XASE:VTG Vantage Drilling Co Quarterly Report 10-Q Filing - 6/30/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

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 001-34094

 

 

VANTAGE DRILLING COMPANY

(Exact name of Registrant as specified in its charter)

 

 

 

Cayman Islands   N/A

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

777 Post Oak Boulevard, Suite 800

Houston, TX 77056

(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (281) 404-4700

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act). (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The number of Vantage Drilling Company ordinary shares outstanding as of July 20, 2012 is 292,350,080.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page  

SAFE HARBOR STATEMENT

     3   

PART I—FINANCIAL INFORMATION

  
 

Item 1

     Financial Statements (Unaudited)   
       Consolidated Balance Sheet      5   
       Consolidated Statement of Operations – for the three and six months ended June 30, 2012 and 2011      6   
       Consolidated Statement of Cash Flows – for the six months ended June 30, 2012 and 2011      7   
       Notes to Unaudited Consolidated Financial Statements      9   
 

Item 2

     Management’s Discussion and Analysis of Financial Condition and Results of Operations      19   
 

Item 3

     Quantitative and Qualitative Disclosures about Market Risk      25   
 

Item 4

     Controls and Procedures      25   

PART II—OTHER INFORMATION

  
 

Item 6

     Exhibits      26   

SIGNATURES

     27   

 

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SAFE HARBOR STATEMENT

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements relate to our plans, goals, strategies, intent, beliefs and current expectations. These statements are expressed in good faith and based upon a reasonable basis when made, but there can be no assurance that these expectations will be achieved or accomplished. These forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Items contemplating or making assumptions about our industry, business strategy, goals, expectations concerning our market position, future operations, margins, profitability, capital expenditures, liquidity and capital resources and other financial and operating information also constitute such forward looking statements. You should not place undue reliance on these forward-looking statements. These forward-looking statements can be identified by the use of terms and phrases such as “believe,” “plan,” “intend,” “anticipate,” “target,” “estimate,” “expect,” and the like, and/or future tense or conditional constructions (“will,” “may,” “could,” “should,” etc.). Our actual results could differ materially from those anticipated in these forward-looking statements. Among the factors that could cause actual results to differ materially are the risks and uncertainties associated with the following:

 

   

our limited operating history;

 

   

our small number of customers;

 

   

credit risks of our key customers and certain other third parties;

 

   

reduced expenditures by oil and natural gas exploration and production companies;

 

   

termination of our customer contracts;

 

   

oil and natural gas prices;

 

   

our failure to obtain delivery of drilling units;

 

   

delays and cost overruns in construction projects;

 

   

general economic conditions and conditions in the oil and gas industry;

 

   

competition within our industry;

 

   

limited mobility between geographic regions;

 

   

operating hazards in the oilfield service industry;

 

   

the impact of the Macondo well incident on offshore drilling;

 

   

ability to obtain indemnity from customers;

 

   

adequacy of insurance coverage in the event of a catastrophic event;

 

   

operations in international markets;

 

   

governmental, tax and environmental regulation;

 

   

changes in legislation removing or increasing current applicable limitations of liability;

 

   

effects of new products and new technology on the market;

 

   

our substantial level of indebtedness;

 

   

our ability to incur additional indebtedness;

 

   

our ability to access the capital markets and to issue additional equity;

 

   

compliance with restrictions and covenants in our debt agreements;

 

   

identifying and completing acquisition opportunities;

 

   

levels of operating and maintenance costs;

 

   

our dependence on key personnel;

 

   

availability of workers and the related labor costs;

 

   

the sufficiency of our internal controls;

 

   

changes in tax laws, treaties or regulations;

 

   

any non-compliance with the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws;

 

   

our obligation to repurchase certain indebtedness upon a change of control;

 

   

potential conflicts of interest with F3 Capital; and

 

   

our incorporation under the laws of the Cayman Islands and the limited rights to relief that may be available compared to U.S. laws.

 

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Many of these factors are beyond our ability to control or predict. Any of these factors, or a combination of these factors, could materially affect our future financial condition or results of operations and the ultimate accuracy of the forward-looking statements. These forward-looking statements are not guarantees of our future performance, and our actual results and future developments may differ materially from those projected in the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels. In addition, 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. We may not update these forward-looking statements, even if our situation changes in the future. All forward-looking statements attributable to us are expressly qualified by these cautionary statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained from time to time in our filings with the Securities and Exchange Commission (the “SEC”), which may be obtained by contacting us or the SEC. These filings are also available through our website at http://www.vantagedrilling.com or through the SEC’s Electronic Data Gathering and Analysis Retrieval System (EDGAR) at http://www.sec.gov. The contents of our website are not part of this Quarterly Report.

Unless the context indicates otherwise, all references to “we,” “our” or “us” refer to Vantage Drilling Company and its consolidated subsidiaries.

 

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PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

Vantage Drilling Company

Consolidated Balance Sheet

(In thousands, except par value information)

 

     June 30,
2012
    December 31,
2011
 
     (Unaudited)        
ASSETS     

Current assets

    

Cash and cash equivalents

   $ 123,709      $ 110,031   

Restricted cash

     5,878        7,028   

Trade receivables

     78,221        100,908   

Inventory

     33,631        24,376   

Prepaid expenses and other current assets

     13,044        16,909   
  

 

 

   

 

 

 

Total current assets

     254,483        259,252   
  

 

 

   

 

 

 

Property and equipment

    

Property and equipment

     2,789,126        1,913,596   

Accumulated depreciation

     (140,900     (108,521
  

 

 

   

 

 

 

Property and equipment, net

     2,648,226        1,805,075   
  

 

 

   

 

 

 

Other assets

    

Other assets

     86,375        58,173   
  

 

 

   

 

 

 

Total other assets

     86,375        58,173   
  

 

 

   

 

 

 

Total assets

   $ 2,989,084      $ 2,122,500   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Current liabilities

    

Accounts payable

   $ 56,843      $ 46,362   

Accrued liabilities

     140,111        103,809   
  

 

 

   

 

 

 

Total current liabilities

     196,954        150,171   
  

 

 

   

 

 

 

Long-term debt, net of premium (discount) of $22,666 and ($38,572)

     2,082,666        1,246,428   

Other long-term liabilities

     20,054        29,755   

Commitments and contingencies

    

Shareholders’ equity

    

Preferred shares, $0.001 par value, 10,000 shares authorized; none issued or outstanding

     —          —     

Ordinary shares, $0.001 par value, 400,000 shares authorized; 292,350 and 291,241 shares issued and outstanding

     292        291   

Additional paid-in capital

     864,921        860,502   

Accumulated deficit

     (175,803     (164,647
  

 

 

   

 

 

 

Total shareholders’ equity

     689,410        696,146   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 2,989,084      $ 2,122,500   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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Vantage Drilling Company

Consolidated Statement of Operations

(In thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Revenues

        

Contract drilling services

   $ 99,683      $ 97,977      $ 204,681      $ 184,731   

Management fees

     956        3,171        3,678        7,214   

Reimbursables

     4,486        19,946        28,615        53,780   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     105,125        121,094        236,974        245,725   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating costs and expenses

        

Operating costs

     50,030        65,433        119,354        142,826   

General and administrative

     6,704        7,402        11,964        14,249   

Depreciation

     16,372        16,025        32,944        32,137   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     73,106        88,860        164,262        189,212   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     32,019        32,234        72,712        56,513   

Other income (expense)

        

Interest income

     21        22        33        60   

Interest expense and other financing charges

     (36,172     (39,350     (72,935     (80,892

Loss on debt extinguishment

     —          (25,196     —          (25,196

Other income, net

     216        (22     861        1,458   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense)

     (35,935     (64,546     (72,041     (104,570
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (3,916     (32,312     671        (48,057

Income tax provision

     6,061        7,758        11,827        10,667   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (9,977   $ (40,070   $ (11,156   $ (58,724
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss per share

        

Basic

   $ (0.03   $ (0.14   $ (0.04   $ (0.20

Diluted

   $ (0.03   $ (0.14   $ (0.04   $ (0.20

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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Vantage Drilling Company

Consolidated Statement of Cash Flows

(In thousands)

(Unaudited)

 

     Six Months Ended
June 30,
 
     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net loss

   $ (11,156   $ (58,724

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

    

Depreciation expense

     32,944        32,137   

Amortization of debt financing costs

     7,438        3,888   

Non-cash loss on debt extinguishment

     —          3,532   

Share-based compensation expense

     4,420        2,415   

Accretion of long-term debt

     —          2,582   

Amortization of debt discount (premium)

     (762     5,415   

Deferred income tax expense (benefit)

     1,860        (128

Loss on disposal of assets

     249        —     

Changes in operating assets and liabilities:

    

Restricted cash

     1,150        22,801   

Trade receivables

     (10,977     (36,303

Inventory

     (9,256     (2,396

Prepaid expenses and other current assets

     1,476        4,130   

Other assets

     1,357        897   

Accounts payable

     10,481        9,394   

Accrued liabilities

     644        2,948   
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     29,868        (7,412
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Additions to property and equipment

