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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 333-75899
______________________
TRANSOCEAN INC.
(Exact name of registrant as specified in its charter)
______________________
CAYMAN ISLANDS 66-0582307
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
4 GREENWAY PLAZA
HOUSTON, TEXAS 77046
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (713) 232-7500
______________________
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 12b-2 of the Exchange Act). Yes X No
--- ---
As of October 29, 2004, 321,166,523 ordinary shares, par value $0.01 per
share, were outstanding.
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TRANSOCEAN INC.
INDEX TO FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2004
Page
----
PART I - FINANCIAL INFORMATION
------------------------------
ITEM 1. Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2004 and 2003. . . . . . . . 1
Condensed Consolidated Statements of Comprehensive Income
Three and Nine Months Ended September 30, 2004 and 2003. . . . . . . . 2
Condensed Consolidated Balance Sheets
September 30, 2004 and December 31, 2003 . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Cash Flows
Three and Nine Months Ended September 30, 2004 and 2003. . . . . . . . 4
Notes to Condensed Consolidated Financial Statements . . . . . . . . . . 5
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . . . . . 20
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. . . . . . 45
ITEM 4. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . 46
PART II - OTHER INFORMATION
---------------------------
ITEM 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . 47
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds . . . . . 47
ITEM 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . 47
ITEM 6. Exhibits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TRANSOCEAN INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2004 2003 2004 2003
----------- ----------- ----------- ----------
Operating Revenues
Contract drilling revenues $ 607.1 $ 597.0 $ 1,789.5 $ 1,759.2
Other revenues 44.7 25.9 147.5 83.6
-----------------------------------------------------------------------------------------------------------
651.8 622.9 1,937.0 1,842.8
-----------------------------------------------------------------------------------------------------------
Costs and Expenses
Operating and maintenance 432.9 403.0 1,251.5 1,203.6
Depreciation 133.9 126.8 398.4 381.1
General and administrative 15.2 21.2 44.3 50.0
Impairment loss on long-lived assets - - - 16.8
Gain from sale of assets, net (1.3) (0.9) (28.9) (2.9)
Gain from TODCO offerings (129.4) - (168.8) -
-----------------------------------------------------------------------------------------------------------
451.3 550.1 1,496.5 1,648.6
-----------------------------------------------------------------------------------------------------------
Operating Income 200.5 72.8 440.5 194.2
Other Income (Expense), net
Equity in earnings of joint ventures 1.7 1.9 7.7 7.3
Interest income 2.5 3.0 6.5 15.7
Interest expense (42.6) (49.0) (132.6) (154.4)
Loss on retirement of debt - - (28.1) (15.7)
Impairment loss on note receivable from related party - - - (21.3)
Other, net 0.1 (0.2) 0.4 (3.5)
-----------------------------------------------------------------------------------------------------------
(38.3) (44.3) (146.1) (171.9)
-----------------------------------------------------------------------------------------------------------
Income Before Income Taxes and Minority Interest 162.2 28.5 294.4 22.3
Income Tax Expense 6.3 17.3 74.2 8.3
Minority Interest 1.0 0.2 (5.4) 0.3
-----------------------------------------------------------------------------------------------------------
Net Income $ 154.9 $ 11.0 $ 225.6 $ 13.7
===========================================================================================================
Earnings Per Share
Basic and Diluted $ 0.48 $ 0.03 $ 0.70 $ 0.04
===========================================================================================================
Weighted Average Shares Outstanding
Basic 320.9 319.9 320.7 319.8
-----------------------------------------------------------------------------------------------------------
Diluted 325.3 321.1 324.5 321.4
-----------------------------------------------------------------------------------------------------------
See accompanying notes.
1
TRANSOCEAN INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2004 2003 2004 2003
----------- ----------- ----------- ----------
Net Income $ 154.9 $ 11.0 $ 225.6 $ 13.7
-----------------------------------------------------------------------------------------------------------------
Other Comprehensive Income, net of tax
Amortization of gain on terminated interest rate swaps - (0.1) (0.2) (0.2)
Change in unrealized loss on securities available for sale 0.2 (0.1) 0.1 0.1
Change in share of unrealized loss in unconsolidated joint
venture's interest rate swaps (net of tax expense of $0.4
and $1.0 for the three and nine months ended
September 30, 2003, respectively) - 0.7 - 1.8
Minimum pension liability adjustments (net of tax
expense of $0.2 and $0.4 for the nine months ended
September 30, 2004 and 2003, respectively) (0.1) - 0.4 0.8
-----------------------------------------------------------------------------------------------------------------
Other Comprehensive Income 0.1 0.5 0.3 2.5
-----------------------------------------------------------------------------------------------------------------
Total Comprehensive Income $ 155.0 $ 11.5 $ 225.9 $ 16.2
=================================================================================================================
See accompanying notes.
2
TRANSOCEAN INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions, except per share data)
September 30, December 31,
2004 2003
--------------- --------------
(Unaudited)
ASSETS
Cash and Cash Equivalents $ 775.8 $ 474.0
Accounts Receivable, net of allowance for doubtful accounts of $14.9
and $29.1 at September 30, 2004 and December 31, 2003, respectively 503.6 480.3
Materials and Supplies, net of allowance for obsolescence of $18.4 and $17.5
at September 30, 2004 and December 31, 2003, respectively 150.1 152.0
Deferred Income Taxes 35.6 41.0
Other Current Assets 41.7 31.6
-------------------------------------------------------------------------------------------------------------
Total Current Assets 1,506.8 1,178.9
-------------------------------------------------------------------------------------------------------------
Property and Equipment 10,672.3 10,673.0
Less Accumulated Depreciation 2,988.9 2,663.4
-------------------------------------------------------------------------------------------------------------
Property and Equipment, net 7,683.4 8,009.6
-------------------------------------------------------------------------------------------------------------
Goodwill 2,257.1 2,230.8
Investments in and Advances to Joint Ventures 4.1 5.5
Deferred Income Taxes 30.0 28.2
Other Assets 222.6 209.6
-------------------------------------------------------------------------------------------------------------
Total Assets $ 11,704.0 $ 11,662.6
=============================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts Payable $ 180.2 $ 146.1
Accrued Income Taxes 48.3 57.2
Debt Due Within One Year 386.7 45.8
Other Current Liabilities 295.8 262.0
-------------------------------------------------------------------------------------------------------------
Total Current Liabilities 911.0 511.1
-------------------------------------------------------------------------------------------------------------
Long-Term Debt 2,674.7 3,612.3
Deferred Income Taxes 85.5 42.8
Other Long-Term Liabilities 320.5 299.4
-------------------------------------------------------------------------------------------------------------
Total Long-Term Liabilities 3,080.7 3,954.5
-------------------------------------------------------------------------------------------------------------
Commitments and Contingencies
Minority Interest 263.7 4.4
Preference Shares, $0.10 par value; 50,000,000 shares authorized,
none issued and outstanding - -
Ordinary Shares, $0.01 par value; 800,000,000 shares authorized,
321,071,783 and 319,926,500 shares issued and outstanding at
September 30, 2004 and December 31, 2003, respectively 3.2 3.2
Additional Paid-in Capital 10,673.9 10,643.8
Accumulated Other Comprehensive Loss (19.9) (20.2)
Retained Deficit (3,208.6) (3,434.2)
-------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 7,448.6 7,192.6
-------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 11,704.0 $ 11,662.6
=============================================================================================================
See accompanying notes.
3
TRANSOCEAN INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2004 2003 2004 2003
----------- ----------- ----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 154.9 $ 11.0 $ 225.6 $ 13.7
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation 133.9 126.8 398.4 381.1
Stock- based compensation expense 4.2 1.4 17.7 4.3
Deferred income taxes (7.6) 19.1 20.4 (40.4)
Equity in earnings of joint ventures (1.7) (1.9) (7.7) (7.3)
Net (gain)/loss from disposal of assets 1.4 4.4 (23.6) 12.2
Gain from TODCO offerings (129.4) - (168.8) -
Loss on retirement of debt - - 28.1 15.7
Impairment loss on long-lived assets - - - 16.8
Impairment loss on note receivable from related party - - - 21.3
Amortization of debt-related discounts/premiums, fair
value adjustments and issue costs, net (5.1) (8.2) (17.6) (16.1)
Deferred income, net 1.0 (5.3) 15.1 (6.9)
Deferred expenses, net (5.8) (5.1) (18.5) (2.4)
Other long-term liabilities (1.5) 0.2 5.4 13.7
Other, net 3.7 6.7 (0.6) 11.8
Changes in operating assets and liabilities
Accounts receivable 8.6 (44.0) (23.2) 7.6
Accounts payable and other current liabilities 61.0 48.2 61.1 46.6
Income taxes receivable/payable, net 3.4 (8.0) 5.4 1.6
Other current assets 5.0 14.3 (10.6) (9.0)
-------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 226.0 159.6 506.6 464.3
-------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (45.1) (22.4) (99.8) (72.6)
Note issued to related party, net of repayments - 1.1 - (44.2)
Proceeds from disposal of assets, net 4.3 0.9 46.3 4.1
Deepwater Drilling II LLC's cash acquired, net of cash
paid - - - 18.1
Proceeds from TODCO offerings 269.9 - 425.6 -
Joint ventures and other investments, net 4.3 0.5 9.0 2.7
-------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities 233.4 (19.9) 381.1 (91.9)
-------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments on revolving credit agreements - - (200.0) -
Repayments on other debt instruments (11.8) (48.0) (407.0) (967.2)
Cash from termination of interest rate swaps - - - 173.5
Net proceeds from issuance of ordinary shares under
stock-based compensation plans 5.0 0.6 20.0 12.3
Other, net 1.1 - 1.1 1.1
-------------------------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (5.7) (47.4) (585.9) (780.3)
-------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 453.7 92.3 301.8 (407.9)
-------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at Beginning of Period 322.1 714.0 474.0 1,214.2
-------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 775.8 $ 806.3 $ 775.8 $ 806.3
=============================================================================================================
See accompanying notes.
4
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - NATURE OF BUSINESS AND PRINCIPLES OF CONSOLIDATION
Transocean Inc. (together with our subsidiaries and predecessors, unless
the context requires otherwise, "Transocean," "we," "us" or "our") is a leading
international provider of offshore contract drilling services for oil and gas
wells. As of September 30, 2004, we owned, had partial ownership interests in or
operated 94 mobile offshore and barge drilling units, excluding the 70-rig fleet
of TODCO (together with its subsidiaries and predecessors, unless the context
requires otherwise, "TODCO"), a publicly traded company in which we have a
majority voting interest. We contract our drilling rigs, related equipment and
work crews primarily on a dayrate basis to drill oil and gas wells. We also
provide additional services, including integrated well services and management
of third party well service activities.
On January 31, 2001, we completed a merger transaction (the "R&B Falcon
merger") with R&B Falcon Corporation ("R&B Falcon"). At the time of the merger,
R&B Falcon owned, had partial ownership interests in, operated or had under
construction more than 100 mobile offshore drilling units consisting of
drillships, semisubmersibles, jackup rigs and other units including the Gulf of
Mexico Shallow and Inland Water segment fleet. As a result of the merger, R&B
Falcon became our indirect wholly owned subsidiary. The merger was accounted for
as a purchase and we were the accounting acquiror.
In July 2002, we announced plans to pursue a divestiture of our Gulf of
Mexico Shallow and Inland Water business, which was a part of R&B Falcon. R&B
Falcon's overall business was considerably broader than the Gulf of Mexico
Shallow and Inland Water business. In preparation for this divestiture, we began
the transfer of all assets and businesses out of R&B Falcon that were unrelated
to the Gulf of Mexico Shallow and Inland Water business. In December 2002, R&B
Falcon changed its name to TODCO and, in January 2004, the Gulf of Mexico
Shallow and Inland Water business segment became known as the TODCO segment. In
February 2004, we completed an initial public offering ("IPO") of TODCO and in
September 2004 we completed a secondary offering (see Note 3). Before the
closing of the IPO, TODCO completed the transfer of all unrelated assets and
businesses to us.
Our operations are aggregated into two reportable business segments: (i)
Transocean Drilling and (ii) TODCO. We provide services with different types of
drilling equipment in several geographic regions. The location of our operating
assets and the allocation of resources to build or upgrade drilling units are
determined by the activities and needs of customers. See Note 9.
For investments in joint ventures and other entities that do not meet the
criteria of a variable interest entity or where we are not deemed to be the
primary beneficiary for accounting purposes of those entities that do meet the
variable interest entity criteria, we use the equity method of accounting where
our ownership is between 20 percent and 50 percent or where our ownership is
more than 50 percent and we do not have significant influence or control over
the joint venture. We use the cost method of accounting for investments in joint
ventures where our ownership is less than 20 percent and where we do not have
significant influence over the joint venture. We consolidate those investments
in joint ventures that meet the criteria of a variable interest entity where we
are deemed to be the primary beneficiary for accounting purposes and for
entities in which we have a majority voting interest. Intercompany transactions
and accounts are eliminated.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - Our accompanying condensed consolidated financial
statements have been prepared without audit in accordance with accounting
principles generally accepted in the United States for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X of the Securities and Exchange Commission ("SEC"). Accordingly, pursuant to
such rules and regulations, these financial statements do not include all
disclosures required by accounting principles generally accepted in the U.S. for
complete financial statements. The
5
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
condensed consolidated financial statements reflect all adjustments, which are,
in the opinion of management, necessary for a fair presentation of financial
position, results of operations and cash flows for the interim periods. Such
adjustments are considered to be of a normal recurring nature unless otherwise
identified. Operating results for the three and 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 our Annual Report on Form 10-K for the year ended December 31, 2003.
Accounting Estimates - The preparation of financial statements in
conformity with accounting principles generally accepted in the U.S. requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues, expenses and disclosure of contingent assets and
liabilities. On an ongoing basis, we evaluate our estimates, including those
related to bad debts, materials and supplies obsolescence, investments,
intangible assets and goodwill, property and equipment and other long-lived
assets, income taxes, workers' insurance, pensions and other postretirement
benefits, other employment benefits and contingent liabilities. We base our
estimates on historical experience and on various other assumptions we believe
are 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.
Stock-Based Compensation - Through December 31, 2002 and in accordance with
the provisions of SFAS 123, Accounting for Stock-Based Compensation, we had
elected to follow Accounting Principles Board Opinion ("APB") 25, Accounting for
Stock Issued to Employees, and related interpretations in accounting for our
employee stock-based compensation plans. Effective January 1, 2003, we adopted
the fair value recognition provisions of SFAS 123 using the prospective method
proscribed in SFAS 148, Accounting for Stock-Based Compensation - Transition and
Disclosure. Under the prospective method, employee stock-based compensation
awards granted on or subsequent to January 1, 2003 are expensed over the vesting
period based on the fair value of the underlying awards on the date of grant.
The fair value of the stock options is determined using the Black-Scholes option
pricing model, while the fair value of restricted stock grants is determined
based on the market price of our stock on the date of grant. Additionally, stock
appreciation rights are recorded at fair value with the changes in fair value
being recorded as compensation expense as incurred. Stock-based compensation
awards granted prior to January 1, 2003, if not subsequently modified, will
continue to be accounted for under the recognition and measurement provisions of
APB 25.
6
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
If compensation expense for grants to employees under our long-term
incentive plan and employee stock purchase plan prior to January 1, 2003 was
recognized using the fair value method of accounting under SFAS 123 rather than
the intrinsic value method under APB 25, net income and earnings per share would
have been reduced to the pro forma amounts indicated below (in millions, except
per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2004 2003 2004 2003
----------- ----------- ----------- ----------
Net Income as Reported $ 154.9 $ 11.0 $ 225.6 $ 13.7
Add back: Stock-based compensation expense included in
reported net income, net of related tax effects 3.2 0.1 12.5 2.6
Deduct: Total stock-based compensation expense
determined under the fair value method for all awards, net of
related tax effects
Long-Term Incentive Plan (4.0) (4.2) (17.4) (12.5)
Employee Stock Purchase Plan (0.6) 0.4 (2.0) (1.7)
----------- ----------- ----------- ----------
Pro Forma Net Income $ 153.5 $ 7.3 $ 218.7 $ 2.1
=========== =========== =========== ==========
Basic Earnings Per Share
As Reported $ 0.48 $ 0.03 $ 0.70 $ 0.04
Pro Forma 0.48 0.02 0.68 0.01
Diluted Earnings Per Share
As Reported $ 0.48 $ 0.03 $ 0.70 $ 0.04
Pro Forma 0.47 0.02 0.67 0.01
New Accounting Pronouncements - In April 2004, the FASB issued FASB Staff
Position ("FSP") 129-1, Disclosure of Information about Capital Structure,
Relating to Contingently Convertible Securities, which applies to all
contingently convertible securities and became effective the date of issue. The
FSP requires disclosure of the nature of the contingency and the potential
impact of conversion on the financial statements, particularly the impact on
earnings per share, and whether the securities have been included in the
entity's calculation of diluted earnings per share. The implementation of this
FSP did not have an effect on our condensed consolidated financial statements
and related notes thereto as our disclosures are in accordance with the
disclosure requirements as stated in this FSP.
In September 2004, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") reached a consensus on issue No. 04-08, The
Effect of Contingently Convertible Instruments on Diluted Earnings per Share
("EITF 04-08"), which is effective for reporting periods ending after December
15, 2004. Contingently convertible instruments within the scope of this EITF are
instruments that contain conversion features that are contingently convertible
or exercisable based on (a) a market price trigger or (b) multiple contingencies
if one of the contingencies is a market price trigger for which the instrument
may be converted or share settled based on meeting a specified market condition.
The EITF requires companies to include shares issuable under convertible
instruments in diluted earnings per share computations (if dilutive) regardless
of whether the market price trigger (or other contingent feature) has been met.
In addition, prior period earnings per share amounts presented for comparative
purposes must be restated. The EITF would not have had an effect on our diluted
earnings per share for the years ended December 31, 2003, 2002 and 2001, the
nine months ended September 30, 2004 or for the three and nine months ended
September 30, 2003. For the three months ended September 30, 2004, diluted
earnings per share would have been reduced by $0.01. We will adopt EITF 04-08
as of December 31, 2004 and do not expect adoption to have a material effect on
our earnings per share for the year then ending.
7
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Reclassifications - Certain reclassifications have been made to prior
period amounts to conform with the current period's presentation.
