| TODCO Item 1A Risk Factors Our business, financial condition, results of operations and the trading prices of our securities can be materially and adversely affected by many events and conditions including the following: Risks Related to Our Business Our business depends primarily on the level of activity in the oil and gas industry in the US Gulf Coast, which is significantly affected by often volatile oil and gas prices |
| Our business depends on the level of activity in oil and gas exploration, development and production primarily in the US Gulf Coast (our term for the US Gulf of Mexico shallow water and inland marine region) where we are active |
| Oil and gas prices and our customers’ expectations of potential changes in these prices significantly affect this level of activity |
| In particular, changes in the price of natural gas materially affect our operations because we primarily drill in the US Gulf Coast where the focus of drilling has tended to be on the search for natural gas |
| Oil and gas prices are extremely volatile and are affected by numerous factors, including the following: • the demand for oil and gas in the United States and elsewhere, • economic conditions in the United States and elsewhere, 11 _________________________________________________________________ • weather conditions in the United States and elsewhere, • advances in exploration, development and production technology, • the ability of the Organization of Petroleum Exporting Countries, commonly called “OPEC,” to set and maintain production levels and pricing, • the level of production in non-OPEC countries, • the policies of various governments regarding exploration and development of their oil and gas reserves, and • the worldwide military and political environment, including uncertainty or instability resulting from an escalation or additional outbreak of armed hostilities or other crises in the Middle East or the geographic areas in which we operate or further acts of terrorism in the United States, or elsewhere |
| Depending on the market prices of oil and gas, companies exploring for oil and gas may cancel or curtail their drilling programs, thereby reducing demand for drilling services |
| In the US Gulf Coast, drilling contracts are generally short-term, and oil and gas companies tend to respond quickly to upward or downward changes in prices |
| Any reduction in the demand for drilling services may materially erode dayrates and utilization rates for our rigs and adversely affect our financial results |
| The US Gulf Coast is a mature oil and gas production region that has experienced substantial seismic survey and exploration activity for many years |
| Because a large number of oil and gas prospects in this region have already been drilled, additional prospects of sufficient size and quality could be more difficult to identify |
| In addition, oil and gas companies may be unable to obtain financing necessary to drill prospects in this region |
| This could result in reduced drilling activity in the US Gulf Coast region |
| We expect demand for drilling services in this area to continue to fluctuate with the cycles of reduced and increased overall domestic rig demand, and demand at similar points in future cycles could be lower than levels experienced in past cycles |
| Our industry is highly cyclical, and our results of operations may be volatile |
| Our industry is highly cyclical, with periods of high demand and high dayrates followed by periods of low demand and low dayrates |
| Periods of low rig demand intensify the competition in the industry and often result in rigs being idle for long periods of time |
| We may be required to idle rigs or enter into lower rate contracts in response to market conditions in the future |
| Due to the short-term nature of most of our drilling contracts, changes in market conditions can quickly affect our business |
| As a result of the cyclical nature of our industry, our results of operations have been volatile, and we expect this volatility to continue |
| Our industry is highly competitive, with intense price competition |
| The US Gulf of Mexico shallow water and inland marine market segments in which we operate are highly competitive |
| Drilling contracts are traditionally awarded on a competitive bid basis |
| Pricing is often the primary factor in determining which qualified contractor is awarded a job |
| The competitive environment has intensified as recent mergers among oil and gas companies have reduced the number of available customers |
| Many other offshore drilling companies are larger than we are and have more diverse fleets, or fleets with generally higher specifications, and greater resources than we have |
| This allows them to better withstand industry downturns, better compete on the basis of price and build new rigs or acquire existing rigs, all of which could affect our revenues and profitability |
| We believe that competition for drilling contracts will continue to be intense in the foreseeable future |
| The increase of supply of rigs in the Gulf of Mexico could create an excess supply of jackup rigs in the Gulf of Mexico and adversely affect utilization rates and dayrates for our rigs |
