ITEM 3. LEGAL PROCEEDINGS
On August 26, 1998, the Company received notice that a class action complaint against the Company and each member of the Board of Directors was filed by a stockholder, on behalf of all of the stockholders of the Company, on August 12, 1998 in the Court of Chancery of the State of Delaware. The complaint alleges
that the directors of the Company did not act in accordance with their fiduciary duties to protect the interests of the stockholders in connection with the Merger. The plaintiff seeks damages as well as injunctive relief. The Company believes the allegations in the complaint are wholly without merit and intends to vigorously defend the lawsuit.
The Company is party to a number of other lawsuits which are ordinary, routine litigation incidental to the Company's business, the outcome of which, individually, or in the aggregate, is not expected to have a material adverse effect on the Company's financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
Under the reduced disclosure format permitted by General Instruction I(2)(c) of Form 10-K, the information otherwise required by this item may be omitted.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company was traded on the New York Stock Exchange under the symbol "CDG" from April 3, 1997 through November 30, 1998. Prior to April 3, 1997, the Common Stock of the Company was traded on the NASDAQ stock market under the symbol "CLDR." The following table sets forth the range of high and low sales prices per share of Common Stock for each calendar quarter, as reported by the NASDAQ stock market for the periods through April 2, 1997, and as reported by the New York Stock Exchange for periods from April 3, 1997 through November 30, 1998, the last trading date for the Common Stock. As a result of the Merger, R&B Falcon owns all of the outstanding Common Stock of the Company, and the Company's Common Stock is no longer publicly traded.
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(a) For the period through November 30, 1998, the last trading date for the Common Stock.
(b) Retroactively adjusted to reflect a two-for-one stock split effected in the form of a 100% stock dividend effective May 22, 1997.
The Company never paid cash dividends on its Common Stock. Under the Company's 10.25% Senior Notes due 2003 (the "Senior Notes") and Revolving Credit Facility with ING, the Company is restricted from declaring, making or paying cash dividends on the Common Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 9 of Notes to Consolidated Financial Statements.
During 1998, 39,437 shares of the Company's Common Stock held by the Company as treasury shares were contributed to the Cliffs Drilling Company Savings Plan in satisfaction of the Company's matching obligations under the Savings Plan. The shares had an aggregate value of $1,089,000 based on market prices on the various dates of transfer ranging from $17.75 to $55.75 per share. These transactions either (i) do not constitute "sales" and therefore are not subject to the registration requirements of the Securities Act of 1933, as amended, or (ii) were made in reliance on an exemption from registration under Section 4(2) of the Securities Act of 1933, as amended, as transactions by the issuer not involving a public offering.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial information of the Company. The amounts as of and for each of the five years in the period ended December 31, 1998 have been derived from audited consolidated financial statements of the Company. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto included elsewhere herein. The selected consolidated financial data provided below are not necessarily indicative of the future results of operations or financial performance of the Company.
The Merger was effective on December 1, 1998 and was accounted for using the purchase method of accounting. The purchase price was "pushed down" and recorded in the consolidated financial statements, which affects the comparability of the post-acquisition and pre-acquisition financial position. See Note 2 of Notes to Consolidated Financial Statements.
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(1) Included in 1998 General and Administrative Expense are merger costs of $1.5 million and incremental restricted stock amortization of $1.8 million related to the accelerated vesting of restricted stock due to the execution of the Merger Agreement with R&B Falcon.
(2) In part to finance the acquisition of the Southwestern Rigs, the Company sold $150 million of Senior Notes on May 23, 1996. On August 7, 1997, the Company sold an additional $50 million of Senior Notes at a premium for various rig acquisitions and upgrades.
(3) The following summarizes items of "Other Income (Expense)":
(4) On January 17, 1996, the Company issued 2,113,557 shares (pre-split basis) of Common Stock upon conversion of 1,115,988 shares of its 1,150,000 issued and outstanding shares of Preferred Stock. The remaining 34,012 shares of Preferred Stock were redeemed for cash in the amount of $25.69 per share plus $0.22 per share in accrued dividends thereon at a cost to the Company of approximately $.9 million.
(5) The net income per common share amounts and weighted average number of common and common equivalent shares outstanding prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"). For further discussion of earnings per share and the impact of SFAS No. 128, see Note 1 of Notes to Consolidated Financial Statements. In addition, net income per common share and weighted average number of common and common equivalent shares outstanding have been retroactively adjusted to reflect a two- for-one stock split effected in the form of a 100% stock dividend effective May 22, 1997.
(6) The Company issued 1,200,000 shares (pre-split basis) of Common Stock on May 23, 1996 in connection with the acquisition of the Southwestern Rigs and 437,939 shares of Common Stock on December 29, 1997 in connection with the Well Services Acquisition.
(7) As a result of the Merger, each outstanding share of Common Stock of the Company was converted into 1.7 shares of R&B Falcon common stock and cash in lieu of fractional shares, as provided for in the Merger Agreement. The Company is now a wholly-owned subsidiary of R&B Falcon.
(8) The Company has not paid any cash dividends on its Common Stock.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Effective December 1, 1998, a change in control of the Company occurred as a result of the Merger. The Company is now a wholly-owned subsidiary of R&B Falcon.
Activity in the contract drilling industry and related oil service businesses has deteriorated significantly in recent months due to decreased worldwide demand for drilling rigs and related services resulting from a substantial decline in crude oil prices. The financial condition and results of operations of the Company and other drilling contractors are dependent upon the price of oil and natural gas, as demand for their services is primarily dependent upon the level of spending by oil and gas companies for exploration, development and production activities. Crude oil and natural gas prices have continued to fluctuate over the last several years. If crude oil prices decline further or the current weakness in crude oil prices continues for an extended period, there could be a further deterioration in both rig utilization and dayrates.
The Company's daywork drilling operations benefited during 1997 and early 1998 from the tight supply of jack-up drilling rigs both in the U.S. Gulf of Mexico and internationally. Increased exploration activity coupled with a reduction in rig availability resulted in increased dayrates and utilization of the Company's drilling rigs. The same factors both positively and negatively affected the Company's engineering services business segment during 1997 and early 1998, in that increased exploration activity caused an increase in demand for the Company's engineering services; however, reduced rig availability made it more difficult for the Company to contract drilling rigs required for performance of turnkey drilling operations. Currently, lower crude oil prices are affecting exploration and production spending, which is creating significantly lower dayrates and utilization for offshore drilling companies, particularly in the U.S. Gulf of Mexico.
The oil and gas industry has experienced extreme market cycles over the past decade. The Company has endeavored to mitigate the effect of this volatility by diversifying its scope of operations. To achieve its strategic objective, the Company established separate but related lines of business in daywork drilling, engineering services and mobile offshore production unit operations. The Company also has pursued foreign drilling and production opportunities in order to expand geographically. Each of the Company's business segments will continue to be affected, however, by the unsettled energy markets, which are influenced by a variety of factors, including general economic conditions, the extent of worldwide oil and gas production and demand therefor, government regulations and environmental concerns.
RESULTS OF OPERATIONS
Year 1998 Versus 1997
The Company recognized net income of $51.1 million in 1998 compared to net income of $46.7 million in 1997. Revenues increased $72.2 million and operating income increased $11.5 million from 1997 to 1998. These increases were partially offset by $2.9 million of decreased gains on disposition of assets and $2.6 million of increased interest expense associated with the Senior Notes. Improved operating results from the engineering services business segment contributed to the increase in operating income.
Daywork Drilling
Daywork drilling revenues increased $48.5 million and operating income increased $.2 million in 1998 compared to 1997. The increase in revenues was primarily due to an expansion of the Company's operating rig fleet, in addition to improved dayrates on several rigs. The decrease in operating margins was primarily due to reduced dayrates and utilization experienced during the second half of 1998, in addition to costs associated with stacking certain rigs.