NOTE 3 - TODCO OFFERINGS
Initial Public Offering - In February 2004, we completed the TODCO IPO in
which we sold 13.8 million shares of TODCO's class A common stock, representing
approximately 23 percent of TODCO's total outstanding shares, at $12.00 per
share. We received net proceeds of $155.7 million from the IPO and recognized a
gain of $39.4 million ($0.12 per diluted share) in the first quarter of 2004,
which represented the excess of net proceeds received over the net book value of
the TODCO shares sold in the IPO.
We entered into various agreements with TODCO to set forth our respective
rights and obligations relating to our businesses and to effect the separation
of our two companies. These agreements included a master separation agreement,
tax sharing agreement, employee matters agreement, transition services agreement
and registration rights agreement.
As a result of the deconsolidation of TODCO from our other U.S.
subsidiaries for U.S. federal income tax purposes in conjunction with the IPO,
we established in the first quarter of 2004 an initial valuation allowance of
approximately $31.0 million ($0.09 per diluted share) against the estimated
deferred tax assets of TODCO in excess of its deferred tax liabilities, taking
into account prudent and feasible planning strategies as required by SFAS 109,
Accounting for Income Taxes. In the third quarter of 2004, we reduced the
initial valuation allowance by approximately $14.0 million ($0.04 per diluted
share) as a result of changes in our estimate of the ultimate utilization of the
benefits from the tax sharing agreement with TODCO. This reduction in the
valuation allowance excludes other partially offsetting adjustments to our
overall valuation allowance that were included in the computation of the annual
effective tax rate. The ultimate amount of such valuation allowance could vary
significantly depending upon a number of factors, including the final allocation
of tax benefits between TODCO and our other subsidiaries under applicable law,
taxable income for calendar year 2004 and our ability to implement planning
strategies under SFAS 109.
In conjunction with the closing of the TODCO IPO, TODCO granted restricted
stock and stock options to certain of its employees under its long-term
incentive plan and certain of these awards vested at the time of grant. In
accordance with the provisions of SFAS 123, TODCO expects to recognize
compensation expense of approximately $17.0 million over the vesting periods of
the awards. TODCO recognized approximately $6.0 million ($0.02 per Transocean's
diluted share) in the first quarter of 2004 as a result of the immediate vesting
of certain awards. TODCO will amortize the remaining amount of approximately
$11.0 million to compensation expense over the next three years with
approximately $5.0 million to be recognized over the remainder of 2004 and
approximately $5.0 million and $1.0 million to be recognized in 2005 and 2006,
respectively. In addition, certain of TODCO's employees held options that were
granted prior to the IPO to acquire our ordinary shares. In accordance with the
employee matters agreement, these options were modified at the IPO date, which
resulted in the accelerated vesting of the options and the extension of the term
of the options through the original contractual life. TODCO recognized $1.5
million additional compensation expense in the first quarter of 2004 as a result
of the modification.
Secondary Offering - In September 2004, we completed the TODCO secondary
offering in which we sold 17.9 million shares of TODCO's class A common stock,
representing approximately 30 percent of TODCO's total outstanding shares, at
$15.75 per share. We received net proceeds of $269.9 million from the secondary
offering and recognized a gain of $129.4 million ($0.40 per diluted share) in
the third quarter of 2004, which represented the excess of net proceeds received
over the net book value of the TODCO shares sold in the secondary offering.
After the secondary offering, we hold an approximate 47 percent interest in
TODCO, represented by 28.3 million shares of class B common stock. Each share of
our class B common stock has five votes per share compared to one vote per share
of class A common stock. We have approximately 82 percent of the outstanding
voting interest in TODCO. We consolidate TODCO in our financial statements as a
business segment, and that portion of TODCO that we do not own is reflected as
minority interest in our condensed consolidated statements of operations and
balance sheets.
8
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
NOTE 4 - ASSET DISPOSITIONS, RETIREMENTS AND IMPAIRMENTS
Asset Dispositions and Retirements - In June 2004, we completed the sale of
a semisubmersible rig, the Sedco 602, for net proceeds of $28.0 million and
recognized a gain of $21.6 million ($0.07 per diluted share), which had no tax
effect, in our Transocean Drilling segment.
During the nine months ended September 30, 2004, we settled insurance
claims and sold marine support vessels and certain other assets for net proceeds
of $18.3 million. We recorded net gains of $1.9 million ($1.3 million, net of
tax) in our Transocean Drilling segment and $5.4 million ($0.02 per diluted
share), which had no tax effect, in our TODCO segment.
In January 2003, we completed the sale of the jackup rig RBF 160 for net
proceeds of $13.1 million and recognized a gain of $0.3 million ($0.2 million,
net of tax) in our Transocean Drilling segment. The proceeds were received in
December 2002.
During the nine months ended September 30, 2003, we settled an insurance
claim and sold certain other assets for net proceeds of $4.1 million. We
recorded net gains of $2.1 million ($1.9 million, or $0.01 per diluted share,
net of tax) in our Transocean Drilling segment and $0.5 million ($0.3 million,
net of tax) in our TODCO segment.
Impairments - During the nine months ended September 30, 2003, we recorded
non-cash impairment charges of $5.2 million ($0.02 per diluted share), which had
no tax effect, in our Transocean Drilling segment associated with the removal of
two rigs from drilling service and the value assigned to leases on oil and gas
properties that we intended to discontinue. The determination of fair market
value was based on an offer from a potential buyer, in the case of the two rigs,
and management's assessment of fair value, in the case of the leases on oil and
gas properties for which third party valuations were not available.
During the nine months ended September 30, 2003, we recorded non-cash
impairment charges of $11.6 million ($7.6 million, or $0.02 per diluted share,
net of tax) in our TODCO segment associated with the removal of five jackup rigs
from drilling service and the write down in the value of an investment in a
joint venture to fair value. The determination of fair market value was based on
third party valuations, in the case of the jackup rigs, and management's
assessment of fair value, in the case of the investment in a joint venture for
which third party valuations were not available.
NOTE 5 - INCOME TAXES
Income taxes have been provided based upon the tax laws and rates in the
countries in which operations are conducted and income is earned. There is no
expected relationship between the provision for or benefit from income taxes and
income or loss before income taxes because the countries have taxation regimes
that vary not only with respect to nominal rate, but also in terms of the
availability of deductions, credits and other benefits. Variations also arise
because income earned and taxed in any particular country or countries may
fluctuate from year to year. Transocean Inc., a Cayman Islands company, is not
subject to income tax in the Cayman Islands.
The effective tax rate for the three and nine months ended September 30,
2004 varies largely as a result of items included in income before income taxes
and minority interest for which there is no tax expense. These items include the
gains from TODCO offerings, losses on retirement of debt and portions of the net
gains from sale of assets. Included in our tax expense for the three months
ended September 30, 2004 is an approximately $10.0 million additional tax
expense that resulted from the increase in our expected annual effective tax
rate during the third quarter. In addition, changes in our valuation allowance
also impact the effective tax rate. See Note 3.
9
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The effective tax rate for the three and nine months ended September 30,
2003 varies in part as a result of items included in income before income taxes
and minority interest for which there is no tax expense or for which a specific
tax rate is applied as a result of the tax jurisdiction to which the transaction
relates. The items that have no tax expense include loss on retirement of debt,
TODCO IPO-related costs recognized as expense and a portion of the impairment
losses on long-lived assets. The items that are taxed in specific tax
jurisdictions primarily include a portion of the impairment losses on long-lived
assets, losses on retirement of certain assets, a portion of the losses on
retirement of debt and an impairment loss on a note receivable from a related
party.
As a result of our estimates related to the ultimate disposition of certain
pre-acquisition tax contingencies arising prior to our merger with Sedco Forex
Holdings Limited effective December 31, 1999, we recorded $26.3 million of
additional goodwill during the nine months ended September 30, 2004.
NOTE 6 - DEBT
Debt, net of unamortized discounts, premiums and fair value adjustments, is
comprised of the following (in millions):
September 30, December 31,
2004 2003
-------------- -------------
6.75% Senior Notes, due April 2005 $ 354.8 $ 361.2
7.31% Nautilus Class A1 Amortizing Notes - final maturity May 2005 30.8 63.6
6.95% Senior Notes, due April 2008 266.3 269.5
9.5% Senior Notes, due December 2008 11.2 357.3
800 Million Revolving Credit Agreement - final maturity December 2008 50.0 250.0
6.625% Notes, due April 2011 788.7 797.3
7.375% Senior Notes, due April 2018 250.4 250.4
Zero Coupon Convertible Debentures, due May 2020 (put options exercisable
May 2008 and May 2013) 16.9 16.5
1.5% Convertible Debentures, due May 2021 (put options exercisable May
2006, May 2011 and May 2016) 400.0 400.0
8% Debentures, due April 2027 198.2 198.1
7.45% Notes, due April 2027 (put options exercisable April 2007) 95.0 94.8
7.5% Notes, due April 2031 597.5 597.5
Other 1.6 1.9
-------------- -------------
Total Debt 3,061.4 3,658.1
Less Debt Due Within One Year 386.7 45.8
-------------- -------------
Total Long-Term Debt $ 2,674.7 $ 3,612.3
============== =============
10
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The scheduled maturity of our debt, at face value, assumes the bondholders
exercise their options to require us to repurchase the 1.5% Convertible
Debentures, 7.45% Notes and Zero Coupon Convertible Debentures in May 2006,
April 2007 and May 2008, respectively, and is as follows (in millions):
Twelve Months
Ending
September 30,
--------------
2005 $ 382.2
2006 400.4
2007 100.0
2008 269.0
2009 60.2
Thereafter 1,750.0
--------------
Total $ 2,961.8
==============
Commercial Paper Program - We have a revolving credit agreement, described
below, which, together with previous revolving credit agreements, provided
liquidity for commercial paper borrowings during 2003. Because we believe our
current cash balances and the revolving credit agreement described below provide
us with adequate liquidity, we terminated our Commercial Paper Program during
the first quarter of 2004.
Revolving Credit Agreements - We are party to an $800.0 million five-year
revolving credit agreement (the "Revolving Credit Agreement") dated December 16,
2003. The Revolving Credit Agreement bears interest, at our option, at a base
rate or London Interbank Offered Rate ("LIBOR") plus a margin that can vary from
0.35 percent to 0.95 percent depending on our non-credit enhanced senior
unsecured public debt rating. At September 30, 2004, the applicable margin was
0.5 percent. A facility fee varying from 0.075 percent to 0.225 percent
depending on our non-credit enhanced senior unsecured public debt rating, is
incurred on the daily amount of the underlying commitment, whether used or
unused, throughout the term of the facility. At September 30, 2004, the
applicable facility fee was 0.125 percent. A utilization fee of 0.125 percent is
payable if amounts outstanding under the Revolving Credit Agreement are greater
than $264.0 million. At September 30, 2004, $50.0 million was outstanding under
the Revolving Credit Agreement.
The Revolving Credit Agreement requires compliance with various covenants
and provisions customary for agreements of this nature, including an earnings
before interest, taxes, depreciation and amortization ("EBITDA") to interest
coverage ratio, as defined by the credit agreement, of not less than three to
one, a debt to total tangible capital ratio, as defined by the credit agreement,
of not greater than 50 percent, and limitations on creating liens, incurring
debt, transactions with affiliates, sale/leaseback transactions and mergers and
sale of substantially all assets.
In December 2003, TODCO entered into a $75.0 million two-year revolving
credit agreement (the "TODCO Revolving Credit Agreement"), which will reduce to
$60.0 million in December 2004. The TODCO Revolving Credit Agreement bears
interest, at TODCO's option, at a base rate plus a margin of 2.50 percent or
LIBOR plus a margin of 3.50 percent. Utilization of the facility is limited by
a borrowing base. Commitment fees on the unused portion of the facility are
1.50 percent of the average daily balance and are payable quarterly. At
September 30, 2004, there were no borrowings under the TODCO Revolving Credit
Agreement. The TODCO Revolving Credit Agreement requires compliance with various
covenants and provisions customary for similar agreements of non-investment
grade facilities. TODCO's Revolving Credit Agreement is not guaranteed by us.
Debt Redeemed, Retired and Repurchased - In March 2004, we completed the
redemption of our $289.8 million aggregate principal amount outstanding 9.5%
Senior Notes due December 2008 at the make-whole premium price provided in the
indenture. We redeemed these notes at 127.796 percent of face value or $370.3
million, plus
11
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
accrued and unpaid interest. We recognized an after-tax loss on the redemption
of debt of $28.1 million ($0.09 per diluted share) in the first quarter of 2004,
which reflected adjustments for fair value of the debt at the date of the R&B
Falcon merger and the unamortized fair value adjustment on the termination of
the related interest rate swap. We funded the redemption with existing cash
balances, which included proceeds from the TODCO IPO. The redemption did not
affect the 9.5% Senior Notes due December 2008 of TODCO, which had an aggregate
principal amount outstanding of $10.2 million at September 30, 2004.
In May 2003, we repurchased and retired all of the $50.0 million principal
amount outstanding 9.41% Nautilus Class A2 Notes due May 2005 and funded the
repurchase from existing cash balances. We recognized a loss on retirement of
debt of $5.5 million ($3.6 million, or $0.01 per diluted share, net of tax) in
the second quarter of 2003.
In May 2003, holders of our Zero Coupon Convertible Debentures due May 24,
2020 had the option to require us to repurchase their debentures. Holders of
$838.6 million aggregate principal amount, or approximately 97 percent, of these
debentures exercised this option, and we repurchased their debentures at a
repurchase price of $628.57 per $1,000 principal amount. Under the terms of the
debentures, we had the option to pay for the debentures with cash, our ordinary
shares or a combination of cash and shares, and we elected to pay the $527.2
million repurchase price from existing cash balances. We recognized additional
expense of $10.2 million ($0.03 per diluted share) as an after-tax loss on
retirement of debt in the second quarter of 2003 to fully amortize the remaining
debt issue costs related to the repurchased debentures.
In April 2003, we repaid the entire $239.5 million aggregate principal
amount outstanding 6.5% Senior Notes, of which $5.0 million principal amount
outstanding was the obligation of TODCO, plus accrued and unpaid interest, in
accordance with their scheduled maturity. We funded the repayment from existing
cash balances.
NOTE 7 - INTEREST RATE SWAPS
In January 2003, we terminated swaps and associated fair value hedges with
respect to our 6.75% Senior Notes due April 2005, 6.95% Senior Notes due April
2008 and 9.5% Senior Notes due December 2008. In March 2003, we terminated swaps
with respect to our 6.625% Notes. As a result of these terminations, we received
cash proceeds, net of accrued interest, of $173.5 million that had been
recognized in connection with the associated fair value hedges as a fair value
adjustment to the underlying long-term debt in our consolidated balance sheet
and the fair value adjustment is being amortized as a reduction to interest
expense over the remaining life of the underlying debt. During the three and
nine months ended September 30, 2004, such reduction amounted to $5.8 million
($0.02 per diluted share) and $18.2 million ($0.06 per diluted share),
respectively. During the three and nine months ended September 30, 2003, such
reduction amounted to $6.5 million ($0.02 per diluted share) and $16.5 million
($0.05 per diluted share), respectively. As a result of the redemption of our
9.5% Senior Notes in March 2004, we recognized $22.0 million of the unamortized
fair value adjustment as a reduction to our loss on redemption of debt (see Note
6).
At September 30, 2004 and December 31, 2003, we had no outstanding
interest rate swaps.
NOTE 8 - SEGMENTS
Our operations are aggregated into two reportable segments: (i) Transocean
Drilling and (ii) TODCO. The Transocean Drilling segment consists of floaters,
jackups and other rigs used in support of offshore drilling activities and
offshore support services. The TODCO segment consists of our interest in TODCO,
which conducts jackup, drilling barge, land rig, submersible and other
operations located in the U.S. Gulf of Mexico and inland waters, Mexico,
Trinidad and Venezuela. We provide services with different types of drilling
equipment in several geographic regions. The location of our rigs and the
allocation of resources to build or upgrade rigs is determined by the activities
and needs of customers. Accounting policies of the segments are the same as
those described in Note 2 within "Item 8. Financial Statements and Supplementary
Data" included in our Annual Report on Form 10-K for the year ended December 31,
2003. We account for intersegment revenue and expenses, if any, as if the
revenue or expenses were to third parties at current market prices.
12
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Operating revenues and income before income taxes and minority interest by
segment were as follows (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2004 2003 2004 2003
----------- ----------- ----------- ----------
Operating Revenues
Transocean Drilling $ 558.7 $ 564.4 $ 1,689.4 $ 1,675.6
TODCO 93.1 58.5 247.6 167.2
----------- ----------- ----------- ----------
Total Operating Revenues $ 651.8 $ 622.9 $ 1,937.0 $ 1,842.8
----------- ----------- ----------- ----------
Operating Income (Loss) Before General and
Administrative Expense
Transocean Drilling (a) $ 218.1 $ 118.9 $ 523.5 $ 347.1
TODCO (b) (2.4) (24.9) (38.7) (102.9)
----------- ----------- ----------- ----------
215.7 94.0 484.8 244.2
Unallocated general and administrative expense (15.2) (21.2) (44.3) (50.0)
Unallocated other expense, net (38.3) (44.3) (146.1) (171.9)
----------- ----------- ----------- ----------
Income Before Income Taxes and Minority Interest $ 162.2 $ 28.5 $ 294.4 $ 22.3
=========== =========== =========== ==========
_______________
(a) The three and nine months ended September 30, 2004 include gains from the
TODCO offerings of $129.4 million and $168.8 million, respectively.
(b) The three and nine months ended September 30, 2004 include $6.9 million and
$26.3 million, respectively, of operating and maintenance expense that
TODCO classifies as general and administrative expense. The three and nine
months ended September 30, 2003 include $3.9 million and $11.2 million,
respectively, of operating and maintenance expense that TODCO classifies as
general and administrative expense.