| If, as a result of improved industry conditions in the Gulf of Mexico, inactive rigs that are currently not being marketed continue to be reactivated, jackup rigs or other mobile offshore drilling units are moved into the US Gulf Coast from other regions or increased rig construction or rig upgrade programs by our competitors continue, a significant increase in the supply of jackups in the Gulf of Mexico could occur |
| Some of our competitors and speculators have ordered new jackup drilling rigs |
| We believe there are currently 51 jackup rigs on order with delivery dates ranging from 2006 to 2009 |
| Most of the rigs on order are premium, cantilevered drilling units with 12 _________________________________________________________________ 350 to 400 foot water depth capability |
| This trend of new jackup construction or other increases in the supply of jackup or other mobile offshore drilling units could curtail a further strengthening of utilization rates and dayrates, or reduce them |
| Most jackup and submersible rigs can be moved from one region to another, and in this sense the marine contract drilling market is a global market |
| Nevertheless, the demand/supply balance for jackup and submersible rigs may vary somewhat from region to region |
| This is because the cost of a rig move is significant and there is limited availability of rig-moving vessels |
| Additionally, some rigs are designed to work in specific regions, in certain water depths or over certain types of seafloor conditions |
| Significant variations between regions tend not to exist on a long-term basis due to the ability to move rigs |
| Because many of our rigs were designed for drilling in the US Gulf Coast, our ability to move our rigs to other regions in response to changes in market conditions is limited |
| Our jackup rigs are at a relative disadvantage to higher specification rigs |
| Many of our competitors have jackup fleets with generally higher specification rigs than those in our jackup fleet |
| Particularly during market downturns when there is decreased rig demand, higher specification jackups and other rigs may be more likely to obtain contracts than lower specification jackups |
| As a result, our lower specification jackups have in the past been stacked earlier in the cycle of decreased rig demand than most of our competitors’ jackups and have been reactivated later in the cycle |
| This pattern has adversely impacted our business and could be repeated |
| In addition, higher specification rigs have greater flexibility to move to areas of demand in response to changes in market conditions |
| Furthermore, in recent years, an increasing amount of exploration and production expenditures have been concentrated in deep water drilling programs and deeper formations, including deep gas prospects, requiring higher specification jackups, semisubmersible drilling rigs or drillships |
| This trend is expected to continue and could result in a decline in demand for lower specification jackup rigs like ours |
| Our business involves numerous operating hazards, and we are not fully insured against all of them |
| Our operations are subject to the usual hazards inherent in the drilling of oil and gas wells, such as blowouts, reservoir damage, loss of production, loss of well control, punchthroughs, craterings, fires and pollution |
| The occurrence of these events could result in the suspension of drilling operations, claims by the operator, damage to or destruction of the equipment involved and injury or death to rig personnel |
| We may also be subject to personal injury and other claims of rig personnel as a result of our drilling operations |
| Operations also may be suspended because of machinery breakdowns, abnormal drilling conditions, failure of subcontractors to perform or supply goods or services and personnel shortages |
| In addition, offshore and inland marine drilling operators are subject to perils peculiar to marine operations, including capsizing, grounding, collision and loss or damage from severe weather |
| Damage to the environment could also result from our operations, particularly through oil spillage or extensive uncontrolled fires |
| We may also be subject to property, environmental and other damage claims by oil and gas companies |
| Our insurance policies and contractual rights to indemnity may not adequately cover losses, and we may not have insurance coverage or rights to indemnity for all risks |
| Moreover, pollution and environmental risks generally are not totally insurable |
| In October 2005, we renewed our principal insurance coverages for property damage, liability and occupational injury and illness for a one-year term |
| Our premium cost increased from approximately dlra8 million to approximately dlra15 million under these new policies, which also included an increase of approximately dlra340 million for insured values |
| Additionally, we reduced our insurance coverage to 70prca of our losses over the applicable deductibles and we are uninsured with respect to the remaining 30prca of such losses |
| We cannot predict what effect Hurricanes Katrina and Rita, or future storms, may have on our insurance costs |