The Company completed the conversion of one of the Company's MOPUs into a drilling rig and mobilized the rig to offshore Venezuela. The rig commenced operations under a one-year drilling contract during the third quarter of 1998.
The Company operates its drilling rigs on both a term and a spot (well-to-well) basis. Drilling rigs contracted on a term basis generally work in various international locations, while drilling rigs contracted on a spot basis generally work in the U.S. Gulf of Mexico. The following table summarizes revenues, utilization and average dayrates for significant classes of the Company's drilling rigs:
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(1) Includes revenues earned from affiliates.
(2) Includes WINDJV operations in Trinidad prior to August 1, 1997, Brazilian operations prior to October 1, 1997, CCDI joint venture operations in Mexico, CCI joint venture operations in Venezuela and labor maintenance contracts in Venezuela and Trinidad.
(3) Utilization rates are based upon the number of actively marketed rigs in the fleet and exclude rigs which are unavailable for operations during periods of refurbishment and upgrade.
(4) Daywork drilling revenues, less non-recurring revenues, divided by aggregate contract days, adjusted to exclude days under contract at zero dayrate.
Engineering Services
Engineering services revenues increased $41.6 million and operating income increased $15.5 million in 1998 compared to 1997. The Company completed 17 turnkey contracts in 1998 compared to 14 turnkey contracts in 1997. Thirteen of the 17 contracts completed during 1998 were international contracts in Venezuela, while 10 international contracts in Venezuela were completed during 1997. International operating margins are currently stronger than domestic margins due to improved drilling efficiencies and a reduction in lost time well activities. Domestic turnkey contractors continue to bid wells very aggressively, resulting in intense competition which has adversely affected the Company's domestic turnkey margins.
The Company had 8 turnkey wells in progress at December 31, 1998, 4 of which were completed by February 28, 1999.
In April, 1998, the Company was awarded a contract from PDVSA to drill 60 turnkey wells in Venezuela. Aggregate revenues for the 60 wells are expected to range from approximately $450 million to $500 million depending upon, among other things, various options to be elected by PDVSA. The Company commenced drilling under the program in March, 1998. The program is expected to extend over approximately three and one-half years and is expected to utilize 7 of the Company's land drilling rigs in Venezuela. During 1998, the Company completed 9 of the 60 wells, with revenues realized in the amount of $74.6 million. No assurance can be given that the remaining wells will ultimately be drilled, or that the program can be completed within the intended time frame.
MOPU Operations
MOPU revenues increased slightly and operating income decreased $.3 million in 1998 compared to 1997. The decrease in operating income was primarily due to the loss of earnings from a MOPU which was converted to a jack-up drilling rig during 1998.
The Company currently owns 4 MOPUs. Three of the MOPUs are under contract and currently operating, and one MOPU is stacked.
Oil and Gas
Oil and gas revenues decreased $.1 million and operating losses decreased $.1 million in 1998 compared to 1997. The Company does not expect any significant activity related to oil and gas exploration and production activities during 1999.
Corporate Overhead
Corporate overhead increased $4.1 million in 1998 compared to 1997. The increase was primarily related to costs associated with the Merger.
Other Income (Expense) and Income Taxes
The Company recognized $46.7 million of other expense in 1998 compared to $39.6 million of other expense in 1997. The net increase in other expense resulted primarily from a $2.9 million decrease in gains on disposition of assets, a $2.6 million increase in interest expense associated with the Senior Notes, a $1.3 million increase in exchange rate losses and an increase in income taxes of $1.4 million. See "Liquidity and Capital Resources."
The increase in income taxes relates primarily to the overall increase in income from 1997 to 1998. The effective tax rates were 34% and 35% in 1998 and 1997, respectively, with 75% and 63%, respectively, of the recorded expense constituting current taxes. See Note 6 of Notes to Consolidated Financial Statements.
Year 1997 Versus 1996
The Company recognized net income of $46.7 million in 1997 compared to net income of $14.4 million in 1996. Revenues increased $130.5 million and operating income increased $61.9 million from 1996 to 1997. These increases were partially offset by $8.6 million of increased interest expense associated with the Senior Notes and $18.1 million of increased income taxes. Improved operating results from the Company's daywork drilling and engineering services business segments contributed to the increases in revenues and operating income.
Daywork Drilling
Daywork drilling revenues increased $95.7 million and operating income increased $48.6 million in 1997 compared to 1996. From May, 1996 through December, 1997, the Company acquired 12 jack-up drilling rigs, 5 land rigs, 3 platform rigs and a 100% interest in the WINDJV, which owns an additional jack- up drilling rig. Of the $48.6 million increase in operating income, $38.9 million was generated from these rig acquisitions. See "Business and Properties -- Industry Conditions and Company Strategy," "Business and Properties -- Contract Drilling and MOPU Operations" and "Liquidity and Capital Resources." Operating income also increased due to improved dayrates for the Company's drilling rigs.
The Company operates its drilling rigs on both a term and a spot (well-to-well) basis. Drilling rigs contracted on a term basis generally work in various international locations, while drilling rigs contracted on a spot basis generally work in the U.S. Gulf of Mexico. The following table summarizes revenues, utilization and average dayrates for significant classes of the Company's drilling rigs:
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(1) Includes revenues earned from affiliates.
(2) Includes WINDJV operations in Trinidad prior to August 1, 1997, Brazilian operations prior to October 1, 1997, CCDI joint venture operations in Mexico, CCI joint venture operations in Venezuela during 1997 and 2 labor maintenance contracts in Venezuela.
(3) Utilization rates are based upon the number of actively marketed rigs in the fleet and exclude rigs which are unavailable for operations during periods of refurbishment and upgrade.
(4) Daywork drilling revenues, less non-recurring revenues, divided by aggregate contract days, adjusted to exclude days under contract at zero dayrate.
Engineering Services
Engineering services revenues increased $31.2 million and operating income increased $12.4 million in 1997 compared to 1996. The Company completed 14 turnkey contracts in 1997 compared to 13 turnkey contracts in 1996. Ten of the 14 contracts completed during 1997 were international contracts in Venezuela, while only 5 international contracts were completed during 1996. International operating margins are stronger than domestic margins and increased during 1997 due to improved drilling efficiencies and a reduction in lost time well activities. Domestic turnkey contractors continue to bid wells very aggressively, resulting in intense competition which has adversely affected the Company's domestic turnkey margins.
The Company had 5 turnkey wells in progress at December 31, 1997.
MOPU Operations
MOPU revenues increased $4.3 million and operating income increased $.7 million in 1997 compared to 1996. The increases in revenues and operating income were primarily due to operations associated with 2 MOPUs, neither of which operated during 1996.
Oil and Gas
Oil and gas revenues decreased $.7 million and operating losses decreased $2.8 million in 1997 compared to 1996. Revenues decreased primarily due to declines in production of both oil and gas. Operating losses in 1996 were primarily due to approximately $2.9 million in costs associated with an unsuccessful well drilled during the fourth quarter of 1996.
Corporate Overhead
Corporate overhead increased $2.6 million in 1997 compared to 1996. The increase was primarily due to increased costs associated with the Southwestern operations and other employment-related costs.
Other Income (Expense) and Income Taxes
The Company recognized $39.6 million of other expense in 1997 compared to $10.0 million of other expense in 1996. The net increase resulted primarily from an $8.6 million increase in interest expense associated with the Senior Notes and an increase in income taxes of $18.1 million. See "Liquidity and Capital Resources."
The increase in income taxes relates primarily to the overall increase in income from 1996 to 1997. The effective tax rates were 35% and 33% in 1997 and 1996, respectively, with 63% and 26%, respectively, of the recorded expense constituting current taxes. The Company has utilized all foreign tax credit carryforwards and current year foreign tax credits as a reduction of 1997 domestic income taxes and accordingly, has eliminated the related valuation allowance of $1.6 million provided in prior years. See Note 6 of Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased $8.2 million from $28.1 million at December 31, 1997 to $36.3 million at December 31, 1998. The increase resulted from $76.0 million provided by operating activities and $.2 million provided by financing activities, offset in part by $68.0 million used in investing activities.