Depreciation expense by segment was as follows (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
2004 2003 2004 2003
---------- ---------- ---------- ---------
Transocean Drilling $ 110.0 $ 103.9 $ 326.4 $ 311.9
TODCO 23.9 22.9 72.0 69.2
---------- ---------- ---------- ---------
Total Depreciation Expense $ 133.9 $ 126.8 $ 398.4 $ 381.1
========== ========== ========== =========
Total assets by segment were as follows (in millions):
September 30, December 31,
2004 2003
-------------- -------------
Transocean Drilling $ 10,964.0 $ 10,874.0
TODCO 740.0 788.6
-------------- -------------
Total Assets $ 11,704.0 $ 11,662.6
============== =============
13
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Total capital expenditures by segment were as follows (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
2004 2003 2004 2003
---------- ---------- ---------- ---------
Transocean Drilling $ 42.6 $ 20.4 $ 93.6 $ 67.5
TODCO 2.5 2.0 6.2 5.1
---------- ---------- ---------- ---------
Total Capital Expenditures $ 45.1 $ 22.4 $ 99.8 $ 72.6
========== ========== ========== =========
NOTE 9 - EARNINGS PER SHARE
The reconciliation of the numerator and denominator used for the
computation of basic and diluted earnings per share is as follows (in millions,
except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
2004 2003 2004 2003
---------- ---------- ---------- ---------
NUMERATOR FOR BASIC AND DILUTED EARNINGS PER
SHARE
Net Income for Basic and Diluted Earnings per
Share $ 154.9 $ 11.0 $ 225.6 $ 13.7
========== ========== ========== =========
DENOMINATOR FOR DILUTED EARNINGS PER SHARE
Weighted-average shares outstanding for basic
earnings per share 320.9 319.9 320.7 319.8
Effect of dilutive securities:
Employee stock options and unvested stock grants 2.8 0.9 2.3 1.1
Warrants to purchase ordinary shares 1.6 0.3 1.5 0.5
---------- ---------- ---------- ---------
Adjusted weighted-average shares and assumed
conversions for diluted earnings per share 325.3 321.1 324.5 321.4
========== ========== ========== =========
BASIC AND DILUTED EARNINGS PER SHARE
Net Income $ 0.48 $ 0.03 $ 0.70 $ 0.04
========== ========== ========== =========
Ordinary shares subject to issuance pursuant to the conversion features of
the convertible debentures are not included in the calculation of adjusted
weighted-average shares and assumed conversions for diluted earnings per share
because the effect of including those shares is anti-dilutive for all periods
presented. Ordinary shares subject to issuance pursuant to the conversion
features of the contingently convertible debentures are not included in the
calculation of adjusted weighted-average shares and assumed conversions for
diluted earnings per share because the conversion features have not been
triggered for all periods presented (see Note 2).
NOTE 10 - CONTINGENCIES
Legal Proceedings - Several of our 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 TODCO's subsidiaries to whom we 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
14
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
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, we anticipate 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. We have
not yet had an opportunity to conduct any discovery nor have we been able to
determine the number of plaintiffs, if any, that were employed by our
subsidiaries or otherwise have any connection with our drilling operations. We
intend to defend ourselves vigorously and, based on the limited information
available to us at this time, we do not expect the ultimate outcome of these
lawsuits to have a material adverse effect on our business or consolidated
financial position.
In 1990 and 1991, two of our subsidiaries were served with various
assessments collectively valued at approximately $5.8 million from the
municipality of Rio de Janeiro, Brazil to collect a municipal tax on services.
We believe that neither subsidiary is liable for the taxes and have contested
the assessments in the Brazilian administrative and court systems. In October
2001, the Brazil Supreme Court rejected our appeal of an adverse lower court's
ruling with respect to a June 1991 assessment, which is valued at approximately
$5 million. We are continuing to challenge the assessment and have an action to
suspend a related tax foreclosure proceeding. We have received a favorable
ruling in connection with a disputed August 1990 assessment but the government
has appealed that ruling. We also are awaiting a ruling from the Taxpayer's
Council in connection with an October 1990 assessment. If our defenses are
ultimately unsuccessful, we believe that the Brazilian government-controlled oil
company, Petrobras, has a contractual obligation to reimburse us for municipal
tax payments required to be paid by them. We do not expect the liability, if
any, resulting from these assessments to have a material adverse effect on our
business or consolidated financial position.
The Indian Customs Department, Mumbai, filed a "show cause notice" against
one of our subsidiaries and various third parties in July 1999. The show cause
notice alleged that the initial entry into India in 1988 and other subsequent
movements of the Trident II jackup rig operated by the subsidiary constituted
imports and exports for which proper customs procedures were not followed and
sought payment of customs duties of approximately $31 million based on an
alleged 1998 rig value of $49 million, plus interest and penalties, and
confiscation of the rig. In January 2000, the Customs Department issued its
order, which found that we had imported the rig improperly and intentionally
concealed the import from the authorities, and directed us to pay a redemption
fee of approximately $3 million for the rig in lieu of confiscation and to pay
penalties of approximately $1 million in addition to the amount of customs
duties owed. In February 2000, we filed an appeal with the Customs, Excise and
Gold (Control) Appellate Tribunal ("CEGAT") together with an application to have
the confiscation of the rig stayed pending the outcome of the appeal. In March
2000, the CEGAT ruled on the stay application, directing that the confiscation
be stayed pending the appeal. The CEGAT issued its opinion on our appeal on
February 2, 2001, and while it found that the rig was imported in 1988 without
proper documentation or payment of duties, the redemption fee and penalties were
reduced to less than $0.1 million in view of the ambiguity surrounding the
import practice at the time and the lack of intentional concealment by us. The
CEGAT further sustained our position regarding the value of the rig at the time
of import as $13 million and ruled that subsequent movements of the rig were not
liable to import documentation or duties in view of the prevailing practice of
the Customs Department, thus limiting our exposure as to custom duties to
approximately $6 million. Following the CEGAT order, we tendered payment of
redemption, penalty and duty in the amount specified by the order by offset
against a $0.6 million deposit and $10.7 million guarantee previously made by
us. The Customs Department attempted to draw the entire guarantee, alleging the
actual duty payable is approximately $22 million based on an interpretation of
the CEGAT order that we believe is incorrect. This action was stopped by an
interim ruling of the High Court, Mumbai on writ petition filed by us. We and
the Customs Department both filed appeals with the Supreme Court of India
against the order of the CEGAT, and both appeals have been admitted. The Supreme
Court has recently dismissed the Customs Department appeal and affirmed the
CEGAT order but the Customs Department has not agreed with our interpretation of
that order. We and our customer agreed to pursue and obtained the issuance of
documentation from the Ministry of Petroleum that, if accepted by the Customs
Department, would reduce the duty to nil. The
15
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
agreement with the customer further provided that if this reduction was not
obtained by the end of 2001, our customer would pay the duty up to a limit of
$7.7 million. The Customs Department did not accept the documentation or agree
to refund the duties already paid. We are pursuing our remedies against the
Customs Department and our customer. We do not expect, in any event, that the
ultimate liability, if any, resulting from the matter will have a material
adverse effect on our business or consolidated financial position.
In October 2001, TODCO was notified by the U.S. Environmental Protection
Agency ("EPA") that the EPA had identified a subsidiary as a potentially
responsible party in connection with the Palmer Barge Line superfund site
located in Port Arthur, Texas. Based upon the information provided by the EPA
and a review of TODCO's internal records to date, TODCO disputes its designation
as a potentially responsible party. Pursuant to the master separation agreement
with TODCO, we are responsible and will indemnify TODCO for any losses TODCO
incurs in connection with this action. We do not expect that the ultimate
outcome of this case will have a material adverse effect on our business or
consolidated financial position.
In August 2003, a judgment of approximately $9.5 million was entered by the
Labor Division of the Provincial Court of Luanda, Angola, against us and one of
our labor contractors, Hull Blyth, in favor of certain former workers on several
of our drilling rigs. The workers were employed by Hull Blyth to work on several
drilling rigs while the rigs were located in Angola. When the drilling contracts
concluded and the rigs left Angola, the workers' employment ended. The workers
brought suit claiming that they were not properly compensated when their
employment ended. In addition to the monetary judgment, the Labor Division
ordered the workers to be hired by us. We believe that this judgment is without
sufficient legal foundation and have appealed the matter to the Angola Supreme
Court. We further believe that Hull Blyth has an obligation to protect us from
any judgment. We do not believe that the ultimate outcome of this matter will
have a material adverse effect on our business or consolidated financial
position.
One of our subsidiaries is involved in an action with respect to customs
penalties relating to the Sedco 710 semisubmersible drilling rig. Prior to our
merger with Sedco Forex Holdings Limited ("Sedco Forex"), this drilling rig,
which was working for Petrobras in Brazil at the time, had been admitted into
the country on a temporary basis under authority granted to a Schlumberger
entity. Prior to the merger with Sedco Forex at the end of 1999, the drilling
contract was moved to an entity that would become one of our subsidiaries. In
early 2000, the drilling contract was extended for another year. On January 10,
2000, the temporary import permit granted to the Schlumberger entity expired,
and renewal filings were not made until later that January. In April 2000, the
Brazilian customs authorities cancelled the import permit. The Schlumberger
entity filed an action in the Brazilian federal court of Campos for the purpose
of extending the temporary admission. Other proceedings were also initiated in
order to secure the transfer of the temporary admission to our subsidiary.
Ultimately, the court permitted the transfer to our entity but has not ruled
that the temporary admission could be extended without the payment of a
financial penalty. During the first quarter of 2004, the customs office renewed
its efforts to collect a penalty and issued a second assessment for this penalty
but has now done so against our subsidiary. The assessment is for approximately
$50 million. We believe that the amount of the assessment, even if it were
appropriate, should only be approximately $7.6 million and should in any event
be assessed against the Schlumberger entity. We and Schlumberger are contesting
our respective assessments. We have put Schlumberger on notice that we consider
any assessment to be the responsibility of Schlumberger. We do not expect the
ultimate outcome of this matter to have a material adverse effect on our
business or consolidated financial position.
We are involved in a number of other lawsuits, all of which have arisen in
the ordinary course of our business. We do not believe that ultimate liability,
if any, resulting from any such other pending litigation will have a material
adverse effect on our business or consolidated financial position.
Letters of Credit and Surety Bonds - We had letters of credit outstanding
totaling $176.4 million and $186.2 million at September 30, 2004 and December
31, 2003, respectively. These letters of credit guarantee various contract
bidding and performance activities under various uncommitted lines provided by
several banks.
16
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
As is customary in the contract drilling business, we also have various
surety bonds in place that secure customs obligations relating to the
importation of our rigs and certain performance and other obligations. Surety
bonds outstanding totaled $21.6 million and $169.5 million at September 30, 2004
and December 31, 2003, respectively. The decrease in outstanding surety bonds is
primarily attributable to the expiration of three such bonds totaling $151.1
million related to our Brazil operations.
NOTE 11 - SALE/LEASEBACK TRANSACTION
We lease the drillship M. G. Hulme, Jr. from Deep Sea Investors, L.L.C., a
special purpose entity formed by several leasing companies to acquire the rig
from one of our subsidiaries in November 1995 in a sale/leaseback transaction.
We are obligated to pay rent of approximately $13 million per year through
November 2005. At the termination of the lease, we may purchase the rig for a
maximum amount of approximately $35.7 million. Effective September 2002, the
lease neither requires that collateral be maintained nor contains any credit
rating triggers.
Effective December 31, 2003, we adopted and applied the provisions of FASB
Interpretation ("FIN") 46, Consolidation of Variable Interest Entities, as
revised December 31, 2003, for all variable interest entities. FIN 46 requires
the consolidation of variable interest entities in which an enterprise absorbs a
majority of the entity's expected losses, receives a majority of the entity's
expected residual returns, or both, as a result of ownership, contractual or
other financial interests in the entity. Because the sale/leaseback agreement is
with an entity in which we have no direct investment, we are not entitled to
receive the financial statements of the leasing entity and the equity holders of
the leasing company will not release the financial statements or other financial
information to us in order for us to make the determination of whether the
entity is a variable interest entity. In addition, without the financial
statements, we are unable to determine if we are the primary beneficiary of the
entity and, if so, what we would consolidate. We have no exposure to loss as a
result of the sale/leaseback agreement. We currently account for the lease of
this semisubmersible drilling rig as an operating lease.
NOTE 12 - RELATED PARTY TRANSACTIONS
Delta Towing - TODCO owns a 25 percent interest in a joint venture, Delta
Towing Holdings, LLC ("Delta Towing"), and TODCO holds notes receivable from
Delta Towing with a face amount of approximately $143.0 million, which at the
time of the R&B Falcon merger were valued at $80.0 million. Delta Towing
defaulted on the notes receivable in January 2003 by failing to make its
scheduled quarterly interest payment and remained in default as a result of its
continued failure to make its quarterly interest payments. As a result of
TODCO's continued evaluation of the collectibility of the notes, TODCO recorded
an impairment on the notes receivable of $21.3 million ($13.8 million, or $0.04
per diluted share, net of tax) in June 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.
In September 2003, we established a reserve of $1.6 million for interest income
earned during the third quarter on the notes receivable. During the nine months
ended September 30, 2003, we earned interest income related to the notes
receivable and the three-year revolving credit facility of $3.1 million and $0.2
million, respectively.
As a result of the adoption of FIN 46 and a determination that TODCO was
the primary beneficiary for accounting purposes of Delta Towing, TODCO
consolidated Delta Towing effective December 31, 2003 and intercompany
transactions and accounts have been eliminated, including the above described
notes receivable.
DDII LLC - In May 2003, WestLB AG, one of the lenders in the Deepwater
Frontier synthetic lease financing facility, assigned its $46.1 million
remaining promissory note receivable to us in exchange for cash of $46.1
million. Also in May 2003, but subsequent to the WestLB AG assignment, we
purchased ConocoPhillips' 40 percent interest in Deepwater Drilling II L.L.C.
("DDII LLC") for approximately $5.0 million. As a result of this purchase, we
consolidated DDII LLC late in the second quarter of 2003. In addition, we
acquired certain drilling and other contracts from ConocoPhillips for
approximately $9.0 million in cash. Through September 30, 2003, we received
payments on the promissory note receivable of $1.9 million.
17
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
NOTE 13 - RETIREMENT PLANS AND OTHER POSTEMPLOYMENT BENEFITS
Defined Benefit Pension Plans - We have several defined benefit pension
plans, both funded and unfunded, covering substantially all U.S. employees
except for TODCO employees. We also have various defined benefit plans that
cover Norway and Nigeria employees and various current and former employees
covered under certain frozen plans acquired in connection with the R&B Falcon
merger. Net periodic benefit cost for these defined benefit pension plans
included the following components (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2004 2003 2004 2003
----------- ----------- ----------- ----------
COMPONENTS OF NET PERIODIC BENEFIT COST (A)
Service cost $ 4.7 $ 4.2 $ 12.5 $ 12.5
Interest cost 4.1 4.8 12.4 14.0
Expected return on plan assets (4.9) (4.9) (14.6) (14.7)
Amortization of transition obligation 0.1 - 0.2 0.2
Amortization of prior service cost (0.9) 0.3 (0.6) 1.0
Recognized net actuarial losses 1.5 0.1 2.8 0.3
SFAS 88 settlements/curtailments - (0.8) - (0.8)
----------- ----------- ----------- ----------
Benefit cost $ 4.6 $ 3.7 $ 12.7 $ 12.5
=========== =========== =========== ==========
______________
(a) Amounts are before income tax effect.
Due to an increase in the number of retirements, including the retirement
of an executive officer, and expected retirements in the fourth quarter of 2004,
we have revised our estimated contributions for 2004. We expect to contribute
approximately $14.0 million, a $4 million increase from amounts previously
disclosed, to our defined benefit pension plans in 2004. Such contributions will
be funded from our cash flows from operations. As of September 30, 2004, $10.2
million in contributions have been made to the defined benefit pension plans.
Postretirement Benefits Other Than Pensions - We have several unfunded
contributory and noncontributory postretirement benefit plans covering
substantially all of our Transocean Drilling segment U.S. employees. Net
periodic benefit cost for these other postretirement plans included the
following components (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2004 2003 2004 2003
----------- ---------- ----------- ----------
COMPONENTS OF NET PERIODIC BENEFIT COST (A)
Service cost $ 0.3 $ 0.4 $ 0.8 $ 1.4
Interest cost 0.5 0.9 1.6 2.6
Amortization of prior service cost (0.6) 0.1 (1.7) 0.3
Recognized net actuarial losses 0.3 0.4 1.1 1.0
SFAS 88 settlements/curtailments - - - (0.6)
----------- ---------- ----------- ----------
Benefit cost $ 0.5 $ 1.8 $ 1.8 $ 4.7
=========== ========== =========== ==========
______________
(a) Amounts are before income tax effect.
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Medicare Act") was signed into law. The Medicare
Act introduced two new features to Medicare that employers must consider in
determining the effect of the Medicare Act on their accumulated postretirement
benefit obligation (''APBO'') and net periodic post retirement benefit cost: (i)
a subsidy based on 28 percent of an individual
18
TRANSOCEAN INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
beneficiary's annual prescription drug costs between $250 and $5,000, and (ii)
the opportunity for a retiree to obtain a prescription drug benefit under
Medicare that is at least actuarially equivalent to Medicare Part D.
In May 2004, the FASB staff issued FASB Staff Position ("FSP") 106-2,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. We adopted FSP 106-2, effective
July 1, 2004, accounting for these new features in the Medicare Act
prospectively as an actuarial gain to be amortized into income over the average
remaining service period of the plan participants. The adoption of these
requirements did not have a material impact on our condensed consolidated
financial position or results of operations for the three or nine months ended
September 30, 2004.
NOTE 14 - SUBSEQUENT EVENTS
6.75% Senior Note Redemption - In October 2004, we redeemed our $342.3
million aggregate principal amount outstanding 6.75% Senior Notes due April 2005
at the make-whole premium price provided in the indenture. We redeemed these
notes at 102.127 percent of face value or $349.5 million, plus accrued and
unpaid interest. We recognized a loss on the redemption of approximately $3.3
million, which reflects adjustments for fair value of the debt at the date of
the R&B Falcon merger and the premium on the termination of the related interest
rate swap. We funded the redemption with existing cash on hand, which included
proceeds from the TODCO secondary offering. The redemption did not affect the
6.75% Senior Notes due April 2005 of TODCO, which had an aggregate principal
amount outstanding of $7.7 million at September 30, 2004.
Tax Matters - In October 2004, we received from the U.S. Internal Revenue
Service ("IRS") examination reports setting forth proposed changes to the U.S.
federal income tax reported for the period 1999-2000. The proposed changes total
approximately $195 million, exclusive of interest. The IRS has also notified us
of its intent to audit our 2002 and 2003 tax years. While we have agreed to
certain non-material adjustments, we believe our returns are materially correct
as filed and intend to defend ourselves vigorously. While there can be no
assurance, we do not expect the ultimate outcome to have a material adverse
effect on our business or consolidated financial position.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the unaudited
condensed consolidated financial statements included herein under "Item 1.