     (816,722     (116,876
  

 

 

   

 

 

 

Net cash used in investing activities

     (816,722     (116,876
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from issuance of senior secured notes, including issue premiums of $62,000 and $15,750

     837,000        240,750   

Repayment of long-term debt

     —          (109,716

Debt issuance costs

     (36,468     (12,693
  

 

 

   

 

 

 

Net cash provided by financing activities

     800,532        118,341   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     13,678        (5,947

Cash and cash equivalents—beginning of period

     110,031        120,443   
  

 

 

   

 

 

 

Cash and cash equivalents—end of period

   $ 123,709      $ 114,496   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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Vantage Drilling Company

Consolidated Statement of Cash Flows

Supplemental Information

(In thousands)

(Unaudited)

 

     Six Months Ended
June 30,
 
     2012     2011  

SUPPLEMENTAL CASH FLOW INFORMATION

    

Cash paid for:

    

Interest

   $ 70,534      $ 64,155   

Taxes

     6,531        12,455   

Non-cash investing and financing transactions:

    

Interest capitalized

     (25,957     (522

Trade-in value on equipment upgrades

     (2,956     —     

Reclassification of receivable in Titanium Explorer acquisition

     33,664        —     

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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VANTAGE DRILLING COMPANY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Recent Events

Vantage Drilling Company is a holding company organized under the laws of the Cayman Islands on November 14, 2007 with no significant operations or assets, other than its interests in its subsidiaries. Through its direct and indirect subsidiaries, Vantage Drilling Company is an international offshore drilling contractor for the oil and gas industry focused on operating a fleet of modern, high-specification drilling units.

At June 30, 2012, our operating fleet consisted of one ultra-deepwater drillship and four ultra-premium jackup rigs. Additionally, we have one ultra-deepwater drillship undergoing customer acceptance testing and one ultra-deepwater drillship under construction. Our global fleet is currently located in India, Asia, West Africa and the drillship undergoing customer acceptance is in the U.S. Gulf of Mexico.

In April 2012, we completed the acquisition of the ultra-deepwater drillship, Titanium Explorer, formerly known as the Dragonquest, from Valencia Drilling Corporation (“Valencia”), an affiliate of F3 Capital, our largest shareholder. The Titanium Explorer is expected to commence drilling operations under an eight year drilling contract in the third quarter of 2012 in the U.S Gulf of Mexico. Our customer for the Titanium Explorer is currently in the process of obtaining the necessary well permits for the U.S. Gulf of Mexico. Although there is no certainty as to when the permits will be obtained, the Titanium Explorer is contracted on an international basis and the customer may direct us to mobilize the vessel to another market.

We funded the acquisition of the Titanium Explorer through the issuance of an additional $775.0 million aggregate principal amount of our existing 11 1/2% Senior Secured Notes (the “Notes”). These additional Notes were issued at a price equal to 108% of their face value and are fully and unconditionally guaranteed, on a senior secured basis, by us and certain of our subsidiaries.

2. Basis of Presentation and Significant Accounting Policies

The accompanying interim consolidated financial information as of June 30, 2012 and for the three and six months ended June 30, 2012 and 2011 has been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and include our accounts and those of our majority owned subsidiaries. All significant intercompany transactions and accounts have been eliminated. They reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods, on a basis consistent with the annual audited financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures made are adequate to provide for fair presentation. The balance sheet at December 31, 2011 is derived from our December 31, 2011 audited financial statements. These interim financial statements should be read in conjunction with the financial statements and the notes thereto, included in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2011. The results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future periods. Certain previously reported amounts have been reclassified to conform to the current year presentation.

Cash and Cash Equivalents: Includes deposits with financial institutions as well as short-term money market instruments with maturities of three months or less when purchased.

Restricted Cash: Consists of cash and cash equivalents posted as collateral for bid tenders and performance bonds.

Inventory: Consists of materials, spare parts, consumables and related supplies for our drilling rigs and is carried at the lower of average cost or market.

Property and Equipment: Consists of the costs of our drilling rigs, furniture and fixtures, computer equipment and capitalized costs for computer software. Drilling rigs are depreciated on a component basis over estimated useful lives ranging from five to thirty-five years on a straight-line basis as of the date placed in service. Other assets are depreciated upon placement in service over estimated useful lives ranging from three to seven years on a straight-line basis. When assets are sold, retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and the gain or loss is recognized.

Interest costs related to the financings of our jackups and drillships and the amortization of debt financing costs were capitalized as part of the cost while they were under construction. In June 2011, we made our initial construction payments on the Tungsten Explorer and began capitalizing interest for this project. In April 2012, we began capitalizing interest on the Titanium Explorer upon acquisition of the drillship. Total interest and amortization costs capitalized for the three and six months ended June 30, 2012 were $22.3 million and $26.0 million, respectively. For the three and six months ended June 30, 2011, we capitalized interest and amortization costs of $0.5 million.

We evaluate the realization of property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss on our property and equipment exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. Any impairment loss recognized represents the excess of the asset’s carrying value over the estimated fair value.

 

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Debt Financing Costs: Costs incurred with debt financings are deferred and amortized over the term of the related financing facility.

Revenue: Revenue is recognized as services are performed based on contracted dayrates and the number of operating days during the period.

In connection with a customer contract, we may receive lump-sum fees for the mobilization of equipment and personnel. Mobilization fees and costs incurred to mobilize a rig from one geographic market to another are deferred and recognized on a straight-line basis over the term of such contract, excluding any option periods. Costs incurred to mobilize a rig without a contract are expensed as incurred. Fees or lump-sum payments received for capital improvements to rigs are deferred and amortized to income over the term of the related drilling contract. The costs of such capital improvements are capitalized and depreciated over the useful lives of the assets.

We record reimbursements from customers for rebillable costs and expenses as revenue and the related direct costs as operating expenses.

Rig Certifications: We are required to obtain regulatory certifications to operate our drilling rigs and must maintain such certifications through periodic inspections and surveys. The costs associated with these certifications, including drydock costs, are deferred and amortized over the corresponding certification periods.

Income Taxes: Income taxes have been provided based upon the tax laws and rates in effect in the countries in which operations are conducted and income is earned. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in future taxable or deductible amounts and are based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized. We recognize interest and penalties related to uncertain tax positions in income tax expense.

Earnings per Share: Basic earnings (loss) per share have been based on the weighted average number of ordinary shares outstanding during the applicable period. Diluted earnings (loss) per share has been computed based on the weighted average number of ordinary shares and ordinary share equivalents outstanding in the applicable period, as if all potentially dilutive securities were converted into ordinary shares (using the treasury stock method).

The following is a reconciliation of the number of shares used for the basic and diluted earnings (loss) per share (“EPS”) computations:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  
     (In thousands)  

Weighted average ordinary shares outstanding for basic EPS

     291,962         290,173         291,690         289,950   

Options

     —           —           —           —     

Warrants

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted weighted average ordinary shares outstanding for diluted EPS

     291,962         290,173         291,690         289,950   
  

 

 

    

 

 

    

 

 

    

 

 

 

The calculation of diluted weighted average ordinary shares outstanding excludes 2.5 million ordinary shares for both the three months and the six months ended June 30, 2012 and 2011, respectively, issuable pursuant to outstanding warrants or stock options because their effect is anti-dilutive as the exercise price of such securities exceeded the average market price of our shares for the applicable periods.

Concentration of Credit Risk: Financial instruments that potentially subject us to a significant concentration of credit risk consist primarily of cash and cash equivalents, restricted cash and accounts receivable. We maintain deposits in federally insured financial institutions in excess of federally insured limits. We monitor the credit ratings and our concentration of risk with these financial institutions on a continuing basis to safeguard our cash deposits. Some of our restricted cash is invested in certificates of deposit. Our customers primarily consist of major integrated and independent exploration and production companies and government-owned oil and gas companies. We bill our customers on a monthly basis and monitor outstanding receivables on an ongoing basis.

Share-Based Compensation: We account for employee share-based compensation using the fair value method as prescribed under U.S. GAAP. Restricted share grants are valued based on the market price of our ordinary shares on the date of grant and the fair value attributable to share options is calculated based on the Black-Scholes option pricing model. The fair values are amortized to expense over the requisite service period which is equivalent to the time required to vest the share options and share grants. We recognized

 

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approximately $2.2 million and $1.5 million of share-based compensation expense for the three months ended June 30, 2012 and 2011, respectively. For the six months ended June 30, 2012 and 2011, we recognized $4.4 million and $2.4 million, respectively, of share-based compensation expense.

Use of Estimates: The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. While management believes current estimates are appropriate and reasonable, actual results could differ from those estimates.

Fair Value of Financial Instruments: The fair value of our short-term financial assets and liabilities approximates the carrying amounts represented in the balance sheets principally due to the short-term or floating rate nature of these instruments. The fair value of the Notes outstanding at June 30, 2012 was approximately $2.2 billion based on quoted market prices.