Operating Activities
Net cash of $76.0 million provided by operating activities included $14.6 million used in working capital and other activities. "Accounts Receivable" decreased from December 31, 1997 to December 31, 1998 due primarily to the timing of turnkey completions and the timing of cash receipts related to domestic and international daywork drilling and engineering services operations. "Drilling Contracts in Progress" increased due to additional turnkey wells in progress at December 31, 1998 and timing of turnkey completions. "Accounts Payable and Other Accrued Expenses" decreased primarily due to fewer rig refurbishment projects in process at December 31, 1998 compared to December 31, 1997.
Investing Activities
Net cash of $68.0 million used in investing activities included capital expenditures totaling $69.9 million. Of that total, $9.3 million was used to fund the reactivation of 2 land drilling rigs acquired in January, 1997 for operations on Venezuelan turnkeys, and $12.3 million was used for the conversion of a MOPU to a drilling rig. The remaining $48.3 million was spent primarily on upgrade and renovation activities on other drilling rigs and MOPUs.
On December 29, 1997, the Company completed the acquisition of 2 offshore platform drilling rigs, one self-propelled jack-up drilling/workover rig and substantially all of the assets used in the offshore contract drilling business in Trinidad previously operated by Well Services. The purchase price totaled $44.0 million, consisting of cash of $23.5 million and the issuance by the Company of 437,939 shares of Common Stock, $0.01 par value per share. One platform rig and the jack-up drilling/workover rig are currently operating under contracts in Trinidad. The contract on the other platform rig was recently terminated by the operator.
The Company's capital expenditures in 1999 are expected to total approximately $7.0 million, related primarily to rig upgrades and drill pipe purchases. The Company intends to fund these capital expenditures with available cash and internally generated cash flow. The Company's projection of 1999 capital
expenditures is based upon a continuation of the Company's program to upgrade rigs and related equipment. The actual level of capital expenditures may be higher due to contract requirements or in the event of unforeseen breakdown of equipment that was not scheduled for replacement, or lower in the event of inadequate cash flow from operations.
Financing Activities
Long-term debt at December 31, 1998 consists solely of Senior Notes in the aggregate principal amount of $200.0 million and debt premium, net of amortization, of $2.9 million. In addition to the $150.0 million of Senior Notes sold during 1996, the Company sold $50.0 million of Senior Notes on August 7, 1997 at a premium of $3.9 million. Considering the premium, the effective interest rate on the $50.0 million Senior Notes is 9.5%. Interest on the Senior Notes is payable semi-annually during each May and November. The Senior Notes do not require any payments of principal prior to their stated maturity on May 15, 2003, but the Company is required to make offers to purchase Senior Notes upon the occurrence of certain events as defined in the indenture, such as asset sales or a change of control of the Company. See Note 5 of Notes to Consolidated Financial Statements.
Upon consummation of the Merger, the Company was required to offer to purchase for cash all of the outstanding Senior Notes at a purchase price equal to 101% of the principal amount of each Senior Note, plus accrued and unpaid interest to the change of control payment date within 60 days following the Merger (the "Change of Control Offer"). The Change of Control Offer expired on January 21, 1999. A total of $.3 million principal amount of Senior Notes were tendered.
On or after May 15, 2000, the Senior Notes are redeemable at the option of the Company, in whole or in part, at a price of 105% of principal if redeemed during the twelve months beginning May 15, 2000, at a price of 102.5% of principal if redeemed during the twelve months beginning May 15, 2001, or at a price of 100% of principal if redeemed after May 15, 2002, in each case together with interest accrued to the redemption date. Notwithstanding the foregoing, the Company may at its option use all or a portion of the proceeds from a public equity offering consummated on or prior to May 15, 1999, to redeem up to $50.0 million principal amount of the Senior Notes at a redemption price equal to 110% of the principal amount, provided that at least $150.0 million in aggregate principal amount of the Senior Notes remain outstanding immediately after such redemption.
The Senior Notes are senior unsecured obligations of the Company, ranking pari passu in right of payment with all senior indebtedness and senior to all subordinated indebtedness. The Senior Notes are unconditionally guaranteed on a senior unsecured basis by the Subsidiary Guarantors, and the Subsidiary Guarantees rank pari passu in right of payment with all senior indebtedness of the Subsidiary Guarantors and senior to all subordinated indebtedness of the Subsidiary Guarantors. The Subsidiary Guarantees may be released under certain circumstances. The Senior Notes and the Subsidiary Guarantees are effectively subordinated to all secured indebtedness, including amounts outstanding under the Revolving Credit Facility. The Subsidiary Guarantees provide that each Subsidiary Guarantor will unconditionally guarantee, jointly and severally, the full and prompt performance of the Company's obligations under the indenture and the Senior Notes. Each Subsidiary Guarantor is 100% owned by the Company. R&B Falcon is not a guarantor of the Senior Notes.
The indenture under which the Senior Notes are issued imposes significant operating and financial restrictions on the Company. Such restrictions affect, and in many respects limit or prohibit, among other things, the ability of the Company to incur additional indebtedness, make capital expenditures, create liens, sell assets and make dividends or other payments. These restrictions could limit the Company's ability to integrate its operations with its parent, R&B Falcon.
The Company currently maintains a $35.0 million Revolving Credit Facility with ING which matures May 31, 2000. At December 31, 1998, the Company had no indebtedness outstanding under the Revolving Credit Facility, but had $.4 million in letters of credit outstanding, thereby leaving $34.6 million available under the credit facility.
Exchange Rate Gains and Losses
Approximately 67% of the Company's revenues and a substantial portion of its operating income were sourced from its foreign operations during 1998. These operations are subject to customary political and
foreign currency risks in addition to operational risks. The Company has attempted to reduce these risks through insurance and the structure of its contracts. The Company may be exposed to the risk of foreign currency losses in connection with its foreign operations. Such losses are the result of holding net monetary assets (cash and receivables in excess of payables) denominated in foreign currencies during periods of a strengthening U.S. dollar. The Company's foreign exchange gains and losses are primarily attributable to the Venezuelan Bolivar. The effects of these transactions are reported as "Exchange Rate Loss" in the Consolidated Statements of Operations. The Company does not speculate in foreign currencies or maintain significant foreign currency cash balances. The Company will continue to be exposed to future foreign currency gains and losses if the currency continues to be volatile. Despite the political and economic risks in Venezuela, the Company believes that the country continues to be a favorable market for its services.
Cautionary Statements
The Company's operations are materially dependent upon the level of activity in offshore oil and gas exploration and production. The level of such activity is affected by both short-term and long-term trends in oil and gas prices. Oil and gas prices and, therefore, the level of drilling, exploration and production activity, can be volatile. Any prolonged reduction in oil and gas prices will depress the level of exploration and production activity and result in a corresponding decline in the demand for the Company's services and, therefore, may have a material adverse effect on the Company's revenues, cash flows and profitability.
The ability of the Company to fund working capital, capital expenditures and debt service in excess of cash on hand will depend upon the success of the Company's domestic and foreign operations. To the extent that internal sources are insufficient to meet those cash requirements, the Company can draw on its available credit facility or seek other debt or equity financing; however, the Company can give no assurance that such other debt or equity financing would be available on terms acceptable to the Company.
In any case, the satisfaction of long-term capital requirements will depend upon successful implementation by the Company of its business strategy and future results of operations. Management believes it has successfully implemented the strategy to achieve results of operations commensurate with its immediate and near-term liquidity requirements.
IMPACT OF YEAR 2000
General Description of the Year 2000 Issue
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. As a result, many computer programs recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in similar normal business activities.