Financial Statements" and the audited consolidated financial statements and the
notes thereto and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" included in our Annual Report on Form 10-K
for the year ended December 31, 2003.
OVERVIEW
Transocean Inc. (together with our subsidiaries and predecessors, unless
the context requires otherwise, "Transocean," "we," "us" or "our") is a leading
international provider of offshore contract drilling services for oil and gas
wells. As of October 29, 2004, we owned, had partial ownership interests in or
operated 94 mobile offshore and barge drilling units, excluding the fleet of
TODCO (together with its subsidiaries and predecessors, unless the context
requires otherwise, "TODCO"), a publicly traded company in which we have a
majority voting interest. As of this date, our fleet included 32
High-Specification semisubmersibles and drillships ("floaters"), 25 Other
Floaters, 26 Jackup Rigs and 11 Other Rigs. As of October 29, 2004, TODCO's
fleet consisted of 24 jackup rigs, 30 drilling barges, nine land rigs, three
submersible drilling rigs and four other drilling rigs.
Our mobile offshore drilling fleet is considered one of the most modern and
versatile fleets in the world. Our primary business is to contract these
drilling rigs, related equipment and work crews primarily on a dayrate basis to
drill oil and gas wells. We specialize in technically demanding segments of the
offshore drilling business with a particular focus on deepwater and harsh
environment drilling services. We also provide additional services, including
integrated well services and management of third party well service activities.
Certain key measures of our total company results of operations and
financial condition are as follows:
Three Months Ended Nine Months Ended
September 30, Three September 30, Nine
------------------------ Months ----------------------- Months
2004 2003 Change 2004 2003 Change
------------------------ ------- ----------------------- -------
(In millions, except dayrates and percentages)
Average dayrate (a) $ 70,100 $ 67,000 $ 3,100 $ 70,400 $ 67,100 $ 3,300
Utilization (b) 57% 59% N/A 57% 57% N/A
STATEMENT OF OPERATIONS
Operating revenue $ 651.8 $ 622.9 $ 28.9 $ 1,937.0 $ 1,842.8 $ 94.2
Operating and maintenance expense 432.9 403.0 29.9 1,251.5 1,203.6 47.9
Operating income 200.5 72.8 127.7 440.5 194.2 246.3
Net income 154.9 11.0 143.9 225.6 13.7 211.9
September 30, December 31,
2004 2003 Change
-------------- ------------- --------
(In millions)
BALANCE SHEET DATA (AT END OF PERIOD)
Cash $ 775.8 $ 474.0 $ 301.8
Total Assets 11,704.0 11,662.6 41.4
Debt 3,061.4 3,658.1 (596.7)
_____________________
"N/A" means not applicable.
(a) Average dayrate is defined as contract drilling revenue earned per revenue
earning day in the period.
(b) Utilization is defined as the total actual number of revenue earning days
as a percentage of the total number of calendar days in the period.
20
Our revenue and operating and maintenance expenses for the nine months
ended September 30, 2004 increased from the comparable period last year due to
the current year effect of including the operations of the drillships Deepwater
Pathfinder and Deepwater Frontier as a result of the 2003 acquisitions of the
portions of the Deepwater Drilling L.L.C. ("DD LLC") and Deepwater Drilling II
L.L.C. ("DDII LLC") joint ventures previously held by ConocoPhillips and the
subsequent payoff of the synthetic lease financing arrangements in late December
2003, as well as from higher integrated services provided to our clients in
2004. In 2003, the Discoverer Enterprise riser incident negatively impacted
revenues and operating and maintenance expense. In 2004, the Discoverer
Enterprise operating and maintenance was partially reduced by an insurance
settlement related to the riser incident (see "-Significant Events"). Also
adding to the increase in operating and maintenance expense were repairs
resulting from a fire on the jackup rig Trident 20 that occurred in the third
quarter of 2004. Revenues were negatively impacted by suspended operations due
to the recently concluded strike in Norway, a fire on the Trident 20 and the
well control incident on the semisubmersible rig Jim Cunningham, all of which
occurred during the third quarter of 2004. Our nine months ended September 30,
2004 financial results included a non-cash charge pertaining to a loss on
retirement of debt partially offset by the recognition of a gain on the sale of
a semisubmersible rig. We also recognized gains on the TODCO initial public
offering ("IPO") and secondary offering that were partially offset by a tax
valuation allowance adjustment and stock option expense recorded in relation to
the IPO (see "-Significant Events"). Cash increased during the nine months ended
September 30, 2004 primarily as a result of proceeds received from the TODCO
offerings and cash provided by operating activities, partially offset by
repayments on debt instruments as we continue to maintain our focus on debt
reduction.
Our operations are aggregated into two reportable segments: (i) Transocean
Drilling and (ii) TODCO. The Transocean Drilling segment consists of floaters,
jackups and other rigs used in support of offshore drilling activities and
offshore support services. The TODCO segment consists of our interest in TODCO,
which conducts jackup, drilling barge, land rig, submersible and other
operations in the U.S. Gulf of Mexico and inland waters, Mexico, Trinidad and
Venezuela. We provide services with different types of drilling equipment in
several geographic regions. The location of our rigs and the allocation of
resources to build or upgrade rigs is determined by the activities and needs of
our customers.
We categorize our Transocean Drilling segment fleet as follows: (i)
"High-Specification Floaters" consisting of our "Fifth-Generation Deepwater
Floaters," "Other Deepwater Floaters" and "Other High-Specification Floaters,"
(ii) "Other Floaters", (iii) "Jackups," and (iv) "Other Rigs". Within our
High-Specification Floaters category, we consider our Fifth-Generation Deepwater
Floaters to be the semisubmersibles Deepwater Horizon, Cajun Express, Deepwater
Nautilus, Sedco Energy and Sedco Express and the drillships Deepwater Discovery,
Deepwater Expedition, Deepwater Frontier, Deepwater Millennium, Deepwater
Pathfinder, Discoverer Deep Seas, Discoverer Enterprise, and Discoverer Spirit.
These rigs were built in the last construction cycle and have high-pressure mud
pumps and a water depth capability of 7,500 feet or greater. The Other Deepwater
Floaters are generally those other semisubmersible rigs and drillships that have
a water depth capacity of at least 4,500 feet. The Other High-Specification
Floaters, built as fourth-generation rigs in the mid to late 1980's, are capable
of drilling in harsh environments and have greater displacement than previously
constructed rigs resulting in larger variable load capacity, more useable deck
space and better motion characteristics. The Other Floaters category is
generally comprised of those non-high-specification floaters with a water depth
capacity of less than 4,500 feet. The Jackups category consists of this
segment's jackup fleet, and the Other Rigs category consists of other rigs that
are of a different type or use. These categories reflect how we view, and how we
believe our investors and the industry generally view, our fleet, and reflect
our strategic focus on the ownership and operation of premium high-specification
floating rigs and jackups.
SIGNIFICANT EVENTS
Transocean Drilling Segment
Operational Incidents - In May 2003, we announced that a drilling riser had
separated on our deepwater drillship Discoverer Enterprise and that the rig had
temporarily suspended drilling operations for our customer. The rig resumed
operations in July 2003 and we resolved a disagreement with our customer
regarding the incident in early 2004, which had no significant effect on our
results of operations. In June 2004, we finalized discussions with our insurers
relating to an insurance claim for a portion of our losses stemming from this
incident and received a
21
significant portion of an insurance settlement in June 2004 and the remainder in
August 2004, which had a favorable effect on pre-tax earnings of $13.4 million.
In July 2004, members of the OFS, one of three unions representing offshore
workers in Norway, called a strike on our semisubmersible units operating in the
country. OFS called the strike after it was unable to reach an agreement with
the Norwegian Shipowners Association, which represents rig owners in Norway. The
rigs affected are the Polar Pioneer, Transocean Searcher and Transocean Leader.
The strike has concluded after government intervention. The Transocean Searcher
and Transocean Leader resumed operations in the Norwegian sector of the North
Sea in November 2004. The Polar Pioneer is expected to commence operations in
November 2004 on a project for Statoil following the completion of planned
survey and upgrade work. Operating income would have been an estimated $8.0
million higher absent the labor strike. See "-Operating Results."
In July 2004, the jackup rig Trident 20 suffered damage resulting from a
fire in the rig's engine room while operating offshore Turkmenistan in the
Caspian Sea. The rig has been under a three-well contract. Pursuant to the
contract, our customer has the right to terminate the contract. While the
contract has been suspended by the customer to allow time for rig repairs and we
expect that drilling will resume under the terms of the original contract upon
completion of the repairs, no assurances can be given that the contract will not
be terminated. The rig is expected to be out of service the majority of the
fourth quarter and we currently estimate the total repair, crew and other costs
to be approximately $18.0 million. Operating income would have been an estimated
$13.0 million higher absent the incident. See "-Operating Results."
In August 2004, the semisubmersible rig Jim Cunningham experienced a well
control incident that resulted in a fire while operating offshore Egypt. The rig
is expected to be out of service until late in the fourth quarter and we
currently estimate the repair, crew and other costs to be between $9 million and
$14 million. Operating income would have been an estimated $1.5 million higher
absent the incident. See "-Operating Results."
Asset Dispositions - In March 2004 we entered into an agreement to sell a
semisubmersible rig, the Sedco 600, for net proceeds of approximately $25.0
million. We expect to close the sale during the fourth quarter of 2004 after
completion of a drilling project.
In June 2004, we completed the sale of a semisubmersible rig, the Sedco
602, for net proceeds of approximately $28.0 million and recognized a gain of
$21.6 million.
Debt Redemption - In March 2004, we completed the redemption of our $289.8
million aggregate principal amount outstanding 9.5% Senior Notes due December
2008 at the make-whole premium price provided in the indenture. We redeemed
these notes at 127.796 percent of face value or $370.3 million, plus accrued and
unpaid interest. We recognized an after-tax loss on the redemption of debt of
$28.1 million in the first quarter of 2004, which reflected adjustments for fair
value of the debt at the date of the merger ("R&B Falcon merger") with R&B
Falcon Corporation ("R&B Falcon") and the unamortized fair value adjustment on
the termination of the related interest rate swap. We funded the redemption with
existing cash balances, which included proceeds from the TODCO IPO. The
redemption did not affect the 9.5% Senior Notes due December 2008 of TODCO,
which had an aggregate principal amount outstanding of $10.2 million at
September 30, 2004.
In October 2004, we redeemed our $342.3 million aggregate principal amount
outstanding 6.75% Senior Notes due April 2005 at the make-whole premium price
provided in the indenture. We redeemed these notes at 102.127 percent of face
value or $349.5 million, plus accrued and unpaid interest. We recognized a loss
on the redemption of approximately $3.3 million, which reflects adjustments for
fair value of the debt at the date of the R&B Falcon merger and the unamortized
fair value adjustment on the termination of the related interest rate swap. We
funded the redemption with existing cash on hand, which included proceeds from
the TODCO secondary offering. The redemption did not affect the 6.75% Senior
Notes due April 2005 of TODCO, which had an aggregate principal amount
outstanding of $7.7 million at September 30, 2004.
IPO and Secondary Offering - In February 2004, we completed the TODCO IPO,
in which we sold 13.8 million shares of TODCO's class A common stock,
representing approximately 23 percent of TODCO's total
22
outstanding shares, at $12.00 per share. We received net proceeds of $155.7
million from the IPO and recognized a gain of $39.4 million in the first quarter
of 2004, which represents the excess of net proceeds received over the net book
value of the TODCO shares sold in the IPO. TODCO was formerly known as R&B
Falcon. Before the closing of the IPO, TODCO transferred to us all assets and
businesses unrelated to TODCO's business. R&B Falcon's business was previously
considerably broader than TODCO's ongoing business.
As a result of the deconsolidation of TODCO from our other U.S.
subsidiaries for U.S. federal income tax purposes in conjunction with the IPO,
we established an initial valuation allowance in the first quarter of 2004 of
approximately $31.0 million against the estimated deferred tax assets of TODCO
in excess of its deferred tax liabilities, taking into account prudent and
feasible planning strategies as required by Financial Accounting Standards
Board's ("FASB") Statement of Financial Accounting Standards ("SFAS") 109,
Accounting for Income Taxes. In the third quarter of 2004, we reduced the
initial valuation allowance by approximately $14.0 million as a result of
changes in our estimate of the ultimate utilization of the benefits from the tax
sharing agreement with TODCO. This reduction in the valuation allowance excludes
other partially offsetting adjustments to our overall valuation allowance that
were included in the computation of the annual estimated effective tax rate. The
ultimate amount of such valuation allowance could vary significantly depending
upon a number of factors, including the final allocation of tax benefits between
TODCO and our other subsidiaries under applicable law, taxable income for
calendar year 2004 and our ability to implement tax planning strategies under
SFAS 109.
In conjunction with the closing of the TODCO IPO, TODCO granted restricted
stock and stock options to certain of its employees under its long-term
incentive plan and certain of these awards vested at the time of grant. In
accordance with the provisions of the SFAS 123, Accounting for Stock-Based
Compensation, TODCO expects to recognize compensation expense of approximately
$17.0 million over the vesting periods of the awards. TODCO recognized
approximately $6.0 million in the first quarter of 2004 as a result of the
immediate vesting of certain awards. TODCO will amortize the remaining amount of
approximately $11.0 million to compensation expense over the next three years
with approximately $5.0 million to be recognized over the remainder of 2004 and
approximately $5.0 million and $1.0 million to be recognized in 2005 and 2006,
respectively. In addition, certain of TODCO's employees held options that were
granted prior to the IPO to acquire our ordinary shares. In accordance with the
employee matters agreement, these options were modified, which resulted in the
accelerated vesting of the options and the extension of the term of the options
through the original contractual life. In connection with the modification of
these options, TODCO recognized approximately $1.5 million additional
compensation expense in the first quarter of 2004.
In September 2004, we completed the TODCO secondary offering, in which we
sold 17.9 million shares of TODCO's class A common stock, representing
approximately 30 percent of TODCO's total outstanding shares, at $15.75 per
share. We received net proceeds of $269.9 million from the secondary offering
and recognized a gain of $129.4 million in the third quarter of 2004, which
represented the excess of net proceeds received over the net book value of the
TODCO shares sold in the secondary offering.
As of October 29, 2004, we hold an approximate 47 percent interest in
TODCO, represented by 28.3 million shares of class B common stock, and we have
approximately 82 percent of the outstanding voting interest in TODCO. Each share
of our class B common stock has five votes per share compared to one vote per
share of the class A common stock. We consolidate TODCO in our financial
statements as a separate business segment and expect to continue to consolidate
TODCO in our financial statements until we no longer have a majority voting
interest.
Our current long-term intent is to dispose of our remaining interest in
TODCO, which could be achieved through a number of possible transactions
including additional public offerings, open market sales, sales to one or more
third parties, a spin-off to our shareholders, split-off offerings to our
shareholders that would allow for the opportunity to exchange our shares for
shares of TODCO class A common stock or a combination of these transactions. We
may also decide to convert our TODCO class B shares to class A shares, the
effect of which would be that we would no longer hold a majority voting
interest.
`
TODCO Deferred Tax Charge - Under the tax sharing agreement entered into
between Transocean and TODCO at the time of the initial IPO of TODCO, Transocean
is entitled to receive from TODCO payment for the tax
23
benefits generated prior to the IPO that TODCO utilizes subsequent to the IPO.
As long as TODCO is included as a consolidated subsidiary of Transocean, we
follow the provisions of SFAS 109 which allow us to evaluate the recoverability
of the deferred tax assets associated with the tax sharing agreement considering
the deferred tax liabilities of TODCO. We have recorded a valuation allowance
for the excess of these deferred tax assets over the deferred tax liabilities of
TODCO, also taking into account prudent and feasible planning strategies as
required by SFAS 109. Once we fall below a majority voting interest so that
TODCO is no longer included as a consolidated subsidiary of Transocean, we will
no longer be able to apply the provisions of SFAS 109 in accounting for the
utilization of our deferred tax assets. At that time, the receivable under the
tax sharing agreement will be accounted for as a contractual receivable from
TODCO and we will write-off this receivable, which at September 30, 2004, would
have resulted in a charge of approximately $166 million. Under these rules the
write-off is necessary as the future payments under the tax sharing agreement
are dependent on TODCO generating future taxable income, which cannot be assumed
until such income is actually generated. In addition, once TODCO is no longer
included as a consolidated subsidiary of Transocean in its consolidated
financial statements, future payments received by Transocean from the
utilization by TODCO of the pre-IPO deferred tax assets will be recognized in
other income as those payments are received.
TODCO Segment
Delta Towing - As a result of the adoption of FASB Interpretation ("FIN")
46 and a determination that TODCO was the primary beneficiary for accounting
purposes of TODCO's joint venture, Delta Towing Holdings, LLC ("Delta Towing"),
TODCO consolidated Delta Towing at December 31, 2003. Due to the consolidation
of Delta Towing, operating revenue and operating and maintenance expense
increased during the nine months ended September 30, 2004 by $21.9 million and
$19.4 million, respectively.
Effective Tax Rate
Tax expense for the third quarter of 2004 totaled $6.3 million, or 3.9% of
pretax income for the quarter. Tax expense decreased approximately $6 million
related to changes in estimates of prior tax years and approximately $14 million
related to the change in the initial TODCO valuation allowance. Excluding these
decreases, the effective tax rate for 2004 is estimated to be approximately 44
percent of earnings before items related to the TODCO offerings, loss on debt
retirements and gains on significant asset sales, for which there is no related
tax expense. Applying the revised tax rate to income before income taxes and
minority interest for the six months ended June 30, 2004 increased our income
tax expense for the quarter by approximately $10 million. The effective tax rate
increased from approximately 35 percent estimated at June 30, 2004 primarily as
a result of a change in the expected amount and geographical concentration of
income for the remainder of 2004 and the impact of an increase in our overall
valuation allowance associated with higher net operating loss carryforwards now
estimated for the remainder of the year for certain subsidiaries.
OUTLOOK
Drilling Market - During the third quarter of 2004, oil prices remained at
levels that at times exceeded record highs. While prices may decline from
current levels, we expect them to remain strong in historical terms. Future
price expectations have historically been a key driver for offshore drilling
demand. The availability of quality drilling prospects, exploration success,
relative production costs, the stage of reservoir development and political and
regulatory environments also affect our customers' drilling programs.