We originally valued the $60.0 million promissory note issued to F3 Capital, our largest shareholder (the “F3 Capital Note”), based on our then weighted average cost of capital, resulting in a discounted present value of $27.8 million. The discount is reported as a direct deduction from the face amount of the note and is being recognized over the life of the note using the effective interest rate method. As of June 30, 2012, if we were to value the F3 Capital Note at our current weighted average cost of capital, the current discounted present value would be approximately $26.3 million.

Derivative Financial Instruments: We may use derivative financial instruments to reduce our exposure to various market risks, primarily interest rate risk. We have documented policies and procedures to monitor and control the use of derivatives. We do not engage in derivative transactions for speculative or trading purposes. We do not currently have any outstanding derivative instruments.

3. Transactions with F3 Capital and Affiliates

Titanium Explorer Acquisition

In April 2012, we completed the acquisition of the Titanium Explorer pursuant to a purchase agreement we entered into with Valencia on March 20, 2012, to purchase the construction contract with Daewoo Shipbuilding and Marine Engineering Co., Ltd. (“DSME”) for the construction and delivery of the Titanium Explorer, formerly known as the Dragonquest (the “Titanium Explorer Acquisition”). The total consideration for the Titanium Explorer Acquisition was approximately $164.0 million comprised of the following; (i) $3.0 million paid to Valencia upon signing of the purchase agreement; (ii) $149.0 million paid upon the closing of the Titanium Explorer Acquisition, which we refer to as the closing payment, and (iii) $12.0 million to be paid within 120 days of the closing. In addition, we paid $5.0 million of Valencia’s costs and expenses related to the Titanium Explorer Acquisition. Approximately $68.6 million of the closing payment was paid to Valencia’s bridge lender in full satisfaction of a bridge loan, the proceeds of which were used to fund certain construction costs related to the Titanium Explorer. Upon full satisfaction of the bridge loan, the bridge lender released its security interest in the Titanium Explorer construction contract and the pledge of shares of our subsidiary that has entered into a drilling contract with a customer for the operation of the Titanium Explorer. The closing payment was further reduced by direct payments of approximately $2.4 million to third parties for specific construction costs related to the drillship. We paid DSME $608.2 million for the remaining balance due under the Titanium Explorer construction contract and DSME delivered the Titanium Explorer to us on April 20, 2012 in accordance with the terms of the construction contract.

Pursuant to the terms of the Titanium Explorer Acquisition, the construction management agreement and the management agreement pertaining to the Titanium Explorer, each between Valencia and certain of our subsidiaries, were terminated.

Drillship Construction Supervision Agreement

We had a construction supervision agreement that entitled us to payments for supervising the construction of Hull 3608, an ultra-deepwater drillship. The counterparty to this agreement is an affiliate of F3 Capital. During the construction of Hull 3608, we were entitled to receive a fee of $5.0 million annually, prorated to the extent construction is completed mid-year. In addition to our annual fee, we were to be reimbursed for all direct costs incurred in the performance of construction oversight services. In September 2009, North Pole Drilling Corporation (“North Pole”), an affiliate of F3 Capital, and the shipyard constructing Hull 3608 agreed to suspend construction activities on Hull 3608. Consequently we agreed with North Pole to suspend for a corresponding period of time obligations under our agreement with North Pole to provide construction supervision services. In November 2009, pursuant to the terms of the construction supervision agreement, North Pole cancelled the agreement. The management fee revenue of approximately

 

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$3.0 million for construction services rendered by us in 2009 prior to the suspension and cancellation has not been paid as of June 30, 2012, and remains currently due and payable. In May 2011, we issued a demand letter to North Pole regarding payment of the overdue amount. We will continue to pursue all remedies, including legal remedies, to collect this outstanding amount.

F3 Capital Note

As part of the purchase price for the acquisition of the remaining interest in the entity that owned the construction contract for the Platinum Explorer (the “Mandarin Acquisition”), we issued a promissory note to F3 Capital. The F3 Capital Note accrues interest at 5% per annum and will mature 90 months from the issue date. The F3 Capital Note contains a preemptive right covenant that provides F3 Capital with the right to purchase a pro-rata portion of any equity or convertible debt that we offer at a price per share less than the conversion price of the F3 Capital Note so long as the F3 Capital Note is outstanding. If we do not repay the F3 Capital Note on its scheduled maturity date or upon the occurrence of certain customary default provisions, the interest rate on any amounts outstanding under the F3 Capital Note will rise to 10% per annum.

In connection with the Titanium Explorer Acquisition, F3 Capital entered into a voting agreement and irrevocable proxy pertaining to its ownership of our shares. Pursuant to the terms of the voting agreement, F3 Capital voted its shares in favor of an increase in our authorized capital by 100,000,000 ordinary shares and the slate of directors proposed by our board of directors at our Extraordinary General Meeting in lieu of Annual General Meeting of Shareholders held on July 10, 2012. Additionally, F3 Capital has a continuing obligation to vote in favor of the slate of directors approved by our board of directors for a period of twelve months after the date of the Titanium Explorer Acquisition.

4. Construction Supervision Agreements

In addition to the Drillship Construction Supervision Agreement mentioned above, we have entered into other construction management agreements with unaffiliated third parties.

On July 21, 2010, we signed an agreement to supervise and manage the construction and marketing of the ultra-deepwater drillship the Dalian Developer. We are receiving management fees and reimbursable costs during the construction phase of the drillship.

5. Debt

Our long-term debt was composed of the following:

 

     June 30,
2012
     December 31,
2011
 
     (Unaudited)         
     (In thousands)  

11 1/2% Senior Secured Notes, net of premium (discount) of $46,601 and ($12,503)

   $ 2,046,601       $ 1,212,497   

F3 Capital Note, net of discount of $23,935 and $26,069

     36,065         33,931   

RBC Credit Agreement

     —           —     
  

 

 

    

 

 

 
     2,082,666         1,246,428   

Less current maturities of long-term debt

     —           —     
  

 

 

    

 

 

 

Long-term debt

   $ 2,082,666       $ 1,246,428   
  

 

 

    

 

 

 

11 1/2% Senior Secured Notes

On July 30, 2010, Offshore Group Investment Limited, one of our wholly-owned subsidiaries (the “Issuer”), issued $1.0 billion aggregate principal amount of Notes under an indenture. These Notes were issued at a price equal to 96.361% of their face value, and are fully and unconditionally guaranteed, on a senior secured basis, by us and certain of our subsidiaries. The original issue discount, reported as a direct deduction from the face amount of the Notes, will be recognized over the life of the Notes using the effective interest rate method. The Notes mature on August 1, 2015, and bear interest from the date of their issuance at the rate of 11.5% per year. Interest on outstanding Notes is payable semi-annually in arrears, commencing on February 1, 2011. The net proceeds, after fees and expenses, of approximately $931.9 million were used to acquire the Platinum Explorer, to retire certain outstanding debt and for general corporate purposes.

In June 2011, the Issuer issued $225.0 million aggregate principal amount of additional Notes. The additional Notes were issued at a price equal to 107% of their face value, and are fully and unconditionally guaranteed, on a senior secured basis, by us and certain of our subsidiaries. The issuance premium, reported as an addition to the face amount of the Notes, will be recognized over the remaining life of the Notes using the effective interest rate method. The net proceeds, after fees and expenses, of approximately $227.8 million were used by the Issuer to purchase from the Company all of the equity interests of P2020 Rig Co., the entity that owns the Aquamarine Driller, and the related purchase of our subsidiary that is the party to the drilling contract for the Aquamarine Driller.

 

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We used the proceeds to repay and terminate a term loan associated with the Aquamarine Driller, make the initial payment to DSME under the construction contract for the Tungsten Explorer and for general corporate purposes.

In April 2012, in connection with the Titanium Explorer Acquisition, the Issuer issued $775.0 million aggregate principal amount of additional Notes. These additional Notes were issued at a price equal to 108% of their face value, and are fully and unconditionally guaranteed, on a senior secured basis, by us and certain of our subsidiaries. The issuance premium, reported as an addition to the face amount of the Notes, is being recognized over the remaining life of the Notes using the effective interest rate method. The net proceeds, after fees and expenses of approximately $820.6 million, were used by the Issuer to fund the Titanium Explorer Acquisition, pay DSME the remaining amounts due under the Titanium Explorer construction contract and for general corporate purposes. The average yield on the entire $2.0 billion aggregate principal amount of the Notes is approximately 10.6%.

The Notes may be redeemed, in whole or in part at specified redemption prices plus accrued and unpaid interest on the Notes redeemed. If a change of control, as defined in the indenture governing the notes, occurs, each holder of Notes will have the right to require the repurchase of all or any part of its Notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase. The indenture governing the Notes, among other things, limits the Issuer and any future restricted subsidiaries’ ability, and in certain cases, our ability to: (i) incur or guarantee additional indebtedness or issue disqualified capital stock; (ii) create or incur liens; (iii) pay dividends, redeem subordinated indebtedness or make other restricted payments; (iv) transfer or sell assets; (v) incur dividend or other payment restrictions affecting restricted subsidiaries; (vi) consummate a merger, consolidation or sale of all or substantially all of our assets or those of the Issuer; (vii) enter into transactions with affiliates; (viii) designate subsidiaries as unrestricted subsidiaries; (ix) engage in businesses other than a business that is the same or similar to our current business and reasonably related businesses; and (x) take or omit to take any actions that would adversely affect or impair in any material respect the collateral securing the notes. Our future subsidiaries may become restricted subsidiaries and guarantors under limited circumstances.