Year 2000 Issue Evaluations and Assessments
Based upon preliminary equipment analyses and evaluations, the Company does not believe that operational equipment programming modifications are necessary. The Company is currently communicating with vendors, suppliers and shippers (collectively referred to as "third party vendors") regarding Year 2000 compliance and will work with them to minimize disruption in the Company's operations as a result of their Year 2000 problems. To date, the Company is not aware of any third party vendors with a Year 2000 issue that would materially impact the Company's results of operations, liquidity or capital resources. Based upon internal assessments, the Company determined that it was necessary to modify or replace portions of its accounting software so that its computer systems would function properly with respect to dates in the year 2000 and thereafter. The Company elected to replace certain accounting software rather than invest in modifications of existing programs. The Company presently believes that with modifications to existing software and conversions to new software, the Year 2000 Issue will not pose significant operational problems for its computer systems.
Costs
The replacement software and related installation costs were approximately $2.0 million, the majority of which was capitalized as of December 31, 1998. The software conversions were substantially completed as of December 31, 1998. The Company expects to incur approximately $.5 million during 1999 for other modifications and conversions.
Risks
Management of the Company believes it has an effective program in place to resolve the Year 2000 Issue in a timely manner. The Company has not yet completed all necessary phases of the Year 2000 program. In the event that the Company does not complete any additional phases, modifications or conversions, disruptions generally resulting from Year 2000 issues could materially adversely affect the Company. The amount of potential liability and lost revenue cannot be reasonably estimated at this time.
The Company has no means of ensuring that third party vendors will be Year 2000 ready. The inability of third party vendors to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. The effect of non-compliance by third party vendors is not determinable.
The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources and other factors. However, there is no guarantee that these estimates will be achieved, and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, the cost and extent of training associated with needed conversions and similar uncertainties.
Contingency Plans
The Company has contingency plans for certain critical applications and is evaluating such plans for others. These contingency plans involve manual workarounds and replacement equipment.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Risk
The Company's earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates. The Company has attempted to reduce these risks through insurance and the structure of its contracts. The Company does not speculate in foreign currencies or maintain significant foreign currency cash balances.
Interest Rate Risk
The Company is exposed to changes in interest rates. Changes in U.S. interest rates affect the interest earned on the Company's cash and cash equivalents and the interest rate paid on any Revolving Credit Facility borrowings. Under its current policies, the Company does not use interest rate derivative instruments to manage exposure to interest rate changes. The Company has long-term debt at a fixed rate of 10.25% with a carrying value of $202.9 million which approximates fair market value. See "Liquidity and Capital Resources."
Commodity Price Risk
The financial condition and results of operations of the Company are dependent upon the price of oil and natural gas, as demand for its services is primarily dependent upon the level of spending by oil and gas companies for exploration, development and production activities. Crude oil and natural gas prices have continued to fluctuate over the last several years. If crude oil prices decline further or the current weakness in crude oil prices continues for an extended period, there could be a further deterioration in both rig utilization and dayrates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and supplementary data of the Company appear on pages 27 through 50 hereof and are incorporated by reference into this Item 8. Selected quarterly financial data is set forth in Note 15 of Notes to Consolidated Financial Statements, which is incorporated herein by reference.
ITEM 9.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in or disagreements with the Company's accountants regarding accounting principles or practices for financial statement disclosures.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Under the reduced disclosure format permitted by General Instruction I(2)(c) of Form 10-K, the information otherwise required by this item may be omitted.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Under the reduced disclosure format permitted by General Instruction I(2)(c) of Form 10-K, the information otherwise required by this item may be omitted.
ITEM 12.
ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Under the reduced disclosure format permitted by General Instruction I(2)(c) of Form 10-K, the information otherwise required by this item may be omitted.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Under the reduced disclosure format permitted by General Instruction I(2)(c) of Form 10-K, the information otherwise required by this item may be omitted.
PART IV
ITEM 14.
ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements
(1) and (2) Financial Statements and Schedules
See "Index to Consolidated Financial Statements and Schedules" on page 27.
(3) Exhibits
See "Exhibit Index" on pages 51 to 55.
The management contracts and compensatory plans or arrangements required to be filed as Exhibits to this report are as follows:
(b) Reports on Form 8-K
One report dated December 1, 1998 was filed by the Company on Form 8-K during the three months ended December 31, 1998. The following information was included in the report:
Effective December 1, 1998, a change in control of the Company occurred as a result of the Merger of Merger Sub, a wholly-owned subsidiary of R&B Falcon, with and into the Company. The Merger was effected pursuant to the Merger Agreement among R&B Falcon, Merger Sub and the Company, which was approved by the stockholders of the Company at a special meeting held November 20, 1998. As a result of the Merger, each outstanding share of Common Stock of the Company was converted into 1.7 shares of R&B Falcon common stock and cash in lieu of fractional shares, as provided for in the Merger Agreement, and the Company is now a wholly-owned subsidiary of R&B Falcon.
As required by the Merger Agreement, the Company executed Amendment No. 2 to the Cliffs Drilling Company Compensation Deferral Plan dated as of November 20, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following on behalf of the Registrant and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
All schedules for which provision is made in the applicable rules and regulations of the Securities and Exchange Commission have been omitted as the schedules are not required under the related instructions, are not applicable or the information required thereby is set forth in the Consolidated Financial Statements or the Notes thereto.
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors Cliffs Drilling Company
We have audited the accompanying consolidated balance sheets of Cliffs Drilling Company as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cliffs Drilling Company at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Houston, Texas February 17, 1999
CLIFFS DRILLING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
CLIFFS DRILLING COMPANY
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
The merger of RBF Cliffs Acquisition Corp., a wholly-owned subsidiary of R&B Falcon Corporation, with and into Cliffs Drilling Company was effective on December 1, 1998 and was accounted for using the purchase method of accounting. The purchase price adjustments were "pushed down" and recorded in the consolidated financial statements of Cliffs Drilling Company, which affects the comparability of the post-acquisition and pre-acquisition financial position. See Note 2.
CLIFFS DRILLING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
CLIFFS DRILLING COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
See accompanying notes to consolidated financial statements.
The merger of RBF Cliffs Acquisition Corp., a wholly-owned subsidiary of R&B Falcon Corporation, with and into Cliffs Drilling Company was effective on December 1, 1998 and was accounted for using the purchase method of accounting. The purchase price adjustments were "pushed down" and recorded in the consolidated financial statements of Cliffs Drilling Company, which affects the comparability of the post-acquisition and pre-acquisition financial position. See Note 2.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Corporate Structure and Principles of Consolidation
Effective December 1, 1998, a change in control of the Company occurred. The Company is now a wholly-owned subsidiary of R&B Falcon Corporation ("R&B Falcon"). See Note 2.
The accompanying consolidated financial statements include the activities and accounts of Cliffs Drilling Company (the "Company"), all wholly-owned subsidiaries of the Company and the Company's international activities which are organized as foreign branches. All significant intercompany transactions and balances are eliminated in consolidation.
The Company uses the equity method to account for affiliates in which it does not have control. On May 23, 1996, the Company acquired the stock of Viking Trinidad Limited (renamed Cliffs Drilling Trinidad Limited), which owned a 50% interest in the West Indies Drilling Joint Venture (the "WINDJV"). The WINDJV was a joint venture between Cliffs Drilling Trinidad Limited and Well Services (Marine) Limited ("Well Services"), which owned a jack-up drilling rig. On August 1, 1997, Cliffs Drilling Trinidad Limited acquired an additional 49% interest in the WINDJV from Well Services. On December 29, 1997, the Company acquired the remaining 1% interest in the WINDJV from Well Services. In 1996, the Company became a 50% joint venture partner with Perforadora Central, S.A. de C.V. by forming Cliffs Central Drilling International ("CCDI") for the marketing of drilling services in Mexico. In 1996, the Company became a 1/3 (33 1/3%) owner of Servicios Integrados Petroleros C.C.I., S.A. ("CCI"). CCI is a joint venture company among the Company, Inelectra S.A. and Cementaciones Petroleras Venezolanas C.A. which markets drilling services in Venezuela.