| But we may again experience significant premium increases or we may be required to again reduce the percentage of our losses that would be covered by insurance |
| If a significant accident or other event, including terrorist acts, war, civil disturbances, pollution or environmental damage, occurs that is not fully covered by insurance or a recoverable indemnity from a 13 _________________________________________________________________ customer, it could adversely affect our consolidated results of operation, financial position and cash flows |
| Moreover, we may not be able to maintain adequate insurance in the future at rates we consider reasonable or be able to obtain insurance against certain risks |
| We are subject to litigation |
| We are also from time to time involved in a number of litigation matters, including, among other things, contract disputes, personal injury, environmental, asbestos and other toxic tort, employment, tax and securities litigation, and other litigation that arises in the ordinary course of our business |
| Litigation may have an adverse effect on us because of potential adverse outcomes, the costs associated with defending the lawsuits, the diversion of our management’s resources and other factors |
| Failure to retain key personnel could hurt our operations |
| We require highly skilled personnel to operate and provide technical services and support for our drilling rigs |
| To the extent that demand for drilling services and the number of operating rig increases, shortages of qualified personnel could arise, creating upward pressure on wages and difficulty in staffing rigs |
| Loss of key management could hurt our operations |
| Our success is to a considerable degree dependent on the services of our key management, including Jan Rask, our President and Chief Executive Officer |
| The loss of any member of our key management could adversely affect our results of operations |
| Unionization efforts could increase our costs or limit our flexibility |
| A small percentage of our employees worldwide work under collective bargaining agreements, all of whom work in Venezuela and Trinidad |
| Efforts have been made from time to time to unionize other portions of our workforce, including workers in the Gulf of Mexico |
| Any such unionization could increase our costs or limit our flexibility |
| Governmental laws and regulations may add to our costs or limit drilling activity |
| Our operations are affected in varying degrees by governmental laws and regulations |
| The drilling industry is dependent on demand for services from the oil and gas industry and, accordingly, is also affected by changing tax and other laws relating to the energy business generally |
| We may be required to make significant capital expenditures to comply with laws and regulations |
| It is also possible that these laws and regulations may in the future add significantly to operating costs or may limit drilling activity |
| Compliance with or a breach of environmental laws can be costly and could limit our operations |
| Our operations are subject to regulations that require us to obtain and maintain specified permits or other governmental approvals, control the discharge of materials into the environment, require the removal and cleanup of materials that may harm the environment or otherwise relate to the protection of the environment |
| For example, as an operator of mobile offshore drilling units in navigable US waters and some offshore areas, we may be liable for damages and costs incurred in connection with oil spills or other unauthorized discharges of chemicals or wastes resulting from those operations |
| Laws and regulations protecting the environment have become more stringent in recent years, and may in some cases impose strict liability, rendering a person liable for environmental damage without regard to negligence or fault on the part of such person |
| Some of these laws and regulations may expose us to liability for the conduct of or conditions caused by others or for acts that were in compliance with all applicable laws at the time they were performed |
| The application of these requirements or the adoption of new requirements could have a material adverse effect on our consolidated results of operations, financial position or cash flows |
| 14 _________________________________________________________________ Our non-US operations involve additional risks not associated with our US operations |
| We operate in regions that may expose us to political and other uncertainties, including risks of: • terrorist acts, war and civil disturbances, • expropriation or nationalization of equipment, and • the inability to repatriate income or capital |
| Our insurance policies and indemnity provisions in our drilling contracts generally do not protect us from loss of revenue |
| If a significant accident or other event occurs and is not fully covered by insurance or a recoverable indemnity from a customer, it could adversely affect our consolidated results of operations, financial position or cash flows |
| Many governments favor or effectively require the awarding of drilling contracts to local contractors or require foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction |
| These practices may adversely affect our ability to compete |
| Our non-US contract drilling operations are subject to various laws and regulations in countries in which we operate, including laws and regulations relating to the equipment and operation of drilling units, currency conversions and repatriation, oil and gas exploration and development, taxation of offshore earnings and earnings of expatriate personnel, the use of local employees and suppliers by foreign contractors and duties on the importation and exportation of drilling units and other equipment |
| Governments in some foreign countries have become increasingly active in regulating and controlling the ownership of concessions and companies holding concessions, the exploration for oil and gas and other aspects of the oil and gas industries in their countries |
| In some areas of the world, this governmental activity has adversely affected the amount of exploration and development work done by major oil and gas companies and may continue to do so |
| Operations in less developed countries can be subject to legal systems which are not as mature or predictable as those in more developed countries, which can lead to greater uncertainty in legal matters and proceedings |
| Another risk inherent in our operations is the possibility of currency exchange losses where revenues are received and expenses are paid in foreign currencies |
| We may also incur losses as a result of an inability to collect revenues because of a shortage of convertible currency available to the country of operation |
| Our Venezuela operations are subject to adverse political and economic conditions |
| A portion of our operations is conducted in the Republic of Venezuela, which has been experiencing political and economic turmoil, including labor strikes and demonstrations |
| The implications and results of the political, economic and social instability in Venezuela are uncertain at this time, but the instability could have an adverse effect on our business |
| Depending on future developments, we could decide to cease operations in Venezuela |
| Venezuela also imposes foreign exchange controls that limit our ability to convert local currency into US dollars and transfer excess funds out of Venezuela |
| Although our current drilling contracts in Venezuela call for a significant portion of our dayrates to be paid in US dollars, changes in existing regulation or the interpretation or enforcement of those regulations could further restrict our ability to receive US dollar payments |
| The exchange controls could also result in an artificially high value being placed on the local currency |
| Risks Related to Our Separation from Transocean The terms of our separation from Transocean, the related agreements and other transactions with Transocean were determined in the context of a parent-subsidiary relationship and thus may be less favorable to us than the terms we could have obtained from an unaffiliated third party |
| Transactions and agreements we entered into after our acquisition by Transocean and on or before the closing of the IPO presented conflicts between our interests and those of Transocean |
| These transactions and agreements included the following: • agreements related to the separation of our business from Transocean that provide for, among other things, the assumption by us of liabilities related to our business, the assumption by Transocean of liabilities 15 _________________________________________________________________ unrelated to our business, our respective rights, responsibilities and obligations with respect to taxes and tax benefits and the terms of our various interim and ongoing relationships, and • the transfer to Transocean of assets that were not related to our business |
| See Note 20 to our consolidated financial statements included in Item 8 of this report |
| Because these transactions and agreements were entered into in the context of a parent-subsidiary relationship, their terms may be less favorable to us than the terms we could have obtained from an unaffiliated third party |
| Our tax sharing agreement with Transocean could require substantial payments by us if an event occurs that accelerates the utilization or deemed utilization of pre-IPO tax benefits or an event could occur that may delay the utilization of the pre-IPO tax benefits |
| In connection with the IPO, we entered into a tax sharing agreement with Transocean |
| Although we are currently disputing the enforceability of the agreement, we may be required to make substantial payments to Transocean, if we are unsuccessful in that dispute |
| For example, the agreement provides that we must pay Transocean for substantially all pre-IPO tax benefits utilized or deemed to have been utilized subsequent to the IPO It also provides that we must pay Transocean for any tax benefit resulting from the delivery by Transocean of its stock to an employee of ours in connection with the exercise of an employee stock option and that if any person other than Transocean or its subsidiaries becomes the beneficial owner of greater than 50prca of the total voting power of our outstanding voting stock, we will be deemed to have utilized all of the pre-IPO tax benefits, and we 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 we are unable to utilize the pre-IPO tax benefits |