RBC Credit Agreement

In June 2012, we entered into a secured revolving credit agreement with Royal Bank of Canada (the “RBC Credit Agreement”) to provide us with advances and letters of credit up to an aggregate principal amount of $25.0 million, maturing June 21, 2015. Advances under the RBC Credit Agreement bear interest at the ABR (as defined in the RBC Credit Agreement) plus a margin of 3.50% or LIBOR plus a margin of 4.50%, at our option. We may prepay outstanding advances subject to certain prepayment minimums at any time.

The RBC Credit Agreement includes customary covenants and events of default, including covenants that, among other things, restrict the granting of liens on certain assets, restrict the incurrence of indebtedness and the conveyance of and modification to vessels and require us to maintain certain financial ratios and provide periodic financial reports. The RBC Credit Agreement also contains certain other covenants similar to those in the indenture governing the Notes. Advances under the RBC Credit Agreement are secured by a lien on certain of our assets, which are substantially similar to those assets pledged in connection with the Notes. We believe we were in compliance with all financial covenants of the RBC Credit Agreement at June 30, 2012.

6. Shareholders’ Equity

Preferred Shares

In December 2009, our shareholders approved a proposal to amend our Memorandum and Articles of Association to increase our authorized preferred shares from 1,000,000 preferred shares, par value $0.001 per share, to 10,000,000 preferred shares, par value $0.001 per share. As of June 30, 2012, no preferred shares were issued and outstanding.

Ordinary Shares

In July 2012, our shareholders approved a proposal to amend our memorandum and articles of association to increase our authorized ordinary shares from 400,000,000 to 500,000,000.

During the six months ended June 30, 2012, we granted 3,467,636 time-vested restricted shares to employees and directors under our 2007 Long-Term Incentive Plan (the “LTIP”), and 1,510,239 performance unit awards. Time-vested restricted share awards issued to employees vest ratably over four years, while awards to directors vest one year from date of grant. Performance unit awards may vest over a three-year period based on the level of attainment of pre-determined criteria; upon vesting, each performance unit award may be converted to ordinary shares at a ratio of 0 to 1.5. The time-vested restricted share awards and performance units are amortized to expense over the respective vesting period based on the fair value of the awards at the grant dates, which was approximately $5.1 million, based on an average share price of $1.03 per share. For purposes of calculating the grant date fair value of the performance units, the target conversion ratio of one ordinary share for one performance unit was used. In the six months ended June 30, 2012, 1,109,086 of the previously granted LTIP share awards vested.

7. Income Taxes

We are a Cayman Islands entity. The Cayman Islands does not impose corporate income taxes. Consequently, income taxes have been provided based on the laws and rates in effect in the countries in which operations are conducted, or in which we or our subsidiaries are considered resident for income tax purposes. We operate in multiple countries under different legal forms. As a result, we are subject to the jurisdiction of numerous domestic and foreign tax authorities, as well as to tax agreements and treaties among these governments. Our operations in these different jurisdictions are taxed on various bases including, (i) actual income before taxes, (ii) deemed profits (which are generally determined by applying a tax rate to revenues rather than profits) and (iii) withholding taxes based on revenue. Determination of taxable income in any jurisdiction requires the interpretation of the related tax laws and regulations and the use of estimates and assumptions regarding significant future events, such as the amount, timing and character of deductions, permissible revenue recognition methods under the tax law and the sources and character of income and tax credits. Changes in tax laws, regulations, agreements and treaties, foreign currency exchange restrictions or our level of operations or profitability in each tax jurisdiction could have an impact on the amount of income taxes that we provide during any given year.

We account for income taxes pursuant to ASC 740, Accounting for Income Taxes, which requires recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. We provide for deferred taxes on temporary differences between the financial statements and tax bases of assets using the enacted tax rates which are expected to apply to taxable income when the temporary differences are expected to reverse. Deferred tax assets are also provided for certain tax credit carryforwards. A valuation allowance to reduce deferred tax assets is established when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

In certain jurisdictions we are taxed under preferential tax regimes, which may require our compliance with specified requirements to sustain the tax benefits. We believe we are in compliance with the specified requirements and will continue to make all reasonable efforts to comply, however, our ability to meet the requirements of the preferential tax regimes may be affected by changes in laws, our business operations and other factors affecting our company and industry, many of which are beyond our control.

 

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Our periodic tax returns are subject to examination by taxing authorities in the jurisdictions in which we operate in accordance with the normal statutes of limitations in the applicable jurisdiction. These examinations may result in assessments of additional taxes that are resolved with the authorities or through the courts. Resolution of these matters involves uncertainties and there are no assurances as to the outcome. Our tax years 2008 through 2011 remain open to examination in many of our jurisdictions. In October 2010 and October 2011, authorities in Thailand commenced an examination for the 2009 and 2010 tax years, respectively. In October 2011, authorities in the Philippines notified us they would begin an examination for the 2010 tax year.

8. Commitments and Contingencies

We are subject to litigation, claims and disputes in the ordinary course of business, some of which may not be covered by insurance. There is an inherent risk in any litigation or dispute and no assurance can be given as to the outcome of any claims. We do not believe the ultimate resolution of any existing litigation, claims or disputes will have a material adverse effect on our financial position, results of operations or cash flows.

We enter into operating leases in the normal course of business for office space, housing, vehicles and specified operating equipment. Some of these leases contain renewal options which would cause our future cash payments to change if we exercised those renewal options.

9. Supplemental Financial Information

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consisted of the following:

 

     June 30,
2012
     December 31,
2011
 
     (Unaudited)         
     (In thousands)  

Prepaid insurance

   $ 5,099       $ 8,676   

Sales tax receivable

     3,355         1,004   

Income tax receivable

     280         280   

Deferred tax asset

     1,498         3,887   

Other receivables

     55         137   

Deferred mobilization costs

     500         1,152   

Other prepaid expenses

     2,257         1,773   
  

 

 

    

 

 

 
   $ 13,044       $ 16,909   
  

 

 

    

 

 

 

Property and Equipment

Property and equipment consisted of the following:

 

     June 30,
2012
    December 31,
2011
 
     (Unaudited)        
     (In thousands)  

Drilling equipment

   $ 1,788,601      $ 1,770,172   

Assets under construction

     989,026        133,369   

Leasehold improvements

     1,558        1,305   

Office and technology equipment

     9,941        8,750   
  

 

 

   

 

 

 
     2,789,126        1,913,596   

Accumulated depreciation

     (140,900     (108,521
  

 

 

   

 

 

 

Property and equipment, net

   $ 2,648,226      $ 1,805,075   
  

 

 

   

 

 

 

 

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Interest costs related to the financings of our drillings rigs and the amortization of debt financing costs are capitalized as part of the cost of the rig while it is under construction. We capitalized approximately $26.0 million of interest and amortization costs for the six months ended June 30, 2012 with regards to the construction of the Titanium Explorer and the Tungsten Explorer.

Other Assets

Other assets consisted of the following:

 

     June 30,
2012
     December 31,
2011
 
     (Unaudited)         
     (In thousands)  

Deferred financing costs, net

   $ 63,062       $ 34,032   

Performance bond collateral

     19,483         19,472   

Deposits

     1,353         1,330   

Deferred tax asset

     774         245   

Deferred mobilization costs

     978         2,109   

Deferred survey fees

     725         985   
  

 

 

    

 

 

 
   $ 86,375       $ 58,173   
  

 

 

    

 

 

 

Accrued Liabilities

Accrued liabilities consisted of the following:

 

     June 30,
2012
     December 31,
2011
 
     (Unaudited)         
     (In thousands)  

Interest

   $ 101,889       $ 63,127   

Compensation

     14,087         21,161   

Deferred payment for Titanium Explorer acquisition

     12,000         —     

Insurance premiums

     3,024         8,070   

Unearned income

     —           379   

Deferred revenue

     1,419         6,321   

Property, service and franchise taxes

     1,610         1,610   

Income taxes payable

     5,019         2,570   

Other

     1,063         571   
  

 

 

    

 

 

 
   $ 140,111       $ 103,809   
  

 

 

    

 

 

 

10. Business Segment Information

Our business activities relate to the international operations of our offshore drilling units, both jackup rigs and drillships, and providing construction supervision services in China for drilling units owned by others.

For the three and six months ended June 30, 2012 and 2011, all of our revenue was from countries outside of the United States. Consequently, we are exposed to the risk of changes in economic, political and social conditions inherent in foreign operations. Four customers accounted for approximately 45%, 30%, 12% and 11% of consolidated revenues for the three months ended June 30, 2012. For the six months ended June 30, 2012, four customers accounted for approximately 42%, 26%, 10% and 10%, respectively of consolidated revenue. Four customers accounted for approximately 42%, 12%, 11% and 10%, respectively, of consolidated revenue for the three months ended June 30, 2011. For the six months ended June 30, 2011, three customers accounted for approximately 41%, 11% and 10%, respectively, of consolidated revenue.