Use of Estimates
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company's policy is to invest cash in short-term investments. Uninvested cash balances are kept at minimum levels. Investments are valued at cost, which approximates market. The Company considers all highly liquid cash investments with a maturity date of three months or less when purchased to be cash equivalents.
Concentration of Credit Risk
The market for the Company's services is the oil and gas industry, and the Company's customers consist primarily of integrated and government-owned international oil companies and independent oil and gas producers. Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. The Company has in place insurance to cover certain exposure in its foreign operations and provides allowances for potential credit losses when necessary. Accordingly, management considers such credit risk to be limited.
Inventories
Inventories, consisting principally of tubular goods consumed in turnkey drilling operations and spare drilling parts, are carried at cost, specific identification method.
Drilling Contracts in Progress
The Company recognizes revenues and expenses related to its turnkey drilling contracts when all terms and conditions of the contract have been fulfilled. Consequently, the costs related to in-progress turnkey drilling contracts are deferred as drilling contracts in progress until the contract is completed and revenue is
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
realized. The amount of drilling contracts in progress is dependent on the volume of contracts, the duration of the contract at the end of the reporting period and the contract amount. Provision for losses on incomplete contracts is made when such losses are anticipated.
The Company's Daywork Drilling business segment frequently leases its jack-up and land drilling rigs to the Engineering Services business segment for turnkey drilling operations. Revenues, expenses and profits generated by the drilling rigs operating under turnkey contracts are deferred until the contract is completed. While the turnkey contract is in progress, the rig operating profit is offset against drilling contracts in progress. Rig operating losses are recognized when incurred and are not deferred.
Rig Mobilization and Demobilization Costs
The Company defers costs of moving a drilling unit or MOPU under contract to a new area of operation. The deferred mobilization costs are amortized on a straight-line basis over the term of the applicable drilling contract. Unamortized mobilization costs were $0 and $2,770,000 at December 31, 1998 and 1997, respectively.
Demobilization charges, in general, are reimbursed by the customer based upon contract terms. In situations where demobilization charges are not reimbursed and are expected to be material, estimated demobilization costs are accrued over the term of the applicable contract. Unanticipated demobilization costs are expensed as incurred at the completion of the contract.
Property and Equipment
Property and equipment are carried at original cost or at adjusted net realizable value, as applicable. Major renewals and betterments are capitalized in the property accounts, while the cost of repairs and maintenance is charged to operating expenses in the period incurred.
Acquisitions of rigs and related equipment have been accounted for under the purchase method of accounting and therefore, the results of the acquired assets are combined with the Company's results only from the acquisition date forward.
Interest on funds borrowed for construction of qualifying assets is capitalized during the construction period. Amortization of capitalized interest is included in "Depreciation, Depletion and Amortization" in the Consolidated Statements of Operations.
Cost and accumulated depreciation, depletion and amortization are removed from the accounts when assets are sold or retired, and the resulting gains or losses are included in the Consolidated Statements of Operations.
Prior to November 30, 1998, depreciation of property and equipment was provided on the straight-line basis at rates based upon expected useful lives of the various classes of assets as follows:
Prior to November 30, 1998, no depreciation expense was recorded during periods of construction or refurbishment. To provide for any deterioration that may occur while the rigs are not operating for an extended period of time, a minimum depreciation charge is provided at a reduced rate of 25% of the normal depreciation rate.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Effective December 1, 1998, depreciation of property and equipment is provided on the straight-line basis at rates based upon expected useful lives of the various classes of assets as follows:
Effective December 1, 1998, depreciation expense is recorded during construction, refurbishment and stacked periods.
Costs related to the exploration and development of oil and gas properties are accounted for under the "Successful Efforts" method of accounting. Lease acquisition costs related to oil, gas and mineral properties are capitalized when incurred. The acquisition costs of unproved properties, which are individually significant, are assessed on a property-by-property basis, and a loss is recognized by provision of a valuation allowance when the assessment indicates an impairment in value. Exploration costs, excluding exploratory wells, are charged to expense as incurred. Costs of drilling exploratory wells are capitalized pending determination as to whether the wells have proved reserves which justify commercial development. If commercial reserves are not found, the drilling costs are charged to dry hole expense. Tangible and intangible drilling costs applicable to productive exploratory wells and to the development of oil and gas reserves are capitalized.
The cost of productive leaseholds is amortized by field on the unit of production basis by applying the ratio of produced oil and gas to estimated proved reserves. Lease and well equipment and intangible drilling costs associated with productive wells are amortized based on proved developed reserves.
Goodwill
Goodwill was created in the Merger which was effective on December 1, 1998. The purchase price adjustments have been "pushed down" to the consolidated financial statements of the Company. The excess of the purchase price over the estimated fair value of net assets acquired is accounted for as goodwill and is amortized on a straight-line basis over 40 years (the period when benefits are expected to be derived). Accumulated amortization as of December 31, 1998 was $150,000.
Impairment of Long-Lived Assets
The carrying value of long-lived assets, principally goodwill and property and equipment, is reviewed for potential impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The determination of recoverability is made based upon the estimated undiscounted future net cash flows of the related asset.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes." Deferred income taxes are provided on items recognized in different periods for financial and tax reporting purposes. Taxable income (loss) of the Company for taxable periods ended prior to December 1, 1998 will be included in the consolidated U.S. federal income tax return of the Company. Thereafter, the taxable income (loss) of the Company will be included in the consolidated U.S. federal income tax return of R&B Falcon. See Note 6 of Notes to Consolidated Financial Statements.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock Options
The Company accounts for stock options in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations. Under APB 25, generally, no compensation expense is recognized for an employee stock option when the exercise price equals the market price of the underlying stock on the date of grant. Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). As provided in the statement, the Company elected to continue to measure compensation expense using the guidelines of APB 25 and to include disclosures of net income and earnings per share as if the fair value based method of accounting were utilized. See Note 9 of Notes to Consolidated Financial Statements.
Revenue Recognition
The Company recognizes revenues from its daywork drilling and MOPU operations as services are rendered, based upon the contracted daily rate multiplied by the number of operating days in the period. Turnkey drilling contract revenues are recognized when all terms and conditions of the contract have been fulfilled. The Company recognizes oil and gas revenues from its interests in producing wells based upon the sales method.
Foreign Currency Translation
The U.S. dollar is the functional currency for all of the Company's operations. Foreign currency gains and losses are included in the Consolidated Statements of Operations during the period incurred.
Earnings Per Share
In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings Per Share," ("SFAS No. 128"). SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is similar to the previously reported fully diluted earnings per share. The earnings per share amounts and weighted average number of common and common equivalent shares outstanding prior to 1997 have been restated as required to comply with SFAS No. 128. See Note 11 of Notes to Consolidated Financial Statements.
Earnings per share and weighted average shares have been retroactively adjusted to reflect a two-for-one stock split effected in the form of a 100% stock dividend effective May 22, 1997 (the "Stock Split").
The Company issued 2,113,557 shares (pre-split basis) of Common Stock, $.01 par value ("Common Stock") upon conversion of 1,115,988 shares of its 1,150,000 issued and outstanding shares of $2.3125 Convertible Exchangeable Preferred Stock ("Preferred Stock") on January 17, 1996. See Note 10 of Notes to Consolidated Financial Statements.
Comprehensive Income
During the first quarter of 1998, the Company adopted Financial Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income," ("SFAS No. 130"). SFAS No. 130 establishes new rules for the reporting and disclosure of comprehensive income and its components in a full set of financial statements. To the extent the Company has comprehensive income, it would present these items in a statement of changes in shareholders' equity. However, the Company had no items of comprehensive income during the years ended December 31, 1998 and 1997 and therefore, comprehensive income is equal to net income for each period.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Segment Reporting
Effective January 1, 1998, the Company adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," ("SFAS No. 131"). SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The adoption of SFAS No. 131 did not affect the results of operations or financial position, but did affect the disclosure of segment information. See Notes 13 and 14.