| Our requirement to make this payment could have the effect of delaying or preventing a change of control |
| Our obligation to make a potentially substantial payment to Transocean may deter transactions that would trigger a payment under the tax sharing agreement, such as a merger in which we are not the surviving company or a merger in which more than 50prca of the aggregate voting power of our stock becomes owned by a single person or group of related persons |
| Even if we complete such a transaction, our obligation to make a substantial payment to Transocean could result in a lower economic benefit of such a transaction to our other stockholders than those stockholders could have received if we had not entered into the tax sharing agreement |
| In September 2005, Transocean instructed us, pursuant to a provision in the tax sharing agreement, to take a tax deduction for profits realized by our current and former employees and directors from the exercise of Transocean stock options during calendar 2004 |
| Transocean also indicated that it expected us to take a similar deduction in future years to the extent there were profits realized by our current and former employees and directors during those future periods |
| It is our belief that the tax sharing agreement only requires us to pay Transocean for deductions related to stock option exercises by persons who were our employees on the date of exercise |
| Transocean disagrees with our interpretation of the tax sharing agreement as it relates to this issue and believes that we must pay Transocean for the tax benefit received for all stock option exercises, irrespective of whether any employment or other service provider relationship may have terminated prior to the exercise of the employee stock option |
| As such, Transocean initiated dispute resolution proceedings against us |
| We recorded our obligation to Transocean based upon our interpretation of the tax sharing agreement |
| However, due to the uncertainty of the outcome of this dispute, we established a reserve equal to the benefit derived from stock option deductions relating to persons who were not our employees on the date of the exercise |
| For the tax year ending December 31, 2004, the deduction related to all of our current and former employees and directors was dlra8dtta8 million, with only dlra1dtta1 million attributable to persons who were our employees on the date of exercise |
| Additionally, we have been informed by Transocean that from January 1, 2005 to December 31, 2005, our current and former employees and directors have realized dlra85dtta3 million of gains from the exercise of Transocean stock options with dlra4dtta3 million relating to persons who were our employees on the date of exercise |
| If Transocean’s interpretation of the tax sharing agreement prevails, we would recognize a tax benefit for former employee and director stock option exercises and pay Transocean cash equal to 35prca of the deduction we took |
| While this would not increase our tax expense, it would defer our utilization of pre-IPO income tax benefits |
| 16 _________________________________________________________________ As of December 31, 2005, we had approximately dlra282 million of estimated pre-IPO income tax benefits subject to the obligation to reimburse Transocean |
| If an acquisition of beneficial ownership had occurred on December 31, 2005, the estimated amount that we would have been required to pay Transocean would have been approximately dlra197 million, or 70prca of the pre-IPO tax benefits at December 31, 2005 |
| The estimated liabilities to Transocean at December 31, 2005 and 2004 and the estimated amount of remaining pre-IPO tax benefits subject to the obligation to reimburse Transocean at December 31, 2005 do not reflect the benefit of the tax deduction for stock option exercises of former employees who were not our employees on the date of the exercise and are presented within “accrued income taxes — related party” in the Company’s condensed consolidated balance sheets |
| Furthermore, even though Transocean no longer owns any shares of our common stock, the agreement provides that Transocean will continue to have substantial control over our filing of tax returns so long as there remains a present or potential obligation for us to pay Transocean for pre-IPO tax benefits |
| See Note 12 to our consolidated financial statements for the period ended December 31, 2005 included in Item 8 of this report |
| The tax sharing agreement with Transocean also provides that if any of our subsidiaries that join with us in the filing of consolidated returns ceases to do so, we will be deemed to have used that portion of any pre-IPO tax benefits that will be allocable to the subsidiary following that cessation, and we will generally be required to pay Transocean the amount of this deemed tax benefit, adjusted by a specified discount factor, at the time the subsidiary ceases to join in the filing of these returns |