11. Supplemental Condensed Consolidating Financial Information

In July 2010, the Issuer issued $1.0 billion aggregate principal amount of its Notes under an indenture. In June 2011, the Issuer issued $225.0 million aggregate principal amount of additional Notes under the existing indenture. In April 2012, the Issuer issued $775.0 million aggregate principal amount of additional Notes under the existing indenture. The Notes are fully and unconditionally

 

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guaranteed, jointly and severally, on a senior secured basis by us and certain of our subsidiaries (the “Subsidiary Guarantors”). Our other existing subsidiaries have not guaranteed or pledged assets to secure the Notes (collectively, the “Non-Guarantor Subsidiaries”).

The following tables present the condensed consolidating financial information as of June 30, 2012 and 2011 and for the three and six months ended June 30, 2012 and 2011 of (i) us, (ii) the Issuer, (iii) the Subsidiary Guarantors, (iv) the Non-Guarantor Subsidiaries and (v) consolidating and elimination entries representing adjustments to eliminate (a) investments in our subsidiaries and (b) intercompany transactions.

Condensed Consolidating Balance Sheet (in thousands)

 

     As of June 30, 2012  
     Parent     Issuer     Subsidiary
Guarantors
     Non-
Guarantors
     Eliminations     Consolidated  

Cash and cash equivalents

   $ 1,424      $ 27,797      $ 93,356       $ 1,132       $ —       $ 123,709   

Other current assets

     353        —          121,956         8,465         —         130,774   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     1,777        27,797        215,312         9,597         —         254,483   

Property and equipment, net

     —         253        2,513,087         134,886         —         2,648,226   

Investment in and advances to subsidiaries

     644,344        1,418,637        1,037,090         1,468         (3,101,539     —    

Other assets

     —         63,062        21,751         1,562         —         86,375   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 646,121      $ 1,509,749      $ 3,787,240       $ 147,513       $ (3,101,539   $ 2,989,084   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Accounts payable and accrued liabilities

   $ 24,798      $ 95,919      $ 42,753       $ 33,484       $ —       $ 196,954   

Intercompany (receivable) payable

     (194,893     (895,186     997,535         92,544         —         —    
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total current liabilities

     (170,095     (799,267     1,040,288         126,028         —         196,954   

Long-term debt

     36,065        2,046,601        —          —           —         2,082,666   

Other long term liabilities

     —         —          16,132         3,922         —         20,054   

Shareholders’ equity (deficit)

     780,151        262,415        2,730,820         17,563         (3,101,539     689,410   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 646,121      $ 1,509,749      $ 3,787,240       $ 147,513       $ (3,101,539   $ 2,989,084   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Condensed Consolidating Statement of Operations (in thousands)

 

     Three Months Ended June 30, 2012  
     Parent     Issuer     Subsidiary
Guarantors
     Non-
Guarantors
    Consolidated  

Revenues

   $ —        $ —        $ 102,444       $ 2,681      $ 105,125   

Operating costs and expenses

     3,241        (154     67,098         2,921        73,106   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from operations

     (3,241     154        35,346         (240     32,019   

Other income (expense)

     (1,925     (34,226     76         140        (35,935
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

     (5,166     (34,072     35,422         (100     (3,916

Income tax provision

     —          8        5,742         311        6,061   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ (5,166   $ (34,080   $ 29,680       $ (411   $ (9,977
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Condensed Consolidating Statement of Operations (in thousands)

 

     Six Months Ended June 30, 2012  
     Parent     Issuer     Subsidiary
Guarantors
     Non-
Guarantors
     Consolidated  

Revenues

   $ —        $ —        $ 210,170       $ 26,804       $ 236,974   

Operating costs and expenses

     6,168        (154     133,326         24,922         164,262   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Income (loss) from operations

     (6,168     (154     76,844         1,882         72,712   

Other income (expense)

     (3,840     (69,062     557         304         (72,041
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     (10,008     (68,908     77,401         2,186         671   

Income tax provision

     —          8        11,032         787         11,827   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ (10,008   $ (68,916   $ 66,369       $ 1,399       $ (11,156
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

 

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Condensed Consolidating Statement of Cash Flows (in thousands)

 

     Six Months Ended June 30, 2012  
     Parent     Issuer     Subsidiary
Guarantors
    Non-
Guarantors
    Consolidated  

Net cash provided by (used in) operating activities

   $ 2,312      $ (53,111   $ 53,088      $ 27,579      $ 29,868   

Net cash provided by (used in) investing activities

     (22     (253     (809,865     (6,582     (816,722

Net cash provided by (used in) financing activities

     (15,815     81,150        759,237        (24,040     800,532   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

     (13,525     27,786        2,460        (3,043     13,678   

Cash and cash equivalents—beginning of period

     14,949        11        90,896        4,175        110,031   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents—end of period

   $ 1,424      $ 27,797      $ 93,356      $ 1,132      $ 123,709   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Condensed Consolidating Balance Sheet (in thousands)

 

     As of June 30, 2011  
     Parent     Issuer     Subsidiary
Guarantors
     Non-
Guarantors
    Eliminations     Consolidated  

Cash and cash equivalents

   $ 33,045      $ 2,981      $ 72,627       $ 5,843      $ —        $ 114,496   

Other current assets

     763        —          99,896         21,534        —          122,193   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total current assets

     33,808        2,981        172,523         27,377        —          236,689   

Property and equipment, net

     1,531        —          1,694,436         107,427        —          1,803,394   

Investment in and advances to subsidiaries

     488,230        424,451        66,559         20        (979,260     —     

Other assets

     —          38,508        18,892         1,298        —          58,698   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total assets

   $ 523,569      $ 465,940      $ 1,952,410       $ 136,122      $ (979,260   $ 2,098,781   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Accounts payable and accrued liabilities

   $ 9,094      $ 58,698      $ 34,239       $ 27,996      $ —        $ 130,027   

Intercompany (receivable) payable

     (310,615     (1,211,208     1,363,843         157,980        —          —     
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total current liabilities

     (301,521     (1,152,510     1,398,082         185,976        —          130,027   

Long-term debt

     31,773        1,210,738        —           —          —          1,242,511   

Other long term liabilities

     —          —          8,997         3,404        —          12,401   

Shareholders’ equity (deficit)

     793,317        407,712        545,331         (53,258     (979,260     713,842   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 523,569      $ 465,940      $ 1,952,410       $ 136,122      $ (979,260   $ 2,098,781   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Condensed Consolidating Statement of Operations (in thousands)

 

     Three Months Ended June 30, 2011  
     Parent     Issuer     Subsidiary
Guarantors
    Non-
Guarantors
     Consolidated  

Revenues

   $ —        $ —        $ 100,098      $ 20,996       $ 121,094   

Operating costs and expenses

     4,402        19        64,669        19,770         88,860   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) from operations

     (4,402     (19     35,429        1,226         32,234   

Other income (expense)

     (1,840     (33,724     (29,042     60         (64,546
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     (6,242     (33,743     6,387        1,286         (32,312

Income tax provision

     —          —          7,332        426         7,758   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (6,242   $ (33,743   $ (945   $ 860       $ (40,070
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Condensed Consolidating Statement of Operations (in thousands)

 

     Six Months Ended June 30, 2011  
     Parent     Issuer     Subsidiary
Guarantors
    Non-
Guarantors
     Consolidated  

Revenues

   $ —        $ —        $ 188,337      $ 57,388       $ 245,725   

Operating costs and expenses

     9,006        20        125,846        54,340         189,212   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) from operations

     (9,006     (20     62,491        3,048         56,513   

Other income (expense)

     (3,696     (65,862     (35,772     760         (104,570
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     (12,702     (65,882     26,719        3,808         (48,057

Income tax provision

     576        —          9,882        209         10,667   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (13,278   $ (65,882   $ 16,837      $ 3,599       $ (58,724
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Condensed Consolidating Statement of Cash Flows (in thousands)

 

     Six Months Ended June 30, 2011  
     Parent     Issuer     Subsidiary
Guarantors
    Non-
Guarantors
    Consolidated  

Net cash provided by (used in) operating activities

   $ (13,566   $ (49,227   $ 60,740      $ (5,359   $ (7,412

Net cash provided by (used in) investing activities

     (757     —          (11,679     (104,440     (116,876

Net cash provided by (used in) financing activities

     (47,916     51,073        3,604        111,580        118,341   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

     (62,239     1,846        52,665        1,781        (5,947

Cash and cash equivalents—beginning of period

     95,284        1,135        19,962        4,062        120,443   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents—end of period

   $ 33,045      $ 2,981      $ 72,627      $ 5,843      $ 114,496   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to assist you in understanding our financial position at June 30, 2012 and our results of operations for the three and six months ended June 30, 2012 and 2011. The discussion should be read in conjunction with the financial statements and notes thereto, included in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2011. The results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future periods. Certain previously reported amounts have been reclassified to conform to the current year presentation.