Change in Presentation
Certain financial statement items have been reclassified in prior years to conform with the current year presentation.
2. BUSINESS COMBINATION
Effective December 1, 1998, a change in control of the Company occurred as a result of the merger of RBF Cliffs Acquisition Corp. ("Merger Sub"), a wholly-owned subsidiary of R&B Falcon, with and into the Company (the "Merger"). The Merger was effected pursuant to an Agreement and Plan of Merger dated August 21, 1998 (the "Merger Agreement") among R&B Falcon, Merger Sub and the Company, which was approved by the stockholders of the Company at a special meeting held November 20, 1998. The Company is now a wholly-owned subsidiary of R&B Falcon.
The purchase price consisted of the following:
The value of the common stock issued to Company shareholders was calculated based on the average of the closing prices of R&B Falcon common stock from August 4, 1998 through August 17, 1998. The combination was announced on August 10, 1998.
In connection with the Merger, the Company recorded merger costs of $1,512,000 associated with waiver and release payments, in addition to incremental restricted stock amortization of $1,806,000 related to the accelerated vesting of restricted stock. These costs are reported as "General and Administrative Expense" in the Company's Consolidated Statements of Operations during 1998.
The Merger was accounted for using the purchase method of accounting. Accordingly, an allocation of the purchase price was assigned to the assets and liabilities of the Company based on their estimated fair values. The purchase price adjustments were "pushed down" to the consolidated financial statements of the Company. The purchase price allocation to the Company consisted of an increase to property and equipment of $97,537,000 and an increase in the deferred tax liability of $34,138,000, which reflects the increase in the difference in the basis for tax and financial reporting purposes of property and equipment. The excess of the purchase price over the estimated fair value of net assets acquired was $70,729,000 and has been accounted for as goodwill.
The accompanying Consolidated Statements of Operations include the effects of the Merger from December 1, 1998 to December 31, 1998. Unaudited pro forma consolidated operating results of the
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company for the year ended December 31, 1998, assuming the Merger was effective as of January 1, 1998, are summarized as follows:
The pro forma information for the year ended December 31, 1998 includes adjustments for additional depreciation of $5,122,000 based on the fair market values of the drilling rigs and other property and equipment, goodwill amortization of $1,649,000 and a reduction in income taxes of $2,315,000. The pro forma information is not necessarily indicative of the results of operations had the Merger occurred on the assumed dates or the results of operations for any future period.
3. NOTES AND OTHER RECEIVABLES, LONG-TERM
Effective January 1, 1993, the Company sold its 4 inland posted barge drilling rigs and rights to certain oil and gas production payment proceeds generated from a proceeds-of-production drilling program for an aggregate sales price of $13,500,000, consisting of $5,000,000 in cash and $8,500,000 in notes. The first note had a face amount of $1,000,000 and was repaid in March, 1995. The second note had a face amount of $7,500,000, with interest calculated at the base rate on corporate loans as quoted by the Wall Street Journal plus one and one-half percent (1 1/2%). Principal and interest on the $7,500,000 note was payable on a monthly basis solely from the proceeds of the oil and gas production payment on which the note was based. The note was scheduled to mature on January 1, 1998; however, it was repaid in May, 1997 in connection with the Company's disposition of the various oil and gas related interests underlying the long-term note receivable. In 1997, the Company recorded a net gain of $2,718,000 related to the disposition of the oil and gas related interests.
4. PROPERTY AND EQUIPMENT
On December 29, 1997, the Company completed the acquisition of 2 offshore platform drilling rigs, one self propelled jack-up drilling/workover rig and substantially all of the assets used in the offshore contract drilling business in Trinidad previously operated by Well Services. The purchase price totaled $44,000,000, consisting of cash of $23,500,000 and the issuance by the Company of 437,939 shares of Common Stock.
Effective October 1, 1997, the Company exercised an option to purchase a platform drilling rig for $4,250,000.
On August 1, 1997, the Company acquired an additional 49% interest in the WINDJV. The purchase price was $8,371,000 consisting of $6,000,000 of cash and $2,371,000 of debt assumed, net of various working capital amounts acquired. On December 29, 1997, the Company acquired the remaining 1% interest in the WINDJV from Well Services.
On January 24, 1997, the Company completed the acquisition of the stock of a subsidiary of Andrade Gutierrez Perfuracao Ltda., which owned the jack-up drilling rig ATENA, four 1,500 HP land drilling rigs, miscellaneous drilling equipment and a contract to operate a platform rig in Brazil. The purchase price was $28,500,000 in cash.
On September 30, 1996, the Company acquired a land rig from Quarles Drilling Corp. for $2,850,000.
On June 19, 1996, Cliffs Drilling No. 11 completed its two-year bareboat charter as a workover rig in the U.S. Gulf of Mexico and the charterer exercised its option to purchase the unit for $5,392,000, resulting in a gain of $2,684,000.
On May 23, 1996, the Company completed the acquisition of 9 jack-up drilling rigs and a 50% interest in the WINDJV, which owned an additional jack-up drilling rig, and their related assets (collectively referred to as the "Southwestern Rigs") operated by Southwestern Offshore Corporation ("Southwestern"). The purchase price of the Southwestern Rigs was (a) $103,800,000 in cash (after reductions of $6,200,000 for
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
required refurbishments of certain Southwestern Rigs not made prior to closing) plus (b) issuance of 1,200,000 shares (pre-split basis) of the Company's Common Stock, and (c) assumption of certain contractual liabilities, including the Company's guarantee of $4,250,000 in indebtedness of the WINDJV to Citibank N.A. related to the refurbishment of the jack-up drilling rig owned by it (together with accrued but unpaid interest thereon and costs of collection).
On May 10, 1996, the Company acquired the jack-up drilling rig OCEAN MAGALLANES from Diamond Offshore Southern Company for $4,500,000. The Company renamed this unit Cliffs Drilling 155.
Interest capitalization associated with rig refurbishments during the years ended December 31, 1998, 1997 and 1996 was $501,000, $629,000 and $730,000, respectively.
5. NOTES PAYABLE
Long-term debt at December 31, 1998 consists solely of 10.25% Senior Notes due 2003 (the "Senior Notes") in the aggregate principal amount of $200,000,000 and debt premium, net of amortization, of $2,935,000. In addition to the $150,000,000 of Senior Notes sold during 1996, the Company sold $50,000,000 of Senior Notes on August 7, 1997 at a premium of $3,875,000. Considering the premium, the effective interest rate on the $50,000,000 Senior Notes is 9.5%. Interest on the Senior Notes is payable semi-annually during each May and November. The Senior Notes do not require any payments of principal prior to their stated maturity on May 15, 2003, but the Company is required to make offers to purchase Senior Notes upon the occurrence of certain events as defined in the indenture, such as asset sales or a change of control of the Company.
Upon consummation of the Merger, the Company offered to purchase for cash all of the outstanding Senior Notes at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest to the change of control payment date, as required by the indenture governing the Senior Notes (the "Change of Control Offer"). On January 28, 1999, the Company purchased all of the $328,000 principal amount of Senior Notes tendered pursuant to the Change of Control Offer.
On or after May 15, 2000, the Senior Notes are redeemable at the option of the Company, in whole or in part, at a price of 105% of principal if redeemed during the twelve months beginning May 15, 2000, at a price of 102.5% of principal if redeemed during the twelve months beginning May 15, 2001, or at a price of 100% of principal if redeemed after May 15, 2002, in each case together with interest accrued to the redemption date. Notwithstanding the foregoing, the Company may at its option use all or a portion of the proceeds from a public equity offering consummated on or prior to May 15, 1999, to redeem up to $50,000,000 principal amount of the Senior Notes at a redemption price equal to 110% of the principal amount, provided that at least $150,000,000 in aggregate principal amount of the Senior Notes remain outstanding immediately after such redemption.