Prospects for our High-Specification Floaters continue to gain strength.
While a few of these units will conclude contracts by the first half of 2005, we
are increasingly confident that most of the available time in 2005 will be
contracted. However, some intermittent idle time remains a possibility,
especially for some of the lower capability rigs in this fleet. We have signed
a number of new contracts or extensions for our High-Specification fleet that
reflect the increased activity in this sector. The Sedco Express was awarded a
three-year contract for BP's Plutonio project in Angola, and the Paul B. Loyd,
Jr. received a two-year contract extension. The Cajun Express was awarded a
210-day contract as well as an additional two-year contract to begin in 2005.
The Deepwater Discovery was awarded a combined three-well commitment, the
Deepwater Navigator was awarded a 240-day extension and the Sedco 709 was
awarded a two-well contract. The Sovereign Explorer was awarded two contracts
totaling 320 days, the Deepwater
24
Pathfinder was awarded a new estimated 475-day contract and the existing
contract for the Discoverer Deep Seas was extended for one year. In addition, a
number of shorter term jobs were awarded to other High-Specification Floaters,
including a six-month contract in the Gulf of Mexico for the Deepwater
Millennium and a 120-day contract for the Transocean Marianas. We continue to
believe that over the long term deepwater exploration and development drilling
opportunities in the Gulf of Mexico, West Africa, India and other market sectors
represent a significant source of future deepwater rig demand, although the risk
of project delays remains, especially in West Africa. We continue to see a
strong customer preference for using fifth-generation equipment in these
deepwater areas, which may lead to a near term shortage of these highest
specification rigs.
The outlook for activity for the non-U.S. jackup market sector is expected
to remain strong, particularly in Asia and the Middle East. There remains a
current overcapacity in the West Africa jackup sector, and we are repositioning
several units to take advantage of better opportunities. The Trident VI has
moved from West Africa to India and the Shelf Explorer will also move from West
Africa to Indonesia. The J. T. Angel is currently mobilizing from India to
South East Asia. All three units are either under contract or are expected to
be under contract in the near term.
The outlook for our Other Floaters that operate in the mid-water sector is
improving from the global oversupply position that has persisted throughout the
first three quarters of 2004. We expect overall North Sea industry fleet
utilization to remain above recent seasonal norms when the winter season begins,
and there is a growing expectation that overall utilization and dayrates will be
higher in 2005 compared to 2004. Demand in the Gulf of Mexico market sector has
risen in recent months, which could cause some of the cold stacked units to
re-enter the market. In other regions, the Actinia recently relocated from the
Mediterranean Sea to India for a seven-month program.
We expect to mobilize the Shelf Explorer, the Transocean Rather and the
Deepwater Pathfinder during the fourth quarter. In addition to these
mobilizations, we expect downtime to result from planned shipyards for the Polar
Pioneer, Searex 10 and J. T. Angel. Also, the Trident 20 and Jim Cunningham
will be in the shipyard for repairs resulting from an engine room fire and a
well control incident, respectively. These rig mobilizations and shipyard
projects are expected to have a negative impact on fourth quarter revenues and
related earnings.
TODCO expects the declining jackup rig supply in the U.S. Gulf Coast region
to continue to support higher dayrates for its jackup fleet compared to the
beginning of the year. TODCO has also seen improvement in dayrates and
utilization for its inland barges in this region.
Our operations are geographically dispersed in oil and gas exploration and
development areas throughout the world. Rigs can be moved from one region to
another, but the cost of moving a rig and the availability of rig-moving vessels
may cause the supply and demand balance to vary somewhat between regions.
However, significant variations between regions do not tend to exist long term
because of rig mobility. Consequently, we operate in a single, global offshore
drilling market.
The offshore contract drilling market remains highly competitive and
cyclical, and it has been historically difficult to forecast future market
conditions. Risks include declines in oil and/or gas prices that reduce rig
demand and adversely affect utilization and dayrates. Major operator and
national oil company capital budgets are key drivers of the overall business
climate, and these may change within a fiscal year depending on exploration
results and other factors. Additionally, increased competition for our
customers' drilling budgets could come from, among other areas, land-based
energy markets in Russia, other former Soviet Union states and the Middle East.
As of October 26, 2004, approximately 71 percent of our Transocean Drilling
segment fleet days were committed for the remainder of 2004 and approximately 45
percent for the year 2005.
25
Tax Matters - We are a Cayman Islands company registered in Barbados. We
operate through our various subsidiaries in a number of countries throughout the
world. Consequently, we are subject to changes in tax laws, treaties and
regulations in and between the countries in which we operate, including treaties
that the U.S. has with other nations. A material change in these tax laws,
treaties or regulations, including those in and involving the U.S., could result
in a higher effective tax rate on our worldwide earnings. On October 22, 2004,
the American Jobs Creation Act of 2004 (the "Act") was signed into law. The Act
contains provisions which apply to certain companies which undertook a
transaction commonly known as an inversion after a specified date. Because our
reorganization transaction occurred prior to the effective dates specified in
the Act, we do not believe there should be any adverse impact to us.
Additionally, a protocol was recently signed by the U.S. and Barbados and
approved by the U.S. Senate, which would amend the tax treaty between the two
countries. We do not expect the amendment to have a material adverse effect on
our business or consolidated financial position.
Our income tax returns are subject to review and examination in the various
jurisdictions in which we operate. In October 2004, we received from the U.S.
Internal Revenue Service ("IRS") examination reports setting forth proposed
changes to the U.S. federal income tax reported for the period 1999-2000. The
proposed changes total approximately $195 million, exclusive of interest. The
IRS has also notified us of its intent to audit our 2002 and 2003 tax years.
While we have agreed to certain non-material adjustments, we believe our returns
are materially correct as filed and intend to defend ourselves vigorously. While
there can be no assurance, we do not expect the ultimate outcome to have a
material adverse effect on our business or consolidated financial position. In
addition, other tax authorities have examined the amounts of income and expense
subject to tax in their jurisdiction for prior periods. We are currently
contesting various non-U.S. assessments that have been asserted and would expect
to contest any future U.S. or non-U.S. assessments. While we cannot predict or
provide assurance as to the final outcome of existing or future assessments, we
do not believe that the ultimate resolution of these asserted income tax
liabilities will have a material adverse effect on our business or consolidated
financial position.
General and Administrative Expense - We expect general and administrative
expense to increase approximately $3 million to $4 million in the fourth quarter
of 2004 primarily as a result of compliance with the Sarbanes-Oxley Act of 2002
(the "Sarbanes-Oxley Act").
Stock-Based Compensation Expense - As a result of the adoption in January
2003 of the fair value recognition provisions of SFAS 123, Accounting for
Stock-Based Compensation, using the prospective method prescribed by SFAS 148,
Accounting for Stock-Based Compensation Transition and Disclosure, our
stock-based compensation expense is expected to increase in 2004. The increase
will result from the impact of a full year of expense related to our 2003 awards
that were granted in July 2003, compared to six months of expense in 2003, and
expense related to our 2004 awards, which were granted in July 2004. As
stock-based compensation expense is recognized over the vesting period of the
underlying award, we expect to have increases in stock-based compensation
expense in future periods until such periods have awards being both granted and
becoming fully vested. In addition, TODCO now has a long-term incentive plan
under which it grants stock options and restricted stock to certain key
employees (see "-Significant Events"). Awards made under this plan in 2004 will
result in an increase in stock-based compensation expense in 2004.
26
PERFORMANCE AND OTHER KEY INDICATORS
Fleet Utilization and Dayrates - The following table shows our average
dayrate and utilization for the quarterly periods ended on or prior to September
30, 2004. Average dayrate is defined as contract drilling revenue earned per
revenue earning day in the period. Utilization is defined as the total actual
number of revenue earning days in the period as a percentage of the total number
of calendar days in the period for all drilling rigs in our fleet.
Three Months Ended
--------------------------------------------
September 30, June 30, September 30,
2004 2004 2003
--------------- ---------- ---------------
Average Dayrates
Transocean Drilling Segment:
High-Specification Floaters
Fifth-Generation Deepwater Floaters $ 193,400 $ 177,800 $ 176,600
Other Deepwater Floaters $ 103,900 $ 107,800 $ 112,500
Other High-Specification Floaters $ 111,200 $ 115,500 $ 117,200
Total High-Specification Floaters $ 142,200 $ 141,100 $ 142,200
Other Floaters $ 65,400 $ 65,000 $ 60,600
Jackups $ 52,500 $ 52,700 $ 54,400
Other Rigs $ 41,900 $ 43,300 $ 48,800
--------------- ---------- ---------------
Segment Total $ 90,700 $ 89,100 $ 89,000
--------------- ---------- ---------------
--------------- ---------- ---------------
TODCO Segment $ 27,800 $ 26,200 $ 19,300
--------------- ---------- ---------------
Total Drilling Fleet $ 70,100 $ 69,600 $ 67,000
=============== ========== ===============
Utilization
Transocean Drilling Segment:
High-Specification Floaters
Fifth-Generation Deepwater Floaters 83% 90% 97%
Other Deepwater Floaters 78% 70% 73%
Other High-Specification Floaters 84% 75% 74%
Total High-Specification Floaters 81% 79% 82%
Other Floaters 45% 45% 51%
Jackups 81% 85% 85%
Other Rigs 47% 46% 49%
--------------- ---------- ---------------
Segment Total 67% 68% 71%
--------------- ---------- ---------------
--------------- ---------- ---------------
TODCO Segment 44% 41% 44%
--------------- ---------- ---------------
Total Drilling Fleet 57% 56% 59%
=============== ========== ===============
Contract Drilling Revenue - Our contract drilling revenues are based
primarily on dayrates received for our drilling services and the number of
operating days during the relevant periods. The level of our contract drilling
revenue depends on dayrates, which in turn are primarily a function of industry
supply and demand for drilling units in the markets in which we operate. During
periods of high demand, our rigs typically achieve higher utilization and
dayrates than during periods of low demand. Some of our drilling contracts also
enable us to earn mobilization, contract preparation, capital upgrade, bonus and
demobilization revenue. Mobilization, contract preparation and capital upgrade
revenue paid on a lump sum basis is recognized over the original contract term.
Bonus and demobilization revenue is recognized when earned.
27
Other Revenue - Beginning with the first quarter of 2004, we began
classifying our revenues into two categories: (1) contract drilling revenues and
(2) other revenues, as other revenue became a more significant component of our
total revenues. Our other revenue represents client reimbursable revenue,
integrated services revenue, management service revenues, revenues from
operation of Delta Towing's fleet of marine support vessels and other
miscellaneous revenues. From time to time, we provide well services in addition
to our normal drilling services through third party contractors. We refer to
these other services as integrated services.
Operating and Maintenance Costs - Our operating and maintenance costs
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, repair and maintenance, insurance, boat
and helicopter rentals, professional and technical fees, freight costs,
communications, customs duties, tool rentals and services, fuel and water,
general taxes and licenses. Labor, repair and maintenance and insurance costs
represent the most significant components of our operating and maintenance
costs.
We do not expect operating and maintenance expenses to necessarily
fluctuate in proportion to changes in operating revenues. Operating revenues may
fluctuate as a function of changes in dayrate. However, costs for operating a
rig are generally fixed or only semi-variable regardless of the dayrate being
earned. In addition, should our rigs incur idle time between contracts, we
typically do not de-man those rigs because we will use the crew to prepare the
rig for its next contract. During times of reduced activity, reductions in costs
may not be immediate as portions of the crew may be required to prepare our rigs
for stacking, after which time the crew members are assigned to active rigs or
dismissed. In addition, as our rigs are mobilized from one geographic location
to another, the labor and other operating and maintenance costs can vary
significantly. In general, labor costs increase primarily due to higher salary
levels and inflation. Equipment maintenance expenses fluctuate depending upon
the type of activity the unit is performing and the age and condition of the
equipment. While our per occurrence deductible levels for our hull and machinery
and our protection and indemnity policies remained unchanged from 2003 at $10
million, we increased our additional aggregate annual insurance deductible for
the current policy year in an effort to reduce costs. This additional aggregate
annual deductible of $20 million is applied after the per occurrence deductible
is met until it is fully utilized at which time the $10 million per occurrence
applies for all remaining claims during the year.
Depreciation Expense - Our depreciation expense is based on estimates,
assumptions and judgments relative to capitalized costs, useful lives and
salvage values of our assets. We compute depreciation using the straight-line
method, generally after allowing for salvage values.
General and Administrative Expense - General and administrative expense
includes costs related to our corporate executives, directors, investor
relations, corporate accounting and reporting, information technology, internal
audit, legal, tax, treasury, risk management and human resource functions.
Interest Expense - Interest expense consists of interest associated with
our senior notes and other debt and related financing cost amortization.
Interest expense is partially offset by the amortization of the fair value
adjustments on interest rate swaps terminated during 2003. We expect the
amortization of these fair value adjustments to continue over the life of the
related debt instruments (see "-Derivative Instruments").
Income Taxes - Provisions for income taxes are based on expected taxable
income, statutory rates and tax planning opportunities available to us in the
various jurisdictions in which we operate. Taxable income may differ from
pre-tax income for financial accounting purposes, particularly in countries with
revenue-based taxes. There is no expected relationship between the provision for
income taxes and income before income taxes because the countries in which we
operate have different taxation regimes. We provide a valuation allowance for
deferred tax assets when it is more likely than not that some or all of the
benefit from the deferred tax asset will not be realized.
28
FINANCIAL CONDITION
SEPTEMBER 30, 2004 COMPARED TO DECEMBER 31, 2003
September 30, December 31,
2004 2003 Change % Change
-------------- ------------- -------- ---------
(In millions, except % change)
TOTAL ASSETS
Transocean Drilling $ 10,964.0 $ 10,874.0 $ 90.0 1%
TODCO 740.0 788.6 (48.6) (6)%
-------------- ------------- -------- ---------
$ 11,704.0 $ 11,662.6 $ 41.4 N/M
============== ============= ======== =========
_________________
"N/M" means not meaningful
The increase in Transocean Drilling segment assets was primarily due to
increases in cash and cash equivalents ($268.0 million), property and equipment,
net of retirements ($71.0 million), goodwill ($26.4 million), accounts
receivable ($22.2 million) and other long-term assets ($24.1 million). The
increase in cash and cash equivalents resulted primarily from proceeds received
from the TODCO offerings ($425.6 million), net proceeds received from the sale
of a semisubmersible rig ($28.0 million) and cash from operations, partially
offset by repayments of debt ($603.5 million) and capital expenditures ($93.6
million) during the nine months ended September 30, 2004. The increase in
goodwill primarily related to changes in our estimates related to our expected
disposition of certain income tax-related pre-acquisition contingencies, and the
increase in other long-term assets related primarily to deferred mobilization
and contract prep costs. These increases were partially offset by asset
depreciation ($326.4 million). The decrease in TODCO segment assets was
primarily due to depreciation ($72.0 million), partially offset by an increase
in cash and cash equivalents ($33.8 million).
LIQUIDITY AND CAPITAL RESOURCES
SOURCES AND USES OF CASH
Nine Months Ended
September 30,
----------------------
2004 2003 Change
----------- --------- --------
(In millions)
NET CASH PROVIDED BY OPERATING ACTIVITIES
Net income $ 225.6 $ 13.7 $ 211.9
Depreciation 398.4 381.1 17.3
Other non-cash items (150.1) 22.7 (172.8)
Working capital 32.7 46.8 (14.1)
----------- --------- --------
$ 506.6 $ 464.3 $ 42.3
=========== ========= ========
Net cash provided by operating activities increased $42.3 million due to an
increase in cash generated from net income adjusted for non-cash activity of
$56.4 million, partially offset by a decrease in cash provided by working
capital items of $14.1 million during the nine months ended September 30, 2004
as compared to the corresponding prior year period.
29
Nine Months Ended
September 30,
-----------------------
2004 2003 Change
----------- ---------- --------
(In millions)
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Capital expenditures $ (99.8) $ (72.6) $ (27.2)
Note issued to related party, net of repayments - (44.2) 44.2
Proceeds from disposal of assets 46.3 4.1 42.2
DDII LLC's cash acquired, net of cash paid - 18.1 (18.1)
Proceeds from TODCO offerings 425.6 - 425.6
Other, net 9.0 2.7 6.3
----------- ---------- --------
$ 381.1 $ (91.9) $ 473.0
=========== ========== ========
Net cash provided by investing activities increased approximately $473.0
million for the nine months ended September 30, 2004 as compared to net cash
used in investing activities in the same period in the previous year. The
increase is primarily the result of proceeds from the TODCO offerings of $425.6
million (see "-Significant Events") combined with an increase in proceeds from
asset sales as compared to the corresponding prior year period, partially offset
by an increase in current year capital expenditures. In addition, we acquired
ConocoPhillips' 40 percent interest in DDII LLC and issued a note receivable to
a related party during the nine months ended September 30, 2003, with no
comparable activity for the same period in 2004.
Nine Months Ended
September 30,
----------- ----------
2004 2003 Change
----------- ---------- --------
(In millions)
NET CASH USED IN FINANCING ACTIVITIES
Repayments on revolving credit agreements $ (200.0) $ - $(200.0)
Repayments on other debt instruments (407.0) (967.2) 560.2
Cash received from termination of interest rate swaps - 173.5 (173.5)
Other, net 21.1 13.4 7.7
----------- ---------- --------
$ (585.9) $ (780.3) $ 194.4
=========== ========== ========
We repaid $200.0 million under our $800.0 million revolving credit facility
during the nine months ended September 30, 2004 while no such payment was made
for the same period in 2003. For the nine months ended September 30, 2004, we
used cash of $370.3 million for the early redemption of our 9.5% Senior Notes
(see "-Significant Events") and $36.7 million in other scheduled debt
maturities. For the nine months ended September 30, 2003, we received interest
rate swap termination proceeds of $173.5 million (see "-Derivative Instruments")
for which there was no comparable activity in 2004. In addition, we used cash of
$527.2 million to repurchase our Zero Coupon Convertible Debentures that were
put to us in May 2003, $50.0 million for the early repayment of our 9.41%
Nautilus Class A2 Notes and $390.0 million for other scheduled debt maturities
during the nine months ended September 30, 2003.
30
CAPITAL EXPENDITURES
Capital expenditures totaled $99.8 million during the nine months ended
September 30, 2004 of which $93.6 million and $6.2 million related to the
Transocean Drilling and TODCO segments, respectively.