Overview

We are an international offshore drilling company focused on operating a fleet of modern, high specification drilling units. Our principal business is to contract drilling units, related equipment and work crews, primarily on a dayrate basis to drill oil and natural gas wells for our customers. We also provide construction supervision services for, and will operate and manage, drilling units owned by others. Through our fleet of drilling units we are a provider of offshore contract drilling services to major, national and independent oil and natural gas companies, focused primarily on international markets.

The following table sets forth certain information concerning our owned offshore drilling fleet.

 

Name

   Ownership   Year Built/
Expected
Delivery
   Water Depth
Rating  (feet)
     Drilling  Depth
Capacity
(feet)
     Status

Jackups

             

Emerald Driller

   100%   2008      375         30,000       Operating

Sapphire Driller

   100%   2009      375         30,000       Operating

Aquamarine Driller

   100%   2009      375         30,000       Operating

Topaz Driller

   100%   2009      375         30,000       Operating

Drillships

             

Platinum Explorer (1)

   100%   2010      12,000         40,000       Operating

Titanium Explorer (1) (2)

   100%   2012      12,000         40,000       Acceptance testing

Tungsten Explorer

   100%   2013      12,000         40,000       Under construction

 

(1) The Platinum Explorer and the Titanium Explorer are designed to drill in up to 12,000 feet of water, but are currently equipped to drill in 10,000 feet of water.
(2) The Titanium Explorer was formerly known as the Dragonquest. We have an eight-year contract with Petrobras to operate this vessel upon completion of acceptance testing.

Business Outlook

The current outlook for global oil and gas remains favorable as global activity continues to increase at a moderate pace. During the second quarter of 2012, expectations for worldwide economic growth were negatively impacted by concerns over European sovereign debt and fiscal policy in emerging economies to reduce inflationary forces. As a result of these lowered expectations, the price of oil was negatively impacted during the quarter; however, this negative impact was not severe enough or long enough in duration to negatively impact long term expectations for oil and gas demand and the demand for our services. If the expectations continue to be lower or are reduced further, this may have a longer term negative impact on the price of oil and gas and a corresponding decrease in the demand for our services.

Due to lack of infrastructure needed to transport natural gas, natural gas remains a regional commodity in comparison to oil. While there is an abundance of natural gas in North America, there continues to be very tight supplies of natural gas relative to demand in Europe and Asia, resulting in significantly higher natural gas prices for these markets. We believe these conditions will continue to increase the demand for our services in West Africa and Asia.

We believe the market for jackups is continuing to improve as operators are actively developing oil and natural gas reserves. As demand from operators for modern, high-specification jackups has increased, contract rates and utilization have risen with recent contracts being awarded with dayrates in excess of $150,000 per day. The continued improvement in the dayrates for modern, high specification jackup rigs could be tempered by several factors, including the future deliveries of newbuild premium jackup rigs and the possible re-activation of older, less efficient rigs by our competitors.

Deepwater and ultra-deepwater projects are typically longer in duration than shallow-water drilling programs, which reduces the volatility of dayrates and utilization to short-term fluctuations in oil and natural gas prices and general economic conditions. Deepwater operators tend to take a longer-term view of the global economic conditions and oil and natural gas prices and demand. We believe the long-term fundamentals for demand for oil and natural gas support a significant increase in deepwater and ultra-deepwater development. This is further supported by significant oilfield discoveries offshore Brazil, West Africa and in the U.S. Gulf of Mexico. We believe oil and gas companies are generally planning to increase their upstream capital spending levels.

As of July 2012, we estimate there are approximately 26 deepwater and ultra-deepwater rigs scheduled for delivery through 2013, most of which are contracted to customers. We believe that demand is likely to exceed rig supply despite newbuilds. The demand has caused an increase in dayrates with recent deepwater contract fixtures awarded in the international markets in excess of $600,000 per day.

 

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Table of Contents

Following the Macondo well incident in April 2010, the U.S. government undertook a comprehensive regulatory review of domestic offshore drilling operations, significantly expanding and enhancing governmental oversight and regulation. Additionally, oil and gas operators are requiring more testing of rig equipment and are extensively reviewing contractors’ drilling and safety procedures. These measures have resulted in increased operating costs.

In April 2012, we completed the acquisition of the Titanium Explorer. The Titanium Explorer is undergoing acceptance testing and is expected to commence drilling operations late in the third quarter of 2012 in the U.S Gulf of Mexico.

Results of Operations

The first of our jackup rigs was delivered in December 2008 and began operations under its initial contract in February 2009. Our second jackup rig began operating under its first contract in August 2009 and our third jackup rig commenced operations in January 2010. Our fourth jackup rig was delivered in December 2009 and began operating in March 2010. Our first drillship, the Platinum Explorer, was delivered in November 2010 and commenced operations in December 2010. Our second drillship, the Titanium Explorer, was delivered in April 2012 and is currently undergoing customer acceptance testing.

The following table sets forth selected contract drilling operational information for the periods indicated:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Jackups

        

Operating rigs, end of period

     4        4        4        4   

Available days (1)

     364        364        728        724   

Utilization (2)

     99.6     99.9     99.8     92.9

Average daily revenues (3)

   $ 144,447      $ 131,286      $ 144,495      $ 126,292   

Platinum Explorer

        

Available days (1)

     91        91        182        181   

Utilization (2)

     91.1     95.1     95.0     94.3

Average daily revenues (3)

   $ 570,524      $ 580,317      $ 576,731      $ 584,382   

 

(1) Available days are the total number of rig calendar days in the period. Newbuild rigs are included upon acceptance by the client.
(2) Utilization is calculated as a percentage of the actual number of revenue earning days divided by the available days in the period. A revenue earning day is defined as a day for which a rig earns dayrate after commencement of operations.
(3) Average daily revenues are based on contract drilling revenues divided by revenue earning days. Average daily revenue will differ from average contract dayrate due to billing adjustments for any non-productive time, mobilization fees and demobilization fees.

The following table is an analysis of our operating results for the three and six months ended June 30, 2012 and 2011.

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     Change     2012     2011     Change  
     (In thousands)     (In thousands)  

Contract drilling services

   $ 99,683      $ 97,977      $ 1,706      $ 204,681      $ 184,731      $ 19,950   

Management fees

     956        3,171        (2,215     3,678        7,214        (3,536

Reimbursables

     4,486        19,946        (15,460     28,615        53,780        (25,165
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     105,125        121,094        (15,969     236,974        245,725        (8,751

Operating costs

     50,030        65,433        15,403        119,354        142,826        23,472   

General and administrative

     6,704        7,402        698        11,964        14,249        2,285   

Depreciation

     16,372        16,025        (347     32,944        32,137        (807
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     32,019        32,234        (215     72,712        56,513        16,199   

Other income (expense)

            

Interest income

     21        22        (1     33        60        (27

Interest expense

     (36,172     (39,350     3,178        (72,935     (80,892     7,957   

Loss on debt extinguishment

     —          (25,196     25,196        —          (25,196     25,196   

Other income (expense)

     216        (22     238        861        1,458        (597

Income tax provision (benefit)

     6,061        7,758        1,697        11,827        10,667        (1,160
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (9,977   $ (40,070   $ 30,093      $ (11,156   $ (58,724   $ 47,568   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Revenue: Total revenue for the three months ended June 30, 2012 was $105.1 million compared to $121.1 million for the three months ended June 30, 2011, a decrease of $16.0 million, or 13%. Contract drilling revenue totaled $99.7 million for the three months ended June 30, 2012 compared to $98.0 million for the same period in 2011, an increase of $1.7 million, or 2%. The increase in drilling revenue was primarily due to increased dayrates on the Topaz Driller in the quarter ended June 30, 2012, offset by the lower utilization for the Platinum Explorer. Jackup utilization for the three months ended June 30, 2012 was 99.6% which was consistent with the 99.9% achieved in the prior year. The Platinum Explorer utilization for the three months ended June 30, 2012 and 2011 was 91.1% and 95.1%, respectively, as the Platinum Explorer had scheduled out-of-service time in 2012 for an equipment vendor to complete upgrades to the rig’s tubular handling system, and in 2011 the Platinum Explorer experienced normal amounts of downtime for a rig which had recently commenced operations.

Management fees and reimbursable revenue for the three months ended June 30, 2012 were $956,000 and $4.5 million, respectively, as compared to $3.2 million and $19.9 million in the prior year. The significant decrease in management fees and reimbursable revenue is due to having one on-going project during 2012 as compared to four projects in 2011. Two shipyard oversight projects we were conducting for a third party were completed at the end of 2011 and with the acquisition of the Titanium Explorer, this shipyard project was completed.