The Senior Notes are senior unsecured obligations of the Company, ranking pari passu in right of payment with all senior indebtedness and senior to all subordinated indebtedness. The Senior Notes are unconditionally guaranteed (the "Subsidiary Guarantees") on a senior unsecured basis by the Company's principal subsidiaries (the "Subsidiary Guarantors"), and the Subsidiary Guarantees rank pari passu in right of payment with all senior indebtedness of the Subsidiary Guarantors and senior to all subordinated indebtedness of the Subsidiary Guarantors. The Subsidiary Guarantees may be released under certain circumstances. The Senior Notes and the Subsidiary Guarantees are effectively subordinated to all secured indebtedness, including amounts outstanding under the Revolving Credit Facility. The Subsidiary Guarantees provide that each Subsidiary Guarantor will unconditionally guarantee, jointly and severally, the full and prompt performance of the Company's obligations under the indenture and the Senior Notes. Each Subsidiary Guarantor is 100% owned by the Company. R&B Falcon is not a guarantor of the Senior Notes.
The indenture under which the Senior Notes are issued imposes significant operating and financial restrictions on the Company. Such restrictions affect, and in many respects limit or prohibit, among other things, the ability of the Company to incur additional indebtedness, make capital expenditures, create liens, sell assets and make dividends or other payments.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Separate financial statements and other disclosures concerning the Subsidiary Guarantors are not presented because management has determined such financial statements and other disclosures are not material to investors. The assets, equity, income and cash flows of the non-guarantor subsidiaries on an individual and combined basis are less than 1% of the consolidated assets, equity, income and cash flows, respectively, of the Company and are inconsequential. The combined condensed financial information of the Company's Subsidiary Guarantors is as follows:
Effective May 31, 1998, three Subsidiary Guarantors were merged into the Company.
The Senior Notes had a fair value of approximately $205,000,000 at December 31, 1998, or a 2 1/2% premium to carrying value, based upon the quoted market price of the debt.
The Company currently maintains a $35,000,000 revolving line of credit ("Revolving Credit Facility") with ING (U.S.) Capital Corporation ("ING"). The Revolving Credit Facility is subject to certain borrowing base limitations. All advances to the Company from the Revolving Credit Facility bear interest at the greater of the prevailing Federal Funds Rate plus one-half percent ( 1/2%) or a referenced average prime rate; or at the adjusted LlBOR rate plus a margin ranging from one percent (1%) to one and five-eighths percent (1 5/8%) per annum, based on certain financial ratios. The Company is also obligated to pay ING (i) a commitment fee ranging from three-eighths percent ( 3/8%) to one-half percent ( 1/2%) per annum, based on certain financial ratios, on the average daily unadvanced portion of the commitments and (ii) a letter of credit fee ranging from one percent (1%) to one and five-eighths percent (1 5/8%) per annum, based on certain financial ratios, on the average daily undrawn and unexpired amount of each letter of credit during the period that sum remains outstanding. The Revolving Credit Facility matures on May 31, 2000.
The Revolving Credit Facility is secured by accounts receivable, certain rig inventory and equipment, and the stock of certain subsidiaries of the Company. Under the Third Restated Credit Agreement with ING, the Company is required to comply with various covenants including, but not limited to, the maintenance of various financial ratios, and is restricted from declaring, making or paying any dividends on the Common Stock. Availability and borrowings under the Revolving Credit Facility are as follows:
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Interest payments on all indebtedness amounted to $20,689,000, $17,035,000 and $7,527,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
6. INCOME TAXES
The Company provided for $26,545,000 and $25,124,000 of income taxes for the years ended December 31, 1998 and 1997, respectively. This represents an effective tax rate of 34% and 35% for the years 1998 and 1997, respectively. Current taxes consist of Federal income taxes and taxes paid in foreign jurisdictions.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. The significant components of deferred tax assets and liabilities are as follows:
The Merger was accounted for using the purchase method of accounting. Accordingly, an allocation of the purchase price was assigned to the assets and liabilities of the Company based on their estimated fair values. The purchase price adjustments were "pushed down" to the consolidated financial statements of the Company. The purchase price allocation to the Company consisted of an increase to property and equipment of $97,537,000 and a resulting increase in the deferred tax liability of $34,138,000, which reflects the increase in the difference in the basis for tax and financial reporting purposes of property and equipment.
Tax benefits of $214,000 and $2,930,000 associated with the exercise of non-qualified stock options during the years ended December 31, 1998 and 1997, respectively, were reflected as a component of shareholders' equity prior to the Merger.
For financial reporting purposes, income before income taxes includes the following components:
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the provision for income taxes attributable to continuing operations are as follows:
The reconciliation of income tax attributable to continuing operations computed at the U.S. federal statutory tax rates to income tax expense is:
Income tax payments amounted to $18,688,000, $11,508,000 and $1,854,000 for the years ended December 31, 1998, 1997 and 1996.
7. PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma financial information gives effect to the acquisition of the Southwestern Rigs using the purchase method of accounting given the related assumptions and adjustments, the offering of $150,000,000 of Senior Notes and the issuance of 1,200,000 shares (pre-split basis) of the Company's Common Stock valued at an average price of $18.51 per share (pre-split basis) in connection with the acquisition of the Southwestern Rigs.
The pro forma financial information is based upon the historical consolidated financial statements of the Company and Southwestern for the year ended December 31, 1996. The historical financial statements of Southwestern include the operating results of the Southwestern Rigs during the periods indicated to the date of acquisition, May 23, 1996. However, the financial statements of Southwestern exclude depreciation expense related to the Southwestern Rigs because Southwestern managed, rather than owned, the rigs. The historical results of Southwestern include the results of operations of the rigs that were available for service during the indicated periods.
The pro forma financial information was prepared assuming that the transactions described above were consummated as of January 1, 1996. The pro forma financial information has been prepared based upon assumptions deemed appropriate by the Company and may not be indicative of actual results. The historical results of Southwestern's operations are included with the Company's results beginning May 23,
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1996. The unaudited Pro Forma Consolidating Statement of Operations for the year ended December 31, 1996 is included in the Company's Form 8-K dated September 19, 1997. The pro forma financial information for the year ended December 31, 1996 was as follows:
8. DEFINED CONTRIBUTION PLAN
The Company has a defined contribution plan ("401(k) Plan"). Under the 401(k) Plan, an employee who has reached age 18 and completed 90 days of service is eligible to participate in the plan through contributions that range in one percent multiples up to 16% of salary, with a 1998 dollar maximum of $10,000. Through November 30, 1998, the Company contributed (or "matched") on behalf of each participant shares of Common Stock equal to 100% of the portion of each participant's contribution which does not exceed 6% of the participant's annual salary. Effective December 1, 1998, employer contributions were made in cash. Employer contributions for certain highly compensated employees may be further limited through the operation of the non-discrimination requirements found in Sections 401(k) and 401(m) of the Internal Revenue Code.
Employee contributions can be invested in any or all of 6 investment options in multiples of 5%. Employee contributions are 100% vested and non-forfeitable. Employer contributions are subject to a graded vesting schedule, with participants becoming fully vested upon completion of five years employment service with the Company. Distributions from the 401(k) Plan are made upon retirement, death, disability or separation of service. Participants may borrow up to one-half ( 1/2) of their vested interest in the plan, limited to a maximum of $50,000. Contributions to the 401(k) Plan and earnings on contributions are not included in a participant's gross income until distributed to the participant. Contributions to the 401(k) Plan by the Company were $1,160,000, $737,000 and $499,000 for the years 1998, 1997 and 1996, respectively.
9. CAPITAL STOCK
The Company's Revolving Credit Facility and the indenture governing the Senior Notes of the Company restrict payment of dividends on the Common Stock. Specifically, the indenture restricts the payment of dividends based on (i) availability of funds under a formula based on previously unapplied cumulative net income since April 1, 1996 plus certain stock sale proceeds raised after May 15, 1996 plus $10,000,000 and (ii) satisfaction of the then applicable minimum interest coverage ratio for debt incurrence. Cumulative net income for purposes of the test excludes gains or losses on asset sales and certain other non-recurring charges or credits as specified in the indenture. No dividends have been paid on the Common Stock.
