionof the 7.125% Senior Notes. In connection with this transaction, we recognized a non-cash charge of approximately $106,000related to the early extinguishment of the debt. In May 2014, we repurchased, and subsequently cancelled, an additional $1.5 millionof the 7.125% Senior Notes and recognized a non-cash charge of approximately $10,600related to the early extinguishment of the debt. In June 2014, we made an additional principal payment of $42.0 millionon the 2017 Term Loan. In connection with this payment, we recognized a non-cash charge of approximately $1.4 millionrelated to the write-off of deferred financing costs and original issuance discount on the debt. We are subject to litigation, claims and disputes in the ordinary course of business, some of which may not be covered by insurance. There is an inherent risk in any litigation or dispute and no assurance can be given as to the outcome of any claims. We do not believe the ultimate resolution of any existing litigation, claims or disputes will have a material adverse effect on our financial position, results of operations or cash flows.
We enter into operating leases in the normal course of business for office space, housing, vehicles and specified operating equipment. Some of these leases contain options which would cause our future cash payments to change if we exercised those options.
Critical Accounting Policies and Accounting Estimates
The preparation of financial statements and related disclosures in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. While management believes current estimates are appropriate and reasonable, actual results could materially differ from those estimates. We have identified the policies below as critical to our business operations and the understanding of our financial operations. 26 -------------------------------------------------------------------------------- Property and Equipment: Our long-lived assets, primarily consisting of the values of our drilling rigs, are the most significant amount of our total assets. We make judgments with regard to the carrying value of these assets, including amounts capitalized, componentization, depreciation and amortization methods, salvage values and estimated useful lives. We capitalize interest costs related to the financings of our drilling rigs while they are under construction and prior to the commencement of each vessel's first contract, which has increased the carrying value of the drilling rigs. Our weighted average cost of capital, which is the key component used in our calculation of capitalized interest, is directly impacted by the volatility in the global financial and credit markets. The completion of a construction project has an impact on the amount of interest expense that is prospectively recognized in our results of operations. Total interest and amortization costs capitalized for assets under construction for the three and six months ended
June 30, 2014were $1.2 millionand $2.4 million, respectively. Total interest and amortization costs capitalized for the three and six months ended June 30, 2013were $3.0 millionand $6.5 million, respectively. We evaluate the realization of property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss on our property and equipment exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. Any impairment loss recognized would be computed as the excess of the asset's carrying value over the estimated discounted cash flows. Estimates of future cash flows require us to make long-term forecasts of our future revenues and operating costs with regard to the assets subject to review. Our business, including the utilization rates and dayrates we receive for our drilling rigs, depends on the level of our customers' expenditures for oil and natural gas exploration, development and production expenditures. Oil and natural gas prices and customers' expectations of potential changes in these prices, the general outlook for worldwide economic growth, political and social stability in the major oil and natural gas producing basins of the world, availability of credit and changes in governmental laws and regulations, among many other factors, significantly affect our customers' levels of expenditures. Sustained declines in oil and natural gas prices, worldwide rig counts and utilization, reduced access to credit markets and any other significant adverse economic news could require us to evaluate the realization of our drilling rigs.
Debt Financing Costs: Costs incurred with debt financings are deferred and amortized over the term of the related financing facility.
Revenue: Revenue is recognized as services are performed based on contracted dayrates and the number of operating days during the period.
In connection with a customer contract, we may receive lump-sum fees for the mobilization of equipment and personnel. Mobilization fees and costs incurred to mobilize a rig from one geographic market to another are deferred and recognized on a straight-line basis over the term of such contract, excluding any option periods. Costs incurred to mobilize a rig without a contract are expensed as incurred. Fees or lump-sum payments received for capital improvements to rigs are deferred and amortized to income over the term of the related drilling contract. The costs of such capital improvements are capitalized and depreciated over the useful lives of the assets. Deferred revenue under drilling contracts was
$34.6 millionand $39.4 millionat June 30, 2014and December 31, 2013, respectively. Deferred revenue is included in either accrued liabilities or other long-term liabilities in our consolidated balance sheet, based upon the initial term of the related drilling contract.
We record reimbursements from customers for rebillable costs and expenses as revenue and the related direct costs as operating expenses.
Rig and Equipment Certifications: We are required to obtain regulatory certifications to operate our drilling rigs and certain specified equipment and must maintain such certifications through periodic inspections and surveys. The costs associated with these certifications, including drydock costs, are deferred and amortized over the corresponding certification periods. Income Taxes: Income taxes have been provided based upon the tax laws and rates in effect in the countries in which operations are conducted and income is earned. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in future taxable or deductible amounts and are based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized. We recognize interest and penalties related to income taxes in income tax expense. Share-Based Compensation: We account for share-based compensation using the fair value method as prescribed under U.S. GAAP. Restricted share grants are valued based on the market price of our ordinary shares on the date of grant and the fair value attributable to share options is calculated based on the Black-Scholes option pricing model. The fair values are amortized to expense over the service period which is equivalent to the time required to vest the share options and share grants. Use of Estimates: The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and 27
liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. While management believes current estimates are appropriate and reasonable, actual results could differ from those estimates.