Total revenue for the six months ended June 30, 2012 was $237.0 million compared to $245.7 million for the six months ended June 30, 2011, a decrease of $8.7 million, or 4%. Contract drilling revenue totaled $204.7 million for the six months ended June 30, 2012 compared to $184.7 million for the same period in 2011, an increase of $20.0 million, or 11%. The increase in drilling revenue was primarily due to the increased dayrates on our jackups operating in Malaysia, and increased fleet utilization for the jackups. The jackup utilization for the six months ended June 30, 2012 was 99.8% as compared to utilization of 92.9% in the prior year. The utilization in the prior year was negatively impacted by out of service time for the Sapphire Driller due to a customer declaring force majeure on a contract in West Africa. The Platinum Explorer achieved utilization of 95.0% for the six months ended June 30, 2012, consistent with the prior year utilization of 94.3%.

Management fees and reimbursable revenue for the six months ended June 30, 2012 were $3.7 million and $28.6 million, respectively, as compared to $7.2 million and $53.8 million in the prior year. The significant decrease in management fees and reimbursable revenue is due to having one on-going project and managing the Titanium Explorer for four months during 2012 as compared to having on average four on-going projects during the six months ended June 30, 2011 as we completed two projects and started two additional projects.

Operating expenses: Operating expenses for the three months ended June 30, 2012 were $50.0 million compared to $65.4 million for the three months ended June 30, 2011, a decrease of $15.4 million, or approximately 24%. This decrease was due primarily to a reduction of reimbursable costs associated with shipyard oversight projects to $1.8 million as compared to $17.8 million in the prior year.

Operating expenses for the six months ended June 30, 2012 were $119.4 million compared to $142.8 million for the six months ended June 30, 2011, a decrease of $23.4 million, or approximately 16%. This decrease was due primarily to a reduction of reimbursable costs associated with shipyard oversight projects to $23.2 million as compared to $50.2 million in the prior year.

General and administrative expenses: General and administrative expenses were $6.7 million and $12.0 million for the three and six month periods ended June 30, 2012 as compared to $7.4 million and $14.2 million, respectively, for the comparable periods in 2011. The decreases of $698,000 for the three month and $2.3 million for the six month comparative periods are primarily due to reduced company expenditures related to information technology projects and legal expenses in 2012.

Depreciation expense: Depreciation expense was $16.4 million and $32.9 million for the three and six month periods ended June 30, 2012, as compared to $16.0 million and $32.1 million, respectively, for the comparable periods in 2011. The increases are primarily due to the depreciation of capital upgrades on the Topaz Driller and the Aquamarine Driller.

Interest expense and other financing charges: Interest expense and other financing charges for the three and six month periods ended June 30, 2012 decreased $3.2 million and $8.0 million, respectively, over the same periods of 2011. The decreases are primarily due to the refinancing of higher interest rate debt in 2011. Additionally, we incurred $2.0 million in fees related to an amendment of a term loan associated with the construction of the Aquamarine Driller in the first quarter of 2011.

We capitalized $22.3 million and $26.0 million of interest and amortization costs in the three and six month periods ended June 30, 2012, respectively. We capitalized $0.5 million of interest and amortization costs in the three and six month periods ended June 30, 2011.

 

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Table of Contents

Loss on extinguishment of debt: For the three and six month periods ended June 2011, in connection with the early retirement of a term loan related to Aquamarine Driller, we paid approximately $21.7 million in prepayment fees. Additionally, we wrote off approximately $3.5 million of deferred financing costs.

Income tax expense: Income tax expense was $6.1 million and $11.8 million, respectively, for the three and six month periods ended June 30, 2012, as compared to $7.8 million and $10.7 million, respectively, for the comparable periods in 2011. The changes are primarily due to revenues in 2012 being earned in jurisdictions where we are subject to deemed profit tax regimes that determine taxes based on specified percentages of revenue rather than profit or loss before tax.

Liquidity and Capital Resources

Long-term Debt

In April 2012, in connection with the acquisition of the Titanium Explorer, one of our wholly-owned subsidiaries issued an additional $775.0 million aggregate principal amount of our existing Notes. These additional Notes were issued at a price equal to 108% of their face value and are fully and unconditionally guaranteed, on a senior secured basis, by us and certain of our subsidiaries. The issuance premium, reported as an addition to the face amount of the Notes, is being recognized over the remaining life of the Notes using the effective interest rate method. The net proceeds, after fees and expenses, of approximately $820.6 million were used by the Issuer to fund the purchase of the Titanium Explorer for approximately $169.0 million, including repayment of certain of the seller’s expenses, and pay DSME the remaining amounts due under the Titanium Explorer construction contract of approximately $608.2 million. The remaining proceeds will be used to outfit and mobilize the Titanium Explorer to the U.S. Gulf of Mexico, pay a portion of the August 2012 interest payment on the Notes and for general corporate purposes.

In June 2012, we entered into a secured revolving credit agreement with Royal Bank of Canada (the “RBC Credit Agreement”) to provide us with advances and letters of credit up to an aggregate principal amount of $25.0 million, maturing June 21, 2015. Advances under the RBC Credit Agreement bear interest at the ABR (as defined in the RBC Credit Agreement) plus a margin of 3.50% or LIBOR plus a margin of 4.50%, at our option. We may prepay outstanding advances subject to certain prepayment minimums at any time.

The RBC Credit Agreement includes customary covenants and events of default, including covenants that, among other things, restrict the granting of liens on certain assets, restrict the incurrence of indebtedness and the conveyance of and modification to vessels and require us to maintain certain financial ratios and provide periodic financial reports. The RBC Credit Agreement also contains certain other covenants similar to those in the indenture governing the Notes. Advances under the RBC Credit Agreement are secured by a lien on certain of our assets, which are substantially similar to those assets pledged in connection with the Notes. We believe we were in compliance with all financial covenants of the RBC Credit Agreement at June 30, 2012.

Our long-term debt was composed of the following:

 

     June 30,
2012
     December 31,
2011
 
     (Unaudited)         
     (In thousands)  

11 1/2% Senior Secured Notes, net of premium (discount) of $46,601 and ($12,503)

   $ 2,046,601       $ 1,212,497   

F3 Capital Note, net of discount of $23,935 and $26,069

     36,065         33,931   

RBC Credit Agreement

     —           —     
  

 

 

    

 

 

 
     2,082,666         1,246,428   

Less current maturities of long-term debt

     —           —     
  

 

 

    

 

 

 

Long-term debt

   $ 2,082,666       $ 1,246,428   
  

 

 

    

 

 

 

11  1/2% Senior Secured Notes

On July 30, 2010, Offshore Group Investment Limited, one of our wholly-owned subsidiaries (the “Issuer”), issued $1.0 billion aggregate principal amount of Notes under an indenture. These Notes were issued at a price equal to 96.361% of their face value, and are fully and unconditionally guaranteed, on a senior secured basis, by us and certain of our subsidiaries. The original issue discount, reported as a direct deduction from the face amount of the Notes, will be recognized over the life of the Notes using the effective interest rate method. The Notes mature on August 1, 2015, and bear interest from the date of their issuance at the rate of 11.5% per year. Interest on outstanding Notes is payable semi-annually in arrears, commencing on February 1, 2011. The net proceeds, after fees and expenses, of approximately $931.9 million were used to acquire the Platinum Explorer, retire certain outstanding debt and for general corporate purposes.

 

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Table of Contents

In June 2011, the Issuer issued $225.0 million aggregate principal amount of additional Notes. The additional Notes were issued at a price equal to 107% of their face value, and are fully and unconditionally guaranteed, on a senior secured basis, by us and certain of our subsidiaries. The issuance premium, reported as an addition to the face amount of the Notes, will be recognized over the remaining life of the Notes using the effective interest rate method. The net proceeds, after fees and expenses, of approximately $227.8 million were used by the Issuer to purchase from the Company all of the equity interests of P2020 Rig Co., the entity that owns the Aquamarine Driller, and the related purchase of our subsidiary that is the party to the drilling contract for the Aquamarine Driller.

We used the proceeds to repay a term loan related to the Aquamarine Driller, make the initial payment to DSME under the construction contract for the Tungsten Explorer and for general corporate purposes.

The Notes may be redeemed, in whole or in part at specified redemption prices plus accrued and unpaid interest on the Notes redeemed. If a change of control, as defined in the indenture governing the Notes, occurs, each holder of Notes will have the right to require the repurchase of all or any part of its Notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase. The indenture governing the Notes, among other things, limits the Issuer and any future restricted subsidiaries’ ability, and in certain cases, our ability to: (i) incur or guarantee additional indebtedness or issue disqualified capital stock; (ii) create or incur liens; (iii) pay dividends, redeem subordinated indebtedness or make other restricted payments; (iv) transfer or sell assets; (v) incur dividend or other payment restrictions affecting restricted subsidiaries; (vi) consummate a merger, consolidation or sale of all or substantially all of our assets or those of the Issuer; (vii) enter into transactions with affiliates; (viii) designate subsidiaries as unrestricted subsidiaries; (ix) engage in businesses other than a business that is the same or similar to our current business and reasonably related businesses; and (x) take or omit to take any actions that would adversely affect or impair in any material respect the collateral securing the notes. Our future subsidiaries may become restricted subsidiaries and guarantors under limited circumstances.