During 2004, we expect to spend approximately $80 million to $90 million on
our existing Transocean Drilling segment fleet, corporate infrastructure and
major upgrades, excluding upgrades required and funded by our drilling
contracts, which we anticipate will be approximately $40 million to $50 million.
These amounts are dependent upon the actual level of operational and contracting
activity. We intend to fund the cash requirements relating to our capital
expenditures through available cash balances, cash generated from operations and
asset sales. We also have available credit under our revolving credit agreement
(see "-Sources of Liquidity") and may engage in other commercial bank or capital
market financings.
TODCO expects to spend approximately $11 million on capital expenditures in
2004.
ACQUISITIONS AND DISPOSITIONS
From time to time, we review possible acquisitions of businesses and
drilling units and may in the future make significant capital commitments for
such purposes. Any such acquisition could involve the payment by us of a
substantial amount of cash or the issuance of a substantial number of additional
ordinary shares or other securities. We would likely fund the cash portion of
any such acquisition through cash balances on hand, the incurrence of additional
debt, sales of assets, issuance of ordinary shares or other securities or a
combination thereof. In addition, from time to time, we review possible
dispositions of drilling units.
Dispositions - In February 2004 and September 2004, we completed the TODCO
IPO and secondary offering, respectively. See "-Significant Events."
In March 2004, we entered into agreements to sell two semisubmersible rigs,
the Sedco 600 and Sedco 602, for net proceeds of $52.7 million in connection
with our efforts to dispose of certain non-strategic assets in our Transocean
Drilling segment. In June 2004, we completed the sale of the Sedco 602 for net
proceeds of $28.0 million and recognized a gain of $21.6 million, which had no
tax effect. The sale of the Sedco 600, for net proceeds of approximately $25.0
million, is expected to close during the fourth quarter of 2004 following
demobilization from its prior operating location.
During the nine months ended September 30, 2004, we settled insurance
claims and sold marine support vessels and certain other assets for net proceeds
of $18.3 million and recorded net gains of $1.9 million ($1.3 million, net of
tax) in our Transocean Drilling segment and $5.4 million, which had no tax
effect, in our TODCO segment.
SOURCES OF LIQUIDITY
Our primary sources of liquidity in the third quarter of 2004 were our cash
flows from operations, proceeds from the TODCO secondary offering and existing
cash balances. Our primary uses of cash were debt repayments and capital
expenditures. At September 30, 2004, we had $775.8 million in cash and cash
equivalents.
We expect to use existing cash balances, internally generated cash flows
and proceeds from assets sales, including potential additional sales of our
interest in TODCO, to fulfill anticipated obligations such as scheduled debt
maturities, capital expenditures and working capital needs. From time to time,
we may also use bank lines of credit to maintain liquidity for short-term cash
needs.
Excluding the acquisition of the Deepwater Pathfinder and Deepwater
Frontier in December 2003, we have significantly reduced our capital
expenditures compared to prior years due to the completion of our newbuild
program in 2001 and ongoing efforts to contain capital expenditures. See
"-Capital Expenditures."
31
When cash on hand, cash flows from operations, proceeds from asset sales,
including potential additional sales of our interest in TODCO, and committed
bank facility availability exceed our expected liquidity needs, we may use a
portion of such cash to reduce debt prior to scheduled maturities through
repurchases, redemptions or tender offers, or make repayments on bank
borrowings.
In October 2004, we redeemed our 6.75% Senior Notes due April 2005 with an
aggregate face value of $342.3 million. See "-Significant Events."
At September 30, 2004 and December 31, 2003, our total debt was $3,061.4
million and $3,658.1 million, respectively. Net debt, a non-GAAP financial
measure defined as total debt less cash and cash equivalents, at such dates was
$2,285.6 million and $3,184.1 million, respectively. During the nine months
ended September 30, 2004, we reduced net debt by $898.5 million. The
reconciliation of total debt to net debt at carrying value is as follows (in
millions):
September 30, December 31,
2004 2003
--------------- --------------
Total Debt $ 3,061.4 $ 3,658.1
Less: Cash and cash equivalents (775.8) (474.0)
--------------- --------------
Net Debt $ 2,285.6 $ 3,184.1
=============== ==============
We believe net debt provides useful information regarding the level of our
indebtedness by reflecting the amount of indebtedness assuming cash and
investments are used to repay debt. Net debt declined each year since 2001
because cash flows, primarily from operations and asset sales, have exceeded
capital expenditures.
Our internally generated cash flow is directly related to our business and
the market sectors in which we operate. Should the drilling market deteriorate,
or should we experience poor results in our operations, cash flow from
operations may be reduced. Also, as a result of the TODCO IPO, we do not have
access to TODCO's cash flows as we do with our wholly owned subsidiaries. We
have, however, continued to generate positive cash flow from operating
activities over recent years and expect cash flow will continue to be positive
over the next year.
We have access to a bank line of credit under an $800.0 million five-year
revolving credit agreement expiring in December 2008. As of September 30, 2004,
$750.0 million remained available under this credit line. Because our current
cash balances, expected cash flow and this revolving credit agreement provide us
with adequate liquidity, we terminated our commercial paper program during the
first quarter of 2004.
The bank credit line requires compliance with various covenants and
provisions customary for agreements of this nature, including an earnings before
interest, taxes, depreciation and amortization ("EBITDA") to interest coverage
ratio and a debt to tangible capital ratio, both as defined by the credit
agreement, of not less than three to one and not greater than 50 percent,
respectively. Other provisions of the credit agreement include limitations on
creating liens, incurring debt, transactions with affiliates, sale/leaseback
transactions and mergers and sale of substantially all assets. Should we fail to
comply with these covenants, we would be in default and may lose access to this
facility. We are also subject to various covenants under the indentures pursuant
to which our public debt was issued, including restrictions on creating liens,
engaging in sale/leaseback transactions and engaging in merger, consolidation or
reorganization transactions. A default under our public debt could trigger a
default under our credit line and cause us to lose access to this facility.
TODCO has access to a bank line of credit under a $75.0 million two-year
revolving credit agreement (the "TODCO Revolving Credit Agreement"), which will
reduce to $60.0 million in December 2004 and expires in December 2005. As of
September 30, 2004, $75.0 million remained available under this line of credit.
The TODCO Revolving Credit Agreement requires compliance with various covenants
and provisions customary for similar agreements of non-investment grade
facilities. TODCO's Revolving Credit Agreement is not guaranteed by us.
In April 2001, the SEC declared effective our shelf registration statement
on Form S-3 for the proposed offering from time to time of up to $2.0 billion in
gross proceeds of senior or subordinated debt securities, preference
32
shares, ordinary shares and warrants to purchase debt securities, preference
shares, ordinary shares or other securities. At September 30, 2004, $1.6 billion
in gross proceeds of securities remained unissued under the shelf registration
statement.
Our access to debt and equity markets may be reduced or closed to us due to
a variety of events, including, among others, downgrades of ratings of our debt,
industry conditions, general economic conditions, market conditions and market
perceptions of us and our industry.
As is customary in the contract drilling business, we also have various
surety bonds in place that secure customs obligations relating to the
importation of our rigs and certain performance and other obligations. Surety
bonds outstanding totaled $21.6 million and $169.5 million at September 30, 2004
and December 31, 2003, respectively. The decrease in outstanding surety bonds is
primarily attributable to the expiration of three such bonds totaling $151.1
million related to our Brazil operations.
DERIVATIVE INSTRUMENTS
We have established policies and procedures for derivative instruments that
have been approved by our Board of Directors. These policies and procedures
provide for the prior approval of derivative instruments by our Chief Financial
Officer. From time to time, we may enter into a variety of derivative financial
instruments in connection with the management of our exposure to fluctuations in
foreign exchange rates and interest rates. We do not enter into derivative
transactions for speculative purposes; however, for accounting purposes, certain
transactions may not meet the criteria for hedge accounting.
Gains and losses on foreign exchange derivative instruments that qualify
and are designated as accounting cash flow hedges are deferred as accumulated
other comprehensive income (loss) and recognized when the underlying foreign
exchange exposure is realized. Gains and losses on foreign exchange derivative
instruments that are not designated as cash flow hedges or no longer qualify or
are terminated as such for accounting purposes are recognized currently in
other, net in our consolidated statements of operations based on the change in
market value of the derivative instruments. At September 30, 2004, we had no
material open foreign exchange derivative instruments.
From time to time, we may use interest rate swaps to manage the effect of
interest rate changes on our future interest rate expense. Interest rate swaps
that we enter into are designated as a hedge of future interest payments on our
underlying debt. The interest rate differential to be received or paid under the
swaps is recognized over the lives of the swaps as an adjustment to interest
expense. If an interest rate swap is terminated or no longer qualifies for hedge
accounting, the gain or loss is amortized over the remaining life of the
underlying debt. We do not enter into interest rate swaps for speculative
purposes.
In January 2003, we terminated swaps and associated fair value hedges with
respect to our 6.75% Senior Notes due April 2005, 6.95% Senior Notes due April
2008 and 9.5% Senior Notes due December 2008. In March 2003, we terminated swaps
with respect to our 6.625% Notes due April 2011. As a result of these
terminations, we received cash proceeds, net of accrued interest, of $173.5
million that had been recognized in connection with the associated fair value
hedges as a fair value adjustment to long-term debt in our consolidated balance
sheet and is being amortized as a reduction to interest expense over the life of
the underlying debt. As a result of the redemption of our 9.5% Senior Notes in
March 2004, we recognized a swap premium of $22.0 million on the termination of
the related interest rate swap as a reduction to our loss on retirement of debt
(see "-Operating Results"). As a result of the redemption of our 6.75% Senior
Notes in October 2004, we will recognize a swap premium of $3.5 million on the
termination of the related interest rate swap as a reduction to our loss on
retirement of debt (see "-Significant Events"). Based on the unamortized
premiums remaining on the terminated interest rate swaps, we expect to reduce
our interest expense by $22.8 million in 2004.
33
OPERATING RESULTS
QUARTER ENDED SEPTEMBER 30, 2004 COMPARED TO QUARTER ENDED SEPTEMBER 30,
2003
Following is an analysis of our Transocean Drilling segment and TODCO
segment operating results, as well as an analysis of income and expense
categories that we have not allocated to our two segments.
Transocean Drilling Segment
Three Months Ended
September 30,
------------------------
2004 2003 Change % Change
----------- ----------- ---------- -----------
(In millions, except day amounts and percentages)
Operating days 5,823 6,101 (278) (5)%
Utilization (a) 67% 71% N/A (6)%
Average dayrate (b) $ 90,700 $ 89,000 $ 1,700 2%
Contract drilling revenues $ 528.0 $ 542.9 $ (14.9) (3)%
Other revenues 30.7 21.5 9.2 43%
----------- ----------- ---------- -----------
558.7 564.4 (5.7) (1)%
Operating and maintenance expense 360.5 342.4 18.1 5%
Depreciation 110.0 103.9 6.1 6%
Gain from sale of assets, net (0.5) (0.8) 0.3 (38)%
Gain from TODCO offerings (129.4) - (129.4) N/M
----------- ----------- ---------- -----------
Operating income before general and administrative expense. $ 218.1 $ 118.9 $ 99.2 83%
=========== =========== ========== ===========
_________________
"N/A" means not applicable
"N/M" means not meaningful
(a) Utilization is defined as the total actual number of revenue earning days
as a percentage of the total number of calendar days in the period.
(b) Average dayrate is defined as contract drilling revenue earned per revenue
earning day.
This segment's contract drilling revenues decreased by approximately $17.0
million as a result of the strike in Norway and the Trident 20 and Jim
Cunningham incidents in the third quarter of 2004. Excluding the impact of these
items and the Deepwater Pathfinder and the Discoverer Enterprise, contract
drilling revenues were also negatively impacted by approximately $26.0 million
due to a slight decline in utilization and average dayrates. These decreases
were partially offset by an approximate $29.0 million increase as a result of
additional revenues from the Deepwater Pathfinder due to the consolidation of DD
LLC late in the fourth quarter of 2003 and lower revenues in 2003 resulting from
the Discoverer Enterprise riser incident during the second quarter of 2003 with
no comparable activity for the same period in 2004. See "-Significant Events."
Other revenues for the three months ended September 30, 2004 increased $9.2
million primarily due to a $12.2 million increase in integrated services
revenue, partially offset by a decrease of $2.8 million in client reimbursable
revenue and the absence of revenue from management fees in 2004 as a result of
the consolidation of DD LLC late in the fourth quarter of 2003.
The increase in this segment's operating and maintenance expenses of
approximately $34.0 million resulted primarily from costs associated with higher
property and indemnity insurance, integrated services, additional expenses
related to the Deepwater Pathfinder as a result of the consolidation of DD LLC
late in the fourth quarter of 2003 and the Trident 20 and Jim Cunningham
incidents in 2004. Partially offsetting these increases were decreased operating
and maintenance expenses of approximately $16.0 million related primarily to the
settlement in 2004 of the Discoverer
34
Enterprise riser incident that occurred in May 2003, lower activity and the
electrical fire on the Peregrine I in 2003 with no comparable activity in 2004.
See "-Significant Events."
The increase in this segment's depreciation expense resulted primarily from
$5.7 million of additional depreciation expense related to the Deepwater
Frontier and Deepwater Pathfinder as a result of the late December 2003 payoff
of the synthetic lease financing arrangements by DDII LLC and DD LLC,
respectively, which were consolidated late in the second and fourth quarters of
2003, respectively, and the Discoverer Enterprise purchase of tensioner system
equipment.
TODCO Segment
Three Months Ended
September 30,
----------- -----------
2004 2003 Change % Change
----------- ----------- ---------- -----------
(In millions, except day amounts and percentages)
Operating days 2,839 2,808 31 1%
Utilization (a) 44% 44% N/A -
Average dayrate (b) $ 27,800 $ 19,300 $ 8,500 44%
Contract drilling revenues $ 79.1 $ 54.1 $ 25.0 46%
Other revenues 14.0 4.4 9.6 N/M
----------- ----------- ---------- -----------
93.1 58.5 34.6 59%
Operating and maintenance 72.4 60.6 11.8 19%
Depreciation 23.9 22.9 1.0 4%
Gain from sale of assets, net (0.8) (0.1) (0.7) N/M
----------- ----------- ---------- -----------
Operating loss before general and administrative expense $ (2.4) $ (24.9) $ 22.5 (90)%
=========== =========== ========== ===========
_________________
"N/A" means not applicable
"N/M" means not meaningful
(a) Utilization is defined as the total actual number of revenue earning days
as a percentage of the total number of calendar days in the period.
(b) Average dayrate is defined as contract drilling revenue earned per revenue
earning day.
This segment's contract drilling revenues increased by $25.0 million due
primarily to an increase in average dayrates, which included the operations of
three jackup rigs in Venezuela (THE 156) and Mexico (THE 205 and THE 206) after
being transferred from the Gulf of Mexico during the fourth quarter of 2003.
Other revenues for the three months ended September 30, 2004 increased $9.6
million due primarily to the consolidation of Delta Towing at December 31, 2003
and increased client reimbursable revenue.
The increase in this segment's operating and maintenance expense was
primarily due to $7.6 million of costs associated with the consolidation of
Delta Towing at December 31, 2003 and $5.1 million of operating and maintenance
expense associated with operating two jackup rigs in Mexico (THE 205 and THE
206) after being transferred from the Gulf of Mexico and compensation expense
related to stock options and restricted stock as the result of the TODCO IPO.
Partially offsetting the above increases were approximately $4.0 million of
costs associated with a fire incident on inland barge Rig 20 and the inland
barge Rig 62 well control incident in 2003 with no comparable activity in 2004.
The increase in this segment's depreciation expense of $1.0 million
resulted primarily from the consolidation of Delta Towing.
35
Total Company Results of Operations
Three Months Ended
September 30,
------------------------
2004 2003 Change % Change
----------- ----------- -------- ---------
(In millions, except % change)
General and Administrative Expense $ 15.2 $ 21.2 $ (6.0) (28)%
Other (Income) Expense, net
Equity in earnings of joint ventures (1.7) (1.9) 0.2 (11)%
Interest income (2.5) (3.0) 0.5 (17)%
Interest expense 42.6 49.0 (6.4) (13)%
Other, net (0.1) 0.2 (0.3) N/M
Income Tax Expense 6.3 17.3 (11.0) (64)%
Minority Interest 1.0 0.2 0.8 N/M
_________________________
"N/M" means not meaningful
The decrease in general and administrative expense was primarily
attributable to the recognition of $8.0 million in expenses relating to the
TODCO IPO during the three months ended September 30, 2003, which had been
deferred in previous periods. The decrease was partially offset by increases in
professional fees related to compliance with the Sarbanes-Oxley Act effective
for 2004.
The decrease in interest expense was attributable to reductions in interest
expense of $7.8 million associated with debt that was redeemed, retired or
repurchased during or subsequent to the third quarter of 2003. Partially
offsetting this decrease was the issuance of new debt subsequent to the third
quarter of 2003, which resulted in an increase in interest expense of $1.2
million.
We operate internationally and provide for income taxes based on the tax
laws and rates in the countries in which we operate and earn income. There is no
expected relationship between the provision for income taxes and income before
income taxes. Income tax expense for the three months ended September 30, 2003
was $11.0 million higher than in the comparable period in 2004. Excluding other
partially offsetting adjustments to our overall valuation allowance, which were
included in the computation of the tax rate, the quarter ended September 30,
2004 included a reduction of approximately $14.0 million in the initial TODCO
valuation allowance recorded in conjunction with the TODCO IPO associated with
changes in our estimate of the ultimate utilization of the benefits from the tax
sharing agreement with TODCO during 2004. Income tax expense was further reduced
by approximately $6.0 million, which related to changes in estimates of prior
year taxes. The income tax expense for the three months ended September 30, 2003
had no comparable adjustments. Partially offsetting these reductions was a
catch-up of approximately $10.0 million in the three months ended September 30,
2004 compared to approximately $3.0 million in the same period for 2003, which
resulted from an increase in the estimated annual effective tax rate for each of
these periods.
The increase in minority interest was primarily attributable to the
minority interest owners' share of TODCO resulting from the TODCO offerings in
2004.
36
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2003
Following is an analysis of our Transocean Drilling segment and TODCO
segment operating results, as well as an analysis of income and expense
categories that we have not allocated to our two segments.