| Payment of amounts for the deemed utilization of tax benefits by us could require additional financing |
| The amount of our payments to Transocean will not be adjusted for any difference between the tax benefits that we are deemed to utilize and the tax benefits that we actually utilize, and the difference between these amounts could be substantial |
| Among other considerations, applicable tax laws may significantly limit our use of these tax benefits, and these limitations are not taken into account in determining the amount of the payment to Transocean |
| Our tax sharing agreement with Transocean could delay or preclude us from realizing post-IPO tax benefits |
| The tax sharing agreement with Transocean provides that if the utilization of a pre-IPO tax benefit defers or precludes our utilization of any post-IPO tax benefit, our payment obligation with respect to the pre-IPO tax benefit generally will be deferred until we actually utilize that post-IPO tax benefit |
| This payment deferral will not apply with respect to, and we will have to pay currently for the utilization of pre-IPO tax benefits to the extent of (a) up to 20prca of any deferred or precluded post-IPO tax benefit arising out of our payment of foreign income taxes, and (b) 100prca of any deferred or precluded post-IPO tax benefit arising out of a carryback from a subsequent year |
| Therefore, we may not realize the full economic value of tax deductions, credits and other tax benefits that arise post-IPO until we have utilized all of the pre-IPO tax benefits, if ever |
| Other Risks We could incur substantial losses during industry downturns and may need additional financing to withstand industry downturns |
| Although we recognized net income of dlra59dtta4 million for the year ended December 31, 2005, our net losses from continuing operations before cumulative effect of a change in accounting principle were approximately dlra29 million and dlra222 million during the years ended December 31, 2004 and 2003, respectively, and we could incur substantial losses during future cyclical downturns in our industry |
| During cyclical downturns in our industry, we may need additional financing in order to satisfy our cash requirements |
| If we are not able to obtain financing in sufficient amounts and on acceptable terms, we may be required to reduce our business activities, seek financing on unfavorable terms or pursue a business combination with another company |
| 17 _________________________________________________________________ We have no plans to pay regular dividends on our common stock, so stockholders may not receive funds without selling their common stock |
| We have no plans to pay regular dividends on our common stock |
| We generally intend to invest our future earnings, if any, to fund our growth |
| Any payment of future dividends will be at the discretion of our board of directors and will depend on, among other things, our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends, and other considerations that our board of directors deems relevant |
| Our credit facility also includes limitations on our payment of dividends |
| In 2005, due to favorable market conditions, our unrestricted cash balances grew to levels that exceeded our foreseeable needs for cash held for reinvestment and unknown contingencies |
| We secured the approval of our lenders and our board of directors declared a special cash dividend of dlra1dtta00 per share that was paid in 2005 |
| This special cash dividend is not indicative of a change in our basic dividend policy nor does it guarantee that any future dividends will be paid |
| Accordingly, investors may have to sell some or all of their common stock in order to generate cash flow from their investment |
| Investors may not receive a gain on their investment when they sell our common stock and may lose the entire amount of the investment |
| Our rights agreement and provisions in our charter documents may inhibit a takeover, which could adversely affect the value of our Class A common stock |
| Our amended and restated certificate of incorporation and bylaws contain provisions that could delay or prevent a change of control or changes in our management that a stockholder might consider favorable |
| These provisions include: • classification of the members of our board of directors into three classes, with each class serving a staggered three-year term, • requiring our stockholders to give advance notice of their intent to make nominations for the election of directors or to submit a proposal at an annual meeting of the stockholders, • limitations on the ability of our stockholders to amend specified provisions of our amended and restated certificate of incorporation and bylaws, • the denial of any right of our stockholders to act by unanimous written consent in lieu of a meeting, • the denial of any right of our stockholders to remove members of our board of directors except for cause, and • the denial of any right of our stockholders to call special meetings of the stockholders |
| We are also party to a rights agreement that could delay or prevent a change of control that a stockholder might consider favorable |