F3 Capital Note

As part of the purchase price for the Mandarin Acquisition, we issued a promissory note to F3 Capital. The F3 Capital Note accrues interest at 5% per annum and will mature 90 months from the issue date. The F3 Capital Note contains a preemptive right covenant that provides F3 Capital with the right to purchase a pro-rata portion of any equity or convertible debt that we offer at a price per share less than the conversion price of the F3 Capital Note so long as the F3 Capital Note is outstanding. If we do not repay the F3 Capital Note on its scheduled maturity date or upon the occurrence of certain customary default provisions, the interest rate on any amounts outstanding under the F3 Capital Note will rise to 10% per annum.

In connection with the Titanium Explorer Acquisition, F3 Capital entered into a voting agreement and irrevocable proxy pertaining to its ownership of our shares. Pursuant to the terms of the voting agreement, F3 Capital voted its shares in favor of an increase in our authorized capital by 100,000,000 ordinary shares and the slate of directors proposed by our board of directors at our Extraordinary General Meeting in lieu of Annual General Meeting of Shareholders held on July 10, 2012. Additionally, F3 Capital has a continuing obligation to vote in favor of the slate of directors approved by our board of directors for a period of twelve months after the date of the Titanium Explorer Acquisition

Liquidity

As of June 30, 2012, we had working capital of approximately $57.5 million. Included in working capital is approximately $123.7 million of cash available for general corporate purposes, including the August 1, 2012 semi-annual interest payment on our Notes. Additionally, we have posted $5.9 million cash as collateral for bid tenders and performance bonds. For the remainder of 2012, we anticipate spending approximately $7.0 million on sustaining capital expenditures and $20.3 million for the outfitting and mobilization of the Titanium Explorer. We expect to fund these expenditures from our available working capital, cash flow from operations including the $38.4 million mobilization fee for the Titanium Explorer and advances under the RBC Credit Agreement. The timing of the Titanium Explorer commencing operations is a significant factor in determining our liquidity position. The timing and extent of our customer’s acceptance testing and, in some cases, third party verification will impact the commencement date of operations and could negatively impact liquidity.

Additionally, we expect to spend approximately $12.4 million, excluding capitalized interest, over the remainder of 2012 on the Tungsten Explorer. In May 2013, the final shipyard payment on the Tungsten Explorer will be due upon completion of construction. We expect to fund pre-delivery expenditures from working capital, from advances under the RBC Credit Agreement or from additional capital raising.

Contingent Obligations

We are subject to litigation, claims and disputes in the ordinary course of business, some of which may not be covered by insurance. There is an inherent risk in any litigation or dispute and no assurance can be given as to the outcome of any claims. We do not believe the ultimate resolution of any existing litigation, claims or disputes will have a material adverse effect on our financial position, results of operations or cash flows.

We enter into operating leases in the normal course of business for office space, housing, vehicles and specified operating equipment. Some of these leases contain renewal options which would cause our future cash payments to change if we exercised those renewal options.

 

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Critical Accounting Policies and Accounting Estimates

The preparation of financial statements and related disclosures in accordance with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. While management believes current estimates are appropriate and reasonable, actual results could materially differ from those estimates. We have identified the policies below as critical to our business operations and the understanding of our financial operations. The impact of these policies and associated risks are discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results.

Property and Equipment: Property and equipment consists of the values of our drilling rigs, furniture and fixtures, computer equipment and capitalized costs for computer software. Drilling rigs are depreciated on a component basis over estimated useful lives ranging from five to thirty-five years on a straight-line basis as of the date placed in service. Other assets are depreciated upon placement in service over estimated useful lives ranging from three to seven years on a straight-line basis. When assets are sold, retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and the gain or loss is recognized.

Interest costs related to the financings of our jackups and drillships and the amortization of debt financing costs were capitalized as part of the cost while they were under construction. In June 2011, we made our initial construction payments on the Tungsten Explorer and began capitalizing interest for this project. In April 2012, we began capitalizing interest on the Titanium Explorer upon acquisition of the drillship. Total interest and amortization costs capitalized for the three and six months ended June 30, 2012 were $22.3 million and $26.0 million, respectively. For the three and six months ended June 30, 2011, we capitalized interest and amortization costs of $0.5 million.

We evaluate the realization of property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss on our property and equipment exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. Any impairment loss recognized represents the excess of the asset’s carrying value over the estimated fair value.

Revenue: Revenue is recognized as services are performed based on contracted dayrates and the number of operating days during the period.

In connection with a customer contract, we may receive lump-sum fees for the mobilization of equipment and personnel. Mobilization fees and costs incurred to mobilize a rig from one geographic market to another are deferred and recognized on a straight-line basis over the term of such contract, excluding any option periods. Costs incurred to mobilize a rig without a contract are expensed as incurred. Fees or lump-sum payments received for capital improvements to rigs are deferred and amortized to income over the term of the related drilling contract. The costs of such capital improvements are capitalized and depreciated over the useful lives of the assets.

We record reimbursements from customers for rebillable costs and expenses as revenue and the related direct costs as operating expenses.

Rig Certifications: We are required to obtain regulatory certifications to operate our drilling rigs and must maintain such certifications through periodic inspections and surveys. The costs associated with these certifications, including drydock costs, are deferred and amortized over the corresponding certification periods.

Income Taxes: Income taxes have been provided based upon the tax laws and rates in effect in the countries in which operations are conducted and income is earned. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in future taxable or deductible amounts and are based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized. We recognize interest and penalties related to uncertain tax positions in income tax expense.

Share-Based Compensation: We account for employee share-based compensation using the fair value method as prescribed under U.S. GAAP. Restricted share grants are valued based on the market price of our ordinary shares on the date of grant and the fair value attributable to share options is calculated based on the Black-Scholes option pricing model. The fair values are amortized to expense over the service period which is equivalent to the time required to vest the share options and share grants.

Use of Estimates: The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. While management believes current estimates are appropriate and reasonable, actual results could differ from those estimates.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our rigs operate in various international locations, and thus are sometimes subject to foreign exchange risk. We may from time to time also be exposed to certain commodity price risk, equity price risk and risks related to other market driven rates or prices. The risks associated with foreign exchange rates, commodity prices and equity prices have not been significant in the first six months of 2012 as all of our drilling contracts thus far have been denominated in U.S. dollars. We do not enter into derivatives or other financial instruments for trading or speculative purposes.

Interest Rate Risk: As of June 30, 2012, we did not have any variable rate debt outstanding.

Foreign Currency Exchange Rate Risk. As we operate in international areas, we are exposed 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 customer acceptance, 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 have not had a material impact on our overall results. If we find ourselves 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. A foreign exchange forward contract obligates us to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates or to make an equivalent U.S. dollar payment equal to the value of such exchange. We do not enter into derivative transactions for speculative purposes. As of June 30, 2012, we did not have any open foreign exchange derivative contracts or material foreign currency exposure risk.

 

Item 4. Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported, within the time periods specified by the SEC rules and forms.

We carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, such officers have concluded that the design and operation of these disclosure controls and procedures were effective as of June 30, 2012 to provide reasonable assurance that information required to be disclosed on our reports filed or submitted under the Exchange Act was (1) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and (2) recorded, summarized and reported within the time periods specified in the SEC’s rules and forms.

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

Item 6. Exhibits

 

Exhibit

No.

  

Description

    3.2    Amended and Restated Memorandum & Articles of Association of Vantage Drilling Company effective December 21, 2009, as amended effective July 10, 2012*
    4.1    Credit Agreement dated as of June 21, 2012 among Offshore Group Investment Limited and Vantage Drilling Company, as borrowers, Vantage Drilling Company and certain subsidiaries thereof as Guarantors, the Lenders, and Royal Bank of Canada as Collateral Agent (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed with the SEC on June 25, 2012)
  10.1    Form of Indemnification Agreement for the Directors and Officers of the Company and its Subsidiaries*
  10.2    Consulting Services Agreement between Vantage Drilling Company and Strand Energy dated May 8, 2012*
  31.1    Certification of Principal Executive Officer Pursuant to Section 302*
  31.2    Certification of Principal Financial and Accounting Officer Pursuant to Section 302*
  32.1    Certification of Principal Executive Officer Pursuant to Section 906*
  32.2    Certification of Principal Financial and Accounting Officer Pursuant to Section 906*
101.INS    — XBRL Instance Document **
101.SCH    — XBRL Schema Document **
101.CAL    — XBRL Calculation Document **
101.DEF    — XBRL Definition Linkbase Document **
101.LAB    — XBRL Label Linkbase Document **
101.PRE    — XBRL Presentation Linkbase Document **

 

* Filed herewith.
** Furnished with this Form 10-Q

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized

 

VANTAGE DRILLING COMPANY
By:  

/S/ DOUGLAS G. SMITH

  Douglas G. Smith
  Chief Financial Officer and Treasurer
  (Principal Financial and Accounting Officer)

Date: July 30, 2012

 

27

XASE:VTG Vantage Drilling Co Quarterly Report 10-Q Filling

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