Transocean Drilling Segment
Nine Months Ended
September 30,
-----------------------
2004 2003 Change % Change
----------- ---------- ---------- -----------
(In millions, except day amounts and percentages)
Operating days 17,555 17,870 (315) (2)%
Utilization (a) 68% 69% N/A (1)%
Average dayrate (b) $ 90,000 $ 89,800 $ 200 N/M
Contract drilling revenues $ 1,580.1 $ 1,605.5 $ (25.4) (2)%
Other revenues 109.3 70.1 39.2 56%
----------- ---------- ---------- -----------
1,689.4 1,675.6 13.8 1%
Operating and maintenance expense 1,031.8 1,013.8 18.0 2%
Depreciation 326.4 311.9 14.5 5%
Impairment loss on long-lived assets - 5.2 (5.2) N/M
Gain from sale of assets, net (23.5) (2.4) (21.1) N/M
Gain from TODCO offerings (168.8) - (168.8) N/M
----------- ---------- ---------- -----------
Operating income before general and administrative expense $ 523.5 $ 347.1 $ 176.4 51%
=========== ========== ========== ===========
_________________
"N/A" means not applicable
"N/M" means not meaningful
(a) Utilization is defined as the total actual number of revenue earning days
as a percentage of the total number of calendar days in the period.
(b) Average dayrate is defined as contract drilling revenue earned per revenue
earning day.
This segment's contract drilling revenues decreased by approximately $22.0
million as a result of the strike in Norway and the Trident 20 and Jim
Cunningham incidents in the third quarter of 2004. Excluding the impact of these
items, the Deepwater Pathfinder and the Discoverer Enterprise, contract drilling
revenues were also negatively impacted by approximately $105.0 million due to a
slight decline in average dayrates that was partially offset by a slight
improvement in utilization, compounded by the release of a provision of $3.3
million due to a favorable settlement of a contract dispute related to penalties
on the Peregrine I during the first quarter of 2003 with no comparable benefit
for the same period in 2004. Partially offsetting these decreases were revenues
for the full nine months in 2004 on the Discoverer Enterprise, which was
inactive for the latter part of the second quarter of 2003 due to a riser
separation incident, and revenues from the consolidation of DDII LLC and DD LLC,
which occurred late in the second and fourth quarters of 2003, respectively.
Additionally, a labor strike in Nigeria and the Peregrine I electrical incident
during the second quarter of 2003 negatively impacted revenues during 2003 with
no comparable activity in 2004. These items resulted in a positive impact of
approximately $105.0 million in 2004 over the prior year.
Other revenues for the nine months ended September 30, 2004 increased $39.2
million primarily due to a $50.1 million increase in integrated services
revenue, partially offset by a decrease of $11.5 million from client
reimbursable revenue and the absence of revenue from management fees as a result
of the consolidation of DDII LLC and DD LLC late in the second and fourth
quarters, respectively, of 2003.
This segment's operating and maintenance expenses increased by
approximately $59.0 million primarily from costs associated with higher property
and indemnity insurance, integrated services, additional expenses related to the
Deepwater Pathfinder as a result of the consolidation of DD LLC late in the
fourth quarter of 2003 and the Trident 20 and Jim Cunningham incidents in 2004.
Expenses also increased approximately $9.0 million due to a
37
loss on retirement and higher provisions for local tax matters in 2004.
Additional increases of $6.7 million resulted from favorable litigation and
turnkey settlements during 2003 with no comparable activity during 2004.
Partially offsetting these increases were decreased operating and maintenance
expenses of approximately $57.0 million primarily related to decreased activity,
the settlement of the Discoverer Enterprise May 2003 riser incident, the
favorable insurance settlement related to the Peregrine I riser incident, the
favorable settlement of a turnkey dispute during 2004 and from costs incurred in
2003 related to the Peregrine I electrical incident with no comparable activity
in 2004.
The increase in this segment's depreciation expense resulted primarily from
$13.9 million of additional depreciation expense related to the Deepwater
Frontier and Deepwater Pathfinder as a result of the late December 2003 payoff
of the synthetic lease financing arrangements by DDII LLC and DD LLC,
respectively, which were consolidated late in the second and fourth quarters,
respectively, of 2003 and the Discoverer Enterprise purchase of tensioner system
equipment.
During the nine months ended September 30, 2003, we recorded non-cash
impairment charges in this segment of $5.2 million associated with the removal
of two rigs from drilling service and the value assigned to leases on oil and
gas properties that we intended to discontinue. The determination of fair
market value was based on an offer from a potential buyer, in the case of the
two rigs, and management's assessment of fair value, in the case of the leases
on oil and gas properties, where third party valuations were not available.
During the nine months ended September 30, 2004, this segment recognized
net gains of $23.5 million related to the sale of the semisubmersible rig Sedco
602 and the sale of other assets. During the nine months ended September 30,
2003, this segment recognized net gains of $2.4 million related to the sale of
the jackup rig RBF 160, the settlement of an insurance claim and the sale of
other assets.
TODCO Segment
Nine Months Ended
September 30,
-----------------------
2004 2003 Change % Change
----------- ---------- ---------- -----------
(In millions, except day amounts and percentages)
Operating days 7,865 8,348 (483) (6)%
Utilization (a) 41% 41% N/A N/M
Average dayrate (b) $ 26,600 $ 18,400 $ 8,200 45%
Contract drilling revenues $ 209.4 $ 153.7 $ 55.7 36%
Other revenues 38.2 13.5 24.7 N/M
----------- ---------- ---------- -----------
247.6 167.2 80.4 48%
Operating and maintenance 219.7 189.8 29.9 16%
Depreciation 72.0 69.2 2.8 4%
Impairment loss on long-lived assets - 11.6 (11.6) N/M
Gain from sale of assets, net (5.4) (0.5) (4.9) N/M
----------- ---------- ---------- -----------
Operating loss before general and administrative expense $ (38.7) $ (102.9) $ 64.2 (62)%
=========== ========== ========== ===========
_________________
"N/A" means not applicable
"N/M" means not meaningful
(a) Utilization is defined as the total actual number of revenue earning days
as a percentage of the total number of calendar days in the period.
(b) Average dayrate is defined as contract drilling revenue earned per
revenue earning day.
38
This segment's contract drilling revenues increased by $55.7 million due to
an increase in average dayrates, which included the operations of three jackup
rigs in Venezuela (THE 156) and Mexico (THE 205 and THE 206) after being
transferred from the Gulf of Mexico during the fourth quarter of 2003.
Other revenues for the nine months ended September 30, 2004 increased $24.7
million due primarily to the consolidation of Delta Towing at December 31, 2003
and increased client reimbursable revenue.
The increase in this segment's operating and maintenance expense was
primarily due to $19.5 million of costs associated with the consolidation of
Delta Towing at December 31, 2003, $13.1 million of operating and maintenance
expense related to the operations of three jackup rigs in Venezuela (THE 156)
and Mexico (THE 205 and THE 206) after being transferred from the Gulf of Mexico
and $10.7 million of higher compensation expense related to stock option and
restricted stock grants as the result of the TODCO IPO. Partially offsetting the
above increases were decreases primarily due to approximately $11.0 million of
costs associated with the fire incident on inland barge Rig 20 and the well
control incident on inland barge Rig 62 during 2003 with no comparable activity
during 2004.
The increase in this segment's depreciation expense of $2.8 million
resulted primarily from additional depreciation expense related to the
consolidation of Delta Towing, partially offset by a reduction in depreciation
resulting from the write down to fair market value of five jackup rigs removed
from active drilling service in 2003.
During the nine months ended September 30, 2003, we recorded non-cash
impairment charges in this segment of $11.6 million associated with the removal
of five jackup rigs from drilling service and the write down in the value of an
investment in a joint venture to fair value. The determination of fair market
value was based on third party valuations, in the case of the jackup rigs, and
management's assessment of fair value, in the case of the investment in a joint
venture, where third party valuations were not available.
During the nine months ended September 30, 2004, this segment recognized
net gains of $5.4 million primarily related to the sale of four marine support
vessels by Delta Towing, as well as the sale of other assets and the settlement
of an October 2000 insurance claim.
Total Company Results of Operations
Nine Months Ended
September 30,
-----------------------
2004 2003 Change % Change
----------- ---------- -------- ---------
(In millions, except % change)
General and Administrative Expense $ 44.3 $ 50.0 $ (5.7) (11)%
Other (Income) Expense, net
Equity in earnings of joint ventures (7.7) (7.3) (0.4) 5%
Interest income (6.5) (15.7) 9.2 (59)%
Interest expense 132.6 154.4 (21.8) (14)%
Loss on retirement of debt 28.1 15.7 12.4 79%
Impairment loss on note receivable from related party - 21.3 (21.3) N/M
Other, net (0.4) 3.5 (3.9) N/M
Income Tax Expense 74.2 8.3 65.9 N/M
Minority Interest (5.4) 0.3 (5.7) N/M
_________________________
"N/M" means not meaningful
The decrease in general and administrative expense was primarily
attributable to the recognition of $8.0 million in expenses relating to the
TODCO IPO during 2003, partially offset by costs related to compliance with the
Sarbanes-Oxley Act effective for 2004.
39
Equity in earnings of joint ventures increased $6.6 million primarily
related to our 50 percent share of earnings from Overseas Drilling Limited,
which owns the drillship Joides Resolution, combined with the absence of our
share of losses from Delta Towing in the nine months ended September 30, 2003
due to the consolidation of the joint venture at December 31, 2003 as a result
of the adoption of FIN 46. Offsetting these increases was a decrease in equity
in earnings of $6.2 million related to our consolidation of DD LLC and DDII LLC
in 2003, which resulted from the completion of the buyout of ConocoPhillips'
share of the joint ventures.
The decrease in interest income was primarily related to a decrease in
average cash balances for 2004 compared to 2003 as cash was utilized for debt
reduction and capital expenditures, which resulted in a reduction of interest
income of $5.5 million. Additional decreases resulted from the absence in 2004
of $3.3 million of interest earned in 2003 on the notes receivable from Delta
Towing, which was consolidated at December 31, 2003 as a result of the adoption
of FIN 46.
The decrease in interest expense was attributable to reductions in interest
expense of $32.3 million associated with debt that was redeemed, retired or
repurchased during or subsequent to the nine months ended September 30, 2003.
Partially offsetting these decreases was the termination of our fixed to
floating interest rate swaps in the first quarter of 2003, which resulted in a
net increase in interest expense of $4.6 million (see "-Derivative Instruments")
and the issuance of new debt subsequent to the nine months ended September 30,
2003, which resulted in an increase in interest expense of $4.8 million. In
addition, we received a refund of interest from a taxing authority that resulted
in a reduction of interest expense of $0.8 million in the nine months ended
September 30, 2003, with no comparable activity for the same period in 2004.
During the nine months ended September 30, 2004, we recognized a $28.1
million loss related to the redemption of $289.8 million aggregate principal
amount outstanding 9.5% Senior Notes due December 2008 (see "-Significant
Events"). During the nine months ended September 30, 2003, we recognized a $15.7
million loss related to the repurchase of $838.6 million aggregate principal
amount of our Zero Coupon Convertible Debentures due May 2020 and the repurchase
and retirement of the $50.0 million principal amount 9.41% Nautilus Class A2
Notes due May 2005.
During the nine months ended September 30, 2003, we recognized a $21.3
million impairment loss on our notes receivable from Delta Towing.
We recognized a $3.6 million favorable change in other, net relating to the
effect of foreign currency exchange rate changes on our monetary assets and
liabilities denominated in non-U.S. currencies, partially offset by proceeds
received from the sale of a patent with no comparable activity for the same
period in 2004.
We operate internationally and provide for income taxes based on the tax
laws and rates in the countries in which we operate and earn income. There is no
expected relationship between the provision for income taxes and income before
income taxes. Income tax expense for the nine months ended September 30, 2004
was $65.9 million higher than in the same period in 2003. Excluding other
partially offsetting adjustments to our overall valuation allowance, which were
included in the computation of the tax rate, the nine months ended September 30,
2004 included a valuation allowance of approximately $17.0 million related to
the TODCO IPO (see "-Significant Events"). Income tax expense was reduced by
approximately $6.0 million, which related to changes in estimates of prior year
taxes. The nine months ended September 30, 2003 included the impact of an
approximate $15.0 million foreign tax benefit attributed to a favorable
resolution of a non-U.S. income tax liability and income tax benefits of
approximately $13.0 million resulting from non-cash impairments and loss on debt
retirements. The estimated annual effective tax rate was 1.4 percentage points
higher for the nine months ended September 30, 2004 compared to the same period
in 2003, which further contributed to the higher income tax expense in 2004
compared to 2003.
The increase in minority interest was primarily attributable to the
minority interest owners' share of TODCO resulting from the TODCO offerings in
2004.
40
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements. This
discussion should be read in conjunction with disclosures included in the notes
to our condensed consolidated financial statements related to estimates,
contingencies and new accounting pronouncements. Significant accounting policies
are discussed in Note 2 to our condensed consolidated financial statements
included elsewhere and in Note 2 to our consolidated financial statements in our
Annual Report on Form 10-K for the year ended December 31, 2003. The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues, expenses and
related disclosure of contingent assets and liabilities. On an on-going basis,
we evaluate our estimates, including those related to bad debts, materials and
supplies obsolescence, investments, property and equipment, intangible assets
and goodwill, income taxes, workers' insurance, pensions and other
post-retirement and employment benefits and contingent liabilities. We base our
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 may differ from
these estimates under different assumptions or conditions.
For a discussion of the critical accounting policies and estimates that we
use in the preparation of our condensed consolidated financial statements, see
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations" in our Annual Report on Form 10-K for the year ended December 31,
2003. There have been no material changes to these policies during the nine
months ended September 30, 2004. These policies require significant judgments
and estimates used in the preparation of our consolidated financial statements.
Management has discussed each of these critical accounting policies and
estimates with the Audit Committee of the Board of Directors.
SECTION 404 OF THE SARBANES-OXLEY ACT OF 2002
The Securities and Exchange Commission, as directed by Section 404 of the
Sarbanes-Oxley Act, adopted rules generally requiring each public company to
include a report of management on the company's internal controls over financial
reporting in its annual report on Form 10-K that contains an assessment by
management of the effectiveness of the company's internal controls over
financial reporting. In addition, the company's independent registered public
accounting firm must attest to and report on management's assessment of the
effectiveness of the company's internal controls over financial reporting. This
requirement will first apply to our annual report on Form 10-K for the year
ending December 31, 2004.
We are engaged in a significant effort to document and evaluate our
internal controls over financial reporting, including assessing and documenting
the adequacy of our internal controls, taking steps to enhance controls and
testing that the controls are operating as designed. We are also working with
our independent registered public accounting firm in an effort to ensure that
they have sufficient time to perform the work necessary to issue their report.
Based on our evaluation of the status of our documentation and testing completed
to date and discussions with our independent registered public accounting firm,
we believe we are well behind in our assessment process. Consequently, there is
a significant risk that (i) we will not complete our assessment of the
effectiveness of our internal controls over financial reporting within the
required timeframe, (ii) our independent registered public accounting firm will
not have sufficient time to attest to and report on our assessment, or (iii) our
reports could indicate that material weaknesses in our internal controls exist.
We cannot predict what impact, if any, these possible events will have on us
since such assessment and reporting under Sarbanes-Oxley Act Section 404 have
not previously been required.
RETIREMENT PLANS AND OTHER POSTEMPLOYMENT BENEFITS
Defined Benefit Pension Plans - We have several defined benefit pension
plans, both funded and unfunded, covering substantially all U.S. employees
except for TODCO employees. We also have several defined benefit plans, both
funded and unfunded, that cover Norway employees, Nigeria employees, and various
current and former employees covered under certain frozen plans acquired in
connection with the R&B Falcon merger.
For the funded plans, our funding policy consists of reviewing the funded
status of these plans annually and contributing an amount at least equal to the
minimum contribution required under the Employee Retirement Income Security Act
of 1974 (ERISA) or other applicable funding regulations. Employer contributions
to the funded plan are
41
based on actuarial computations that establish the minimum contribution required
under ERISA and the maximum deductible contribution for income tax purposes.
Due to an increase in the number of retirements, including the retirement
of an executive officer, and expected retirements in the fourth quarter of 2004,
we have revised our estimated contributions for 2004. We expect to contribute
approximately $14.0 million, a $4 million increase from amounts previously
disclosed, to our defined benefit pension plans in 2004. Such contributions will
be funded from our cash flows from operations. As of September 30, 2004, $10.2
million in contributions have been made to the defined benefit pension plans.
Net periodic benefit cost for these defined benefit pension plans included
the following components (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2004 2003 2004 2003
----------- ----------- ----------- ----------
COMPONENTS OF NET PERIODIC BENEFIT COST (A)
Service cost $ 4.7 $ 4.2 $ 12.5 $ 12.5
Interest cost 4.1 4.8 12.4 14.0
Expected return on plan assets (4.9) (4.9) (14.6) (14.7)
Amortization of transition obligation 0.1 - 0.2 0.2
Amortization of prior service cost (0.9) 0.3 (0.6) 1.0
Recognized net actuarial losses 1.5 0.1 2.8 0.3
SFAS 88 settlements/curtailments - (0.8) - (0.8)
----------- ----------- ----------- ----------
Benefit cost $ 4.6 $ 3.7 $ 12.7 $ 12.5
=========== =========== =========== ==========
______________
(a) Amounts are before income tax effect.
Postretirement Benefits Other Than Pensions - We have several unfunded
contributory and noncontributory postretirement benefit plans covering
substantially all of our Transocean Drilling segment U.S. employees. Funding of
benefit payments for plan participants will be made as costs are incurred. Net
periodic benefit cost for these other postretirement plans included the
following components (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2004 2003 2004 2003
----------- ---------- ----------- ----------
COMPONENTS OF NET PERIODIC BENEFIT COST (A)
Service cost $ 0.3 $ 0.4 $ 0.8 $ 1.4
Interest cost 0.5 0.9 1.6 2.6
Amortization of prior service cost (0.6) 0.1 (1.7) 0.3
Recognized net actuarial losses 0.3 0.4 1.1 1.0
SFAS 88 settlements/curtailments - - - (0.6)
----------- ---------- ----------- ----------
Benefit cost $ 0.5 $ 1.8 $ 1.8 $ 4.7
=========== ========== =========== ==========
______________
(a) Amounts are before income tax effect.