The Company had a 1988 Incentive Equity Plan under which stock options, stock appreciation rights, restricted stock and deferred stock awards for up to 650,000 shares (pre-split basis) of the Company's Common Stock were available for award to officers, directors and key employees. During 1998, shareholders approved the 1998 Incentive Equity Plan, thereby authorizing the Company to make stock awards for up to 1,000,000 shares of the Company's Common Stock. The Company's incentive equity plans were designed to attract and reward key executive personnel.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock Options
Stock options granted pursuant to the 1988 and 1998 Incentive Equity Plans expire not more than ten years from the date of grant and typically vest over three years, with 50% vesting after one year and 25% vesting in each of the succeeding two years. All of the options granted by the Company were granted at an option price equal to the fair market value of the Common Stock at the date of grant. All outstanding stock options vested on August 21, 1998, the date the Company signed the Merger Agreement, pursuant to change of control provisions in the related incentive equity plans.
Changes in the number of outstanding options on the Company's Common Stock through December 31, 1998 are summarized as follows:
Pro forma information regarding net income and earnings per share is required by SFAS 123, and was determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value of its employee stock options. The calculated weighted average fair values of options granted during 1997 and 1996 were $17.41 and $5.67, respectively.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' expected life. This pro forma financial information is calculated in accordance with SFAS 123, but is not likely to be representative of the effects on reported net income in future years. The Company's pro forma information follows:
Restricted Stock
The Company's Board of Directors awarded restricted stock to the Company's officers and key employees from time to time. Awards totaling 90,600 shares and one award of 5,000 shares (pre-split) were made during 1997 and 1996, respectively. Restrictions on awards lapsed with respect to either 33 1/3% of the entire award after one year and after each of the succeeding two years or 25% of the entire award after one year and after each of the succeeding three years. The 1996 award of 5,000 shares (pre-split) was forfeited during 1997. All restricted stock vested on August 21, 1998, the date the Company signed the Merger Agreement, pursuant to change of control provisions in the incentive equity plans. Expense related to amortization of restricted stock was $2,212,000, $430,000 and $29,000 for the years 1998, 1997 and 1996, respectively. Prior to August 21, 1998, deferred compensation expense relative to non-vested shares of restricted stock, measured by the market value of the stock on the date of grant, was amortized on a straight-line basis over the restriction period. The unamortized deferred compensation expense, which was deducted from equity in the Consolidated Balance Sheets at December 31, 1997 was $2,467,000.
Effective December 31, 1992, the Company's Board of Directors approved the sale of 35,000 shares of restricted Common Stock to certain key executives. The price paid for the restricted stock was $6.63 per share. The Company extended full recourse, interest-bearing loans to the key executives in the aggregate amount of $232,000. Interest was calculated at seven and one-half percent (7 1/2%) per annum payable quarterly and accrued on the last day of March, June, September and December until the notes were due on December 31, 1997. All such loans were paid by December 31, 1997. In connection with the restricted stock sale, the Company executed deferred stock agreements with the executives which provided for a share match in the event certain performance criteria were achieved over the five-year period ending December 31, 1997. The performance measures were attained by the Company, resulting in an award of 14,400 additional shares of Common Stock on February 18, 1998. Compensation expense of $590,000 related to the deferred stock awards was accrued during 1997 when it became probable that the Company performance criteria would be met. No such compensation expense was accrued during the year ended December 31, 1996.
10. REDEEMABLE PREFERRED STOCK
On January 17, 1996, the Company issued 2,113,557 shares (pre-split) of Common Stock upon conversion of 1,115,988 shares of its 1,150,000 issued and outstanding shares of Preferred Stock. The remaining 34,012 shares of Preferred Stock were redeemed for cash in the amount of $25.69 per share plus $0.22 per share in accrued dividends thereon at a cost to the Company of approximately $881,000.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share:
12. COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases its headquarters office, office equipment and other items under operating leases expiring at various dates during the next five years. Management expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases. Total rent expense under operating leases was $1,956,000, $1,534,000 and $856,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Minimum future obligations under non-cancelable operating leases at December 31, 1998 for the following five years are $1,446,000, $952,000, $261,000, $58,000 and $1,000, respectively.
The Company has other contingent liabilities resulting from litigation, claims and commitments incidental to the ordinary course of business. Management believes that the probable resolution of such contingencies will not materially affect the financial position or results of operations of the Company.
13. BUSINESS SEGMENTS
Description of reportable segments
Daywork Drilling -- domestic and foreign drilling of oil and gas wells on a dayrate basis for major and independent oil and gas companies on land, inland waters and offshore.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Engineering Services -- domestic and foreign drilling of oil and gas wells on a turnkey basis for major and independent oil and gas companies on land, inland waters and offshore and foreign well engineering and management services.
MOPU Operations -- domestic and foreign operation of mobile offshore production units on a dayrate basis for major and independent oil and gas companies.
Oil and Gas -- domestic exploration, development and production of hydrocarbon reserves.
Measurement of segment profit or loss and segment assets
The Company evaluates performance and allocates resources based on profit or loss from operations before income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Intersegment sales are accounted for at prices comparable to unaffiliated customer sales.
Factors management used to identify the Company's reportable segments
The Company's reportable segments are business units that offer different services. The reportable segments are each managed separately because they offer distinct services, including drilling, engineering services and production.
Intersegment sales between the Daywork Drilling and Engineering Services business segments were $28,545,000, $10,766,000 and $10,775,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Segment assets include assets directly identified with those operations. Purchase price adjustments of $97,537,000 related to the Merger were "pushed down" and recorded in "Rigs and Related Equipment" in the Consolidated Balance Sheets as of December 31, 1998. Expenditures for long-lived assets for the year
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ending December 31, 1997 include $20,500,000 of non-cash investing activity related to 437,939 shares of Common Stock issued in connection with the acquisition of the assets used in the offshore contract drilling business in Trinidad of Well Services and $9,250,000 of non-cash investing activity related to the acquisition of substantially all of the remaining 50% interest of the WINDJV. Expenditures for long-lived assets for the year ending December 31, 1996 include $22,215,000 of non-cash investing activity related to 1,200,000 shares (pre-split basis) of Common Stock issued in connection with the acquisition of the Southwestern Rigs.
The Company derived a significant amount of its revenues from a few customers in each of the three years in the period ended December 31, 1998. The following table summarizes information with respect to these major customers.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. GEOGRAPHIC INFORMATION
The following table sets forth financial information with respect to the Company and its subsidiaries on a consolidated basis by geographical area.
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(a) Revenues are attributed to countries based on the location of the drilling operations.
(b) The Merger was effective on December 1, 1998 and was accounted for using the purchase method of accounting. The purchase price adjustments were "pushed down" and recorded in the consolidated financial statements of the Company, which affects the comparability of the post-acquisition and pre-acquisition long-lived assets. See Note 2.
CLIFFS DRILLING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly operating results for the years ended December 31, 1998 and 1997 are summarized as follows:
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(a) Reduced dayrates and utilization affected operating results during the fourth quarter of 1998.
(b) As a result of the Merger, each outstanding share of Common Stock of the Company was converted into 1.7 shares of R&B Falcon common stock and cash in lieu of fractional shares on December 1, 1998. The Company is now a wholly-owned subsidiary of R&B Falcon.
(c) The second quarter of 1997 includes a net gain on disposition of assets of $2,575,000.
(d) The first three quarters of 1997 earnings per share amounts have been restated to comply with SFAS No. 128. In addition, the first quarter of 1997 earnings per share and weighted average shares have been retroactively adjusted to reflect the Stock Split.
EXHIBIT INDEX
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* Filed herewith
All other exhibits are omitted because they are not applicable, or not required, or because the required information is included in the Consolidated Financial Statements or Notes thereto.