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Medicare Act") was signed into law. The Medicare
Act introduced two new features to Medicare that employers must consider in
determining the effect of the Medicare Act on their accumulated postretirement
benefit obligation (''APBO'') and net periodic post retirement benefit cost: (i)
a subsidy based on 28 percent of an individual beneficiary's annual prescription
drug costs between $250 and $5,000, and (ii) the opportunity for a retiree to
obtain a prescription drug benefit under Medicare that is at least actuarially
equivalent to Medicare Part D.
42
In May 2004, the FASB staff issued FASB Staff Position ("FSP") 106-2,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. We adopted FSP 106-2, effective
July 1, 2004, accounting for these new features in the Medicare Act
prospectively as an actuarial gain to be amortized into income over the average
remaining service period of the plan participants. The adoption of these
requirements did not have a material impact on our condensed consolidated
financial position or results of operations for the three or nine months ended
September 30, 2004.
SALE/LEASEBACK TRANSACTION
We lease the drillship M. G. Hulme, Jr. from Deep Sea Investors, L.L.C., a
special purpose entity formed by several leasing companies to acquire the rig
from one of our subsidiaries in November 1995 in a sale/leaseback transaction.
We are obligated to pay rent of approximately $13 million per year through
November 2005. At the termination of the lease, we may purchase the rig for a
maximum amount of approximately $35.7 million, and we intend to exercise our
purchase option. Effective September 2002, the lease neither requires that
collateral be maintained nor contains any credit rating triggers.
Effective December 31, 2003, we adopted and applied the provisions of FIN
46, Consolidation of Variable Interest Entities, as revised December 31, 2003,
for all variable interest entities. FIN 46 requires the consolidation of
variable interest entities in which an enterprise absorbs a majority of the
entity's expected losses, receives a majority of the entity's expected residual
returns, or both, as a result of ownership, contractual or other financial
interests in the entity. Because the sale/leaseback agreement is with an entity
in which we have no direct investment, we are not entitled to receive the
financial statements of the leasing entity and the equity holders of the leasing
company will not release the financial statements or other financial information
to us in order for us to make the determination of whether the entity is a
variable interest entity. In addition, without the financial statements, we are
unable to determine if we are the primary beneficiary of the entity and, if so,
what we would consolidate. We have no exposure to loss as a result of the
sale/leaseback agreement. We currently account for the lease of this
semisubmersible drilling rig as an operating lease.
NEW ACCOUNTING PRONOUNCEMENTS
In April 2004, the FASB issued FSP 129-1, Disclosure of Information about
Capital Structure, Relating to Contingently Convertible Securities, which
applies to all contingently convertible securities and became effective the date
of issue. The FSP requires disclosure of the nature of the contingency and the
potential impact of conversion on the financial statements, particularly the
impact on earnings per share, and whether the securities have been included in
the entity's calculation of diluted earnings per share. The implementation of
this FSP did not have an effect on our condensed consolidated financial
statements and related notes thereto as our disclosures are in accordance with
the disclosure requirements as stated in this FSP.
In September 2004, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") reached a consensus on issue No. 04-08, The
Effect of Contingently Convertible Instruments on Diluted Earnings per Share
("EITF 04-08"), which is effective for reporting periods ending after December
15, 2004 (December 31, 2004 for calendar year companies). Contingently
convertible instruments within the scope of this EITF are instruments that
contain conversion features that are contingently convertible or exercisable
based on (a) a market price trigger or (b) multiple contingencies if one of the
contingencies is a market price trigger for which the instrument may be
converted or share settled based on meeting a specified market condition. The
EITF requires companies to include shares issuable under convertible instruments
in diluted earnings per share computations (if dilutive) regardless of whether
the market price trigger (or other contingent feature) has been met. In
addition, prior period earnings per share amounts presented for comparative
purposes must be restated. The EITF would not have had an effect on our diluted
earnings per share for the years ended December 31, 2003, 2002 and 2001, the
nine months ended September 30, 2004 or for the three and nine months ended
September 30, 2003. For the three months ended September 30, 2004, diluted
earnings per share would have been reduced by $0.01. We will adopt EITF 04-08
as of December 31, 2004 and do not expect adoption to have a material effect on
our earnings per share for the year then ending.
43
FORWARD-LOOKING INFORMATION
The statements included in this quarterly report regarding future financial
performance and results of operations and other statements that are not
historical facts are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Statements to the effect that we or management "anticipates,"
"believes," "budgets," "estimates," "expects," "forecasts," "intends," "plans,"
"predicts," or "projects" a particular result or course of events, or that such
result or course of events "could," "might," "may," "scheduled" or "should"
occur, and similar expressions, are also intended to identify forward-looking
statements. Forward-looking statements in this quarterly report include, but are
not limited to, statements involving contract commencements, revenues, expenses,
commodity prices, customer drilling programs, supply and demand, utilization
rates, dayrates, planned shipyard projects and rig mobilizations, expected
downtime, future activity in the deepwater, mid-water and the shallow and inland
water market segments, market outlook for our various geographical operating
sectors, effects of increases in utilization in the U.S. Gulf of Mexico market
sector, rig classes and business segments, plans to dispose of our remaining
interest in TODCO, the valuation allowance for deferred net tax assets of TODCO,
the write-off of TODCO deferred tax assets and related contractual receivables,
intended reduction of debt, planned asset sales, timing of asset sales,
including the Sedco 600, proceeds from asset sales, the effect and duration of
the Norway strike, the effect of the Trident 20 fire and the Jim Cunningham well
control incident, our effective tax rate, the purchase of the M.G. Hulme, Jr.,
changes in tax laws, treaties and regulations, our Sarbanes-Oxley Section 404
process, our other expectations with regard to market outlook, operations in
international markets, expected capital expenditures, results and effects of
legal proceedings and governmental audits and assessments, adequacy of
insurance, liabilities for tax issues, liquidity, cash flow from operations,
adequacy of cash flow for our obligations, effects of accounting changes,
pension plan contributions and the timing and cost of completion of capital
projects. Such statements are subject to numerous risks, uncertainties and
assumptions, including, but not limited to, those described in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Risk Factors" included in our Annual Report on Form 10-K for the
year ended December 31, 2003, the adequacy of sources of liquidity, the effect
and results of litigation, audits and contingencies and other factors discussed
in this annual report and in our other filings with the SEC, which are available
free of charge on the SEC's website at www.sec.gov. Should one or more of these
risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those indicated. All
subsequent written and oral forward-looking statements attributable to us or to
persons acting on our behalf are expressly qualified in their entirety by
reference to these risks and uncertainties. You should not place undue reliance
on forward-looking statements. Each forward-looking statement speaks only as of
the date of the particular statement, and we undertake no obligation to publicly
update or revise any forward-looking statements.
44
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Our exposure to market risk for changes in interest rates relates primarily
to our long-term and short-term debt obligations. The table below presents
scheduled debt maturities and related weighted-average interest rates for each
of the 12-month periods ending September 30 relating to debt obligations as of
September 30, 2004. Weighted-average variable rates are based on the London
Interbank Offered Rate in effect at September 30, 2004, plus applicable margins.
At September 30, 2004 (in millions, except interest rate percentages):
Scheduled Maturity Date (a) (b) Fair Value
------------------------------------------------------------------------ -----------
2005 2006 2007 2008 2009 Thereafter Total 09/30/04
------------ ------- ------- ------- ------ ------------ --------- -----------
Total debt
Fixed Rate $ 381.5 $400.4 $100.0 $269.0 $10.2 $ 1,750.0 $2,911.1 $ 3,253.1
Average interest rate 6.8% 1.5% 7.5% 6.7% 9.5% 7.2% 6.3%
Variable Rate $ 0.7 $ - $ - $ - $50.0 $ - $ 50.7 $ 50.7
Average interest rate 17.0%(c) - - - 2.3% - 2.6%
__________________________
(a) Maturity dates of the face value of our debt assume the put options on 1.5%
Convertible Debentures, 7.45% Notes and the Zero Coupon Convertible
Debentures will be exercised in May 2006, April 2007 and May 2008,
respectively.
(b) Expected maturity amounts are based on the face value of debt.
(c) Reflects line of credit used in Venezuela by TODCO at Venezuelan interest
rates customary for similar agreements.
At September 30, 2004, we had $50.7 million of variable rate debt at face
value (1.7 percent of total debt at face value). This variable rate debt
represented revolving credit bank debt. Given outstanding amounts as of that
date, a one percent rise in interest rates would result in an additional $0.5
million in interest expense per year. Offsetting this, a large part of our cash
investments would earn commensurately higher rates of return. Using September
30, 2004 cash investment levels, a one percent increase in interest rates would
result in approximately $7.0 million of additional interest income per year.
FOREIGN EXCHANGE RISK
Our international operations expose us to foreign exchange risk. We use a
variety of techniques to minimize the exposure to foreign exchange risk. Our
primary foreign exchange risk management strategy involves structuring customer
contracts to provide for payment in both U.S. dollars, which is our functional
currency, and local currency. The payment portion denominated in local currency
is based on anticipated local currency requirements over the contract term. Due
to various factors, including local banking laws, other statutory requirements,
local currency convertibility and the impact of inflation on local costs, actual
foreign exchange needs may vary from those anticipated in the customer
contracts, resulting in partial exposure to foreign exchange risk. Fluctuations
in foreign currencies typically have not had a material impact on overall
results. In situations where payments of local currency do not equal local
currency requirements, foreign exchange derivative instruments, specifically
foreign exchange forward contracts or spot purchases, may be used to mitigate
foreign currency risk. We do not enter into derivative transactions for
speculative purposes. At September 30, 2004, we had no open foreign exchange
derivative contracts.
45
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of September 30, 2004 to provide reasonable
assurance that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms.
Pursuant to our efforts relating to Section 404 of the Sarbanes-Oxley Act,
we have made certain changes to our internal controls over financial reporting
during the most recently ended quarter that we believe better align these
controls to the Section 404 requirements. However, there were no changes in
these internal controls during this quarter that have materially affected, or
are reasonably likely to materially affect, our internal controls over financial
reporting.
46
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Several of our 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 TODCO's subsidiaries to whom we 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, we anticipate 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. We have not yet had an opportunity to
conduct any discovery nor have we been able to determine the number of
plaintiffs, if any, that were employed by our subsidiaries or otherwise have any
connection with our drilling operations. We intend to defend ourselves
vigorously and, based on the limited information available to us at this time,
we do not expect the ultimate outcome of these lawsuits to have a material
adverse effect on our business or consolidated financial position.
The Indian Customs Department, Mumbai, filed a "show cause notice" against
one of our subsidiaries and various third parties in July 1999. The show cause
notice alleged that the initial entry into India in 1988 and other subsequent
movements of the Trident II jackup rig operated by the subsidiary constituted
imports and exports for which proper customs procedures were not followed and
sought payment of customs duties of approximately $31 million based on an
alleged 1998 rig value of $49 million, plus interest and penalties, and
confiscation of the rig. In January 2000, the Customs Department issued its
order, which found that we had imported the rig improperly and intentionally
concealed the import from the authorities, and directed us to pay a redemption
fee of approximately $3 million for the rig in lieu of confiscation and to pay
penalties of approximately $1 million in addition to the amount of customs
duties owed. In February 2000, we filed an appeal with the Customs, Excise and
Gold (Control) Appellate Tribunal ("CEGAT") together with an application to have
the confiscation of the rig stayed pending the outcome of the appeal. In March
2000, the CEGAT ruled on the stay application, directing that the confiscation
be stayed pending the appeal. The CEGAT issued its opinion on our appeal on
February 2, 2001, and while it found that the rig was imported in 1988 without
proper documentation or payment of duties, the redemption fee and penalties were
reduced to less than $0.1 million in view of the ambiguity surrounding the
import practice at the time and the lack of intentional concealment by us. The
CEGAT further sustained our position regarding the value of the rig at the time
of import as $13 million and ruled that subsequent movements of the rig were not
liable to import documentation or duties in view of the prevailing practice of
the Customs Department, thus limiting our exposure as to custom duties to
approximately $6 million. Following the CEGAT order, we tendered payment of
redemption, penalty and duty in the amount specified by the order by offset
against a $0.6 million deposit and $10.7 million guarantee previously made by
us. The Customs Department attempted to draw the entire guarantee, alleging the
actual duty payable is approximately $22 million based on an interpretation of
the CEGAT order that we believe is incorrect. This action was stopped by an
interim ruling of the High Court, Mumbai on writ petition filed by us. We and
the Customs Department both filed appeals with the Supreme Court of India
against the order of the CEGAT, and both appeals have been admitted. The Supreme
Court has recently dismissed the Customs Department appeal and affirmed the
CEGAT order but the Customs Department has not agreed with our interpretation of
that order. We and our customer agreed to pursue and obtained the issuance of
documentation from the Ministry of Petroleum that, if accepted by the Customs
Department, would reduce the duty to nil. The agreement with the customer
further provided that if this reduction was not obtained by the end of 2001, our
customer would pay the duty up to a limit of $7.7 million. The Customs
Department did not accept the documentation or agree to refund the duties
already paid. We are pursuing our remedies against the Customs Department and
our customer. We do not expect, in any event, that the ultimate liability, if
any, resulting from the matter will have a material adverse effect on our
business or consolidated financial position.
We have certain other actions or claims pending that have been previously
discussed and reported in our Annual Report on Form 10-K for the year ended
December 31, 2003 and our other reports filed with the Securities and Exchange
Commission. There have been no material developments in these previously
reported matters. We are involved in a number of other lawsuits, all of which
have arisen in the ordinary course of our business. We do not believe that
ultimate liability, if any, resulting from any such other pending litigation
will have a material adverse effect on our business or consolidated financial
position. We 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 our beliefs 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.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
(c) TOTAL NUMBER OF (d) MAXIMUM NUMBER
SHARES PURCHASED AS (OR APPROXIMATE DOLLAR
(a) TOTAL NUMBER PART OF PUBLICLY VALUE) OF SHARES THAT MAY
OF SHARES (b) AVERAGE PRICE ANNOUNCED PLANS OR YET BE PURCHASED UNDER
PERIOD PURCHASED (1) PAID PER SHARE PROGRAMS (2) THE PLANS OR PROGRAMS (2)
-------------- ----------------- ------------------ -------------------- --------------------------
July 2004 3,325 $ 28.61 N/A N/A
August 2004 - - N/A N/A
September 2004 - - N/A N/A
----------------- ------------------ -------------------- --------------------------
Total 3,325 $ 28.61 N/A N/A
================= ================== ==================== ==========================
__________
(1) The issuer purchase during the period covered by this report represents
shares withheld by us in satisfaction of withholding taxes due upon the
vesting of restricted stock granted to our employees under our Long-Term
Incentive Plan to pay withholding taxes due upon vesting of a restricted
stock award.
(2) In connection with the vesting of restricted stock awards under our
Long-Term Incentive Plan, we generally withhold shares to satisfy
withholding taxes upon vesting.
ITEM 5. OTHER INFORMATION
Our independent registered public accounting firm, Ernst & Young LLP
("E&Y") recently notified us that certain non-audit services were performed in
China for Transocean which could raise a question regarding their independence
in their performance of audit services.
E&Y's member firm in China performed certain tax compliance services for
Transocean in 2000 and 2001 related to a contract for drilling services offshore
China. In January 2001, we utilized E&Y's member firm in China to make a
payment to the Chinese tax authorities of the relevant taxes on our behalf. The
payment of these taxes involved E&Y's member firm having custody of company
funds, which is not permitted under the SEC's auditor independence rules. We
forwarded approximately $3,500 to the E&Y member firm in China for payment of
these taxes of which approximately $350 of residual funds remained after payment
was made. These funds were repaid to us in July 2004. No such services were
performed subsequent to 2001.
In response, we have performed an internal review of other payments to
local tax authorities to determine if other instances have occurred by which an
E&Y member firm made a payment to a local tax authority on our behalf after
having taken possession of company funds to make such payments. We have
identified other such instances that occurred during 2002 and 2003. During 2002,
we provided approximately $39,000 to the E&Y member firm in Thailand for payment
to the Thai tax office on our behalf of withholding taxes due. In addition,
corporate income tax payments and local employee tax payments totaling
approximately $369,000 were made by the E&Y member firm in Spain on our behalf
to the Spanish tax authorities during 2002 after receiving the funds from us.
During 2002 and 2003, we provided approximately $637,000 and $381,000,
respectively, to an E&Y member firm in Egypt for payment of 2001 and 2002
corporate income taxes. In each of these cases, the E&Y member firm forwarded
the funds to the local tax authorities on our behalf in accordance with our
instructions. No such services were performed subsequent to 2003. In all
instances, management believes that the fees paid to the E&Y member firms for
these tax compliance services were reasonable and appropriate in light of the
services performed.
The Audit Committee and E&Y discussed E&Y's independence with respect to
Transocean in light of the foregoing facts. E&Y, company management and the
Audit Committee concluded that these occurrences did not, in their opinion,
impair E&Y's independence with respect to the company.
47
Item 6. Exhibits
The following exhibits are filed in connection with this Report:
NUMBER DESCRIPTION
------ -----------
*3.1 Memorandum of Association of Transocean Inc., as amended (incorporated by reference to Annex E to the
Joint Proxy Statement/Prospectus dated October 30, 2000 included in a 424(b)(3) prospectus filed by us on
November 1, 2000)
*3.2 Articles of Association of Transocean Inc., as amended (incorporated by reference to Annex F to the Joint
Proxy Statement/Prospectus dated October 30, 2000 included in a 424(b)(3) prospectus filed by us on
November 1, 2000)
*3.3
Certificate of Incorporation on Change of Name to Transocean Inc. (incorporated by reference to Exhibit 3.3
to our Form 10-Q for the quarter ended June 30, 2002)
*10.1 Amendment No. 1 to Registration Rights Agreement dated September 7, 2004 between Transocean Inc. and
TODCO (incorporated by reference to Exhibit 10.15 to TODCO's Registration Statement on Form S-1 (Reg.
No. 333-117888))
**31.1 CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
**31.2 CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
**32.1 CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
**32.2 CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
_________________________
* Incorporated by reference as indicated.
** Filed herewith.
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, hereunto duly authorized, on November 8, 2004.
TRANSOCEAN INC.
By: /s/ Gregory L. Cauthen
--------------------------
Gregory L. Cauthen
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
By: /s/ William G. Henderson
----------------------------
William G. Henderson
Vice President and Controller
(Principal Accounting Officer)
49